http://ijfr.sciedupress.com International Journal of Financial Research Vol. 10, No. 3, Special Issue; 2019 Published by Sciedu Press 299 ISSN 1923-4023 E-ISSN 1923-4031 Government-Linked Investment Companies and Real Earnings Management: Malaysian Evidence Rahayu Abdul Rahman 1 , Asheq Rahman 2 , Erlane K Ghani 3 & Normah Hj Omar 3 1 Accounting Research Institute and Faculty of Accountancy, Universiti Teknologi MARA, Perak, Malaysia 2 Department of Accounting, Auckland University of Technology, Auckland, New Zealand 3 Accounting Research Institute, Universiti Teknologi MARA, Selangor, Malaysia Correspondence: Rahayu Abdul Rahman, Accounting Research Institute and Faculty of Accountancy, Universiti Teknologi MARA, Tapah Campus, 35400, Tapah Road, Perak, Malaysia. Received: April 20, 2019 Accepted: May 7, 2019 Online Published: May 19, 2019 doi:10.5430/ijfr.v10n3p299 URL: https://doi.org/10.5430/ijfr.v10n3p299 Abstract This study examines the association between government-linked investment companies‘ (GLICs‘) shareholdings and real earnings management activities in Malaysia. Consistent with prior research, this study uses three proxies to measure real earnings management; abnormal cash flow from operations (RCFO), abnormal production costs (RPC), and abnormal discretionary expenses (RDE). This study segregates GLICs‘ shareholdings into two categories; Federal Government Pension Investment Funds (FGPIF) and other GLICs (OFGLIC). Using a sample of 213 firm-year observations of Malaysian government-linked companies from 2010 to 2015, this study finds that FGPIF is a more effective monitoring mechanism than OFGLIC in limiting real earnings management. The findings also show that there is a significant and negative relationship between Employee Provident Fund (EPF), Khazanah Nasional Berhad (Khazanah), Permodalan Nasional Berhad (PNB) and RCFO and RPC. The evidence suggests that these three are the most effective government institutional investors in promoting corporate governance, which in turn limit real earning management activities in Malaysia. In general, the findings support the incentive alignment hypothesis, which argues that companies with government intervention are normally better governed. Keywords: government ownership, government linked investment companies, real earnings management, institutional investors, Malaysia 1. Introduction Prior studies have highlighted that government institutional investors play an important role in controlling managerial moral hazard including earnings management (Ding, Zhang & Zhang, 2007; Har, Majdi & Mohammed, 2012; Jamaludin, Mohd-Sanusi & Kamaluddin, 2015; Jow, Loo, Zainal-Abidin, Noordin & Ariffin, 2007). In general, there are two competing views on the effects of government institutional ownership on companies‘ earnings management practices. According to the incentive alignment argument, companies controlled by government institutional investors are normally better governed (Ang & Ding, 2006; Lau & Tong, 2008) and more politically sensitive (Mohd Ghazali, 2007). More specifically, the activities of these firms are not only under the watchful eyes of the public, i.e., the investors and shareholders, but also the government. As a result, the management of these firms is more conscious of the importance of maximising shareholders‘ value over self-interest, which might limit managerial opportunism (Lau & Tong, 2008; Morgan & Alcocer 2017). On the other hand, Wang (2002) contends that government intervention is the main factor for the inefficiency of state shareholdings, resulting from poor governance practices and greater agency problems. Ding et al. (2007) argue that the agency problems in state-owned firms are more complex than in privately-owned firms because there is an extra agency relationship in such firms as the controlling owners are themselves agents of the true owners i.e., the state. In particular, there is the agency cost between the state and the controlling owner, in addition to the agency cost between the controlling owner and minority shareholders. Further, Jow et al. (2007) argue that unlike owner-managers, who have to risk their own resources, government-linked companies‘ (GLCs) managers are using public funds as their major resources. The nature of their compensation, which is directly tied to accounting numbers, creates more incentive for top management to manage the reported earnings in order to maximise their compensation.