CHAPTER ONE

INTRODUCTION

1.1background of the Study

Earnings Management refers to the practice of managers of the firm to undertake some managerial actions on company’s performance variables, which are reflected in the company annual financial statements. The practice of earnings management in the firms aims at giving the impression of smooth annual earnings by showing high profit for the current accounting period at the expense of future earnings or to lower the current earnings in order to report high earnings in the future (Ronen & Yaari, 2008). It is therefore the deliberate altering of financial information reported in the annual financial report in order either to mislead the users on the underlying economic condition of the firm or to gain some contractual benefits, which depend on the reported accounting numbers in the financial statement (Healy and Wahlen, 1999, Bergstresser and Phillippon, 2003).

Earnings management is a problem, which has recently gained more importance among the users of financial information, shareholders and other stakeholders. Managers of company have been reported to use various accounting methods to mislead the users of financial statement and stakeholders about the true financial performance of the company hence gain at the expense of the owners and users of the financial statement. The magnitude of earnings management problem and its impact on the organisation performance is highly contributed or caused by lack of financial reporting transparency among the firms. This due to the fact that most organisations use accrual accounting methods which is the components of earnings, that are not reflected in the current cash flows and which the firm managers have discretion in reporting it (Bergstresser& Phillippon, 2003). Secondly, earnings management is motivated by the strong incentives among the managers to use judgment in financial reporting when preparing the financial

statements as well as in structuring of transactions to alter the financial statements so that they can achieve their personal goals such as increasing managerial compensation which is highly related to the earnings of the firm (Degeorge et al., 1999, Cornett et al, 2008).

The impact of earnings management practices on the firm’s performance and value is very high which has resulted in major accounting scandals in the history of accounting such as the Xerox 2000, Enron 2001 and the WorldCom in 2002. As a results of such scandals most of investors trust on accuracy of accounting statement and the information contained in has been reduced and has also led to increased attention of the regulators, the governments and other bodies (Ronen & Yaari, 2008). It has also resulted in increasing demand for financial information transparency since the earnings manipulation have impact even to the stock prices for companies registered in the capital markets.

Problems of earnings management are indicated to be very large in developing countries like Tanzania as a result of weak rules of law and corruption. Studies have shown that earnings management problem is more common in countries with weak rule of law as compared to countries with strong rule of law especially on financial matters (Dyreng et al 2011). It is clearly known that the financial reports prepared by an organisation are the mirror used by stakeholders to judge the performance of the company hence the quality of the reports is very important. Users of the statements make financial decision basing the information displayed, judge the management competence using the information and serve as the benchmark for forecasting future performance of the firm. The manipulation of earnings by either reason is therefore detrimental practice to the users of the financial statements who make decision depending on such statement, detrimental to the performance of the firm as well as to the wealth of the shareholders (Cornett et al., 2008, Bergstresser & Phillippon, 2006).

1.2 Statement of the Problem

Although the problem of earnings management and its impact to the performance of the firms is indicated to be high in developing countries (Dyreng et al. 2011), the extent of the problem in Tanzania is not yet known. This is due to the fact that little empirical studies have been conducted in the area of earnings management and especially on the impact of the earnings management to the performance of the firm. Since the capital market in the country is at its growth stage and more firms want to register and acquire the public funding, there are possibilities of earnings management in order to attract the investors to buy the shares, but which have not yet been explored to know the extent of the problem and its impact to the performance of the companies.

Studies which have been conducted in the country and which relate to these areas have provided some insight into what is prevailing in the field. The study by Patrick et al. (2014) on corporate governance reported that more than half of the institutions reviewed do not comply with corporate governance requirements. Since corporate governance requires high disclosure especially on management and director’s non-disclosure of financial information suggests the possibilities of earnings management. The study by Okiro (2014) on capital markets of Tanzania, Kenya and Uganda reports on the presence of significant relationship between the corporate governance and performance which also portray that financial disclosure is very important on performance as it one way of minimizing earnings management practices in firms.

Although some authors have presented findings on the studies relating to financial disclosure, governance and performance of the firms, studies on earning management practices in Tanzania could not be found, hence little is known about this problem regardless of the use of accrual accounting in most of the firm both registered and unregistered. Therefore, this study aimed at assessing the impact of earnings management of firm’s performance for the manufacturing companies registered at Nigeria stock exchange market. The study sought to generate knowledge on the

earnings management practices and their impact on the firm’s performance and suggest the ways that can be used to manage the problem in Nigerian context.

1.3 Objectives

The general objective of the study was to assess the impact of earnings management on the firm’s performance for the manufacturing companies registered at Nigeria stock exchange market. The specific objectives of the study were:

i.                    To assess the earnings management level of the manufacturing companies listed at NSE

ii.                  To examine the performance of manufacturing companies registered at NSE

iii.                To assess the relationship between earnings management and firm’s performance for the manufacturing companies registered at NSE

1.4 Research Questions

In order to the meet the above specific objectives; the following research questions were used:

i.        What is the level earnings management in manufacturing companies at NSE?

ii.      What is the performance level of manufacturing companies listed at NSE?

iii.    What is the relationship between earnings management and the performance of manufacturing companies listed at NSE?

1.5 Scope

This study focused on the assessment of the impact of earnings management on firm’s performance taking manufacturing companies listed at NSE as the case study. The study considered only manufacturing companies, which have been registered at NSE to enable the researcher to measure firm’s performance using, market measures. The study did not focus on other issues related to the capital market rather on the earnings management issues and the performance of the selected firms.

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