The Relationship Between Discretionary Accruals and Earnings Quality Among Firms Listed at the Nairobi Securities Exchange

Abstract

One of the most pressing concerns about how the market perceives high earnings quality is the impact of financial reporting quality on a company's subsequent performance. The market favourably judges those firms that have are highly capable of providing quality financial data to shareholders and other stakeholders, having demonstrated that firms with quality financial data have a relatively better worth in the future, aiming for the elimination or avoidance of information asymmetries among market participants. The overall objective of the study was to establish the impact of discretionary accruals on the earnings quality of Nairobi Securities Exchange-listed companies. It also aimed at reviewing the increasing body of theoretical and empirical studies that have endeavored to examine the range of magnitude and effects of discretionary accruals on earnings quality. The agency, stakeholder, and signalling theories guided the current study. The current study utilized the descriptive research design. The target population was all the 64 listed firms at the Nairobi Securities Exchange. The study employed a census and it analyzed the whole population. The unit period of analysis was annual, and data was collected for the period from 2016 to 2020; the period comprised of five years. The study applied correlation analysis and multiple linear regression model with the technique of estimation being Ordinary Least Squares (OLS) so as to establish the relationship of discretionary accruals and earnings quality. The study findings were that total accruals (R=0.0081; p=0.8929>0.05), deferred tax expense (R=0.0235; p=0.6946>0.05), Modified Jones dis. accruals (R=-0.0112; p=0.8512>0.05), Fwd-Look Dis. accruals (R=0.0062; p=0.9170>0.05), and firm size (R=0.0638; p=0.2855>0.05) do not have a significant correlation with firm value. Further study findings established that the model entailing; total accruals, deferred tax expense, Modified Jones dis. accruals, and Fwd-Look Dis. accruals, as well as firm size explains earnings quality to a very least extent with a coefficient of determination value of 0.45%. Additional study findings were that the model consisting of total accruals, deferred tax expense, Modified Jones dis. accruals, and Fwd-Look Dis. accruals, as well as firm size significantly predicts earnings quality (Prob>chi2=0.0000<0.05). Final study findings were that total accruals (p=0.319>0.05), deferred tax expense (p=0.962>0.05), Modified Jones dis. accruals (p=0.532>0.05), Fwd-Look Dis. accruals (p=0.868>0.05), and firm size (p=0.475>0.05) do not each individually have a significant relationship with firm value. Policy recommendations are made to the government officials and policy formulators in the financial sector, mainly the regulator, the Capital Markets Authority (CMA), and the Treasury, to focus on discretionary accruals when endeavouring to boost firm earnings quality in order to spur the development of capital markets. CMA as well as NSE should boost their surveillance and monitoring of listed firms to stem discretionary accruals which will in turn boost the firms’ earnings quality, and ultimately their value. Recommendations are also generated to the financial analysts to estimate market capitalization, and by extension, securities value, by gauging the extent to which firms employ discretionary accruals. The earnings quality of firms that rampantly utilize discretionary accruals will most likely to be poor. Finally, recommendations are made to consultants and listed firms practitioners should focus on discretionary accruals to time strategies like securities exchange listings, rights issues, and dividend pay-outs. Less use of discretionary accruals will signal earnings quality which will rave up demand of the firms’ security instrument offerings.