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Corporate governance mechanisms are essential for establishing an attractive investment climate and an efficient capital market, butthe accounting ethics ofmanagers tend have tremendous affect on the quality of earnings and thus the investment climate is distorted. These motivated the researcher to investigate the relationship between some sets of corporate governance (CG) mechanisms and earnings quality (EQ) of listed manufacturing companies in Nigeria. Four null hypotheses were formulated in line with the objectives of the study to test the variables. Correlation research design and multiple regression were adopted as research design and technique of data analysis. The results indicate that the corporate governance proxies have a significant impact on earnings quality of Nigerian Manufacturing companies.This establishes the fact that corporate governance plays a significant role in checkmating the unethical behaviours of managers in the Nigerian manufacturing sector and thus improving the earnings quality. The study therefore, recommends that the proportion of independent directors’on the board should be increased. More institutional shareholders should be allowed to invest, and audit committee members should comprise of persons with high integrity and experience to ensure effective monitoring. Also, the quantum of shares held by managers should be minimized to reduce unethical practice.



1.1         Background to the Study

The financial scandals that sunk the once „high profile‟ companies such as Enron, Worldcom and Xerox in the United States, Parmalat in Italy and many other big companies around the world confirmed that there was an opaqueness in financial reporting that had hitherto not been penetrated. Corporate Governance (CG) was then introduced to facilitate and stimulate the performance of firms by creating and maintaining the incentives to motivate insiders to maximize the firm‟s performance and serve as control mechanism. The CG limits insiders‟ abuse of power over corporate resources and provides the means to monitor behaviour of managers for accountability and giving protection to investors (Ahmed, 2006). However, it becomes glaring that the existing Corporate Governance mechanisms are inefficient as they fail to protect the owners‟ interest. Consequently, the Sarbanese-Oxley Act was introduced in 2002 in the U.S. with a view to improving Corporate Governance practices. Many other countries, both developed and developing, followed suit. The Nigerian Stock Exchange (NSE) was not left out in the struggle for a better CG. However, despite the various measures adopted by Security and Exchange Commission (SEC) to foster efficient Corporate Governance structure and restore investors‟ confidence, there are still cases of manipulation or abusive accounting which is unethical by managers (Shehu, 2012).

Accounting information is relevant to the extent that it is capable of influencing a decision maker by helping him to form predictions about the outcomes of past, present, and future events or to confirm or correct prior expectations (Bushman, Cheng, Engel and Smith, 2004). In order for information to be relevant, it must be timely, and it must have predictive value or feedback value or both (Ahmad, 2006). Financial statements should always provide reliable information to assist users in decision making. The statements should disclose relevant, reliable, comparable and understandable information (Kamaruzaman, 2009). Reliability has to do with the quality of information which assures that information is reasonably free from error and bias and faithfully represents what it intend to represent. Financial statement of firms can never be completely free from bias, since economic phenomena presented in annual reports are frequently measured under conditions of uncertainty because many estimates and assumptions are included in the report (Shehu, 2011). Although complete lack of bias cannot be achieved, a certain level of accuracy is necessary for financial report to be decision useful (IASB, 2008). Therefore, it is important to examine the arguments provided for the different estimates and assumptions made in the annual report, if valid arguments are provided for the assumptions and estimates made, they are likely to represent the economic phenomena without bias (Jonas and Blanchet, 2000).

The need for a good Corporate Governance structure arose because of the seperation of ownerhip between a firm and its owners, which turns the firm into a nexus of relationship between it and all its stakeholders such as managers, employees, shareholders, creditors, government and all its stakeholders. The seperation of ownership and control by the sophistication of the modern day business redefines the relationship that exists between the owners and the managers to that of an agent and a principal. Being the agent, the manager is expected not to pursue goals that are geared towards the achievement of his own interest at the expense of shareholders‟ wealth maximization. The existence of conflict of interest between managers and owners naturally compromises the value of the firm and only transparency can eliminate the conflict. For a company to be transparent, it should be able to disclose financial information properly, that is, providing a full and frank account of a company‟s activities (Thompson and Yeung, 2002). This is due to the fact that corporate transparency is the widespread availability of relevant and reliable information about the periodic performance, financial position, investment opportunities, governance, value and risk of publicly traded firm (Bushman and Smith, 2001).

Furthermore, it has long been recognized that financial statements play an important role in assessing managers‟ performance by the board of directors, outside investors and external regulators. It is therefore, not unlikely that managers will manipulate financial reports in order to produce a good image of themselves and the firms that they manage through unethical accounting by managing earnings. Earning management is the manipulation of earnings by firms using financial statement elements that are largely at the discretion of the managers to achieve personal or firms goals. These elements are peculiar to industries depending on their nature of operations and external regulatory framework. Researchers such as Klien (2002) have identified that accruals arising from depreciation are used to manipulate earnings in manufacturing firms. The use of discretion by firm managers to influence reported earnings has long being recognized by accountants and financial economists (Amat, Gothorpe and Perramon 2005, Ahmed 2006). Similarly, torrent of literature exists on the impact of corporate governance on firm performance using one or more of the governance variables of audit committee, board composition, ownership concentration and institutional shareholding (Sanda, Mikailu & Garba 2005: Belkhir 2009). Similarly, several studies conclude that good governance mechanisms can impact on the discretionery behaviour of managers (Warfield, Wild & Wild 1995, Klein 2002, Ahmed 2006 and Shehu, 2011).

Specifically, this study concentrates on Corporate Governance mechanisms of board composition, institutional shareholdings, audit committee and managerial ownership in relation to Earnings Quality. The study is motivated by several factors such as the attributes of the manufacturing sector being a sector that occupies a crucial position of every economy yet little or no attention is given by researchers in ensuring its growth. Even though the banking industry is said to acts as an engine of any economy, and it dominates the Nigerian financial sector (Augusto, 2004), the manufacturing industry also plays a very significant role in providing labor to the grassroots. Added to these is that the issues of CG has long been accepted by most countries including Nigeria to be one of the easiest ways of combating financial irregularities, agency problems, and improving an attractive investment climate. However this is not always the case, and this is what the study intends to find.

1.2         Statement of the problem

Limited access to managerial information causes the providers of finance such as shareholders and debt holders to heavily rely on the financial statement of firms. As financial reporting provides value-relevant information to the external parties of the organization, the heavy reliance placed on accounting numbers create powerful incentives for managers to manipulate earnings to their own advantage (Rahman & Ali, 2006). Hence, it is important for financial accounts to provide the truthfulness and accuracy of financial information to enable the shareholders to make decisions wisely. The lack of accuracy in the financial results will lead to the shareholders and other users making wrong judgments and decisions.

Managers manage earnings to gain investors‟ confidence by encouraging and convincing stakeholders to invest, however, there are inherent activism that are unethical and fraudulent. The central concern of board composition (which is the extent to which outside directors are represented on the board) with earnings quality is that independent outside directors are expected to protect shareholders specific interest when there is no agency problem. However, this depends on who is on the board, and thus the composition of board members may significantly affect the quality of financial information. It is still not very clear whether the independent directors of Nigerian Manufacturing companies protect the interest of shareholders by preventing earnings management and thus earning quality is increased, does the independent directors of listed my companies in Nigeria protect the interest of stake holders by increasing earning quality?

While for the institutional Shareholdings it is expected that the more the institutional investors‟ participate the more the minority shareholder‟s interest is protected. The significant increase in the institutional investors‟ shareholdings led to the formation of a large and powerful constituency to play a significant role in corporate governance. The question that still, remains is to what extent does an institutional shareholder checkmate the accounting ethics by managers, thus improving earning quality?

The Audit Committee and Earnings Quality problem may be from the fact that the function of the audit committee is to monitor a firm‟s financial performance and financial reporting; the audit committee may have a more direct role in improving earnings quality. The presence of well enlightened audit committee may deter unethical intentions by managers thus; it is expected that the quality of earnings will be improved. However, the question that still remains is, to what extent audit committee play a role in improving Earning Quality.

Managerial Owners are expected to reduce accounting ethics in order to protect the shares they own. Many reasons can be adduced for the accounting ethics that may lead to preparation of misleading financial statements. One of such reasons is the demand for high returns by shareholders on their investments. This expectation from investors places management of some companies under undue pressure that they resort to indulging in unethical forms of financial-disclosure and reporting. Another reason is the quest to maintain a giant corporate status in the eyes of the business community despite some crippling internal problems, odds in the business terrain or sporadic changes in competitiveness. Also, the craze to satisfy the interest of company‟s insiders by manipulating the financials, understating or reclassifying expenses is another reason. These of course set the stage for the failure of the company with time. The consequences of these unethical accounting practices include, but not limited to a wide gap between reality and the reported position of the company such that any person placing reliance on such reports for decision making will be misled, erosion of investor’s confidence in corporate entities, attrition of revenue to the government via evasion or avoidance of taxes, reduction in the inflow of foreign direct and portfolio investment. And the question still remains, as to what extent does the managerial owners protect the interest of shareholders and improve the quality of earnings?

The Corporate Governance Culture in Nigeria failed to be Responsible to the Stakeholders, Accountable to the Shareholders and has no deep-rooted mechanism to maintain a balance among the major players (board of directors, shareholders, and management) in corporate governance which have resulted in poor financial reporting quality (Shehu, 2011). The challenges and failure of corporate governance in Nigeria stems from the culture of corruption and lack of institutional capacity to implement the codes of conduct governing corporate governance. Company executives enjoy an atmosphere of lack of checks and balances in the system to engage in gross misconducts since investors are not included in the governing structure. How strictly the listed manufacturing firms comply with the provisions of corporate governance code?

Studies such as (Mark 1996, Bello 2002, Klien 2002, Adams and Mehran 2003, Schipper and Vincent 2003, Park and Shinn 2004, Borgia 2005, Sanda et al 2005, Fodio 2006, Rahman and Ali 2006, Ahmad 2006, Devi and Hashim 2010), concentrated on either the banking sector or some sectors of manufacturing companies. In addition, most of the studies used Ordinary Least Square (OLS) without considering the robustness of the techniques, while this study conducted a robustness test to ensure the validity of the statistical inference derivable from the results. However, this study is said to fill the obvious methodological gap discovered by the previous studies specifically the robustness tool of analysis.

The study therefore examines the influence of Corporate Governance mechanisms on the quality of financial reports of quoted manufacturing firms in Nigeria.

1.3         Objectives of the study

The main objective of the study is to examine the effect of Corporate Governance on Earnings Quality of listed Manufacturing companies in Nigeria. The specific objectives include:

  1. To determine the effect of Board Composition on the Earnings Quality of listed manufacturing Companies in Nigeria.
  2. To determines the effect of Institutional Ownership on the Earnings Quality of listed manufacturing Companies in Nigeria.
  3. To determine the effect of Audit Committee on the Earnings Quality of listed manufacturing Companies in Nigeria.
  4. To determine the effect of Managerial Ownership on the Earnings quality of listed manufacturing Companies in Nigeria.

1.4         Hypotheses of the study

In line with the studies objectives, the following hypotheses were formulated in a null form.

Ho1:    Board Composition has no significant effect on Earnings Quality of listed manufacturing firms in Nigeria.

Ho2:    Institutional Shareholdings has no significant effect on Earnings Quality of listed manufacturing firms in Nigeria.

Ho3:    Audit Committee has no significant effect on Earnings Quality of listed manufacturing firms in Nigeria.

Ho4:    Managerial Ownership has no significant effect on Earnings Quality of listed manufacturing firms in Nigeria.

1.5         Scope of the study

The scope of the study is limited to the listed Manufacturing companies in Nigeria. There are 59 Manufacturing Industries in Nigeria which are divided into four strata, that is, Food and Beverages, Building Materials, Chemicals & Paints and Conglomerates. It covers period of 6 years (2006 – 2011). And the selection of the period is informed by the commencement of compliance investigation by SEC on the code of CG. The study focuses on only four of the CG mechanisms; that is Board Composition (BC), Institutional Ownership (IO), Audit Committee (AC) and Managerial ownership (MO) which stands for the independent variable and the accounting ethics which is measured as Earnings Quality (EQ) as the dependent variable.

1.6 Significance of the study

The findings of this study can have implications for users of financial statements such as shareholders, potential investors, policy makers, the regulatory bodies and also students. The study is expected to practically contribute in strengthening the areas of concern by practitioners such as external auditors and financial consultants in manning the financial records of Nigerian Listed Manufacturing Companies (NLMC) relating to the role of CG practice. Again, the Board of directors and regulatory agencies of NLMC in discharging their duties of policy making and regulating respectively. And also to consider the prominent roles or activities that CG mechanisms play in checkmating and preventing as well as minimizing the possible opportunistic accounting by managers in preparing the financial statement of the firms.

Theoretically, the findings of this study is expected to provide additional literature in the areas of CG and quality of accounting numbers. This will go a long way in validating theories, such as agency that anchored CG mechanism and EQ in NLMC.

In particular, financial statement users should be aware of income the users should be aware of income smoothing and the factors affecting such behavior when they rely on financial statements to help them make decisions. Specifically, users are expected to know the influence of the independent or non-executive directors, institutional shareholdings and the audit committee on such behavior. Further, since extensive accounting ethics may lead to inadequate or misleading income disclosure, thus regulators should concentrate their efforts where such practices are likely and most extensively to happen.


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