THE EFFECT OF STOCK OPTION COMPENSATION ON EARNINGS MANAGEMENT WITH CORPORATE GOVERNANCE AND AUDIT QUALITY AS MODERATING VARIABLES

Agency theory stated that stockholders must establish contractual relationships to provide reasonable compensation for managers to make decisions that maximize shareholder value even in uncertain situations and imperfect monitoring. One of them is stock option compensation. According to positive accounting theory, stock options compensation increase earnings management. The inconsistency of previous study encourages research by adding corporate governance and audit quality as moderating variables. The results prove the tendency of theory that occurs in business practices and provide input for policy makers to suppress earnings management. The sample consists of 16 manufacturing companies in Indonesian Stock Exchange with 81 observation data taken by purposive sampling. Earnings management is measured by real earnings management. Stock option compensation and audit quality with dummy while corporate governance is measured by corporate governance disclosure index. Hypothesis testing was performed using moderated regression analysis. The result of the study proves that stock option compensation has a positive effect on earnings management. Corporate governance reinforces the effect of stock option compensation on earnings management. Audit quality does not moderate the effect of stock option compensation on earnings management. Based on this result, companies should use other incentive plan to reduce earnings management. Practitioners and governments also need to reevaluate corporate governance requirements in order to protect stockholders not only from accrual earnings management but also real earnings management. The auditor profession is advised to continue to develop methods that can detect real earnings management. • Agency theory, positive accounting theory, earnings management, stock option compensation, corporate governance, audit quality.