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Journal of Critical Reviews THE FINANCIAL DETERMINANTS OF EARNINGS

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 Journal of Critical Reviews
ISSN- 2394-5125 Vol 7, Issue 9, 2020

THE FINANCIAL DETERMINANTS OF EARNINGS MANAGEMENT AND THE

PROFITABILITY OF LISTED COMPANIES IN NIGERIA
Abdullahi Bala Ado1, Norfadzilah Rashid2*, Umar Aliyu Mustapha3,
Lateef Saheed Ademola4
1School of Accounting, Finance and Quantitative Studies, Universiti Sultan Zainal Abidin, Malaysia. abdallahkmata@yahoo.com
2*School of Accounting, Finance and Quantitative Studies, Universiti Sultan Zainal Abidin, Malaysia.

nikmfadzilah@unisza.edu.my
3School of Accounting, Finance and Quantitative Studies, Universiti Sultan Zainal Abidin, Malaysia. umaraliyu2011@gmail.com
4School of Accounting, Finance and Quantitative Studies, Universiti Sultan Zainal Abidin, Malaysia. latsad4real@yahoo.com

Received: 06.03.2020 Revised: 08.04.2020 Accepted: 10.05.2020

Abstract
This study attempts to explore the financial determinants of Earnings Management and the profitability of listed companies in Nigeria.
The objective is to investigate the level of financial determinants of Earnings Management on the profitability of companies. This study
employed a panel data approach on 84 listed companies on the NSE with 756 firm-year observations for the period 2010-2018 financial
years. The study employs a secondary method to retrieve data from annual statement of listed companies and Thompson Reuters
DataStream. The data is analysed with the using multiple regression to examine the model. The current study reveals that earnings
ability shows a significant and positively related to the profitability, which was measured using ROA. This result from this study indicates
that the more the earnings ability of a company, the profitability of the listed companies in Nigeria will increase. Financial structure
ability shows a significant negative association with the ROA. This further indicates that any increase in financial structure ability,
profitability of listed companies in Nigeria will also increase in the same value. Furthermore, the statistical results offer evidence that
non-financial factor is positively and significantly associated with the ROA. This implies that a percentage increase in non-financial factor
will result in the increase of profitability of listed companies in Nigeria. The result also indicates that companies that engaged in financial
determinants of Earnings Management are also seen to be more profitable. Overall, this present study explains the connection between
the financial determinants of earnings management and the profitability of listed companies in Nigeria.
Keywords: Earnings Management, Financial Determinants, Profitability, Nigeria, Firms.

© 2020 by Advance Scientific Research. This is an open-access article under the CC BY license (http://creativecommons.org/licenses/by/4.0/)
DOI: http://dx.doi.org/10.31838/jcr.07.09.06

INTRODUCTION well as advertising. The second assumption is that, it is risky

Earnings management has been a huge and consistent issue
among regulators and practitioners and has gain significant
attention in the field of accounting. Several reasons and
techniques exist for earnings management practice and most of
which are the aims of the management’s (Bassiouny, 2016).
earnings management and earnings manipulation remained a
great concern for the published financial statement reliability.
Academic literature indicated that the earnings management
practice is widely conducted within publicly listed firms (Rudra
& Bhattacharjee, 2012). In emerging markets, like Nigeria
because of their relatively feeble legal administration
capabilities, earnings management issue is more commonly
practiced.
According to Cohen and Zarowin (2010) and Roychowdhury
(2006), they provide evidence and discuss that corporate
managers shifted their focus from accrual based earnings
management to the real activities manipulation (real earnings
management). Real activities manipulation occurs when
management deliberately manipulates the real operational
activities. This includes given out a discount to customers to
improve sales, timing of profitable investment and reduction of
expenditure to increase the profit level. In another argument,
Graham, Harvey and Rajgopal (2005), they indicate that as a
result of the disadvantage related with the accrual earnings
management, the earnings manipulations are most likely to be
realized through the real operational practices. The first
assumption is the effort of auditors and regulatory organisation
to detect the accruals earnings activities have shifted the focus of
managers from the accrual-based practices to the real activities
manipulation, such as those associated to production,
expenditures on research, product pricing and development as
focusing on accrual manipulation alone. The deficit between the
uncontrollable earnings and the anticipated level can surpass the
stated amount through which it is feasible to exploit accruals
following the fiscal year ending. If the revenue reported drops
beneath the level and all the strategies accrual-based to
encounter it are drained, corporate managers do not have an
alternatives since the real activities manipulation cannot be
amended at or following the end of the financial year (Inaam,
Khmoussi, & Fatma, 2012).
In Nigeria, the well-publicized corporate failures which include
big corporations like Lever Brothers Plc, the Cadbury Nigerian
Plc and African petroleum (Ajibolade, 2008). The insolvency of
these big companies, internationally and locally, curtailed from
manipulating earnings, as a result of fraudulent practices by the
executives as well as ineffective Corporate Governance
Mechanism (Fodio, Ibikunle, & Oba, 2013). The Nigerian
corporations are tremendously involved in this threat that led to
the failure of several institutions (Mustapha, Rashid, Ado, &
Ademola, 2019). This incidence has weakened the public
confidence, most particularly those within the accounting circle.
Furthermore, it has also brought to attention the issues
regarding weak internal control systems and the financial
reporting quality oamong firms (Uwuigbe, 2014). The corporate
failures of this large companies in Nigeria have emphasised the
deliberate transgression of managers in a broader spectrum.
Moreover, there are worries about the vulnerability of corporate
governance in the past, as it was not efficient enough to protect
potential and existing investors from expropriation (Patrick,
Paulinus, & Nympha, 2015).
Profitability have been recognised as the factors that affect
management ability to exploit the reported earnings (Miko &

Journal of critical reviews 31

 THE FINANCIAL DETERMINANTS OF EARNINGS MANAGEMENT AND THE PROFITABILITY OF LISTED COMPANIES IN
NIGERIA
Kamardin, 2016). This argument was consistent from the
previous study as profitability information was significantly
influence the stakeholders confidence in the capital market,
(Dakhlallh, Rashid, Wan Abdullah, & Al Shehab, 2020). Several
researches have documented variables such as profitability and
leverage influence the level of firm’s activities of earnings
management (Adeyemi & Fagbemi, 2010; Bassiouny, 2016).
Furthermore, profitability of firm is found to significantly impact
managers desire to employ creative accounting strategy in
reporting earnings. Signalling theory believes that profitable
firms have a strong reason to reveal quality earnings information
to the market participant. On the contrary, it is ascertained that
low level of profitability causes management to overstate their
earnings so as to exceed or meet up with the analyst prediction
(Iatridis & Kadorinis, 2009). Therefore, it is very essential to
study whether profitability is associated with the earnings
management financial determinants in the Nigerian listed
companies.
Despite the growing importance and interest on Earnings
Management activities by managers, only few research try to
explore the profitability and financial determinants of the
Earnings Management in the Nigerian listed firms, this study
intent to fill this gap in the literature. In addition, the study
combine the three main drivers of Earnings Management in other
to measures the activities of Earnings Management in the
companies. The study is motivated by the recent case of Sterling
Bank and Skye Bank in 2016 and Arik Airline in 2017 were part
of the recent incidents of financial scandals that further bring to
light managerial exploitative behaviours in Nigeria (SEC,
2019). More recently, the Case of Oando Oil Plc that was caught
declaring a dividend from unrealized profit and issuing a false
financial statement (Guardian, 2017; Nairametrics, 2017; Sahara,
2017). Based on this, the paper investigates the financial
determinants of Earnings Management on the profitability of
companies listed in Nigeria. The remaining content of the paper
is designed in the following way. The next section provides
details of literature review and the development of hypothesis
evidence from prior studies. This is followed by details of the
methodology and the model selection. Next section presents a
concise summary of empirical results and compares these
outcomes to those of other prior studies by answering the three
research questions. The last section presents the conclusion.
LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT
The reviewed literature has shown that the term earnings
management can be described from the two basic perspectives;
from the informational perspective and opportunistic
perspective. The first perspective which is the informational
perspective, sees earnings management as an instrument used in
reporting private information that is linked to the firm's
potential performance within the financial market. The second
perspective which view earnings management as a strategic
instrument employed by corporate managers in other to prevent
certain conditions which might affect the firm and also deceive
investors on the current condition of the firm. Along these lines,
in a form of decrease or increase of revenue, corporate managers
disclosed to investors about the achievement of results and they
would be rewarded by optimizing the personal benefit. This
optimistic perspective is in many time observed before some
major transactions such as in a situation of mergers and
acquisitions (Mahjoub & Miloudi, 2016).
Prior scholars have categorised earnings management from two
different dimensions: the real earnings management or real
activities manipulation (i.e., which is affecting the cash flows)
and the accruals management which involves adjustment of
accounting method and estimates. Previous scholars have
similarly recommended that the specific cost of earnings
management varies across these techniques, the real earnings
Journal of critical reviews
management mostly deemed to be much more costly for the firm
(Roychowdhury, 2006). From another point of view, Graham,
Harvey, and Rajgopal (2005) conducted a critical survey and they
come to conclusion that corporate managers are likely to involve
in the real earnings management than the accruals management:
decrease discretionary spending by 80%, 55% would defer the
value of a project, when compared to only 28% that might pull
down reserves and that the 8% might have change the
accounting assumptions. Accordingly, the critical survey is being
found to be inconsistent with the higher cost of the real earnings
management.
However, prior research investigated the application of several
financial attributes of earnings management. These studies make
emphasis on the influence of the financial determinants that
could be employed to examine its possible association with the
earnings management in the company’s activities. It has been
identified that the importance of earnings ability, financial
structure ability and also the non-financial factor could be
relevant in assessing the influence regarding the financial
determinants of earnings management in the companies (Chen,
2011).
Earnings ability is believed to have a significant effect in
influencing existing and potential shareholders of the companies
during investment decision in the capital market (Sutthirak &
Gonjanar, 2012). In general, the earnings ability of the companies
was found to be associated with the market competitive
advantage among the capital market players (Hunsader &
Pennywell, 2011). Thus, as stated by Miloud (2014), earnings
ability of the companies can be regarded as a strategic
instrument used by companies so as to make sure that the
financial report disclosed for use by the existing and potential
shareholders is capable of drawing their attention. Earnings
ability is also being used in identifying financial irregularities
(Shiri, Salehi, & Khalatbari, 2013). Furthermore, Menaje, (2012)
in his research, he examine the effect of the financial variables on
the price of share on the quoted firms in Philippines employing
the Return on Assets (ROA) and EPS. The result indicates that
there is statistically significant positive correlation between the
share price and EPS, whereas there is a negative association
between the share price and ROA. On the other hand, Abisola and
Femi (2019), studied the investors profitability and perception of
quoted firms evidence from Nigeria, they found that investors
perception have a statistically significant positive effect on the
profitability.
According to a study conducted by Moro, Lucas, and Grimm
(2012), they described financial structure ability as an indicator
by which the companies gather their financial resources for the
sake of financing their business activities in the equity market. In
spite of the benefit of the financial structure ability in the
activities of earnings management by companies, there has been
a disputing argument which suggests reducing down the debts
level in the companies so as to enhance more profits to be made
in the capital market (Yang, 2011). The financial structure ability
might offer direct benefits to the financial viability of the
company and it also offers an opportunity to the corporate
managers to exploit the use of capital in the operation of the
business. In another study by Abor, (2005), he examine the
impact of capital structure on the profitability which is an
empirical study of the listed companies in Ghana. The outcome
shows a positive and statistically significant relationship
between the ratio of total debt to total assets as well as the
profitability. Gill, Biger, and Mathur (2011) found a positive
relationship between long-term debt to total assets and
profitability. In another related findings by Shubita and
Alsawalhah (2012), they found a statistically significant and
negative association between debt and the profitability. This
implies that profitable firms rely more on equity as their main
source of financing.
32
 THE FINANCIAL DETERMINANTS OF EARNINGS MANAGEMENT AND THE PROFITABILITY OF LISTED COMPANIES IN
NIGERIA

Asides from earnings ability, financial structure ability, another to shareholder’s

significant stock market indicator in the capital market, is non- equity
financial ability proxy as dividend. Payment of dividend is said to Independent Variables:
be an act of profit distribution to owners of the firm (Thafani & Earnings Management:
Abdullah, 2014). Also, dividend is considered to be the portion of 1. Earnings (Net Income – EAB Chen,
the firm’s net income which is to be shared by the executives to Ability Preferred Div) / (2011)
the shareholders which is a fraction to their ownership in the Number of
firm (Bierman Jr, 2012). Non-financial factor indicate how Outstanding
profitable a firm is and above all things, show the dividend Shares =
payment and the financial strength of a company is a Earnings Per Share
2. Financial Total Liability / FSAB Chen,
determining factor that identify a suitable corporate composition
Structure Total Equity = (2011)
(Jo & Pan, 2009). Decision regarding payment of dividend is also
Ability Debt to Equity
being recognised as a fundamental component of corporate
3. Non- Dividend NFF Chen,
finance strategy (Uwuigbe, Jafaru, & Ajayi, 2012). Accordingly, Financial Percentage (%) (2011)
public listed firms profitability and earning capacity are Factor
important because of dividends are distributed from the income Control Variables:
earned from the firm and also failure to pay dividends show a 1. Firm Measured as the FMGRH (Collins,
bad financial position (Uwuigbe et al., 2012). Therefore, study by Growth percentage change Pungaliya,
Abisola and Femi (2019) reveal perception of investors when in sales divided by & Vijh,
proxy by the dividend per share, is likely to possess a positive the previous sales 2017;
and statistically insignificant effect on the profitability. In view of Huang,
the foregoing, the following hypothesis are formulated: Lao, &
McPhee,
H1: There is a significant positive relationship between the 2017)
earnings ability and profitability of listed companies Nigeria. 2. Firm Age Measured as the FMAGE (Gao &
H2: There is a significant positive relationship between the Number of years Huang,
financial structure ability and profitability of listed companies of observation 2016;
Nigeria. minus of years of Kouaib &
H3: There is a significant positive relationship between non- listing Jarboui,
2017)
financial factor and profitability of listed companies Nigeria.

METHODOLOGY RESULTS AND DISCUSSION

The data utilized in this study are taken from the Nigerian
Stock Exchange and Thomson Reuters DataStream. The
population of the study consists of 169 companies from eleven
sectors of the Nigerian Stock Exchange (NSE) as at December
2018. From the population, 56 companies from the financial
services sector have been removed, leaving a total of 113
firms. Furthermore, 18 companies have been removed due to
the fact that they were delisted by NSE in 2018. From the
remaining companies, 11 firms did not disclose full
information. The final sample of this study are 84 companies
from a population of 169 companies. The period within which
this study ranges is between (2010 to 2018) that is for 9 years.
The main reason for the selection of this timeframe is as a
result of number financial related cases where many
companies collapsed in Nigeria.
1) Descriptive Statistics
Table 2 offers a discussion of the summary statistics for all the
incorporated variables in the study which includes, the number
of observation, mean, standard deviation, minimum as well as
the maximum value. The statistics also provides an insight into
the form of the data from which analysis is carried out. Table 2
below reported the mean value of the return on Asset (ROA) is
0.054, with a minimum of -0.707 and a maximum of 0.524 for the
Nigerian listed companies. This indicates a positive level of
profitability by the Nigerian listed companies. It also presents
that Earnings Ability (EAB) has a mean score of 2.822, a
minimum of -0.939 and a maximum value of 75.645. Regarding
Financial Structure Ability (FSAB), the result shows a positive
mean score of 0.188 with a minimum of 0.010 and a maximum of
0.956 respectively.

1) Model Specification and Variable Measurement
The outcome from the regression analysis represent an
equation that best predict the outcome variable from
numerous experimental variables. This technique is usually
employed when the experimental variables are associated
with one another and also with the dependent variable. The
regression equation is said to be estimated as follow:
ROA α0 + β1 EAB + β2 FSAB + β3 NFF + β4 FMGRH + β5
= FMAGE + ε
Also, the result shows Non-Financial factor has a positive mean
value of 1.020 with a minimum and maximum of 0 and 20
respectively. FMGRH has a positive mean value of 0.151 with the
minimum of -0.192 and a maximum value 1.824 respectively.
Finally, FMAGE show the average age for listed company in
Nigeria is 22 years with a minimum of 2 years and the maximum
value of 53 years, respectively. However, this shows that
companies in Nigeria have 22 years length after listing, the
minimum value shows that some of the firms have 2 years of
listing at the beginning of 2010.

Where: ROA = Profitability, α 0 = Constant, EAB = Earnings Table 2: Descriptive Statistics

Ability, FSAB = Financial Structure Ability, NFF = Non-
Financial Factor, FMGRH = Firm Growth, FMAGE = Firm Age,
and ε it = Error term.

Table 1: Summary of Variable Measurement

S/N VARIABLES MEASUREMENTS PROXIES SOURCES
Dependent Variable:
1. Profitability Measured as the ROA (Chen &
proportion of Chen,
income before tax 2011)

Journal of critical reviews 33

 THE FINANCIAL DETERMINANTS OF EARNINGS MANAGEMENT AND THE PROFITABILITY OF LISTED COMPANIES IN
NIGERIA

Note: ROA= Return on Asset; EAB= Earnings Ability; FSAB= structure ability, non-financial factor and the two constant
Financial Structure Ability; NFF= Non-Financial Factor; variables which are firm growth, firm age for 84 companies listed
FMGRH= Firm Growth; FMAGE= Firm Age on the board of NSE. Table 5 also presents the analysis of the
linear regression model.
2) Correlation Analysis
This section presents the outcome of the correlation analysis Table 5: The Relationship between ROA and Financial
between the outcome, explanatory and the constant variables. Determinants of Earnings Management
Correlation analysis offers an insight into the magnitude and ROA Coef. Std. t- P> VIF 1/VIF
extent of association between two or more variables (Gujarati & Err. value [t]
Porter, 2012). Table 3 display the Pearson correlation for the EAB 0.004 0.001 6.86*** 0.000 1.40 0.714
studied variables. As specified in the Table 3, the maximum FSAB - 0.019 - 0.000 1.04 0.957
coefficient is 0.526 between Earnings Ability (EAB) and Non- 0.098 5.21***
Financial Factor (NFF). Therefore, this provides a positive and NFF 0.005 0.002 2.39* 0.017 1.40 0.716
statistically significant correlation between the EAB and NFF at FMGRH - 0.016 -3.01** 0.003 1.02 0.982
1% level of significant and also offers a direction of the extent of 0.049
association between the variables in the regression model. EAB FMAGE 0.001 0.000 2.18* 0.029 1.05 0.952
and NFF were also discovered to be positive and statistically CONS 0.052 0.007 7.29*** 0.000
significantly correlated with the ROA at 1% significant level each. F(5,750) 26.53
FSAB and FMGRH were discovered to be negatively and Prob > F 0.000
statistically significant associated with the ROA at 1% and 5% R2 0.150
significant level respectively. Adj R2 0.145
Hettest 0.79
Table 3: Correlation Statistics (Chi2)
ROA EAB FSAB NFF FMGR FMAG P.value 0.374
H E Mean VIF 1.18
ROA 1.000 Number of 756 756 756 756 756 756
EAB 0.312* 1.000 Obs
* Note: ROA= Return on Asset; EAB= Earnings Ability; FSAB=
FSAB - 0.011 1.000 Financial Structure Ability; NFF= Non-Financial Factor;
0.169* FMGRH= Firm Growth; FMAGE= Firm Age
*

NFF 0.242* 0.526* - 1.000 Table 5 above presents the result of the association between the
* * 0.001 Earnings Management financial determinants with Profitability
FMGR - 0.100* 0.076* 0.025 1.000 which presents a cumulative R2 0.150 and the F ratio which is
H 0.082* * statistically significant at 1% (P<0.01) showing that the overall
FMAG 0.045 0.006 0.194* 0.084 0.049 1.000 model is fit in describing the extent of variability between the
E * *
outcome and the explanatory variables. The model indicates that
15% of the total variation in ROA is described by the joint effect
Note: ROA= Return on Asset; EAB= Earnings Ability; FSAB= of the explanatory variables (earnings ability, financial structure
Financial Structure Ability; NFF= Non-Financial Factor; ability, non-financial factors, and the control variables such as
FMGRH= Firm Growth; FMAGE= Firm Age firm growth, firm age). The R2 as presented in Table 5 is higher
**. Correlation is significant at the 0.01 level (2-tailed). than the R2 of 0.118 as reported by Li, Tseng, and Chen (2016)
*. Correlation is significant at the 0.05 level (2-tailed). using Taiwan listed firms, and 0.136 as reported by Amran,
Ishak, and Manaf (2016) using Malaysian listed firms.
Table 4 below displays the outcome of the multicolinearity test
using the variance inflation factor (VIF) and with a tolerance However, the outcomes from Table 5 above shows that the five
values for all the independent variables is less than 1 and less variables in this study are shown to be significant with the
than 10 which indicates that the independent variables are profitability predictors (as being measured by ROA). EAB
within the normal range as opined by (Hair, Black, Babin, & exhibits a positive and significantly associated with ROA. This
Anderson, 2014; Olive, Olive, & Chernyk, 2017). It is therefore has been shown from the table 5 which displays the regression
believed that this present research is free from multicollinearity. coefficient value of >0.004 and a p-value of 0.000. This result
signifies that the more the earnings ability of a company, the
Table 4: Collinearity Diagnostics profitability of the company will increase. This findings is similar
Variables Collinearity Statistics to that found in a study by Dichev and Tang (2009), they found
Tolerance VIF that earnings instability provides extensive enhancements in the
EAB 0.714 1.40 estimation of both short and long-term earnings.
NFF 0.716 1.40
FSAB shows a significant and negatively association with the
FMAGE 0.952 1.05
ROA, with a regression coefficient value of >-0.098 and a p-
FSAB 0.957 1.04
value of 0.000. This displays that FSAB is significantly and
FMGRH 0.982 1.02 negatively associated to ROA at 1% level of significant. This
Mean VIF 1.18 indicate that an increase in financial structure ability will reduce
Note: EAB= Earnings Ability; FSAB= Financial Structure Ability; the profitability of listed companies in Nigeria. Table 5 also
NFF= Non-Financial Factor; FMGRH= Firm Growth; FMAGE= display that NFF is significantly and positively associated to ROA.
Firm Age This is consistent with the outcomes of a research by Nissim and
Ziv, (2001), which examine the relationship between changes in
3) Regression Results dividend and impending profitability and found that changes in
This section puts forward the result of linear regression and the dividend are positively related to profitability. Regarding the
diagnostic checks carried out to check the assumption of the control variables and ROA, FMGRH with coefficient value of >-
relationship that arise amongst the outcome and three 0.049 and a p-value of 0.003 reveals a negative and significant
explanatory variables comprising earnings ability, financial relationship with the ROA whereas FMAGE with coefficient value

Journal of critical reviews 34

 THE FINANCIAL DETERMINANTS OF EARNINGS MANAGEMENT AND THE PROFITABILITY OF LISTED COMPANIES IN
NIGERIA
of >0.001 and a p-value of 0.029 reveals a significant positive
relationship with the ROA.
CONCLUSIONS
The study aims to explore the financial determinants of Earnings
Management on the profitability of listed companies in Nigeria. It
provides evidence on the relationship between the three
explanatory variables (Earnings Ability, Financial Structure
Ability and Non-financial Factor) and the dependent variable
which is profitability measured by ROA. From the result of the
panel data analysis, two out of the three examine variables
namely EAB and NFF were found to be statistically significant
and positively related with the profitability which was measured
using ROA. FSAB is found to be statistically significant and
negatively related to ROA. Our findings are similar to that found
by Mosebach and Simko (2005) in their study on earnings
management within the emergence of profitability. They found a
positive and statistically significant relationship between the
earnings management and profitability. The positive association
between EAB, NFF and the profitability imply that an increase in
earnings ability, as well as non-financial factors, might result to a
rise in the profitability. The negative relationship of FSAB
indicates that the decreased level of FSAB in the company’s
activities contributed to the rise of Earnings Management
strategies in the business transactions. The study findings should
serve as guidance to policymakers and regulators on the
importance of earnings management financial determinant on
improving the profitability of companies.
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