CHAPTER
ONE
INTRODUCTION
1.1 Background to the Study
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).
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