CHAPTER ONE
INTRODUCTION
1.1   Background to the Study
Earnings management is an area of accounting research that elicits attention from across a wide spectrum of management and other stakeholders. The Financial Accounting Standard Board (FASB 1990) refers to earnings management as the distortion of the reliability, relevance and predictive value of information presented in financial statement. Schipper (2009) defined earnings management as ‘the process of taking deliberate steps within the constraint of Generally Accepted Accounting Principles (GAAP) to bring about a desired level of reported income. Healy and Wahlen (2009) saw earnings management as when managers use judgment in financial reporting in structuring transactions to alter financial reports, either to mislead some stakeholders or to influence contractual outcomes that depend on reported accounting about the underlying economic performance of the company.
The connection between corporate governance and earnings management has been the subject of an ongoing debate. It is believed that the diffuseness of a firm’s ownership structure plausibly serves the firm’s shareholders better than a concentrated ownership structure. The users of financial information are of the notion that managers of organizations utilize earnings management opportunistically for selfish reasons rather than for the benefit of the stakeholders. This misalignment of stakeholders and manager’s interest has cited a basis for the occurrence of earnings management as managers could use the latitude provided by accounting standards to manage income opportunistically therefore, creating a distortion in reported earnings. The very nature of accounting accruals gives managers a great deal of discretion in determining the earnings a firm reports in any given period because of the information asymmetry between managers and owners. Accounting earnings are more reliable and more informative when managers opportunistic behaviours are controlled through a variety of monitoring systems (Dechow, Sloan & Sweeney, 2006).
As a result of this misalignment of interest between managers and shareholders, there has been an international trend towards developing and implementing corporate governance to fight against the opportunistic behaviours that have undermined investors’ credibility in
financial report. Corporate governance attributes help investors by aligning the interest of managers with the interest of shareholders and also by enhancing the reliability of financial information and integrity of
the financial reporting process (Watts, 2011).
It is against this background that this study is undertaken to exploratively examine the relationship between corporate governance and earnings management in Nigeria.
1.2   Statement of Problem
Several studies on earnings management such as the study carried out by Olayinka (2012), Shehu (2012) and other researchers have highlighted the presence of earnings management practice in Nigeria at different times. These practices include: profit overstatement, account falsification, price manipulation, etc which have led to the distortion of the credibility of financial reports. To mitigate these financial reporting improprieties and enhance the decision usefulness of financial statements, corporate governance emerged as a veritable mechanism to stifle the windows of earnings management. Corporate governance is a mechanism that is employed to reduce the agency cost that arises as a result of the conflict of interest that exist between managers and shareholders
Due to the incessant practice of earnings management in Nigeria, the problem of whether corporate governance variables such as board composition, audit quality, audit committee, board effectiveness, etc. can be used in curbing earnings management arises. This research is embarked upon to critically ascertain the extent to which these governance variables mitigate the existence of earnings management in Nigerian organizations.