This study examines whether managers of politically connected listed firms in Malaysia, a unique institutional arrangement, are more likely to manage earnings opportunistically (OEM) during an economic downturn. Further, this study investigates whether more independent board of director can mitigate the positive association between political connection and OEM. OEM is measured in terms of (1) income increasing discretionary accruals and (2) the likelihood that managers choose income increasing discretionary accruals over income decreasing discretionary accruals. As a subsidiary objective, this study also examines whether politically connected firms are assessed by auditors as having higher levels of inherent risks and therefore higher audit fees since politically connections are associated with higher OEM. The research questions developed in this study are based on two important strands of literature. The first strand is based on the work of Rajan and Zingales (1998) who argue that corporate governance systems can be characterized as either relationshipbased or market-based. Relationship-based system is described as a system with a lot of opacity, corruptions compared with its counterpart, market-based system, which is more transparent, more efficient and more powerful in resource allocation and legal enforcement. One important argument by Rajan and Zingales (1998) is that relationship-based system ONLY works well when contracts are poorly enforced and capital scarce. However, ‘the contact between the two systems creates a fragile hybrid, which while mutually beneficial to relationship borrowers and arm’s length investors in normal times, is excessively prone to shocks.’ Gul (2004) points out that ‘in Malaysia, these characteristics are even more pronounced for politically affiliated firms’. Therefore, he argues that while, in normal times firms in a relationship-based system survive, and in some cases thrive, they are excessively susceptible to shocks such as financial crisis. The second strand of the organizational literature examines, in any one country, the linkages between institutional arrangements in the corporate sector, management incentives, rent seeking behavior and firm level performance (Johnson and Mitton, 2003). For example, earlier work by Morck et al. (2000) shows that when the 1988 Canada-US free trade agreement reduced barriers to foreign capital, well connected family owned firms were less efficient. These results are consistent with the broader framework suggested by Olson (1982) who argue that when societies remain relatively stable, they tend to develop rent seeking organized groups that collude and reduce efficiency. These organized rent seeking groups that emerge in the corporate sector in some countries are likely to act against the interest of other shareholders. Further, managers of these firms are also likely to be engaged in ‘non-value maximizing’ ventures and act opportunistically (Blanchard, 2000). All these activities maybe described broadly under the rubric of agency problems which is derived from agency theory. Agency theory which has its roots in economic and organizational theory posits that managers as agents for shareholders act in their own interests i.e. opportunistically. Thus, agency theory provides a broader framework to understand and explain the activities of rent seeking groups. In Malaysia, politically connected firms have emerged as the primary rent seeking group in the corporate sector (Johnson and Mitton, 2003). Evidence in the Johnson and Mitton (2003) study shows that managers of politically connected firms are more likely to misappropriate the firm’s assets and are more likely to be associated with poorer market performance during a financial downturn. In summary, this study, based on the theoretical background and prior evidence discussed earlier, examines whether politically connected firms are associated with higher levels of opportunistic earnings management during a period of financial downturn in the Malaysian economy and whether firms with more independent members on the board of directors can mitigate this problem. In addition, the study also examines whether audit fees are also affected by this relationship. Results of regression analysis of 215 Malaysian companies for 2001 show that, political connection is associated with a higher likelihood that managers of politically connected firms choose income increasing discretionary accruals over income decreasing discretionary accruals. The results also show that more independent boards measured by the number of independent members on the board of director mitigate the positive association between political connections and opportunistic earnings management. As to the subsidiary test, the results of the audit fee regression model show that political connection is positive and significant. However, size of independent members is found to be associated with higher audit fees. Reasons for these results are discussed in the thesis. In general, the results are consistent with the findings of Johnson and Mitton (2003) and Gul (2004) that institutional arrangements do matter in the corporate sector. The results obtained in this study add to the body literature which suggests that managers of politically connected firms in a relationship-based system are rent seekers and are likely to be associated with non-value maximizing activities, and that independent boards can mitigate the agency problem of political connections.