CHAPTER ONE

INTRODUCTION

 

1.1       Background ofthe Study.

 

Over the years and present, the quality of an audit still remain a great value to its stakeholders, simply because it is the product of a competent third party known as the auditor who is believed to have no personal interest in the affairs of the organization, and also being one who is professionally bound to discharge his duty with utmost diligence, objectivity, independence and professional competence. Audit involves performing procedures to obtain evidence about amounts and disclosures in the financial statements so as to evaluate the appropriateness of accounting estimates made by management (KPMG, 2008).

In the wake of various financial reporting scandals and audit failures associated with some corporations in Nigeria, such as Intercontinental Bank Plc. (2009), African Petroleum Plc. (2009), Afribank Plc. (2009) etc., financial regulators, accounting bodies and policy makers have come to elicit ways to combat these misfortunes and enhance quality audit. Among various issues in concern, the long tenure of an audit engagement is believed to be a compromising factor in guaranteeing the independence of an external auditor as there is increased level of familiarity between the auditor and the client, which as a result puts the auditor’s independence at a high risk of being jeopardized. Independence is fundamental to audit and is the credibility of the audit report; an audit conducted without ‘independence’ is essentially meaningless,(Fogarty & Lansley, 2002).

In order to solve the familiarity threat and improve audit quality, mandatory rotation of external auditors have been suggested as one of the measures to be adopted, meaning that a maximum limit is set for the tenure of an auditor with a firm in order to preserve auditors independence and aid quality audit report (healey & Kim, 2003);(Francis J. R., 2004). Audit quality also appears to improve when the duration of the audit–client relationship is truncated (Chung, 2004). The massive audit cases that occurred in different stock markets in recent years have shown that the reason for audit failure is not merely the technical failure, but a quite important factor is that auditors have lost independence (Li & Wang, 2005). In response to the financial reporting scandals which robed the banking sector of its credibility in Nigeria, the Central Bank of Nigeria (CBN) in 2010 issued a directive in line with the provisions of the CBN Code of Corporate Governance for banks, which stipulates that “the tenure of the auditors in a given bank shall be for a maximum period of ten years after which the audit firm shall not be re-appointed in the bank until after a period of another ten years. For the avoidance of doubt, the maximum period of ten years shall include the period on audit firm which later merged, changed name, and/or first commenced audit assignment in the bank.” (Central Bank of Nigeria, 2010).

However, various issues have been raised about the Mandatory rotation of auditors whereby some proponents do support its implementation with the view that it would secure auditors independence which would eventually aid audit quality and prevent audit failures, other opponents argue that the “mandatory audit firm rotation may not be the most efficient way to enhance auditor independence and audit quality (U.S General Accounting Office, 2003). This study seeks to examine the effect of mandatory audit firm rotation on auditor independence and audit quality in Nigeria.

1.2       Statement ofthe Problem

 

Credible financial information is vital to the growth of any economy; also auditors are expected to be independent and objective in the discharge of their responsibilities (Adelaja, 2009). The most vexing issue hindering credible financial information is the problem of audit failure and it is believed that at the heart of audit failure lies the issue of lack of external auditor’s independence which in turn hinders audit quality. The report of external auditors in corporate financial statements is seen as providing key assurance to the interest of shareholders (Gallegos , 2004). But where the independence of the auditor is in doubt, the stakeholders lose their confidence in the credibility of the financial statement and this result to a great deal of disappointment to various corporate stakeholders/investors in Nigeria. The lack of auditor independence and poor audit are also attributed to various financial reporting scandals (such as Intercontinental Bank Plc (2009), African Petroleum Plc. (2009), Afribank Plc. (2009) etc.,) which have occurred over the years and which have also put some big organizations out of business.

The issue of mandatory audit rotation is one of the measures proposed to counter this problem of audit failure. The study seeks to address the knowledge gap on how the fate of audit quality is determined by auditor’s independence, and how both can be invariably affected by the implementation of mandatory rotation of auditors. As many scholars do support its implementation, many also are against its effects and usefulness in addressing the issue of audit failure of which one of the sensitive issues behind this is the lack of auditor independence. Therefore, on this premise, this research focuses on the effect of mandatory audit firm rotation on auditor’s independence, audit quality and investors’ confidence.

 

1.3       Objectives ofthe Research

 

The objectives of this study are thus stated as follows:

1. To determine the relationship between mandatory audit firm rotation and auditor independence.
2. To ascertain the effects of mandatory audit firm rotation on audit quality.
3. To ascertain the extent to which mandatory audit firm rotation strengthens Nigerian investors’ confidence.

 

1.4       Research Questions

 

The research questions are given as below:

1. What is the level of impact of mandatory audit firm rotation on auditor independence?

 

2. To what extent does mandatory audit firm rotation enhance audit quality?

 

3. To what extent does mandatory audit firm rotation strengthen the Nigerian investors’ confidence?

 

 

1.5       Research Hypotheses

 

The hypotheses for this study are thus stated in the null form:

1. There is no significant relationship between Mandatory audit firm rotation and auditor’s independence.
2. Mandatory audit firm rotation has no significant effect on audit quality.
3. Mandatory audit firm rotation has no significant effect on investors’ confidence.

 

1.6       Scope and Limitations ofthe Study

 

In the spotlight of this research work, the study observed the effect of mandatory rotation of auditors on auditor independence and audit quality in South-east Nigeria. The researcher focused on public and private sectors of the economy, eliciting the perception of Nigerian investors and professional accountants in Anambra State and Enugu State, and covering a period of 2012 to 2015.

The degree of success attributed to this research work mostly depended on the timely response and pleasant cooperative attitude of some sources of information.

 

1.7       Significance ofthe Study

 

This research elaborates on effects of mandatory audit firm rotation on auditor’s independence, audit quality, and investors’ confidence, particularly eliciting the perception of various practitioners and investors in Nigeria. The study is of great importance as it is one which is aimed at evaluating the possible means of strengthening the ethical conducts of an external auditor in maintaining professional skepticism in the course of duty, and also being one which is globally debated based on its implementation, advantages and disadvantages, and its effect on various professional ethics of the discipline. The research and its findings are expected to contribute to the existing body of knowledge, and to various professionals and academics in the discipline.

 

1.8       Operational Definition of Terms

 

AUDIT is an independent examination of, and expression of opinion on the financial statements of a business enterprise by an appointed auditor in accordance with his terms of appointment and in compliance with the relevant statutory and performance requirements.

 

EXTERNAL AUDITOR also known as an independent auditor is an audit professional who performs an audit on the financial statements of a company, government, individual or other legal entity and who is independent of the entity being audited.

AUDITOR INDEPENDENCE is a mental attitude and physical appearance which portrays the auditor as being uninfluenced by others in judgment and decision.

AUDIT TENURE is the number of years an auditor is retained by the firm.

AUDIT QUALITY is the market-assessed joint probability that an auditor will discover a breach in a client’s accounting system although diverse, reflect the same structure.

MANDATORY AUDIT FIRM ROTATION is the imposition of a limit on the period of years in which a particular registered public accounting firm may be the auditor of books of accounts for a particular issuer.

INVESTORS’ CONFIDENCE is the confidence stakeholders place on investments remaining liquid or paying expected income.

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The effect of audit quality on the performance of listed manufacturing firms in Nigeria

CHAPTER ONE INTRODUCTION

Background

Audit quality is vital for every organization to achieve efficient and effective management of resources. It leads to the improvement of financial performance as a  key implementation strategy of the  accounting system and helps management check  the work of each department within the firm as a whole. Around the world, audit  quality assures the achievement of quality financial statements or reports for firms  listed on the stock markets of any country.  This is the cornerstone of institutions of   any type that are charged with the responsibility of checking records related  to  business activities. The functions of internal audit reflect the quality of the financial reports or information that the institutions maintain to create confidence among the stakeholders, and also reflect the efficiency and credibility of the institution’s audit department within the organization’s practices as part of the corporate governance structure of the firm’s management and practices.

According to Clarkson (1995), stakeholders have the  organization’s interest at heart  and are impacted by its operations, it could be negative or positive  in  the  way in  which it affects them. Stakeholders normally mentioned are employees, government, customers, competitors and political activist groups and the viability of  any organization is greatly influenced by them. (Dill, 1958; Murray & Vogel, 1997). In stakeholder theory, the firm intends to convert the stakeholders’ interests into goods  and services thereby creating value for them. Profits can no longer be taken solely as success of a firm, but its success is influenced greatly by stakeholder relationships and  is a broad range of issues which need to be addressed.

Agency theory is a contract whereby a person (agent) is appointed  by another person  or a number of people (principal(s)) to perform some service on their behalf. Conflicts may arise when the agent and the principal have interests which are different and  do  not align. An internal audit function can address this when it is independent and  has  the support of top management. Legitimacy theory is established on the belief that companies are always seeking for confirmation that they are doing business within the norms which their society finds acceptable to ensure they continue operating. Legitimacy is very important for businesses and all organizations. Strategy can be changed, when what society thinks is realized, to meet their needs and expectations. Value will be added to the business when financial statements meet the user’s expectations.

Eighme & Cashell (2002) state that the internal audit department is charged with providing information that enhances the system support, the responsibility of the management of the institution and employees as well as the stakeholders of the institution in operation and financial performance of the institution. The internal auditors are neutral information providers to the top management of the institution for smooth management of the entity in lieu of their resources. The internal audit department also provides neutral, reliable and objective  information that helps  with  the management of the organization. The stakeholders are more interested  in  the  return made by the institution, sustainable growth, and reliable information reported about financial performance as a sign of financial health of the organization and its practices (Al-Shammari, 2010).

The Institute of Internal Auditors (2000) propose that, to provide a  systematic  approach that is well able to assess and enhance the strength of risk management, organization and the process of governance is the internal audit function. However, on the role of internal audit, there is a likelihood that this will lead to amplified responsibilities. In addition, internal audit is required to increase responsibilities  that are crucial to the support of the management and the audit committee.

According to DeAngelo (1981), internal audit quality is the combined possibility that  an auditor will become aware of and account for material misstatement.  In this case,  the meaning of audit quality is composed of two mechanisms that are: the capacity to spot misstatements and the readiness to divulge  the misstatements that are discovered  in an audit assignment. Measuring the internal audit quality is divided into two  variables that are aimed to be captured which are the accounting qualifications (AQ)  and the auditing experience (AEXP) of the internal audit staff. The impact of internal audit quality on a company’s financial performance has an impact on  the  firm’s  agency relationship and this has not been studied extensively by most scholars in emerging economies, although auditing services has been well perceived as one of the mechanisms that is used to mitigate the agency problem  that mostly exists  between   the management of the firms and the shareholders. The auditing service is just another element of the corporate governance structure and significant aspect of the regulatory system for protecting the interests of shareholders and to serve the  other stakeholders  in public firms around the world.

Audit quality is defined as the independence, objectivity, consulting activity and assurance designed to provide an accurate picture over a period of time of a firms’ performance (The Institute of Internal Auditors, 2008). It is an exercise of improving risk management, operations and administration of the entity to achieve the intended goals and the protections of the shareholders wealth  and  provides  accurate  information to financial accounting information users. It helps the institution create discipline, improve management process and risk management to achieve the organizational goals. Firm managers are always engaged in returns management to increase their incentive and maximize shareholders wealth. However, if there is an auditor who can assure the quality of returns, the principal will have more confidence  in the return generated by the firm and place greater weight in that measure in  designing the managers’ contract to avoid a conflict of interest (Dunn et al., 2000).

Internal audit performs an essential part in enhancing the achievement of company goals.  Additionally,  it also influences the implementation of strategies that are aimed  at ensuring their success (Ljubisavljević & Jovanovi, 2011). Internal audit is charged with the responsibility for improving management and audit committees (Hutchinson   & Zain, 2009). Therefore, the internal audit report is prepared as a form of communication between internal audit and the management. Additionally, it is established as a crucial guideline to enhance the management of the company and ensure its success (Ljubisavljević & Jovanovi, 2011).

The measurement of the outcome of a company’s operations and policies in financial terms is what defines financial performance (Yan, 1997). It is also the firm’s willingness and ability to meet its agreements as well as long  term  financial  obligations to provide services in the near future (Meckling, 2000).

According to Raw (1986), performance is used in reference to a  business  that  generates significant and positive cash flow which increases at a faster rate in comparison to the overall economy. The firm performance which is a dependent variable is assessed on a few indicators. The return on assets (ROA), return on equity (ROE) and the return on investment (ROI) are mentioned as three indicators of accounting based performance (Schiuma, 2003). These indicators are used widely to check the performance of firms and capture their internal efficiency. A company associated with growth often has a profitable reinvestment opportunity to meet its retained earnings. Businesses that grow are often seen in the technology industries. Firms that have experienced consistent strong performance tend to employ external directors as they have the edge to do so.

According to the agency and resource dependence theories, people play a role  in helping to improve the performance of the firm given that they possess insight in regards to dealing with operation and achieving their responsibilities at  the  highest level of quality. Hutchinson and Zain (2009) have discovered using several regression analyses that between firm’s performance and the internal audit quality there exists a positive correlation.

According to Fadzil et al. (2005), it is clear that internal auditors are more capable of running a company more competently and effectively in  the interest of  shareholders.  A study by KPMG (1999) established that internal audit plays a crucial part in enhancing performance and assisting in profit verification in corporate scandal identification. This is predominantly in relation to financial fraud that relates to weak governance. In this case, internal audit works as a control measure which saves the organization from irregularities and malpractices and enables the organization to accomplish its objectives of enhancing a high level of productivity and profit.

Roth (2004) indicates that for the accomplishment of goals and objectives through reliable financial reports which management uses for decisions, there is the need for adept and effective internal controls. Poor or unnecessary internal controls lower productivity and increase the complexity of processing transactions without adding value to the activities. Humphrey (2006) highlights that employees get a better appreciation of their contribution through audit interviews and review of audit reports with internal auditors. Meletta (2004) equally states that audit committees, leaders and management teams are constantly searching for better approaches for performance management within audit departments. This can be accomplished by outlining quality assurance programs and implementing effective performance  measurement frameworks.

Statement of the Problem

In recent years, corporate accounting scandals coupled by an outcry for transparency and integrity in financial reporting have given rise to two logical outcomes. Internal audit skills are now critical in resolving the complicated accounting manipulations which have muddled financial statements. In addition, public outcry for change and regulatory action has modified the face of corporate governance. As a result, the bar     of ethical and legal scrutiny has been raised for agents of companies working for the principals. These outcomes are jointly responsible for addressing investors’ anxieties about the financial reporting system. However, laxity still exists  in  implementing  these internal audit findings and recommendations. (Kinyua et al., 2015).

Tighter regulations and enhanced standards for accounting and governance of firms   has been the result of the occurrence of financial scandals. The  Corporate  and  Auditing Accountability and Responsibility Act (Sarbanes and Oxley, 2002) was enacted in 2002 in the USA after the World.com and Enron scandals, where investors lost huge amounts of money. These scandals were caused by weak financial controls and ineffective internal audit practices that the Act tries to address.

Audit quality was measured by Geiger and Rghunandan (2002) to check whether a going concern had been issued in the previous year for clients that went  bankrupt.  They discovered that a going concern judgement was likely to be  presented  by  auditors in the later years but less likely in the initial years, which is contradictory to  the concern that audit quality is affected adversely by  a  long  client-auditor relationship.

They highlighted that as auditors;  they should have identified the deficiencies especially in the financial  statements  which were contrary to International Financial  Reporting  Standards  (IFRS)  and should have pointed them out. The International Standards  of  Auditing  (ISA) however, state that the external auditor’s use professional skepticism and report any irregularities or fraud they encounter but their work does not involve unearthing them. Before the external auditor realizes it, the internal audit should already know and through the internal audit reports made, the audit committee should be aware of it.

This study is therefore aimed at answering the question: What is the effect of internal audit quality on firm financial performance in Nigeria?

 

Objectives

• To scrutinize The effect of audit quality on the performance of listed manufacturing firms in Nigeria.
• To examine the proficiency of internal auditors on firms listed on the NSE
• To examine the relationship between financial performance and auditing reporting standard of firms listed on the NSE
• To understand the level of effectiveness of the Internal Audit Function in manufacturing firms in Nigeria

Research Questions

• Are there any proficiency of internal auditors on firms listed on the NSE?
• What are the relationship between financial performance and auditing reporting standard of firms listed on the NSE?
• What are the level of effectiveness of the Internal Audit Function in manufacturing firms in Nigeria?

Limitations

Due to inadequate funds the researcher conducted this research under serious financial constraints. This made it hard for an in-depth study to be  conducted.  Some  respondents were biased while giving information due to  reasons  such  as  victimization as such the research findings were skewed.

 

 

Secondly the limitation of time was much evident since the sources of  the  data  operate on working days and the researcher is equivalently equally an employee. Respondents were naturally skeptical and uneasy when asked to contribute to a  study  in which they were not aware of its ramifications.  To make the respondents feel at  ease, the researcher made it clear the nature  of the  study and its  proposed function. The researcher further explained that the research  was  purely  an  academic undertaking and that data divulged would be kept in secret by the researcher. The research process was an expensive and tiresome exercise since the researcher had to commute frequently to where the respondents were and also had to communicate frequently to follow up with the respondents.

Significance

This study may benefit the Government of Nigeria by providing an understanding of  how audit quality attributes affect firm operations and the effective management of resources. The study will also recommend how audit practices can be improved. The study will provide useful insight to the NSE on the current status of auditing in the  listed firms. It will also be useful to stakeholders in the Nigerian financial sector as it provides ample evidence in regards to the association between audit quality and their

firm performance.Furthermore, academic scholars will find this study as a useful guide  to  conduct  further research in the field of auditing and as a source for audit quality literature in particular by providing evidence drawn from audit practice in Nigeria and also help  them to appreciate and enhance their knowledge of internal auditing.

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THE CHALLENGES OF RATING VALUATION IN NIGERIA (CASE STUDY OF LAGOS STATE )

CHAPTER ONE

 

INTRODUCTION

• Background to the Study

It was in 1987, in the wake of some well publicized research works by actuaries Hager and Lord that Drivers Jonas first sponsored Investment Property Databank (IPD) to carry out detailed research into valuation accuracy in the United Kingdom. The Royal Institution of Chartered Surveyors (RICS), as the valuers’ professional body, later took over the role of sponsor. In doing so, they were adopting one of the principal recommendations of Sir Bryan Carlsberg’s Working Party on valuation practices.

In 1985, Udo-Akagha, one of the leading estate surveyors and valuers in Nigeria, while writing a foreword to “Guidance Notes on Property Valuation” noted that;

“there ought to be no reason why two or more valuers valuing the same interest         in a property for the same purpose and at the same time should not arrive at

the same or similar results if they make use of the same data and follow the   same valuation approach”.

In the same vein, in 1998, an editorial on page 2 on “property valuation and the credibility problems” in The Estate Surveyor and Valuer, the professional Journal of the Nigerian Institution of Estate Surveyors and Valuers stated inter alia that

“the valuation process has been the focus of recent debate and controversy both within and outside the profession as cases of two or more valuers giving different capital values with wide margins of variation for the same property abound”.

Comments of this nature have led many to ask whether estate surveyors and valuers are interpreters or creators of value. From the above statements, it is evident that the twin problems of inaccuracy and inconsistency (variance) in the valuation practice exist in Nigeria. Even in developed countries such as Britain, Australia, Canada and USA, the valuers’ estimates, methods and processes have been increasingly criticized for over the past thirty years as clients seek advice in increasingly sophisticated investment markets (Baum and Macgregor, 1992).

In the same vein, there has also been a focus on the seeming inability of valuation estimates to accurately represent/interpret market prices or serve as a security for bank loans. Bretten and Wyatt (2002) observed that valuers do not operate with perfect market knowledge while valuers in many instances follow clients’ instructions, analyze available information, make judgments and respond to different pressures from stakeholders when preparing a valuation in a market atmosphere of heterogeneity. However, the study of valuation accuracy should be a continuing one as is the case in the United Kingdom (UK) where the RICS of late teamed up with the Investment Property Databank (IPD) to produce investigations into valuation accuracy in Britain on a two (2) yearly basis.

The effort in this work will accordingly be the study of valuation accuracy and consistency and the factors influencing their occurrences, to cover a more up to date time period with a view to validating/invalidating, expanding and updating the results in the pioneering efforts of Ogunba (1997), Ogunba and Ajayi (1998) and Aluko (2000). Accordingly, the present effort will be to deal with valuation of properties in the Lagos metropolis which is regarded as the most active investment property market city in Nigeria.

 

  1.2 Statement of the Research Problem

Property valuation performs an essential role in property transactions. It provides advice on prospective purchases and sales in addition to supplying material information to underpin property lending decisions. Moreover, since the 1960s and 1970s, property valuations have been used to proxy the exchange price of property investments for performance measurement purposes. This more recent use of valuation indices is a major difference between the property performance measurements and the performance measurement of other investment media markets wherein measurement are undertaken by reference to market transactions.

The differences have led some analysts to argue against property as a portfolio asset, which in turn has led to the under-representation of property in many portfolios. Moreover, the lack of confidence in the use of valuation-based indices might be evidence that the portfolio industry does not readily accept valuations as accurate indicators of prices (and hence returns) in the absence of accuracy studies proving that they are proxies for each other.

Ajayi (2003) noted that increased valuation accuracy and consistency are the demand of the more sophisticated and enlightened clients in the emerging property market of today and the property market has seen remarkable change within the past forty years. Europe and the US have witnessed the emergence of institutional investors, the management of investments on portfolio basis and the recent advent of new property finance methods including securitization and unitization. Clients are now getting much more sophisticated and analytical in their decision making approaches and therefore increasingly require more accurate and consistent valuation estimates from their consultant valuers.

While Accountants, Stockbrokers and other financial consultants have progressively refined their financial analytical techniques to meet and satisfy their changing clients’ expectations, it is rather unfortunate that the property professionals – represented in Nigeria by the Estate Surveyors and Valuers – have been rather slow and lukewarm in their attitudes and approach to the required accuracy changes in valuation practice thereby resulting into complaints from clients about valuation estimates (Ojo, 2004).

The issue of accuracy is also imperative because the profession as it is today is facing stiff competition in all facets of its traditional areas of practice, taking into consideration the fact that the estate agency aspect of the profession has become an “all comers” affair and moreover, that Engineers, Lawyers, Facility Managers and even some stark illiterates (“quacks” of the profession) do engage in property management functions. At the same time, Quantity Surveyors are agitating to take-over the insurance valuation aspect of the profession, whilst Engineers are also seeking to be plant and machinery valuers. In the face of such stiff competition, the estate surveyors can ill afford to be found negligent in the accuracy of their work.

The implication is that the valuation surveyor is faced with both increasing client requirements for accuracy as well as stiffer competition from related professionals. These twin issues of stiff competition and consistency cry out, as it were, for the valuer to respond with pace setting levels of accuracy, and sophistication in his valuation advice. The problem of inaccuracy in valuation manifested itself recently in the case of the valuation of the assets of Nigeria Telecommunication Limited (NITEL) for privatization/disposal purposes when members of staff of the company as well as the interested stakeholders and members of the public in Nigeria openly voiced out their complaints against the excessively low valuation figures/estimates the estate surveyors ascribed to the assets of the company. It was on the strength of such complaints that the then Federal Government under President Olusegun Obasanjo canceled the whole privatization exercise and ordered a re-valuation.

Other instances of valuation estimate inaccuracy according to Ojo (2004) came from financial institutions who continuously complained about the accuracy and reliability of mortgage valuation figures supplied them, which they considered as under-representing the values of such foreclosed collateral securities. He went further to note other instances of alleged inaccuracy which were being investigated by the Professional Practice Committee of the Nigerian Institution of Estate Surveyors and Valuers.

In addition, Ogunba (1997) and Ogunba and Ajayi (1998) alluded to the fact that the average layman nowadays casts doubt on valuation estimates emanating from estate surveyors and valuers. No matter how unjustifiable the criticisms might be, that estate surveyors and valuers are often influenced to hike their valuation estimates because of the need to increase or generate their fees, such criticisms or allegations are a pointer to the fact that inaccurate valuation estimates call to question the valuation skill, integrity and competence of Estate Surveyors and Valuers especially in their core area of practice. From the legal perspective, there is danger that valuers in Nigeria are increasingly found liable for negligence in cases where their valuation figures or estimates mislead unsuspecting and uninformed clients, notwithstanding the exclusion clauses often entrenched in Nigerian valuation reports (Okoror, 1995).

Besides, there is the looming possibility that the property investing public, faced with continuously unreliable estimates, may decide to dump the services of estate surveyors and valuers in favour of services from other consultants such as the Accountants, Financial Analysts, Engineers or Quantity Surveyors who, they think may be able to provide more realistic and reliable estimates.  It is therefore important for estate surveyors and valuers to wake up from slumber and take the issue of valuation accuracy and consistency more seriously.

Other envisaged consequences of continuous and unchecked inaccuracy and inconsistency are adequately summarized by Aluko (2004) as:

• Constraints on property performance analysis due to uncertainty surrounding valuations. This may be damaging to the operation of both the property market and property indices;
• Adverse influence on the relevance of the valuer because if a valuation can only have a limited likelihood of accuracy, the client may question why a valuation is necessary at all;
• Adverse influence on the credibility of the valuer as inaccuracy in valuation means that professional advice would be meaningless as the whole basis of property advice rests on the assumption that valuations are a good proxy for prices; and,
• There could be damage to confidence imposed on the property market.

There seems to be relatively sparse research work in Nigeria on valuation accuracy, reliability and credibility as against such studies in the UK, US, Canada and Australia especially in the past three decades. Also, in the face of the globalization of efforts in this very important and core area of the profession; Nigeria and the rest of Africa cannot afford to feel unconcerned and lukewarm if they want to be relevant in the emerging scheme of things.

In the face of such increasing needs for accuracy, reliability and credibility in valuations, we cannot therefore afford to fold our arms in the face of these problems, observations and criticisms and expose ourselves and the profession to ridicule. It is against the foregoing background that the following questions agitate the mind of the researcher in a bid to ensure that valuation estimates become more accurate and standardized in Nigeria. The study focuses in the main on valuations and sale prices of properties as well as valuations between firms by examining the degree to which they are proxies for each other and if not, the reasons why they fail to be proxies. In view of the foregoing, the questions to be addressed include:

• What is the maximum acceptable margin of error (acceptable to all stakeholders) of valuations relative to realized prices?
• Are Nigerian valuations a good proxy for valuations of other firms?
• Are rating valuations a good proxy for property market transaction prices?
• What are the causes of inaccuracy in property  rating valuations in Nigeria, if it at all inaccuracy exists?
• What are the condition(s) necessary to ensure correct estimates of market price?
• Are client influences significant contributors to inaccurate valuations in Nigeria?

 

1.3 Aim and Objectives of the Study

The main aim of this study is to examine the degree of accuracy and consistency in valuers’ estimation of realized property market prices in Lagos metropolis with a view to improving on the quality of valuation practice.

The specific objectives of the study are to:

1. Ascertain the perceptions of stakeholders as to the maximum acceptable margin of error in valuation estimates relative to sale prices within the study area
2. Determine if open market valuations are good proxies for real property investment markets in the study area
3. Examine if open market valuation estimates of one firm are good proxies for contemporaneous valuations of other firms in the study area, and
4. Identify and examine clients’ mode of influence on valuation estimates.

The essence of the study is to address the above issues and problems by focusing mainly on the questions of reliability/consistency benchmarks and the nature and causes of reliability and consistency of the professionally prepared  rating valuations in the Lagos metropolitan property market.

 

1.4 Significance of Study

The RICS teamed up with the Investment Property Databank (IPD) to carry out investigations into valuation accuracy in Britain on a bi-yearly basis. Since the Nigerian Institution of Estate Surveyors and Valuers (NIESV) and the Estate Surveyors and Valuers Registration Board of Nigeria (ESVARBON) are yet to follow suit, there is the need for estate surveyors in academics to continuously investigate valuation accuracy and consistency and share with their colleagues in practice results and implications of their findings and induce them to fund future research efforts on this issue.

The huge sums of money invested in real estate on an annual basis are enormous. The current happenings in the US with regards to bubble burst from the mortgage sector of the country’s economy are already affecting the fortunes of other countries. To avoid such risks in Nigeria, this study serves as an eye opener for estate surveyors and valuers in practice, other professionals and stakeholders in the real estate business as to the extent of risk they are about to take.

Valuer’s clients are handicapped in decision making by the absence of adequate and reliable information in the property market, unlike the capital market where values of securities can be imputed quickly and easily from the prices at which identical assets trade in regular active markets.  Information about market values in the property market is much more difficult to ascertain due to the heterogeneity of properties, the infrequency with which they trade, and the difficulty in observing or tracking transaction prices due to secrecy.  Additionally, the decentralized nature of most property markets give rise to a dispersion of privately agreed transaction prices about notional market values. The implication of this is that capital market operators and portfolio managers require valuations as a proxy for price. The Nigerian Institution of Estate Surveyors and Valuers therefore needs to encourage research to determine the veracity of inaccuracy claims and if proven, to take corrective action. The present research is in this direction, in an attempt at assisting the profession to justify its property price predicting relevance.

The outcomes of earlier studies carried out by Ogunba (1997), Ogunba and Ajayi (1998), Aluko (2000) and Ogunba (2004) in the area of valuation accuracy/variation have tended to be contradictory in the sense that while Aluko’s work found that valuation estimates emanating from Nigerian valuers were accurate others concluded otherwise. It is necessary to clarify the position as to what can be considered as the acceptable margin of error and identify plausible reasons for valuation inconsistency amongst valuers operating in the same region and with similar educational background. This is necessary to instill confidence in the ever increasing clients searching for genuine information about the real estate market trends over time and in the near future.

 

1.5 Scope of Study

No matter how ambitious a researcher could be, no single study can be all encompassing. Hence, study limits have to be defined clearly. Investments in real estate are an ongoing issue on daily basis all over the country. However, time constraint does not allow for the coverage of the entire country. For this reason, the scope of of this research is restricted to Lagos metropolis where the vast majority of Nigerias’ valuation practice is generated. The Directory of the NIESV (2002 edition) shows that out of 439 registered estate surveying and valuation firms in Nigeria, 52% of the firms are based in Lagos metropolis alone. Lagos Metropolis consists of five convenient business districts namely:  Marina/Broad Street, Lagos Mainland consisting of Yaba/Ebute Meta, Apapa/Ijora,  Ikoyi/Victoria Island  and Ikeja from which deductions are made for each of the districts and for the whole of the Lagos metropolis. The five districts represent the major business sectors of Lagos metropolis, where the bulk of valuation activities normally takes place and where most practicing surveyors are concentrated.  Lagos Island harbours majority of banks, multi-national companies, insurance companies, and also where wholesale and retail commercial activities are concentrated. Lagos Mainland on the other hand represents the intermediary between the former Federal/State capital territory and the new Lagos State capital. Ikeja is the present Lagos State capital with its attendant employment opportunities as well as concentration of commercial activities. Apapa/Ijora axis represents the commercial neighbourhood that has developed overtime as result of the presence of Apapa seaport acting as the drawing force of both people and commercial activities.

In the choice of property to be studied, Ajayi (1990) noted that wide and detailed studies provide stronger basis for rigorous comparative analysis and more generalizeable conclusions. However, the study concentrated on residential property valuation only. This is necessary because sampling all sectors of property valuation may be impossible for a single researcher given the nature of the study and the time limit to complete the study.

In the choice of valuers, three basic classifications of estate surveyors and valuers has been identified namely private-sector estate surveyors and valuers (i.e. those estate surveyors and valuer working in private practice), public-sector estate surveyors and valuers (i.e. estate surveyors and valuers working in government establishments such as Ministries, Corporations etc) and the academicians. The study focused on valuers in private practice because they are in the majority and are actually the people mostly engaged for valuation assignments by various stakeholders.

There are various methods of valuation such as Investment, Cost/Contractor, Residual, Profit and Comparative methods. For this study, emphasis is given to the Investment Method of valuation because most investors look up to the returns they can make on whatever they put into any venture within reasonable time limits. An intensive study of the five methods of valuation, on the other hand would be too wide and cumbersome.

The purposes for demanding for a valuation exercise are varied. There are valuations for rating and taxation, compulsory acquisition, insurance, balance sheet, merger, mortgage, auction, etc. This study is limited to valuation for property sale purposes only. This is to avoid wide study of all purposes of valuation which could lead to conclusions which may be general and without specific implications or applications in the real estate business.

Notwithstanding the above limitations, the validity of the study would not be affected.

 

1.6 The Study Area

Lagos State covers an area of about 3,577 square kilometers, representing 0.4% of Nigeria’s territorial landmass according to Esubiyi (1994). The State shares boundary in the North with Ogun State, West with the Republic of Benin, and stretches for over 180 kilometers North of the Guinea Coast of the Atlantic Ocean. Politically, Lagos State according to Ogunba (1997) had expanded as a result of rural-urban drift and had become a metropolis enclosing settlements such as Mushin, Oshodi, Ikeja, Agege, Shomolu, Bariga, Epe, Ikorodu and Badagry. The 2006 National census put the population of the State at 9,013,534.

Lagos Metropolis has been chosen as the study area because it is the most important commercial city in Nigeria thus providing a sufficiently vibrant economic base and valuation activity which the researcher hopes would provide a vigorous and robust study base Lagos apart from being Nigeria’s former capital, is the largest metropolitan city in Africa. The metropolis is located within the coastal frontage of Lagos State and is bounded in the West, by the Republic of Benin, in the East by Ondo State and Atlantic Ocean in the South and in the North by Ogun State. The metropolis covers an approximate land area of 2,350 square kilometers spreading over four main islands of Lagos, Iddo, Ikoyi and Victoria islands.

On the economic scene, Lagos metropolis has grown from a small farming and fishing settlement to become an important centre of commerce, finance and maritime in Nigeria, housing the headquarters of several banks, industries and commercial enterprises. According to the NIESV Directory (2002), most Estate Surveyors and Valuers aggregate around major business districts of the metropolis such as Lagos Island, Ikeja, Apapa/Ijora, and Lagos Mainland where there is the expectation of a very active property market.

 

 

 

1.7 Definition of Key Terms

In a study of this nature, it is considered necessary and desirable to define key terms with a view to clarifying both operational and constructive definitions to avoid ambiguity. Constructive definition involves substituting the concept or construct of the term we are defining with other concepts or constructs, the operational definition requires that the concept or construct be assigned a type of meaning which the researcher wants to carry throughout the study.

 

1.7.1 Market Value:

Market Value is the estimated amount for which a property should exchange on the date of valuation between a willing buyer and willing seller in an arm’s length transaction after proper marketing wherein the parties had acted knowledgeably, prudently, and without compulsion IVSC (2002). The accuracy of any valuation is, therefore, defined as how close the valuation is to the exchange price in the market place.

 

1.7.2 Market Price:

 Market price refers to realized prices; the recorded consideration paid for a property which has ostensibly been left in the market for a reasonable period of time. The recorded consideration is taken as the best price that a property asset could realistically command in the free market. Transactions do not occur at the point where most players in the market would assess its worth; the transaction occurs at a point which the seller considers to be the highest bid. Market price should therefore capture the highest price at which the property can be sold. Ordinarily, in a perfectly competitive market where there is full information, market value should equate with market price.

 

1.7.3 Valuation Reliability/Accuracy:

Reliability according to Allan (2000) is the degree to which a measurement instrument gives the same results each time it is used, assuming that the underlying object/situation being measured does not change. One can test reliability by determining whether several observers of an object/situation will give similar accounts of it. Reliability is used interchangeably with the term accuracy in this study. Mathematically, reliability/accuracy is usually measured either in terms of percentage standard deviations ranging from ±5% to ±15%, or through statistical tests such as regression equation, where it is expected that the intercept of the equation would be statistically indistinguishable from zero and the constant indistinguishable from one. The study adopts Crosby et al (2003) definition of reliability/accuracy as the closeness (proximity) of the valuation to the realized exchange price.

According to French (2007) uncertainty was defined as anything that is not known about the outcome of a venture at the time the decision was made. Similarly, Mallision and French (2000) observed that “normal uncertainty is a universal and unsurprising fact of property valuation. The open acknowledgement of that fact, and transparent management of its implications, will enhance the utility of valuations”.

 

1.7.4 Valuation Consistency and Variation:

Consistency is a term used interchangeably with the term variation in this thesis. It describes the quality of being mutually constant or not being contradictory. Relating this to the present study, consistency in this study will be taken to refer to the closeness or otherwise of the valuation predictions of two or more valuers who carry out valuations of the same property or properties at the same period of time. The terms reliability and consistency are mathematically measured either in terms of percentage standard deviations or through statistical tests such as regression equation, where it is expected that the intercept of the equation would be statistically indistinguishable from zero and the constant indistinguishable from one.

French (2007) observed that the problem with variance research is that information pertaining to it either has to be set up artificially with a number of valuers asked to provide valuation on set of properties or the analysis relate to valuation s carried out at different points of time in the market. The outcomes of such studies varies substantially and in essence simply reports that different valuers have different ideas and thus produce different valuation figures.

 

1.7.5 Valuation

This is the process of estimating the market value, insurance value, investment value or some other properly defined value of an identified interest or interests in a specific parcel(s) of real estate as at a given date. It is the estimate of the most likely selling price, the assessment of which is the most common objective of the valuer. The most likely selling price is commonly termed “open market” or “market price”. Baum and Crosby (1988) distinguish between two types of valuation: price prediction to the market or to an individual. Valuation in this thesis is taken to be the prediction of most likely sale prices in the market rather than to the individual.

 

1.8 Limitations of Study

In the course of the study the under-listed constraints were encountered. These constraints included:

1. Limited human, material and financial resources at the disposal of the researcher which imposed restrictions on study coverage.
2. The technical nature of some of the questions that were put across to respondents which necessitated the researcher resorting into the use of personal interviews for some respondents thus taking a toll on the time of the researcher.
3. Getting actual selling prices of properties is usually tricky and problematic because the sale of a property is always conducted with a high degree of secrecy. Moreover the market / sales prices stated in documents transferring ownership usually submitted to the Land Registries are, more often than not, manipulated to avoid/reduce tax payments.
4. The study of a few selected towns and cities can not be completely typical of all towns and cities in a country as big as Nigeria. However, since majority of estate surveyors and valuers in Nigeria aggregate and concentrate in the study area, the findings of the study is believed to be applicable to majority of valuers in the country.

The constraints however did not significantly affect the results of the study because necessary precautions were put in place to consult experienced professionals who had practiced across varying economic spheres before and after Nigeria got her independence. For this reason, the findings, observations and recommendations that emanated from the study could be tested across the major cities within the country and found useful.

1.9 Chapter Summary

In this Chapter, a comprehensive introductory overview to the study was undertaken. The research problem was defined against the background of increasing criticism of valuation methodologies in recent times in Nigeria. The study therefore examined the nature and causal factors of inaccuracy in valuers’ estimation of realized residential property market prices in Lagos metropolis, Nigeria.  The justification for the study was premised on three issues: First is the need for estate surveyors in academics to continuously investigate into valuation accuracy and consistency and share with their colleagues in practice results and implications of their findings and induce them to fund future research efforts on this issue.  The second justification for the study is to serve as an eye opener for estate surveyors and valuers in practice, other professionals and stakeholders in the real estate business about inherent risk in inaccurate and inconsistent valuation.  The third justification arose from the need to determine the veracity of inaccuracy claims and if proven, to take corrective action. The present research is in this direction, in an attempt at assisting the profession to justify its property price predicting relevance. The scope of the study was limited to Lagos Metropolis which is Nigeria’s major commercial/industrial nerve centre. The next Chapter is a review of relevant literature on the subject of study.

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