Yudha Pramana, Anis W.

Hermawan

THE SCIENTIA JOURNAL OF

ECONOMICS ISSUES
ISSN
E-ISSN
VOLUME 1 NO 1 2022
PP: 7-11

The Urgency of Agency Theory in Minimizing Financial Fraud: A Case Study

in the Construction Industry
Yudha Pramana, Anis W. Hermawan
Faculty of Economics, Udayana University, Denpasar, Indonesia. E-mail:
[email protected]
Fakultas Hukum Universitas Terbuka, Jakarta. Indonesia.E-mail: [email protected]

Abstract
Fraud that still occurs in certain corporations, including in specific construction industries, is a
problem that must be addressed in the current era of good corporate governance (GCG). Based on
secondary data and with a qualitative approach, it is concluded that the weakness of corporations
in applying agency theory has led to fraud in the form of motives, incentives, opportunities, and
rationalizations carried out by agents. In comparison, one of the implementations of agency theory
in tackling fraud in financial statements is to apply accountability through contractual
relationships that are strictly binding on agents and principals.
Keywords: Agency Theory, Fraud, Financial Statement

A. Background.
The rise of fraud that occurs through construction companies' misuse is an essential issue
in the contemporary good corporate governance (GCG) era. This issue becomes urgent and
urgent to resolve when it involves a company that is required to organize books
objectively and be audited by a public accounting firm. However, the expectation of the
implementation of GCG still needs to be fully implemented by all these companies, as
revealed by several cases of fraudulent financial statements of several companies,
including the construction industry, in several countries. Of course, financial statement
fraud and all errors in financial reporting are a very significant threat to the existence and
efficiency of stakeholders, including capital markets in related countries (Amiram et al.,
2018).
Krishnan (2009) asserts that fraud, such as corruption and bribery, in the construction
sector is so massive in many countries that it causes enormous casualties, such as loss of
life, financial losses, and diversion and destruction of resources, to name a few facts. In the
Netherlands in 2002, the Cabinet, the Ministry of Justice, and the Dutch Competition

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Authority undertook extensive investigative efforts to uncover malpractice in public

sector procurement in light of documentary evidence showing collusive behavior, bid
rigging, and corrupt practices among construction companies and civil servants (Doree,
2004). In South Africa, the spread of corruption through construction companies is
massive, with Bowen et al. (2012) describing 4 (four) causes of rampant corruption by
construction companies, i.e., involvement in corruption, forms of corruption, factors likely
to increase corrupt activity, and the means used to combat corruption.
The involvement of certain corporations in economic crimes, such as collusion and
corruption, cannot be separated from the active role of their public officials through
bribery and tender manipulation. Forms of corruption in construction companies center
on the weakness of rules in terms of appointments and tenders and the lack of rules and
administration related to contracts / agreements, which is one of the important
characteristics of agency theory. Thus, it is necessary to conduct a literature review related
to the urgency of agency theory in minimizing inevitable corporate fraud, with case studies
in the construction industry sector.
B. Research Methods
This study, which uses secondary data, uses a qualitative approach. Studies with this
qualitative approach emphasize the analysis of the deductive inference process and the
use of scientific logic (Saifuddin, 2010). Furthermore, Sekaran (2013) argues that a
qualitative study is a type of conclusive research that primarily describes something,
usually an explanation of market characteristics or functions.
C. Analysis and Discussion
a. Financial Statements and Their Potential for Misuse
Rezaee (2005) asserts that financial statement fraud that can lead to a decline in
stock market reputation shows how vital the quality of financial statements is because
the occurrence of fraud has raised serious concerns about the effectiveness of corporate
governance, the integrity and ethical behavior of top executives, the adequacy and
effectiveness of internal controls, the reliability of financial statements, and the quality
of financial statement audit results. Thus, the occurrence of fraud, according to Rezaee
(2005), cannot be separated from the lack of supervisory functions (board of directors,
audit committee), arrogant and greedy management, inappropriate business behavior
by top executives, lax regulations, inadequate and less transparent financial
disclosures; and negligence of the board of commissioners and shareholders. Later,
Lennox and Pittman (2010) revealed that the Big Five of public accounting firm clients'
sharp increase in accounting fraud is merely an artifact of firm size. Controlling well for
firm size and other determinants, such as firm age, percentage of independent directors,
percentage of the independent audit committee, and the number of audit committee
meetings, shows that the incidence of financial reporting fraud is consistently lower for
Big Five clients.
Of course, the fraudulent financial statements show a deliberate effort by the
company involving actors who are experts and have sufficient authority in the company

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 Yudha Pramana, Anis W. Hermawan

to deceive or mislead users. Users of the published financial statements, especially

investors and creditors. The fraud is carried out through the preparation and disclosure
of materially misstated financial statements, which according to Rezaee (2005),
involves 6 (six) well-planned and neat schemes, including:
1. falsification, alteration, or manipulation of material financial records, supporting
documents, or business transactions;
2. Intentional material misstatements, omissions, or misrepresentations of events,
transactions, accounts, or other significant information that differ from the
supporting documents from which the financial statements were prepared;
3. Intentional misapplication, intentional misinterpretation, and incorrect
implementation of accounting standards, principles, policies, and methods used
to measure, recognize, and report economic events and business transactions;
4. omissions and intentional disclosure or presentation of inadequate disclosures
regarding accounting standards, principles, practices, and related financial
information;
5. Use of aggressive accounting techniques through unauthorized earnings
management; and
6. Manipulation of accounting practices based on existing regulatory-based
accounting standards that turn out to be too detailed and too easy to circumvent
and contain loopholes that allow companies to hide the economic substance of
their financial performance.
The description of the financial reporting fraud scheme as described above still
shows that financial statement fraud has a typical fraud that is different from other
fields considering that financial statement fraud is usually carried out by management
by exploiting improper accounting and recording that is not following its nature due to
ambiguity and the availability of choices to present financial statements that meet the
financial targets imposed on management (Brennan & McGrath, 2007).
b. Agency theory in company practice
The existence of a principal-agent relationship in every action of company
management further emphasizes the use of agency theory in minimizing fraud in
construction companies, especially those listed on the IDX. By definition, Black's Law
Dictionary (Garner, 2009) emphasizes agency as a "fiduciary relationship created by
express or implied contract or by law, in which one party (the agent) may act on behalf
of another party (the principal) and bind that other party by words or actions." The
same thing was also stated by Ross (1973), stating that the agency relationship is a
relationship between the parties (two or more parties), where one party is called an
agent (agent) who acts against, on behalf of, or behalf of another party called the
principal, as "one who authorizes another to act on his or her behalf as an agent"
(Garner, 2009).
The existence of agency theory as a fiduciary relationship between the agent and
the principal shows that in a company, there is a contractual relationship where the
principal is the party who mandates the agent to carry out all activities on behalf of the

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 Yudha Pramana, Anis W. Hermawan

principal. Agency theory, according to Eisenhardt (1989), is instrumental in solving

agency problems that arise when (a) the desires or goals of the principal and agent
conflict and (b) it is difficult or expensive for the principal to verify what the agent has
done (information asymmetry). The problem that arises is that the principal needs to
check whether the agent has behaved appropriately so that in Good Corporate
Governance, it is necessary for the professional accountability of the parties involved in
a company's governance. Clarkson, Miller, and Cross (2012) suggest that violating the
law in professional behavior is a reflection of a violation of "honesty or trustworthiness,
or propriety as a professional worker," where a professional worker is considered to
have failed to exercise reasonable care, professional judgment, and violate the duty of
care which causes harm to the company itself, or investors, or to third parties
(suppliers, customers, creditors), or the government, so that liability in the form of
malpractice or professional negligence can be imposed.
D. Conclusion
Based on the background, methods, analysis, and discussion, it can be concluded that the
occurrence of fraudulent financial statements in certain corporations cannot be separated
from the weak application of agency theory, resulting in motives, incentives,
opportunities, and rationalizations made by the agent against the principal. One way to
minimize financial statement fraud is to apply strict liability and contractual binding
strictly to the agent and principal.

References
Amiram, D. et al. (2018) ‘Financial reporting fraud and other forms of misconduct: a
multidisciplinary review of the literature’, Review Accounting Study,
https://doi.org/10.1007/s11142-017-9435-x.
Bowen, P.A., Edwards, P.J., dan Cattell, K. (Oktober 2012) ‘Corruption in the South African
construction industry: a thematic analysis of verbatim comments from survey
participants’, Construction Managmenet and Economics, Vol. 30, hal. 885-901.
Brennan, N.M. dan McGrath, M. (2007) ‘Financial Statement Fraud: Some Lessons from US
and European Case Studies’, Australian Accounting Review, Vol. 17, No. 2, hal. 49-61.
Clarkson, K.W., Miller, R.L. dan Cross, F.B. (2012) Business Law: Text and Cases - Legal,
Ethical, Global, And Corporate Environment, South-Western Cengage Learning, Ohio.
Gardner, Bryan A., (Chief of Editor). 2009. Black’s Law Dictionary. West Publishing Co.,
Minnessota.
Krishnan, C. (2009) ‘Combating corruption in the construction and engineering sector:
The role of transparency international’, Leadership and Management in Engineering,
Vol. 9, No. 3, hal. 112–114.

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 Yudha Pramana, Anis W. Hermawan

Lennox, C., dan Pittman, J.A. (2010) ‘Big Five Audits and Accounting Fraud’, Contemporary
Accounting Research, Vol. 27 No.1, hal. 209-247.
Rezaee, Z. (2005) ‘Causes, consequences, and deterence of financial statement fraud’,
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Ross, S.A. (1973) ‘The Economic Theory of Agency: The Principal’s Problem’, The
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