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EARNINGS MANAGEMENT AND FIRM’S PERFORMANCE IN NIGERIA

CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND OF THE STUDY

Concern about corporate governance has developed historically in response to major crises of confidence, fraud and market failure and with it development of advances in our thinking about the socio economic role and contribution of corporate entities (Nerd berg 2007). In recent times the perverseness of corporate failure has led to the loss of investors’ confidence on both financial reports and reporting accountants (auditors). Although many studies had explored how financial reporting quality can be improved through good corporate governance, there is scarcity of literature on the relationship between specific governance mechanisms and ethical misconduct of accountants .Ethics is viewed in this study as absence of attempt to cooked/doctored or tailored financial accounting reports to a giving desired or what is popularly referred in the literature as earnings management/creative accounting-financial engineering.

Earnings, sometimes called the “bottom line“ or “net income” are the single most important in financial statements. They indicate the extent to which a company has engaged in value added activities. They are signal that helps direct resource allocation in capital markets. Infact the theoretical value of a company’s stock is the present value of its future earnings. Increased earnings represent an increase in company value, while decreased earnings signal a decrease in that value.

Given the importance of earnings, it is no surprise that company management has a vital interest in how they are reported. That is why every executive needs to understand they can make the best possible decisions for the company. They must in other words learn to manage earnings.

Earnings management may be defined as “reasonable and legal management decision making and reporting intended to achieve stable and predictable financial results.”Earnings management is not to be confused with illegal activities to manipulate financial statements and reports results that do not reflect economic reality. These type of activities popularly known as “cooking the books “miss representing financial results. Many executives face a lot of pressure to cross the line from earnings managements to cooking the book. A 2009 survey at a conference sponsored by CFO magazine found that 78prercent of the chief financial officers (CFOS) in attendance had been told to cost financial result s in a better light, though still using generally accepted by accounting principles (GAAP). Half of them complied with the request worse however 45 percents of the group attendees reported that they had been asked to misrepresent their companies financial result s and 38 percent admit with complying.

The intense pressure to report better earnings was confirmed by a similar survey at a business week CFO conference. It found that 55 percent of the CFO’s had been asked to misrepresent financial results and 17 percent had complied. A number of phrases have been used to describe earnings management activities:

Income smoothing

Accounting hocus-pocus 

The numbers game

Financial statement management 

Aggressive accounting 

Re-engineering the income statement 

Toggling the books 

Creative accounting 

Financial statement manipulation 

Accounting magic 

Borrowing income from the future

Banking income for the future

Financial shenanigans 

Window dressing

Accounting alchemy 

There is no standard universally accepted definition for any of these terms. People use them in different ways and with different degrees of appreciation to cover a wide variety of activities, many perfectly legal. This tends to blur the distinction between ethically legal earnings management and illegally cooking the books.

Unethical practices could be attributed to the flexibility inherent in generally accepted accounting principles (GAAP) in the preparation of financial statements which gives financial managers some freedom to select among accounting alternatives.

Earnings management uses this flexibility in financial reporting to alter the financial results of a firm (Ortega and Grant, 2003). Levit (1998), describes earnings management as a gray area where the accounting is being perverted, where managers are cutting corners and where earnings reports reflects the desire of management rather than underlying financial performance of a company. If earnings are considered to be the most revealing figure of financial reports, then adequate measures need to be put in place to ensure its quality and reliability.

Recent studies revealed that large companies that have failed or filed bankruptcy have engaged in earnings smoothing years prior to their failures, Abdelghany (2005). This unethical practice was also evident from most pronounced failure to recent times, World Com, Pharmalat, Societe generale, among others. Even recent Global Financial Crisis that engulfed world economies was largely attributed to unethical accounting practices. 

Moreover, concern about corporate governance has grown historically in response to major crises of confidence, fraud and market failure and with development of advances in our thinking about the role of corporation in the economy and society. However, since the modern form of corporation is that which management is diverted from ownership conflict will continue to exist. Board of trustees of owners whose major role is to supervise holistically the activities of management, may likely to some greater extent curve any excesses or deterred possibility of misrepresentation in financial.

These expectations depend largely on the size, speed, competence and vigilance and to subsume it all the general structure of the board.

1.2   STATEMENT OF RESEARCH PROBLEM 

It is not known whether corporate governance has impact on earnings management.

Is there any implication of earnings management on corporate governance?

It is not known whether earnings management have implications on firms profitability in Nigeria.

It is not known whether there is a relationship between corporate governance and earnings management.

1.2.1  STATEMENT OF RESEARCH QUESTIONS 

For the purpose of this research work, the following research questions are examined:

What is the impact of corporate governance on earnings management?

What are the implications of earnings management in corporate governance?

What are the implications of earnings management in firm’s profitability in Nigeria?

It there a relationship between corporate governance and earnings management?

1.3   OBJECTIVES OF THE RESEARCH 

The objectives of the study are:

To find out the detail meaning of earnings management.

To find out the impact of corporate governance on earnings management.

To find out the implications of earnings management in corporate performance of Nigerian firms.

To find out if there is relationship between corporate governance and earnings management.

1.4   RESEARCH HYPOTHESIS 

For the purpose of this study, the following hypothesis is formulated:

H0:There is no relationship between corporate governance and earnings management. 

H1:There is a relationship between corporate governance and earnings management. 

1.5   RELEVANCE AND SIGNIFICANCE OF THE STUDY 

The study is relevant and significant for the following reasons:

The study examines the corporate structure of Nigerian firms. This is a yardstick to find out the effectiveness of corporate governance in Nigerian firms as it affects the ethical practice in financial reporting. An unethical and sharp malpractice that is being perpetrated is revealed through the structure of corporate governance that is in place. Hence this study is useful to corporate organizations in finding lasting solutions to the problems of ineffective corporate governance that may lead to unethical financial reporting.

This study is also useful to prospective researchers who intend carrying out research work on similar topics.

1.6   SCOPE OF THE STUDY 

The scope of the study is to look into those areas of corporate governance structure which influence to a greater extent the ethics in financial reporting (Earnings Management). The objective is to estimate the relationship between the board size, board composition and board effectiveness in determining unethical practices. The rest of the research work comprises of chapter one – proposal, chapter two – review of the literature, chapter three – research methodology, chapter four presents and discusses the results and finally five is summary, recommendations and conclusion.

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