CHAPTER TWO

LITERATURE REVIEW

In this part of the dissertation, the review of relevant and related literatures to the topic of interest

will be done. Therefore, in this part of the dissertation, there will be the conceptualisations of some

key works such as the stock price, the creating accounting concept, the earning management

concept, income smoothing, off balance sheet finance. Also, the empirical review will be done in

addition to the theoretical framework of the study.

2.1. Conceptual Review

This part of the dissertation will be making conceptualisations and examining what literatures have

said and discussed about the concept of creative accounting, earnings management, stock prices,

income smoothing, shareholder’s wealth and off balance sheet finance.

2.1.1 Creative Accounting

Depending on the management's preference, creative accounting procedures entail making the

financial statements appear better and stronger financially on the one hand, or possibly poorer

financially on the other (Gupta & Kumar, 2020). According to Branka Remenaric & Ivo Mijoc

(2018), the several financial crises that seriously threatened the accounting profession were caused

by creative accounting. They added that the credibility of financial statements is impacted when

inventive accounting techniques are used with blatantly dishonest motives, and as a result, the

decisions made by those who use financial accounts may not be founded on the truth and fairness

of transactions and occurrences. This is because the accounting principles and standards are

manipulated which affects the reliability, objectivity and comparability of such statements. Hence

decisions based on such financials may be misleading. Ababneh & Aga (2019) opined that creative

accounting practices are widely practiced among companies. They further stated that the major

1
cause of creative accounting among entities were due to tax avoidance and tax evasion reasons.

Apart from tax evasion and avoidance reasons, management may have other reasons and

incentives why they might want to present their accounts in the manner that suits them. For

instance, the directors may want to sell the company in the near future. This they do to make it

look attractive to attract interest from potential buyers and ensure higher valuation, where the

company is experiencing a difficult and bad times such as decreasing profits, possible takeover or

decreasing shareholders and investors’ confidence, also where the manager’s remuneration is tight

to the profit and finally, where the company is at the verge of defaulting in its loan covenants.

Creative accounting practices in a study by Comandaru et al. (2021) take several methods. Firstly,

it may be done in the form of off statement of financial position financing, where transactions are

deliberately constructed to allow the non-recognition of assets and particularly liabilities for loans.

Secondly, it may be in the form of aggressive earnings management where revenues are being

recognised before they are earned by the company. Thirdly, creative accounting could be carried

out by way of unjustifiably altering accounting policies or accounting estimates for example,

increasing the economic lives of non-currents assets with the aim of reducing their depreciation

expenses and increasing earnings and vice versa. Finally, management could embark on the

distortion of profit figure by including fictitious assets and liabilities in the accounts and spreading

these amounts over time. This is called profit smoothing (Cugova & Cug, 2020).

Creative accounting and earnings management according to Egwurube (2021) are terms referring

to accounting practices that should follow the letter of the rules of standard accounting practices,

but certainly deviate from the spirit of these rules. They are characterised by excessive

complication and the use of novel ways of characterising income, assets or liabilities and the intent

2
is to influence readers towards the interpretations desired by the authors. The terms “innovative”

or “aggressive” are sometimes used (Kenfelja et al., 2019) . Creative accounting also known as

aggressive accounting involves matters of accounting appraisal, conflicts items and events. Hence,

this flexibility gives room for manipulation, deceit and misrepresentation. Hence, the accountants

use their knowledge of accounting rules to manipulate the figures reported in the accounts of a

business (Saleh et al., 2021).

2.1.2 Earnings Management

According to Santana et al. (2020), earnings management is an outright accounting fraud practice

designed by management to record bogus, inflated, revenue, and earnings smoothing to meet

earnings projections, financial market, and analyst expectations. Earnings management has a

negative impact on earnings quality and dilutes the transparency of financial reporting (Baskaran et

al., 2020). Therefore, to produce transparent, timely and reliable financial statements, accounting

process should follow objective and consistent set of rules (Baskaran et al., 2020). Even when a

strong International Financial Reporting Standards is in place to guide financial accounting

activities; sometimes it becomes almost impossible to prevent the manipulative behavior of the

preparers of financial statement, who want to effect the decisions of the financial statement users

in favor of their companies (Gandhi, 2021). This is as a result of the flexibility, limitations, and

inconsistencies that are embedded in the Generally Accepted Accounting Principles (GAAP)

which have given the managers the latitude of making accounting decisions that will drive revenue

results (Gandhi, 2021).

Earnings management often involves the artificial increase (or decrease) in revenue, profit, or

earnings per share figure through aggressive tactics. Aggressive earnings management is a form of

fraud and differs from reporting error (V. Li, 2019). The management that wishes to show earnings

3
at a certain level or following a certain pattern seeks loopholes in financial reporting standards that

allow them to adjust the numbers as far as it is practicable to achieve their desired aim or to satisfy

projections by financial analysis (Beyer et al., 2019). These adjustments results into fraudulent

financial reporting since they fall outside the confines of acceptable accounting practice.

Lo (2008) asserted that managers are often criticized by investors when the organizations do not

meet the pre-determined earnings expectation. The stock price of the firms who do not meet the

earnings expectation tend to decline, therefore, to steer stock prices higher some management

engage in a variety of earnings manipulation (Lo, 2008). Almarayeh, Aibar-Guzmán & Abdullatif

(2020) asserted that earnings management is a deliberate action taken within GAAP to bring about

desired earnings outcomes. They argue that GAAP is rule based, but the wide latitude flexibility

that exist in its application, and many subjective judgments and assumptions must be made in

determining accrual-based earnings (Almarayeh, Aibar-Guzmán & Abdullatif, 2020). Corporate

profits are the measurement that is central to capital allocation within the economy and to a variety

of economic policy decisions (Huguet & Gandía, 2016). He argues that investors infer a

company’s prospects and value from reported earnings, adjusting portfolio decisions in response to

changed estimates and aggregate corporate profits are often employed to forecast overall stock

market (San Martin Reyna, 2018). Under performing firms may be tempted to use questionable

accounting techniques to boost earnings to meet market expectations, if undetected might mislead

and confuse potential investors, creditors, and other users of financial statements. Earnings

manipulation therefore occurs when management use judgment in financial reporting and

structuring transactions to alter financial report to make earnings appear higher than they actually

are. Gandía & Huguet (2021) stated that one of the reasons why firms manage or manipulate

earnings is to meet market expectations or forecasts by analysts. They argue that the companies

4
that meet or exceed earnings expectations enjoy the benefit of higher stock prices and earnings per

share relative to companies that do not meet earnings expectations (Xue & Hong, 2016).

Earnings management can also be viewed as an unfavorable activity that has the tendency to affect

the reputation and credibility and the stock performance of companies (Srivastava, 2019).

Moreover, this implies that companies are usually attracted to deliberately alter their earnings, for

some reasons such as attracting investors, satisfying shareholders and creditors. Lo, Ramos &

Rogo (2017) in a study posits that earnings management in whatever form refers to the

misrepresentation of true fact and figures of accounts that erode shareholder's confidence on the

reported companies' financials. This practice distorts the reported earnings which affects their real

performance and consequently their ability to pay dividends (Lo, Ramos & Rogo, 2017). A major

motivation for companies to engage in earnings management practice may be to increase their

earnings and stock price and thus attract potential investors (El Diri et al., 2020). However, this

practice usually results into an increase in the accrual components of earnings. Consequently, there

may be an increase in reported earnings and stock market price without a corresponding increase in

dividend payment of the companies (Khanh & Thu, 2019).

2.1.3 Income Smoothing

According to Zhong, Li & Li (2021), management's deliberate endeavour to purposely reduce

volatility in their firm's income realisations through the use of accounting flexibility. It is also

known by the name income easing. Therefore, to increase or decrease reported net income at will,

including balance sheet transactions, is said to be the concept of account manipulation (Monjed &

Ibrahim, 2020). It is intended to move the net profit made during a specific accounting period from

low income to high income in order to produce a steady stream of income for shareholders and

other market participants (Monjed & Ibrahim, 2020). One of the most famous definitions of

5
Income smoothing presented by, they defined income smoothing as a form of earnings

management that is designed to remove peaks and valleys from a normal earnings series, including

steps to reduce and store profits during good years for use during slower years (Doan et al., 2020).

Income smoothing aims to provide a relatively stable series of profits in order to reduce risk and

consequently increase the value of the enterprise in the long run (Ozili, 2019). According to

Indrawan and Damayanthi (2020), there are two types of income smoothing: real and artificial.

Real smoothing refers to those practices that involve decisions on production and investment that

can minimize income variability; meanwhile, artificial smoothing is done through accounting

practices (Indrawan & Damayanthi, 2020).

Indrawan & Damayanthi (2020) also stated essentially that operational definition of Income

smoothing is the potential use of accruals management by objectives personal gain. Skała (2021)

defines Income smoothing as action of a manager to increase (or decrease) the reported current

earnings of the unit manager without generating correspondence in long-term profitability of the

economic unit. This definition is however not limited to behaviour but more broadly to include the

entire actions taken by management to manage earnings (Meiryani et al., 2020). Hence, the

practice about Income smoothing is seen as a form of earnings manipulation (Meiryani et al.,

2020). According to (Baik et al., 2020; Chang et al., 2021), income smoothing is the shifting of

revenue and expenses among different reporting periods in order to present the false impression

that a business has steady earnings. Management typically engages in income smoothing to

increase earnings in periods that would otherwise have unusually low earnings. Income smoothing

has long been discussed as a management tactic (S. Li & Richie, 2016). Income smoothing also

refers to “The equalization of income in each period to a certain level. Monetary compensation,

management’s reputation, and other factors have been mentioned as motivations for income

6
smoothing. Its use has also been explained from the standpoint of economic rationality (Kustono

et al., 2021).

2.1.4 Off Balance Sheet Finance

These are items which are ways of funding liabilities that are not explicitly acknowledged in the

budget in order to keep the debt to equity ratio low and keep a high bank certification classification

(Ablaza et al., 2021; Huang, 2018). Although they are characterised as contractual obligations,

they have a direct impact on the overall value of the banks even though they do not directly entail

financial obligations for the banks (Ablaza et al., 2021). Due to financial liberalisation and

technological advancement, off-balance items have become more significant for banks globally in

recent years (Zhang & Liu, 2020).

This increased the competitive pressures the banks faced, which in turn caused the interest margins

they charged for conventional banking products, like all types of loans, to decline. Incidental

traditional commitments arising from issuance of letters of guarantee for loans, to work

performance or to documentary credits and other things in addition to the obligations arising from

dealing in derivatives contracts are off balance sheet finance (Vu, 2003). Furthermore, Richard

(2001) defined off-balance items as the financial activities that provide financing sources to the

enterprise without stating the financial obligations in the financial statements. However Goodacre

(2003) defined them as potential assets and liabilities which effect in future budgeting, as well as

they effect the liquidity, profitability and security of the bank. It is a promise or commitment to

grant a credit, which is in turn forms an emergency commitment does not appear in the budget of

the Bank, and for this reason it is referred to as off-balance items. Basel Committee on banking

supervision also defined off-balance items as financial contracts in an asset value or a particular

7
indicator, where it is allowed to transfer risks to another party (Lander & Auger, 2008). From

all the aforementioned interpretations, it can be shown that there is broad consensus among

scholars about the main traits of off-balance items, such as their disappearance in the financial

statements but possible existence in the explanations that go along with those statements. These

things involve revenues while also posing a lot of risks. Kraft (2015) emphasised that these things

are one of the inventive accounting techniques that can be employed to deceive financial statement

users.

2.1.5 Shareholders Wealth

According to the purpose of maximising shareholder wealth, management should work to

maximise the current value of anticipated future returns to the company's owners, or shareholders.

Periodic dividend payments or the revenues from the sale of the common stock are two examples

of these returns (Ewelt-Knauer et al., 2015). The value of a future payment or stream of payments

today, when assessed using the appropriate discount rate, is known as the present value (Chuang,

2017). The discount rate considers the potential returns from different investment options over a

particular (future) time horizon (Rao & Bharadwaj, 2008). Investors place less value on benefits

that take longer to materialise, such as cash dividends or increases in the price of a company's

stock (Rao & Bharadwaj, 2008). Furthermore, Brandon-Jones et al. (2017) reported that the greater

the risk associated with receiving a future benefit, the lower the value investors place on that

benefit. Stock prices, the measure of shareholder wealth, reflect the magnitude, timing, and risk

associated with future benefits expected to be received by stockholders (Brandon-Jones et al.,

2017). Shareholder wealth is measured by the market value of the shareholders’ common stock

holdings. Market value is defined as the price at which the stock trades in the market place, such as

on the Nigeria Stock Exchange (Thirumagal & Vasantha, 2018). Thus, total shareholder wealth

8
equals the number of shares outstanding times the market price per share. The objective of

shareholder wealth maximization has a number of distinct advantages (Alora & Barua, 2021).

First, this objective explicitly considers the timing and the risk of the benefits expected to be

received from stock ownership. Similarly, managers must consider the elements of timing and risk

as they make important financial decisions, such as capital expenditures (Denis, 2016). In this way,

managers can make decisions that will contribute to increasing shareholder wealth (Denis, 2016).

It is conceptually possible to determine whether a particular financial decision is consistent with

this objective. If a decision made by a firm has the effect of increasing the market price of the

firm’s stock, it is a good decision (Lin et al., 2020). If it appears that an action will not achieve this

result, the action should not be taken (at least not voluntarily). Farah & Li (2022) in a study

reported that shareholder wealth maximization is an impersonal objective. Stockholders who

object to a firm’s policies are free to sell their shares under more favourable terms (that is, at a

higher price) than are available under any other strategy and invest their funds elsewhere.

Therefore, if an investor has a consumption pattern or risk preference that is not accommodated by

the investment, financing, and dividend decisions of that firm, the investor will be able to sell his

or her shares in that firm at the best price, and purchase shares in companies that more closely

meet the investor’s needs (Farrukh et al., 2017). For these reasons, the shareholder wealth

maximization objective is the primary goal in financial management (Farrukh et al., 2017).

However, concerns for the social responsibilities of business, the existence of other objectives

pursued by some managers, and problems that arise from agency relationships may cause some

departures from pure wealth maximizing behaviour by owners and managers (Teschner & Paul,

2021). Nevertheless, the shareholder wealth maximization goal provides the standard against

9
which actual decisions can be judged and, as such, is the objective assumed in financial

management analysis (Teschner & Paul, 2021).

2.1.6 Stock Price

According to Badruzaman (2020), stock value is the amount an individual is prepared to pay right

now for shares of a company. The stock market affects a nation's economy significantly since it

determines a firm's valuation and its ability to borrow money in addition to serving as a direct

source of funding (Nguyen et al., 2020). It offers a pathway for capital formation and investment,

and it can serve as a gauge or forecaster of the state of the economy as a whole. It serves as a

liaison between savers and businesses looking for additional capital for business expansion, which

promotes industrialization and the creation of job opportunities that raise societal standards of

living (Luo & Zhang, 2020). It provides a platform to individuals, governments, firms and

organizations to trade and invest in savings through the purchase of shares (Andreou et al., 2021).

A stock market is very crucial to sustainable economic growth as it can assure the flow of

resources to the most productive investment opportunities. So, as an important institution of a

country, stock market is of a great concern to investors, stakeholders and the government. The

market price of a share is a key factor that influences investment decision of stock market

investors. The share price is one of the most important indicators available to the investors for their

decision to invest in or not a particular share. . The stock price in the market is not static rather it

changes every day. The most obvious factors that influence are demand and supply factors. i.e,

when demand is higher than supply, stock prices go up and when supply is higher than demand,

stock prices decreases (Ding, 2021). The price of any commodity is affected by both micro-

economic and macro-economic factors. In the securities market, whether the primary or the

10
secondary, stock price can be significantly influenced by a number of micro environmental factors

including dividend per share, book value (asset value) of the firm, earnings per share, price

earnings ratio and dividend cover etc. (Ghazo et al., 2021). Eldomiaty et al. (2020) reported that

macro-economic factors include politics, general economic conditions - i.e. how the economy is

performing, government regulations, etc. The company's performance, as well as its performance

relative to the industry and other players in the industry, may also have an impact on other

variables like demand and supply conditions. Once more, some eminent authors contend that

changes in fundamental variables important for share valuation, such as Dividend per share,

Earnings per share, dividend pay-out ratio and firm size, are related to changes in share prices

(Badruzaman, 2020; Sholichah et al., 2021; Zaman et al., 2021).

2.2 Theoretical Review

This section or subsection of the research will be dealing with the theoretical review of the study.

In this part, already established theories in the topic of interest will be conceptualized as well as

applied to the on-going study. Hence, the theoretical framework for this study will be the

information asymmetry theory as well as the legitimacy theory.

2.2.1 The Information Asymmetry Theory

According to Chod & Lyandres (2018) the idea holds that there is a tendency for information

asymmetry, with managers having better knowledge of the organization's financial situation than

shareholders and other users. There is therefore, a conflict between the advantaged managers and

the stakeholders due to the information asymmetry (Chod & Lyandres, 2018). It is presumed that

accounting disclosures contain information that is very important and relevant to the stakeholders

11
in terms of signalling (Yazdanfar, 2012). As a result, the accountant is always required to present a

genuine and fair assessment of the transactions in the financial statements (Yazdanfar, 2012).

However, Dawson, Watson & Boudreau (2010) asserted that the managers as a result of the

positions they occupy and privileged information tend to take advantage or streamline the activities

of the organization into a course that is suitable to them. They went further to state that the

efficiency of the secondary trading of debt securities would be increased by decreasing information

asymmetry regarding a borrower through conservative reporting (Dawson, Watson & Boudreau,

2010). Omar, Sell & Rover (2017) and Chod & Lyandres (2021) opined that conservatism and

accrual accounting can be tolls of creative accounting as they have direct effect on the financial

statements since it involves a doubtful situation in the accounting field.

2.2.2 Legitimacy Theory

According to the legitimacy hypothesis, businesses work hard to carry out operations that adhere to

the laws of the environments in which they work. It suggests a situation in which an entity acts in

accordance with societal norms (Sari & Prihandini, 2019; Silva, 2021). Legal businesses must

abide by social norms. Conflicts arise when actions don't follow expectations for the setting in

which they take place (Vitolla & Rubino, 2017). According to the notion, a social contract

connects a corporation with a domain or society's functions (Vitolla & Rubino, 2017).. These are

the social demands placed on business operations. The company should adhere to social norms

because disobeying them could result in criticism and punishment (Vitolla & Rubino, 2017).

According to Guthrie & Parker (1989), over a certain time frame, rules are dynamic and fluid.

Therefore, in order for a firm to maintain its legitimacy, it must both adapt to these changes and

meet the new demands of the society in which it operates. Consequently, firms’ weather additional

social responsibility costs such as employees’ health, safety, and environment hazards (Dube &

12
Maroun, 2017). Additionally, society’s expectations regulate firm activities through certain

requirement at predetermined periods (Dube & Maroun, 2017). In summary, legitimacy theory

examines how firms manage relationships with diverse stakeholders essential to its existence as

going concern. The ways in which firm can legitimatize its activities are described as follows

i. By adjusting objectives, methods, and output, as well as adjusting activities to reflect modern

conceptions of legitimacy

ii. Information is used by the company to re-evaluate social legitimacy and guarantee compliance

with modern procedures, its values, and production.

Patten (2020) asserted that legitimacy is achieved through provision of adequate information in

accounts and other public disclosure forum such as firm’s website. Hence, accounting provide

framework to legitimize the efforts and accomplishments of the entity (Pittroff, 2014). Reporting is

key for information dissemination to interested parties on social responsibility activities or actions

embarked upon by entity (Alam, 2021). It can support or counter negative news that is already

publicly available (Janang et al., 2020). Managers can use Voluntary disclosures reports to

influence stakeholders and show that firms operations are legitimate. This is accomplished using

Voluntary disclosures of cost of social responsibility actions and environmental activities (Islam et

al., 2021).

The Information Asymmetry Theory is the foundation of this investigation. This is due to the fact

that business analysts and economists base their decisions on the data included in an entity’s

financial statements. The shareholders can determine the status of their investments and, more

significantly, whether the company is successful thanks to the data in the financial statements.

However, management occasionally takes use of the flexibility in the accounting standards to

13
change the reported earnings in order to accomplish their goal. This is due to information

asymmetry, as the managers have more knowledge about the organization they oversee than the

shareholders, the company's owners.

2.3 Empirical Review of Literatures

In a research, Calmès & Théoret (2009) aimed to test the impact of off-balance activities on the

budget between the returns and risks of banks, through a sample of eight banks in Canada during

the period 1988-2007. The outputs of the study showed that balance between the returns of the

bank shares and their risks showed a structural change in 1997. It also found that during the period

(1997-2007) the non-interest income resulting from the off-balance activities has no any negative

impact on the returns of the bank shares, while during the period (1988-1996) the volatility in

stock returns had any significant impact on the returns of the banks, risk premium, or the pricing of

risks associated with off-balance activities risks. Furthermore, Gunny (2010) has examined the

future operating performance of firms that use earnings management to just meet earnings

benchmarks. After controlling for size, performance, growth opportunities, and industry, she found

that earnings management practices were positively associated with firms just meeting earnings

benchmarks. In addition, the findings of the study revealed that firms engaging in earnings

management to just meet earnings benchmarks had relatively better subsequent performance than

firms that did not engage in earnings management and missed or just met the benchmarks. As a

result she concluded that engaging in earnings management was not opportunistic, but consistent

with the firm attaining current-period benefits.

14
A research by Jones (2011) revealed that the income smoothing behaviour of firms listed on the

Istanbul Stock Exchange, for the five-year period 2006-2010. He used logic analysis and found

that very large sized firms were less likely to have smoothing behaviour than small-sized firms,

and firms in service industry were less likely to have smoothing behaviour than firms in financial

industry. Additionally, Sajid et al. (2012), examined the influence of dividend policy on

shareholder wealth by taking a sample of 75 companies from 2005-2010. By performing a multiple

regression analysis, they found that the difference between the book value of equity and the

average market is highly significant among companies paying dividend rather than non- paying

companies. They further stated that the companies paying dividend regularly led to the shareholder

wealth maximization.

Idris et al. (2012), using survey method, they investigated the practice of creative accounting, its

nature, techniques, and prevention. The findings of the study showed that the current GAAP in

Nigeria created a gap that can permit the practice of creative accounting, and also revealed that the

International Financial Reporting Standard will go a long way to reduce the practice, since it

covers more areas that the former practice. They concluded that one of the best ways to prevent the

practice of creative accounting is to enforce both preventive as well as strong enough punitive

measures on those that engage in the practice. Also, Efiok & Eton (2012) tried to explore the

environment of creative accounting in the Nigeria, focusing on the motivations and constraints on

such practices, by examining the accounting practices of two companies which issued creative

financing instruments. They found out that creative accounting is influenced by two key

motivators: stakeholder contracts and performance indicators. Moreover, analysis showed that

management took advantage of gaps in accounting standards to present a biased picture of

financial performance

15
Sanusi & Izedonmi (2014) investigated why, how, to what extent, and in what direction creative

accounting was practiced in banks. The results of the study indicated that creative accounting was

practiced in banks frequently, and to a considerable extent mainly with the blessing of the law. The

findings also suggested that large firms augmented profits for external financing, while small firms

understated profits to reduce income taxes.

Sanusi & Izedonmi (2014) focused on the scope, incentive factors, limits, practice methods and

results of creative accounting. In order to determine the creative accounting practices of firms they

used accruals method and used modified Jones model by adding country specific variables. One of

the important findings of his study was that the motivation of creative accounting practices by

using accruals diminished as the size of the firm increased. They also revealed that as the degree of

financial leverage increased the motivation of using creative accounting practices also increased.

In Jordan, Alzoubi (2016) analyses the connection between company management and earnings

management in Jordan. He arrived to the conclusion that ownership structure has a significant

influence on earnings management. Thus, managerial ownership, institutional ownership,

shareholders, as well as family and foreign ownership affect the quality of financial reporting,

because they greatly reduce the ability to manage earnings.

Lau & Ooi (2016) in a study conducted a study on fraudulent financial reporting, focusing on the

creative accounting methods used and the motives for such actions. The research results showed

that the most commonly used method of creative accounting was the overestimation of revenues

through recognition of fictitious revenues from product sales to bogus customers. The main motive

for this is increasing the company’s capital, not settling debts and maintaining the level of capital.

One of the key conclusions of the research is that auditors should review the effectiveness of their

16
analytical and material procedures since there is a significant number of cases of creative or

fraudulent accounting that remain undetected by the audit process. Also, the bodies that set

accounting rules should reconsider whether managers have too much discretion in the application

of accounting standards. In other words, the question arises whether they use this discretion to

provide useful information to the decision makers or to obtain personal gain. It turned out that in

most accounting scandals, unethical decisions of managers have led to significant adverse

consequences for decision-makers and society as a whole. Therefore, managers should re-examine

their own responsibilities and role in financial reporting.

CHAPTER THREE

METHODOLOGY

3.0. Introduction

This part of the dissertation deals with the methodology aspect of the research. Hence, in the

methodology phase has to do with the way and approach of data collection and analysis. Therefore,

in this section of the study, the research design will be explained, the population of the study will

be outlined, the sample will be selected, source of the data stated and the model specified.

3.1. Research Design

The study adopted ex-post facto design. This method is considered appropriate because it draws

historical data from the financial statements of the selected listed money deposit banks for analysis

and conclusion purpose.

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3.2 Population of the Study

The population of the study comprises of twenty-five (25) deposit banks listed on the Nigerian

Stock Exchange (NSE) as at January, 31st 2022.

3.3. Sample and Sampling Technique

In order to have a sizable number for this study, non-probability method in the form of judgmental

sampling technique will be used. Based on the judgemental sampling technique, ten (10) deposit

money banks were chosen from 2012-2022 (which represents 10 years).

3.4. Sources of Data

In order to meet the objective of this study, the study utilized only the secondary source of data.

This is because the estimation of the models in the study requires the use of time-series data in the

form of financial information which are available through the financial statements of the sampled

bank. The data were sourced from the annual reports and accounts of the sampled bank for the

years reviewed in the study (2012-2022).

3.5. Model Specification

The basic objective of the study is to examine the effect of creative accounting on the shareholders

wealth of Nigerian Banks. Earnings management, Income smoothing, and off balance sheet

finance are the independent variables used to measure creative accounting. The dependent variable

which is shareholders wealth is proxied by Stock price (SP).

The Model which will be used in this study is outlined below;

SP = b0 + b1DPSit + b2 EPSit + b3PER + b4RERit + µ ………………. Adopted model

18
Modifications were made on the model to examine the causal-effect relationship among Earnings
management, Income smoothing, and off balance sheet finance and stock price

Expressing the models in functional form it becomes:

Model 1:

SP = f (EM, IS, OBSF)…………..3.1

Where:

SP = Stock Price

EM = Earnings Management

IS = Income Smoothing

OBSE = Off-Balance Sheet Finance

Transforming this model into a multivariate regression model, it becomes:

Model:

SPit= b0 + b1EMit + b2ISit + b3OBSFit + u………….3.2

Where:

b0= Intercept of the model

b1= coefficient of Earnings management

b2= coefficient of Income smoothing

b3= coefficient of off balance sheet finance

u= Error Term

3.6. Discussion of Variables

3.6.1. Creative accounting

19
 The study adopted earnings management, income smoothing and off balance sheet finance as the

variables to serve as proxies for creative accounting. Since the sampled banks are quoted

organization on the Nigerian Stock Exchange (NSE), earnings management, income smoothing

and off balance sheet finance expertise are reliable yardstick to measure creative accounting.

Variable name Description Measurement Source

Earnings This has to do with artificially
Management improving earnings and profits by
recognising sales revenue before
it have been earned.
This can be calculated by (Lo et al., 2017; Xue &
Hong, 2016)
accruals divided by total
assets

Income This has to do with manipulating It is measured by

the (Doan et al., 2020; Lo
et al., 2017; Ozili,
smoothing reported profits by recognising ‘Eckel’ model or the so
2019; Xue & Hong,
usually artificial assets or called coefficient of 2016)
liabilities and releasing them to variation Model.
profit or loss as required.

Off balance These are transactions arranged
sheet finance deliberately so as to enable an
entity to keep significant assets
and liability out the statement of
financial position
Stock price A stock price is the amount
someone is willing to pay for a
company’s shares at a particular
Off balance sheet finance is (Ablaza et al., 2021;
measured as the ratio of off Leland & Skarabot,
balance items to the total 2005)
assets.
The stock price is measured (Sezgin Alp et al.,
by the price to earnings ratio 2022; Sukesti et al.,
multiplied by earnings per

20
 point in time. share 2021)

3.6.1. Creative Accounting

The study adopted earnings management, income smoothing and off balance sheet finance as the

variables to serve as proxies for creative accounting. Since the sampled banks are quoted

organization on the Nigerian Stock Exchange (NSE), earnings management, income smoothing

and off balance sheet finance expertise are reliable yardstick to measure creative accounting.

3.6.2. Earnings Management

This has to do with artificially improving earnings and profits by recognising sales revenue before

it have been earned. Earnings management can be calculated by accruals divided by total assets

3.6.3. Income Smoothing

This has to do with manipulating reported profits by recognising usually artificial assets or

liabilities and releasing them to profit or loss as required. It is measured by the ‘Eckel’ model or

the so called coefficient of variation Model. The model is based on comparing the income variance

with the sales variance to determine whether or not the company smoothed its income. If the ratio

of the index is less than one between two years, there is a smoothed income. Therefore, Income

smoothing is equal to 1, where otherwise, Income smoothing is equal to 0.

3.6.4. Off Balance Sheet Finance

These are transactions arranged deliberately so as to enable an entity to keep significant assets and

liabilities out of the statement of financial position Off balance sheet finance is measured as the

ratio of off balance items to the total assets.

21
3.6.5. Stock Price

A stock price is the amount someone is willing to pay for a company’s shares at a particular point

in time. The stock price is measured by the price to earnings ratio multiplied by the Earnings per

share.

3.7. Method of Analysis

The data is analyzed using the multivariate regression analysis. The regression analysis is found

suitable for the study, because it estimates the causal-effect relationship between variables (one

dependent and one or more independent). It is equally used for estimating parameters of unknown

coefficients in models of functional relationship

22
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