CHAPTER V

CONCLUSION AND RECOMMENDATION

As stated earlier in the previous chapter, the purpose of this research is to

examine the relationship between earnings management and debt covenant
violation by analyzing manufacturing company during 2011-2013. The result of
this research is expected to have negative influence in which management may
choose to manage earnings in order to avoid debt covenant violation.
Furthermore, this research is extended by examining the use of real and accrual
earnings management as the tools of earnings management. The conclusion of this
research will be explained in this chapter along with the limitation faced by the
researcher.

5.1 Conclusion

Recall that there are 2 hypothesis in this research which are the use of
accrual and real earnings management. Accrual earnings management will be
measured using 5 approaches while real earnings management will be measured
using 3 approaches. The conclusion of that results are as follows:

Hypothesis 1: Firms that are close to debt covenant violations are likely to
use accrual-based earnings management?

According to the result which measured by Alcarria and Gill (2004)

regression model, interest cover ratio is significant with WCDAC with positive
influence. Thus, this result implies that debt covenant violation did influence the
use of accrual earnings management but the result is different with the expectation
because the farther company to debt covenant violation, the more earnings
management will be used. However, it is consistent with the result of comparison
mean of variable controls for firms that are close to violation and firms that are
not close to violation. According to the result, it is proven that firms that engage
in earnings management have higher size, profitability, and growth. It maybe due
to manipulation of net income and sales during the year that will affect to the

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higher result of size, profitability, and growth. Therefore, size, profitability, and
growth are not necessarily represent company’s performance during that year.

Moreover, measured by other regression models, the result indicating

insignificant result which means that earnings management practice is not
influenced by debt covenant alone, instead it can be influenced by other motives.
In other word, there is weak evidence that the use of accrual earnings management
is to avoid debt covenant violation. It can be the reason or can be for other
intentions as stated previously about 4 main motivations of management.

Hypothesis 2: Firms that are close to debt covenant violations are likely to
use real-based earnings management?

All regression models which used to measure real activity shows

insignificant result. Therefore, there is weak evidence about the influence of debt
covenant violation with the use of real activity. It might be caused by the
economically consequences of real activity compare with accrual activity as
supported by Gunny (2005) findings such as lower cash flow in the following
year.

5.2 Limitations

During the process of this research, there are some limitations faced by the
researcher such as:

1. There are a lot of annual reports being eliminated due to incomplete

data thus, it will impact to the reduction of total samples. In addition,
there are a lot of data that are not suitable with the requirements so
only few samples are selected.
2. Some of the regression model used in this research is insignificant to
be used as measurement tool in which the models are unable to explain
the earnings management practice. As a result, it will impact to the
invalid hypothesis result.

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 3. Since this research only use manufacturing company so, it may be
difficult to make a comparison with other sectors thus it cannot be
generalized for other sectors related with the earnings management
behavior. For the next researcher, it suggests to include other sectors if
necessary.
4. This research only make analysis of company’s performance during 1
period only. Even if the samples use 3 years annual reports but the
researcher doesn’t make comparison between current year and
previous year. Therefore, it will be difficult to determine the period of
pre-violation and violation. Thus, it will impact to the difficulty of
determining what is the reason behind earnings management practice.
5. The difficulty of obtaining debt contracts or other contracts between
the entity and other parties (shareholders, suppliers, creditors, and
other related parties) which stated that the entity will try to increase
profit to fulfill the contract’s requirements. Therefore, the researcher is
facing difficulty in making a conclusion about the real motivation of
earnings management done by the management.

5.3 Recommendations

This research suggests to the next researcher to:

1. Broaden the samples by including other sectors other than

manufacturing sector and the period as well to get more valid and vary
result.

2. Use other approaches that can be used to explain earnings

management to measure accrual and real earnings management to get
more comprehensive result.

3. Divide the period of observation data more specific into pre-violated

period, violated period, and post-violated period.

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4. Obtain debt contracts or other contracts with related parties to get
more evidence about the entity’s motivation.

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