Journal of Management Studies
An Investigation of the Relationship between the Quality of Earnings and the
Movement of Stock Prices of Banks in Nigeria Using the Q Test Model
MUSA, I. FODIO AND ATOYEBI, A. TAIBAT (Mrs.)
Abstract
This study utilises the Q test model to measure the quality of reported earnings of 15 listed banks in
Nigeria between 2006 and 2010. The study also investigates the association between earnings quality
and stock price movement of the banks and whether global financial crisis impacted significantly on
the earnings quality-stock price relationship. The Q Test analysis shows that Q test model is a good
measure of earnings quality of banks in Nigeria. Our OLS regression analysis further shows that there
is a significant positive relationship between earnings quality and stock price movement of banks in
Nigeria, although earnings quality are not the only stock drivers of the banks. The results also reveal
that global financial crisis impacted negatively and significantly on the earnings quality-stock price
relationship of the banks. The study suggests among other things that auditors should always carry out
an earnings quality assessment before attesting to the truth and fairness of the reported financial
statements.
Key words:
Stock Prices, Quality of Earnings, Nigeria Stock Exchange, Global
Financial Crisis
Introduction
In a recent paper, Putman, Griffin and Kilgore (2005) developed and tested a model
(known as the Q test model), which they utilised in determining the quality of
earnings of 20 US non-financial publicly held companies. The model, which was
designed along the same line as Altman’s Z-score, uses a mathematical approach to
earnings quality determination. The results of the study show that the Q test model is
a reliable measure of quality of earnings of their sampled firms. Furthermore, they
compared Q test scores of the companies to their stock price movements and reported
that the companies with the most consistent Q test scores during the study period
posted the greatest gain in their stock prices-an indication that improvement in Q test
scores was accompanied by gains in stock prices.
The tradition in the intellectual world is that new models are usually subjected to
series of tests using different samples and or periods, and in different environments to
confirm their robustness. However, we are not aware of any subsequent studies that
tested the robustness of the Q test model. The current study tests the robustness of the
model using data from banks listed in the Nigerian Stock Exchange during the period
2006 to 2010. The study further examines the association between the quality of
earnings and stock prices of the banks, and whether the global financial crisis that
occurred during the period impacted on the earnings’ quality-stock price relation.
The banking sector has been considered appropriate for this study because the quality
of earnings of banks in Nigeria came under scrutiny in recent time when the banks,

.
Musa I. Fodio and Atoyebi A. Taibat (Mrs.) are lecturers in the Department of Accounting,
University of Abuja, Nigeria.
An Investigation of the Relationship between the Quality of Earnings and the Movement of Stock Prices
of Banks in Nigeria using the Q Test Model
which have been declaring profits with fantastic Earnings Per Share (EPS) and paying
dividends, suddenly became distressed and then became nationalised.
In 2009, the Central Bank of Nigeria (CBN) conducted an audit of the country’s 24
banks with the aim of stabilising the banking sector reeling from bad debts. The result
of this audit exercise led the CBN to fire the chief executives of eight banks and
injected at least N620 billion ($4.12 billion) capital into those and two other banks to
boost their capital and liquidity. The sudden down turn of events portrayed by various
companies including banks in Nigeria whose stocks were thought to be well behaved
and who were considered movers of the stock market still requires an explanation.
Ekwu (2009) suggests an explanation for this by setting the example of Afribank. He
notes that Afribank is a victim of the selfishness of many people, the Transnational
corporation Plc, owes it $200 million and the loan had been tagged non- performing
loan which in financial term means that the loan had not been serviced for over 3
months. The irony was that the director of the stock exchange, who was among the
directors of the corporation, could not dare come out in public to suspend the shares
of Afribank and similar banks. The provisions of the prudential guidelines stipulating
suspension of interest on non performing loans and adequate provision for
substandard and doubtful loans with an outright write off of lost loans were ignored
by these banks. It was therefore quite surprising to note the ignorance of the stock
market over the bad debts in these banks prior to the announcement of the CBN.
How then can the quality of reported earnings of banks be measured in order to make
informed judgement based on them? Many accounting and finance journals have
included articles that identified ways of distinguishing quality earnings from managed
earnings (Brown, 1999; Branner, 2001; Schipper & Vincent, 2003; Dechow &
Schrand, 2004; Francis, Olsson & Schipper, 2008; Dechow, Ge, & Schrand, 2010;
Starmine, n.d). With the models and options coming up and the auditing guidelines
springing up to level of assurances, it is necessary to test the quality of earnings of
Nigerian banks.
In this paper, we extend the work of Putman et al (2005). We thus contribute to the
knowledge base in three ways. First we redefined two of the fundamental variables
used in the original model-sales and accounts receivable because of the peculiar
nature of banking activities. These two variables were appropriately substituted with
gross earnings and loans and advances respectively, since banks do not deal with sales
and accounts receivable.
Second, the previous work stopped at the level of descriptive comparison of the Q test
scores with stock price movements of the sampled companies. Rather than
descriptively analysing the relation between earnings’ quality (proxied by Q test
scores) and stock price movement, we extend the previous study by utilising the
ordinary least squares (OLS) regression technique to analyse the association between
the two variables.
Although there is a body of evidence that suggests that the information contained in
accruals (a proxy for earnings’ quality) is not efficiently impounded in stock prices
when it enters the public domain (Sloan, 1996; DuCharma, Liu & Malatesta, 2004;
Chan, Jegedeesh and Lakonishok; 2008), a number of studies in most recent time
have found evidence of a relationship between stock price and earnings’ quality
54
Musa, I. Fodio, and Atoyebi, A. Taibat (Mrs)
(Zhou, 2008; Samadiyan & Razaei, 2012). We contribute to this debate by testing the
association between quality of earnings’ and stock price movement of banks in
Nigeria.
Third, we introduced a variable to control for the effect of global financial crisis on
the quality of earnings’ stock price relationship. The rationale for this is that our study
period coincided with the global crisis period which began in 2008. A number of
studies such as Ravichandra and Maloain (2010), Mahran (2011), and Angabani and
Wasiuzzaman (2011) have revealed that the global crisis had significant impact on
prices of stocks in the financial markets of both developed and developing economies.
The financial sector was also discovered to be one of the sector that was worst
affected by the crisis. We therefore assessed the effect of the crisis on the quality of
earnings’ stock price relation of the banks in Nigeria.
The stakeholders in the Nigeria banking industry are enormous (shareholders,
depositors, investors, employees, customers, creditors, tax authorities, and
communities where they operate) and there is a need to satisfy every interest in order
to achieve the essential aim of maximizing shareholders’ wealth. The results of this
study are expected to assist depositors and investors who are among the badly
affected parties in the event of bank distress and eventual liquidation by providing
them with an early signalling device for assessing a bank’s real earnings performance.
The remainder of the paper is organised in to four sections. The next section provides
the conceptual framework and literature review of the paper. Section three highlights
the methodology of the study; section four discusses the findings, while section five
provides the conclusions and recommendations of the study.
Conceptual Framework and Literature Review
Earnings’ quality has been viewed by various authors in different ways depending on
the angle from which these authors have viewed earnings in whole or in parts.
According to Dechow, Ge and Schrand (2009) earnings’ quality is meaningless
without specifying the decision context, because the relevant features of the firm’s
fundamental earnings process differ across decisions and decision makers. Earnings’
quality can be seen as having two guises- a fundamental attribute and a financial
reporting attribute. The fundamental earnings are the accounting profitability
measures that gauge a firm’s ability to make future dividend payments. On the other
hand, reported earnings are the imperfect signal of fundamental earnings that a firm
announces. Earnings’ quality is viewed as the speed and degree of precision with
which reported earnings reveal fundamental earnings; the higher the earnings, the
more quickly and precisely, reported earnings convey shocks to the present value of
expected dividends (Yee, 2006). Mc Clure (2010) explains the three characteristics of
'quality earnings' as those earnings that are repeatable, controllable, and are efficient
cash generators; that are bankable. Sales growth and cost cutting are the best routes to
high-quality earnings. Both are repeatable. Earnings’ figures that closely resemble
cash (that is cash sales) that is left after expenses are subtracted from revenues are
said to be of high quality. The fact that customers can cancel or refuse to pay after the
arrival of receivables creates large uncertainties, which also lower earnings’ quality.
According to Bellovary, Giacomino and Akers (2005), earnings’ quality refers to the
ability of reported earnings to reflect the company’s true earnings, as well as the
55
An Investigation of the Relationship between the Quality of Earnings and the Movement of Stock Prices
of Banks in Nigeria using the Q Test Model
usefulness of reported earnings to predict future earnings. Earnings’ quality may also
refer to the stability, persistence, and lack of variability in reported earnings. StarMine
(n.d) defines earnings’ quality as a measure of the degree to which past earnings are
reliable and are likely to persist. High quality earnings accurately reflect a company's
current and past operating performance. They are indicative of future operating
performance, and are reliable valuation measures for the company, regardless of the
level of earnings. Companies with poor earnings’ quality are not necessarily engaging
in earnings manipulation; in most cases, low earnings’ quality reflects a likelihood of
deteriorating fundamentals relative to the past. Dechow and Dichev (2002) note that
the determinants of earnings’ quality include firm size, proportion of losses, sales
volatility, cash flow volatility, and operating cycle. Stickney, Brown and Wahlen
(2004) note that quality accounting information should be a fair and complete
representation of a firm's economic performance, position, and risk. Further, quality
accounting information should provide relevant information to forecast the firm's
expected future earnings and cash flows. Ebrahim (2001, p.2) maintains that “Because
part of the financial reporting process depends on the judgment of managers, they
have the opportunity to manage reported earnings to achieve their own goals”.
Earnings’ quality is also viewed as the ability of reported earnings to be useful for
decision making. The quality of accounting information is influenced by an array of
factors, most of which stem from the demand for such information for use in
contractual arrangements and from the incentives and opportunities of management to
manage the reported numbers. The need to unnecessarily maintain high earnings leads
many managers into trying to manage their earnings.
Lev (1989) investigates the usefulness of financial information to investors and finds
that this usefulness has been deteriorating over the past years because the current
reporting system adopted by the accounting profession does not reflect the fast
changes in firms’ operations and economic conditions. Scott (1997) identifies
earnings management as one of the factors that can affect the quality of reported
earnings of a firm and defines it as the choice of accounting policies so as to achieve
some specific managers’ objective. Earnings’ management usually consists of one or
a combination of over-statement of revenue, understatement of expenses, and
misrepresentation of accruals. Such earnings’ management practices typically cause
long-term disastrous results (Putman, Griffin & Kilgore 2005).
Many studies have identified various forms of motivations that can lead to managers
to want to manage their reported earnings. Managers try to manage the reported
earnings as a result of bonus plans motivation (Healy, 1985), the motivations to
satisfy the debt covenants (Sweeny, 1994; Defond & Jiambalvo, 1994), or the
motivations to reduce political costs (Cahan, 1992; Jones, 1991). Francis, Huang and
Zang (2006) document that earnings’ quality varies inversely with CEO reputation.
They measured CEO reputation with the number of articles mentioning the executive.
They found that the number of news articles pertaining to the company’s CEO and
earnings’ quality are negatively associated. The cases of the glamorous Nigerian
bankers like the CEOs of Oceanic and Intercontinental banks tend to go in line with
their findings. The motivation for earnings’ management may also exist around the
time of CEO change. In one hand, the CEO of a poorly performing firm may try to
increase the reported earnings to prevent or postpone being fired. On the other hand, a
new CEO may take a “big bath” in the year of change to increase the probability of
56
Musa, I. Fodio, and Atoyebi, A. Taibat (Mrs)
higher future earnings when his/her performance will be measured, especially when
low earnings in the change year can be blamed on the previous CEO. Latif, Strickland
and Yang (2011) have studied 51 firms with the use of regression analysis and
discovered that, incoming CEOs who take control after the sudden death of their
predecessor exhibit accounting big bath behaviour in the initial period of taking
control. This phenomenon is not seen among new CEOs in non-sudden death event
cases. This, consistent with the findings of DeAngelo et al. (1994 as cited in Ebrahim
2001), and Murphy and Zimmerman (1992).
Firms may also try to manage reported earnings before going public; Bergstresse and
Philippo (2006) find that earnings’ management is more pronounced in firms where
the compensation of top management is more closely tied to the performance of
company’s stock. Tsui, Gul and Srinidhi (2011), test the relationship between female
participation in corporate boards and earnings’ quality using a sample of US listed
firms from 2007 - 2011. They employed two measures of earnings’ quality. Their first
measure is discretionary accruals quality which is the estimation error in accruals after
controlling for current, past, and future cash flows, sales and long-term assets, and
operating cycle and volatility in sales. Their second measure of earnings’ quality is
the propensity of firms to beat earnings benchmarks by a small amount. When a firm's
unmanaged earnings are just shy of earnings’ benchmarks such as prior-year earnings
or analyst-forecasted earnings, managers have an incentive to manipulate earnings to
meet/beat those benchmarks. The study finds that earnings’ quality is significantly
higher in firms with female board participation. One interesting thing to note here is
that one of the sacked bank CEOs in Nigeria was a female and she had been tried,
found guilty in a court of law for financial misappropriation, and was jailed. This
event may not be in agreement with the findings of Tsui, Gul and Srinidhi (2011).
Earnings’ management occurs when managers use judgment in financial reporting and
in structuring transactions to alter financial reports to either mislead some
stakeholders about the underlying economic performance of the company or to
influence contractual outcomes that depend on reported accounting numbers (Healy &
Wahlen, 1999). Beneish and Nichols (2005) examine the relation between the
probability of manipulation, accruals, and future returns using descriptive statistics,
and discover that firms that have a high likelihood of earnings’ manipulation
experience lower future earnings. However, the investors expect these firms to have
higher future earnings. Their result shows that accrual mispricing arises because
investors are misled by managers opportunistic management of earnings. Chan, Chan,
Jegadeesh and Lakonishok (2006) studied firms listed on the NYSE, AMEX and
NASDAQ markets that are covered on both the Centre for Research in Security Prices
(CRSP) file and the Compustat files. They discover that a measure of earnings
surprise predict stock returns. They further analyse this earnings surprise and their
results from both US and UK firms show that a small number of accrual items
including changes in inventory and accounts receivable, which seem to contain
information about the quality of earnings, help to predict the cross section of future
earnings. Sloan (1996) investigates whether stock prices reflect information about
future earnings contained in the accruals and cash flow components of current
earnings using firms with similar properties as replicated in Chan et al (2006). The
study found that firms with high accruals (or a large gap between net income and
operating cash flow) experience a decline in earnings’ performance not anticipated by
investors, resulting in predictable future returns. The result shows that stock prices do
57
An Investigation of the Relationship between the Quality of Earnings and the Movement of Stock Prices
of Banks in Nigeria using the Q Test Model
not reflect information about accrual and cash flow as contained in current earnings
until this information’s impact is reflected in future earnings regardless of the level of
efficiency of the market. This implies that abnormal stock returns can be earned by
exploiting investors’ inability to distinguish correctly between the accrual and cash
flow components of earnings. The continual increase in stock prices of Nigerian
banks despite the expected effect of the global economic crisis on the Nigeria Stock
Exchange could be seen to go in line with the findings of Sloan (1996). Richardson
(2003), tries to improve on the result of Sloan (1996) by examining whether investors
short sell securities with high accruals. Such a strategy is able to directly profit from
the predictable lower future returns by using a sample of U.S traded firms from 19901998. His study did not find evidence that short sellers trade on the basis of
information contained in accruals. This further explains the naivety and fixated
behaviour of the investors.
Putman, Griffin and Kilgore (2005), studied and tested the quality of earnings of 20
companies in US using the Q Test and discover that the test could be used to
discriminate between quality earnings and traditional bottom line earnings. They
claim that the test could give an early detection of management schemes on earnings.
Although some studies suggest that the information contained in accruals (a usual
proxy for earnings’ quality) is not efficiently impounded in stock prices when it enters
the public domain, Teoh, Welch and Wong (1998a, 1998b) and Ducharme, Malatesta
and Sefcik (2001, 2004) found that abnormal working capital accruals around the time
of stock issues are significantly negatively related to subsequent abnormal stock
returns.
In addition, Sloan (1996) and Xie (2001) provide evidence that accruals have
significant power to predict subsequent stock returns in general. They suggest that
buying stock in firms with low accruals and selling stock in firms with high accruals
generate significantly positive abnormal returns relative to the Sharpe (1964) CAPM
and the three-factor model of Fama and French (1993).
Zhou (2008) examines the effect of earnings’ quality on the synchronicity of stock
prices. The results of the study support the hypothesis that with or without the
presence of financial analysts and institutional investors, the higher the quality of
earnings the lower the synchronicity of the stock price, and vice-versa. Samadiyan
and Rezaei (2012) investigate the relationship between stock prices and earnings’
quality of 65 firms listed in Tehran stock exchange from 2004 to 2009 using Leuz’s
model, Penman’s model and Barton-Simko’s model. The Leuz’s model and BartonSimko’s model reveal a significant negative relationship between stock price and
earnings quality of the firms during the three phases of their life cycle (growth,
maturity and decline).The penman’s model however shows a negative but
insignificant relationship between stock price and earnings’ quality of the firms
during all the three phases of their life cycle. This study replicates the Q Test using
data from Nigerian banks.
There are several studies that investigated the effect of global financial crisis (GFC)
on stock prices. For example, Ravichandran and Maloain (2010) examine the linkages
between GFC and Gulf Cooperation Council (GCC) stock markets. The empirical
results show that the markets were strengthened after the crisis, and that the crisis
made the markets more vulnerable to external shocks from other markets. Mahran
58
Musa, I. Fodio, and Atoyebi, A. Taibat (Mrs)
(2011) investigates the impact of global crisis on stock prices and liquidity of stocks
in the Egyptian stock market. The results show a significant difference in both price
and liquidity between the periods before and after the crisis. The results further reveal
that the financial sector was one of the sectors that was most affected by the crisis.
Angabini and Wasiuzzaman (2011) also examine the impact of GFC on the volatility
of the Malaysian stock market. The study reveals a volatility clustering effects during
the crisis period for the stock market. The present study hypothesises that GFC will
have a significant effect on the stock price movement of banks in Nigeria in relation
to the quality of their earnings.
Methodology
Sample Selection
To test the hypothesis of this study we considered all the twenty 0ne (21) quoted
banks existing in Nigeria as at 31st December 2010. Following the tradition in
literature, we excluded the three banks that were nationalised and three other banks
without complete data for the period under study. We included only banks with
complete data and some of the banks that were in grave financial condition according
to the result of the CBN/NDIC joint special examination carried out in 2009. The final
sample is made up of fifteen listed banks.
Data
The data for this study were obtained from secondary sources. These sources include
the annual reports and accounts of the chosen banks for the various years, and the
Nigerian dailies for the Nigerian stock exchange daily listings (each price picked three
months after the financial year end of the banks).
Hypotheses
This study first uses the Q test model to measure the earnings quality of banks in
Nigeria. The study further investigates the association between earnings’ quality and
stock price movement of banks, and whether global financial crisis impacted
significantly on the earnings’ quality-stock price relationship. In line with these
objectives, we formulated the following two null hypotheses.
1.
2.
There is no significant relationship between the quality of earnings’ and the
movement of stock price of banks in Nigeria.
Global financial crisis has no significant effect on the relationship between the
quality of earnings’ and the movement of stock price of banks in Nigeria.
Model Specification
The study uses a model identified as the Q Test that provides a mathematical
approach to the determination of the quality of earnings. The Q Test model was
designed by Putman, Griffin and Kilgore (2005) along the same line as Altman's Z
score. The model consists of variables from the major financial statements required by
generally accepted accounting principles which include the profit and loss account,
balance sheet and cash flow statement. The Q Test model is tested using financial
59
An Investigation of the Relationship between the Quality of Earnings and the Movement of Stock Prices
of Banks in Nigeria using the Q Test Model
statements of selected publicly quoted banks and the result is compared to the stock
price movements of these banks. The model is stated as follows:
Q Test = 10(CFO/S) + (IS/IAR) + (CFO/EBIT) + (COI/NI) + 10(CFO/TL)
Symbol
CFO
S
IS
IAR
EBIT
COI
NI
TL
Variable Definitions
Description
Financial Statement
Cash flow from operating activities
Cash Flow Statement
Gross earnings
Income Statement
Increase in Gross earnings from previous year
Income Statement
Increase in Loans and Advances
Balance Sheet
Earnings before interest and taxes
Income Statement
Income from continuing operations
Income Statement
Net Income
Income Statement
Total liabilities
Balance Sheet
Summary of the Model and Integration of Variables
Q Test = 10(CFO/S) + (IS/IAR) + (CFO/EBIT) + (COI/NI) + 10(CFO/TL)
Cash Efficiency
Consistency
Revenue Quality
Core Operations
Risk
Due to the nature of bank businesses, gross earnings and loans and advances in the
original model have been substituted for sales and loans and advances respectively.
Measurement of Variables
The
variables
in
the
model
are
measured
as
follows:
CFO = CG – T – VAT, where CFO is Net cash from operating activities, CG is
generated or used in operations, T is tax paid and VAT is Value Added Tax remitted.
S = ISI + FCI + OI, where S is Gross Earnings, ISI is interest and other similar
income and OI is other income (foreign exchange, investment, etc.)
IS = St – St-1, where IS represents changes in gross earnings, St is the gross earnings of
the current year and St-1 is the gross earnings of the previous year.
IAR = Lt – Lt-1, where IAR is changes in Loans and advances, Lt is the Loans and
advances of the current year and Lt-1 is the Loan and advances for the previous year.
EBIT = profit before exceptional items and tax.
COI = ISI – ISE, where COI is income from continuous operations (net interest
income), ISI is interest and other similar income and ISE is income and other similar
expenses. Net interest income is used because interest forms a source of continuous
income for banks through loans and advances.
TL = TA – E, where TL is total Liabilities, TA is total Asset and E is equity
The results of the Q Test measurements are to be read as follows. First, anything
below 5.0 indicates suspect quality of earnings. When one obtains a measurement at
60
Musa, I. Fodio, and Atoyebi, A. Taibat (Mrs)
this level, it should lead to further investigation of the company involved to determine
the quality of other reported financial information such as asset values and liabilities.
Next, if the Q Test falls between 5.0 and 9.99, the reported earnings number is
accepted as better than average quality. Finally, any Q Test over 10.00 (double digit)
indicates superior quality earnings and, therefore, reported earnings can be relied
upon as indication of true earnings and consequently true corporate growth.
Tools of Analysis
Data was analysed using ordinary least squares (OLS) regression analysis. The first
equation is formulated in order to test the relationship between earnings’ quality
(measured by the Q test) and stock prices. The expected linear relationship is in the
form:
Pit = αit + βQTit + µ............................................................................................ (1)
Where: Pit is stock price of the banks for the 5-year period, α is the intercept, β is the
slope of the line, QT is calculated Quality Test, and µ is the error term.
In order to control the effect of global financial crisis on the earnings’ quality-stock
price relationship, we introduced GC (a proxy for global financial crisis) in the second
equation as follows:
Pit = αit + βQTit + λGCit + µ............................................................................. (2)
GC is captured as a dummy variable. It is represented by 1 for the years in which the
crisis was experienced in the Nigerian stock market and 0 for the years in which the
crisis was not experienced. The price used in the equation is the price of the banks
three months after the financial year. This is because banks release their financial
statements during the period of three to four months after their financial year end as
stipulated by BOFIA (2001).
Results
Test of the QT Model
We first present the results of the Q test in relation to stock price movement for our
sampled banks. Table 1 below shows the Q Test calculated and the stock price
movement for five years.
61
An Investigation of the Relationship between the Quality of Earnings and the Movement of Stock Prices
of Banks in Nigeria using the Q Test Model
Table 1: Computed Q Test and Stock Price Movement
BANK
FYE*
Q-TEST
2006
Q-TEST Q-TEST Q-TEST
2007
2008
2009
Q- TEST
2010
AVG
Q-TEST
PRICE
2006
PRICE
2007
PRICE
2008
PRICE
2009
PRICE
2010
FIRST
3
26.88
30.56
-9.37
22.12
12.04
16.45
63.00
40.40
41.45
19.61
13.30
UNITY
6
21.18
32.24
40.15
-41.50
-258.20
-41.23
NA
5.91
1.15
1.06
1.18
OCEANIC
9
44.92
38.80
0.10
-20.11
5.68
13.88
15.73
38.62
6.42
2.00
2.00
ZENITH
6
17.98
43.51
34.58
28.87
79.98
40.98
24.50
44.61
23.28
18.11
15.10
UNION
3
-13.45
7.16
8.35
-9.70
1.17
-1.29
22.20
41.01
33.40
15.49
3.67
UBA
9
111.80
-5.68
33.14
-0.70
27.14
33.14
25.3
48.01
12.66
15.00
6.12
SKYE
9
43.07
43.31
28.12
-17.93
-1.26
19.06
4.13
17.19
7.93
7.79
8.69
ACCESS
3
65.66
61.98
85.69
85.34
9.79
61.69
2.47
19.32
17.80
10.81
8.45
FCMB
4
46.76
-116.15
-2.94
-45.30
-1.80
-23.89
4.76
15.50
13.57
9.01
7.28
FIDELITY
6
56.05
45.15
19.04
15.52
12.11
29.57
2.26
11.99
7.22
3.33
2.66
GTB
2
20.79
13.67
-13.73
5.52
18.39
8.93
12.99
36.82
29.35
20.89
14.66
ECO
12
26.71
51.62
-2.32
-8.35
52.64
24.06
6.35
7.95
27.96
6.50
4.26
STANBIC IBTC3
29.57
33.06
15.61
-6.27
1.83
14.76
4.80
21.65
5.25
10.98
9.26
DIAMOND
4
31.25
26.03
16.37
-6.10
-13.74
10.76
4.32
17.50
12.94
9.52
5.33
STERLING
9
-10.52
79.19
26.35
-8.80
15.75
20.40
4.00
7.28
2.39
1.16
2.19
FYE=Month of end of fiscal year (* month of end of fiscal year changed for all banks by 2010 to December); Price=Stock price three months after the close of each
year
Source:
Stock exchange Daily Official Listing in Nigerian National Dailies and
Researchers computations based on Annual reports and Accounts of the
Banks.
As earlier explained, the stock prices were observed three months after the end of
each bank’s financial year. Stanbic IBTC bank changed its financial year to end 31st
December in 2007 while Eco bank maintained 31st December year end throughout the
period of study. All other banks’ financial years changed in 2009 to 31st December
2010 except for First and Union banks whose changes occurred in 2010 due to the
new CBN directive on uniformity in accounting period of 1st January to 31st
December yearly, (KPMG, 2008).
To test the efficacy of the model in reliably measuring the quality of earnings of
reported banks, we obtained figures from oceanic bank which was acquired by Eco
bank in 2011. The Q test computed for the three years preceding the acquisition of the
bank (that is 2008, 2009, 2010) were 0.10, -20.11 and 3.68 respectively. This result
clearly indicates that the earnings’ quality of the bank for these years were within the
“suspect” region which is an alarm signal. Coincidentally, the stock prices for the
same period moved in the same direction. The bank’s stock price fell from N38.62 in
62
Musa, I. Fodio, and Atoyebi, A. Taibat (Mrs)
2007 to N6.42 in 2008. It further declined to N2.00 in 2009 and 2010. Although, the
global financial crisis which stroke the Nigeria stock market in 2008 is a contributory
factor, (as subsequent analysis portrays) our results show that the bank’s inferior
earnings’ quality also played a major role in its stock crash. The other banks that fell
under the “suspect” region are Stanbic IBTC, Skye, Union, Unity, Diamond and
FCMB. These banks were among those labelled as unsound banks by the CBN as at
2009.
We subjected the results in the table to two further major analyses in relation to the Q
Test scores and stock price movement of the banks used in this study.
First, eight out of fifteen (which is more than 50%) of the sampled banks exhibit an
upward or downward trend in their Q Test scores which correlates with an increase or
decrease in their stock prices. Diamond bank had an impressive Q Test score of 26.03
in 2007.Its stock price for the same year was N17.50. The bank recorded a persistent
decline in its Q Test scores for 2008, 2009 and 2010 (16.37,-6.10 and -13.74). This
directly reflected in the persistent fall in its stock prices for the same years (N12.94,
N9.52 and N5.33). Sterling bank also showed the same trend. Its Q Test scores
declined in 2007 from an impressive 79.19 to a suspect earnings quality of -8.80 in
2009. Its stock prices also plummeted from N7.28 in 2007 to N1.16 in 2009. When
the Q Test score picked up again in 2010 to N15.75, the stock price also increased to
N2.19 in the same year. The six other banks (Eco, Stanbic IBTC, Zenith, Oceanic,
Skye and Fidelity) showed the same trend. However, two of these banks (Eco and
Stanbic IBTC) showed a slight deviation from the trend in two out of the five year
period used in the study. For example, while the Q Test for Eco bank declined from
51.62 in 2007 to -2.32 in 2008, its stock price increased from N7.95 in 2007 to
N27.96 in 2008. Also, the Q Test score for the bank increased significantly from -8.35
in 2009 to 52.64 in 2010, however, the bank’s stock price fell from N6.50 in 2009 to
N4.26 in 2010. This could be attributed to the effect of global financial crisis that led
to the stock crash in Nigeria Stock Exchange beginning from 2008. This possibly also
explains why the Q Test scores of Stanbic IBTC bank declined from 15.61 in 2008 to
-6.27 in 2009, and increased in 2010 to 1.83 while its stock price increased from
N5.25 in 2008 to N10.98 in 2009 and then declined in 2010 to N9.26. These eight
banks have provided evidence of between 60% to 100% compliance with the QT
model. Coincidentally, the two banks (Eco bank and Stanbic IBTC) have their parent
banks outside Nigeria (Eco Transnational Incorporated and Stanbic African Holdings
Ltd respectively) whose influence can affect both earnings’ quality and price as the
groups consist of networks of banks and financial institutions. The shares of Eco bank
Nigeria Plc were first listed on the floor of the Nigeria stock exchange within this
same period. The remaining seven which accounted for less than 50% of the sampled
banks (that is First, Unity, Union, UBA, Access, FCMB, and GTB) only showed
evidence of between 0% to 40% compliance with the model. It will be observed that
with the exception of Unity bank, all other banks that are considered as old generation
and/or prominent banks have fallen within this category. This could be attributed to
the contagious effect of the global financial crisis which arises as a result of stock
market linkages1. First, Union, UBA and GTB for example are banks whose stocks
are listed in some of the international stock markets like the London Stock exchange
1.
See for example Ravichandran & Maloain (2010) for evidence of linkages among world stock
markets and the greater influence the crisis had on the stock prices of commercial banks.
63
An Investigation of the Relationship between the Quality of Earnings and the Movement of Stock Prices
of Banks in Nigeria using the Q Test Model
(LSE). Thus their stock prices plummeted persistently from 2008 to 2010. The effect
of the global economic crisis must have significantly hit these banks to the extent that
it masks the Q Test effect on the stock prices. It was also discovered that the years in
which these banks had negative QT scores, the volume of their deposits were low as
compared to the volume of loans and advances made by them in the same year. For
example, First bank in 2008 posted a change in deposit of N79,797 million and
change in loans and advances of N224,662 million as against a change of N190,981
million and N46,414 in deposit and loans and advances respectively in 2007. This
accounted for the QT scores of -9.37 posted by First bank in 2008.
Second, the results in Table 1 show that global financial crisis had a devastating effect
on stock prices of the banks in Nigeria. From 2008 when the crisis first hit the Nigeria
Stock market to 2010, the stock prices of 10 (that is about 70%) of the banks
(Diamond, Eco, First, Zenith, Oceanic, Union, Access, FCMB, Fidelity and GTB)
showed persistent downward trend. This event clearly obscured the real effect of
earnings’ quality on the stock price movement of the sampled banks. As Ravichandra
and Maloain (2010) indicate, there is evidence of linkages amongst world stock
markets. The global financial crisis thus affects all but a few stock exchange markets
across the globe. In addition, the study established that the banking sector in the entire
globe was affected by the crisis. In the case of the remaining 5 banks (Sterling,
Stanbic IBTC, Unity, UBA and Skye) the effect was slightly mix. The stock price of
Stanbic IBTC, for instance declined in 2008 but picked up (though insignificantly)
and dropped again in 2010. In the case of the four other banks, their stock prices
plummeted in 2008 and 2009 but picked up again in 2010. By and large, it could be
observed that the global financial crisis hit the entire banks in the sample, but some
few started recovering, although gradually.
The Association between EQ and stock price movement
We first present our descriptive statistics in table 2
Table 2:
Price
QTest
GC
Descriptive Statistics
N
Mean
75
75
75
12.4100
15.1517
.4667
Std. Deviation
12.93492
6.54953
.50225
Valid N (listwise) 75
The descriptive statistics in table 2 above show that the price has a mean of 12.41 and
a standard deviation of 12.93 while QT has mean of 15.15 and a standard deviation of
6.55 for the period of 5 years from 2006-2010. The mean value of price has not
deviated widely from the actual stock prices of the banks within the study period.
Table 3 presents our model summary for equation 1. The equation examines the
association between earnings’ quality and stock price movement of the sampled
banks.
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Musa, I. Fodio, and Atoyebi, A. Taibat (Mrs)
Table 3: Model Summary
Model
R
R Square
Adjusted
Square
1
.705a
.497
.490
RStd. Error of the
Estimate
9.23520
a. Predictors: (Constant), Qtest
The value of the adjusted R2 from table 3 is 0.49. This signifies that 49% of the
variation in stock prices of the banks is explained by QT. The remaining 51% of the
variation is due to factors other than QT. Table 4 further shows the ANOVA results.
Table 4: ANOVAa
Model
Sum
ofDf
Squares
Regression 6155.015
1
1
Residual
6226.093
73
Total
12381.108
74
a. Dependent Variable: Price
b. Predictors: (Constant), Qtest
Mean Square F
Sig.
6155.015
85.289
.000b
72.167
The ANOVA table shows that the model is well fitted. The value of the F-Statistic is
72.167 and is significant at 1%. The coefficients of the variables are shown in table 5
Table 5: Coefficientsa
Model
Unstandardized
Coefficients
B
Std. Error
(Constant) -8.689
2.703
1
Qtest
1.392
.164
a. Dependent Variable: Price
Standardized t
Coefficients
Beta
-3.215
.705
8.495
Sig.
.002
.000
From the above table, the linear regression model fit for the data is
P = 1.392QT – 8.689
This means that stock Price increases by N1.392 for every 1 unit increase in QT score.
The results show that the relationship between QT and Price is positive and
significant at 1%. In other words, QT has a significant positive effect on the stock
prices of Nigerian banks.
The results provide evidence for the rejection of the null hypothesis 1 that the stock
prices of Nigerian banks are not affected by the quality of their reported earnings.
These results are parallel with the findings of (Putman, Griffin & Kilgore 2005).
65
An Investigation of the Relationship between the Quality of Earnings and the Movement of Stock Prices
of Banks in Nigeria using the Q Test Model
The results of equation 2 are presented in tables 6 to 8. Equation 2 tests whether
global financial crisis has an effect on the earnings’ quality-stock price relationship.
Table 6 presents our model summary for equation 2
Table 6: Model Summary
Model R
R Square Adjusted
Square
a
1
.729
.531
.518
Predictors: (Constant), GC, Qtest
RStd. Error of
the Estimate
8.97712
The value of adjusted R2 from table 6 is 0.518. This means that 51.8% of the variation
in stock prices of the banks is explained by the model. The result has shown an
improvement in the explanatory power of equation 2 over that of equation 1. This
implies that global financial crisis has an incremental explanatory power in the model.
Table 7 further shows the ANOVA results.
Table 7: ANOVAa
Model
Sum
ofdf
Squares
Regression 6578.722
2
1
Residual
5802.386
72
Total
12381.108
74
a. Dependent Variable: Price
b. Predictors: (Constant), GC, Qtest
Mean Square F
Sig.
3289.361
80.589
.000b
40.817
The ANOVA table shows that the model is well fitted. The value of the F-Statistic is
40.817 and is also significant at 1%. The coefficients of the variables are shown in
table 8.
Table 8: Coefficientsa
Model
Unstandardized
Coefficients
B
Std. Error
(Constant) -4.656
3.162
1
Qtest
1.280
.167
GC
-4.985
2.174
a. Dependent Variable: Price
Standardized t
Coefficients
Beta
-1.473
.648
7.677
-.194
-2.293
Sig.
.145
.000
.025
The results in table 8 show that the relationship between QT and Price is still positive
and significant at 1%. The relationship between GC and price is however negative but
significant at 5%. This implies that global financial crisis adversely affected stock
prices of banks listed in the Nigerian stock exchange market.
The results provide evidence for the rejection of our null hypothesis 2 that the global
financial crisis has no significant effect on the relationship between the quality of
earnings’ and stock price of banks in Nigeria. Our results support the findings of
Rivachandran and Maloain (2010), Zhang (2010), Ugur and Tetik (2010), Angabini
and Wasiuzzaman (2011), and Mahran (2011).
66
Musa, I. Fodio, and Atoyebi, A. Taibat (Mrs)
Policy Implications
The findings of the study have some important policy implications. First, it shows that
the price movement in the Nigerian Stock Exchange follows a definite technique or
pattern in relation to earnings’ quality. The investors’ fixated habit may partly explain
why prices failed to reflect the quality of earnings in full, and this also made the stock
market authorities to be deceived into the belief that the global economic crisis will
not affect the Nigerian Stock Exchange. However, the global financial crisis
eventually caused crash of prices, distortion in economic policies, and then loss of
investment. The events made organizations like banks to purchase their own shares
during offers in a bid to cover the imminent crash in prices. It also led to the crisis in
the banking industry and eventual need for bailout despite the immunity to global
financial crisis as claimed by the apex bank at that point in time. When quality of
earnings is compromised, sharp practices like round tripping become the order of the
day in a bid to survive the wave of unhealthy competition.
Second, the findings of the study underscore the need for banks’ management to pay
serious attention to the quality of their earnings and for bank auditors to assess the
quality of the banks’ earnings at the time of audit. Finally, the findings indicate the
need for government to take proactive measures to absorb any possible financial crisis
that may arise in the future.
Conclusions and Recommendations
A firm that reports fantastic earnings in its financial statements may not necessarily be
profitable due to different methods of measuring and reporting earnings as allowed by
law. From the analysis in this study, it could be concluded that the Q Test scores
reflected low quality earnings when cash flow is deficient. The analysis showed that
QT is a good measure of the quality of earnings of Nigerian banks although; earnings’
quality is not the only stock price driver. Our findings support the hypotheses that
earnings’ quality significantly affected the stock prices of Nigerian banks and that
global financial crisis impacted significantly on the relationship between quality of
earnings’ and the stock price of banks in Nigeria.
The study therefore recommends that Earnings’ Quality Assessment (EQA) should be
carried out by the auditors of banks before attesting to the truth and fairness of the
financial statements audited by them. Other stakeholders should also carry out a
quality test on reported earnings before they make any decision with regards to
earnings of a company. Finally, as another financial crisis which presently looms in
Europe is anticipated to have effect on other economies, there is need for regulatory
agencies to cushion its ripple effect on Nigeria. Adequate measures should be put in
place to absorb any possible shock from the impending crisis. This can be done
through diversification of the economy, enactment of policies that promote
macroeconomic stability and good regulatory practices that preserve financial
stability.
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An Investigation of the Relationship between the Quality of Earnings and the Movement of Stock Prices
of Banks in Nigeria using the Q Test Model
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