CHAPTER ONE
INTRODUCTION
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1.1
Background to the study
Accounting is the measurement, processing and communication of financial information about
economic entities. It is a systematic process of providing information about the wealth and the
effects of economic events. It reveals profit or loss for a given period, and the value and nature of
a firm‘s assets, liabilities and owners‘ equity. In order for accounting information to be useful, it
must possess certain qualities – relevance, reliability, comparability and consistency; and meet
certain standards (e.g. International Financial Reporting Standard – IFRS). Accounting means
different things to different stakeholders and the conceptions held by every user may influence
the impact of accounting information on their behaviour. Accounting information is meaningfulif
it is relevant. The primary decision-specific qualities that make accounting information useful
are relevance and reliability (Barth, Beaver & Landsman,2012).
Value relevance is the ability of the information contained in the financial statement to capture
and summarize firm value; explain and reflect stock market measures. Accounting information is
measured based on how accounting numbers translate to share price. Investors are guided on the
pricing of shares to make investment decisions (Vishnani & Shah, 2008).An indication of
relevant accounting information is market reaction at the time of announcement of information
observed through the movements in stock prices (Naimah, 2012). The reaction of the stock
market to accounting information is dependent on the efficiency of such market. An efficient
market is one in which stock prices behaviour reflect publicly available information – this done
on a sophisticated manner.
As accounting numbers are available in the financial statements, the share price measurement are
based on two perspectives; information perspectives and measurement perspective; information
perspective measures the usefulness of accounting to individuals without much emphasis on the
structural precision of the relation between accounting data and firm value and measurement
perspective; share price movement is based on the degree of volume or price change following
the release of the information – this is rooted from theoretical framework of equity valuation
model (Ohlson, 1995). The Ohlson model expressed firm value as a function of book value and
earnings. The Ohlson model assumes that there is no information asymmetry between managers
and investors.
The most important criterion in choosing an accounting measurement method is the decision
usefulness of accounting information for users. According to the decision-usefulness theory, the
best accounting standards is the one that provides the most helpful financial information to users
in their decision process. Equity shareholders require adequate, complete, relevant, comparable,
verifiable, timely and understandable information that has high level of information content.
Information content is the information about risk conveyed by accounting income numbers.
Accounting numbers that is relatedto decision making of investors include; Earnings per share
(EPS), Book value per share (BVPS), dividend per share (DPS), cash flowand so on as used in
various researches.(Jabbari, Sadeghi & Askari, 2013; Du, 2008; Vijitha & Nimalathasan, 2014)
EPS is the profit attributable to each unit of outstanding ordinary share in a company. EPS is
arguably the most important significant single measure of an entity‘s performance that is
required to be published in financial statements (Ijeoma, 2015). The objective of presenting the
EPS is to enable the user to assess a company‘s current performance and compare this with that
of previous years at a glance.
Book value of the equity represents past performance and current earnings as indicative of future
performance. Book value is the total assets minus the total liabilities of a company; the
stockholder‘s equity or net assets. Therefore, the book value of equity per share is the book value
of common equity per total number of shares outstanding. BVPS is a factor that investors use to
determine whether a stock price is undervalued or otherwise. If the BVPS of a firm increase, its
investors may view the stock as more valuable, and the stock prices may increase and vice versa.
The BVPS is usually different from the market price; it is therefore an indication of what the
shareholders will receive had the company been wound up on the date the accounts were
published (Musa, 2015).
DPS is the dividend (amount to be divided) declared (or profit ―paid out‖) during a period
attributable to each equity share. Companies pay dividends for varying reasons; to rewards
investors for risking their money as they are the residual claimant in case of bankruptcy, attract
new investors – who will invest in the company at higher share prices. Furthermore, the payment
of dividends signals to the investors about the confidence of the managers in the firm‘s future
profitability. Also, this reduces the information asymmetry as shareholders have a hint of the
financial health of the company through the dividend payment. Investors may consider the EPS
figure to be a superior indicator of performance to the DPS figure. This is because the amount of
an entity declared as dividend may not necessarily reflect the performance of the entity.
Nonetheless, DPS remains an important investment yardstick for investor – for example in the
computation of dividend yield and dividend cover.
Cash flow is the excess of cash revenues over cash outlays in a given period of time (not
including non-cash expenses). Cash flows measures are expected to provide value relevant
information about the firm‘s growth opportunity or lack of it (Karunarathne & Rajapakse, 2010).
It
shows the firm‘s ability to cover cash needs internally. Although, there have been
controversies about whether cash flow is a good value driver like earnings or dividend.
Some researchers claimed that the most important variable in explaining the stock return is cash
flow (Malik & Ali, 2013). However, cash flow as a determinant of stock prices seems industry
specific. The nature of the operations of the financial sector firms is largely based on cash flow.
They deal in cash as the inventory as they provide various services and also cash takes a
dominant role in the financial statements of these companies and has the cash flow statement
dedicated for it. In addition, Du (2008) found that operating cash flow outperformed earnings
and dividend in the multiple valuation tests for cash based business.
All the above stated accounting information is presented in the financial statements (either
consolidated or separate financial statements). According to IFRS 10, ―consolidated financial
statements are the financial statements of a group in which the assets, liabilities, equity, income,
expenses and cash flows of the parent and its subsidiaries are presented as those of a single
economic entity.
Also, according to IAS 27, separate financial statements (SFS) contains accounting and
disclosure requirements for investments in subsidiaries, joint ventures and associates when an
entity prepares separate financial statements. SFSs are those presented by a parent (i.e. an
investor with control of a subsidiary) or an investor with joint control of, or significant influence
over, an investee, in which the investments are accounted for at cost or in accordance with IFRS
9 (Financial Instruments).
Among the users of financial statements, the stockholders of a company are arguably at the
height of importance to the company as they have existing investments that generate cash flows
for every day operations. Also, if a company is targeting expansion, the expected value will be
created by future investment either from the existing shareholders (right issue) or from new
(prospective) ones. The information required by shareholders to make timely, effective and
efficient decisions that may affect the market value of the firm are available in the financial
statement; earnings and dividend from income statement, Book value of equity from the
statement of financial position and cash flow from operations from the cash flow statement.
Investors and creditors use financial statements to make predictions, assess risk and evaluate
profitability, solvency and management‘s performance. In the annual reports and accounts, the
CFS and SFS are presented side by side and these two statements may create confusion and
reduce the ability of users to make informed decision. For example, the information from a
solvent subsidiary when combined with that of a less solvent parent and/or other subsidiaries
may show an averagely solvent group there not showing the actual view of the entire scenario –
this also applies when checking for the profitability, riskiness and general health of companies.
Therefore, to enhance their ability todecide precisely where to obtain more quality information
frombetween the CFS and SFS is key and of great essence so that at a glance all the needed
information is seen from a single type of statement.
5
Nigeria is Africa’s most populous nation and second largest economy, as well as one of the
largest recipients of foreign direct investment (FDI). Nigeria’s financial sector has undergone
significant changes in recent years. In the past years, the banking sector went through major
consolidation, which reduced the number of banks from 89 to 20 (and now 15) and considerably
increased capitalization. However, the global financial crisis posed substantial challenges to
Nigerian bank reform efforts. While the initial effects were contained due to low levels of
exposure to complex financial instruments, the large swings in oil prices, combined with the
resulting depreciation of the naira and a drop in investor confidence led to growing pressures on
the sector’s health. Market speculation about the quality of some bank balance sheets was evident
in the breakdown of the naira interbank market as well as perceptions that some banks were
using the Central Bank discount window as an ongoing source of funding. Some banks were
heavily involved in margin lending for investments in equity, which subsequently crashed by 70
percent reflecting both domestic and global market developments.
Although, the Nigerian capital markets are not fully developed, the country’s Stock Exchange is
increasingly active. The Nigerian equity market boomed in 2007 and early 2008 with average
return rates of 75 percent but then plunged in the second half of 2008 as oil prices fell and the
global financial crisis spread. Reforms, focused on enhance market rules and regulations,
promote collective investment schemes and improve shareholder management have however
restored some confidence in the market. The investor base continues to be dominated by the
financial sector which holds more than 60 percent of securities. Foreign investors are allowed on
the bond market but are restricted to government securities with maturities longer than one year,
but can also invest in short-term commercial papers and negotiable certificates of deposit, and
are subject to a lock-in period of one year for their first investment. Retail investors, for their
part, can access government securities through the intermediary of mutual fund and sub-accounts
of primary dealers.The secondary market has increased in liquidity over the years but remain
largely dominated by banks and discount houses.The pension fund industry in Nigeria is
expanding and 19 firms currently manage pension funds. The secondary market has increased in
liquidity over the years but remains largely dominated by banks and discount houses.
There are several investors in the financial sector and itserves as the engine that keeps the
Nigerian economy in motion. As at the last day of trading in 2017, it was revealed that the
financial services Sector is the most capitalized sector with its market capitalization standing at
N4.31trn and contributed 31.62% to Total Market Capitalization. Increase in investment in this
sector will lead to improved performance of the economy – it intermediates funds between the
surplus and the deficit economic units, thus stimulating and promoting investments and
economic growth and development. For informed decisions in investment to occur in the sector,
quality information regarding share price and other performance indicators are essential (Umoren
& Enang, 2015).
1.2
Statement of the problem
It is the practice andrequirement of some companies to prepare and present their financial
statements as the consolidated and separate financial statements which provide accounting
information to investors and other stakeholders. Accounting information is required by investors
for investments decisions and actions. This information is value relevant if it may have effects on
stock prices; this information may include the value of earnings per share, dividend per share,
cash flow, book value per share and among others. To make decisions or take an action,
investors require, with a level of certainty, adequate and relevant knowledge of accounting
information in relation to share prices (market value) of companies of interest. This information
is available via companies‘ financial statements. However,in a company with a group structure,
information is available in two folds – from the consolidated financial statements (group
accounts) and separate financial statements (parent or holding company accounts). The
availability of the same class of information in two different statements carrying two different
figures may be confusing. The investor therefore, will require information as to the relevance of
each set of this information to make better informed decisions.
Several studies have been carried out to determine the value relevance of accounting information
but results aredivergent. Some of these studies showed that accounting information are relevant
when it comes to making investment decisions based on the share prices of companies studied
(Irsath, Haleem, Ahamed, 2015 and Adeyemo, Ajibolade, Uwuigbe and Ranti, 2017) while
others found irrelevance of accounting information (Shamki & Abdulrahman, 2011). The
divergent results may be due to several issues in the researches; differences in the economic
conditions, structure of the capital markets in various countries, sample size, variable selection
among other things. Although, some of these studies used data from the consolidated against the
separate financial statements; Abad, Laffarga, Garcia-Borbolla, Larran, Pinero and Garrod
(2000), Larran and Rees (1999) and Muller (2011) found consolidated statements to be more
value relevant than unconsolidated financial statements. Other studies were on value relevance of
IFRS based accounting information and found variant results (Kargin, 2013; Bolibok, 2014;
Alkali & Lode, 2016; Okafor, Anderson &Warsame, 2016) and also on value relevance of
interim and annual financial statements (Zulu, Klerk & Oberholster, 2017).
In Nigeria several studies have been carried out on value relevance of accounting information
(Olugbenga&Atanda,2015; Adedeji, 2016; Bagudo, 2016; Adetoso, 2016) butbased on the
information gathered from literature, this study found no existing study in Nigeria that compare
the value relevance of accounting information for consolidated and separate financial statements
and by extension in the financial sector. Therefore, the users of accounting information
(especially investors) having two differing information available to them through the
consolidated financial statements and the separate financial statements need to be guided as to
which set(s) of information to base decisions on in terms of relevance.
In addition, the financial sector due to its size and contribution to the capital market and the
economy at large require vitality and its efficiency and effectiveness may depend on the
robustness of financial reporting that are useful to decision making. In Nigeria,the financial
sector precisely, some banks in recent years have been involved in bail outs by the Central Bank
of Nigeria (CBN) to help them recover from inadequate adequacy ratios and stabilize
irrespective of the information put out to the public. There is need for the sector‘s existing and
potential investors to be well aware of what is relevant to their (or intended) investments to be
able to have an expectationsfrom these companiesbased on the published accounting numbers.
The financial firms present their financial information in both on consolidated and separate
financial statements (for a group) and have a large number of investors therefore a wider
requirement to understand all information needed adequately and reliably.
The objective of accounting after its preparation is the presentation the financial statement and
other reports to financial information users for making informed decisions and actions. The study
aims at examining the comparative value relevance of accounting information from consolidated
and separate financial statement in the Nigerian financial sector. The users of financial
information are numerous and usually require relevant information that will assist them in
making decisions. Therefore, the need for quality financial reporting cannot be overemphasized
that will show the current economic reality of companies and has the ability to predict into the
future and also signal stock prices based on consolidated or separate financial statement. With all
the above issues raised, this study therefore will examine the comparative value relevance of
accounting information for consolidated and separate financial statements in Nigerian financial
sector.
1.3
Research questions
Based on the problems identified, the study seeks to address the following questions:
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1.4
To what extent does the value relevance of earnings per share of consolidated and
separate financial statementsaffect the share price of financial sector firms in Nigerian?
To what extent does the value relevance of book value per share ofconsolidated and
separate financial statements affect the share price of financial sector firms in Nigerian?
To what extent does the value relevance of dividend per share of consolidated and
separate financial statements affect the share price of financial sector firms in Nigeria?
To what extent does the value relevance of cash flow per share of consolidated and
separate financial statements affect the share prices offinancial sector firms in Nigerian?