BOARD CHARACTERISTICS AND FIRM PERFORMANCE: EMPIRICAL EVIDENCES FROM NIGERIA
Published accounting information in financial statements are required to provide various users - shareholders, employees, suppliers, creditors, financial analysts, stockbrokers and government agencies – with timely and reliable information useful for making prudent, effective and efficient decisions. The widespread failure in the financial information quality has created the need to improve the financial information quality and to strengthen the control of managers by setting up good firms structures. A financial statement is said to be misleading if it lacks the qualities of accuracy, relevancy, comparability, reliability, compatibility and it contains fundamental errors or is prepared with the intention to deceive and/or confuse the users. This study examines the impact of firms’ characteristics from perspective of structure, monitoring and performance elements on the quality of financial reporting measured by modified model of Dechew and Dechev (2002) of quoted manufacturing firms in Nigeria. The study adopted correlation research design with pooled panel data and 24 are drawn out of 39 firms that served as population of the study. Multiple regression is used as a tool of analysis in examining the hypotheses of the study. The result reveals firm size, leverage, institutional shareholding and firm growth are significant and positively associated with the earning quality at 5% level of significance. This indicates that larger and more leveraged firms in Nigerian manufacturing sector are less likely to manage earnings and increase in sales as well as institutional investors serve as a monitoring tool of preventing managers from opportunistic behaviour in managing earnings. In addition, profitability and independent directors are positively associated with earnings quality while liquidity is inversely related with quality of financial reporting despite significant at 1% level of significance. In sum, firm characteristics of quoted manufacturing firms in Nigeria have impacted significantly on their financial reporting quality. Therefore, it is recommended among others that the shareholders of Nigerian quoted manufacturing firms should ensure all the seven firm characteristics used in this study keep on improving to decrease manipulative accounting in order to increase the quality of financial reporting.
TABLE OF CONTENTS
CHAPTER ONE: INTRODUCTION
1.1 Background of the Study
1.2 Research Problem
1.3 Objective of the Study
1.4 Research Questions
1.6 Significance of the Study
1.7 Scope of the Study
1.8 Limitation of Study
CHAPTER TWO: LITERATURE REVIEW
2.3 Firm Characteristics and Financial Reporting Quality
2.4 Firm Structure and Financial Reporting Quality
CHAPTER THREE: RESEARCH METHODOLOGY
3.2 Research Design
3.3 Population and Sampling of the Study
3.4 Source and Methods of Data Collection
3.5 Techniques of Data Analysis
CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS
4.2 Descriptive Statistics
4.3 Presentation and Analysis of Regression Results
4.4 Hypothesis Testing and Robustness Test
4.5 Discussion of Findings
CHAPTER FIVE: SUMMARY, DISCUSSION OF FINDINGS, CONCLUSION AND RECOMMENDATIONS
1.1 BACKGROUND TO THE STUDY
The board of directors has long been recognized as an important corporate governance mechanism for aligning the interests of managers and all stakeholders to a firm. The need to adopt the right corporate governance mechanisms is driven by the agency problem and the associated free-rider problem that makes it difficult for any single investor or stakeholder to bear the cost of monitoring managers. The central role of board of directors in this process has therefore been recognized and in recent years has gained significant attraction for at least two reasons. Transition countries and other developing countries are struggling to attract resources for investment in an increasingly competitive global environment. Events at Enron and several other large corporations suggest the need for policies to promote board independence and other aspects of corporate governance. Levine (2004) also sees a link between corporate governance and the economy, arguing that it has the capacity to foster economic growth. According to him sound corporate governance makes it more likely for owners of capital to monitor the activities of managers either directly through voting on crucial matters or indirectly through the board of directors.
One key element of corporate governance is the role of board of directors in overseeing management. Managerial oversight is needed because managers have their own preferences and may not always act on behalf of the shareholders. Shirking, excessive perks, and non-optimal investments are examples of abusive actions by managers (Jensen and Meckling, 1976). The board of directors can reduce agency conflicts by exercising its power to monitor and control management (Fama and Jensen, 1983). Independent outside directors are presumed to carry out the monitoring function on behalf of shareholders to ensure that management is in place and to maximize shareholders’ interests because shareholders themselves would find it difficult to exercise control due to the wide dispersion of ownership of common stock (John and Senbet, 1998). A key contention is that outside board members should be independent of the executive management and free from any business or other relations with the company that could compromise their autonomy. Fama (1980) and Fama and Jensen (1983) argue that including outside directors as professional referees not only enhances the viability of the board but also reduces the probability of top management colluding to expropriate shareholder wealth. The generalization of this effective monitoring argument is that the more independent the outside directors serving on the board, the higher the firm performance.
Empirical evidence, however, has been quite inconsistent with regard to the positive impact of board composition on firm performance (Bhagat and Black, 1998). Rosenstein and Wyatt (1990) document significant positive stock returns around announcements of appointments of outside directors. Several studies also obtain indirect evidence in support of the positive impact of outside directors (Weisbach, 1988; Cotter, Shivdasani, and Zenner, 1996; Baysinger and Butler, 1985). Using a sample of non-financial companies listed on the Stock Exchange of Thailand during 1999-2001, Limpaphayom and Sukchareonsin (2003) find a positive relation between board composition and firm market valuation. Contrary to the argument that outside directors help ensure management behavior and incentives are better aligned with the interests of shareholders, several studies suggest that outside directors may not necessarily act in the interests of shareholder since CEOs often dominate the director nomination process (Mace, 1986). In addition, Morck, Shleifer and Vishny (1988) suggest that outside board members are capable of becoming entrenched and inefficiencies result, in the form of unchecked deployment of corporate assets or transactions favoring management, to name two examples. Agrawal and Knoeber (1996) point out the possibility that outside directors are appointed as a result of political rather than monitoring reasons. In the end, they document a negative relation between board composition and firm performance. Hermalin and Weisbach (1991) observe that a high proportion of independent directors does not always predict better future accounting performance. Thus, the entrenchment view predicts a negative relation between board composition and firm performance. Using a sample of Thai non-financial companies, Limpaphayom and Sukchareonsin (2003) also find that the relation between board composition and market valuation for firms with high insider ownership is not statistically significant, indicating an entrenchment effect when ownership structure is concentrated.
The other crucial characteristic of the board of directors is its size. When considering the size of the board, there is a trade-off between additional value-added expertise or monitoring benefits and disadvantages stemming from the coordination problem. Jensen (1993) posits that larger board size leads to less candid discussion of critical issues which, in turn, leads to poor monitoring. Jensen (1993) contends that the optimal size of the board is eight members. Yermack (1996) finds a negative relation between board size and firm value among large firms in the US. Huther (1997) examines a sample of US public utilities, firms with limited managerial discretion since utilities operate with strict regulatory oversight and high public disclosure requirements. Huther (1997) finds that board size negatively relates to firm efficiency. Eisenberg, Sundgren and Wells (1998) also document a significant negative correlation between board size and profitability in a sample of small- and medium-sized Finish and Swedish firms. Overall, there is strong international evidence supporting the idea that board size has an effect on firm performance.
1.2 STATEMENT OF PROBLEM
In recent years, the wave of accounting scandals that occurred within the international financial community has raised many questions and concern about financial reporting quality (Agrawal and Chadha, 2005; Brown, Falaschetti, and Orlando 2010). Several prominent firms were involved in accounting frauds, such as Enron, WorldCom, Marconi, Parmalat, Cadbury, and Oceanic bank. These have weakened the investors’ confidence in the management team and the financial reports (Biddle, Hilary and Verdi, 2009). The widespread failure in the financial information quality has created the need to improve the financial information quality and to strengthen the control of managers by setting up good firms structures. Financial information quality in Nigeria remains weak compared to many advanced jurisdictions. This resulted in hampering of the growth of efficient equity markets. A common complaint among investors in Nigeria is that financial information on company performance is either unavailable or, if provided, lacks reliability (Shehu, 2011).
Corporate financial reporting has become a global concern particularly in recent time due to the reported cases of corporate failures arising from improper, false and misleading financial reporting in firms which hitherto had enjoyed good reputation due to the track record of great success in their lines of business (Agrawal and Chadha, 2005). A financial statement is said to be misleading if it lacks the qualities of accuracy, relevancy, comparability, reliability, compatibility and it contains fundamental errors or is prepared with the intention to deceive and/or confuse the users. Such deception can be carried out in a number of ways, among which are distortions of accounting records, falsification and omission of transactions, or misapplication of accounting principles (Higgs, 2003). Many reasons can be adduced for the preparation of such misleading financial statements. As argued by the different convergence views. There is a view that misleading financial statements are prepared for the demand of high returns by shareholders on their investments.
1.3 OBJECTIVE OF THE STUDY
By using four corporate governance mechanisms (audit committee size, Audit Committee composition, board size and board composition), this research aims to examine the impact of corporate governance mechanisms in the performance of Nigeria firms by using one firm performance measurement (ROA), this study particular aims to examine the association between:
1.4 RESEARCH QUESTION
In line with the objectives of the study, the following hypotheses have been formulated in null form:
i. HO1: Firm structure variables (firm size and leverage) have no significant impact on the financial reporting quality of quoted manufacturing firms in Nigeria.
ii. HO2: Firm monitoring variables (board composition and institutional shareholding) have no significant impact on the financial reporting quality of quoted manufacturing firms in Nigeria.
iii. HO3: firm performance variables (profitability, liquidity and firm growth) have no significant impact on the financial reporting quality of quoted manufacturing firms in Nigeria.
1.6 SIGNIFICANCE OF THE STUDY
The motivation for this study hinged on a number of reasons. Nigeria is the largest market in Africa by the virtue of her size. She also plays significant and dominant roles in the economics and politics of the region, both in the ECOWAS and the African Union. Furthermore, there is gap in our knowledge of disclosure or reporting practices from this region of the global economy. Improvements in our insight on this issue are crucial for a more transparent global market where cross listing and cross border activities is growing. The importance is more clearly highlighted in the case of internationalization of standards and the impact of accounting standard differences on value relevance of the information in the financial statements for different users.
One of the significance of this study, therefore, is to help standard setters adjust and determine an optimal level of management judgment and discretion to ensure an effective communication between managers and investors and to discourage widespread abusive earnings management. Researches on value relevance of financial reporting are motivated by the fact that quoted firms use financial statements as one of the major medium of communication with their equity shareholders, creditors and public at large. Furthermore, lot of efforts are been made by stock market regulators and accounting standard setters in order to improve the quality of financial reporting and increase the level of transparency in financial information reporting. The level of research interest in this area directly reflects the effect that the adequacy of financial reporting quality has on decisions making by the various users of financial statements of quoted manufacturing firms in Nigeria. Therefore, the findings of this study is expected to have particular positive implications of coming up with policies and standards that will control manipulative accounting by regulators responsible for ensuring high quality financial reporting such as Financial Reporting Council of Nigeria, Nigerian Securities and Exchange Commission and Corporate affairs Commission. In addition, the financial analysts, stock market stakeholders and shareholders and management of Nigerian manufacturing firms stand to benefit tremendously from the outcome of this research.
1.7 SCOPE OF THE STUDY
The study examines board’s characteristics and firm performance. It dwells on quoted manufacturing firms in Nigeria only and covers a period of five years (2006-2010). This period is chosen because it was the time when difference scandals of reported accounting numbers is witness. Financial reporting quality is the dependent variable of the study while profitability, leverage, firm size, board composition, liquidity, firm growth and institutional shareholding are independent variables of the study. This study will control the firm characteristics into structure variables, monitoring variables and performance variables. These categories are based on Wallace et al. (1994) and Chen and Jaggi (2007).The performance variables include profitability, defined as the ratio of profit after tax to total asset and liquidity defined as the ratio of current assets to current liabilities as well as firm growth defined as changes in total sales. The structure variables on the other hand covers leverage, defined as the ratio of long-term debt to equity, firm size defined as the total assets and the monitoring variables composed of board composition defined as ratio of outside or non-executive directors to total directors and institutional shareholding defined as the percentage of shares owned by institutions.
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