e-sRC

CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
The financial report of a firm has a great value on the organization‟s activities and aid decision
making by users of financial information. Earnings are a significant part of the financial reports
that help users of accounting information to evaluate firm performance. The quality of
accounting information is always inspected by the quality of accounting earnings. Hence,
earnings quality is an important factor in determining the validity and reliability of reported
figures.
Earnings quality is the honest expression of the reported profit. It is the ability of the present
earnings to give a real picture about the company and its ability to survive in future (Salawu,
2017). The scandals in Enron, WorldCom, Cadbury Nigeria plc, Intercontinental bank, Afribank,
and Oceanic bank have casted doubt on the quality of reports and the ability to meet the
expectations and needs of the users (Uwuigbe, Peter & Oyeniyi, 2014). The challenges
necessitated review and globalization of accounting standards, adoption of the International
Financial Reporting Standards (IFRS), and Corporate Governance Code in order to evolve
efficient accounting practice. It also led to the birth of Financial Reporting Council of Nigeria
(FRCN) Act No 6 of 2011.
Earnings management has a lot in common with earnings quality because high earnings
management can produce low quality of earnings, as the manipulated information may lead to an
incorrect decision but earnings management is not the only factor that affects quality of earnings.
Other factors such as capital market and management compensation also contribute to the quality
of earnings (Azzoz & Khamees, 2016). Prior research (Ayadi & Boujelbene (2016); Hashim &
Devi (2014)) related earnings quality to the level of earnings management because of the
difficulties in measuring earnings quality and established that firms use accounting accruals to
manage earnings.
Ownership structure is generally referred to as the type of shareholders in a firm, which may
influence firms‟ decisions that affect firm performance (Phung, 2015). The structure of a
company is very important as they determine the economic efficiency of corporations being
managed (Owiredu, Oppong & Churchill, 2014). Ownership is one of the main sources of
agency problems between managers and shareholders or dominant and minority shareholders.
Imbalances between ownership, control and monitoring may provide opportunities for some
parties to exploit others. Managers perform services on behalf of shareholders and in most cases,
the goals of the managers and shareholders may not align. The separated ownership leads to
various conflict and controversies between shareholders, stakeholders and the managerial
behavior. The ownership structure is also a factor that affects quality of accounting data because
different ownership structures exist in different firms and as such influences performance,
degree, and manner of management control (Namazi & Kermani, 2008).
More equity ownership by managers may encourage them to make value- maximizing decision
and lead to increase in earnings quality which results to the alignment of managerial interests
with the shareholders. On the other hand, high managerial ownership and lack of discipline from
the financial market paves way for managers to pursue an opportunistic behavior and may
attempt to maximize their gains at the expense of shareholders and this may promote
entrenchment of managers which may be costly and hereby reduces the quality of earnings
(Owiredu, Oppong & Churchill, 2014).
Institutions with large shareholdings play an active role in monitoring the management of
reported earnings because when they have long term investments, they are more concerned with
the underlying profitability of the companies and cautious of the use of discretional accruals to
manage earnings, thereby enhancing the quality of earnings reported (Yang,Chun, & Ramadili,
2009). The institutional investors also have the ability, opportunity and resources to monitor,
discipline, and influence managers‟ decisions in the firm. Researchers like Hashim and Devi
(2014), Alves (2012), Koh (2003) and Mashayekh (2008) argued that institutional share
ownerships may have implications for earnings quality as they are able to influence the
company. When institutional investors exert more control over company management than when
they are mere investors, earnings quality is expected to increase because they are able and
motivated to encourage high quality reports (Velury & Jenkins, 2006).
Large shareholders also known as block holders also impact greatly in governance because their
sizable stakes gives the incentives to bear the cost of monitoring manager. Large shareholders
are expected to monitor managerial behavior and actions effectively and in turn reduce the scope
of managerial opportunism to engage in earnings management. This results to an improvement in
earnings quality reported by managers. A firm is said to be highly concentrated if a significant
proportion of its equity lies in the hands of few individuals (Roodposhti & Chasmi, 2010). In
concentrated firms, there may be conflict of interest between the majority and minority
shareholders as the controlling shareholders may be entrenched due to their concentrated voting
power and hide their personal benefits by reporting low earnings which reduces the quality of
earnings. On the other hand, controlling shareholders may align their interest with minority
shareholders by reporting high quality earnings (Kiatapiwat, 2010). Empirical studies have
revealed mixed relationship, researchers like Shleifer and Vishny (1997), Amador (2012),
Anderson and Reeb (2003a), and Haioui and Jerbi (2012) have revealed positive relationship
while Wang (2006), Baba (2016), Alves (2012), Kiatapiwat (2010) revealed negative
relationship.
Foreign ownership can also be considered as a good source of managerial and monitoring skills.
Most times, foreign owners choose the best domestic firms to invest in or firms belonging to
high-productivity industries. Studies have shown that the foreign investors may act as a
monitoring force to mitigate the decision of managers or insider owners that may be costly to
other shareholders as they are believed to have the ability to monitor managers and unite the
interests of both the managers and shareholders. It is argued that when foreign investors increase
their stock holding to a certain level, and become large shareowners, they have the power to
influence managerial decisions in ways that benefit them, perhaps by expropriating wealth from
minority shareholders. When foreign ownership level is minor or moderate, it may improve firm
performance by monitoring which results to high quality earnings. However, when large, it may
damage performance (Choi, Park, & Hung, 2012).
Nigerian firms are not left out of the great concern on earnings quality following the evidence of
inappropriate accounting disclosures and financial recklessness that led to the fall of five biggest
Nigerian banks in 2009 and Cadbury Nigeria Plc. scandal in 2006. The situation of Nigerian
firms is similar to other developing countries where deliberate manipulation and
misappropriation of shareholders‟ funds are widespread due to weak legal and financial reporting
frameworks, unbalanced share ownership structure and corruption (Sadiq, 2011). Hence,
eliminating these problems will make the Nigerian economy a more realistic target for
international investments that will improve the country‟s market and economy. In an effort to
improve the overall trust in the Nigerian capital market, the Securities and Exchange
Commission (SEC) and the Financial Reporting Council of Nigeria (FRCN) have continually
improved the corporate governance codes of which the latest review was in 2017.
The consumer goods sector has been chosen because it is one of the most vibrant sectors of the
Nigerian capital market. The sector has attracted and retained foreign investment over decades
which have resulted in boom in the retail sector. The fall in crude oil prices since 2014 has
adversely affected the sector resulting to high production costs and reduction of profits, and this
is mainly due to scarcity of foreign exchange in importing inputs for the companies. However,
despite the importance of consumer goods sector to the Nigerian market, there is paucity of
studies on impact of ownership structure on earnings quality in this sector. The level of research
interest in this area will reflect the contributions of the various forms of ownership on the
earnings quality of listed consumer firms in Nigeria.
1.2 Statement of the Problem
The financial reports of an organization should provide relevant and reliable information that
will assist in making useful decisions. Hence, it is important that the financial information show
a true and fair view of the organization‟s financial transactions during a period. Earning on the
financial reports of companies summarizes the performances to various users. However, several
factors may affect the quality of earnings reported such as; firm‟s business model, accounting
standards, company industry, internal controls, macro-economic conditions, directors reporting
choices and operating cycle (Dichev, Graham, Harvey & Rajgopal, 2013). The varying factors
have resulted in a wide gap between what is reported and the actual position of the company
which can be misleading to people placing reliance on such reports for decision making,
investors‟ confidence become eroded and there may be reduction in the inflow of foreign
investments. To overcome these issues, control mechanisms are being put in place of which,
ownership structure of firms is one of the control mechanisms.
The accounting scandals that rocked Oando in 2017, the Nigerian banking sector in 2009 and
the scandal of some public quoted companies like Cadbury Nigeria Plc between 2003- 2006,
Unilever Brothers, African petroleum and the Nigerian Stock Exchange(NSE) in 2010 were seen
to be attributed to non-compliance with regulations, connivance of board of directors with
company managers against uninformed minority shareholders and other stakeholders, weak
board governance due to lack of or insufficient independence, ability and heterogeneity in board
composition, and weak executive monitoring due to lack of active institutional shareholders and
unethical shareholders activism by shareholders‟ association. As a result of this, the Federal
Government of Nigeria through some agencies came up with institutional structures to protect
investors of their investments from corrupt practices. (Ugowe, 2016). The Securities and
Exchange Commission (SEC) introduced Code of Corporate Governance in 2003, which was
updated in 2011and 2014 respectively, the Nigerian banking industry also introduced Guidelines
for Whistle blowing (Mall, 2016). The Asset Management Corporation Act of 2010 was enacted
for banks and the Financial Reporting council of Nigeria Act No 6 of 2011 was also established.
Despite all this, the quality of financial reports still remains questionable.
Several studies have been conducted to examine the relationship between ownership structure
and earnings quality in the developed and emerging markets including Nigeria. Some of the
studies include; Affan, Rosidi, and Liliki (2017), Ayadi (2014), Hashim and Devi (2014),
Amador (2012), Karuntarat (2013), Spinos (2013), Alves (2012), Ismail (2011), Habbash,
(2010), Kiatapawat (2010), An (2009), , Katz (2008), which were conducted in other countries
while Shehu and Yero (2012), Muhammad (2014), Mohammed (2014), Musa (2014), Adebiyi
and Olowookere (2016), , AbdulHadi (2016), Lawal and Mohammed (2014), Ogbonnaya, Ekwe
and ihendinihu (2016), Shehu and Ahmed (2012), Amos, Ibrahim, Ibrahim and Nasidi (2016) ,
Baba (2016), and Uwuigbe, Erin, Uwuigbe, Igbinoba and Jafaru (2017) were studies conducted
in Nigeria. The results of their findings were mixed and there was no general agreement on the
relationship between ownership structure and earnings quality.
From the empirical studies reviewed on ownership structure and earnings quality, except for the
works of Affan, Rosidi, and Liliki (2017), and Uwuigbe, Erin, Uwuigbe, Igbinoba and Jafaru
(2017) whose study ended in 2015, the most recent works ended in 2014. The results obtained
during these periods can be regarded as not being too current because a lot of activity has taken
place such as changes in corporate governance code of 2003 which has been updated in 2011,
2014 and the most current in 2017. The recession that hit the Nigerian economy in 2016 which
created a lot of challenges for companies must have also overtaken the position of these
companies as at that period (Ibenegbu, 2016). Hence, there is need to conduct a more recent
research that will capture the changes. It is to this end, that this study extends its scope of
research to 2016.
Prior studies (AbdulHadi (2016); Musa (2014); Spinos (2013); Alves (2012); Al-Zyoud (2012);
Shehu & Abubakar (2012); Yang Chun & Ramadili (2009)) have related ownership structure to
earnings management and have interpreted earnings management to be the same as earnings
quality because of the significance of the relationship between earnings management and
earnings quality. Earnings management has a lot in common with earnings quality because high
earnings management can produce low quality of earnings but earnings management is not the
only factor affecting earnings quality. This study fills the gap by measuring earnings quality as
the inverse of the results of earnings management proxy of modified Jones model.
Furthermore, most of the studies on the effect of ownership structure on earnings quality in
Nigeria have been concentrated on other sectors of the economy especially the banking sector
and the manufacturing sectors. But there is paucity of studies in the listed consumer goods firms
in Nigeria despite its relevance to the Nigerian market. This study is an attempt to fill the gap for
the Nigerian consumer goods firms and further examines the effect of ownership structure on
earnings quality of listed consumer goods firms in Nigeria. Therefore, it extends the very limited
research on this issue and adds to a growing body of research.
1.3 Research Questions
The following research questions were answered:
i. How does managerial ownership affect the earnings quality of listed consumer goods
firms in Nigeria?
ii. What is the effect of institutional ownership on the earnings quality of listed consumer
goods firms in Nigeria?
iii. Does ownership concentration have effect to the earnings quality of listed consumer
goods firms in Nigeria?
iv. What is the effect of foreign ownership on the earnings quality of listed consumer goods
firms in Nigeria?