Topic: A STUDY OF NIGERIAN STOCK EXCHANGE (NSE)

Chapter One

INTRODUCTION

1.1 Background of the Study

Accounting provides a vital service to broadand diverse users. Investors use financial accounting information for investment decisions; government agencies need it particularly for tax purposeswhile regulatory agencies use it to determine whether existing statutory pronouncements are complied with, among others (Kajola and Adedeji, 1999). According to Meyer (2007:2),“accounting plays a significant role within the concept of generating and communicating wealth of companies”. Financial statements still remain the most important source of externally feasible information on companies. Nevertheless, in the wake of the recent accounting scandals and economic meltdown where billions of naira of investment and retirement wealth have disappeared, the very integrity and survivability of the value relevance of this service has been called to question. Value relevance is defined as the ability of accounting numbers contained in the financial statements to explain the stock market measures (Beisland, 2009). Accounting data, such as earnings per share, is termed value relevant if it is significantly related to the dependent variable, which may be expressed by price, return or abnormal return (Gjerde, Knivsfla and Saettem, 2007). Studies on value relevance of accounting information are motivated by the fact that listed companies use financial statements as one of the major media of communication with their equity shareholders and public at large (Vishnani and Shah, 2008). For instance, in Nigeria, Companies and Allied Matters Act (CAMA), (1990)and the subsequent amendments require the Directors of all companies listed on the Nigerian Stock Exchange to prepare and publish annually the financial statements. Beyond this, the Nigerian Stock Exchange mandates all companies listed on first tier market to submit quarterly, semi-annual and annual statements of their accounts to the Stock Exchange. Companies on second tier market are to submit their statements of accounts annually to Stock Exchange (Osaze, 2007). Accounting information is any data or information obtains from the accounting system of a firm whether contained in a financial statement, a special report, or verbal statement (William, 1968).However, for the purpose of this research, accounting information refers to written information contained in a complete or partial financial report –balance sheet or profit and loss account or fund flow statement. This study investigates whether these various items of financial statements are value relevant in the Nigerian Stock Exchange or not. The Nigerian Stock Exchange (NSE) commenced operation in 1961with only 19 securities worth N80million. As at May 2009, the number of listed securities had increased to 294, made up of 86 Government Stocks with Industrial Loans Stocks and 208 Equity/ Ordinary Shares(including emerging market) with a total market capitalization ofN9.45 trillion (The Nigerian Stock Exchange, Factbook, 2009). However, the Nigerian Stock Exchange still seems to have a long way to go when compared with developed stock markets (Ologunde, Elumilade and Asaolu, 2006). Nigerian Stock Exchange, as a medium of funds mobilization for economic growth may not function well without relevant and reliable accounting information. The researcher is thus motivated to study the extent to which accounting information summarizes stock prices inthe Nigerian stock market as an indicator of value relevance.The study of likelihood of the market prices of stock listed in the Nigerian Stock Exchange being a reflectionof accounting information is very essential to investors as well as policy makers.Recent evidence shows that stock markets have positive impact on economic growth (Healy and Williston,2005 andCharles,2008).In a bid to corroborate or repudiate the afore-mentioned, the perception of institutional and individual investors about value relevance of various items of financial statements for equity valuation is also considered. As a result, the study attempts to fill the gap in literature by investigating the ability of accounting information to capture or summarize information that affects equity value by examining the relationship between accounting numbers and share prices in the Nigerian Stock Exchange. This in turn is expected to accelerate development of the Nigerian stock market.

1.2 Statement of Problem

Stock markets worldwide had turbulent time in 2008 which brought value relevance of accounting information under severe criticisms. There are some concerns that accounting theory and practice have not kept pace with rapid economic and high-technology changes which invariably affect the value relevance of accounting information. The claim is that financial statements are less relevant in assessing the fundamental market value of service-oriented companies, which are by nature high-technology driven. According to Sutton (1997:1), “while accounting can be an important factor in some decisions, accounting that masks or fails to capture meaningful information for the benefit of all investors is not sound and puts investors at risk”. This will make those who have money to lend and invest to take it to where their need for accounting information is met (Germon and Meek, 2001). The value and the quality of accounting information are determined by how well it meets the needs of users (Khanagha, 2011). Therefore, the flow of reliable information is crucial to the growth of the Nigerian Stock Exchange- without it, savers would simply keep their hard-earned savings under their mattress. It may not be an overstatement to say that Nigerian Stock Exchange will not function well without relevant and reliable accounting information. Deficiencyin Nigerian Stock Exchange will affect Nigerian economy because capital market is the engine of economic growth (Okeke, 2004). Hence, the study of whether the market prices of stock listed on the Nigerian Stock Exchange reflect accounting information is not only important to investors but also crucial to Nigerian economic growth. Negah (2008) asserts that studies on the value relevance of accounting numbers in emerging markets are limited. He further claims that the scanty literature replicates works done in mature markets and that closer examination of these works reveals that they face both epistemological and empirical challenges. In other words, accounting for a significant portion of the existing value relevance studies in capital market research are works carried out in the developed economy. However, it is evident that these studies are not free of problems and challenges that call for further examination (Holthausen and Watts, 2001). For instance, most of these studies were carried out in United States of America and United Kingdom that have developed stock markets and focused exclusively on earnings and book value to explain share price behavior. Besides, value relevance research is afield in which the empirical results are sometimes mixed. The results presented in the literature are contradictory. The belief is that the divergence of opinions is somewhat due to econometric problems adopted in these studies. Particularly the deviation of the characteristics of accounting data from the assumptions of the applied methods and the misuse of statistical indicators led to contradicting inferences in these literatures. It is important to investigate whether the result will agree or digress from the previous studies. However, are these accounting practices and standards really relevant in Nigerian context? Given the above, it is pertinent to carry out a detailed assessment of the value relevance of accounting information in meeting Nigerian emerging stock market speedy needs for growth and development. Although much has been written on the subjects of value relevance of accounting information using United States of America (USA) and United Kingdom (UK) data, empirical research in this area has been less forthcoming in developing countries. Hence, the researchon the relationship between the market prices of stock listed in the Nigerian stock market and accounting information is not only of vital importance to investors but also to policy makers. The implications are enormous for foreign and local investors who make their decisions based on accounting information. Stakes are equally high for policy makers who consider information as very important to capital market development(Ologunde et al, 2006), and the stock market as the primary vehicle for transforming the Nigerian economy to economic prosperity (Okereke-Onyiuke, 2008).

1.3 Aim and Objectives of the Study

The broad objective of this study is to investigate the dynamic relationship betweenaccounting numbers and market values of listed companies on the Nigerian Stock Exchange. The specific objectives based on the identified problems are to: 1. Analyze the ability of accounting information to affect share prices of firms listed on the Nigerian Stock Exchange; 2. Determine the differences between the accounting information of manufacturing and service sectors in Nigeria; 3. Analyze the relationship between negative earnings and market values of companies listed on the Nigerian Stock Exchange and 4. Examine the differences in perception of institutional and individual investors about the value relevance of financial statements in equity valuation.

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