Effect of Leverage on Earnings Management for Companies Listed at the Nairobi Securities Exchange

Abstract

An important item in a firm’s financial statement is the level of earnings generated. This is because of the value-added benefits associated with the level of earnings generated and as a result the company management would attempt to monitor the same in a meaningful manner, as per the existing accounting standards and the discretion provided by the accounting standards. The main objective of the study was to examine the effect of leverage on earnings management of firms listed at the Nairobi Securities Exchange. The study was anchored on three theories; Agency Theory, Prospect Theory, and Positive Accounting Theory. The study used descriptive design while the target population consisted of the 66 firms listed at the NSE. Since the population of the study was small, the research was a census. Secondary data was collected from audited financial information ranging between 2016 and 2020. The study used SPSS in analysis where the findings established that degree of operating leverage had an insignificant impact on earnings management (β=0.000, α=0.476) it therefore implied that additional resources that boosts degree of operating leverage may not be realized in the outcome of earnings management. Similarly, the study found a regression coefficient β=0.784 and significance value α=0.784 for the degree of financial leverage. As a result, it was established that the degree of financial leverage insignificantly affects earnings management. However, the study found a positive (β=0.165) and a significant (α=0.004) relationship between property, plant and equipment and earnings management. As a result, the findings implied that an increase in organizational tangible assets increases organizational earnings management activity. The study findings in relation to operating cashflow found that there is a positive (β=0.034) and an insignificant (α=0.746) relationship with earnings management. The findings show that an increase in operating cashflow result to increased earnings management by a factor of 0.034 but the effect may not be significant effect. Contrary to the relationship between operating cashflow and earnings management, the study established a negative and significant relationship between firm size and earnings management. From the regression model, an increase in the size of a firm significantly (α=0.014) reduces earnings management by a factor of 0.034. From the overall effect of leverage on earnings management, the coefficient of determination computed was 0.060 implying that the determinants of leverage; degree of financial leverage, operating cashflow, degree of operating leverage, property plant and equipment intervened by firm size explains 6% of the overall earning management outcome. From the inferential statistics, the study concluded that degree of operating leverage and degree of financial leverage have an insignificant effect on earnings management. Though the impact might be positive, the result on the outcome may not be realized. On the other hand, increase in tangible assets enhances earnings management process. As a result, the study recommends that more time for the study and additional variables for the study resources in order to establish the most appropriate dimensions of leverage that should be incorporated in order to establish more impact on earnings management.