ownership structure and earnings management in emerging markets

International Research Journal of Finance and Economics
ISSN 1450-2887 Issue 38 (2010)
© EuroJournals Publishing, Inc. 2010


Ownership Structure and Earnings Management in
Emerging Markets: The Case of Jordan


Nedal Al-Fayoumi
Department of Finance, Faculty of Business, University of Jordan
E-mail:

Bana Abuzayed
Talal Abu-Ghazaleh College of Business, German Jordanian University
E-mail:

David Alexander
Birmingham Business School, University of Birmingham, UK
E-mail:


Abstract

This study examines the relationship between earnings management and ownership
structure for a sample of Jordanian industrial firms during the period 2001-2005. Earnings
management is measured by discretionary accruals. The three types of ownership studied
are insiders, institutions and block-holders. Using the Generalized Method of Moment
(GMM), the results indicate that insiders' ownership is significant and positively affect
earnings management. This result is consistent with the entrenchment hypothesis which
states that insiders' ownership can become ineffective in aligning insiders to take value-

maximizing decisions. Further analysis shows insignificant role for institutions and block-
holders in monitoring managerial behaviour earnings management. Our findings have
important policy implications since they support encouraging applying corporate
governance principles in order to motivate institutions and block-holders to provide
effective monitoring of managers in Jordanian firms. As a result, the reliability and
transparency of reported earnings may be enhanced
.


Keywords: Earnings management, Discretionary Accruals, Ownership Structure, Size.

1. Introduction
The global markets crisis of 2008 has stimulated a vast body of research on financial information
quality and corporate control. In corporations, finance and management are usually separated.
However, this separation action poses two conflicts. First, fund suppliers face collective action
problems preventing them to monitor and discipline managers of the company they are investors of
(see Macey, 1998). Second, managers need to convince market participants (current and potential) of
the firm performance, in order to be able to allocate enough funds for the firm investments. Since the
value of these investments is tied to the firm, this value depends on the future prospects of the business
relationship between the firm and its suppliers. Consequently, the perception of these stakeholders
about the firm’s future prospects affects their incentive to undertake such investments. From this point
International Research Journal of Finance and Economics - Issue 38 (2010) 29
of view, researchers suggest that managers may engage in earnings management to influence
stakeholders (Graham et al., 2005).
There is no consensus on the definition of earnings management (Beneish, 2001). For example,
Davidson et al., (1989) cited in Schipper (1989, p. 92) defined earnings management as “the process of
taking deliberate steps within the constraints of Generally Accepted Accounting Principles to bring
about a desired level of reported income”. Healy and Wahlen (1999) state that "earnings management
occurs when managers use judgment in financial reporting in structuring transactions to alter financial
reports, to either mislead some stakeholders about the underlying economic performance of the

company, or to influence contractual outcomes that depend on reported accounting".
Earnings management occurs in three ways: (1) via the structuring of certain revenue and/or
expense transactions; (2) via changes in accounting procedures; and/or (3) via accruals management
(McNichols and Wilson 1988, and Schipper 1989). Of the above mentioned earnings management
techniques, accruals management is the most damaging to the usefulness of accounting reports because
investors are unaware of the extent of such accruals (Mitra and Rodrigue , 2002). Accrual is defined as
the difference between the earnings and cash flow from operating activities. Accruals can be further
classified into non-discretionary accruals and discretionary accruals. While non-discretionary accruals
are accounting adjustments to the firm’s cash flows mandated by the accounting standard-setting
bodies, discretionary accruals are adjustments to cash flows selected by the managers (see Rao and
Dandale, 2008).
A number of previous studies attempt to examine whether earnings management exist in firms
reports (Healy, 1985; Burgstahler and Dichev, 1997; and DeAngelo et al., 1994), endeavor to
determine the types of earnings management (Sirgar and Utama, 2008; and Beneish, 2001), or question
the motives behind earnings management (Healy and Wahen, 1999). Factors like management
compensation contract incentives (Guidry et al., 1999, and Dechow and Solan 1991), regulatory
motivations (Key, 1997), capital market motivations (Teoh et al., 1998), and external contract
incentives (Watts and Zimmerman, 1986) have been examined to interpret managers behavior towards
earnings management.
In this paper, we are turning our focus on the relationship between ownership structure and
earnings management practices among firms operating in an emerging market. With globalalization of
business and financial markets, there has been strong demand for quality of information from firms
across countries so that investors can conduct comparative evaluation of risk and return of firms in
different countries (Jaggi and Leung, 2007). Consequently, regulators in several countries outside the
USA also started paying attention to corporate governance and especially ownership structure
components (e.g., insider managers, institutional investors, and block-holders) to improve the quality
of reported accounting information.
There is a public perception that earnings management is utilized opportunistically by firm
managers for their own private gain rather than for the benefit of the stockholders. This misalignment of
managers' and shareholders' incentives could induce managers to use the flexibility provided by the

accounting standards to manage income opportunistically, thereby creating distortions in the reported
earnings (Jiraporn, 2008). However, a number of academic studies have argued that earnings management
may be beneficial because it potentially enhances the information value of earnings. Managers may
exercise discretion over earnings to communicate private information to stockholders and the public (e.g.,
Arya et al., 2003; Demski, 1998; Guay et al., 1996).
The ability of managers to opportunistically manage reported earnings is constrained by the
effectiveness of external monitoring by stakeholders such as institutional and external block-holders.
These investors have the opportunity, resources, and ability to monitor, discipline, and influence
managers of firms (Monks and Minow, 1995). Whether they use these powers is partially a function of
the size of their individual or collective shareholdings (Chung et al., 2002). And this implies less
opportunity for accruals management or earnings manipulation (see Yeo et al. (2002) and De Bos and
Donker, 2004). This will be especially the case when major stakeholders know managers’ incentives
for earnings management. If managers have no self-serving incentives to use discretionary accounting
30 International Research Journal of Finance and Economics - Issue 38 (2010)
accruals, these stakeholders will be less inclined to monitor discretionary accounting choices (Chung et
al, 2002). Yet many argue that institutions do not monitor effectively because they either lack expertise
or suffer from free rider problems among themselves (Admat et al., 1999), or strategically ally with the
management (Pound, 1988). A similar argument can be made for the individual block-holders (Jung
and Kwon, 2002).
This study contributes to the literature in the following ways. First, from the previous literature
it appears that there is no general agreement regarding the effect of ownership structure on earnings
management. Therefore, this study investigates the determinants of earnings management activities and
extends the very limited research on the association between ownership structure and earnings
management. Unlike most existing research, which usually studies just one aspect of ownership
structure, we focus on three ownership categories: insiders, institutions, and block-holders.
Second, it represents the first known study, to the best of our knowledge that examines the
relationship between ownership structure and earnings management in Jordan. Jordan has been
selected in the current study because recently it has displayed a significant interest in consolidating the
pillars of corporate governance. Additionally, we use Jordanian data because they generally reflect an
institutional setting similar to many emerging countries, where a high share of insider ownership, weak

investor rights and less mature block-shareholders are prevalent. Our analysis and results are therefore
likely to be generalisable across many emerging economies and we would encourage empirical work in
other settings to investigate this proposition. Fundamental stakeholders in the Jordanian corporations
include families, banks, social security institution, and individual investors. Thus, this study provides
empirical evidence to assess the merits of calls for different types of investors to play a greater role in
corporate governance practices.
Third, it provides further evidence on the possibility of coexistence of the opportunistic and
informative managerial ownership in addition to active and myopic institutional and block-holders
ownership and their differential associations with earnings management. Understanding the nature of
these associations is important for portfolio managers and decisions makers because they may convey
information about the quality of financial information and firm value.
The paper is structured as follows: Section 2 gives a brief overview of the accounting system in
Jordan. Section 3 presents the theoretical background. Section 4 summarizes earnings management
literature. Section 5 discusses the data and methodology, while section 6 reports the main results.
Finally, section 7 summarize and concludes this paper.


2. The Accounting System in Jordan
Jordan has a political stability in a very volatile region, a liberal economy, and relatively advanced
stock market. However, the Jordanian economy is private sector oriented; the state ownership is
relatively small. Recently, a series of privatization initiatives has been implemented to reduce public
shares in the productive sectors.
All registered firms in Jordan are subjected to the obligation of certification and publishing
their accounts. Since 1987, a body is in charge of checking the quality of the accounting information
called the Jordanian Association of Certified Public Accountants (JACPA). The certification and the
control of accounts in Jordan refer to the recommendations from the JACPA which adopt International
Accounting Standards. Only the auditors who have received this certification are authorized to certify
annual reports. In addition, there are a number of internationally recognized accounting and auditing
firms in the kingdom. In general, government's accounting and auditing regulations are regarded as
being compatible with international standards.

Public shareholding companies were set up and their shares were traded in, long before the
setting up of the Jordanian Securities Market. In the early thirties, the Jordanian public already
International Research Journal of Finance and Economics - Issue 38 (2010) 31
subscribed to and traded in shares
1
. The Amman Financial Market (AFM) was established in 1978.
However, the passage of Securities Law No. 23 in 1997 was indeed a landmark and a turning point for
the Jordanian capital market. Three institutions emerged: the Jordan Securities Commission (JSC), the
Amman Stock Exchange (ASE), and the Securities Depository Center (SDC)) out of what has been the
Amman Financial Market till 1997. The ASE is one of the largest stock markets in the region that
permits foreign investment (in year 2008, Market Capitalization to GDP was about 226.3 per cent).
Securities listed in ASE are electronically traded.
According to the Jordanian Securities Commission (JSC) Law (23/1997) and Directives of
disclosures, auditing, and accounting standards (1/1998), all entities subject to JSC’s supervision are
required to apply International Financial Reporting Standards (IFRS)
2
. These Directives specify the
information required by public shareholding companies to be disclosed and filed with the Commission
for the purpose of enhancing transparency. Public shareholding companies are required to apply the
International Auditing and Accounting Standards under the supervision of the Jordan Security
Commission (JSC)
3
. Firms operating in Jordan are required to submit annual reports and announce
yearly statements within a period not exceeding 3 months after the end of their fiscal year and to
announce a half yearly statement within a period not exceeding one month after the end of the mid-
year. Additionally, these directives contain chapters on insider trading and how firms are obliged to
submit to the JSC material information related to the dealings. In 2002, a new Securities Law number
76 has been issued, which authorized setting up other stock exchanges and allowed forming an
independent investor protection fund, stricter ethical and professional codes, and a more stringent
observance of the rule of law (ASE, 2009). By December 2008, the exchange recorded 5,442.3 million

shares traded
4.
The Accountancy Profession Law (APL) 73/2003 was issued in 2003. Important features of the
APL include the establishment of a “High Council for Accounting and Auditing” headed by the
Minister of Industries and Trade, and the creation of an improved JACPA. However, Rahman and
Waly (2004) argued, for more clarification and refinement in the law in addition to upgrade its contents
with the new global developments
5
. Given that more robust auditing should capture any earnings
management practices, this study tries to bring evidence that the level of earnings management and
thus the quality of reported financial information are influenced by firms ownership structure.


3. Theoretical Background
Mainly focusing on the effect of ownership structure on earnings management (discretionary accruals),
we account for the complexity of interests represented in a given company, by consider the main
dimensions of ownership structure – insiders, institutions and external block-holders
.

1
Where the Arab Bank was the first public shareholding company to be established in Jordan in 1930, the first corporate
bonds were issued in the early sixties. See the Jordan Security Commission web site at
2
IFRS refers to all International Accounting Standards (IAS) and related interpretations issued by the former International
Accounting Standards Committee (IASC), and the International Financial Reporting Standards (IFRS) and related
interpretations issued by IASC’s successor body, International Accounting Standards Board (IASB).
3
The Jordan Securities Commission is the regulator of the capital market. Its mission is reforming and developing
legislation and regulations, emphasizing transparency and disclosure, revitalization Jordan’s investment culture,
encouraging and protecting investors and most importantly enforcing the rule-of-law.

4
See ASE website at: www.ase.com.jo
5
Rahman and Waly (2004) state "the term “practicing professional” needs to be better defined; the provision on auditor
rotation gives rise to ambiguity about rotation of partners or firms; and it appears to be impractical to implement the
provision on composition of the Board of High Council having ministers without the same right of proxy as members of
the High Council Board. While the Law focuses primarily and in great depth on JACPA regulations and by law 4, it
overlooks important elements that could strengthen the auditing regulatory framework in Jordan, particularly auditors’
independence. It does not include provisions specifically focusing on monitoring and enforcement mechanisms for
ensuring compliance with the applicable auditing standards and code of ethics, not only in appearance but also in
substance"
32 International Research Journal of Finance and Economics - Issue 38 (2010)
The effect of managerial ownership (insiders) on incentives to act in the interests of
shareholders is inarticulate in the previous literature. The traditional agency theory suggests that
shareholdings held by managers help align their interests with those of shareholders (Jensen and
Meckling, 1976). This incentive, alignment effect, is anticipated to have more impact as managerial
ownership increases, suggesting that as managerial ownership increases, efficient earnings
management may exist to improve earnings informativeness in communicating of value-relevant
information (Siregar and Utama, 2008). Thus, under the convergence-of-interest hypothesis, insider
ownership can be seen as a mechanism to constrain the opportunistic behavior of managers and,
therefore, the discretionary accruals (a proxy of earnings management) is predicted to be negatively
associated with insider ownership (Warfield et al., 1995).
In contrast, when there is narrow separation between owners and managers, managers face less
pressure from financial markets to signal the firm value to the market and they pay less consideration
to the short-term financial report (Jensen, 1986; Klassen, 1997); therefore, highly managerial
ownership are more likely to manipulate earnings, since this lack of market discipline may lead
insiders to make accounting choices that reflect personal motives rather than firm economics (Sanchez-
Ballesta and Garsa-Meca, 2007). In this context, Morck et al., (1988) argue as managerial ownership
increases, the managerial labour market and the market for corporate control become less effective in
aligning managers to take value maximizing decisions. This is because high ownership by management

implies sufficient voting power to guarantee future employment.
Additionally, these managers have incentives to pursue self-interest non-value maximizing
actions at the expense of shareholder wealth. This managerial behavior is consistent with the entrenchment
hypothesis which states that high levels of insider ownership can become ineffective in aligning insiders to
take value-maximizing decisions. Hence, this entrenchment effect potentially confounds the agency theory
predictions. As managerial ownership increases, earnings management may increase (see Yeo et al., 2007,).
Warfield et al., (1995) indicate that this positive relationship is expected if either accounting-based
constraints mitigate managers' accounting
choices or higher ownership results from difficulties in
accounting numbers measuring performance as reflected in increased accruals variability.
The effect of institutional ownership on earnings management behavior has been examined
before (e.g. Velury and Jenkins, 2006; Balsam et al., 2002; and Siregar and Utama 2008). It is possible
to explain this effect based on an active monitoring hypothesis and passive hands-off hypothesis (see
Koh, 2003). Under an active monitoring hypothesis (Bushee, 1998 and Majumdar and Nagarajan,
1997), institutional investors influence the monitoring mechanism a firm uses, including the
monitoring of earnings management activity. Academic researchers believed that institutional investors
who have large magnitude of investments are more sophisticated investors. They are, on average, better
informed than individual investors due to their large-scale development and analysis of private pre-
disclosure information about firms. So, systematic differences exist in the amount and precision of
private information in the hands of institutional and individual investors.
The higher level of understanding of institutional investors also implies that with the increase in
institutional investor shareholdings in a firm, the information asymmetry between shareholders and
managers will decline thereby making it more difficult for managers to manipulate earnings. Thus,
earnings management and institutional ownership is supposed to be negatively correlated (Mitra,
2002). Under the passive hand hypothesis (Bhide, 1993 and Portter, 1992), the institutional investors
are inherently short-term oriented. Such investors are often referred to as myopic investors who focus
mainly on current earnings rather than long-term earnings. This orientation deters institutional
investors from incurring monitoring costs and they will tend to concentrate on current earnings news.
Therefore, managers have incentives to manage earnings aggressively (Koh, 2003).
The monitoring by substantial external block-shareholders is similar to the effect of institutional

ownership on earnings management (Yeo, 2007).Two competing views exist. First, outside block-
holders require a higher return from their investment and pose a bigger threat of intervention to the
firm's management. Thus, they might not be as inclined to encourage management to report high
quality earnings (Velury and Jenkine, 2006 and Zhong et al., 2007). Second, outside block-holders,
International Research Journal of Finance and Economics - Issue 38 (2010) 33
with higher motivation and ability to monitor managers' actions than small shareholders, might reduce
earnings management through their closer monitoring (Dechow et al., 1996).


4. Literature Review
Previous studies bring evidence that ownership structure influences the monitoring mechanism a
company uses including the monitoring of earnings management activities. Wang (2006) states that
ownership structure has important effects on reported earnings. However, the influence of insiders,
institutional investors, and block-holders on the ability of managers to manipulate earnings remains a
controversial issue.
The literature discriminates between inside and outside holders (e.g. Dempsey et al., 1993; and
Warfield et al., 1995). Dempsey et al., (1993) distinguish between owner-managed firms, in which
managers own substantial blocks of the firms' outstanding stocks, and external-controlled-firms, in
which one or more external block-holders own a substantial block of the firm's stocks while the
managers do not substantially own the firm's stocks. The study suggests that large ownership by
management is the underlying factor that reduces earnings management whereas the existence of
external block-holders does not seem to significantly affect earnings management. In addition,
Warfield et al. (1995) provide evidence that managerial ownership is negatively related to the
magnitude of earnings management. Warfield et al. (1995) also find evidence that the inverse
relationship between managerial ownership and absolute abnormal accruals becomes moderated in the
case of regulated firms. They suggest that regulation provides monitoring on managers’ choice of
making accrual adjustment to manage earnings.
Sanchez-Ballesta and Garsa-Meca (2007) examine the relationship between ownership structure
and discretionary accruals for a sample of Spanish non-financial companies. Their results support the
hypothesis that insider ownership contributes to the constraining of earnings management when the

proportion of shares held by insiders is not too high. When insiders own a large percentage of shares,
however, they are entrenched and the relation between insider ownership, discretionary accruals
reverses. Morck et al., (1988) argue that greater ownership would provide managers with deeper
entrenchment and, therefore, greater scope for opportunistic behavior. Gabrielsen et al. (2002) find a
positive but non-significant relation between managerial ownership and discretionary accruals in a
sample of Danish firms, which they attribute to the different institutional settings between the US and
Denmark.
The manner in which earnings management is associated with institutional ownership is an
empirical issue. Extant literature posits two competing views on institutional investors. One group of
the literature such as El-Gazzar, 1998; Wahal and McConnell, 2000; Velury and Jenkins, 2006 among
many others, provide evidence indicating institutions are playing an active role in monitoring and
disciplining managerial discretion. On the other hand, the second group of studies (e,g Porter 1992 and
Bushee, 1998) alleges that frequent trading and fragmented ownership discourage institutions from
becoming actively involved in the corporate governance of their portfolio firms (Grace et al., 2005).
Chung et al., (2002) find evidence supporting that the presence of large institutional
shareholdings inhibit managers from increasing or decreasing reported profits towards the managers’
desired level or range of profits. This evidence is consistent with institutional investors monitoring and
constraining the self-serving behavior of corporate managers. Koh (2003) examines the association
between institutional ownership and income increasing discretionary accruals and finds a concave
association where (a) a positive association is found at a lower institutional ownership region and (b) a
negative association at a higher institutional ownership region. In a more recent study, Koh (2007)
extends the literature by classifying institutional investors into transient or long-term by their
investment horizons to examine the association between institutional investor type and firms’
discretionary earnings management strategies in two mutually exclusive settings – firms that (do not)
use accruals to meet/beat earnings targets. The results support the view that long-term institutional
investors constrain accruals management among firms that manage earnings to meet/beat earnings
34 International Research Journal of Finance and Economics - Issue 38 (2010)
benchmarks. This suggests long-term institutional investors can mitigate aggressive earnings
management among these firms. Transient institutional ownership is not systematically associated with
aggressive earnings management and is evident only among firms that manage earnings to meet/beat

their earnings benchmarks.
On the other hand, external block-holders are considered to be an important external
mechanism to influence earnings management. Jensen and Meckling (1976) is one of the earliest
studies that suggest monitoring by block-holders can be a way to reduce agency costs. Many
subsequent studies have suggested that external block-holders could effectively monitor management
of firms (Koch 1981, Mikkelson and Ruback 1985, Shleifer and Vishny 1986, and Barclay and
Holderness 1991). The higher incentive of outside block-holders in monitoring managers' actions
potentially reduces earnings management by restricting managers' discretion with financial reporting
and/or mitigating their incentive to manage earnings.
Dechow et al. (1996) suggest that outside block-holders are effective monitors of managers'
earnings overstatements that violate GAAP. Yeo et al. (2003) show a strong positive relationship
between external unrelated block-holdings and earnings informativeness. However, McEachern (1975),
Shleifer and Vishny (1986), Holderness and Sheehan (1988), and Barclay and Holderness (1991)
among some others argue that outside block-holders may create extra pressure for their firms' managers
to engage in income-increasing earnings management. Zhong et al., (2007) study the association
between outside block-holder ownership and earnings management for NYSE firms. Their results
indicate that outside block-holder ownership is positively associated with discretionary accruals for
firms that face declining pre-managed earnings. Thus, the evidence, consistent with the second view,
suggests that outside block-holders are not effective monitors of income-increasing earnings
management that is generally within the bounds of GAAP.
Although extant literature examined the determinants of earning management, the evidences are
mixed, and what are the determinants of firms' earnings management remains an empirical issue.
Therefore, this study contributes to the literature by examining the effect of ownership structure on
earnings management behavior in an emerging market. This paper is examining an important issue
among research topics in accounting and finance. The importance behind examining the determinants
of earnings management is to minimize potential wrongdoing, conflict, and a sense of mystery in
accounting information used by financial managers because, as argued by Lo (2007), highly managed
earnings have low quality.

5. Research Design
In this section we will develop the study hypotheses, describe the main models used in this paper,
clarify the operational definition of the variables used, and explain the procedures of sample selection.

5.1. Hypotheses and Research Models
The aim of this study is to test the association between ownership structure and earnings management
and to examine if this association differs between small and large firms.
The standard assumption is that each of the ownership categories has different objectives with
implications for corporate strategy and performance (Edwards and Nibler 2000; Morck et al. 2000;
Thomsen and Pedersen 2000). Therefore, each ownership category is expected to influence earnings
management differently.
We examine whether each of the ownership structure categories (insiders, external block-
holders, and institutional investors) is associated with earnings management after controlling for
factors that are likely to impact earnings management such as size, the level of debt, firm growth, and
profitability. Our primary hypotheses (stated in null form) are as follows:
H
1
: Earnings management is not associated with the level of insiders' ownership.
H
2
: Earnings management is not associated with the level of institutional ownership.
International Research Journal of Finance and Economics - Issue 38 (2010) 35
H
3
: Earnings management is not associated with the level of external block-holders'
ownership.
We employ Models 1to 4 to examine the above mentioned hypotheses:
itititit
ContINSIEM
ε

α
α
α
+
++=
321
(1)
itititit
ContEBHEM
ε
α
α
α
+
++=
321
(2)
itititit
ContINSTEM
ε
α
α
α
+
++=
321
(3)
itititititit
ContINSTEBHINSIEM
ε

α
α
α
α
α
+
+
+
++=
54321
(4)
Where, EM
it
is earnings management measured by discretionary accruals for firm i at time t,
INSI
it
is insiders (managerial) ownership variable, INST
it
is institutional ownership variable for firm i
at time t, and EBH
it
is external block-holders' ownership variable for firm i time t, and. Cont
it
stands for
control variables and ε
it
is the error term.

Finally, we examine the interaction between the significant ownership category and size to
check whether the association between earnings management and ownership structure differs among

large and small firms. The following hypothesis in its null form can be stated as follows:
H
4
: The association between earnings management and ownership structure does not differ
among firms of different size.
The above formulated hypothesis is examined using the following model:
itititititititit
ContSIZEOSINSTEBHINSIEM
ε
α
α
α
α
α
α
+
+
+
+++=
654321
*
(5)
Where, OS
it
stands for one or more significant ownership categories for firm i at time t and
SIZE
it
is firm i size at time t.
To examine the above mentioned tests, Ordinary Least Squares (OLS) estimation may be used
in this study. However, Hsiao (1985) shows that in the presence of firm specific effects, OLS

coefficients are biased assuming that co-variances between the independent variables and the firm
specific variable and the disturbance terms
it
ε
are nonzero. If variables are endogenous, using OLS
estimates may lead to inconsistency. Therefore, we employ a dynamic panel, the Generalized Method
of Moment (GMM) estimator proposed by Arellano and Bond (1991).
Under GMM, the consistency of the estimator depends on the validity of the instruments and
the assumption that the difference error terms do not exhibit second order serial correlation. To test
these assumptions, Arellano and Bond proposed a Sargan test of overidentifying restrictions, which
tested the overall validity of the instruments by analyzing the sample analog of the moment conditions
used in the estimation procedure (Liu and Hsu, 2006). Besides, they also tested the assumption of no
second-order serial correlation. Failure to reject the null hypotheses of both tests gives support to our
estimation procedure
6
. All regressors are treated as strictly exogenous except the lagged dependent
variables. Therefore, we conduct the analyses with lagged independent variables dated t−2 and earlier
together with the lagged changes of endogenous variables, and exogenous variables used as instrument
variables.

5.2. Definition of Variables
5.2.1. Measuring Earnings Management
In this study, we use accounting accruals approach to measure earnings management. Accruals
includes a wide range of earnings management techniques available to managers when preparing
financial statements, such as, inter alia, accounting policy choices, and accounting estimates (Grace et
al., 2005; and Fields et al., 2001)
7
.

6
See also the discussion in Baltagi (2008).
7
As stated by Aljifiri (2007, p.77), “accounting accruals changes may be less costly when compared to accounting
methods changes as a mean to transferred earnings between periods and maybe more difficult to detect by auditors”. The
two main components of accounting accruals (discretionary and non discretionary accruals) are not directly observed.
Therefore, all studies have used an indirect estimation of discretionary accruals.
36 International Research Journal of Finance and Economics - Issue 38 (2010)
In general, accounting accruals, which is the difference between earnings and cash flows from
operating activities, have been used in different terms in the previous literature. While Healy (1995)
used total accruals to measure earnings management, subsequent studies attempt to separate them into
components, discretionary and non discretionary accruals. Discretionary accruals are extensively used
to demonstrate that managers transfer their accounting earnings from one period to another. In other
words, managers exercise their discretion over an opportunity set of accrual choices within GAAP, for
example, choosing the depreciation method of fixed assets (Healy, 1995). Additionally, total accruals
include non-discretionary accruals which reflect non-manipulated accounting accruals items because
they are out of managers’ control.
Consistent with the previous literature on earnings management (Jones, 1991; and
Subramanyam, 1996), we used discretionary accruals to measure the extent of earnings management.
Following recent literature (e.g. Jaggi and Leung 2007), this study uses the cross sectional variation of
the modified Jones model (Jones, 1991; and Dechow et al., 1995) to obtain a proxy for discretionary
accruals. Dechow et al., 1995; Guay et al., 1996 among some others argue that the modified Jones
model is the most powerful model for estimating discretionary accruals among the existing models.
Furthermore, Bartove et al., (2000) indicate that the cross sectional model outperforms its time- series
counterpart in detecting accruals management.
The dependent variable in our model, earnings management, is measured as discretionary
accruals using a cross-sectional version of the modified Jones model (Dechow et al. 1995) as follows:
First, total accruals (TACC) is defined in this study as the difference between net income before
extraordinary items (NI) and cash flow from operating activities (OCF):-
OCFNITACC −=

(6)
Equation 2 below is estimated for each firm and fiscal year combination
itititiitititiittitit
APPEARECREVAATACC
ε
α
α
α
+
+
Δ
−Δ+=
−−−−
]/[]/)[]/1[/
121111
(7)
Where, TACC is the total accrual, ∆REV is the change in operating revenues, ∆REC is the
change in net receivables, PPE is gross property, plant and equipment, t and t-1 are time subscripts and
i is the firm subscript. Changes in revenues is included to control for the economic circumstances of a
firm; whilst gross property, plant and equipment are included to control for the portion of total accruals
related to non-discretionary depreciation expenses (Jones, 1991). Dechow et al., (1995) modified the
Jones (1991) model by removing the discretionary components of revenues through changes in
accounts receivable. Firms are considered to have engaged in income increasing (decreasing)
discretionary accruals if they have positive (negative) estimated discretionary accruals. Earnings means
the reported earnings before interest and tax and before extraordinary items. Earnings target is the prior
year earnings level (Degeorge et al., 1999). Non-discretionary earnings (NDE) are earnings less
discretionary accruals (DACC). To estimate the coefficient values, an Ordinary Least Squares (OLS)
regression with no intercept is employed.
The Difference between total accruals and the non-discretionary components of accruals is
considered as discretionary accruals (DACC) as stated below

8
:
]/[
ˆ
]/)[(
ˆ
)]/1(
ˆ
[/
121111 −−−−
+
Δ
−
Δ
+−=
ititiitititiittititit
APPEARECREVAATACCDACC
α
α
α
(8)
All variables are scaled by prior year total assets A
t-1
to control for heteroscedastisity.

8
Since any accrual effect is included in net income, it is therefore also included in discretionary accruals (if it was 'non-
discretionary' then it cannot be outside GAAP). Therefore our working definition of DACC makes no distinction between
GAAP and non-GAAP accruals.
International Research Journal of Finance and Economics - Issue 38 (2010) 37

5.2.2. Measuring Ownership Structure and Firm Size
Insider ownership (INSI), external block-holders ownership (EBH) and institutional ownership (INST)
were collected from the annual reports of the sampled firms in the Amman Stock Exchange (ASE) data
base
9
. INSI was defined as the percentage of shares held by officers or directors within the firm and
their families (see Karathanssis and Drakos, 2004). EBH was measured as the percent of shares held by
the individual block-holders
10
. For each party, we only consider the ownership percentage that
represents 5% or more of firm's equity share capital. INST was measured as the percent of shares held
by institutions, which includes shares owned through social security and other funds. Consistent with
Koh (2003), the following organizations are classified as institutional investors: insurance companies
(life and non-life), pension funds, investment companies, and financial institutions including banks.
Additionally, firms' accruals management decisions are likely to be influenced by firms' size.
The size hypothesis (Watts and Zimmerman, 1986) posits that large firms are more politically visible
and are more likely to manage earnings to reduce their political visibility (Moses, 1987; Hsu and Koh
2005). However, Ashari et al., (1994, p. 293) has an opposite view and argues that more information is
available about larger firms, which are closely scrutinized by analysts and investors. Smoothed income
signals from larger firms add little value; accordingly, they have less incentive to smooth income (Atik,
2008). Thus, there is no specific prediction on the association between firm size and discretionary
accruals. This study uses the natural logarithm of total assets as a proxy for firm size (SIZE).

5.2.3. Measuring Other Variables
Given that firms' accruals management decisions are likely to be influenced by factors other than the
three ownership categories (INSI, EBH, INST) or the size of the firm, several control variables are
introduced to capture the incentives that have been found to influence managers' discretionary
accounting choices. The control variables included in this study are firm financial leverage (LEV),
profitability (ROE), and growth (GROW).
Firm financial leverage, measured as the ratio of debt to assets, is included, as a proxy for risk,

because managers are more likely to exercise their accounting discretion granted by GAAP when they
are closer to default on debt covenants (Press and Weintrop, 1990). Trueman and Titman (1988, p.
128) argue that managing earnings enables managers to reduce estimates of various claimants of the
firm about the volatility of its earnings process and so lowers their assessment of the probability of
bankruptcy. Consequently, as discussed by Atik (2008), this provides an opportunity to borrow at
lower interest rates and decreases cost of capital. Consistent with this debt hypothesis, we expect that
managers in more leveraged firms are more likely to adopt aggressive earnings management techniques
to prevent violation of debt covenants (Watts and Zeimmerman, 1986).
Since accruals could also relate to growth opportunity, this variable (Grow), measured as year-
over-year sales changes is considered in our estimation. This variable will be used as a control for
demand conditions and product-cycle effects on profitability. As argued by Chan et al. (2001) and Lui
(2004), firms with the highest growth opportunities usually have higher valuation ratio and higher
growth because the market uses the dividend discount models to value the firm equity (Lee et al.,
2005). Firms with the highest growth opportunities are likely to have more private information about
these prospects, which would exacerbate the problems of asymmetric information. Therefore, insiders
try to reveal this relevant information through financial statements in which earnings have been
managed to signal the profitable projects available to the firm (Healy and Palepu, 2003). Our
prediction is, consistent with the before mentioned discussion, firms with higher growth rate have
higher discretionary accruals.
Finally, profitability, measured by return on equity, is included to control the relationship
between earnings management and ownership structure. Orlitzky et al. (2003, p. 408), argue that “

9
Government ownership has been excluded. Because the Jordanian economy is private sector oriented, the state ownership
is relatively small.
10
Individual external block-holders exclude managerial owners.
38 International Research Journal of Finance and Economics - Issue 38 (2010)
indicators such as Return on Assets (ROA) and Return on Equity (ROE) are subject to managers’
discretionary allocations of funds to different projects and policy choices, and thus reflect internal

decision making capabilities and managerial performance rather than external market responses to
organizational actions”. Thus, in this study ROE is included as a proxy for profitability. As examined
by Chen et al. (2006), listed firms with lower profitability have higher behavior of earnings
management. Therefore, we expect a negative relation between earnings management and
profitability
11
.
Table 1 summarizes the definitions and interpretations of the study variables.

Table 1: Variables Definitions

Variable Definition

Interpretation
A- Dependent Variable
DACC Discretionary Accruals
measured using modified
Jones model.
Measures the managers' ability to transfer their accounting earnings from
one period to another (see Jones, 1991; and Subramanyam, 1996, and Jaggi
and Leung 2007.
B- Independent variables
1- Test variables
INSI Insider ownership defined as
the percentage of shares held
by officers or directors within
the firm and their families.
Based on convergence of interest hypothesis (alignment effect),
discretionary accruals is predicted to be negatively associated with insider
ownership (see Warfield et al., 1995). In contrast, entrenchment hypothesis

implies that high level of insider ownership can become ineffective in
aligning insiders to take value maximizing decisions. Therefore, a positive
relationship between earnings management and managerial ownership may
exist. Yeo et al., (2007).
INST Institutional investors'
ownership measured as the
percent of shares held by the
institutions.
The relationship between earnings management and the level of
institutional ownership is ambiguous. Under an active monitoring
hypothesis (Bushee, 1998 and Majumdar and Nagarajam, 1997), the higher
the level of institutional investors the lower the earnings management. On
the other hand, passive hand hypothesis supports the positive relationship
between earnings management and institutional ownership (see Bhide,
1993, and Porter, 1992).
EBH External block-holders
measured as the percent of
shares held by the individual
block-holders (excluding
managers), owning 5% or
more of firm's equity share
capital.
Negative or Positive relationship between EBH and DACC may exist.
External owners with higher motivation and ability to monitor managers'
actions might reduce DACC through their closer monitoring (Dechow et
al., 1996). On the other side, EBH require returns from their investment.
Thus they might encourage managers to increase DACC (Velury and
Jenkine2006 and Zhong et al., 2007).
2- Control Variables
SIZE Firm size measured by the

natural logarithm of total
assets.
Large firms are likely to manage earnings to reduce their political visibility
(Moses, 1987; Hsu, and Koh 2005). However, Ashari et al., (1994, p. 293)
have an opposite view and argue that larger firms have less incentive for
earnings management (Atik, 2008).
ROE Firm profitability measured
as Return on Equity.
The lower profitability the lower the behavior of earnings management.
Therefore, we expect a negative relation between earnings management and
profitability (see Jiang Yihong, 1999; and Chen et al., 2000).
GROW Growth opportunity measured
as year-over-year sales
changes.
Firms with higher growth rate are expected to have higher discretionary
accruals (see Healy and Palepu, 2003).
LEV Firms financial leverage,
measured as the ratio of debt
to total assets.
Managers in more leveraged firms are more likely to adopt aggressive
earnings management techniques to prevent violation of debt covenants
(Watts and Zeimmerman, 1986).


11
Some literature uses other factors like research & development outlays and advertising expenditures, in this study these
will not be included due to the absence of reliable available data.
International Research Journal of Finance and Economics - Issue 38 (2010) 39
5.3. Sample Selection
The population used in this study comprises the listed industrial companies in Amman stock exchange

between 2001 and 2005. The industrial sector in Jordan is very important to the economy, as a source
of employment and economic growth. Therefore, understanding the characteristics of earnings
management within this sector is vital to enhance the reliability and transparency of reported earnings,
and therefore improve the ability of investors to determine the fair value.
Data are collected manually from the Jordanian shareholding companies guide issued by
Amman Stock Exchange and annual reports of Jordanian shareholding companies. The firms selected
are well settled companies in the Jordanian economy; they are the major players in the Jordanian
industrial sector. At least for the time of the study these companies have continued to work
progressively, they have a high trading volume and no merging or acquisition were announced for any
of them. Additionally, firms with insufficient data for ownership and firms with inadequate financial
data are excluded from the sample. After applying these conditions, 39 were included in the analysis,
which represents around 64% of Jordanian Industrial firms. The final sample consists of 195 firm-year
observations for accrual estimation and empirical analysis. Of these, 94(101) firms have positive
(negative) discretionary accruals.


6. Results
6.1. Descriptive Statistics
Table 2 reports the descriptive statistics for the dependent and explanatory variables.

Table 2: Descriptive Statistics

Variable Mean Standard Deviation Minimum Maximum
DACC
0.117% 10.098% -38.700% 34.400%
INSI
38.053% 24.497% 6.330% 97.290%
EBH
20.301% 22.046% 2.14% 77.240%
INST

23.101% 25.935% 0 97.24%
ROE
6.1521% 10.573% -55.960% 32.423%
SIZE
16.340 1.231 13.971 19.829
GROW
16.468% 52.745% -85.329% 454.46%
LEV
35.667% 18.837% 5.302% 84.422%
DACC= discretionary accruals, DINSI= Insider ownership measured as percentage of shares owned by board of directors
their wives and children and influential executives, EBH= External block holders measured as the sum of shares
that exceeds 5% for every individual share holder. INST= Institutional block holder measured as the sum of shares
that exceeds 5% for every institutional share holder. SIZE= the size of the firm approximated by total assets.
GROW = Growth of the company approximated by percentage change in sales. LEV= Leverage ratio calculated by
total liabilities over total assets.

While the discretionary accruals, DACC, ranges between about 34 per cent and 39 percent, the
mean and standard deviation for it are about 0.12%, 10%, respectively. On average, the sample firms
have positive discretionary accruals. This may indicate that Jordanian firms in our sample are
managing their earnings upwardly. Most prominent result is the high standard deviation of growth
(about 53%) relative to the standard deviation of the other variables included into our models (which
range between 10% and 26%). This high standard deviation of growth may indicate that our sample
firms are of different size and maturity. This is supported by the high standard deviation of size (1.23),
and this justified the inclusion of size and growth in our models.
On the other hand, insider investors, on average, hold around 38 per cent of total shares
outstanding of the sample firms. Comparing this ownership category with the other categories, we find
about 20 per cent on average are external block-holders. The level of external block-holders is far from
what Hso and Koh (2005) report for the period from to 1993 to 1997 within Australian firms (about 12
40 International Research Journal of Finance and Economics - Issue 38 (2010)
per cent). However, Institutional investors represent 23 per cent of shareholders on average. This is

significantly lower than the average institutional ownership level reported by Koh (2003, 2007) of 47-
48 per cent between 1993 and 1997 inclusive, and Stapledon (1998) of around 49 per cent in 1997 for
more developed countries. These statistics are not surprising due to the nature of emerging markets
investing. Most of the listed firms are owned and controlled by individuals rather than institutional
investors. This is supported by the reported institutional investors in Indonesian firms, which account
for only 7 % of total shareholding for the period from 1994 to 2002 (see Siregar and Utama, 2008).
The average leverage ratio for the sample firms is about 36 per cent. While this average leverage ratio
was far from what is found by Hso and Koh (2005), around 54 per cent, it is near to the average
leverage found in China, about 34 per cent (see Wei and Verela, 2003).
Pearson correlations between the explanatory variables are documented in Table 3.

Table 3: Correlation Matrix

Variable DACC INSI EBH INST ROE SIZE GROW
DACC

INSI
0.146**
EBH
0.007 0.4692***
INST
-0.136** 0.265*** -0.516***
ROE
-0.182** 0.125* -0.199** 0.259***
SIZE
-0.499*** 0.095 0.280*** 0.295*** 0.307***
GROW
-0.074 -0.012 0.105 -0.099 0.107 -0.016
LEV
-0.076 -0.197** 0.135** 0.020 -0.218*** 0.306*** 0.144**

See Table 1 for variables definitions.
Each value in this table represents Pearson product moment correlation coefficient between each pair of the variables listed
in column 1.
*, **, *** stands for 10%, 5%, and 1% significance levels respectively.

DACC has a positive (negative) and significant correlation with insider (institutional) investors,
which is consistent with the nature of managers. Managers seems to engage more (less) in
manipulating their accounting information and smoothing their income the greater are the insiders
(institutional) holding of stocks. On the other hand, external block-holders, growth and leverage seem
to be not correlated with the earnings management behavior of managers. Size (SIZE) is positively
associated with leverage (LEV), consistent with Cotter's (1998) finding that larger firms have higher
leverage constraint levels. A negative correlation between profitability (ROE) and DACC indicates that
more profitable firms are less likely to witness earnings management. Negative and significant
correlation between EBH and ROE signify that the more concentrated the ownership the less the
profitability. However, larger firms seem to be more profitable firms (positive and significant
correlation between SIZE and ROE).

6.2 Ownership Structure and Earnings Management
The results of the regression models, which test the relation between ownership structure and earnings
management, are presented in Table 4.
International Research Journal of Finance and Economics - Issue 38 (2010) 41
Table 4: Ownership Structure and Earnings Management
itititit
ContINSIEM
ε
α
α
α
+
++=

321
(Model 1)
itititit
ContINSTEM
ε
α
α
α
+
++=
321
(Model 2)
itititit
ContEBHEM
ε
α
α
α
+
++=
321
(Model 3)
itititititit
ContINSTEBHINSIEM
ε
α
α
α
α
α

+
+
+
+
+
=
54321
(Model 4)
itititititititit
ContSIZEOSINSTEBHINSIEM
ε
α
α
α
α
α
α
+
+
+
+++=
654321
*
(Model 5)

Model
(1) (2) (3) (4) (5)
-0.249** -1.491** -1.587** -0.441** -0.473
Intercept
(0.124) (0.724) (0.748) (0.146) (0.442)

320*** 245*** -0.247 *** 331 -0.346***
L1
(0.021) (0.068) (0.063) (0.018) (0.023)
.0554** 0.144*** 1.664**
INSI
(0.025) (0.045) (0.754)
-0.046 -0.003 -0.183
EBH
(0.122) (0.028) (0.124)
-0.001 0.041 0.004
INST
(0.145) (0.03) (0.048)
0.017** 0.090** 0.095** 0.023*** 0.029**
SIZE
(0.008) (0.044) (0.044) (0.008) (0.029)
0.007 0.078 0.089 0.023 0.084***
LEV
(0.030) (0.100) (0.982) (0.025) (0.026)
0.001*** 0.000 0.0002 0.001* 0.002***
ROE
(0.000) (0.001) (0.001) (0.000) (0.000)
-0.006 0.018 0.0172 -0.008 0.003
GROW
(0.006) (0.111) (0.012) (0.005) (0.009)
0.102**
INSI*SIZE

(0.047)
Autocorrelation(1)
-3.4964*** -3.3244*** -3.375*** -2.874*** -3.042***

Autocorrelation(2)
-1.2395 1.160 -1.096 -1.212 -1.706
SarganTest (df)
7.094(5) 7.792(5)* 8.792(5) 8.753(5) 7.434(5)
Wald (df)
24.87(6)*** 26.160(6)*** 26.60(6)*** 27.81 (8)*** 39.74(9)***
The dependent variable Earnings Management (EM) is measured by Discretionary Accruals (DACC). DINSI is the insider
ownership measured as percentage of shares owned by board of directors their wives and children and influential
executives. EBH is the external block holders measured as the sum of shares that exceeds 5% for every individual share
holder. INST is the institutional block holder measured as the sum of shares that exceeds 5% for every institutional share
holder. SIZE is the size of the firm approximated by the natural logarithm of total assets. GROW is the growth of the
company approximated by percentage change in sales. LEV is the leverage ratio calculated by total liabilities over total
assets. In all the reported Models DACC is regressed on the aforementioned independent variables. Models 1 to 3 each of
the ownership measures are included individually in addition to the control variables. In Model 4 the entire ownership
structure variables are included at ones. In Model 5 the interaction effect of size and the portion of insider ownership are
examined wither the relation between earnings management and insiders differ among different firms size. All models are
examined using GMM estimation. Four test statistics are reported: (1) and (2) first and second order autocorrelation of
residuals respectively, which are asymptotically distributed as standard normal N (0, 1) under the null of no serial
correlation. Wald is the Wald test of joint significance of the estimated coefficients which is asymptotically distributed as
Chi-square under the null of no relationship. Sargan test of overidentifying restrictions which is asymptotically distributed
as chi-square under the null of instruments validity. All estimations were carried out using the Stata program. ***,**, and *
indicate coefficient is significant at the 1, 5, 10% levels, respectively.


The first three models are examined to test the relation between each ownership structure
category (INSI, INST, and EBH) and earnings management measured by DACC. Then models 4 and 5
look at the effect of the three ownership categories collectively. We control for a number of factors that
may affect earnings management, like SIZE, LEV, ROE and GROW.
The hypothesised concave association between DACC and INSI is found and is statitically
significant. The coefficient of INSI in model 1 is positive and equal to 0.0554 (see row 3 in Table 4).

42 International Research Journal of Finance and Economics - Issue 38 (2010)
We interpret the results as support for Morck et al., (1988) hypothesis that management entrenchment
could occure when insider holdings are high. This suggest that the managerial ownership has a
determinantal effect on earnings management. This result supports the agency problem that appears
between managers and shareholders in Jordanian firms. Managers have weak incentives to act in
shareholders interest. Managers use their discretion to maximize their utility, thereby grabing earnings
(see Subramanyam, 1996). Based on these results, we can reject the first null hypothesis.
Looking at the relation between institutional ownership and discretionary accruals, in model 2,
a negative relation emerged. However, it has not been supported statistically. This insignificant
association indicates that institutional investors are not a major consideration in managers' aggressive
earnings management strategy. This result is not surprising. In Jordan, most institutional owners are
social security institution (government pention funds) and financial firms. There is no existence of
developed mutual funds or investment companies. As a result, institutional investors in Jordan are not
effective in constraining managerial behaviour of earnings management. Consistent with the argument
that institutional investors in Jordan are short-term oriented and create incentives for managers of their
portfolio firms to manage earnings aggressively, these institutional investors focus excessively on
current earnings performance (see Koh, 2003). The result of non influencial effect of institutional
investors on earnings management found in this study is not consistent with what Velury and Jenkins
(2006) found in a sample of US based firms. However, similar evidence is found by Siregar and Utama
(2008) for Indonisian firms. The same result is evident regarding the relationship between earnings
management and external block-holders. The negative coefficient value of the EBH variable in model 3
of -0.046 is not statistially significant. Therefore, the proportion of external block-holders has no
influence on management of earnings. Based on the above mentioned results, our second and third
hypothesis cannot be rejected.
In addition, model 4 brings togather the three ownership categories. All signes remain the same
to confirm the previos results. While the level of insider investors continued to be influential factor on
earnings management, the other ownership categories (INST and EBH) continued to be not important
variables, and have no effect on the level of earnings management within the Jordanian firms.
Regarding the other variables, included as control variables, we found that firms growth
(GROW) and leverage (LEV) are not significantly affecting the quality of accounting information.

Managers in Jordanian firms with higher sales growth and high financial leverage have no more (less)
incentives to manage their income. On the other side, the association between earnings management
and profitability within the Jordanian firms are different than what we expect. Firms with higher
profitability measured by ROE are engaged more with earnings management (positive and significant
coefficients of ROE in 3 out of 5 models, Table 4). This positive relation is not strange and consistent
with Chen and Yuan (2004) findings. One of the explanation for this positive relation is that Amman
Stock Exchange (ASE) requires firms to achieve a minimum profitability to continue to be listed or
apply for permission to issue additional shares (Directives for Listing Securities on the Amman Stock
Exchange, 2004)
12
.
Size appears to affect earnings management significantly (significant SIZE coeffecients in
models 1 to 4). However, we find that larger Jordanian firms have less earnings quality since they
engage more in earnings management. Furthermore, the size effect is further examined by introducing
one interaction variable in model 5. The only influencial ownership category, insider investors, is
multipled by firm size (INSI*SIZE) to develope the interaction variable. The coefficient is positive and
statitiscally significant. This result is quantitavely the same as the main finding of models 1 to 4. It
confirms that larger firms are engaging more in earnings manipulation. Based on these results, we can
reject the fourth null hypothesis.
Finally, in order to check the accuracy of our models, we apply autocorrelation and Sargan
tests. In all models, autocorrelation 1 test brings evidence for negative first order serial correlation.
However, autocorrelation 2 test suggests that second order serial correlation is not supported. These

12
See the web site of ASE at http:// www. exchange.jo
International Research Journal of Finance and Economics - Issue 38 (2010) 43
results are not violating the assumptions of GMM estimation because as mentioned by Arellano and
Bond (1991), the first order residuals autocorrelation need not to be zero, but the consistency of the
GMM estimators relies heavily on the assumption that the second order residuals autocorrelation
should equal zero. The Wald test of the joint significance of the regressors is satisfied suggesting that

aggregate factors exert a significant influence on DACC levels in the firms reported information in all
models. The Sargan test also indicates that the instruments used in the GMM estimation are valid in all
models. This is consistent with the assumption that the instruments used are not correlated with the
error term.


7. Conclusions
In this paper, we use Generalized Method of Moment (GMM) methodology to examine the
relationship between ownership structure and earnings management (discretionary accruals) for a
sample of Jordanian industrial companies listed on Amman Stock Exchange during the period 2000–
2005. In our first analysis we find a positive and significant relationship between insider ownership and
earnings management, which supports Morck et al., (1988) who argue that greater ownership would
provide managers with deeper entrenchment and, therefore, greater scope for opportunistic behavior.
This finding indicates that Jordanian insiders tend to make discretionary accounting choices. In this
case, we expect earnings quality and earnings informativeness to decrease. This result is not surprising
since the owner–largest shareholder in Jordan, typically a founder or his immediate family, usually
participates in firm management directly or indirectly, and influences most of the management
decisions.
We then examine the role of institutions and block-holders, proposing two opposing
hypotheses- an active monitoring role and a passive hand hypothesis. We find insignificant relationship
between each of these two variables and earnings management. These results suggest that institutions
and block-holders generally play a myopic role in Jordanian companies. They do not monitor
effectively because they may either lack expertise or suffer from free rider problems among themselves
(Admat et al., 1994), or strategically ally with the management (Pound, 1988).
Regarding the control variables, we found that firms growth and leverage are not significantly
affecting the quality of accounting information. However, there is no conclusive result for profitabiliy.
Size appears to affect earnings management significantly and larger firms are engaging more in
earnings manipulation.

Our findings have important policy implications since they suggest the need to encourage

applying corporate governance principles by institutions and individual block-holders to provide
effective monitoring of earnings management in Jordanian firms, especially those with a large size.
These firms operate in the business environment of insider ownership domination and control, where
managers have greater motivation and opportunity to manage earnings to maximize their private
benefits. This suggests that similar efforts in other countries in the region would be rewarding in
controlling the management of reported earnings, to enhance the reliability and transparency of
reported earnings in order to promote economic efficiency.
44 International Research Journal of Finance and Economics - Issue 38 (2010)
References
[1] Amman stock Exchange Web Site (2009), URL: http:// www. exchange.jo.
[2] Amat, O., Blake, J., and J., Dowds. 1999. "The ethics of creative accounting.
URL:. rs/downloads/455.pdf]; 10.9.2005.
[3] Aljifri, K., 2007, " Measurement and motivations of earnings management:A critical
perspective", Journal of Accounting- Business and Management 14:75-95
[4] Arellano, M., and S., Bond. 1991. "Some tests of specification for panel data: Monte carlo
evidence and an application to employment equations" Review of Economic Studies, 58: 277-
297.
[5] Arya, A., Glover, J., and S. Sunder. 2003. “Are Unmanaged Earnings Always Better for
Shareholders?”, Accounting Horizons (Supplement): 111-116
[6] Ashari, N., Koh, H., Tan, S., and W., Wong. 1994. "Factors affecting income smoothing among
listed companies in Singapore", Accounting and Business Research 24 (96), 291-301
[7] Atik A., 2008. "Detecting income-smoothing behaviors of Turkish listed companies through
empirical tests using discretionary accounting changes", Crit. Perspect Account.
doi:10.1016/j.cpa.2008.01.003
[8] Balsam, S., Chen .X., and S., Sankaraguruswamy. 2003. "Earnings management prior to stock
option grants". Working paper.
[9] Baltagi, B., 2008. "Econometric Analysis of Panel Data", 4
th
ED, John Whiley &Sons, LTD
[10] Barclay, M., and C., Holderness, 1991. “Negotiated block trades and corporate control,” The

Journal of Finance 46: 861-878.
[11] Bartove, E., Gul, F., and J., Tsui. 2001." Discretionary accruals models and audit
qualifications", Journal of Accounting and Economics, 30, 421–452
[12] Beneish, M., 2001. "Earnings Management: a perspective”, Managerial Finance 27: 3 –17.
[13] Bhide, A., 1993. "The hidden costs of stock market liquidity', Journal of Financial Economics,
34: 31–51.
[14] Burgstahler, D. and I. Dichev. 1997. "Earnings management to avoid earnings decreases and
losses", Journal of Accounting and Economics 24: 99-126.
[15] Bushee, B., 1998. “The influence of institutional investors on myopic R&D investment
behavior”, The Accounting Review 73:305-333.
[16] Chan, D., Ferguson, A., Simunic, D. and D. Stokes. 2001. " A spatial analysis and test of
oligopolistic competition in the market for assurance services" Working Paper, University of
British Columbia.
[17] British Columbia.Chen, G., Firth, M., Gao, D., and O., Rui. 2006. "Ownership structure,
corporate governance, and fraud: evidence from China", Journal of Corporate Finance 12,
424–448.
[18] Chen, K., , and H., Yuan. 2004. "Earnings management and capital resource allocation:
evidence from China's accounting-based regulation of rights issue', The Accounting Review, 74:
645–665
[19] Chung, R., Firth. M., and J., Kim. 2002. "Institutional monitoring and opportunistic earnings
management". Journal of Corporate Finance 8: 29-48.
[20] Cotter, J., 1998. "Utilization and restrictiveness of covenants in Australian private debt
contracts", Accounting and Finance 38: 181-196.
[21] Davidson, R., Goodwin-Stewart, J. and P., Kent. 2005. “Internal governance structures and
earnings management”, Accounting and Finance 45: 241-67
[22] De Bos, A. and H., Donker. 2004. " Monitoring accounting changes: empirical evidence from
the Netherlands, Corporate Governance: An International Review 12: 60–73.
[23] DeAngelo, H., DeAngelo, L., and D., Skinner. 1994. "Accounting choice in troubled
Companies", Journal of Accounting and Economics 17: 113-143.
[24] Dechow, P. and R.G. Sloan. 1991 Executive incentives and the horizon problem: An empirical

investigation. Journal of Accounting and Economics, 14: 51-89.
International Research Journal of Finance and Economics - Issue 38 (2010) 45
[25] Dechow, P., Sloan, R., and A., Sweeney.1996. "Causes and consequences of earnings
manipulations: An analysis of firms subject to enforcement actions by the SEC. Contemporary
Accounting Research 13: 1-36.
[26] Dempsey, J., Hunt, H., and N., Schroeder, "Earnings management and corporate ownership
structure: An examination of extraordinary item reporting", Journal of Business Finance &
Accounting 20: 479-500.
[27] Edwards, J., and M., Nibler. 2000. “Corporate Governance in Germany: The Role of Banks and
Ownership Concentration”, Economic Policy 31:237- 260.
[28] El-Gazzar, S., 1998. " Pre-disclosure information and institutional ownership: A cross-sectional
examination of market revaluation during earnings announcement periods", The Accounting
Review 73: 119–129.
[29] Fields, T., Lys T., and L., Vincent. 2001. "Empirical research on accounting choice". Journal of
Accounting & Economics 31: 255–307.
[30] Gabrielsen, G., Gramlich, J. and T., Plenborg. 2002. "Managerial ownership, information
content of earnings, and discretionary accruals in a non-US setting', Journal of Business,
Finance and Accounting 29: 967–988.
[31] Grace, H., and P., Koh. .2005. "Does the presence of institutional investors influence accruals
management? Evidence from Australia", Corporate Governance 13: 809-823
[32] Graham, J., Harvey, C., and S., Rajgopal. 2005. The economic implications of corporate
financial reporting", Journal of Accounting and Economics 40: 3-73
[33] Guay, W., Kothari, S., and R., Watts. 1996. “A market-based evaluation of discretionary-
accrual models”, Journal of Accounting Research 34: 83-105
[34] Guidry, F., Leone, J., and S., Rock. 1999. "Earnings-based bonus plans and earnings
management by business-unit managers". Journal of Accounting and Economics 26: 113-142.
[35] Healy, P., 1985. "The effect of bonus schemes on accounting decisions". Journal of Accounting
and Economics 7: 85-107
[36] Healy, P., and J., Wahlen. 1999. “A review of the earnings management literature and its
implication for standard setting”, Accounting Horizons, Vol. 13 No. 4, pp. 365-83

[37] Healy, P and K., Palepu. 2003. How the quest for efficiency corroded the market. Harvard
Business Review (July): 76-85.
[38] Holderness, C., and D., Sheehan. 1988.”The role of majority shareholders in publicly held
corporations: An exploratory analysis,” Journal of Financial Economics, 20: 317-346.
[39] Hsiao, C., 1988, Analysis of Panel Data, Cambridge University Press, Cambridge.
[40] Hsu, G., and P., Koh. 2005. "Does the presence of institutional investors influence accruals
management? Evidence from Australia", Corporate Governance 13, 809-823
[41] Jaggi, B., S., Leung. 2007. "Impact of family dominance on monitoring of earnings
management by audit committees: evidence from Hong Kong", Journal of International
Accounting, Auditing and Taxation 16:27-50.
[42] Jensen, M., 1986. “Agency costs of free cash flow, corporate finance and takeovers”, American
Economic Review, 76: 323-329
[43] Jensen, M., Meckling,W., 1976. "Theory of the firm: managerial behavior, agency costs and
ownership structure", Journal of Financial Economics, 3: 305–360.
[44] Jiraporn, P., Miller, G., Yoon, S., and Y., Kim. 2008. "Is earnings management opportunistic or
beneficial? An agency theory perspective", International Review of Financial Analysis 17: 622–
634
[45] Jones, J., 1991." Earnings management during import relief investigations" Journal of
Accounting Research 29: 193–228.
[46] Jung K., and S., Kwon. "Ownership structure and earnings informativeness - evidence from
Korea", The International Journal of Accounting 37: 301-325.
[47] Key, K., 1997. "Political Cost Incentives for Earnings Management in the Cable Television
Industry", Journal of Accounting and Economics 23: 309-337.
46 International Research Journal of Finance and Economics - Issue 38 (2010)
[48] Klassen, K., 1997. The impact of inside ownership concentration on the trade-off between
financial and Tax reporting", The Accounting Review 72: 455–474.
[49] Koch, B.,1981. “Income smoothing: An experiment,” The Accounting Review, 3: 574-586.
[50] Koh, P., 2003 ‘On the Association between institutional ownership and aggressive corporate
earnings management in Australia’, The British Accounting Review 35:.
[51] Koh, S., 2007. " Institutional investor type, earnings management and benchmark beaters",

Journal of Accounting and Public Policy 26: 267–299
[52] Krishnaswami, S., and V., Subramaniam, 1999. "Information asymmetry, valuation and the
corporate spin-off decision. Journal of Financial Economics, 53:73−113.
[53] Lee, C., Li,L., Yue, L., and H., Yue, 2005. "Performance, growth and earnings management
performance, growth and earnings management "Working Paper, SSRN at:
ber 20,
[54] Lui, D., 2004. "When accruals meet growth: Do analysts' forecasts fully reflect the future
earnings implications of accruals and growth?’, Working Paper Series (London Business
School).
[55] Liu, W., and C., Hsu. 2006. "Corporate Finance and Growth of Taiwan’s Manufacturing
Firms", Review of Pacific Basin Financial Markets and Policies 9: 67-95
[56] Lo , K., 2007. "Earnings Management and Earnings Quality", Working Paper, University of
British Columbia- Sauder School of Business. SSRN:

[57] Moses, O., 1987. “Income Smoothing and Incentives: Empirical Tests Using Accounting
Changes,” Accounting Review 62: 358-377
[58] Macey, J., 1998. “Measuring the effectiveness of different corporate governance systems:
[59] Toward a more scientific approach”, Journal of Applied Corporate Finance 10: 16-25.
[60] McEachern, W., 1975. " Managerial control and performance, Lexington, Mass.: Lexington
Books.
[61] Majumdar, S., and A., Nagarajan, 1997. "The impact of changing stock ownership patterns in
the
[62] United State: Theoretical implications and some evidence'. Revue D’E' conomie Industrielle
82: 39–54.
[63] Mitra S., 2002. 'The Impact of institutional stock ownership on the firm earnings management
practices: An empirical investigation", Louisiana State University and Agricultural and
Mechanical College, PhD Thesis
[64] McNichols, M., and G., Wilson. 1988. " Evidence of earnings management from the provision
of bad debt", Journal of Accounting Research 26: 1-31.
[65] Mikkelson, W., and R., Ruback. 1985. “An empirical analysis of the inter firm equity

investment process,” Journal of Financial Economics 14: 523-554.
[66] Mitra, S. and J., Rodrigue, 2002. "Discretionary accounting accruals: A methodological issue in
earnings management research 3:185-206.
[67] Monks, R. and N., Minow. 1995.' Corporate governance". Blackwell. Cambridge. M.A.
[68] Morck, R., Shleifer, A. and R., Vishny. 1988. "Management ownership and market valuation:
An empirical analysis, Journal of Financial Economics 20: 293–315.
[69] Orlitzky, M., Frank L. and L. Rynes. 2003. "Corporate Social and Financial Performance: A
Meta-analysis", Organization Studies, 24: 404-441
[70] Osma, B., and B., Noguer. 2007. "The effect of the board composition and its monitoring
committees on earnings management: evidence from Spain, Corporate Governance 15: 1413-
1428.
[71] Porter, M., 1992. "Capital choices: Changing the way America invests in industry". Journal of
Applied Corporate Finance 5: 4–16.
[72] Pound, J., 1988. "Proxy contest and the efficiency of shareholder oversight", Journal of
Financial Economics, 20: 237–265.
International Research Journal of Finance and Economics - Issue 38 (2010) 47
[73] Press, E., and J., Weintrop. 1990. "Accounting-based constraints in public and private debt
agreements: their association with leverage and impact on accounting choice', Journal of
Accounting & Economics 12: 65-95
[74] Rao, N., and S., Dandale. 2008. "Earnings Management: A Study of Equity Rights Issues in
India", The Icfai Journal of Applied Finance. 14: 20-34
[75] Rahman, Z., and H., Waly. 2004. " Report on the observance of standards and codes (ROSC) ,
Hashemite Kingdom of Jordan, accounting and auditing. World Bank Report.
[76] Schipper, K. 1989. “Commentary on earnings management”, Accounting Horizons, 3: 91-102.
[77] Sanchez-Ballesta, J., and B., Garcia-Meca. 2007. "Ownership structure, discretionary accruals
and the informativeness of earnings", CORPORATE GOVERNANCE, 15:677-691
[78] Stapledon, G. 1998. " Astralian sharemarket ownership". In G. Fisse and I. Ramsay(ed).
"Securities regulation in Australia and NewZealand. Sydney: LBC Information Services.
[79] Saudagaran S, and J., Sepe. 1996. "Replication of Moses’ income smoothing tests with
Canadian and UK data: a note". Journal of Business Finance and Accounting 23: 19–22.

[80] Siregar, S., and S., Utama. 2008. " Type of earnings management and the effect of ownership
structure, firm size, and corporate-governance practices: Evidence from Indonesia", The
International Journal of Accounting 43: 1-27
[81] Trueman, B., and S., Titman. 1988. "An explanation for accounting income smoothing",
Journal of Accounting Research 26:127–139 (Supplement).
[82] Teoh, S., Welch, I. and T., Wong. 1998. “ Earnings management and the post issue
performance of seasoned equity offerings”, Journal of Financial Economics 50: 63-99.
[83] Thomsen S., and T., Pedersen. 2000. " Ownership structure and economic performance in the
largest European companies ", The Strategic Management Journal 21: 689-705.
[84] Velury, U. and D., Jenkins. 2006. "Institutional ownership and the quality of earnings", Journal
of Business Research 59: 1043-1051
[85] Wahal, S. and J., McConnell. 2000. "Do institutionalInvestors Exacerbate Managerial
Myopia?", Journal of Corporate Finance 6: 307–329.
[86] Wang, D. 2006. "Founding family ownership and earnings quality", Journal of Accounting and
Research 44: 619–655.
[87] Warfield, T.; J, Wild, and K., Wild. 1995. “Managerial ownership, accounting choices, and
informativeness of earnings”. Journal of Accounting and Economics 20: 61-91
[88] Watts, R., and J., Zimmerman. 1986. "Positive accounting theory. Englewood Cliffs, NJ:
Prentice-Hall.
[89] Wei, Z., A., Varela. 2003. "State equity ownership and firm market performance: evidence
from China's newly privatized firms", Global Finance Journal 14:65-82.
[90] Welch, I., and, T., Wong. 1998. “Earnings management and the Long-term under performance
of initial public offerings”, Journal of Finance 53: 1935-1974.
[91] Yeo, G., Tan, P., Ho, K. and S., Chen. 2002. ‘Corporate ownership structure and the
informativeness of earnings’, Journal of Business Finance & Accounting 29: 1023-1046.
[92] Zhong, K., Donald W., and X., Zheng. 2007. "The effect of monitoring by outside blockholders
on earnings management", Quarterly Journal of Business & Economics 46:38-60