The Effect of Profitability on the Accrual Quality-Cash Holding Relationship of Indonesian Listed Firms

Abstract

This study is to investigate the effect of profitability on the relationship between accruals’ quality and cash holdings. The investigation is carried out on all Indonesian public listed companies, except for companies in the financial industry, from 2013 to 2017. It is found that there is a significant inverse relationship between firms’ accruals’ quality and level of cash. With regard to the effect of profitability on the relationship, it is found that accruals’ quality plays a less important role in the determination of cash holdings in loss-making firms. The results support the argument that in an obscure environment with less-developed financial systems, weak investor protection and legal enforcement, issuing financial reports containing high earnings’ quality can lead to an improvement in cash holdings’ management. Although the role of accruals’ quality in cash-holding reduction is diminished due to the low informativeness of loss-making firms’ financial reports on the future of the firms, investors in Indonesia, an emerging market, still demand a high level of informativeness of financial reports, since it is difficult and costly to force a bankrupt firm into liquidation as a result of weak investor protection and legal enforcement.