Effect of Corporate Governance on Earnings Management in Firms Listed at the Nairobi Securities Exchange

Abstract

Board governance directly impacts on managers’ decision making and activities. It can also impact the selection of external auditors as well as internal control systems by the audit committee. Also, board governance can use internal control systems to monitor earnings management practices in a firm. Past studies have reported that board independence can constrain earnings management by managers; this is because independent directors are not after their personal gain. The aim of the study was to establish the effect of corporate governance on earnings management of the quoted firms at the NSE. The population of the study was all the 64 firms quoted at the NSE as at 31st December 2017. Data was obtained from 53 out of the 64 listed companies giving a response rate of 82.81%. The independent variable for the study was corporate governance with four measures: board independence as measured by the ratio of independent directors to total directors, board size as measured by natural logarithm of the total number of board members, ownership concentration as measured by proportion of ownership held by main shareholders of institutional nature of the listed firm and board activity as measured by the number of board meetings in an year. The control variable was firm size as measured by natural logarithm of total assets. Earnings management was the dependent variable which the study sought to explain and it was measured using the financial structure model. Secondary data was collected for a 5-year time frame (January 2013 to December 2017) annually. The descriptive cross-sectional research design was employed for the study and the association between the study variables established using multiple linear regression model. Statistical package for social sciences version 22 was used to analyse the data. The results of the study produced R-square value of 0.314 which means that about 31.4 percent of the variation in the earnings management of companies quoted at NSE could be explained by the five selected independent variables while 68.6 percent in the variation of earnings management was associated with other factors not covered in this research. The study also found that the independent variables had a strong correlation with earnings management (R=0.560). ANOVA findings show that the F statistic was significant at 5% level with a p=0.000. Therefore, the model was fit to explain the association between the selected variables. The results further revealed that board independence and board activity produced negative and statistically significant values for this study while firm size produced positive and statistically significant values for this study. Board size and ownership characteristics were found to be not statistically significant determinants of earnings management of firms at the NSE listing. The study’s recommendations were that measures should be put in place to enhance board independence and board activity as this will significantly reduce earnings management among firms at the NSE listing. The researcher suggests that future researchers can focus on corporate governance and earnings management of non-listed firms.