The Effects of Financial and Managerial Slack on Earnings Management:

The Role of Investment Efficiency

Aulia Fuad Rahman¹, Suhal Kusairi², Kadek Weda Noveadjani Tista³

¹ Faculty of Economics and Business, University of Brawijaya, Indonesia.

² School of Economics and Business, Telkom University, Indonesia

³ Polytechnic of Health Denpasar, Indonesia

Abstract

This paper aims to investigate the effect of financial and managerial slack on earnings management with the role of investment efficiency as a moderator in three scenarios namely underinvestment, average investment, and overinvestment. The sample is firms from the manufacturing sector of the Indonesia Stock Exchange. Using panel data analysis, results indicate that financial and executive slack significantly has negative effect on earnings management, while the experience slack does not affect earnings management. Moreover, the negative effect of financial and executive slack on earnings management strengthens for firms with efficient investments. These results were confirmed through a robustness test using two investment scenarios, namely underinvestment and average investment. However, the results changed when firms with overinvestment as the managers be more aggressive in implementing income-increasing practices. Therefore, investment efficiency plays a critical role in determining the effect of financial and managerial slack on earnings management.

Keywords: earnings management, financial slack, executive slack, experience slack, investment efficiency