Leverage And Earnings Quality Of Nigerian Listed Banks


Leverage And Earnings Quality Of Nigerian Listed Banks

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In the quest to optimize their objective, which hinges primarily on quantifiable performance, financial managers have adopted various capital structures as a means to that goal. A firm can finance its investment by debt and/or equity.

Leverage and earnings quality is a key concern for all investors and potential investors in any organization. As posited by Biddle et al. (2009), financial information quality is termed as the precision with which financial reporting conveys information about the firm’s operations, in particular its expected cash flows that inform equity investors. Their definition is consistent with the Financial Accounting Standards Board (FASB) Statement of Financial Accounting Concepts No. 1 (1978), which states that one objective of financial reporting is to inform present and potential investors in making rational investment decisions and in assessing the expected firm cash flows. Literature on stewardship accounting posits that an accounting number is deemed value relevant if it has a significant association with equity market value (Barth, Beaver, & Landsman, 2001), and could be used to estimate future returns (Beaver, 1968). Thus, if reported earnings are considered by investors to be value relevant and useful in estimating future returns, market value of shares and earnings should normally be related.

Corporate scandals in organization in the last decade and the collapse of big firms in recent around the world have raised concerns about leverage and earning quality which led to the passage of Sarbanes–Oxley Act which had a focus on the financial aspects of corporate governance. The Nigeria Banking Sector was not also free of these said corporate scandals which led to the various reforms by Central Bank of Nigeria (CBN) that forced some of those affected banks out of Business.

Leverage and earnings information is relevant to the extent that it is capable of influencing a decision maker by helping him/her to predict the outcomes of present event or to confirm or correct prior expectations (Bushman, Chen, Engel and Smith, 2004).

The use of fixed-charged funds, such as debt and preference capital along with the owner’s equity in the capital structure is described as leverage or gearing (Dare and Sola, 2010). An unlevered firm is an all-equity firm, whereas a levered firm is made up of ownership equity and debt. leverage takes the form of a loan or other borrowing (debt), the proceeds of which are (re)invested with the intent to earn a greater rate of return than the cost of interest. If the firm’s marginal rate of return on asset is higher than the rate of interest payable on the loan, then its overall return on equity will be higher than if it did not borrow (Laurent, 2005). On the other hand, if the firm’s return on assets is lower than the interest rate, then its return on equity (ROE) will be lower than if it did not borrow. Leverage allows a greater potential return to the investor than otherwise would have been available, but the potential loss is also greater: if the investment becomes worthless, the loan principal and all accrued interest on the loan still need to be repaid (Andy et al., 2002). This constitutes financial risk (Pandey; 2005). The degree of this financial risk is related to the firm’s financial  structure.  The total combination of common equity, preferred stock and short and long term liabilities is referred to as financial structure. That is, the manner in which the firm finances its assets constitutes its financial structure. If short-term liabilities are subtracted from the firm’s financial structure, we obtain its capital structure. In other words, the firm’s permanent or long- term financing consisting of common equity, preferred stock and long term debt is called capital structure.

It is to this end that the study examines leverage and earnings quality of Nigerian listed banks. The Deposit Money Banks is one of the most vital sectors in Nigeria economy such that whatever happens to it may affect other sector within the economy and as such it is important to study these internal and external variables that may affect the leverage and earnings quality of Banks.


Leverage and earnings quality has become a global concern particularly in recent time due to the reported cases of corporate failures arising from improper, false and misleading financial reporting in firms which hitherto had enjoyed good reputation due to the track record of great success in their lines of business (Agrawal and Chadha, 2005). A financial statement is said to be misleading if it lacks the qualities of accuracy, relevancy, comparability, reliability, compatibility and it contains fundamental errors or is prepared with the intention to deceive and/or confuse the users. Such deception can be carried out in a number of ways, among which are distortions of accounting records, falsification and omission of transactions, or misapplication of accounting principles (Higgs, 2003).

Leverage andearning quality plays a vital role in constraining managers (account information preparers) from man over the accounting numbers which will ultimately improve the quality of reported accounting information. There has been inconclusive findings and divergent views in prior literatures as to whether firm leverage and earning quality have impact on performance and financial information quality. Fraud is a complex phenomenon; It is rampant in both private and public sectors of Nigeria Economy.



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