6.3 Inferential statistics results
6.3.2 Objective 1: Ascertainment of the prevalence of RAM
This current research uses three different measures of RAM, namely, sales manipulation, discretionary expenses manipulation and production cost manipulation.
Each type of manipulation is measured separately using Roychowdhury’s (2006) models discussed in Chapter Five. These models predict normal earnings which are then subtracted from actual reported earnings to find out the amounts of managed earnings (that is, residuals). Afterwards, absolute values of residuals compute a composite value of RAM proxy.
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Table 6.5 shows the correlations matrix between the three models of RAM. The upper matrix represents the Spearman correlation matrix, while the lower part represents the Pearson correlation matrix.
Table 6.5: Pearson and Spearman correlation matrices
ab_cfo ab_disx ab_prod
ab_cfo 1.000 0.074* -0.341*
ab_disx 0.014 1.000 -0.626*
ab_prod -0.260* -0.562* 1.000
* denotes significance at 5% level
ab_cfo, ab_disx, and ab_prod denotes sales, discretionary expenses and production cost manipulations
Table 6.5 reports the correlations for the entire sample of 1,036 firm-year observations over the period 2001-2014. The correlation matrix significance is recognised at the five per cent level. Consistent with prior studies, the correlation coefficients between abnormal discretionary expenses and abnormal production cost in both matrices are strongly negative. The Pearson correlation is -0.56 while the Spearman correlation is 0.63. It may indicate that managers engage in activities leading to abnormally high production cost while also reducing discretionary expenses, all with the sole desire of reporting high earnings, which further confirms the findings that listed firms in Nigeria engaged more in income-increasing RAM. There is a similar significant negative relationship between sales manipulation and production cost manipulation.
The Pearson and Spearman correlation coefficients between abnormal production cost and abnormal sales are -0.26, and -0.34, respectively. It may reveal that managers engage in sales manipulation while at the same time engaging in production cost manipulation. Overproduction will lead to an increase in goods available for sale, which will necessitate credit sales or granting of sales discounts which invariably leads to a reduction in the current period cash flow. The correlation coefficient between sales manipulation and discretionary expenses manipulation is positive in both matrices. The Pearson and Spearman correlation coefficients are one per cent and seven per cent respectively, though it is strongly positive in Spearman correlation. It is probably because, in an income-increasing manipulation, both models move in the same direction. This finding is similar to the findings in Roychowdhury (2006).
6.3.2.2 The RAM component models’ estimates
Table 6.6 lists the results for the three models’ equations stated in Chapter Five. The coefficient signs are similar to the prior studies of Roychowdhury (2006), Gunny
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(2010), and Bjurman and Weihagen (2013). In the sales manipulation model, the only coefficient that is not significant is the change in the current sales level (∆SL/TAt-1). It indicates a low probability that change in the current sales affects cash flow from operations significantly.
Table 6.6: RAM models’ estimates
1 2 3
Dependent Variables ab cfo ab disx ab prod
1/TAt-1 0.084*** 0.172*** -0.132***
SL/TAt-1 0.024*** 0.852***
SLt-1/TA it-1 0.060***
∆SL/TAt-1 0.004 0.060
∆SLt-1/TA it-1 0.069
Observations 1036 1036 1036
F 3.620 12.010 435.460
Prob>F 0.032 0.001 0.000
r2 0.020 0.080 0.890
r2_a 0.020 0.080 0.890
***, ** and * denotes significance at 1%, 5% & 10% respectively
ab_cfo, ab_disx, and ab_prod denotes sales, discretionary expenses and production cost manipulations
Prior research indicates similar results about the significance of the discussed coefficient (Aflatooni & Mokarami, 2013; Cupertino et al., 2016). The estimated firm- year variables are winsorised at 99% (from both ends) to mitigate observed outliers’
effects. Other studies that also winsorise are 99% in Roychowdhury (2004), 99% in Zang (2012), 95% in Chen et al. (2014), 95% in Wang (2015), 98.5% in Cupertino et al.
(2016).
6.3.2.3 Descriptive statistics of RAM models’ residuals
Table 6.7 shows descriptive statistics for the three metrics of manipulation vis-á-vis sales manipulation (ab_cfo), discretionary expenses manipulation (ab_disx), and production cost manipulation (ab_prod).
Table 6.7: RAM measurement
Variable Observations Mean Standard
deviation. Minimum Maximum
RAM 1036 0.026 0.460 -3.676 1.518
ab_cfo 1036 -0.006 0.166 -0.616 0.490
ab_disx 1036 -0.005 0.151 -0.330 0.659
ab_prod 1036 0.015 0.293 -3.148 1.321
ab_cfo, ab_disx, and ab_prod denotes sales, discretionary expenses and production cost manipulations
Nigerian prior studies on RAM do not produce the descriptive statistics on the three models. The results in Table 6.7 reveal the prevalence of manipulation through real
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activities which generates abnormally low operational cash flow, abnormally low discretionary costs, and abnormally high production costs. It indicates that the sampled firms during the period under review engage more in income increasing RAM. It is important to state that manipulations of earnings could have either upwards or downwards directions. Income-increasing and income-decreasing manipulation decisions arise due to managers’ earnings targets (Idris, 2012). This result is similar to that of Cohen and Zarowin (2010), and Cohen et al. (2008). There are studies on RAM in Nigeria by Hassan and Ibrahim (2014), Okolie (2014b), Okolie et al. (2014), and Bello et al. (2015), but they fail to reveal the direction of RAM prevalence.
6.3.2.4 Estimation of sales manipulation model
The sales manipulation model estimates in Column ‘1’ of Table 6.6 is an indication of the prevalence of sales manipulations with an income-increasing motive by Nigerian listed companies. The current sales level exerts significant effects on current cash flow from operations, while the change in the current sales level has no significant effect.
After estimating the parameters in Equation 1, abnormal cash flow (ab_cfo), representing sales manipulation is a measure of the residual value of Equation 1. Since the signed value of abnormal cash flows from operations decreases with sales manipulation, a negative value of the model estimate indicates high sales manipulations.
With the value of the R square of 0.02, both current sales and current change in sales level account for about 2% systemic change in cash flow from operations in the Nigerian listed companies.
The negative mean value of the residual as revealed in Table 6.7 is an indication that there is an income-increasing sales manipulation in Nigerian listed companies. This finding is in agreement with Bello et al. (2015), which covers six years (2008-2013), concentrating on 20 listed manufacturing firms in Nigeria. Okolie (2014b), using 342 firm-year observations of firms listed on the NSE during the period between 2006 and 2011, also records a dominant (heavy) presence of cash-based earnings management (RAM) among the sampled firms. Therefore, this further suggests that listed companies in Nigeria are engaging in such acts as could promote sales manipulation such as using price discounts to boost sales in order to reduce margins because as margins decline, the cash inflow per sale decreases while the sales volume increases.
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Likewise, they may be offering more lenient credit terms like lower interest rates (for example, zero per cent financing) which reduces cash inflow and leads to a high sales volume. All these are activities that promote sales manipulations which are an indication of RAM in the Nigerian listed companies. The residual of the equation is estimated, then multiplied by minus one before included in the RAM measurement.
6.3.2.5 Estimation of discretionary expenditure model
The next aspect of RAM is discretionary expenses manipulation. Equation 2 in the methodology represents the model. The result of the model estimation is in Column ‘2’
Table 6.6. The result in Table 6.6 is an indication of the prevalence of income- increasing manipulation through abnormal discretionary expenses in Nigerian listed companies. The previous sales or sales of the preceding year are statistically significant at one per cent level; it is, therefore, an important determining factor of discretionary expenses in these companies. The model is also statistically significant, meaning the independent variables in the model improve the model fit, and they are jointly significant in explaining the variability in the dependent variables. The R square value is 0.08. The negative mean value of the residual, as revealed in the summary Table 6.7, is an indication that there is a high level of discretionary expenses manipulations by Nigerian listed companies.
The residual of the estimated model, as revealed in Table 6.7, is the abnormal discretionary expenses, the second measurement of RAM in the companies listed on NSE, as examined in this study. The results suggest that the sampled companies are also engaging in practices that reduce discretionary expenditures to increase earnings. These discretionary expenses are usually period costs, as when a firm incurs these costs it accounts for them in the same period, thus reducing them will bring down the period cost while increasing the period earnings. The estimation of the equation generates residuals, the residuals are multiplied by minus one before adding it to the RAM measurement.
6.3.2.6 Estimation of production cost manipulation model
The third and the last measurement of RAM in this study is the production cost manipulation. The model’s regression result for the firms’ production costs is in column 3 of Table 6.6. The result describes the production cost relationship with sales variables.
The critical reason for the model estimation like others is to ascertain the prevalence of
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the production cost manipulation, which is the third measurement of RAM in the listed companies in Nigeria. The results show that the current sales level, change in current sales level and change in the preceding year’s sales level are essential determinants of production cost. The coefficients of these variables pass the individual test of statistical significance.
The R square of the model is 0.89. It indicates that the current sales level, change in current sales level and change in the preceding year’s sales level all explain 89%
systemic variations in the production cost of the firms. The F-statistics also shows that the production cost manipulation model is statistically significant. The positive mean value of the residual as revealed in the summary Table 6.7 is an indication that there is an income-increasing manipulation of earnings through abnormal production cost in Nigerian listed companies.
The implication is that the sampled firms during the period under review are engaging in overproduction to boost earnings. The equation estimation also generates residuals that are added-up to the RAM measurement. The production cost manipulation model residual is not multiplied by minus one because the high values of the residual already indicated a high level of manipulation by production cost.
It is essential to generate the composite RAM measure as this is required as the dependent variable in the models for objective two and three. The result in Table 6.7, with a mean value of 0.0259, confirms the income-increasing nature of RAM prevalence among companies listed on the NSE during the observation period.
Therefore, an aggregate measure of RAM following Roychowdhury (2006), Cohen and Zarowin (2010), Sun et al. (2014), was generated. It was computed by summing up the three RAM measures to give a composite RAM value which is the dependent variable in model 4 and 5.
In concluding this section, the assessment of the prevalence of RAM in the sampled listed companies appears to be income-increasing manipulations. The signed values of the residuals in the three models (sales manipulation, discretionary expenses manipulations, and production cost manipulations) as evidenced in Table 6.7 are all indication of income-increasing RAM common among the listed sampled firms for the period under review. The next section presents the results of the inferential statistics using panel regression models.
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