MOTIVATION FACTORS FOR EARNING
MANAGEMENT PRACTICE IN PUBLIC
LISTED COMPANIES IN KENYA
By
Onesmus Waiguru Kaboyo, (Mcom, BBM, (CPAK))
and
George Macharia Wamwea (Ph.D ongoing, MBA, BA(Econ.))
A R e s e a rc h P a p e r P re s e n t e d a t t h e 5 th A f r i c a n
International Business and Management (AIBUMA)
Conference
July 2014
Background
 Different




academicians, researchers, practitioners and
various authoritative institutions have different meanings
and names over earnings management.
Some refer to it as creative accounting (Catherine and Orial,
2005; Tiina and Linh, 2002),
Others refer to it as corporate fraud. (Copeland, 1968),
(Pravean Nisen, 2009)
Lawrence (2009) calls it fraudulent financial reporting.
As such a universally accepted meaning of the term
earnings management is still a matter of academic debate.
Background (continued)
 The rising issue of earning management fraud therefore
fastens the need to define ‘earning management’.
 Earning management is normally discussed in relation with
financial statements fraud.
 Financial statements fraud cases have described various
methods of earning management used to commit fraud
(Rezaee, 2002).




include revenue recognition illegitimately,
inappropriate deferral of expenses,
fictition of sales and early sales,
reversed or use of unjustified reserves
 Many accountants accept that some earnings management
techniques are not fraudulent and that managers are there to
manage earnings (Magrath and Weld, 2002).
Background (continued)
 Jooste, (2011) argues that there is positive and
negative side to earning management.

The negative side is the misallocation of resources which is
cost created

the positive side is the potential in the development of
management’s credible communication of private information
to external stakeholders to improve resources allocation
decisions.
Background (continued)
 According to Hand (1990), earnings management
is an opportunistic practice. This approach is based
on the functional addiction hypothesis
users of financial information are not able to correctly
interpret and understand accounting numbers and
accounting choices.
 In that case, earnings management can be seen as a way
to mislead investors and other users of accounting
figures, about the performance of the firm.

Background (continued)
 The line that separates earning management and
management fraud is too thin and managers are becoming
reluctant to discuss the linking of these two concepts
(Brown, 1999).
 Fraudulent reporting was first exposed after the United
State of America great economic crash in 1929, then after
Savings & Loans financial scandals in the 1980s and soon
after the dot-com bubble of the early 1990s to 2000s
(Robert,2011).
 The rising pressure to reduce fraudulent financial reporting
over the years has resulted in new laws, commission reports
and standards.
Background (continued)
 The Global Economic Crime Survey (2011) targeting firms
around the world found out that,




18% was done by senior executives, and
41% was done by middle level managers,
39% was done by junior staff members and
2% done by other employees.
 This expressed that middle level management and senior
executives are the biggest fraudsters
Problem of Research
 Scandals from 2000 to 2012 involving companies listed at
the Nairobi Securities Exchange (NSE) dented investor
confidence which resulted in downgrading the country’s
global competitiveness standing in the year 2012 (World
Economic Forum, 2012).
 Kenya which was ranked 102nd in 2011 was downgraded to
106th most competitive economy in 2012 out of the 144
economies surveyed.
 Kenya dropped as a result of unethical behavior of firms
that led to fraud and corruption, thus doubting the integrity
of auditing and reporting standards, strength of investor
protection and the protection of minority shareholders.
Justification (continued)
 Boardroom wars over the same period resulted to negative
publicity that has adversely affected investor’s perception of
listed companies (Mugwe, 2012). .
 The boardroom wars were partly triggered by poor
corporate
governance,
alleged
corruption
and
mismanagement of investors funds raising the questions as
to how well investors are protected in Kenya.
 In 2012 alone CMC motors and East Africa Portland
Cement were among the listed companies at NSE that had
board room wars.
Justification (continued)
 Further, a number of companies have collapsed including
Uchumi Supermarkets Limited (under receivership),
Francis Thuo & Partners, Nyaga Stock Brokers, Discount
Securities, and Ngenye Kariuki Stock Brokers among others
where corporate governance issues, and falsification of
financial information were cited as the root causes
(Wamwea, 2010).
 Inaccurate financial statements expose investors to risks
that can dent confidence in the bourse.

Justification (continued)
 Companies involved could collapse along with billions of
shillings in public investments, if rogue auditors are left to
release misguided reports.
 These observations beg to ask the question, what motivates
listed companies in Kenya to practice earnings
management?
Theoretical frame work
 Agency theory

In the modern corporation; there is a partition between the
individuals making decisions regarded as managers and people
bearing the wealth consequences of those decisions regarded as
shareholders (David. et al, 1999).

Agency Theory is also based on hypothesis that principals and agents
act rationally and that they will use the contracting route to
maximize their wealth (Michael, 1994).

Managers may sometimes not act in the best interest of shareholders
when the control of company is different from its ownership (Livia et
al., 2007).
Theoretical frame work (contd.)

Livia et al 2007 further states that managers can be ‘satisfiers’ rather
than ‘maximisers’ that is, they play it safe and look for a suitable level
for growth because their main concern is to perpetuate their own
existence rather than maximizing the value of the firm for its
shareholders.

This means that because managers (agents) have personal interest,
there is possibility for them to take the opportunity to act against the
interest of the owners of the firm.

In some situations like fraudulent earning management, managers
may opt to undertake deeds that are not in preferences of
shareholders.
Objectives
 The general objective of the study was to investigate the
motivation factors for earning management practice in
public listed companies in Kenya.
 Specifically,
1.
2.
To examine the motivation behind the practice of
earnings management,
To examine how earnings management is practiced in
public listed companies,
Research design and population
 The study was exploratory in nature and sought to
determine the main factors that led to earning management
practice in Kenya.
 The target population was all the fifty six (56) active listed
public companies at NSE as at 31st March 2013.
 Census sampling was employed where all the 56 listed
organizations were selected for the study.
 The respondents were the accountants of the institutions or
persons charged with overseeing the finance function in the
institutions.
Sampling
 Only 33 organizations responded giving a response rate of
59%. Kothari (2007) says that 50 percent return rate is
adequate, 60 percent good and 70 percent very good.
 Cohen and Manion (1989), further argue that a sample
should have 30 0r more test items to be a good
representative. The data collected were therefore deemed
adequate for the study.
Data and data methods
 The data used for this study was primary. Primary data
included first-hand information that was collected by the
use of online questionnaires.
 The researchers emailed questionnaires to finance
department of all the targeted companies.
 A follow up call was made after every two days.
 In a two weeks period the targeted population filled the
questionnaires and sent them back to the researcher.
Data analysis
 Multiple Regression modeling was used in the study.
 The study adopted the multiple regression model as
developed by (Summer and Sweeney, 1998).
 The multiple regression equation was given as follows:

Earning Management =
= α + β1 Incentives
+ β2 Wealth increase
+ β3 Poor financial conditions
+ β4 Shareholders expectations
+ β5 Company Growth
+ β6 Accounts receivable/inventory
+ β7 Auditors changes
+ε
Data analysis (contd.)
 The significance of the relationship was indicated by the
coefficient of determination (R Squared) and the P-values
of the respective coefficients.
 A 95% confidence level was adopted.
Findings
 Extent of earnings management practice,
 (your company recognizes revenue in a period not related
to it).

Table 1
Response
Frequency
Percent
Strongly agree
5
16
Agree
17
53
Not sure
7
22
Disagree
3
9
Total
32
100
 earnings management is practiced in 69% of public listed
companies. (16% strongly agree plus 53% agree)
Findings (contd.)
 Globally the practice in prevalent.
 Greenspan (2002), affirms that “the business community
has developed some greed where companies executives
looked for ways to ‘harvest’ gains.
 In Berrie v Ebbers Case, According to the prosecutor Ebber
(CEO WorldCom) was motivated to do fraud when there
was pressure on share price and had to look for ways to
manipulate the share price.
 Descriptive statistics and Multiple regression techniques
were employed to establish the factors that motivate
earning management practice in Kenyan public companies
as shown in Table 1.
Statement
N
Mean
33
1.82
33
2.03
33
2.06
33
2.45
33
2.45
33
2.91
33
3.24
High shareholders’ expectations in terms of high profitability induces
management to mis-report financial performance
Poor financial performance of a company that negatively affects its reputation
in the public induces management to mis-report financial performance
Management incentives based on company performance induces managers to
mis-report financial performance
Purposeful possession of the company’s shares by mgt. with intent to sell
them to increase their wealth induces management to mis-report performance
Weak internal controls systems of the company induces management to misreport financial performance
Management ‘subjective judgment on adjustments of accounts receivable and
inventory with no proper accounting procedures
High external auditor turnover, (changing auditors after every 1 or 2 years)
Factors influencing earning management practice in
Kenyan public companies
Table 2.
SUMMARY OUTPUT
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
Intercept
mgt_incentives
shares
poor_performance
Shareholders exp.
internal_controls
accounts_receivables
auditors
0.55431
0.307259
0.113292
0.781851
33
Coefficients
3.000807
-0.22359
-0.24813
0.344899
-0.05015
-0.13449
0.057007
-0.04114
Standard Error
0.520667
0.175369
0.119529
0.173088
0.157267
0.139362
0.132336
0.158037
t Stat
5.763389908
-1.2749377
-2.07592072
1.992625661
-0.31890922
-0.96503226
0.43077567
-0.26032966
P-value
5.25075E-06
0.021405396
0.048337944
0.047327588
0.027524648
0.343771628
0.670322871
0.796741724
 E M = 3.0081 - 0.22359 I - 0.24813W + 0.344899 PFC - 0.05015 SE + ε
EM
=
Earnings Management.
I
=
Incentives.
W
=
Wealth Increase.
FC
=
Financial Condition.
SE
=
Shareholders Expectation.
ε
=
Error term
 E M = α + β1 I + β2 W + β3 FC + β4 S E + ε
 Y = α + β1X1 + β2X2 + β3X3 + β4X4 + ε
 Y = 3.0081 - 0.22359 X1 - 0.24813 X2 + 0.344899 X3 - 0.05015 X4 + ε
 The coefficient of determinant (R2) was 0.31 implying the
explanatory power of the model was only 31%.
 Some caution is therefore necessary while dealing with the
model since the error term accounts for 69% of the
variations in the model.
 This suggests that there are other variables responsible for
variations in earnings management in Kenyan companies
other than the four identified by the model.
Other factors influencing earning management
practice in Kenyan public companies
1.
2.
3.
4.
5.
6.
7.
8.
To safeguard management reputation through financial
performance
Avoidance of heavy taxation
To avoid the issue of profit warning
To meet the statutory and regulators requirements
Projection of sustainability in the company
Poor accounting systems, that are difficult to understand
thereby giving room to alterations
Cover up for theft of company resources
Maintenance of favourable stock prices
9 Avoidance of pressure from workers asking for higher
wages
10 Subjective application of international reporting
standards
11 Related party transactions
How earnings management is practiced in public
listed companies in kenya.
 Improper revenue recognition where the management
realizes revenue in the wrong accounting period to increase
its sales.
 Inventory misstatement since it constitutes a significant
portion of corporate assets and has different accepted stock
valuation methods.
 Amortization of goodwill – it creates opportunities for its
manipulation where it either increases or reduces profit.

Ansa, et al (2002), Catherine and Oriol (2005) have also observed
persistent use of these three techniques to perpetrate earnings
management.
Other techniques employed to perpetrate earnings
management among the Kenyan public companies
1.
2.
3.
4.
5.
6.
7.
8.
9.
Banks entering into buy back deals on bonds
Capitalization of expenses to make the company appear
profitable
Ficticious Investments
Vendor scams
Overstatement of sales revenue
Movement and transfer of balances
Posting or releasing provisions to alter operating costs
Profit repatriations to related parties
provisions to show losses especially when there is
abnormal growth
10 provision for bad debts misstatement,
12. provision for expenses that are work in progress,
13. loan amortization schedules for work not completed,
Conclusion
 Listed companies in Kenya do practice earnings
management in one way or another.
 The practice is commonly motivated by;
 High shareholders’ expectations
 Management of public reputation
 Management incentives
 Taxation policies
 Statutory regulation policies
 Management fraud
Public companies also practice earnings management to
deal with their own unique situations.
Conclusion (contd.)
Some of the ways the companies perpetrated the practice
include
 improper revenue recognition,
 inventory misstatement, and
 amortization of goodwill
 Posting or releasing provisions
 Related party transactions
 Bank buy back arrangements
 vendor scams
 Management fraud
Recommendations
 that; Capital Markets Authority (CMA)
 provides clear guidelines on management incentives that are
based on company performance;
 enforces their rules on ownership of shares by management
 that CMA provides clear guidelines on related party
transactions where listed companies trade with their
subsidiaries and parent companies
 that CMA compels public companies to adopt accounting
systems that are easy to understand;
 That Kenya Revenue Authority (KRA) and the sector specific
regulators (CBK, IRA, )
 engage the public listed companies positively with a view of
assisting them manage their tax and other statutory obligations
without having to manipulate their books of accounts.
Further research
 Further research is necessary on:
 Motivation factors for earning management practice in
unlisted public companies in Kenya
 Motivation factors for earning management practice in
private companies in Kenya
 Motivation factors for earning management practice in
state corporations in Kenya
Discussion
 Earning management can either be restricted to a given
accounting period or carried over a period of time.
 Academicians have used a variety of
measures while
attempting to address the level of earning management and
have attempted to find conditions under which it is
practiced (Lawrence, 2009)
 Earnings management has an
edge on the income
statement, although the apparent association to the balance
sheet is important part of understanding the practice.
 Standard setters are adopting a balance sheet emphasis,
which targets on the valuation of assets and liabilities,
rather than on income statement approach, which stress on
the income statement measurement (Lawrence, 2009).
 Future research should be directed towards defining and
measuring earnings management.
 THE END