CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
Earnings management and Corporate Governance study has received considerable attention from
academics, market participants, and regulators. This is due to among other things financial
scandals around the world and the collapse of major corporate institutions in the USA, Asia,
Europe and Nigeria such as Adelphia, Enron, World Com, Vivindi, Xerox, Royal Dutch Shell,
China Aviation, Tyco, Wema Bank, NAMPAK, Fin bank, Spring bank, Commerce Bank,Global
Crossing and Cadbury which have shaken the confidence of investors in the capital markets
(Effiok&Effiong, 2012). This phenomenon led to a global movement towards developing and
implementing good corporate governance that will eliminate the opportunistic behaviors that
have hampered stakeholder‟s reliance on financial information (Hassan & Ahmed, 2012).
The need for earnings quality and uniformity in the preparation and presentation of financial
statements gave birth to International Financial Reporting Standards (IFRS). Before the adoption
of IFRS in 2012 in Nigeria, there were legal and regulatory frameworks of Accounting in respect
to preparation of financial report in Nigeria (Christensen, 2012). The Company and Allied
Matter Act (CAMA) 1990 prescribe some format and content of company financial statement
disclosure requirements and auditing. It requires that the financial statement of all corporate
organizations comply and adhere with the Statement of Accounting Standards (SAS) issued from
time to time by the Nigerian Accounting Standard Board (NASB). This also requires that audit
be carried out in accordance with the General Auditing Standards. The IFRS adoption was
organized in such a way that the entire stakeholders that prepare and present financial statement
use it by the beginning of 2014. It was made in such a way that all the first tier companies listed
on the stock exchange and are of public interest use it by 2012, all other company of public
interest but not first tier were to adopt it in 2013, and all small and medium scale entity were to
use it by January, 2014. Financial reporting standard exists because it serves as stewards to the
owner of firms as ownership is divorced from controlling the activities of the business (Kabara,
2013).
The Nigerian Security and Exchange Commission (SEC) mandated companies to prepare and
publish annual audited financial statement in conformity with guidelines and principles issued by
the apex regulatory institutions. Nonetheless, managers still upheld on earnings management
practices in order to increase its market value and maximize shareholders wealth (Ekoja, 2012).
The regulatory flux and the alternative accounting policies have habitually necessitated the
exercise of judgment in preparing financial statements. The inference of using such decisions is
that information provided by management which always arouses a certain decision by different
users takes a wrong pronouncement when preparers decides to convey deceptive information.
Despite the guiding principles, possibilities of judgment in accounting within the parameter of
Generally Accepted Accounting Principles (GAAP) are not altered as managers do. It is
inconceivable situation to have accounting systems that are totally ruled based without room for
occasional judgments (Bello, 2005). Since new situation may require new accounting rules, then
it is not possible to wipe-off the generally accepted accounting principle judgment opportunities
created for management in accounting. Therefore, efforts have been made by researchers to
devise methods and system in which the opportunistic behavior exhibited by managers can be
reduced. The self-serving information provided by managers may be as a result of manager‟s
intention to influence a particular contractual outcome among others that relies on reported
earnings or to mislead the stakeholders about the underlying economic performance of its
organization. The issue of occasional judgment in accounting has come to stay rather than its
possible elimination as it has become an unimaginable situation to have accounting systems that
are totally ruled based (Bello, 2005).
Separation between ownership and control, will lead managers to manipulate earnings in order to
maximize their own interest thus influencing the informativeness of earnings (Gulzar & Wang,
2011). When the interests of shareholders and managers diverge, managers tend to maneuver
earnings for their own purposes at the cost of shareholders‟ interest (Isenmila & Elija, 2012). For
these reasons, how to improve corporate governance mechanisms is an interesting topic for
research. Thus, in order to protect the rights of the stakeholders, it is vital for an organization to
have effective corporate governance mechanisms which can control the pervasive practice of
earnings manipulation.
The IFRS allow firm managers greater flexibility in choosing from among alternative accounting
treatments. These choices can have different effects on a firm‟s reported income. Hashem,
Bahman and Azam (2012) argue that managers tend to prefer accounting choices that benefit
them economically. The likelihood of this opportunistic behaviour rises in the presence of weak
governance structures, eventually causing the quality of reported earnings to deteriorate and
reducing investors‟ confidence in corporations (Johnston & Rock, 2005). This opportunistic
behaviour, known as earnings management, entails the creative use of accounting techniques in
such a way that the financial reports produced give an excessively positive picture of firms‟
business activities. Earnings management can include changes in the estimated amount of assets
impaired, the volume of bad debts written off, the amount of inventory recorded, the estimated
useful life of long-term assets, and estimated post-employment benefits and warranty costs
(McKee, 2005).
Better governance is supposed to lead a better corporate performance by preventing the
expropriation of controlling shareholders and ensuring better decision making (Ekoja, 2012).
This expropriation may be due to the result of smoothening of earnings intention which is known
as earnings management. Good governance means little expropriation of corporate resources by
managers or controlling shareholders, which contributes to better allocation of resources and
better performance. As investors and lenders will be more willing to put their money in firms
with good corporate governance and this will lead to lower costs of capital. Other stakeholders
including employees and suppliers will also want to be associated with and enter into business
relationships with such firms, as the relationship are likely to be more successful than those firms
with less effective governance. However, having a good set of rules and regulations do not
guarantee good corporate governance practices unless regulatory authorities effectively enforce
these requirements. Over the past two decades a number of prominent participants in the debates
surrounding professional accounting and auditing standards have increased the attention given to
the role of corporate governance procedures in earnings management practices (Uadiale, 2012).
Corporate governance is not just about the process by which management of firms such as
directors make decisions, it is also about the way the organizations are held accountable.
Growing evidences from prior researches supports the argument that earnings management is a
common practice in firms (Dye, 1988; Kao & Chen, 2004; Kabara, 2013). Bakre (2007), Ekoja
(2002), Okike (2009), Alhaji, (2014) had all cited evidences of earnings management in
Nigerian firms. Given that managers have flexibility in choosing accounting policies, they
choose policies that maximize their own utility. Several studies on earnings management take
this opportunistic perspective (Vafeas, 2000; Romano, 2005; Saleh, Iskandah &Rahmat, 2005).
The healthcare industry in Nigeria, like any other industry in the country is required to comply
with the requirements of code of CG for public companies in Nigeria. The code is expected to
ensure highest standards of transparency, accountability and good CG, without unduly inhibiting
enterprise and innovation. Similarly, IFRS provides guide on accounting practices and reporting
formats to be followed by companies listed on the stock exchange and are of public interest.
Despite the strategic importance of the industry to the economy, not much attention in research is
given to the CG practices of healthcare companies in Nigeria. This study, therefore, aims to
determine the impact of corporate governance and IFRS on the earnings management of
Nigerian healthcare firms.
This study is motivated by two considerations. First, the health care industry in Nigeria being
one the fastest growing in the economy (estimated 7-9% growth rate), is characterized by
several companies. However, there is a clear dominance of the multinational brands due to their
relative earnings capacity, market capitalization, track record and strategic international
alliances. Second, the country‟s investment climate is not attractive, given that firms involved in
earnings management are liable to spread false information in the market. This induces investors
to make sale or purchase decisions that lead to losses, eventually eroding their confidence. In
order to attract more capital and enhance investor confidence, companies need to provide an
attractive investment climate and good governance, increase overall transparency, and reduce
information asymmetry.
1.2 Statement of the Problem
Ineffective corporate governance mechanisms provide incentives to management to manipulate
earnings and this results in corporate failure. A comprehensive study of Nigerian listed firms by
World Bank Group (2004) and Uwalomwa, Daramola and Anjolaoluwa (2014) show that
corporate governance practices in Nigeria is somehow weak. Considering the importance of
corporate governance in influencing earnings manipulation, there has been little research on the
link between corporate governance and earnings management using the moderating effect of
IFRS in the healthcare industry.
In Nigeria, concerns have been expressed about the negligence and abuse of the system by
capital market operators especially following the incidence of collapse of some healthcare
companies. Companies that have gone into liquidation could be for reasons of ineffective or nonexisting system of corporate governance. Examples are Arewa Pharmaceutical Ltd, Zarinject
Healtcare Ltd and Zazzau Pharmaceutical Industries Ltd (Joshua, Anthony and Titus, 2014). In
Nigeria, performance indices for the healthcare sector showed poor performance as a result of
excessive earnings manipulation in the industry.
A number of studies have been conducted on corporate governance and earnings management at
different times in developed, as well as, developing countries, most of which are well
documented in accounting and finance literature. These studies include that of Garcia-Meca. &
Sanchez-Ballesta, (2009); Gulzar & Wang, (2011); Uadiale, . (2012); Usman & Yero, (2012)
and Uwalomwa, Daramola & Anjolaoluwa, (2014). These studies used few ttributes of
corporate governance such as board composition, power separation and audit committee
composition as corporate governance proxies. This study employed different proxies of corporate
governance which include board size, audit committee size and ownership concentration, in
order to have robust results. In addition, most of the studies on corporate governance in Nigeria
concentrate on banks paying little or no attention to healthcare firms despite the important role
they play in the economic development of the country, resulting to the dearth of studies on
corporate governance and earnings management in Nigerian healthcare industry. In addition,
none of these studies uses the moderating variable of IFRS on corporate governance and earnings
management of companies in Nigeria. Using moderating variable may reinforce corporate
governance mechanisms in blending together to halt the menace of earnings manipulation since
they independently serves as internal control mechanisms.
Despite the importance of healthcare industry to the growth and development of the Nigerian
economy, there is paucity of research in corporate governance and earnings management in
Nigerian healthcare sector. Consequently, there is the need to examine the impact of corporate
governance on the earnings management by relating the activities of board size, audit committee
size, ownership concentration and moderating effect of IFRS to the earnings management of
those companies with a view to determine the extent of the relationship. This study is carried out
to fill this gap for the Nigerian healthcare industry.
1.3 Objectives of the study
The main objective of the study is to examine the moderating effect of IFRS on the relationship
between corporate governance and earnings management of listed healthcare firms in Nigeria.
The specific objectives of the study are to:
i. Access the effect of board size on earnings management of listed Healthcare Firms in
Nigeria.
ii. Examine the effect of audit committee size on earnings management of listed Healthcare
firms in Nigeria.
iii. Investigate the effect of ownership concentration on earnings management of listed
Healthcare firms in Nigeria.
iv. Assess whether the effect of IFRS is influenced by the relationship between earnings
management and corporate governance of listed Healthcare firms Nigeria.
1.4 Research Questions
a) Does board size have any effect on earnings management of listed Healthcare firms in
Nigeria?
b) Does audit committee size have any effect on the earnings management of listed
Healthcare firms in Nigeria?
c) Does ownership concentration have any effect on the earnings management of listed
Healthcare firms in Nigeria?
d) Does moderating effect of IFRS have any effect on the relationship between earnings
management and corporate governance of listed Healthcare firms Nigeria?