Corporate Governance, Firm Characteristics and Earnings Management in an Emerging Economy

AbstractThe main objective of this paper is to investigate the influence of corporate governance and firm specific characteristics on earnings management by Kenyan listed companies. Using panel data of 148-firm years obtained from the annual reports of the 37 companies listed on the Nairobi Stock Exchange (NSE), the study found that ownership structure and Board Composition were the main corporate governance characteristics influencing earnings management by Kenyan listed Companies.Highly leveraged firms were found to be more likely to engage in earnings management. The results of this study are important to the Kenya Capital Markets Authority (KCMA) and other accounting regulators in Kenya, in the determination of whether to develop more corporate governance guidelines so as to improve the quality of information reported by Listed Companies. The study is also important to investors in developing countries, who must interpret financial statement numbers reported in the companies while making investment decisions. Furthermore, the study contributes to our understanding of how corporate governance influences financial reporting in developing economies, such as Kenya.Key WordsCorporate Governance,Earnings Management,Reporting quality,Kenya(ProQuest: . denotes formulae omitted.)IntroductionThe main motivation for this study is to examine the relationship between the quality of corporate governance and earnings management in a developing country, Kenya. Specifically this paper investigates the influence of corporate governance characteristic (Ownership structure, Independence of the Audit Committee and Board Composition) and firm specific characteristics (Firm size, Firm Performance and Leverage) on earnings management by Kenyan listed companies. We seek to contribute to the debate of whether good corporate governance may be viewed as a prerequisite to good business (Che Haat et al., 2008) by reducing earnings management.Whereas many of corporate governance studies have been carried out in developed countries of Europe, United States of America (USA) and Japan (Joshi and Wakil, 2004), only a few studies have been completed in developing countries of Africa (for example Uddin and Choudhury, 2008). According to Zoysa and Rudkin, (2010) empirical studies on corporate governance and reporting quality reveal that the majority of them have been conducted in countries with developed capital markets, and studies conducted in countries with emerging capital markets are extremely sparse. The conclusions of the studies conducted in developed capital markets cannot be considered as applicable to emerging capital markets due to the large differences in political, cultural, technological, economic, and social factors between the two markets. It is therefore necessary to study the question of quality of information reported by Kenya listed companies (an emerging capital market) and examine whether corporate governance and firm specific variables have an impact on the quality of this information.MotivationRazaee (2003) stated that good corporate governance promotes relationships of accountability among the primary corporate participants and this may enhance corporate performance. Good corporate governance holds management accountable to the board and the board accountable to shareholders. A number of prominent participants in the debates surrounding financial reporting and auditing practices have increased attention given to the role of corporate governance procedures in the development of credible financial statements information (Levitt, 1998). Prior studies (Karamanou and Vafeas, 2005; Beekes and Brown, 2006) suggest that corporate governance can be associated with higher financial reporting quality. Most of these studies have investigating the impact of governance mechanisms on the quality of financial information in developed contexts. For example in the USA context, empirical evidences find that the percentage of outside and independent directors reduces the fraud in financial statements and the earnings management and so it's associated with a higher financial disclosure quality (Beasley, 1996; Klein, 2002; Karamanou and Vafeas, 2005). …