EARNINGS MANAGEMENT AND FINANCIAL REPORTING QUALITY OF LISTED COMMERCIAL BANKS IN KENYA

Abstract

Earnings management is described as a technique or procedure used by accountants in conformity with the guidelines of Generally Accepted Accounting Principles (GAAP) to adjust earnings or change the reported figure to present more favorable financial information. It has existed for decades but has lately acquired prominence owing to corporate scandals. Therefore, this study aimed to evaluate the effect of earnings management on the financial reporting quality of commercial banks in Kenya. The specific objectives of the study included; evaluating the effects of revenue management on financial reporting quality of commercial banks in Kenya, to examine the effects of asset management on financial reporting quality of commercial banks in Kenya, to assess the effects of debt management on financial reporting quality of commercial banks in Kenya, to examine the effects of expenses management on financial reporting quality of commercial banks in Kenya and, to examine the moderating effect of corporate governance on the relationship between earnings management and financial reporting quality of commercial banks in Kenya. The study was anchored on positive accounting theory, agency theory and legitimacy theory. The study adopted an ex-post facto panel-based quantitative research design. The study's target population was all listed commercial banks in Kenya. A secondary data collection sheet was used to collect study data. Panel data was analyzed using descriptive and inferential statistics. The study employed panel data regression analysis to examine the effect of earnings management practices and corporate governance on financial reporting quality among listed commercial banks in Kenya. Diagnostic tests confirmed that the data satisfied the assumptions of regression analysis, and the Hausman specification test indicated that the random effects model was the most appropriate for the study. The study found that earnings management practices, revenue, asset, debt, and expense management, negatively and significantly affect financial reporting quality in listed commercial banks in Kenya. Regression results show revenue management (β = −0.4089, p <0.001), asset management (β = −0.3719, p < 0.001), debt management (β = −0.2857, p < 0.001), and expense management (β = −0.2140, p < 0.001) all reduce reporting quality. Corporate governance positively influences financial reporting quality (β = 0.6127, p = 0.001) and moderates the effect of earnings management, with the interaction term significantly buffering its negative impact (β = 0.4796, p < 0.003). The overall model is statistically significant (Wald χ² = 323.47, p < 0.001) and explains 63.15% of the variation in reporting quality. These findings suggest that while earnings management undermines transparency, strong corporate governance mitigates its adverse effects, enhancing the quality of financial reporting. This study provided insights into how earnings management affects the reliability of financial statements in Kenyan commercial banks. The findings may help the Central Bank of Kenya strengthen transparency policies and curb manipulative reporting. For bank managers and accountants, it offers guidance on ethical reporting, IFRS compliance, and building investor confidence.

JEL: M40, M41, M42, M48, M49, H83, G32