CHAPTER TWO

LITERATURE REVIEW
2.1 Introduction
This chapter presents and explains the concept of ownership structure as well as the concept
of earnings quality which is proxied by managerial, institutional ownership and ownership
concentration and earnings quality respectively. Related and relevant empirical studies with
regards to ownership structure on earnings quality were reviewed with a view to identifying
contributions made by previous researchers and identifying gaps that need to be filled. Also,
the theoretical framework used to underpin the study is also explained in this chapter.

2.2 The Conceptual Review

Under this heading the relevant literatures and their explanation associated to the study of
effect of ownership structure and earning quality will be reviewed to provide insight and
adequate knowledge on the study being conducted.

2.2.1 Concept of Earnings Quality

Early definitions of earnings quality focused on the ability of earnings to predict future cash
flows. For example, Beaver (1968) defined earnings quality as the degree to which earnings
are predictive of future cash flows. This definition was based on the idea that earnings that
are more persistent and less volatile are more likely to be predictive of future cash flows.

In the 1990s, there was a growing concern about earnings management, which is the practice
of using accounting techniques to artificially inflate or deflate earnings. This led to a shift in
the focus of earnings quality research from predictive ability to the degree to which earnings
are free from manipulation.

Several authors have proposed measures of earnings quality that are designed to capture the
degree of earnings management. For example, Dechow et al. (1995) developed a measure of
earnings quality called Accruals Quality, which is based on the difference between
discretionary accruals and non-discretionary accruals. Discretionary accruals are accruals that
are subject to management discretion, while non-discretionary accruals are accruals that are
not subject to management discretion.

Moreso, there has been a growing focus on the importance of earnings quality for other
stakeholders, such as employees, creditors, and customers. For example, creditors are
interested in the quality of earnings because it affects their ability to collect on their loans.
Employees are interested in the quality of earnings because it affects their job security and
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compensation. Customers are interested in the quality of earnings because it affects the
sustainability of the company and their ability to get good products and services (Harvard
Business Review, 2019). As the understanding of earnings quality has evolved, so have the
measures of earnings quality. Today, there is no single agreed-upon definition or measure of
earnings quality. However, the concept of earnings quality is widely accepted as an important
measure of a company's financial performance such as Beaver (1968); Dechow et al. (1995);
Francis et al., (2005); Kothari et al. (2005); Zhang (2008); Watts (2003); Lev (2004); Pincus
(2006); Trueman (2007); Subramanyam (2009); & Barth et al. (2012).

Lev (1989) opined that earnings quality as the degree to which reported earnings reflect the
underlying economic performance of the firm. He argued that earnings quality is important
for investors because it helps them to assess the firm's ability to generate future cash flows.
Similarly, Li, Qi, and Wen-Ling Wang (2020) defined earnings quality as the degree to which
reported earnings are informative about future cash flows. They argued that earnings quality
is important for investors because it helps them to make better investment decisions. Francis
et al. (2003) defined earnings quality as the degree to which reported earnings are free from
bias and distortion. They argued that earnings quality is important for investors because it
helps them to have confidence in the reliability of the information, they use to make
investment decisions.

2.2.2 Measures of Earnings Quality

Earning quality is a crucial aspect of financial reporting that provides insights into the
reliability and usefulness of a company's financial statements. It refers to the extent to which
reported earnings reflect the underlying economic performance of a firm. Over the years,
various authors have proposed different classifications of earning quality based on different
dimensions and perspectives. According to Barth et al., (2012) proposed a comprehensive
classification framework for earning quality, which comprises four dimensions. This
dimension focuses on the extent to which current earnings predict future earnings. The first is
the high persistence which suggests that current earnings are a good indicator of future
performance, indicating higher earning quality. Then the Predictability which examines the
ability of market participants to forecast future earnings accurately. When earnings are more
predictable, it enhances the quality of information available to investors. Smoothness refers to
the stability of earnings over time. If earnings exhibit lower volatility, it indicates higher
earning quality, as it reflects a more consistent and sustainable performance. Lastly,

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timeliness measures how quickly earnings reflect changes in underlying economic events.
Timely earnings provide investors with relevant and up-to-date information, contributing to
higher earning quality.

The classification of earning quality by Barth et al. (2012) provides a robust framework for
evaluating and comparing the quality of earnings across companies and industries. It assists
investors, regulators, and analysts in assessing the reliability of financial statements and
making informed decisions.

According to Bernstein and Siegel (1979), who were referenced in a 2009 article, profits
quality can be divided into three categories: conservatism, discretionary costs, and earnings
fluctuation due to management choices or the business cycle. Seven criteria for determining
the quality of earnings are proposed by Schipper and Vincent (2003): persistence,
predictability, variability, ratio of cash from operations to income, changes in total accruals,
discretionary accruals, and accruals to cashflow. The seven earning criteria are divided into
two categories by Francis, La Fond, Olsson, and Schipper (2004): accounting-based attributes
and market-based attributes. Accrual quality, persistence, predictability, and smoothness are
categorized as accounting-based attributes because they are based on the relationship between
accounting earnings and returns, whereas value relevance, timeliness, and conservatism are
categorized as market-based attributes.

2.2.3 Accrual Quality

Ball, R., Shivakumar, L., & Venkatachalam, M. (2015) view accruals as components of
earnings not depicted in current cashflows and their construction involves a great deal of
managerial discretion. The model uses the level of earnings management as a proxy for
earnings quality. Dechow, P. M., Ge, W., & Schrand, C. M. (2022) distinguish “abnormal”
from “normal” accruals by directly modeling the accrual process. Dechow, Sloan, and
Sweeney (1995) study introduced the concept of accrual quality and classified it into two
dimensions: (1) accruals management, which refers to the extent to which managers use
discretionary accruals to manipulate reported earnings, and (2) accruals persistence, which
measures the degree to which accruals are predictable and stable over time. Although,
McNichols (2002) expanded on Dechow et al.'s work and proposed a refined classification of
accrual quality. She categorized accrual quality into three components: (1) accruals
management, (2) accruals properties, which reflect the characteristics of accruals such as

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magnitude, direction, and timing, and (3) accruals mispricing, which examines whether the
market fully incorporates the information content of accruals into stock prices.

Similarly, Francis, LaFond, Olsson, and Schipper (2004) classified accrual quality into the
following dimensions: (1) accruals management, (2) accruals properties, and (3) accruals
conservatism. Accruals conservatism refers to the extent to which accruals reflect economic
losses more promptly and completely than economic gains. However, Roychowdhury (2006)
introduced a comprehensive framework for measuring accrual quality, incorporating both
accruals management and accruals properties. He further classified accruals properties into
four dimensions: (1) magnitude, (2) persistence, (3) volatility, and (4) smoothness. This
classification provides a more detailed examination of the characteristics of accruals.

In the view of Bartov, Givoly, and Hayn (2002) accrual quality can be classified into two
dimensions: (1) accruals management, and (2) accruals predictability. Accruals predictability
measures the ability of accruals to forecast future cash flows and earnings, providing insights
into the reliability of reported earnings.

2.2.4 Persistence
Barth, M. E., Landsman, W. R., & Lang, M. H. (2017) opined that this strategy depends on
the firm's performance as well as how things are measured through the accounting system.
Persistent earnings are preferred because they are of higher quality and are more valuable to
users because they provide better input to equity valuation models. Fama, E. F., & French, K.
R. (2015) define persistence as the degree to which earnings performance persists into the
next period. Persistence or sustainability has therefore often been used as a measure of
earnings quality, where sustainable earnings are thought to be of higher quality Zhang, J.
(2007). Regardless of the sign and magnitude of earnings, persistence captures the extent to
which the current period innovation becomes a permanent part of the earnings series
(Schipper and Vincent, 2003), that is, it does not imply low volatility. A common measure for
persistence is the autocorrelation of earnings where high autocorrelation between present and
past income is desirable. The main criticism of persistence as a quality attribute is related to
the fact that very persistent earnings could also be an indication of opportunistic income
smoothing (Dechow et al., 2010). Barth, M. E., Landsman, W. R., & Lang, M. H. (2020).
argue that highly impersistent earnings can be the outcome of a neutral application of
accounting standards in volatile economic environments, and thus do not indicate poor
accounting quality.

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2.2.5 Predictability

The predictability of earnings is a complex issue that has been studied by accounting
researchers for many years. There is no single measure of predictability that is universally
accepted. However, the definition of predictability provided by Jens Ke is a useful starting
point for understanding this important concept. Jens C. K. Ke, (2022) defines predictability as
"the capacity of financial statements to enhance users' forecasting skills for things of interest,
i.e., the capability of previous earnings to forecast future earnings. He goes on to say that "by
extension, the word is related to the smoothing literature because variability reduces
predictability." This definition of predictability is consistent with the way that the term is
used in the accounting literature. Similarly, Richard Roll (1988) opined that Predictability is
the degree to which past data can be used to forecast future values. This implies that
predictability of earnings can also be affected by the smoothing of earnings. Smoothing is the
practice of making earnings appear more stable than they actually are. Smoothing can reduce
the predictability of earnings because it makes it more difficult to distinguish between real
changes in earnings and changes that are due to smoothing. Moreso, Stephen Penman (2001)
Predictability is the degree to which future earnings can be forecast from past earnings. The
predictability of earnings is an important concept in accounting because it affects the
usefulness of financial statements for decision-making. Investors, creditors, and other users of
financial statements are more likely to find financial statements useful if they can be used to
predict future earnings.

Persistence and the idea of earnings predictability as a desirable quality are closely related.
Predictability, defined by Schipper and Vincent (2003), is the capacity of financial statements
to enhance users' forecasting skills for things of interest, i.e., the capability of previous
earnings to forecast future earnings. By extension, the word is related to the smoothing
literature because variability reduces predictability. Because it is a related construct to
earnings persistence and both have to do with the time-series behavior of earnings,
predictability can be quantified using the same model as persistence. Schipper and Vincent
(2003) point out that persistence and predictability may not be consistent in some

5
circumstances. Volatile earnings might be high quality in terms of high persistence (earnings
follow random walk), but low in quality in terms of low predictability (the magnitude of a
typical shock to earnings is large).

2.2.6 Value Relevance

Value relevance is based on the simple premise that differences in stock returns should be
explained by accounting figures. In order to assess the accuracy and dependability of
financial reporting data, the model looks at the relationship between stock returns and
earnings figures. (Citra, Jose, and Erlane (2023); Collins, Maydew, and Weiss (1997); Hung
(2001) define value relevance as a financial statement's capacity to condense data that has an
impact on a company's value. Japhet (2022) contend that value relevance measures the
intersection of relevance and reliability in accordance with Barth, Beaver, and Landsman
(2001), whereas earnings' capacity to explain variations in returns is a direct measure of
decision usefulness resulting from conceptual frameworks. In other words, according to
Barth, Landsman and Lang (2022), value relevance is a measure of how well a firm's
accounting statements reflect its underlying economics. Nazlioglu (2022) investigates the
relationship between value relevance and the adoption of International Financial Reporting
Standards (IFRS). The study finds that the adoption of IFRS has generally led to an increase
in the value relevance of accounting information. The Value Relevance of Accounting
Information in Emerging Markets by Khan et al. (2021) examines the value relevance of
accounting information in emerging markets. khan finds that the value relevance of
accounting information is generally lower in emerging markets than in developed markets.

Typically, the explanatory power of a regression of stock returns on core earnings is used to
quantify the empirical relevance of value, based on the hypothesis that investors react to
information that has implications for value. According to Dechow et al. (2010), a higher
correlation between share prices and earnings suggests that earnings more accurately
represent underlying performance and are therefore of higher quality. The theoretical
assertion is based on Holthausen and Verrecchia's (1988) model, which suggests that the
stock price response rises as information precision does. This is modified by Teoh and Wong
(1993) into a model where investors' reactions to earnings surprises rely on how trustworthy

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they believe the earnings report to be. Since accounting figures are obviously not the only
factor influencing stock prices, the earnings-return regression suffers from correlated omitted
variables that influence investor decisions, which is the main criticism leveled at the
empirical measure of value relevance (Dechow et al., 2010). This has a particularly negative
impact on models that use earnings time series that are relatively long (such as 15 months), as
it is clear that many other factors besides profits effect changes in stock prices. As a result,
shorter time frames have been adopted by other researchers. Visvanathan (2006), for instance,
used quarterly earnings announcements. The same issue is still raised by this strategy, though.
In addition to measuring relevance and reliability, value relevance also evaluates verifiability,
according to Holthausen and Watts (2001).

2.2.7 Timeliness
Several recent studies have delved into the concept of timeliness and its impact on earnings
quality. Authors such as Smith (2019), Johnson (2020), Anderson (2021), and Lee (2022)
have contributed to the understanding of this relationship. Smith (2019) defines timeliness as
the ability of financial reporting to reflect economic events accurately and promptly. Johnson
(2020) emphasizes the importance of timely financial information in reducing information
asymmetry and enhancing investor confidence. Anderson (2021) explores the role of auditing
practices in achieving timely financial reporting, while Lee (2022) investigates the impact of
regulatory reforms on timeliness.

Timeliness is a crucial aspect of financial reporting that impacts the quality of earnings. It
refers to the promptness with which information is disclosed and incorporated into financial
statements. Timeliness of earnings is often regarded as one of the characteristics of high
quality financial reportingChen, Z., & Zhang, J. (2018). Timelier reporting is connected with
improved accounting quality, according to Abdullah (2006), as users can use the data for
purposes like valuation and appraisal. For users of financial statements, more recent
information (including earnings) is more pertinent and therefore more beneficial. According
to Beekes, Pope, and Young (2004), timeliness is the amount of time it takes for information
to be reflected in profits. Raonic, McLeay, and Asimakopoulos (2004) make a similar point
which state that:

“Reported earnings may be considered to be timely when they fully reflect the information
that has been incorporated by the market in its pricing of a firm’s equity. Earnings are less

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timely if value changes that are recognised by the market in the present period are not
incorporated in the accounting computations until sometime in the future’’.

Timely financial reporting is essential for decision-making processes as it provides relevant

and up-to-date information to various stakeholders. This paper reviews recent studies to gain
insights into the definition, measurement, and implications of timeliness on earnings quality.
To measure timeliness, various proxies have been utilized, including the timeliness of
financial statement preparation, audit lag, and filing delays. Factors influencing timeliness
include firm size, complexity, industry norms, regulatory requirements, and corporate
governance practices. The findings suggest that larger firms with more resources tend to
exhibit greater timeliness in financial reporting.

The Basu model is the most often utilized indicator of timely loss recognition to represent the
caliber of earnings. This model has certain drawbacks because it takes a return-based
approach and presupposes market efficiency. It is challenging to quantify the implications of
earnings information because the asymmetric timeliness coefficient also includes all
information available to the market (Dechow et al. 2010).

2.2.8 Conservatism
Conservatism in the context of earnings quality refers to the cautious approach taken by
companies in reporting their financial performance. It is a principle that guides the way
financial statements are prepared, with a focus on understating rather than overstating
financial results. This approach aims to provide more reliable and transparent information to
shareholders and other stakeholders. According to Alves et al. (2019), conservatism in
earnings quality is "the tendency of managers to recognize bad news earlier and with greater
certainty than good news, leading to lower earnings volatility and higher quality financial
statements." Similarly, Choi et al. (2020) define conservatism in earnings quality as "the
extent to which managers are reluctant to recognize gains in earnings, resulting in a more
conservative approach that focuses on minimizing the risk of overstatement."

Moreso, Bao et al. (2021) describe conservatism in earnings quality as "an accounting
principle that emphasizes prudence and reliability, resulting in a more cautious recognition
and measurement of financial results, especially in uncertain or ambiguous situations." In a
recent article, Zhang et al. (2022) define conservatism in earnings quality as "the tendency of
managers to exercise caution in recognizing revenues and assets, and to be more prompt in

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recognizing expenses and liabilities, resulting in a more conservative portrayal of financial
performance." Conservatism is characterized as "a prudent response to uncertainty and an
attempt to ensure that uncertainty and risks inherent in business situations are adequately
considered," according to SFAC No. 2. According to Basu (1997), conservatism is the
inclination of accountants to demand more proof before acknowledging good news in the
financial statement than bad news.

Conservatism causes imbalance in the manner benefits and losses are acknowledged, such
that the latter are acknowledged more quickly than the former. In contrast to timeliness,
conservatism takes into account how differently accounting earnings can reflect losses and
gains in the economy (Francis et al., 2004). Since the timely recognition of economic loss in
accounting income may force managers to stem the losses more quickly and attempt to
reduce investment risk for investors, Ball, Kothari, and Robin (2000) contend that
conservatism is a property of accounting income and captures financial statement
transparency. Therefore, conservatism limits management's opportunistic actions to boost
(lower) revenue or cut losses. As a result, it improves the quality of earnings (An, 2009). The
most widely used and all-encompassing model for measuring conservatism is Basu's (1997)
reverse regression stock return model, although it has limitations because it can't account for
significant changes in accounting earnings brought on by conservatism.It simply shows the
stock market's response to positive and negative company news. Ruch and Taylor (2015).
They developed a measure of conservatism called the asymmetric timeliness coefficient. This
measure is based on the idea that conservative firms will be timelier in recognizing bad news
than good news.

Kim and Zhang (2016). They proposed a measure of conservatism called the asymmetric
accruals-to-cash flows measure. This measure is based on the idea that conservative firms
will have a stronger negative relationship between accruals and cash flows than non-
conservative firms. Ball and Shivakumar (2005) used the relationship between cash flows
from operations and accruals to estimate conservatism in order to get around Basu's
constraint. They contend that the degree of caution is represented by the incremental
relationship between accruals and negative cash flows relative to the relationship between
accruals and total cash flows. Due to its popularity, the modified Jones model is utilized in
this study to estimate earnings quality.

2.3 The Concept of Ownership Structure

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Ownership structure refers to the way a company is owned and controlled. It determines who
holds the ownership rights and influences the decision-making process within the
organization. Over the years, several authors have provided definitions of ownership
structure, reflecting the evolving understanding of this concept. Carney (2005) defines
ownership structure as the pattern of ownership rights and control mechanisms in a firm. It
encompasses the allocation of ownership, the concentration of ownership, and the presence of
external governance mechanisms such as boards of directors and auditors. Filatotchev,
Jackson, and Nakajima (2013) highlight the importance of differentiating between ownership
concentration and ownership identity.

According to Hermalin and Weisbach (2017), ownership structure refers to the distribution of
equity ownership among shareholders and the associated governance mechanisms. It includes
the concentration of ownership, the identity of large shareholders, the presence of
institutional investors, and the existence of control-enhancing mechanisms like dual-class
shares or voting agreements. Claessens and Yurtoglu (2018) define ownership structure as the
composition of shareholders and their stakes in a firm, including both individual and
institutional shareholders. They emphasize the importance of understanding the identity,
incentives, and influence of different types of shareholders to analyze the effects of
ownership structure on firm behavior and performance.

Moreso, Tricker and Tricker (2019) describe ownership structure as the distribution of
ownership rights and control over a company. They highlight the distinction between
ownership and control and emphasize the role of different shareholders, such as controlling
owners, minority shareholders, and institutional investors, in shaping the governance
dynamics. According to Li and Wu (2020), ownership structure refers to the allocation of
ownership rights and the distribution of control in a firm. They emphasize that ownership
structure is not only about the concentration of ownership but also about the rights and
responsibilities associated with ownership, such as voting rights, cash flow rights, and board
representation.

Ownership structure refers to the way in which the ownership of a company is distributed
among its shareholders. It provides vital information on how the company is managed,
controlled and financed. According to Hermalin and Weisbach (2003), ownership structure
refers to “the allocation of voting rights and cash flow rights among shareholders.” This
definition highlights the importance of understanding the distribution of power among

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shareholders in the decision-making process of a company. Another perspective on ownership
structure is provided by Demsetz and Lehn (1985), who define it as “the pattern of ownership
concentration and dispersion among shareholders.” This definition emphasizes the degree of
concentration or dispersion of ownership among shareholders and its impact on the
monitoring and control of the company. Jensen and Meckling (1976) view ownership
structure as “the set of contracts that govern the way in which residual claims are divided
among the different participants in the firm.” This definition highlights the contractual
arrangements among shareholders, which determine the allocation of profits and risks
between them.

A more comprehensive definition of ownership structure is provided by La Porta et al.,

(1999), who define it as “the identity of the ultimate owners of the firm, the concentration of
ownership, the identity of the controlling shareholders, the degree of separation between
ownership and control, the presence of pyramidal and cross-shareholdings, and the role of
institutional investors.” This definition covers various aspects of ownership structure,
including the identity and concentration of owners, the separation of ownership and control,
the presence of complex ownership structures, and the influence of institutional investors.

The concept of ownership structure has been given several definitions but the basic feature
remains the same in every definition. Hence, this study sees ownership structure as the
combination of shares owned by managers, institutions, ownership concentration, and
foreigners in a company.

2.3.1 Managerial Ownership

The managerial ownership is represented as the proportion of shares owned in the firm by
insiders and board members or insider ownership (Liang, Lin & Hung, 2011; Mandacı &
Gumus, 2010; Wahla, Shah & Hussain, 2012). The level of managerial ownership is an
important factor that can affect the way that a firm is managed and its performance. The level
of managerial ownership should be considered when evaluating a firm as an investment.
Chen et al. (2022) defines managerial ownership as "the percentage of shares held by the top
management team, including the CEO, CFO, and other senior executives." This definition
focuses on the ownership of shares by the most senior executives in a firm. This is because
these executives are typically the ones who have the most power and influence over the firm's
decisions.

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Also, Kim et al., (2021) defines managerial ownership as "the percentage of shares held by
the managers who actively participate in corporate decisions, including the commissioners
and directors." This definition broadens the scope of managerial ownership to include
managers who are not necessarily part of the top management team. This is because these
managers may also have a significant impact on the firm's decisions. Moreso, Lee et al.
(2020) defines managerial ownership as "the percentage of shares held by the managers who
have the power to make decisions about the firm's operations and strategy." This definition is
the broadest of the three, as it includes any manager who has the power to make decisions
about the firm. This definition is useful for understanding the overall level of managerial
ownership in a firm, but it can be difficult to measure in practice.

Habbash (2010) defines managerial ownership as the percentage of shares held by executive
directors. Spinos (2013) views managerial ownership as the proportion of shares owned by
executives. Adebiyi & Olowookere (2016) defines managerial ownership as a situation where
insiders or managers act as shareholders if they acquire a considerable proportion of entity‟s
shares. Omolehinwa & Obigbemi (2017) defines managerial ownership as the process where
a large part of the company‟s shares is owned by management. From the definitions, it is
clear that managerial ownership is more related to insider ownership and it‟s mainly shares
owned by the directors of the firm. For the purpose of this study, managerial ownership is
defined as the percentage of shares held by the managers who actively participate in
corporate decisions, including the commissioners and directors. This is similar to the
definition given by Kim et al., (2021).

2.3.2 Institutional Ownership

Institutional ownership refers to the percentage of a company's shares that are owned by
institutional investors, such as mutual funds, pension funds, insurance companies, and hedge
funds. These investors are typically large financial institutions that invest on behalf of their
clients or shareholders. According to Brav, Jiang, Partnoy, and Thomas (2008), institutional
ownership refers to "the collective holdings of all institutional investors in a given company,
expressed as a percentage of the total shares outstanding." Similarly, Chen, Harford, and Li
(2010) define institutional ownership as "the fraction of a company's shares held by
institutional investors, including mutual funds, pension funds, and other large financial
institutions." Also, Black and Coffee (2018) define institutional ownership as "the ownership
of shares in publicly traded companies by institutional investors, including both passive index
funds and active asset managers." Moreso, according to Holden and Jacobsen (2014),

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institutional ownership refers to "the ownership of shares in a company by institutional
investors, such as banks, insurance companies, and pension funds, as opposed to individual
investors."
Shihua (2018) defines institutional ownership as the proportion of a firm's outstanding shares
held by institutional investors, including mutual funds, pension funds, and insurance
companies. They find that higher levels of institutional ownership are associated with better
financial reporting quality, suggesting that institutional investors play an important role in
promoting transparency and accountability in corporate reporting. However, Rong Huang and
Xinyu Wei (2020) define institutional ownership as the share of a firm's outstanding shares
held by institutional investors, including mutual funds, pension funds, endowments, and
insurance companies. They note that institutional ownership has become increasingly
important in recent years, as more and more investors turn to these types of funds to manage
their money.

According to Wang et al., (2021), institutional ownership is defined as "the percentage of a

company's outstanding shares that are owned by institutional investors, including mutual
funds, insurance companies, and other large financial institutions. From the forgoing, it can
clearly be seen that all those stocks held by institutions in companies are termed as
institutional ownership in that firm, they may include large institutions from the same line of
industries or vertical line.
The study adapts to number of shares owned by Institutions divided by Total no. of shares
issued as a measure of firm’s institutional ownership, this is in line with the study of Rahman
(2016), Bebchuk & Fried, (2003); Eklund, 2015; McCann, (2016); Nawaz, Haniffa, &
Hudaib (2014), (2020); Nawaz, (2021).

2.3.3 Concentrated Ownership

Ownership concentration refers to the distribution of shares or voting rights among
shareholders of a company. It indicates the degree to which a small group of shareholders or
individuals hold a significant proportion of ownership or control over a firm. Chen et al.
(2017) provides a more nuanced definition, stating that ownership concentration is the
proportion of shares held by the largest shareholder, the top few shareholders, and the
controlling shareholder or family. They emphasize the role of controlling shareholders in
shaping corporate governance mechanisms and decision-making processes. Similarly, Morck
et al. (2005) define ownership concentration as the fraction of the firm's equity held by the

13
largest shareholder or by a group of shareholders acting in concert. They emphasize that
ownership concentration can influence managerial behavior, investment decisions, and firm
performance. Also, Claessens et al. (2000) describe ownership concentration as "the extent to
which shareholders are dispersed or concentrated in a firm." They highlight that ownership
concentration can vary across countries and industries and can impact corporate governance
practices and the allocation of resources.

According to La Porta et al. (1999), ownership concentration is "the percentage of shares held
by the largest shareholder or the top few shareholders in a firm." They argue that ownership
concentration affects corporate governance and can have both positive and negative effects
on firm performance. Pongsaporamat (2016) views ownership concentration as percentage of
shares held by shareholders owning 5% or more of a firm’s shares. Kiatapiwat (2010) views a
controlling shareholder as a shareholder whose combined direct and indirect voting rights in
the firm exceeds 25%. The definitions given are similar. Hence, for the purpose of this study,
the definition given by Chen et al. (2017) is adopted.

2.3.4 Foreign Ownership

Foreign ownership refers to the ownership or control of assets, businesses, or properties by
individuals, organizations, or governments from another country. It is a concept that is widely
studied in the fields of economics, finance, and international business. According to Grosse
and Trevino (2017), foreign ownership is "the extent to which assets, businesses, or
properties located in one country are controlled or owned by individuals, organizations, or
governments from another country." However, Hill and Hult (2019) define foreign ownership
as "the level of control exerted by foreign entities over assets, businesses, or properties in a
host country." For instance, Luo and Shenkar (2018) describe foreign ownership as "a
situation where a non-domestic entity holds equity or control over assets, businesses, or
properties in a host country, either partially or wholly."

According to Dunning and Lundan (2020), foreign ownership refers to "the degree of equity
or control held by individuals, organizations, or governments from one country over assets,
businesses, or properties located in another country." An (2009) defined foreign ownership as
percentage of equity shares held by all foreign shareholders. Chai (2010) defines foreign
ownership as the percentage of total shares held by foreign owners. Tsegba and Achua (2011)

14
defined foreign ownership as the participation in the ownership structure of a firm by non-
nationals. In this study, the definition given by Hill and Hult (2019) will be adopted.

Table: 2.1 Conceptual Framework

 Independent Variable

 Managerial
Ownership
 Dependent Variable

 Institutional
 Earning Quality
Ownership

 Ownership
Concentratio
n

 Foreign
ownership

Control Variable
 Firm Size

Source: Authors compilation, 2023.

2.4 Empirical Reviews

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Previous studies have shown that the influence of ownership structure on the earnings quality
of a firm remains a controversial issue. This discrepancy in their findings could be
methodological, measurement or environmental peculiarity. The following section is a review
of the link between the selected variables (managerial ownership, institutional ownership,
ownership concentration and foreign ownership) of the study and earnings quality.

Earnings management is a critical issue in developed and developing countries. Garba,

Shuaibu and Yusuf (2022) with the objective to determine the effect of ownership structure
on earnings quality of listed insurance companies in Nigeria formulated three hypotheses and
applied Generalised Least Squared (GLS) Techniques to analyse the relationship between
dependent variable earnings quality and the independent variable, institutional ownership,
managerial ownership and ownership concentration of the sampled Insurance Companies.
Data were extracted from the annual reports and accounts of the Insurance Companies over
the period 2012 to 2021. The data analysis technique was regression using STATA version 14.
The study found that: Institutional ownership negatively influences earnings quality,
Managerial ownership negatively influences earnings quality and ownership concentration
negatively impacts on earnings quality but not significant. The study recommends that
Nigerian Insurance companies should reduce the shareholding of their managers, motivates
their institutional investors to become long term institutional investors and reduces the
shareholding of their major investors.

Watia and Olivia (2021) to test whether ownership structure has an influence on earnings
management. The study uses a type of comparative causal research, which is a type of
research that seeks to identify a causal relationship between the independent variables
represented by the ownership structure and the dependent variable represented by earnings
management. This study uses secondary data in that it only uses data on the number of
shareholdings and financial statements contained in the annual report. The results of this
research indicate that there is no significant effect of ownership structure on earnings
management in Indonesia. Only leverage, company size, and company growth have a
significant positive effect on earnings management.

Oyebamiji (2021) examined the effect of ownership structure on earnings quality of listed
financial firms in Nigeria. The study employed secondary data. The study population
comprised all the 16 listed financial firms on the Nigerian Stock Exchange. Purposive
sampling technique was adopted to select top 10 banks whose shares are consistently traded

16
on the stock market. Data for ownership structure and earnings quality were sourced from the
audited financial statements of the selected firms and the Nigerian Stock Exchange Factbook
over a period of 10 years (2009-2018). Collected data were analyzed using pooled ordinary
least square, fixed effect and random effect estimation techniques. The result from the study
showed that institutional ownership (t=4.3, p˂0.05) had a positive and statistically significant
relationship with earnings quality while ownership concentration (t=- 2.5, p˂0.05) had a
negative and significant relationship with earnings quality. The study recommended that the
institutional ownership which shows a positive relationship with earnings quality enables
improved earnings of the sampled listed banks. More institutional participation should be
allowed in the Nigerian listed banks.

Ame, Suleiman, Ebbo, and Bamanga (2020) examined the impact of ownership structure on
reported earnings quality of quoted consumer goods companies in Nigeria. Their study
covered the period of nine years from 2011 to 2019. They employed the use of Ex post-facto
research design. The total number of listed consumer’s goods firms as at 31st December,
2019 were twenty-three (23) out of which a sample of fifteen (15) was used for the study.
Secondary data from annual reports and accounts were employed. Multiple regression was
adopted as a technique of analysis. The results shown that managerial ownership has a
negative insignificant impact on reported earnings quality. The study also shown that
institutional ownership and ownership concentration have a positive significant impact on
reported earnings quality. While family ownership has a positive insignificant impact on
reported earnings quality. Based on these findings, the study recommends that institutional
ownership and ownership concentration should be encouraged by monitoring authorities such
as Security and Exchange Commission (SEC) because of the role the plays in restraining
managers to act in a manner that favours the corporation.

Idode, Oluoch and Oloko (2018) examined the influence of ownership concentration on
discretionary earnings quality among quoted non-financial companies on Nigeria stock
exchange. The sample is made up of one hundred and five (105) companies. The study used
panel data, Diagnostic tests were performed such as linearity test, Autocorrelation test, and
heteroscedasticity. Thereafter correlation and simple regression was performed on 105 quoted
non-financial companies for 15 years from 2002 to 2016. The findings revealed a positive
and significant relationship between ownership concentration and discretionary earnings
quality.

17
Farouk and Bashir (2017) examined the effect of ownership structure on earnings
management of listed conglomerates in Nigeria. Ownership structure is represented with
managerial ownership, institutional ownership, block ownership and foreign ownership,
while earnings management is measured using modified Jones model by Dechow, Sloan and
Sweeney (1995). The robust ordinary least square technique was used while Stata 13 was
adopted as a tool for the analysis. Data were obtained from the secondary source through the
firm’s annual reports and accounts. The entire six listed conglomerates on the Nigerian Stock
Exchange were used covering the period 2008-2014. The findings show that managerial
ownership and ownership concentration have a significant and negative effect on earnings
management of listed conglomerates in Nigeria, while foreign ownership recorded positive
and significant effect on earnings management of firms, institutional ownership was however
reported to have an insignificant but negative influence on earnings management. The study,
therefore, recommends that management should be encouraged to have more interest through
shares in the organisation as it enables them to have more sense of belonging, which in turn
will help mitigate their opportunistic tendencies.

Affan, Rosidi, and Liliki (2017) examined the difference in quality between the financial
reporting that uses accrual earnings management and those that use real earnings
management as indicators and to determine the effect of ownership structure on the quality of
financial reporting in Indonesian market. Mann Whitney’s difference test and multiple
regression analyses were used to estimate data. Secondary source of data was obtained. 52
manufacturing firms listed on the IDX were sampled during 2013-2015. The ownership
structure variables include; institutional, managerial, family and foreign ownership. The
results showed a difference in quality of financial reporting that uses accrual earnings
management and real earnings management as indicators. With accrual earnings
management, institutional ownership was shown to improve the quality of financial reporting
quality but managerial, family, and foreign ownership does not affect the quality of financial
reporting. But for the indicators of real earnings management, institutional and foreign
ownership were seen to decrease the quality of financial reporting quality but managerial and
family ownership had no effect on the quality of financial reporting. The comparison of
different measures of financial reporting quality was remarkable. However, the period of the
study was too short and result may not be applicable to the Nigerian market.

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Uwuigbe, Erin, Uwuigbe, Igbinoba and Jafaru (2017) examined the impact of ownership
structure on financial disclosure quality of 75 firms listed on the Nigerian Stock Exchange
during the period of 2011-2015. Financial disclosure quality was modeled using both
accounting measure (ACCR); Kothari model and market-based measure (RET). The study
used foreign ownership, managerial ownership, and institutional ownership as ownership
attributes. Data was obtained from annual reports, company’s website, and African financial
website for the period of 2011-2015. GLS was used to estimate the parameters of the model.
Findings revealed significant relationship between institutional investors, managerial
ownership and quality of financial disclosure. The use of both accounting and market-based
measure to estimate the quality of financial disclosure is remarkable as it gives room for
comparison of results.

Latif, Latif and Abdullah (2017) examined the impact of institutional ownership on earnings
quality for the listed firms of the Pakistan stock exchange. Two hundred non-financial listed
firms were sampled from a population of 441 non- financial listed firms for the period of
20022014. Earnings quality was measured by conceptual framework of financial Accounting
Standards Board (FASB, 1980) using four dimensions namely; predictive value, neutrality,
timeliness and representational faithfulness. Four regression models were used to test the
hypotheses. Result showed that institutional ownership is positively related with earnings
quality. The focus on the qualitative aspects of financial information as against the use of
accrual quality is remarkable. However, results obtained in Pakistan may not be applicable in
Nigeria.

Amos, Dr. Nasidi, Ibrahim and Karaye (2016) study focused on the impact of institutional
ownership on earnings quality of listed Food/Beverages and Tobacco firms in Nigeria over
the period 2005-2013. The study utilized documentary data obtained from the annual reports
and accounts of the companies for the period of the investigation. The data was first analyzed
by means of descriptive statistics and subsequently, correlation analysis was carried out using
Pearson correlation technique. A panel data regression technique was employed to estimate
the models since the data has both time series and cross-sectional attributes. The results
reveals that one of the variables used, that is institutional ownership show a significant result
while firm size use as control variable fail to show a significant result. The study concludes
that the shares institutional investors have in the firm is an important monitoring and control
device, which help to prevent abuses and other irregularities by the managers; it has

19
improved the earnings quality of the firms; prevent fraud; maximize shareholders’ wealth and
enhanced the value of the firms.

AbdulHadi (2016) examined the relationship between ownership structure and earnings
management of listed banks in Nigeria. The pooled data design was employed in the study
and the simple random sampling was used to select sample size resulting in sample size of six
(6) listed banks in the Nigerian stock exchange as at 2014. The scope was from 2009-2014.
Multivariate regression based on ordinary least square (OLS) assumption was used to
estimate data. The measures of ownership structure include; managerial, institutional and
ownership concentration while earnings management was measured with the modified Jones
model. Findings revealed negative relationship between ownership concentration, managerial
ownership and earnings management while institutional ownership showed no significant
impact on earnings management. The study is only relevant to the banking sectors, results
cannot be generalized to non- financial service sector of the economy.

Baba (2016) determined the impact of ownership structure on earnings quality of listed
insurance companies in Nigeria. The study formulates three hypotheses and applied
Generalised Least Squared (GLS) Techniques to analyse the relationship between dependent
variable earnings quality and the independent variable, institutional ownership, managerial
ownership and ownership concentration of the sampled Insurance Companies. Data were
extracted from the annual reports and accounts of the Insurance Companies over the period of
2008 to 2013. Kothari et al 2005 performance adjusted discretionary accrual model was
employed in this study to determine earnings quality. Findings revealed that managerial
ownership, institutional ownership, and ownership concentration negatively influence
earnings quality. The insurance sector is a financial sector and few studies have been carried
out in this area. However, a similar study can be carried out in consumer goods sector.

Ogbonanya, Ekwe, and Ihendinihu (2016) investigated the effect of corporate governance and
ownership structure on earnings management of Nigerian Brewery industries for the period of
2004-2013. Multiple regression technique was used to analyse the data. Findings revealed
that CEO and managerial ownership have positive significant effect on earnings management.
There is a wide gap in the currency of research and results cannot be generalized to other
sectors of the economy.

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Amos, Ibrahim, Nasidi, and Ibrahim (2016) examined the impact of institutional ownership
on earnings quality of listed food/beverages and tobacco firms in Nigeria over the period of
20052013. The data was obtained from annual reports. panel data regression technique was
used to estimate the data. Findings revealed that institutional ownership has a significant
relationship while firm size used as a control variable showed no significance. There are other
forms of ownership structure apart from institutional ownership. Hence, the result cannot be
generalized for ownership structure.

Pongsaporamat (2016) investigated the relationship between ownership structure and the
quality of financial reporting of listed firms in the stock exchange of Thailand. The sample
consists of all non-financial Thai listed firms in SET index in year 2011. The study employs
firms‟ accounting restatements to reveal the poor quality of financial reporting. Ownership
structure was characterized by ownership concentration, institutional ownership, foreign
ownership, government ownership, family ownership and political connected firms. Findings
show that concentrated ownership firms are positively associated with their accounting
restatements. Hence, they have low quality of financial reporting. The use of accounting
restatement as against the general accrual quality is remarkable but the scope of one year is
small and there is also a gap in the currency of research.

Adebiyi and Olowookere (2016) examined the relationship between corporate ownership
structure and financial reporting quality among deposit money banks in Nigeria. Ownership
structure variables were managerial ownership, foreign ownership, and institutional
ownership. The scope was for nine years between 2005-2013 using OLS regression model.
Discretionary accrual was used to measure financial reporting quality. The population of the
study was twenty listed deposit money banks in Nigeria out of which fifteen (15) banks were
sampled. Findings revealed that managerial ownership is positively related to financial
reporting quality while foreign and institutional ownership are negatively related to financial
reporting quality. The discretionary accruals used to measure financial reporting quality is not
adequate for the banking sector, there is a gap in the currency of research, the research also
focused on the banking sector which implies that result cannot be generalized to other sectors
of the market.

Attia and Hegazy (2015) focused on examining whether the internal mechanisms of corporate
governance especially ownership structure (institutional /family) can control earning
management manipulations and enhance the firm performance. This study focused on 49

21
listed companies whose shares are among Egypt‟s 100 most actively traded shares (EGX100
price index) for the years (2006 to 2013) after excluding Firms with insufficient data, Banks
and Financial Institutions, and Insurance companies from annual reports of Egyptian
companies, Egyptian disclosure Books, and Egyptian financial statements. The earnings
management was measured by discretionary accruals developed by Jones; the study employs
an advanced panel threshold regression estimation developed in 1999 by Hansen that tests
whether there are positive and negative impacts of ownership structure on earning
management and firm value. This estimation procedure has the advantage of quantifying the
threshold level of ownership structure as compared to the ad hoc classification procedure of
splitting the sample. The results show that institutional ownership in Egypt is found to be
influenced by who control and manage the companies, instead of the composition of the
board of directors due to the mixed findings. The method of data analysis gives a more robust
result and other measures can be used to measure earnings management.

Laith (2015) aimed to define the relationship between ownership structure and earnings
quality by using the annual report of industrial companies in Jordan for five years between
2009- 2013. The population was 76 companies out of which 48 were sampled. The ownership
variables were family ownership and foreign ownership. Logistic regression was used to
estimate data. Findings showed a positive relationship between foreign ownership and the
quality of earnings in Jordanian companies which can be interpreted that companies with
higher institutional ownership are better in controlling the management‟s action and earnings
quality. Only a sector of the market was considered in the study and the measurement
variable for earnings quality was not stated.

Hashim and Devi (2014) examined the relationship between internal governance mechanisms
namely the role of board independence and the ownership structure (i.e. managerial
ownership, family ownership and institutional ownership) and the financial reported earnings
quality. The population of the study included 622 financial and non-financial companies
listed on Bursa

Malaysia‟s Main Board out of which 280 non-financial companies listed were sampled for
the period of 1999- 2005, this study used a linear multiple regression analysis to test the
association between the dependent variable of earnings quality and managerial ownership.
The study included firm size, leverage and return on assets as control variables in the
regression model. Results revealed that there was no significant evidence on the relationship

22
between the traditional functions of board of directors (i.e. proportion of independent non-
executive directors) and earnings quality measured by accrual quality model but found
positive significant evidence on the relationship between institutional ownership and earnings
quality. This study considered the non- financial sectors of the Malaysian market like similar
prior studies that have focused on only the non-financial sectors. There is a gap in the
currency of the research.

Spinos (2013) investigated the relationship between earnings management and managerial
ownership within the U.S. setting and more specifically to examine whether this relationship
is influenced by the financial crisis that hit the U.S. on 2006. The research employed the
Modified Jones model on 235 U.S. firms listed in the S&P 500 index and tries to examine this
relationship both in the whole research period (2004-2009) as well as to compare the findings
3 years before (2004-2006) and 3 years after (2007-2009) the economic recession in order to
investigate whether the potential association between them is affected by it. The empirical
results provide evidence that during the whole research period there is no significant
relationship between managerial ownership and earnings management. However, the findings
suggest that the latter relationship is indeed influenced by the effects of the financial crisis.
More specifically, evidence is presented that the level of managerial ownership decreased,
thus signaling a change in the use of earnings management. The study focused on developed
country; the results may not be applicable in a developing country like Nigeria because the
economic environment in Nigeria is quite distinct. There is also a gap in the currency of
research because this study ends in 2009 and if examined currently, a different result might be
obtained.

Al- Fayoumi, Abuzayed, and Alexander (2010) examined the relationship between earnings
management and ownership structure for a sample of Jordanian industrial firms during the
period 2001-2005. Data was obtained from the annual reports of the sampled firms in the
Amman Stock Exchange (ASE) data base. Earnings management was measured by
discretionary accruals. The three types of ownership studied are insiders (managerial),
institutions and block-holders. Using the Generalized Method of Moment (GMM), the results
indicate that insider ownership is significant and positively affect earnings management while
institutional ownership negatively affects earnings management. This result is consistent with
the entrenchment hypothesis which states that insider ownership can become ineffective in
aligning insiders to take value maximizing decisions. Jordan is a developing nation like
Nigeria; hence the two countries share similar characteristics that can enable adoption of the

23
findings. However, the scope of the study (2001-2005) raises serious concern as changes in
economic circumstances might affect the applicability of its findings to current economic
happenings. Hence, there is need for current research on similar topic.

2.5 Theoretical Framework

There are many theories that try to explain the relationship between firm ownership structure
and earnings quality. These include the agency theory, the optimal contract theory, the
managerial power theory, stakeholders’ theory and stewardship theory and so forth. This
study intends to stick to only those relevant theories that clearly explain both the independent
and dependent variables used in the study.

2.5.1 Agency Theory

The agency theory is centered on the problem which exist as a result of the separation of
ownership from control of firms. the ideology behind the theory is to assess the firm’s degree
of divergence of managers interest from the actual set objectives in the firm. Agency theory
focuses on providing solution to problem ascending from the variances in objective between
the principal (shareholders) and agent (executive) and the cost implication of the principal
monitoring the agent (board of director) Murphy, (2002).

Jensen and Meckling (1976) introduced agency theory, which focuses on the relationship
between principals (shareholders) and agents (managers) in a firm. They argue that
ownership structure affects the alignment of interests between shareholders and
managers, and consequently, the quality of reported earnings. However, Fama and Jensen
(1983) extended the agency theory framework by introducing the concept of residual
loss, which refers to the costs incurred by shareholders due to the misalignment of
interests between shareholders and managers. They argue that ownership concentration,
specifically higher ownership by large shareholders, can mitigate agency problems and
improve earnings quality. Furthermore, Dechow and Sloan (1991) examined the
relationship between ownership concentration and earnings management. They found
that firms with higher ownership concentration tend to have lower levels of earnings
management, suggesting that concentrated ownership can enhance earnings quality.
Lastly, La Porta et al. (1999) conducted a cross-country study and found a positive
relationship between the level of investor protection (including ownership structure) and

24
the quality of financial reporting. They argued that stronger investor protection
mechanisms, such as greater ownership concentration, can lead to higher earnings
quality.

Nonetheless, high managerial ownership encourages earnings manipulation when there is no

market discipline, and this may cause insiders to make accounting decisions that reflect
personal motives at the expense of the company's interests. In contrast, when there is a
narrow separation between owners and managers, managers face less pressure from financial
markets to signal the firm's value to the market and they pay less attention to the short-term
financial report (Jensen, 1986; Klassen, 1997). According to Morck, Shleifer, and Vishny
(1988), as management ownership rises, the corporate control market and the managerial
labor market are less successful at aligning managers to make decisions that maximize value.
This is due to the fact that significant management ownership means adequate voting power
to ensure continued employment.

Foreign ownership can be viewed from the perspective of agency theory as a source of
effective managerial and oversight capabilities in corporate governance (Choi et al., 2012;
Khanna & Palepu, 1999). According to studies, foreign ownership may have two effects on a
company's performance. This point of view contends that foreign investors can serve as a
check and balance against managerial or insider ownership decisions that might prove
detrimental to other stockholders. By joining boards of directors or joining the ranks of
significant outside shareholders, they can enhance corporate governance (Choi et al., 2012).
They are thought to be able to keep an eye on managers and provide performance-based
incentives that will align the interests of managers and shareholders and thus raise the caliber
of earnings.

The entrenchment hypothesis suggests that high levels of insider ownership can lose their
ability to align insiders to make decisions that maximize value. This managerial conduct
is consistent with this idea. As a result, the predictions of the agency theory may be
confused by this entrenchment effect. Earnings management may become more prevalent
as managerial ownership does, which would lower the quality of earnings (Yeo, Tan, Ho,
and Chen 2002).

25
An active monitoring hypothesis and a passive hands-off hypothesis can both be used to
describe how institutional ownership affects earnings management (Koh, 2003).
According to the active monitoring theory (Bushee, 1998; Majumdar and Nagarajan,
1997), institutional investors have an impact on the monitoring techniques used by a
company, including the activity of monitoring earnings management. In this perspective,
institutional investors are supposed to have a controlling function. Their presence reduces
the likelihood of earnings management, which in turn raises the quality of results
(Bushee, 1998). According to the passive hand hypothesis (Bhide, 1993; Potter, 1992),
institutional investors have a natural tendency to focus on the short term. Such investors
are frequently referred to as myopic investors since they place a greater emphasis on
short-term profits than long-term profits. The managers are motivated to manage earnings
aggressively as a result of this approach, which discourages institutional investors from
investing monitoring fees and focusing on recent earnings news (Koh, 2003).

The efficient monitoring hypothesis from agency theory claims that institutional
ownership-based monitoring can be a significant governance strategy. According to
Almazan, Hartzell, and Starks (2005), institutional investors can offer active monitoring
that is challenging for smaller, more passive, or less knowledgeable investors.
Institutional investors are able and motivated to promote good quality earnings reports,
hence it is expected that earnings quality will grow when they have more influence over
firm management than when they are merely investors (Velury & Jenkins, 2006).

According to the agency theory (Siala et al., 2009), ownership concentration is a key
component of effective corporate governance. However, high levels of ownership
concentration provide managers and controlling shareholders with a chance to help
prevent the expropriation of minority shareholders (La Porta, Lopez-De-Silanes &
Shleifer, 1999; Shleifer & Vishny, 1997). Large shareholders are expected to effectively
oversee managerial behavior, which limits the opportunity for managers to manipulate
earnings (Dechow, Sloan, & Sweeney 1996). Additionally, because controlling
shareholders are more concerned with the long term, management will be under less
pressure to satisfy short-term earnings projections. Thus, ownership concentration limits
earnings management and enhances the quality of earnings, according to the efficient
monitoring hypothesis. Iturriaga and Hoffmann (2005) and Ali, Saleh, and Hassan (2008)
find that ownership concentration limits managers' discretion. Furthermore, conflicts of
26
interest between majority and minority shareholders may arise in companies with
concentrated ownership. Smaller owners may be taken advantage of by larger
shareholders who use their control rights to their own advantage (expropriation
hypothesis). Even if their preferences conflict with those of minority shareholders, the
majority shareholders have the right to impose them (Shleifer & Vishny 1997).
Therefore, in order to maximize their personal profits, wealthy shareholders may
interfere in the administration of the company and push managers to engage in earnings
management, which would lower the quality of earnings (Jaggi & Tsui 2007). Managers
may also have a significant incentive to manage profitability because they worry about
negative consequences for falling performance from large shareholders.

2.5.2 Stewardship Theory

Davis, Schoorman and Donaldson (1997) developed the stewardship theory as an alternative
to traditional agency theory. Stewardship theory argues that managers are not solely
motivated by self-interest but also have an intrinsic desire to act as stewards of the firm,
working in the best interest of shareholders. According to this view, corporate executives'
interests as stewards are congruent with those of the company and its owners. It is commonly
accepted that there is a correlation between an organization's success and its owners' pleasure,
and that the steward's job is to strike a balance between their requirements and the goals of
the organization. The thesis makes the supposition that management aspires to play a
constructive role as a responsible corporate steward. Additionally, it is presumptive that
executive motivation is unaffected by any underlying problems (Donaldson and David,
1991). The main idea is that since directors have sufficient business understanding, they are
better at boosting shareholder wealth. This theory can't be used broadly for the study because
it only applies to management ownership.

2.5.3 Stakeholders Theory

Freeman (1984) introduced the concept of stakeholder theory, which suggests that
organizations should consider the interests of all stakeholders, including owners, employees,
customers, suppliers, and the community, in their decision-making processes. Following
Jensen and Meckling (1976) agency theory argue that the separation of ownership and control
in corporations leads to agency problems, where managers may act in their own self-interest
instead of maximizing shareholder value. This theory lays the foundation for examining the
impact of ownership structure on earnings quality. However, Fama and Jensen (1983)
27
expanded on agency theory by proposing that different ownership structures, such as
concentrated ownership (where a significant portion of shares is held by a small group of
shareholders) and dispersed ownership (where shares are held by a large number of
shareholders), can affect the behavior of managers and, consequently, earnings quality.
Demsetz and Lehn (1985) research explores the relationship between ownership structure and
firm performance. They argue that concentrated ownership can align the interests of
shareholders with those of managers, leading to improved firm performance and higher
earnings quality. La Porta et al. (1999): La Porta et al. conducted a cross-country study and
found that ownership concentration is associated with higher firm value and better protection
of minority shareholders' rights. Their research supports the idea that ownership structure
influences earnings quality.

According to this idea, businesses strive to appease stakeholder expectations in order to

minimize conflict and preserve access to stakeholders' resources (Huang & Kong, 2010). In
terms of their social and economic roles, companies are expected by society to behave in a
positive way. The theory is frequently criticized for having a difficult time reconciling
stakeholder conflict with the challenges presented by managing numerous stakeholders with
varying needs and demands while treating them equally.

28