Earnings Management of Quoted Corporate Firms: Detecting and Rethinking the Key Drivers in an Insensitive Capital Market as a Panacea for Investors’ Resource Abuse

Abstract

Both mechanistic and positive accounting theories were postulated to explain the drivers of earnings management. Scholars postulated the theories perhaps under the belief that market would always be sensitive to firm performance reports. Since the emergence of these theories, many empirical researches have been based on such a framework. They found that positive relationship exists between capital market and earnings management. The key questions we want to address in this present study is whether the direction will remain unaltered if market goes insensitive. In addition, if it has altered, what key factors could determine earnings management in the turn of the market? Given that some developing economies capital markets are now insensitive to performance stimuli for over a long period, the reality of metrics constituting the real drivers of earnings management needs rethinking for avoidance of investors’ resource misallocation. In this study, we examined variables that could really constitute the key drivers using a cross-sectional survey research design in an insensitive market among the quoted firms in Nigeria. We analyzed data we obtained from survey using logistic regression model, which helped us to detect earnings management maximum likelihood in an insensitive stock market. The result revealed that market capitalization and compensation contracting based on share options negatively drive managers to engage in earnings management as opposed to mechanistic theories if market turns insensitive to performance. However, non- market based factors including debt covenant, compensation based on cash options, loss deletion and regulation positively drive managers to engage in earnings management practices whether market is sensitive or insensitive to performance report. Therefore, we found the key drivers of earnings management in an insensitive market to constitute non-market based compensation incentives. We recommend that in order to encourage earnings quality and eschew investors’ resource misallocation, earnings management containment based on the efficient, sensitive market premises should be reviewed, and emphasis should be placed on non-market based containment strategies.

Key Words: Earnings; Earnings Management; Drivers, Market Capitalization; Market Sensitivity; Capital Market Insensitivity