Bao Quan Lock1 , Ei Yet Chu1 , Saw Imm Song2 & Lian Yin Lee1
1Graduate School of Business, Universiti Sains Malaysia, Malaysia
2Faculty of Business Management, Universiti Teknologi Mara, Malaysia.
Abstract: Foreign exchange risk is unavoidable when firms involved in international financial transactions. The extant literature in foreign exchange exposure contends that firms in developing countries have limited abilities to manage the price changes due to their credit constraints and lacks of hedging opportunities. Consequently, many firms suffer unfavourable exchange rate translation on their reported earnings. The paper aims to examine the relationship between the exchange rate movements and the uses of accounting earnings management practices and how it affects the stock returns of the Malaysian public listed firms. The study covers a population of 839 nonfinancial firms from 2012 to 2016. The study applies discretionary accruals as a proxy for earnings management, while exchange rate movement is measured using annual changes in average quarterly exchange rate. The discretionary accruals is further classified into positive and negative earnings management to analyse the different exchange rate movements’ scenarios. The findings proved that exchange rate movements do contribute to earnings management by firms when the exchange rates weakened. However, earnings management does not present a significant relationship with foreign exchange rates when the exchange rate strengthened. Secondly, the findings conclude that earnings management positively affects annual stock returns in Malaysia. The findings suggest that when earnings management practices are applied, it tends to mislead investors to invest further on the stocks and increase the stock returns. The study concludes that during the weakening of the exchange rate of Ringgit Malaysia, published earnings shall be reevaluated. Investors shall disentangle earnings management so that to provide an actual view of the firms’ performance. The study contributes to the earnings management literature by bringing in the issues of exchange rate movements.