EVALUATION OF AUDIT COMMITTEE CHARACTERISTICS AND EARNINGS MANAGEMENT: EVIDENCE FROM NIGERIA

EVALUATION OF AUDIT COMMITTEE CHARACTERISTICS AND EARNINGS MANAGEMENT: EVIDENCE FROM NIGERIA

ABSTRACT

There exists divergence of opinions in the literature on the relationship between Audit Committee characteristics and earnings management. The mix of opinions makes the direction of their relationship ambiguous. This study investigated the relationship between Audit Committee characteristics and earnings management of listed food and beverages Firms in Nigeria. The study covered the period of six years from 2007 to 2012. Data for the study were extracted from the Firms’ annual reports and accounts. After running the OLS regression, a robustness test was conducted for validity of statistical inferences. The dependent variable was generated using two steps regression in order to determine the discretionary accrual of the sample Firms. Multiple regression was employed to run the data of the study using Random Model. The results from the analysis revealed significant association between audit committee characteristics and earnings management of the Firms. While audit committee size and committees’ financial expertise showed inverse relationship with earnings management, committee’s independence and frequency of meetings are positively and significantly related to earnings management. In line with the findings, the study recommended among others that listed food and beverages Firms in Nigeria should strictly comply with the provision of Companies and Allied Matters Act (CAMA) and SEC Code of Corporate Governance on the issues regarding Audit Committees. And regulators such as SEC should increase the minimum number of Audit Committee members with financial expertise and also have a statutory position on the maximum number of Audit Committees meetings, which should not be greater than four meetings in a year as SEC code of corporate governance is silent on this.

CHAPTER ONE

INTRODUCTION

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).

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. This practice, according to Levitt (2015) “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 2016). 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.

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.

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.

By focusing on the listed Food and Beverages Firms in Nigeria, the study identifies a suitable context in which earnings management may be more easily carried out. This is can be clearly deduced from the accounting scandal by Cadbury Nigeria plc which is one of the firms of listed Food and Beverages; where the company’s share price declined from N86.52 per share as at December, 2005 to N8.65 as at October, 2009. 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 other researchers reported no relationships (Nelson and Janil 2012). These mix findings make the direction of these relationships to be the best of our knowledge, there is no study in Nigeria that has attempted to resolve the mixed result particularly in listed Food and Beverages Firms in Nigeria.

The used of 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.

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 Food and Beverages 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;

1. To determine the influence of audit committee size on earnings management of Listed Food and Beverages Firms in Nigeria.
2. To find out the effect of audit committee independence on earnings management of Listed Food and Beverages Firms in Nigeria.
3. To ascertain the extent to which audit committee financial expertise affects earnings management of Listed Food and Beverages Firms in Nigeria.
4. To examine the influence of audit committee meetings on earnings management of Listed Food and Beverages Firms in Nigeria..

1.4     Research Questions

          These are some of the research question used.

• Does audit committee size has effect on earning management of food and beverage in Nigeria firms.
• Does audit committee independent has effect on impact of earning management on listed food and beverage in Nigeria firms.
• Does audit committee meeting has influence on earning management of listed food and beverage in Nigeria firms.

1.5     Research Hypotheses

In order to achieve the above mentioned objectives and to empirically solve the problem of this study following null hypotheses were formulated.

H0¹ Audit committee size has no significant effect on earnings management of Listed Food and Beverages Firms in Nigeria.

H0² Audit committee independence has no significant impact on earnings management of Listed Food and Beverages Firms in Nigeria.

H0³ Audit committee financial expertise has no significant effect on earnings management of Listed Food and Beverages Firms in Nigeria.

H0⁴ Audit committee meetings have no significant influence on earnings management of Listed Food and Beverages Firms in Nigeria.

1.6     Scope of the Study

The study covers the period of six years from 2015 to 2020. The data used for the study was purely from secondary sources extracted from the annual reports and accounts of listed food and beverages 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.

1.7     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 Food and Beverages 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.