Assessment of Earnings Management and Corporate Governance Practices in Nigeria

Assessment of Earnings Management and Corporate Governance Practices in Nigeria

Abstract of Assessment of Earnings Management and Corporate Governance Practices in Nigeria

Earnings management has received considerable attention in recent times. This is due to its linkage with the reliability of published accounting reports. Indication from the academic literature has shown that the practice of earnings management is quite extensive among publicly traded firms. In response to the demand for greater proportion of independent directors on corporate boards and the need for financial sophistication of audit quality, this study examines the role of independent board of directors, audit quality and board effectiveness in preventing earnings management in Nigeria. Secondary data were extracted from annual reports of the sample firms for the period between 2002 and 2011 and univariate OLS multiple regression was used as a tool for data analysis. Using an experimental research design, the study finds that board dominated by independent non-executive directors brings a greater breadth of experience to the firm and are in a better position to monitor and control managers, thereby reducing earnings management. Also, it was observed that audit quality reduces the likelihood of earnings management. It earnings management and hence, help to reduce earnings management tendencies. The study recommends that the financial reporting council of Nigeria should strengthen its role in ensuring higher quality financial reporting. Also, certain measures should be put in place to reduce the tendencies for reporting accountants to outfox the reporting principles for their private benefits. Finally, corporate governance code should be given wider applicability across companies in different sectors.

Chapter One of Assessment of Earnings Management and Corporate Governance Practices in Nigeria

INTRODUCTION

Background to the Study

Earnings management is an area of accounting research that elicits attention from across a wide spectrum of management and other stakeholders. The Financial Accounting Standard Board (FASB 1990) refers to earnings management as the distortion of the reliability, relevance and predictive value of information presented in financial statement. Schipper (2009) defined earnings management as ‘the process of taking deliberate steps within the constraint of Generally Accepted Accounting Principles (GAAP) to bring about a desired level of reported income. Healy and Wahlen (2009) saw earnings management as when managers use judgment in financial reporting in structuring transactions to alter financial reports, either to mislead some stakeholders or to influence contractual outcomes that depend on reported accounting about the underlying economic performance of the company.

The connection between corporate governance and earnings management has been the subject of an ongoing debate. It is believed that the diffuseness of a firm’s ownership structure plausibly serves the firm’s shareholders better than a concentrated ownership structure. The users of financial information are of the notion that managers of organizations utilize earnings management opportunistically for selfish reasons rather than for the benefit of the stakeholders. This misalignment of stakeholders and manager’s interest has cited a basis for the occurrence of earnings management as managers could use the latitude provided by accounting standards to manage income opportunistically therefore, creating a distortion in reported earnings. The very nature of accounting accruals gives managers a great deal of discretion in determining the earnings a firm reports in any given period because of the information asymmetry between managers and owners. Accounting earnings are more reliable and more informative when managers opportunistic behaviours are controlled through a variety of monitoring systems (Dechow, Sloan & Sweeney, 2006).

As a result of this misalignment of interest between managers and shareholders, there has been an international trend towards developing and implementing corporate governance to fight against the opportunistic behaviours that have undermined investors’ credibility in
financial report. Corporate governance attributes help investors by aligning the interest of managers with the interest of shareholders and also by enhancing the reliability of financial information and integrity of
the financial reporting process (Watts, 2011).

It is against this background that this study is undertaken to exploratively examine the relationship between corporate governance and earnings management in Nigeria.

Statement of Problem

Several studies on earnings management such as the study carried out by Olayinka (2012), Shehu (2012) and other researchers have highlighted the presence of earnings management practice in Nigeria at different times. These practices include: profit overstatement, account falsification, price manipulation, etc which have led to the distortion of the credibility of financial reports. To mitigate these financial reporting improprieties and enhance the decision usefulness of financial statements, corporate governance emerged as a veritable mechanism to stifle the windows of earnings management. Corporate governance is a mechanism that is employed to reduce the agency cost that arises as a result of the conflict of interest that exist between managers and shareholders

Due to the incessant practice of earnings management in Nigeria, the problem of whether corporate governance variables such as board composition, audit quality, audit committee, board effectiveness, etc. can be used in curbing earnings management arises. This research is embarked upon to critically ascertain the extent to which these governance variables mitigate the existence of earnings management in Nigerian organizations.

Research Questions

The following are the following questions raised.

1.     Is there a significant relationship between board composition and earnings management?

2.     Is there a significant relationship between audit quality and earnings management?

3.     Is there any relationship between board effectiveness and the level of earnings management?

Objective of the Study

The broad objective of this study is to investigate the relationship between earnings management and corporate governance as well as the effect of corporate governance on earnings management. The following are the specific objectives:

1.     To ascertain if there is a significant relationship between board composition and earnings management.

2.     To determine if there is a significant relationship between audit quality and earnings management.

3.     To find out if there is a significant relationship between board effectiveness and earnings management.

Statement of Hypotheses

The following are the hypotheses that will be tested in the course of the study and they are stated in their null and alternate forms.

Hypothesis One

HO:   There is no significant relationship between the proportion of independent board of directors and earnings management.

HI:    There is significant relationship between the proportion of independent board of directors and earnings management.

Hypothesis Two

HO:   There is no relationship between audit quality and earnings management

HI:    There is relationship between audit quality and earnings management

Hypothesis Three

HO:   There is no significant relationship between the board effectiveness and earnings management.

HI:    There is significant relationship between the board effectiveness and earnings management.