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CHAPTER ONE INTRODUCTION
1.1 Background to the Study
Accounting has developed over time as an essential stewardship function, which
enables owners of the business to extract accountability from the managers who are entrusted
with the task of running the organization. The custodianship function is at the root of
corporate governance, and provides the basis for the sacred trust upon which modern
business is built (Osisioma, 2001). The separation of ownership and control due to growth in
the size of businesses during the industrial revolution in the 19th century led to the
development of stewardship accounting, where those in control of business were made to
report to the owner by providing them with accounting information through annual reports
and accounts. The annual reports which are usually prepared on historical basis at the end of
every financial year are expected to serve as a measurement of firm value which should more
or equal to market value. Any change in the value of the firm as a result of income generated
from operations indicates an improvement in firm‟s value. The level of improved earnings
reported in the annual reports determines the informativeness of the accounting figures in the
firm‟s financial statement.
Informativeness of accounting earnings involved the accounting process of measuring
earnings as the change in firm‟s wealth and focusing on fair valuing of assets and
liabilities(Dechow, Ge and Schrand,2009). The information quality of reported earnings is
influenced by an array of factors, most of which stem from the demand for such information
for use in contractual arrangements. Firm‟s ownershipstructure are among the factors that
influences quality of reported earnings due to incentive alignment and monitoring effects of
1
the selected components of ownership structure. Managers to a greater extent are the ones
entrusted with the affairs of firms whom in most cases have little or no equity interest in it.
The real equity owners on the other hand have little or no direct day-to-day running of the
firm. In that respect, managers are vested with the responsibility of preparation and reporting
of the earning figures (profit) of the firm they managed. Consequently these pave way for
manouvering the information content of the report to suit their interest.
Thus, the managers as agents need to be monitored to ensure that they discharge their
stewardship role to their principal (firm owners) rather than adjusting reports to earn high
rewards at the detriment of the equity holders. As long as managers‟ oppotunistic tendency
are not monitored by shareholders because of diverse nature of equity holdings, reported
earnings will continue to be manipulated and the informativeness it deserves to portray to
firm owners for decision making is eroded. Block of shareholders if effectively were in
control of a firm, they could also control the production of the firm‟s accounting information
and reporting policies and vice versa.
Literature on stewardship accounting posits that an accounting number is deemed
value relevant if it has a significant association with equity market value (Barth, Beaver, &
Landsman, 2001), and could be used to estimate future returns (Beaver, 1968). Thus, if
reported earnings are considered by investors to be value relevant and useful in estimating
future returns, market value of shares and earnings should normally be related.
Ownership structure is considered as an important factor that influences the quality of
a firms financial reports and that it is possible to use ownership structure to predict the
informativeness of a bank‟s reported earnings by considering the earnings-returns
2
relationship with managerial ownership, earnings returns relationship with Institutional
Ownership as well as earnings-returns relationship with Ownership Concentration.
Managers may impair the faithful determination of accounting numbers in order to
meet the performance measures imposed by accounting-based contracts. Therefore,the
quality of accounting information may be positively associated with the level of managerial
ownership (Warfield, Wild and Wild, 1995). On the other hand, there are countervailing
incentives for managers to reduce the quality of accounting information. As managerial
ownership increases, managers are increasingly less subject to accounting-based constraints.
Thus, managers will reduce reporting quality if there exist the proprietary costs of disclosure,
since the less managers disclose, the less competitors and suppliers know about the firm‟s
financial position (Dye, 1985 and Hayes & Lundholm, 1996).
Institutional investors are often characterized as sophisticated investors who have
advantages in acquiring and processing information compared with individual investors
(Bushee, 1998). However, their specific role in improving reporting quality is quite
controversial. There are two opinions about the role of institutional ownership in the capital
market. The speculation argument is that institutional investors act as “traders” rather than
“owners.” Prior research provides several reasons why they act as transient investors. First,
institutions are subject to strict fiduciary responsibilities so that they have incentives to trade
frequently based on short-term financial performance in order to show fund sponsors and the
courts the prudence of their investment (Gompers & Metrick, 2001). Second,
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