CORPORATE GOVERNANCE AND EARNING QUALITY OF INSURANCE FIRMS IN NIGERIA
This research proposal is aimed to examine the effect of corporate governance on the earnings quality of insurance firms in Nigeria.
CHAPTER ONE
INTRODUCTION
Background of the Study
The financial community and investors generally express concern about financial reporting, particularly when it comes to the quality of reported earnings and the effectiveness of corporate governance systems. Regulatory bodies are calling for improved corporate governance and accounting quality and have enacted reforms in developed country financial reporting processes (the Sarbanes Oxley Act 2002). The debate on corporate governance and earnings quality has extended as well to emerging countries as weak corporate governance is cited as one possible cause of financial crises in emerging markets.
The need for a good corporate governance structure arose as a result of the separation of ownership between a firm and its owners which turns the firm into a nexus of relationships between it and all its stakeholders such as managers, employees, shareholders, creditors government, etc. the separation of ownership and control by the sophistication of modern-day business redefines the relationship that exists between the managers and owners to that of agent and principal. As an agent, the manager is expected to pursue goals that are in line with the wealth maximization objectives of the shareholders. The existence of conflicting interests between managers and owners naturally compromises the value of the firm and only transparency can eliminate that conflict. For a company to be transparent, it should be able to disclose in full the financial activities of the company. (Thompson and Yeung 2002) it has been recognized that financial statements play a crucial role in assessing the performance of managers by the board of director’s financial analysts, investors and external regulators. It is therefore not unlikely that managers will perform earnings management in order to produce a good image for themselves and the firms that they manage through unethical accounting by managing earnings.
Earnings management is the act of intentionally influencing the process of financial reporting to obtain some private gain; it involves the alteration of financial reports to mislead shareholders about the underlying performance or to influence the contractual outcomes that depend on reported numbers. These elements are peculiar to industries depending on the nature of their operation and external regulatory framework. Researchers such as Klien (2002) has identified that accruals arising from depreciation are used to manipulate earnings in most firms. The use of discretion by firm managers to reported earnings has long been identified by accountants and financial economists (Amat, Gothorphe and Perramon 2005). Several studies have shown that good governance mechanism can impact on the discretionary behavior of managers (Warfield, Wild and Wild 1995, Klien 2002, Ahmed 2006 and Shehu 2011).
Earnings are the backbone of organizations as they are an essential area of consideration thereby determining success and sustainability. The earnings of organizations vary as they are influenced by governance. Good corporate governance brings about financial report that is of high quality. (Nkanbia – Davies, Gberebge, Ofurum and Egbe, 2016). Earnings are essential in organizations as they affect the decisions of investors and this is one of the reasons why firms at times carry out financial practices that are unhealthy in their financial reports (Norwani, Mohammad and Chek, 2011), knowing that the value of reports has significant value relevance to investors, thereby influencing their investment decisions (Ibrahim, 2017). Good and strong corporate governance makes managers uncomfortable in carrying out activities that may be deceptive in their financial reporting, thereby increasing the quality and reliability of financial reporting of such companies. (Heirany, Sandrabadi and Mehjordi, 2013). Governance mechanisms are put in place so as to enhance companies’ financial statement credibility and curtail the behavior of managers (Lee 2013). The financial reports of Enron indicated an understatement of liabilities and overstatement of equity and earnings which brought failure to their financial reporting and they were declared bankrupt prior to the end of 2001 (Norwani et al, 2011).
The financial scandals that sunk large companies like Enron and WorldCom in the United States and many other companies around the world show that there was a veil that had hitherto not been penetrated. The fall of Enron was due to their financial reporting inadequacies coupled with the oversight functions of board of directors, advisors, lenders and analysts. For WorldCom’s lack of transparency of the senior management and board of directors revealed the absence of internal control, the pressure to keep the stock price of WorldCom high misled their financial reporting and instead of reporting losses, the company consistently reported meeting its target (Norwani et al, 2011).
In Nigeria, corporate scandals in organizations are as a result of lapses in the financial practices by firms, the corporate scandal involving Cadbury Nigeria revealed findings by the SEC (2008) that one of the managing directors of the company had been conniving with the company’s board, he used stock buybacks, cost deferrals, trade loading and false suppliers certificate to manipulate the financial reports of the company that were issued to the public and filed with the commission. This was however due to non-compliance with the corporate governance code (Ibadin and Dabor, 2015). In the case of Lever Brothers (now Unilever) it was discovered that billions of naira of stock were overvalued (Jimoh, Idogho and Iyoha, 2012).there is also the case of AP Nigeria Plc and ailing banks in Nigeria. The corporate scandals evidenced in companies stress the urgent need of accounting standards, auditing processes and financial reporting practices effectiveness so as to have reliable accounting information (Adeyemi and Asaolu,2013).
Corporate governance pillars are essential as they reflect on the financial reporting process in organizations. These pillars include disclosure and transparency, responsibility and accountability, integrity and fairness (Holm and Schuler, 2010, Keay and Loughrey, 2015). Strong corporate governance brings about a broad vision of the accounting process and this is associated with reported earnings (Heirany et al 2013). Firms sometimes carry out financial practices that are unhealthy to achieve targets, thereby manipulating their financial reports (Norwani et al 2011). Some of the practices lead to companies having poor earnings quality. Earnings is crucial in organizations as it affects the decision of investors. The quality of financial reports has significant value relevance to investors and it influences their investment decisions (Ibrahim, 2017). Poor earnings quality gives rise to the quest for good governance so as to ensure the reduction of asymmetric information and agency conflict between shareholders and managers (Gaio & Raposo, 2014). Corporate governance is set for oversight and monitoring of management activities so as to have good practices in organizations (Lee 2013). Strong corporate governance brings about a broad vision of the accounting process and this is associated with reported earnings.
Accounting information, on one hand, plays a crucial role in the corporate governance process (Bushman and Smith 2001, 2005) and financial reporting and disclosure are seen as a significant component of corporate governance (La Porta, Lopes de Silanes, Shleifer and Vishny 1998). There is also evidence that corporate governance structures and practices are vital to aid the quality of reported earnings, in particular by reducing earnings management opportunistic behavior (Decrow, Sloan and Sweeny 1996). As financial accounting is a major part of corporate governance, higher quality of earnings may lead to a more effective governance mechanism and a more effective mechanism may contribute to the higher quality of earnings suggesting complementarity between corporate governance and earnings quality. On the other hand, limitations of poor accounting information, particularly reported earnings could force costly information acquisition and monitoring mechanism. Indeed investors may demand stronger governance arrangements when the firm’s earnings are ambiguous and firms shift towards the use of more expensive performance measures when accounting information is of little or no usefulness (Bushman and Smith 1996). In this sense, corporate governance and earnings quality could be seen as substitutes.
Many literatures have broadly supported the existence of a relationship between corporate governance and reported earnings, both in theoretical and empirical studies. However, the relationship between corporate governance and earnings quality is far from understood. It is not clear whether corporate governance and earnings quality are complementary or substitute mechanisms. Corporate governance aims at improving the earnings quality of firms. The financial information presented in the financial reports of companies reflects the management of such companies. There are processes that are being followed by companies to prepare those reports which influence the firms’ earnings. The financial reporting of companies in Nigeria is found to be weak and deficient over the years, thus making the information presented by companies not to be aligned with the economic reality for stakeholders to make informed decisions (World bank, 2004). Empirical evidence signifies that reporting in Nigeria is seen to be weak (Unuagbon and Oziegbe, 2016). The weakness of the regulatory authority supervisory level results in difficulty in discovering and resolving issues involving ethics and corporate governance in Nigeria Adegbie & Fofah, 2016). The financial practices of managers have effects on companies in the long run.
In this paper, we examine the relationship between corporate governance and earnings quality of insurance firms in Nigeria. Our main contribution is to empirically assess whether corporate governance affects the earnings quality of insurance firms and also to assess the level of this relationship. We investigate whether corporate governance in any way affects Earnings quality in insurance firms because corporate governance consists of a complex set of interrelated internal and external mechanisms and prior studies have examined earnings quality using either a single attribute of earnings or a subset of earnings attributes. Moreover, because of the difficulty in measuring earnings quality, we use several measures to study the relationship between corporate governance and earnings quality.
Though the banking industry is said to act as an engine of any economy coupled with larger or more prominent industries, the insurance industry also plays a vital role in indemnify risks and making cash available to the business sector for investment which leads to growth in the economy, in addition, corporate governance has been accepted by most countries including Nigeria to be one of the easiest ways of combating financial irregularities, agency problems, and improving an attractive investment climate, however, this might not always be the case and this is what this study intends to uncover.
Statement of the Problem
The importance of corporate governance in the administration of companies cannot be overemphasized especially as it relates to earnings quality. Over the years financial reporting quality has become of topmost importance to the stakeholders and shareholders, regulatory agencies and the academic world not only in Nigeria but also globally. Corporate governance is to reduce the divergence of interest between shareholders and managers. Such divergence of interest could border along with the management of earnings through the use of accounting accruals. In addition, corporate governance has been accepted by most countries including Nigeria to be one of the easiest ways of combating financial irregularities, agency problem and improving an attractive investment climate. Some researchers have observed that agency relationship arises in any situation involving a cooperative effort by two or more people. The relationship between the stakeholders and the board of directors is a pure agency relationship. Agency theory provides a natural backdrop for this study because financial reporting concerns arise when there is a conflict of interest between managers and owners coupled with information as symmetries. For example in Nigeria, the corporate scandal involving Cadbury Nigeria revealed findings by the SEC (2008) in which one of the managing directors of the company had been conniving with the company’s board, he used stock buybacks, cost deferrals, trade loading, and false suppliers certificate to manipulate the financial reports of the company that were issued to the public and filed with the commission and there is also the instance of Lever plc. Corporate governance serves as a device to mitigate the potential conflicts that exist between the principal and the agent thereby leading to high earnings quality. The insurance industry is an important element of the Nigerian financial system and it plays the vital role of indemnifying risks and making cash available to the business sector for investment which leads to growth in the economy. Notwithstanding the numerous contributions, the sector is faced with some problems that have hindered progress and goal actualization. This problem ranges from ethical issues, poor premium management, poor labour practices and weak regulatory mechanisms (Akingbola, 2010). Also, insurance in Nigeria lacks proper code of conduct on how businesses should be carried out and lack of ethical behavior in insurance business practice. It is in the light of these identified problems and to bridge the gap in the body of existing literature, an empirical investigation is carried out on Corporate governance and Earnings quality in Insurance companies in Nigeria.
Aims and Objectives of the Study
The aim of the study is to examine the effect of corporate governance on the earnings quality of insurance firms in Nigeria. The specific objectives include;
- To determine if board composition has significant effects on accruals quality, conservatism and earnings predictability of insurance firms
- To ascertain whether the audit committee affects accruals quality, conservatism and earnings predictability in insurance firms
- To assess the effect of board size on the accruals quality, conservatism and earnings predictability of insurance firms.
Research Questions
Based on the above objectives, the researcher develops the following research questions.
- What is the effect of Corporate governance on Accrual quality, Earnings predictability and earnings conservatism of insurance firms in Nigeria?
- What effect has corporate governance have on Accrual quality, Earnings predictability and Earnings conservatism in insurance companies in Nigeria?
- How does corporate governance affect Accrual quality, Earnings predictability and Earnings conservatism in Nigeria?
The hypothesis of the Study
In line with the studies objectives, the following hypothesis was formulated in a null form
HO1; Board composition has no significant effect on accruals quality of insurance firms
HO2; Board composition has no significant effect on the conservatism of insurance firms.
HO3; Board composition has no significant effect on earnings predictability of insurance firms
HO4; Audit Committee has no significant effect on accrual quality of insurance firms
HO5; Audit Committee has no significant effect on the conservatism of insurance firms
HO6; The audit committee has no significant effect on the earnings predictability of insurance firms.
HO7; Board size has no significant effect on accrual quality of insurance firms
HO8; Board size has no significant effect on the conservatism of insurance firms
HO9; Board size has no significant effect on earnings predictability of insurance firms.
Scope of the Study
The scope of the study is limited to insurance firms in Nigeria. There are 51 insurance firms in Nigeria which are divided into two strata, that is Life insurance Non-life insurance. The study was limited to 17 quoted insurance companies, spanning a period of five years (2014 – 2018). The justification for selecting these 10 companies was based on their stock listing in the Nigerian Stock Exchange (NSE) and the availability of required data to carry out the research for the aforementioned period.
The limitation of the study is that 34 out of 51 insurance companies were either not listed in the Nigerian stock exchange or they did not have the complete required data for the stated period. It was therefore not possible to include them in the study due to the paucity of data and therefore, the sample was limited to 17 out of 51 insurance firms in Nigeria.
Significance of the Study
The findings of this study will have implications for the user of financial statements such as stakeholders, potential investors, policymakers the regulatory body and students. The study is expected to contribute to strengthening the areas of concern by practitioners such as financial consultants and external auditors in manning the financial records of insurance firms relating to the role of corporate governance practice.
Theoretically, the findings of this study are expected to provide additional literature and shed more light on the areas of corporate governance and the quality of accounting numbers. This will go a long way in validating theories such as that of agency that anchored corporate governance mechanism and earnings quality in insurance firms.
Particularly, financial statement users should be aware of income smoothing and other factors affecting earnings quality when they rely on financial statements to help make decisions, specifical users should know the influence of the independent or non-executive directors and the audit committee on such behavior.
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