The International Financial Reporting Standards (IFRS) is a high quality and principle based reporting standards that remove many accounting alternatives. It is therefore, consequently expected to limit the management’s discretion and lessen practices on earnings management. Quite the opposite, some researchers argue that the flexibility in IFRS and its fair value pre-eminence might afford greater opportunities for firms to manage earnings. It is this inaptness which incited and aggravated the conduct of this study.
This study applies a desktop review to investigate the worldwide existing empirical research evidence on the effect of IFRS on earnings management post- IFRS adoption and in relation to other reporting standards and reports whether the results are indistinguishable between developed and developing economies. Accounting research in developed economies has long identified earnings management as a means by which managers manipulate financial reports to mislead other stakeholders on the underlying economic performance of the firm. However, earnings management research did not receive much attention in developing countries such as Nigeria until recently.
The findings reveal that the existing empirical crams and conclusions there on are mixed, inconsistent and difficult to generalise. This indicates the pressing need for country, especially Nigeria to engage on studies of this nature. The study further, stumbles on the fact that IFRS can indistinctly benefit both developing and developed markets when coupled with appropriate effective enforcement machinery. Substantially, the results entail that IFRS is a critical determinant for quality reporting but not a ‘prima facie’ guarantor for quality reporting.
At a glance
- Reviews Bui’s study of 18 British oil and gas companies
- Reviews Enekwe, Agu and Eziedo’s study of three Nigerian pharmaceutical companies
- Uses trade-off theory as its framework for the leverage–performance relationship
- 26 sources in the bibliography
Table of Contents
1.0 INTRODUCTION
2.0 REVIEW OF RELATED LITERATURE
2.1 Theoretical Framework
2.1.1 Pecking order Theory
2.1.2 Trade off Theory
2.1.3 Agency Theory
2.1.4 Irrelevancy Theory
2.1.5 Free Cash flow Theory
2.2 Conceptual Framework
2.2.1 Concept of Financial leverage
2.2.2 Concept of firm Performance
2.3 Empirical Review
3.0 CONCLUSION
4.0 RECOMMENDATIONS
Objectives and Themes
This work reviews empirical evidence on how financial leverage affects firm performance, asking how the relationship is understood across developed and developing economies and identifying gaps relevant to further research.
- Debt, equity and capital structure choices
- Theories of financing and firm value
- Measures of leverage and profitability
- Empirical evidence from different industries and economies
- Research opportunities in developing markets, particularly Nigeria
Excerpt from the Book
Agency Theory
Another theory is the agency theory which is more like asymmetry of information as stockholders favour high-risk projects, in contract with the preferences of debt holders (Jensen & Meckling, 1976). In practice, there may exist a conflict of interest among shareholders, debt holders and management. These conflicts give rise to agency problems, thus, have influence on the firm’s capital structure. These authors identify in fact two types of conflicts that have different implications leading to opposite theories on the link leverage-performance. Firstly, agency costs result from the conflicts of interest between shareholders and managers. The key problem here is the moral hazard behavior of managers that can waste firm resources or minimize their effort rather than increasing firm value, as they have their own objectives. In this way, debt financing raises the pressure of managers to perform (meaning to reduce their waste of resources and to increase their effort) as it reduces “free cash-flow” at the disposal of managers (Jensen, 1986).
Secondly, agency costs also arise because of the conflicts of interest between shareholders and debtholders. Indeed shareholders have incentives to take actions that benefit themselves at the expense of debtholders, and consequently that do not necessarily maximize firm value. This divergence of interests has two manifestations. On one hand, it gives incentives to shareholders to invest in riskier projects than those preferred by debtholders (Jensen and Meckling, 1976). On the other hand, conflicts between shareholders and debtholders can also create underinvestment, as demonstrated by Myers (1977). As a result, the agency costs resulting from the conflicts of interest shareholders-debtholders suggest that a higher leverage is correlated with a lower firm performance.
Chapter Summaries
1.0 INTRODUCTION: Introduces the debate over leverage and firm performance, the financing problem and the purpose of reviewing existing empirical studies.
2.0 REVIEW OF RELATED LITERATURE: Examines capital structure theories, definitions and performance measures, then reviews empirical studies across countries and industries.
3.0 CONCLUSION: Synthesizes the review’s evidence and considers the difficulty of generalizing across studies and markets.
4.0 RECOMMENDATIONS: Calls for further country-specific empirical research, particularly in developing capital markets.
Keywords
financial leverage, firm performance, capital structure, debt financing, equity financing, profitability, trade-off theory, agency theory, pecking order theory, return on assets, return on equity, empirical evidence, developing economies, Nigeria
Frequently Asked Questions
What is the work about?
It reviews empirical research on the relationship between financial leverage and firm performance.
What are its central themes?
The work addresses financing choices, capital structure theories, profitability measures and evidence from firms in different markets and industries.
What is the primary research objective?
The objective is to review evidence on the effect of financial leverage on firm performance and consider differences between developed and developing economies.
What research method is used?
The author uses a desktop and library review of secondary sources, including journal articles and research papers.
What does the main discussion cover?
It presents theoretical and conceptual frameworks before reviewing individual empirical studies of leverage and performance.
Which keywords characterize the work?
Key terms include financial leverage, capital structure, firm performance, profitability, trade-off theory and developing economies.
Which capital structure theories are discussed?
The theoretical framework covers pecking order, trade-off, agency, irrelevancy and free cash flow theories.
How is firm performance measured in the discussion?
The work discusses profitability measures including return on investment, return on equity and return on assets.
Why does the review give particular attention to Nigeria?
Nigeria is considered in the discussion of developing economies and the need for further country-specific research.
- Quote paper
- John Joseph (Author), 2018, The Leverage Effect on Financial Performance. A Review of Empirical Evidence, Munich, GRIN Verlag, https://www.grin.com/document/429684
