CORPORATE GOVERNANCE. POLITICAL CONNECTIONS. AND EARNINGS MANAGEMENT CORPORATE GOVERNANCE. POLITICAL CONNECTIONS, AND EARNINGS MANAGEMENT Ni Nyoman Iin Purnama Sari . Ni Wayan Rustiarini . Ni Putu Shinta Dewi . 1,2,3 Department of Accounting. Faculty of Economic and Business. Mahasaraswati Denpasar University. Indonesia Abstract Earnings management is management exertion to manage the company's financial statements. This study aims to examine the effect of corporate governance and political connection on earnings management. The corporate governance variable was reviewed using four proxies: bonus compensation, institutional ownership, independent commissioners, and financial expertise of audit committee. The study was conducted on 183 manufacturing companies on the Indonesian Stock Exchange for three research periods, namely 2017-2019. This study uses multiple linear regression to test the research hypotheses. The results support that bonus compensation increase the propensity of earnings management, while institutional ownership it is confirmed that institutional ownership reduces earnings management. However, the other three variables, namely independent board of commissioners, financial expertise of audit committee, and political connections, do not affect earnings management practices. This research contributes policy for the government to focus on the implementation of good Besides, the government needs to consider the impact of bonus compensation on increased earnings management. Keywords: earning management, corporate governance, bonus compensation, political INTRODUCTION Earnings information is one of the indicators to assess management performance. Performance appraisal based on earnings information motivates management to meet the targeted profit value. Profit shows management's achievement and becomes a means to maintain management's position in the company (Mardjono & Chen, 2. This condition triggers management to make all efforts to meet management's expectations (Dalia et al. , 2021. Yustiningarti & Asyik, 2. Therefore, one activity that is frequently committed is earnings Earnings management is management exertion to manage the company's financial statements by selecting specific accounting policies (Prasetya & Gayatri, 2. Management tends to do earnings management if it cannot meet the profit target set by the One of the earnings management cases that occurred in Indonesia was carried out by the airline company PT Garuda Indonesia Tbk. In 2017, the company claimed a company loss of US$ 58 million. However, this company announced US$ 809,846 as a net profit in 2018. Also, there was a significant increase in profit due to the company's overstatement of revenue recording (Cnbcindonesia. com, 2. This case raises public questions about corporate governance's role in the financial information reporting process. Moreover. Garuda Indonesia is one of the SOEs with a mandate from the people and the state. Therefore, this study explores the role of corporate governance and the political connection to earnings management. *Corresponding author. Email address: rusti_arini@unmas. AFEBI Economic and Finance Review (AEFR) Volume 6. No 2 . This study uses four variables representing corporate governance: bonus compensation, institutional ownership, independent commissioners, and financial expertise of audit One of the factors that inspire management to commit earnings management is bonus contracts. Managers tend to manage net income to maximize their bonuses (Moradi et , 2015. Scott, 2. However, this study still leads to inconsistencies. Previous research states that bonus compensation improves earnings management (Elfira, 2014. Yustiningarti & Asyik, 2. However, other results stated that bonus compensation reduces earnings management (Azizi et al. , 2. Based on the corporate governance context, institutional ownership has a crucial part in monitoring financial reporting. Significant share ownership motivates them to commit adequate supervision (Sumanto et al. , 2. Thus, institutional ownership reduces the possibility of earnings management (Nazir, 2014. Sumanto et al. , 2. Independent commissioners also implement the role of supervision. This member is free from the company's internal interests so that it is considered capable for reducing the potential of earnings management (Mardjono & Chen, 2020. Nazir, 2014. Rahmawati et al. , 2. Another company organ that reduces earnings management frequency is the audit committee. Audit committee members with accounting or financial expertise analyze and evaluate financial statements to prevent earnings management (Dwiharyadi, 2017. Widasari & Isgiyarta. Other factors, such as political connections, also determine the potential for earnings management (Dalia et al. , 2. Political connections encourage companies to commit earnings management, mainly when tax evasion (Antonius & Tampubolon, 2. This study aims to examine the effect of corporate governance and political connection on earnings management. Theoretically, this study supports the agency theory that shareholders as the principal want to improve welfare through achieving maximum profitability. Therefore, the implementation of good corporate governance reduce the potential for earning This research contributes policy for the government to focus attention on the implementation of good governance. Besides, the government considers the impact of political connections to increase earnings management. LITERATURE STUDY Agency Theory Jensen and Meckling . definite an agency relationship as an employment contract between principal and agent. Shareholders as the principal want to improve welfare through achieving maximum profitability. Likewise, managers as agents are also motivated to maximize their interests. Thus, the existence of a difference of interest gives rise to an agency Moreover, agents seek to engage in opportunistic behavior to maximize their interests, such as earnings management. Bonus Compensation and Earnings Management Bonus compensation motivates managers to work to maximize company profits (Moradi et al. , 2. Compensation includes financial and non-financial benefits, as well as other benefits received by employees. The provision of compensation encourages managers to maximize performance to achieve the targeted profit value (Haque, 2. Managers will get several bonuses if the company's profit achievement is in the range of the lower limit . and the upper limit . set (Healy, 1. However, this demand encourages managers to manipulate earnings if the profit achievement is not according to the targeted value. Previous research has proven that bonus compensation positively affects earnings management (Elfira. Yustiningarti & Asyik, 2. Thus, the hypothesis formulated is: H1: Bonus compensation has a positive effect on earnings management. CORPORATE GOVERNANCE. POLITICAL CONNECTIONS. AND EARNINGS MANAGEMENT Institutional Ownership and Earnings Management Institutional ownership is share ownership by the institution. Jensen and Meckling . asserted that institutional ownership is effective in minimizing agency conflict. Institutional investors have sufficient experience and information about the company's operational activities. Thus, this ownership can reduce information asymmetry through an effective monitoring process (Nazir, 2. A large percentage of share ownership in a corporate governance context allows investors to influence preparing financial statements. This authority can rule out the possibility of accrual of financial information by the management (Marsha & Ghozali, 2. Thus, institutional ownership effectively reduces earnings management (Nazir, 2014. Sumanto et al. , 2. Thus, the hypothesis formulated is: H2: Institutional ownership has a negative effect on earnings management. Independent Commissioner and Earnings Management The board of commissioners is a corporate element that has monitoring management performance function. The board of commissioners consists of independent members who are not affiliated with the company's management. Independent commissioners are deemed capable of performing a practical supervisory function on management performance, including financial reporting (Murni et al. , 2. It is because this membership is free from various internal company interests. Furthermore, an independent monitoring process in preparing financial statements creates the presentation of quality earnings information (Nazir, 2. Thus, an independent commissioner effectively reduces the fraud possibility (Nazir, 2014. Rahmawati et al. , 2. Thus, the hypothesis formulated is: H3: independent commissioners have a negative effect on earnings management. Audit Committee with Financial Expert and Earnings Management The audit committee is a company organ that carries out its duties as the company's internal This role is regulated in the Financial Services Authority regulation No. 55/POJK. 04/2015 about the establishment and guidelines for audit committee duties The regulation emphasizes the importance of audit committee members having an accounting or financial education background . inancial or accounting exper. (Mardjono & Chen, 2020. Zalata et al. , 2. Audit committee members with financial expertise can intensively analyze and evaluate financial statements (Dwiharyadi, 2017. Juhmani, 2. Besides, the audit committee can monitor the company's internal control system to prevent managers' opportunistic behavior (Khosheghbal et al. , 2. The more members of the accounting or financial experts, the lower the earnings management probability (Zalata et al. , 2. Previous research has proven that financial experts of audit committee members reduce earnings management practices (Inaam & Khamoussi, 2016. Mardjono & Chen, 2020. Widasari & Isgiyarta, 2017. Zalata et al. , 2. Thus, the hypothesis formulated H4: The audit committee with financial experts has a negative effect on earnings management. Political Connections and Earnings Management Political connection is the condition of the existence of a particular party's affiliation relationship with other parties that have political interests or links to reach an agreement that benefits both parties (Haryati et al. , 2021. Sugiyarti, 2. Political connections are a valuable opportunity for companies to establish unique relationships with government agencies or political parties with close ties to the government (Pranoto & Widagdo, 2. The political connections measure from the proximity of the commissioners or directors to the government or political parties (Antonius & Tampubolon, 2. Previous research stated that politically connected companies tend to practice tax avoidance because they feel close to tax regulators (Antonius & Tampubolon, 2019. Kovermann & Velte, 2. One of the actions to carry out AFEBI Economic and Finance Review (AEFR) Volume 6. No 2 . tax avoidance is through earnings management. Thus, the political connections increase the potential for earnings management (Braam et al. , 2. Thus, the hypothesis formulated is: H5: Political connection has a positive effect on earnings management. RESEARCH METHODOLOGY The research population consists of manufacturing companies on the Indonesian Stock Exchange in 2017-2019. This study uses manufacturing companies because most companies listed on the Indonesian Stock Exchange are manufacturing companies. Sampling used the purposive sampling method because sampling requires specific criteria, such as earning a profit and having the variables needed in this study. Thus, 61 companies meet these criteria or 183 data observations for the three years of the study. The dependent variable is earnings The independent variable consists of five variables: bonus compensation, institutional ownership, independent commissioners, audit committees with financial experts, and political connections. The earnings management variable is measured by discretionary accruals, calculating the difference between total accruals and non-discretionary accruals . odified Jones mode. the calculation of discretionary accruals, the total accruals are first measured. Furthermore, total accruals are classified into two categories, namely discretionary and non-discretionary (Sulistyanto, 2008:. , through the following stages: The measurement of total accrual using the modified Jones model. Total Accrual (TAC) = net income Ae cash flow from operatinga. Calculating the estimated accruals value using Ordinary Least Square (OLS), with the a. Information: TAit total accruals of a company i in period t Ait-1 total assets for sample company i at the end of year t-1 REVit change in revenue of company i from year t-1 to year t PPEt fixed assets . ross property plant and equipmen. company year t regression coefficient . IU Calculating non-discretionary accruals model (NDA) is as follows: Information: NDAit = non-discretionary accruals of a company i in year t Ait-1 = total asset change i at the end of year t-1 RECit = receivables of a company i in year t RECit-1 = receivables of a company i in year t-1 REVit = change in revenue of company i from year t-1 to year t PPEit = total fixed assets of a company i at the end of year t Calculating discretionary accruals: Information: DAit = discretionary accruals of a company i in year period t CORPORATE GOVERNANCE. POLITICAL CONNECTIONS. AND EARNINGS MANAGEMENT TAit = total accruals of a company i in period t Ait-1 = total asset change i at the end of year t-1 NDAit = non-discretionary accruals of a company i in year t t The bonus compensation variable is the company's reward to the manager, which is given in the form of a bonus. This variable uses a nominal scale in the form of a dummy variable, namely if it is coded 1 . if there is a bonus compensation given to management and code 0 . for the opposite (Elfira, 2. The institutional ownership variable is measured using the percentage of institution shares compared to the total share capital outstanding in the stock An independent board of commissioners variable uses a ratio scale in the form of a percentage, namely the number of independent commissioners compared to the total number of commissioners. Furthermore, an audit committee with a financial expert is measured using a percentage, namely the number of financial . experts members compared to the total number of audit committee members. Finally, the political connection variable is explained using a nominal scale in the form of a dummy variable, coded 1 if the company has political connections and code 0 otherwise. The criteria for identifying political connections refer to previous research (Rustiarini & Sudiartana, 2. , namely: One of the directors or commissioners of the company is a member of the legislature, an organization executive member, a government institution official, including the military, or a member of a political party. One of the directors or commissioners is a former member of the legislature, former executive member of the organization, former official in a government institution, including former military or former political parties. One of the owners/shareholders of the company above 10% is a member of a political party, official, or government official, including military and political members. The analytical technique to examine the research hypotheses is multiple linear regression analysis using SPSS. RESULT AND DISCUSSION Result Descriptive statistics describe data to provide information related to variable characteristics, such as mean, standard deviation, maximum, minimum (Ghozali, 2016:. The descriptive statistical calculation of this variable is presented in Table 1. Table 1. Descriptive Statistics Test Results Std Variables Minimum Maximum Mean Deviation Earning management 183 -. Bonus compensation Institutional ownership Independent commissioner 183 . Audit committee financial 183 . Political connection Valid N . Source: processed data . Table 1 shows that the earnings management variable has an average value of -0. The average value of the bonus compensation is 0. It means that 60% of companies distribute bonus compensation to management. Meanwhile the institutional ownership variable has a mean value of 0. The variable, independent commissioners, has a mean of 0. Finally, the audit committee variables with financial expert and political connection have an average of 0. 62 and Furthermore, this study tested the classical assumptions, namely normality, multicollinearity, heteroscedasticity, and autocorrelation tests. AFEBI Economic and Finance Review (AEFR) Volume 6. No 2 . The results of the normality test using the Kolmogorov-Smirnov have a value of 1. 21 and Asymp. Sig. -taile. 11 is more significant than 0. Thus, the data is normally distributed. The results of the multicollinearity test show that there is no independent variable that has a tolerance value of less than 0. %). Besides, the VIF value is less than 10, so it can be concluded that there is no multicollinearity. This study conducted a heteroscedasticity test using the Glejser test and had a sig value greater than 0. Thus, this study did not show the occurrence of heteroscedasticity. Finally, the autocorrelation test has a Durbin-Watson value 928 and a du value of 1. The findings position between du