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

Abstract

Managers use earnings management to lure unsuspecting shareholders to financial scams. Since managers have discretion in making some of the accounting choices, some unscrupulous managers take advantage of this opportunity to make the financial statements look better than they are. Over the years, some Kenyan firms have collapsed while others have been put under receivership because of financial misappropriation. This has led to the loss of shareholders’ wealth, unemployment, and loss of revenue to the Kenyan government. Thus, the present study sought to investigate the effect of corporate governance on earnings management of companies listed at NSE. The study covered board activity, audit committee independence, ownership concentration, board size and board independence as the independent variables, firm size as the control variable and earnings management as the dependent variable. The study adopted descriptive research design that with a longitudinal approach covering 65 listed firms at the Nairobi Securities Exchange. Census was used and thus all the 65 firms were covered. Data was gathered from auxiliary sources covering a five year period (2015-2019) that was summarized using means and standard deviations as the descriptive statistics while correlation and regression analysis were the inferential statistics. The findings indicated that after controlling for firm size, board size had the largest beta followed by audit committee independence, board independence, ownership concentration and board activity. The study concluded that size of the board and the independence of the audit committee are the dimensions of corporate governance that significantly enhances the earnings management of the listed firms. The study recommended that shareholders should ensure that audit committees of their listed firms are properly constituted to have independent directors who will bring in outside experience and expertise that would minimize earnings management. The policy makers at the Capital Markets Authority should establish sound policies and regulations on the ideal board size and the independent directors of the audit committee that would bring about minimization of the earnings management. The policy makers at the Central Bank of Kenya should formulate sound prudential guidelines and regulations on corporate governance of the listed commercial banks that would maximize their earnings. The study was limited by a small sample size of 65 listed firms at the Nairobi Securities Exchange. This relatively smaller sample size made it hard to generalize the findings to other non-listed firms. The study recommended that further studies should be conducted further studies should be conducted by covering the cross listed firms on the East Africa Security Exchange (EASE) aside from the firms listed at the NSE. This will give room for in-depth comparative analysis.