Abstract
This study examines the effect of audit tenure on earnings management of listed firms in Nigeria. Audit tenure defines the length of the auditor-client relationship while earnings management is defined as a manner of influencing the income of firm by using the discretionary accruals. An excessively long association between the auditor and his client may constitute a threat to independence which may affect the report on earnings management. This paper provides a literature review of audit tenure on earnings management based on four theories that explain the use of earnings management: the agency theory, the stakeholder’s theory, the stewardship theory and opportunistic earnings management theory. The study relies on secondary data derived from various companies’ financial statements and the Nigerian Stock Exchange fact book to determine and measure the level of earnings manipulations in corporate financial statements. The descriptive statistics result reveals a minimal presence of discretionary accrual management by the companies in the sample and on the average.
I recommend that mandatory rules, regulations, and guidelines to be set and applied to control the auditor rotation frequency and transition period to ensure auditor independence. The study also recommends that there is need for the Central Bank of Nigeria and other regulatory bodies to look into the issue of audit firm tenure and its effect on audit quality in Nigeria, and review the policies on audit firm tenure.
TABLE OF CONTENTS
Title Page i
Declaration ii
Certification iii
Dedication iv
Acknowledgements v
Table
of contents vi
List
of Tables ix
Abstract x
CHAPTER ONE: INTRODUCTION 1
1.1Background
to the Study 1
1.2Statement
of the Problem 4
1.3Objectives
of the Study 5
1.4Research
Questions 6
1.5Research
Hypothesis 6
1.6Significance
of the Study 7
1.7Scope/Limitation
of the Study 9
CHAPTER
TWO: REVIEW OF RELATED LITERATURE 11
2.1Conceptual
Framework 11
2.1.1Concept
of Audit 11
2.1.2Concep
to audit tenure 12 2.1.2.1Short
audit tenure 13
2.1.2.2Long
audit tenure 14
2.1.3Concept
of audit firm size 15
2.1.4Concept
of audit industry specialization 16
2.1.5Concept
of audit quality 18
2.1.6Concept
of earnings management 19
2.1.6.1Capital
Market Incentives 21
2.1.6.2Management
Compensation Contract Incentives 22
2.1.6.3Debt
Contract Incentives 22
2.1.6.4Regulatory
Requirements and Political Cost Incentives 24
2.2Theoretical
Framework/Model of the study 25
2.2.1The
agency theory 25
2.2.2The
stake-holders theory 26
2.2.3The
stewardship theory 27
2.2.4The
opportunistic earnings management theory 28
2.3Empirical
Review 29
2.4Summary/Gap
in Literature 33
CHAPTER THREE: METHODOLOGY 35
3.1Research
Design 35
3.2Area
of the study 35
3.3Population
of the study 35
3.4Sample
size determination 36
3.5Method
of data Collection 36
3.6Model
Specification 37
3.7Data
Analysis Techniques 38
CHAPTER
FOUR: DATA PRESENTATION AND DATA ANALYSIS 39
4.1
Descriptive Statistic 39
4.1.1
Test of hypothesis 1 40
4.1.2
Test of hypothesis 2
4.1.2
Test of hypothesis 3 42
CHAPTER
FIVE: SUMMARY OF FINDINGS CONCLUSION
AND
RECOMMENDATION 43
5.1
Summary 43
5.2
Conclusion 44
5.3
Recommendations 45
REFERENCES
LIST OF TABLES
Table
4.1
Table
4.2 Test of Hypothesis 1
Table
4.3 Test of Hypothesis 2
Table
4.4 Test of Hypothesis 3
CHAPTER
ONE
INTRODUCTION
1.1
Background to the study
Audit ownership reflects independence
which in the context of government is a signal whether there is fraudulent
financial reporting or not. Furthermore, audit industry specialization shows
audit competencies in certain industries, so auditors of industrial
specialization have more ability to detect material misstatements as a result
of fraudulent financial reporting.
The auditing and the audit process provide
an evaluation of the probability of material misstatements and reduce the
possibility of undetected misstatement to a reasonable or appropriate assurance
level (Watts & Zimmerman, 1986; Knechel, 2009). Consequently, auditing has
been acknowledged to influence financial reporting and provide robust impact on
investors’ confidence (Levitt, 1998). Essentially, external auditors perform
significant and greatly challenging tasks in guaranteeing the credibility of
financial reports. Arrunada (2000) shows that the demand for auditing services
arises from a need to facilitate dealings between the parties involved in
business relationships shareholders, creditors, public authorities, employees,
customers, etc. Exchanges between such parties are usually costly since
information asymmetries give rise to uncertainty concerning the performance of
contractual obligations.
Auditor Tenure defines the length of the
auditor-client relationship while auditor independence (measured by the quantum
of audit fees received) defines an auditor’s quality of being free from
influence, persuasion or bias, and hence the unbiased mental attitude in making
decisions throughout the audit and financial reporting process. The absence of
independence may greatly impair the value of the audit service and the audit
report. On the other hand, an excessively long association between the auditor
and his client may constitute a threat to independence. This study examines the
relationship and effects of auditor tenure and auditor independence on the
earnings management of firms in Nigeria
Johnson, Khurana & Reynolds, (2002)
and Myers, & Omer, (2003) define audit tenure as the number of years that
an auditor is retained by a firm. Tenure within three years is considered short
tenure, and more than nine years is considered long tenure. Similarly, this
study also defines short tenure when the audit period falls within three years.
However, tenure of more than three years is treated as long audit tenure. Prior
research shows that auditors engaged in short tenure are associated with a
lower earning quality than those auditors who are engaged in long tenure.
Earnings management may be defined as
reasonable and legal management decision making and reporting intended to
achieve stable and predictable financial results. Earnings management is not to
be confused with illegal activities to manipulate financial statements and
report results that do not reflect economic reality. Earnings, sometimes called
the bottom line or net income, are the single most important item in financial
statements. They indicate the extent to which a company has engaged in
value-added activities. They are a signal that helps direct resource allocation
in capital markets. In fact, the theoretical value of a company’s stock is the
present value of its future earnings. Increased earnings represent an increase
in company value, while decreased earnings signal a decrease in that value.
According to Fields et al. (2001),
earnings management is initiated from the flexibility of accounting choices
given by the Accounting Principles, allowing managers to choose the proper
reporting procedures and pick assumptions and estimations that are suitable for
each business environment. Giving managers with an opportunistic behavior a
chance to choose certain reporting procedure that helps them maximize their
wealth (Watt & Zimmerman, 1990). Therefore, Stakeholders find it hard to
recognize the exact net worth and economic value of a firm, as financial
reports do not reflect the actual performance of the firm.
1.2 Statement of the Problem
Recent
corporate accounting slander has cast doubt on the quality of reported earnings
and the ability of audit process to effectively constrain earnings management
of companies across the world and Nigeria in particular (Badawi, 2008; Enofe,
2010). Differences in quality of the audit process and auditors’ reports result
in variations in the credibility of auditors and the reliability of the
earnings reports of companies. These recent corporate financial failures pose a
great challenge to the authenticity, integrity, effectiveness and significance
of the audit function.
Several
studies (Arrunada and Paz-Ares, 1997; Healey and Kim, 2003; Brody and Moscove,
1998; Dopuch, King and Schwartiz, 2001; Myers, & Omer, 2003; Mgbame,
Eragbha and Osazuwa, 2012) have attempted to analyze some explanatory variables
for the state of audit quality. In view of these studies, auditor tenure has
become the focus of much debate. Should a firm replace its auditors on a
regular basis, or should the auditor be allowed to build a long-term
relationship with the client? Studies on the effect of auditor tenure on audit
quality are at divergent. The spate of audit failure in the world, especially
in Nigeria, has brought great disappointment to the users of financial reports.
The bane of the problem has been linked to long term of audit firm tenure which
has also been linked with creative accounting.
Also,
most of the prior studies on audit quality and earnings management in Nigeria
such as Okolie, Izedonmi and Enofe (2013) and Okolie (2014) focused more on
audit firm size, audit fees and auditor tenure even though the literature has
listed other proxies of audit quality. This approach limits the generalizability
of findings concerning the effect of audit quality on earnings management of
listed firms in Nigeria.
Recent
studies have been carried out on audit quality to earnings management but none
has been able to specifically point out the relevance of audit tenure has it
relate to earnings management focusing on the audit firm size, auditor industry
specialization and audit quality. This a problem because the number of years an
auditor works or renders services to an organization can also influence earning
management.
1.3
Objectives of the Study
The broad objective of
this study is to examine the effect of audit tenure on earnings management of
listed firms in Nigeria. This study specifically sought to:
i.
Examine the effect of
auditor tenure on earnings management of listed firms in Nigeria.
ii.
Ascertain the effect of
audit firm size on earnings management of listed firms in Nigeria.
iii.
Assess the effect of auditor industry
specialization on earnings management of listed firms in Nigeria.
iv.
To determine whether the
length of auditor tenure enhance audit quality on earnings management of listed
firms in Nigeria.
1.4
Research Questions
i.
What is the effect of
audit tenure on earnings management of listed firms in Nigeria?
ii.
What is the effect of
audit firm size on earnings management of listed firms in Nigeria?
iii.
What is the effect of
auditor industry specialization on earnings management of listed firms in
Nigeria?
iv.
To what extent does the
length of auditor tenure enhance audit quality on earnings management of listed
firms in Nigeria?
1.5 Research Hypothesis
In
line with the research questions and objectives, the following hypotheses are
formulated:
HO1: Audit tenure has no significant effect on
earnings management of listed firms in Nigeria.
HO2: Audit firm size has no significant effect
on earnings management of listed firms in Nigeria.
HO3: Auditor industry specialization has no
significant effect on earnings management of listed firms in Nigeria.
HO4: There is no significant relationship between
the lengths of audit tenure to enhance audit quality on earnings management of
listed firms in Nigeria.
1.6 Significance of the Study
The
study will be quite significant to different group of people. The importance of
this study on the effect of audit tenure on earnings management on firms in
Nigeria needs not to be overemphasized.
i. Regulatory Authorities: Regulatory
bodies such as the Securities and Exchange Commission (SEC) and Central Bank of
Nigeria (CBN) among others, can use it to strengthen existing regulatory
policies that would enhance audit quality and the integrity of financial
reports of companies quoted on the NSE. This is important because most of the
existing regulatory policies in Nigeria were adopted from developed countries
with different economies and sophisticated regulatory framework.
ii.
Financial Institutions: The
study can also serve as a yardstick in the assessing of information and also
guide in the decision making of the institution as it concerns auditing and the
reporting of financial statement of the users of the firm.
iii. The Financial Reporting
Council of Nigeria (FRCN): This study would also
beneficiary to the FRCN from its findings and recommendations. This is because
the results and recommendations of the study are a useful input into the
ongoing public debate for the FRCN code of corporate governance for public
companies in Nigeria.
iv. Public Companies: The
study also contributed to the existing literature on audit quality and earnings
management of public companies in developed and developing economies.
v.
Government: The government will find this work relevant to
future policy and decision making, which will particularly reconstruct it
agencies for better performance in auditing in firms Nigeria.
vi.
Investors: The
study could also benefit both current and potential investors in Nigeria. This
is because the effect of audit tenure on earnings management would guide
current investors to either divest or maintain their investments in the firms
on the Nigerian Stock Exchange (NSE).
vii. Future Research: This
will serve as a data to the future researchers who intend to carry out research
n auditing and earnings management related topics. The study could also serve as a good library
material for students and researchers who intend to carry out similar studies
in this area.
1.7 Scope/ Limitation of the Study
The
study aims at showing the effect of audit tenure on earnings management on
firms in Nigeria. The limitations of this study included some of unavoidable
constraints and challenges encountered in the process. They include the
following:
i.
Access to Literature: In
the majority of cases, studies start when researchers identify gaps in the
literature and try to address them. However, the identification or
understanding that there is a gap depends on the researchers’ level of access
to the existing literature. This includes the problems of easily getting the
appropriate data due to bureaucracy which hinders the information flow in the
country. Even with this challenge, the researcher is to make do with available
materials.
ii.
Time: This
is also one of the limitations to this study, due to the fact that the student
also has other courses of study, this tend to give limited time. Often students
have a deadline to turn in their work. Other academics have conference or
journal deadlines. Inspire of this challenge, the researcher is expected to
make good use of the available time to get the work done properly.
iii. Financial Resources: Money
is always a challenge. Sometimes we need it to purchase the necessary equipment
for a study, to hire people for data collection, to purchase a specific
statistical software or to simply reward participants with products or
giveaways for having participated in the study. When financial resources are
scarce, all of these possibilities are compromised. Insufficient fund will hinder an in-depth
study of this research since it is finance from pocket money of the researcher.
Even with this challenge, the researcher has no option but to make good use of
the available resources to get the job done.
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