Chapter Two: Literature Review
The ensuing chapter looks into the literature that underscores the factors that influence financial reporting quality. It commences with a theoretical framework that showed the key theories of Resource Based View Theory, Agency Theory, and Stakeholder Theory that shall shape its discussion before embarking on the empirical literature to determine some of the key factors influencing financial accounting reporting with a view of presenting the relationship between the factors and financial reporting quality. The main features of accounting quality that are explored in this literature include (i.e. faithful representation, relevance, understandability, comparability, timeliness, and reliability).Moreover, this literature highlights the factors that affect financial quality which are (i.e. accounting conservatism, corporate governance, culture, earning management, and auditing).
2.2 Financial Reporting Quality
Towards the last decades of the 20th century, there was a growing concern over the number of mega corporations collapsing on account of poor financial reporting standards. Firms such as Enron and WorldCom made regulators in jurisdictions such as the US consider stricter financial reporting regulations in the form of the Sarbanes-Oxley Act of 2002 and the Companies Act of 2004 in the UK. The need of a high quality financial reporting standards has been a growing concern for many jurisdiction as a means to protect the greater public from financial loss as witnessed during the Global Financial Crisis of 2007/2008. In this regard, it becomes imperative to first decipher what it means to have a financial report of good quality and then to further determine what influences such.
2.2.1 Theoretical Framework
In support of the ensuing literature review, there are three core theories that shall shape the areas for examination; these are Resource-Based View (RBV), Agency Theory and Stakeholder Theory.
188.8.131.52 Resource-Based View (RBV)
Russo & Fouts (1997) defined the resource based view (RBV) infers to the internal resources of a firm that are heterogeneously distributed throughout a firm and remains so over a period of time. Example of internal resources includes human resource, physical assets and effective organizational systems (Henri, 2006). From the above, it becomes apparent that RBV infers to the various elements within an organization that are used to build frameworks such as governance and auditing that, as shall be discussed, are key ingredients in the understanding of financial reporting quality. It then holds that RBV can be used to ensure that a firm maintains a competitive edge over its competitors and thus secure its longevity within an industry and market as a whole.
184.108.40.206 Agency Theory
The Agency Theory can be understood as to being a contractual agreement between the owners of an organization (principals) and the management of the entity (agents) (Jensen & Meckling, 1976). The theory holds that the mere existence of the two parties leads to the emergence of two parties with divergent interests that would in turn lead to a conflict of interest. Such a conflict of interest leads to emergence of a moral hazard where the agents may result in undertaking an operation that might not be entirely in the best interest of the principals. An example of such a scenario is the Enron accounting scandal that was a result of misreporting by the management without explicit instructions from the shareholders for such an undertaking.
In this regard, the theory holds that agents often run the entity taking into consideration their self-interests as opposed to those of the principals. Such a dichotomy of interests led to the emergence of a board of directors as a means of mitigating such a risk. Other risks mitigation measures taken involve offering shares to management with a view of the agent seeing their interest as to being intertwined with that of the principals.
220.127.116.11 Stakeholder Theory
Freeman (1984) advanced the notion of having the accountability of an organization spread out to incorporate other players, stakeholders, within its input-output model. In this regard, the stakeholder becomes any party whose interests may be affected by the welfare of the organization. It is argued that where all the stakeholders are working towards a common goals, accountability is likely to be realized. In other words, there is need to have transparency within any organization.
2.2.2 Features of Accounting Quality
Suffice to assert that it is imperative to decipher some of the key elements that are instead used in determining what it entails to have a financial reporting/ accounting that is of good standards. On this account, it then becomes important to underscore the objectives of assessing financial reporting quality as outlined by the IASB; such calls for such reports to be objective amongst other qualitative features with a view of enhancing the probability of the report to be accepted in the corporate community. Gajevszky (2015) opined that emphasis ought to be placed towards ensuring that the report is transparent and absent of any misleading information within the framework of information that is precise. As such, the IASB and FASB have developed a framework of financial reporting that embodies the following qualitative characteristics as outlined below.
18.104.22.168 Faithful Representation
Willekens (2008) opined that faithful representation entails the presentation of financial data pertaining to an entity that underscores the true economic status of the outfit. In this regard, the concept calls for a fair outlook of detailed economic elements of the entity such as financial obligations as well as endowments. It therefore holds that such a data would only be useful where the information presented is objective; such is important as it would then enable the various stakeholders make the appropriate determination on actions to take once such information is presented to them. Following the consequences of the financial information presented on account of how faithful it is, it then follows that the extent to which the information can be said to be faithful is highly dependent on the state of the corporate governance regime of the entity (Van Beest et al., 2009). Cognizant of the fact that financial report tends to offer clarifications on the data presented, it then becomes evident that faithful representation as a feature of accounting quality is key in securing the integrity of financial statements.
As alluded to earlier, one use of financial reports is geared towards enabling the owners of the data to make decisions as stakeholders on the entity. For this to happen, the financial information presented needs to be relevant to the stakeholders; in other words, it ought to be useful within the context required by the stakeholders. For example, where a firm is looking towards a merger or acquisition, financial information such as debts and liabilities is critical in ensuring that stakeholders can make the right decision. Cheung, Evans & Wright (2010) opined that fair value from financial information is essential into making sure that the information presented is relevant to the stakeholders. The above assertion if further emphasized by Van Beest et al (2009) who alluded to the need to ensure financial information is relevant in so far as it goes towards disclosing all the required information that would make it possible for the stakeholders to make decisions revolving the corporation with an objective mind-set.
Any financial information is only useful as far as it can be understood by the stakeholders. Cheung, Evans & Wright (2010) opined that financial information would only be understandable where effective communication has been used to present the same. In this regard, understandabilty can be best understood as to being a complimentary quality for financial reports that would in turn go a long way into allowing its users indulge with the information. Van Beest et al (2009) go as far as to propose that there is need for financial reports to use all manner of visual aids such as graphs and tables so as to ensure that the information is presented in such a manner that can only be said as to being well communicated. As such, with the deployment of the right communication tools, it is then possible for stakeholders from different technical background to decipher technical jargon used in the financial reports.
Comparability of financial statements infers to a situation where stakeholders are able to match financial position of a corporation by line items such as debts and cash flow across different periods of time (Cheung, Evans & Wright, 2010). The above feature is an essential quality of any financial statement is it gives the stakeholders an opportunity to compare the financial position of the firm from one point in time to another. Such a comparison would enable them to determine whether the firm is heading in the right financial direction or otherwise. Cheung, Evans & Wright (2010) opined that a true measure of comparable financial statements would be where identical events in different situations reflect identical accounting information. For the above to be possible, it is imperative that the financial statements make a concerted effort to include notes that denote any changes in the accounting principle used as well its subsequent implications (Van Beest et al., 2009). Suffice to say that for the comparisons to be of greater value, there is need to ensure that such is made for the same length of period for the preceding years.
Van Beest et al (2009) have made extensive averments on matters to do with presenting financial information that would be useful to its stakeholders. In this regard, it then holds that, the concept of timeliness is essential. For the information to be of use, it ought to be presented in a timely manner so as the stakeholders can assess the data and make an informed decision at the earliest time possible. Such is essential especially where a firm has negative readings on its books that would in turn call for urgent attention to prevent the firm from going bankrupt or become susceptible to fraud. In this regard, Van Beest et al (2009) opined that the timeliness of the report is often measured based on the number of days that it took for the auditors to sign the report at the end of the financial year.
Cheung, Evans & Wright (2010) opined that financial information ought to be reliable enough to the extent that it can be useful to its stakeholders. In this regard, for the financial information to attain the reliability status, it ought to be free from bias and be both verifiable and faithful.
2.2.3 Factors Affecting Financial Quality
There are several factors that affect the quality of financial reports from corporations; such factors are best understood as influences that have a direct bearing on the level of quality of financial reports. In this regard, it becomes apparent to concur with the averments of Barth (2008) who suggested that measuring quality of financial reports can, by extension, be measured using other variables other than a review of financial reports. Ergo, the ensuing discussion offer a literature review of some of the factors/ influencers of financial reporting quality; these are accounting conservatism, corporate governance, culture, earnings management and auditing. Key to note is that the order discussion of the different factors does not follow any degree of relevance.
22.214.171.124 Accounting Conservatism
Accounting conservatism is seen as an attempt to any uncertainty and risk associated in corporations are duly considered (Chen, Folsom, Paek & Sami, 2014). In this regard, LaFond & Watts (2008) opined that the above concept inevitably becomes a key influence on the quality of financial reports on account of the fact that the concept would call for the financial information be accurate and verifiable with a view of making sure that it can be used to offer stakeholders with adequate information that would in turn go towards aiding the group avert uncertainty and risks; such would not be possible where the financial report is of poor quality. The above thinking seems to be an extension of an earlier proposition by Watts (2003) who averred that through accounting conservatism, managers are less likely to manipulate earnings reports; this makes sense if one entertains the notion that the concept is by extension a proxy of financial reporting quality. As will be alluded to later in this exercise, it is the role of the audit committee to oversee the implementation of accounting conservatism in corporations (Gajevszky, 2015).
126.96.36.199 Corporate Governance
Corporate governance infers to the system processes that relate to how a corporate ought to run its affairs with a view of not only realizing its bottom-line but also manage the relationship between shareholders and managers (Humera, 2011). There is a well-documented correlation between corporate governance and the quality of financial reporting. For example, Klai & Omari (2011) and Honu & Gajevszky (2014) opined that good corporate governance principles have a positive bearing on the quality of financial information. Similarly, Hope, Thomas & Vyas (2011) opined that strong corporate governance principles breed ground for auditors to press corporations to produce high quality financial reports.
In addition to the above, Cao et al., (2011) opined that firms founded on principles of strong corporate governance principles are more likely to develop financial reports of greater quality than those that lack the same. Moreover, the same report went to further suggest that the concentrated ownership decreases the propensity of managers to manipulate their earnings. However, such a conjecture was later opposed by Usman (2013) who instead opined that ownership structure does not reduce earnings and as such does not affect the financial reporting quality. Suffice to say that where ownership is outside concentrations such as family, there is a greater room for external scrutiny and thus higher corporate governance principles.
Based on the principle of corporate governance, it then holds that there is a close correlation between the reputation of a firm and the quality of the financial information. In this regard, firms that have a reputation for financial restatements implies that their subsequent financial statements are of low quality (Cao et al., 2011). Conversely, firms with a good reputation of near zero financial restatement implies that its financial reports are more likely to be of higher quality, assuming the other quality discussed herein hold true.
AICPA1 notes that for financial reports to have any semblance of quality, there is a consensus on the need to ensure that such the internal controls of the corporation are high. In turn, high internal controls imply that risks associated with financial reports would be effectively lowered. Such an understanding is also shared by Elbannan (2009) who opined that internal controls has a direct bearing on the credit ratings and information risk of a firm as a direct consequence of the quality of the financial reports. It then holds that higher quality financial reports can be best achieved where the internal control is not only effective but also strong.
Suffice to say that the internal reporting system of a corporation ought to be designed in such a manner that allows for the financial information is relevant, understandable, comparable and reliable enough to allow the various stakeholders make various decisions on the business entity (Cavélius, 2011).
Tang et al (2016) offered an empirical study of 166,903 annual financial statements from 38 main capital markets from developed nations between 2000 and 2007 with a view of determining whether there is any correlation to a firm operating in a Capital Market from a developed economy as compared to that from emerging markets. The study revealed that firm participating in Capital Markets from the developed markets is viewed as to having financial reports of higher quality as opposed to those from the emerging markets. The reason offered in support of the above conjecture is that such Capital Markets tend to have higher financial regulatory standards that protect stakeholders’ interests. On this account, it become evident that corporate governance, within the context of the entire industry as a whole, has a direct bearing on a nation’s financial regulation and subsequently quality on its financial reports.
Interestingly, Hope, Thomas & Vyas (2011) opined that there is a correlation between financial reporting quality and size of business entity whereby larger firms exude negative discretionary accruals. Moreover, Hashim (2012) not only supported the above assertion but also went to further assert that older firms tend to have a higher propensity to produce higher quality financial reports.
Choi & Pae (2011) opined that based on the overall understanding of corporate governance, it then holds that business ethics is an essential tool for entities looking producing financial reports of better quality as such firms would in turn tend to have a higher likelihood towards offering faithful reflections on its cash flows.
Closely associated with corporate governance vis-à-vis financial reporting quality is culture. There have been studies designed to understand the correlation between financial reporting quality and ethnic composition of boards of management and employee rank and file. Such points towards the political cost theory were fronted by Hashmi (2012). Through the study, it was found that where a firm has staff and management from economies with strict financial regulations are more likely to have higher quality financial reports. Nevertheless, the above research is not exhaustive as investigated by Tang et al., (2016) who opined that the global accounting industry is still rife with diversity in its auditing and accounting practices and thus any conclusions drawn from global harmonization vis-à-vis financial reporting quality are inconclusive.
188.8.131.52 Earnings Management
Schipper (1989) defined earnings management as the purposeful intervention of an external financial information with a view of securing private gain. Such an understanding is equally share by Mulfor & Comiskey (2002).
Usman (2013) opined that the bulk of stakeholders are often concerned with making sure that they get a return of their investment and as such would be keen to ensure that the subsequent financial report coming from the business entities are of high quality especially in terms of its as to being reliable. Evert & Wagenhofer (2011) opined that there are several tools that can be used to measure the quality of earnings; such includes predictability, smoothness, persistence, value relevance, accruals quality, earnings variability, timeliness and conservatism. In addition to the above, earnings are also affected by regulatory actions and managerial incentives. However, Choi & Pae (2011) opined that accruals are more perceptible to manipulation on account of the fact that it is less visible from stakeholders when it is compared to cash flows. Nevertheless, Barth (2008) opined that high levels of accuracy in financial statements often tends to improve it quality; such would be particularly helpful where it is to be used to making financial forecasts.
Sacer & Oluic (2013) opined that financial information, especially the accounting information system ought to produce reliable and relevant data that can in turn only be secured through the correct use of IT frameworks. Key to note is that the use of IT has a direct bearing in improving the quality of financial reports especially where the notion of timeliness is concerned.
Francis et. al., (1999) defined auditing as the independent verification of financial information with a view of enhancing its usefulness and reliability. It then holds that including audits in financial reports tends to reflect a transparent outlook of information that can in turn be understood to be a show of verifiable and accurate information that would in turn instill confidence amongst the stakeholders. Ordinarily, firms utilize audit committees in the auditing processes. DeZoort (1997) opined that an audit committee is tasked with the hiring and management of the external auditors as well as all disclosures from the same. Literature suggests that the independence of the audit committee has a direct bearing on the ability of a firm to combat financial misstatements that would in turn deter the management for manipulating financial records. Krishnan & Visvanathan (2008) opined that audit committees that had financial accounting experts often led to the production of financial reports of higher quality; such a notion was further emphasized by (Zang, et al., 2013). Gajevszky (2015) opined that the above move would go a long way into making sure that any subsequent forecast would be measured and objective.
Another important component of the role of auditing on the quality of financial reporting pertains to financial restatements. Huang et al (2012)noted that whereas financial restatements can be viewed as a corrective measure within any auditing process, it cannot escape the possibility that it could also be tantamount as to being an indication for improper accounting especially where it become a frequent feature of the auditing cycle of a corporation year by year. On this account, it was observed by Downen (2014) that larger corporations tend to have more robust and effective internal controls on account of their subjection to greater monitoring from the industry regulators.
2.3 Summary of Chapter
The above chapter has examined some of the key theories and empirical works that aids in the understanding of the financial reporting quality. Central to the discussion has been the basis of the theoretical framework that showed role played by Resource-Based View (RBV), Agency Theory and Stakeholder Theory in shaping the discussion that first canvassed some of the key features of accounting quality, that is, faithful representation, relevance, understandabilty, comparability, timeliness and reliability. Such laid the foundation to understand the factors influences financial accounting quality. It became apparent that there was a correlation between accounting conservatism, corporate governance, culture, earnings management and auditing and financial reporting quality.
Chapter Three Methodology
Through this paper overall methodology of the research approach could be understood. Sampling technique has been mentioned here through type of data collected in this approach could be understood. Overall sampling procedure has been designed by focusing on the research design and approach. Overall issues of corporate governance in organizations and their accounting quality could be measured properly through collecting appropriate sample. Through this approach significant evaluation on this approach could be obtained.
3.2 Research study sample and design
The sample data for the research will be obtained from the non-financial firms that are listed in the FTSE 100 for a period of 5 years between 2014 and 2018. We use non-financial firms since the nonfinancial and financial firms have different disclosure requirements. The data is collected from Thomson Reuter DataStream alongside the published financial reports and also from the company websites.
Research design is a comprehensive plan of the sequence of operations the study undertakes to achieve the objectives of the research (Baltagi, 2005). This empirical research adopts a panel data to regression analysis to examine the relationship between the variables of interest. This is because, in the study, two sets of informational data are available. Two types of data sets are used in this research approach; one is cross sectional information and other is time series data. Cross sectional data illustrates different types of corporate variables exist in various UK based organizations and time series data helped to find out the performance variance in the organizations over the time. In the year of 2008, Hambrick highlighted that panel data analysis would be highly effective if data contains both cross sectional element and time series element. For doing this type of approach, large number of data points would be required where degrees of freedom would be high and this will reduce the collinearity quotient of the variables which normally generated through regression analysis. Baltagi (2005) stated that Panel data has huge benefits compared to cross sectional or time series data. As collinearity would be less in panel data analysis, this could generate more reliable and valid outcome. Any kind of individual difference might be controlled through panel data analysis whereas in cross sectional and time series examinations are too hard to control. Complex behavioural framework is there that could reduce any sort of limitation from studies.
Panel data analysis could be segregated in three aspects like pooled effects, random effects and fixed effects. Fixed effect model is highly efficient compared to other two models. This model allows fixed explanatory variables. Non-correlation status between explanatory variables and independent variables could be observed and obtained through panel data analysis. Here two tests have been done for examining the effectiveness like Hausman and Breusch-Pagan.
Before examining the model used for methodology, it’s important to first understand the variables that would be used.
3.3 Operationalization of study variables
The variables used in this study are based on previous literature and generally fall under 3 broad categories;
3.3.1 Dependent Variable
Significant analytical viewpoints would be needed in a research approach for getting approval from corporate sector. IASB has highlighted the financial reporting process and this should be incorporated in the study for increasing its value. Gajevszky (2015) evaluate the essential aspect of having a strong content in a research. According to the scholar, information must be precise and concrete in an approach for increasing its reliability. Accounting quality would be judged on the basis of earning quality.
3.3.2 Independent Variables
Accounting quality of any firm is highly depended on the skills and potential of board members and that has been discussed in the previous part of analysis. Therefore, the selected corporate governance variables that serve as explanatory variables in the model are the board diversity, board size, CEO duality and board independence.
3.3.3 Control Variable
The size of a firm is a key feature when investigating the relationship between accounting quality and corporate governance since the board characteristics are often correlated to the size of the firm [CITATION VoD14 \l 1033 ]. This therefore necessitates that the size of the firm needs to be controlled for in the model and the proxy for this in the study would be the log of the company’s assets. The following table summarizes the variables.
Table 3.1: Summary of the operationalization of variables
|Earnings quality||Calculated as the ratio between net cash provided by operating activities by the net income of the business|
|Board Independence||Ratio of non-executive independent directors to the total number of directors on the board|
|Board Size||Natural log of the number of directors in the bank board|
|CEO duality||1 if the chairperson of the board is also the CEO of the company and 0 otherwise|
|Board Diversity||Proportion of female professionals present in bank board|
|Firm Size||Represented by the natural log of the total assets of a bank|
3.4 Research Design
The two key things being examined in the research are accounting quality and corporate governance practices. Specifically, the study examines if the various aspects of the corporate governance practices of FTSE 100 firms affects their accounting quality. The variables to be analysed to examine this relationship include earnings quality,board diversity, board size, CEO duality and board independence. The regression equation that will associate these variables to examine the relationship will be:
= Constant term
X1= Board Independence
X2= Board Size
X3= Board Diversity
X4= CEO Duality
X5= Company Size (Control Variable)
= Error term
3.5 Panel Data
The panel data method will be used to study the correlation between corporate governance and the accounting quality of firms. Stata software will applied in analysing data since it is relevant for panel data regression. Panel data has a number of pros. it can provides higher level of accuracy n relating to inference of model parameters. This is because the idea that panel data has a higher degree of freedom as well as wider range of sample variability when comparing with cross-sectional data (Baltagi et al., 2003). Moreover, unlike time series or cross sectional data, panel data enables the researcher from having bigger capability in identifying the complexity of people behaviour. This can be done through establishing and measuring hypotheses about more complicated human behaviour. Furthermore, capturing and measuring human behaviour can be done through controlling the effect of omitted factors. It can be discussed that the actual reason one identify/not-identify specific impacts is because dismissing the impacts of particular factors in the model specification which are associated with the included explanatory factors. Furthermore, additional pros for the using of panel data is because
it simplifies the statistical inferences. It includes at minimum two dimensional (i.e. time series and cross -sectional). In ordinary situations, a researcher would anticipate that calculation of panel data inference might have deeper complexity than time series or cross sectional. Nonetheless, in particular circumstances, the existence of panel data will lead to simplify the inference and computation because it analyses of non-stationary time series (Chen and Conley, 2001). Also, panel data is simplifies statistical computation as it reduces measurement errors due to the availability of many observations for a particular item. These multiple observations would allow the researcher from doing distinctive transformations so as to produce various and deductible changes in regarding to the estimators; accordingly, to underline an otherwise unspotted model (Baltagi et al., 2007).
When performing an econometric examination of panel data, it is not presumed that the observations are distributed independently over time. Therefore, special methods and models have been established for analysis of panel data (Wooldridge, 2009). It has been suggested that OLS (simple ordinary least squares) is only suitable when each parameter of the model is constant spatially. Thus, the panel estimation method acts as a solution to the elimination of heterogeneity bias, employing either the random effects model or the fixed effects model (Baddeley & Barrowclough, 2009).
As earlier mentioned, there exist a number of panel data methods and the two main ones are the following:
3.5.1 Fixed Effects Model
This type of regression procedure can be implemented for identifying and controlling of immeasurable variables. Fixed measurement of the entities could be measured through appropriate equations. Consequently, this model permits the correlation between the observed and unobserved variable as used in the study. If correlation would be there then unresolved variables couldn’t be controlled. Nonetheless, the fixed effects model may at time not be effective when the correlations stand at zero which is usually the case in most real time scenarios and further details can be observed in the study by Baltagi (2005).
The use of fixed effects method does have its disadvantages. For one, it is not possible for one to study the time constant independent factors that are used in the regression model of the study (Shan & McIver, 2011). Additionally, the standard errors of the estimates obtained with the model can at times be larger than that of the alternative random effects model in a few occasions which results in higher p values alongside larger confidence intervals. Odendaal & De Jager (2008) however, did note that it is more important for researchers in accounting to be aware that not having the controls for the fixed effects lead to inconsistent approximations in the regression values and omitted variable bias problems may arise (Holly and Gardiol, 2000). Furthermore, this method of regression cannot approximate the coefficients of the time invariant variables and this is very clear from the idea that taking away the individual average of the time invariant variable from each of the factor values results in a value of zero for each of those individual factors.
3.5.2 Random Effects Model
Regression model could be used in the case of Random effect model where time invariable variables are present. This is because of the fact that the random effects model assumes that the unobserved variable is not correlated with each of the other explanatory variable irrespective of whether the factor is fixed over a given period of time or not [ CITATION Woo02 \l 1033 ]. This modeling technique is very appropriate when choosing individual observations from a very large population on a basis that’s random to come up with conclusions about the features of that population. The model also does not actually control for the unobserved differences because it assumes that there exists no relationship between the observed and the unobserved variables. This model is simpler compared to the fixed effects model and it does result in values that are way more accurate compared to the fixed effects model (Woolridge, 2002).
3.6 Testing the most appropriate model
To determine which is the more appropriate model for the study there are usually two tests that are performed in that determination and they are the Hausman and Breusch-Pagan LM test.
3.6.1 Breusch-Pagan test
This is used in the measuring of the pooled regression model which allows for concurrent correlation caused by the random effects model (Baltagi, 2005). If the test yields are statistically very big, the random effects model is applied taking into account the OLS model for estimation. The 2-hypotheses relevant in this test are;
H0: Pooled Regression model is more appropriate
H1: Random Effects model is more appropriate
With a large value of the p value, the null hypothesis is rejected and thus the alternative is accepted which is what was earlier mentioned (Tsafa-Karakatsanidou and Fountas, 2018). The combination of these two tests in many studies have concluded that the random effects model is the more appropriate model for use in such studies and thus it is going to be the model that is adopted in our study (Baltagi et al., 2006).
3.6.2 Hausman Test
This is usually a test to determine whether there is a considerable difference between the uses of a fixed or random effects model (Bell and Jones, 2015). To determine that the random effects model more effective, the Hausman test is run. If it is the case that the test does not support it, then the fixed effects are chosen over it. This is usually done using a statistical approach to determine whether their biases that are linked with the random effects model that make it more applicable in a study (Allison, 2009). It is of importance to note the assumptions that are made by both models which then informs the need for the test of the following two hypotheses;
H0: The unobserved factor is not related with the predictor variable
H1: The unobserved variable is related to every predictor variable
The null hypothesis predicts the application of the random effects model while the alternative hypothesis assumes that the application of the fixed effects model is more appropriate. In both cases the p value is gotten from the Hausman test and a p value depending on the critical value determines whether the null hypothesis is rejected or accepted based on the value the researcher chooses as the significance level. For instance, if a p value of 0.1 is chosen, the null is rejected with any value less than this and is accepted with any value greater than this (Baltagi et al., 2003).
3.7 Ethical Considerations
The study made sure that the data collected was well represented with cases of missing data being left out of analysis to maintain the sanctity of the data available to us. The tool of analysis, Stata, was also one with a licensed since it is not free software. Additionally, the study adopted the laid down framework of Data collection and analysis and is entirely the work of the researcher.
This chapter discusses the research design and why the design was chosen. It then goes to discuss the variables that would be used and how they are operationalized for the study and then goes to explain the need to use panel regression for the data analysis. The two types of regression models applicable for regression analysis that is the fixed effects model and the random effects models are discussed and it is explained why the random effects model is more applicable for the study as opposed to the fixed effects model. The chapter then goes to explain the population of study and the period of investigation, how the data is collected and analyzed and also highlights the various aspects of the variables to be used in the regression model. The chapter concludes with the ethical considerations that would be taken into account while conducting the data collection and analysis.
Chapter Four: Data Analysing and Discussion (3000 words)
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1 American Institute of Certified Public Accountants