ABSTRACT
The objective of this study is to audit committee characteristics and earnings management of listed consumer goods in Nigeria the source of data was secondary data which was obtained from the annual reports and accounts of the sampled companies and Nigerian Stock Exchange Fact Book is used to find out the listed Firms for the period of 2014 to 2018. Findings from the study revealed that larger audit committee members are more effective in monitoring the activities of the management, and they are also better at maintaining the financial reporting process. A correlation research design was adopted due to the fact that the study measures relationships between audit committee characteristics and earnings management of listed consumer goods Firms in Nigeria. Finally, it was recommended that: The composition of audit committee members should clearly be spelt out so as to enable them perform their functions effectively, because SEC is silent with regards to the composition of audit committee members. Also, the composition may be stated in such a way that the independent members should have financial knowledge, resulting in dual attributes like audit committee independence with financial knowledge rather than independence alone....
CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
Financial scandals and the collapse of
some multi-national corporations can be as a result of the unethical Accounting
practices. One of such unethical issues in Accounting is earnings manipulations
that come under the umbrella of earnings management and serves as a strategic
tool used by management under the pretext of maximizing firm‟s value and
reducing risks. This is possible by distorting and/or manipulating the
application of Generally Accepted Accounting Principles (GAAP). (Bhaghat and
Bolton 2009)
Earnings management
is seen as an attempt by management to induce, or influence or manipulate
reported earnings by using specific accounting method or changing methods;
recognizing one-time non current items, deferring or increasing expenses or
revenue transactions or using other methods designed to influence short term
earnings (Rahman, Muniruzzaman Sharif 2013). This practice, according to Levitt
(1998) "causes in erosion in the quality of earnings, and consequently the
quality of financial reporting will lose out to illusion".
The importance of
accounting earning to stakeholders of any given firm cannot be over emphasized
as the entire faith of the firm and consequently of its stakeholder relies on it.
In addition, from the accounting point of view, earning is the final product of
the entire accounting process. It will thus be of interest for accounting
scholars to observe that their most important variable continue to maintain its
relevance in the decision making of various users for varying applications. It
is believed that earning is said to be relevant if only it can be relied upon
(Iyire 1966). On the other hand, earnings management reduces the needed
reliability and hence it relevance (Bugshan 2005). For earning to maintain its
importance, there is hence the need to device ways that can be used to enhance
the practice of reporting quality earnings. After the recent world major
financial crisis in 2008, there is ever increasing need to look up for
indicators of earnings reliability.
The reality facing
stakeholders of financial reporting is that corporate financial reporting
failure has been on the increase, especially in the past decades. Window
dressed accounts generated concerns in the USA with the collapse of the energy
corporation (ENRON) in 2001. The company filed for bankruptcy after adjusting
its accounts. WorldCom, Global Crossing and Rank Xerox are other companies in
the USA with similar problems. In Italy, parmalat failed in 2003 when it engaged
in accounting scandals worth eight billion Euros (Demaki, 2011 and Norwani, et
al., 2011).
Nigeria has had its own share of
financial reporting failure with the problems in Cadbury Nigeria Plc in 2009,
Afribank Nigeria Plc faced problem of financial reporting in 2009, and
Intercontinental Bank Plc in 2009. With this development, most countries all
over the world decided to set codes of best practice as guideline to address
governance and financial reporting anomalies. Thus, reports like Cadbury report
in United Kingdom and Sarbanes Oxley in the United States of America were
produced. Similarly, Day Report in Canada, the Vienot Report in France, the
Olivencia Report in Spain and the Kings Report in South Africa were all
produced. In the same vein, the principles and guidelines on corporate
governance in New Zealand and the Cromme code in Germany were produced. The
goal of these regulations was to improve firms‟ corporate governance
environment (Bhagat and Bolton 2009).
In Nigerian, the
regulatory authorities have responded by compelling companies to comply with
stringent corporate governance codes. Idornigie (2010) reported that Nigeria
has multiplicity of code of corporate governance with distinctive
dissimilarities namely; Security and Exchange Commission (SEC) code of
corporate governance 2003 to guide the operation of public companies listed in
the Nigerian Stock Exchange, which was reviewed in 2011, Central Bank of
Nigeria (CBN) code of 2006 and National Insurance Commission (NAICOM) code of
2009. Owing to the above, every public company in Nigeria is required under
section 359(3) and (4) of the CAMA to establish an audit committee. It is the
responsibility of the Board to ensure that the committee is constituted in the
manner stipulated and is able to effectively discharge its statutory duties and
responsibilities. At least one board member of the committee should be
financially literate; and members of the committee should have basic literacy
and should be able to read financial statements. In addition, at least one
member should have knowledge of accounting or financial management, whenever
necessary; and the committee may obtain external professional advice.
Audit committees have been regarded as
integral to quality financial reporting. Companies establish audit committees
to improve quality of financial reporting practices and earning, (Ramsay;
2001). The basic functions of audit committee are to oversee the financial
reporting process and to monitor managers tendencies to manipulate earnings, regulators
in recent years have questioned the effectiveness of audit committee in
ensuring that financial statement are fairly stated, and are without earning
management.
Studies have been conducted on the role
of audit committee in monitoring management (Nelson & Jamil, 2012). These
studies provide different opinions on the direction of their association. The
outcome of the studies, which are mostly, conducted in developed nations
motivated more studies in the area in order to investigate whether audit Committee
characteristics can reduce earnings management in different economies. This is
because despite the attention given by practitioners and regulators to
corporate failure, it has become the order of the day. This further
necessitates the need to investigate the likely impact of audit committee
characteristics on earnings management of listed foods and beverages Firms in
Nigeria.
By focusing on the listed consumer
goods companies in Nigeria, the study identifies a suitable context in which
earnings management may be more easily carried out. This scandal according to
Okaro and Okafor (2013) "has since been euphemistically dubbed as
Nigerian‟s Enron equivalent". Hence, studying audit committee attributes
and earnings management in the subsector of manufacturing of Food and Beverages
is expected to be of great importance considering the fact that it has larger
number of Firms.
1.2 Statement of the Problem
Financial
Statements are a major means through which companies communicate to its users
its financial results as well as its position. Financial analysts cum investors
make use of financial statement to make rational decisions. The Nigerian
Accounting Standards Boards, now Financial Reporting Council, in its statement
of accounting standards, states that the objective of financial statements is
to provide information about the reporting entity‟s financial performance and
position that are useful for assessing the stewardship of the entity‟s
management and making economic decision. Some of the qualitative characteristics
of this information are reliability, relevance and understandability. To
achieve quality of financial reporting, a monitoring committee is often put in
place to serve as a watchdog in ensuring that companies produce relevant and
reliable information which will eventually protect the interest of both
existing and prospective investors. The most important of these monitoring
committees is the Audit Committee, which is responsible for the review of
audited and unaudited financial statements of organizations thereby improving
the quality of such information and reducing the possibilities of unethical or
abuse of accounting practices by management when preparing financial
statements.
Despite the
existence of this monitoring committee, there were a lot of corporate failures
in recent years, for instance, the accounting scandals by Cadbury plc,
Intercontinental Bank Plc, and Oceanic Bank Plc. This has brought about doubt
in the minds of shareholders on the credibility and reliability of financial
reports. It was as a result of the foregoing statements that researchers
consider it of paramount importance to investigate the effect of this audit
committee on earnings management. However, the literature on the relationship
between audit committee characteristics and earnings management is
inconclusive. Some studies found positive relationships (Beasley &
Selterio, 2001), while others found negative associations (Yang & Krishman,
2005; Lin et al, 2006; Beasley & Salterio, 2001; and kuang &
Sharma 2013). And yet, other researchers reported no relationships (Nelson and
Jamil 2012). These mix findings make the direction of these relationships to be
illusive, and to the best of our knowledge, there is no study in Nigeria that
has attempted to resolve the mixed result particularly in listed Consumer Goods
Firms in Nigeria.
In Nigeria, studies
in this area have ignored the financial expertise variable. The work of Leslie
and Okoeguale (2013) and Ugbede, Lizam & Kaseri (2013) only used one
independent variable (Audit committee size). Similarly, Fodio et al.
(2013) used two variables (audit committee size and audit committee
independence). Hassan (2012) used three independent variables. (Audit committee
size, audit committee independence and audit committee meetings). The non-use
of the financial expertise which is generally believed to play a significant
role in the activities of audit committee provided a gap that needed to be
filled.
Additionally, the time period covered
by some of the previous studies leaves a gap. The works of Leslie and Okoeguale
(2013) for instance, covered the period from 2005 to 2010. Hassan (2012)
covered the period of 2008 to 2010, and Fodio et al. (2013) covered the
period of 2007-2010. These periods can be regarded as not too current as a lot of
activities have taken place, which include the changes in the current corporate
governance code of 2011 by Nigeria Securities and Exchange Commission. Some of
the findings of these studies may not be relied upon in view of the fact that
the studies have been taken over by the changes. Similarly, the work of Hassan
(2012) covered only three years, this considered too short to enable the
generalization of findings. Furthermore, most studies in this area were either
conducted in conglomerate sector or banking sector (see Uadiale 2012; Fodio et
al. 2013; Okoeguale 2013 and Ugbede, Lizam & Kaseri; 2013), and none
has specifically covered the listed Consumer Goods Firms in Nigeria.
In view of the above, there is the need
to conduct a study with a view to filling these gaps that exist in the
literature. This study will therefore seek to answer the question of how audit
committee characteristics affect earnings management of Consumer Goods Firms in
Nigeria.
1.3 Objectives of the Study
The main objective
of this study is to empirically investigate the effect of audit committee
characteristics on earnings management. Thus, the specific objectives are;
i.
To determine the influence of audit committee size on
earnings management of Listed Consumer GoodsFirms in Nigeria.
ii.
To examine the influence of
audit committee meetings on earnings management of Listed Consumer
GoodsFirms in Nigeria.
iii.
To
ascertain the extent to which audit committee financial expertise affects
earnings management of Listed Consumer GoodsFirms in Nigeria.
1.4 Research Hypotheses
In order to achieve
the above mentioned objectives and to empirically solve the problem of this
study following null hypotheses were formulated.
i.
H01:
Audit committee size has no significant effect on earnings management of Listed
Consumer GoodsFirms in Nigeria.
ii.
H02: Audit committee financial expertise has no
significant effect on earnings management of Listed Consumer GoodsFirms in
Nigeria.
iii.
H03:
Audit committee meetings have no significant effect on earnings management of Listed
Consumer Goods Firms in Nigeria.
1.5 Scope of the Study
The study covers
the period of six years from 2013 to 2018. The data used for the study was
purely from secondary sources extracted from the annual reports and accounts of
listed Consumer Goods Firms in Nigeria. The variables of the study include
audit committee characteristics representing the independent variables, the
proxies of which are audit committee size, audit committee independence, audit
committee meetings and audit committee financial expertise, and the dependent
variable represented by earnings management proxy by discretionary accruals
measured by modified Jones model by Dechow et al. (1995).
1.6 Significance of the Study
This study titled audit committee
characteristics and earnings management will contribute immensely to the
existing literature. Even though there are lots of literature on the audit
committee characteristics and earnings management around the globe, there is
limited evidence from prior literature that empirically investigates the
relationship between audit committee and earnings management of Listed Consumer
Goods Firms in Nigeria. This will therefore serve as a reference for further
researchers in this area, by critically looking at the empirical finding
thereby discussing the implication from the Nigerian perspective.
The study also has
the potential to inform regulators, practitioners (auditors and forensic
accountants) and board of directors who are responsible and more concerned with
improving the oversight of public corporations, thereby reducing opportunities
for managers and others to engage in financial fraud. In the same vein, it will
also serve as a basis for formulation of laws and policy implications. For
example, the Companies and Allied Matters Act 1990 has only recommended that
company’s audit committee should have at least one member with financial
knowledge, not necessarily financial expert. In this regards, if it is found
that there is significant relationship between audit committee financial expertise
and earning management as hypothesized, a recommendation will follow, which may
require those regulators to make use of the recommendation in an appropriate
manner.
The study will also
contribute to debate on the mix of opinion in the existing literature between
audit committee characteristics (audit committee size, audit committee
independence, audit committee expertise and audit committee meetings and
earnings management. In that, the study will be among those that may provide
additional evidence for future research.
The Government will find it very
relevant, in the sense that earnings manipulation will in one way or the other
affects the earnings of companies, which in turn affect their profit, from
which the government is expected to receive its portion. For example if the
company over estimates future provision for bad and doubtful (i.e. the cookie
jar reverse technique), that will bring about lower profit figure, this will
make them to pay low tax. When the government understands the negative implications
of this, it will therefore force the regulators to formulate or review the
existing policies which will be favorable to the entire economy.
The study will also serve as a guide to
the existing and potential investors as well as financial analysts who are also
the direct users of financial statements. Where earnings manipulation exists;
shareholders would be negatively affected, in that, the study will recommend
possible solutions to the identifiable problems that may affect those users and
also suggest possible ways for policy implications that may protect the
interest of investors.