ISSUE AND CHALLENGES OF AGENCY THEORY IN ACCOUNTING CHOICE IN NIGERIA

Abstract

This study examines agency theory and accounting choice: issue and challenges in Nigeria. The broad objective of the study is to find out if there is a relationship between fixed compensation for the employees and the firm’s profitability and also to find out if there is a relationship between commission based rewards and firm’s profitability. In the majority of large publicly traded corporations, agency conflicts are potentially quite significant because the firm’s managers generally own only a small percentage of the common stock. The secondary source of data collection was used in the study. The stratified random sampling technique was used to select a sample size of 20 companies which serves as the sample size of the study, in respect of this, the ordinary least square method was used in the data analysis. The findings revealed that there is a negative relationship between fixed compensation for the agent and firm’s profitability. It was concluded that share of profit fixed compensation has provide to be a powerful tool in aligning the interests of the principal and the agent as far as financial compensation of the managers/employees is concerned in the agency relationship. It was recommended among others that managers/employees should be allowed to participate in profit sharing.

TABLE OF CONTENTS

Title Page                                                                                i

Certification                                                                            ii

Dedication                                                                               ii

Acknowledgements                                                                 iv

Table of Contents                                                                    v

Abstract                                                                                  vi

Chapter One: Introduction                                                    1

1. Background to the Study                                                                  1
2. Statement of Problem                                                              3
3. Research Questions                                                                 3
4. Objectives of the Study                                                           4
5. Statement of Hypothesis                                                                  5
6. Significance of the Study                                                         5
7. Scope of the Study                                                                            6
8. Limitations of the Study                                                                    6
9. Definition of Terms                                                                 6

Chapter Two: Review of Related Literature                         8

2.1     Introduction                                                                            8

2.2     Origin of Agency Theory                                                                  8

2.3     Agency Relationship                                                               10

2.4     The Principal-Agent Problem                                                  13

2.5     The Cost of Agency Relationship                                            22

2.6     Aligning the Principal-Agent Interest                                      27

2.7     The Concept of Accounting Choice                                         49

2.8     Classification of Accounting Choice                                                 54

2.9     The Effects of Managers Accounting Choices                          56

Chapter Three: Research Method and Design                    68

1. Introduction                                                                                      68
2. Research Design                                                                      68
3. Description of Population of the Study                                   69
4. Sample Size                                                                             69
5. Sampling Technique                                                                69
6. Sources of Data Collection                                                      69
7. Method of Data Presentation                                                  70
8. Method of Data Analysis                                                        70

Chapter Four: Data Presentation, Analysis      

and Interpretation                                                                  72

4.1     Introduction                                                                            72

4.2     Presentation of Data                                                                72

4.3     Data Analysis                                                                          73

4.4     Hypothesis Testing                                                                 74

Chapter Five: Summary of Findings, Conclusion

and Recommendations                                                                    77

5.1     Introduction                                                                                      77

5.2     Summary of Findings                                                             77

5.3     Conclusion                                                                              78

5.4     Recommendations                                                                             79

References                                                                               81

Appendix                                                                                83

CHAPTER ONE

INTRODUCTION

1.1     Background to the Study

According to Jensen (2006), an agency relationship is a contract under which one or more persons (principal) engages another person (the agent) to perform some services on their behalf which involves delegating some decision-making authority to the agent. The cornerstone of agency theory is the assumption that the interests of principals and agent diverge. According to agency theory, the principal can limit divergence from his/her interest by establishing appropriate incentives for the agent, and by increasing monitoring costs designed to limit opportunistic action by the agent. Agency theory suggests that the firm can be viewed as a nexus of contracts (loosely defined) between the resource holders. Agency relationship arises whenever one or more individuals hire one or more individuals called agent to perform some services and then delegate decision making authorities to the agent. The primary agency relationships in business are those:

1.       between stockholders and managers; and

2.       between debt holders and stockholders.

These relationships are not necessarily harmonious; indeed, agency theory is concerned with agency conflict or conflict of interest between agent and principal and this has implication for among other things, corporate governance and business ethics. When agency theory occur, it also tends to give rise to agency costs, which are expenses incurred in order to sustain an effective agency relationship (e.g., offering management performance bonuses to encourage managers to act in the shareholder’s interests). Anderson and Macie (2006) said there will be continual diverging interests between the principal and the agent, unless an effort is made in order to align these interests. According to Ilaboya (2008), two of the contents of financial statements required by CAMA 2004 to be prepared by company directors, provided each for the interest of the shareholders (principal) and that of the management/employees.

The profit and loss account shows the level of profit of a firm and is in line with the shareholders’ profit maximization interest, while the value added statement which shows the wealth created and how it is distributed to all stakeholders, shows the portion of the wealth created that goes to the management/employee the (the agent) as well as treat the agent as a team member in the wealth creation process.

The primary focus of this study is on how the various reward systems especially the financial reward systems helps to resolve the conflicts between the principal and agent without compromising the accounting policies, standards (accounting standards) and regulations.

1.2     Statement of Problem

Divergence of interest between firm owners and the management cannot result to the achievement of the primary objectives and goals of any business organizations which is profit maximization. This is because the synergy required and the strategic fit will be lacking in a firm operating under conflicts of interests. Therefore, efforts must be made to reconcile the interests of the agent and his principal. So, while the principal would be fine with profit maximization, the agent would want the best possible reward system for his efforts.

1.3     Research Questions

In view of the above, one would want to find answers to the following questions;

1.       What is the relationship between fixed compensation for the employee and firm’s profitability?

2.       Is there any relationship between commissions based reward and firm’s profitability?

3.       Is there any relationship between profit sharing in addiction to fixed compensation and firm’s profitability?

4.       What is the relationship between year end performance bonus and firm’s profitability?

1.4     Objective of the Study

          The objective of the study includes the following: 

1.       To find out if there is a relationship between fixed compensation for the employees and the firm’s profitability.

2.       To find out if there is a relationship between commission based rewards and firm’s profitability.

3.       To find out if there is a relationship between profit sharing in addition to fixed compensation and firm’s profitability. 

4.       To find out if there is a relationship between end of year performance bonus and firm’s profitability.

1.5     Statement of Hypothesis

          The following research hypotheses will aid this study.

Hypothesis One

HO:    There is no relationship between fixed compensation and firm’s profitability.

HI:    There is a relationship between fixed compensation and firm’s profitability.

Hypothesis Two

HO:    There is no relationship between commission based reward and firm’s profitability.

HI:    There is a relationship between commission based reward and firm’s profitability.

Hypothesis Three

HO:    There is no relationship between profit sharing in addition to fixed compensation and firm’s profitability.

HI:    There is a relationship between profit sharing in addition to fixed compensation and firm’s profitability.

Hypothesis Four

HO:    There is no relationship between end of year performance bonus and firm’s performance.

HI:    There is a relationship between end of year performance bonus and firm’s profitability.

1.6     Significance of the Study

          The followings are the significance of the study.

1.       To add to the current body of knowledge in the area of agency theory and accounting choice.

2.       It is also hoped that this study will broaden the knowledge of the students of accounting.

3.       Furthermore, this research work will assist resource owners by enlightening them on more of how to use various financial reward systems to motivate agents for better efforts leading to maximum performance and maximization of firm’s profit.

4.       Finally, it is hoped that this research work will be a guide and research material to students who wish to carry out similar research in the future.

1.7     Scope of the Study

The scope of this study is limited to some selected non-financial firms listed on the floor of the Nigerian stock exchange.

This study is aimed at surveying the nature and effects of financial reward systems available for firms on the profitability of the firms and how it can be used to reduce the principal-agent problems in business organizations.

1.8     Limitations of the Study

The major limitation of this study is the short time frame used to execute this project in addition to the fact that the research work has to be done alongside the normal academic work. In addition to this, dearth of literature and the paucity of current and up to date research materials and information in my vicinity. Thus, the literature review was more of materials from journals, internet amongst others which are difficult to come by and even more difficult to analyse than textbooks. However, not all the information required could be found from available records.

1.9     Definition of Terms

1.       The Agent: This refers to the management/employee who utilizes shareholders’ resources to generate expected profit.

2.       The Principal: This refers to the shareholders/stockholders who own the business which the agent manages.  

3.       Operating Income: This is defined as profit after tax.   

4.       Fixed Compensation: This is defined as all financial rewards independent of performance which is fixed and constant every year irrespective of performance.

5.       Commission: This is defined as a reward system based on level of performance or certain percentage of sales.

6.       Profit Sharing: This is defined as the sharing of profit after tax with managements/employees.

7.       Performance Bonus: This is defined as the monetary reward given to employees after improved performances.