Board characteristics, sustainability reporting and earnings management among listed firms in East Africa

Abstract

Manipulation of financial information through earnings management affect firm value and lowers investors’ confidence. The recent corporate accounting scandals at Enron, WorldCom, Mumias, Uchumi, among others, is an indicator of managerial motive in earnings management and the need for an effective board in mitigating opportunistic managerial behaviours. Although prior studies have examined the relationship between board characteristics and earnings management the findings are inconclusive. Studies show that the board influences the adoption of environmental and social initiatives. Similarly, another stream of literature indicates that sustainability practices mitigates against unethical practices such as earnings manipulation. Therefore, this study sought to investigate whether sustainability reporting mediates the relationship between board characteristics and earnings management among listed firms in East Africa. The specific objectives were to examine the effect of; board size, board independence, board financial expertise and board gender diversity on earnings management. Additionally, the study determined whether sustainability reporting mediated the relationship between; board size, board independence, board financial expertise, board gender diversity and earnings management. The study was anchored on several theories; agency theory, signalling theory, stakeholder theory and the legitimacy theory. This study adopted the explanatory and longitudinal research designs. The target population consisted of the 122 listed firms in East Africa. However, after applying the inclusion/exclusion criteria the final sample comprised of 88 firm. Data was secondary and quantitative in nature and was for the period 2010 -2020. In total, the study had 799 firm-year observations. The data that was extracted from the firms’ annual financial reports with the aid of a data collection schedule. Data was analyzed using both descriptive and inferential statistics. The results of the Hausman test determined the choice between the fixed effect and the random effect panel data estimation model. The study found out that board size (β=0.233, ρ<0.05), board independence (β= -0.347, ρ<0.05), board financial expertise (β= -0.218, ρ<0.05) and board gender diversity (β= -0.610, ρ<0.05) had a significant effect on earnings management for firms listed in East Africa securities exchange. Further the study established that sustainability reporting had a significant negative effect on earnings management (β=-0.6118, ρ<0.05). Moreover the study established that sustainability reporting mediates the relationship between board size (β=0.061, ρ<0.05), board independence (β=-0.133, ρ<0.05), board financial expertise (β=-0.063, ρ<0.05) board gender diversity (β=-0.078, ρ<0.05), and earnings management among listed firms in East Africa. Based on the findings, the study concluded that sustainability reporting mediated the relationship between board characteristics and earnings management. The findings have several recommendations. First, policy makers should address corporate governance mechanisms that mitigates earning management. For example, there is need for a lean board that is more independent and with a higher proportion of women. Besides, a high percentage of board members with financial expertise is effective in controlling accounting fraud. Second, there is need for voluntary and mandatory sustainability practices and disclosures as a strategy for mitigating earnings management. This study was limited to East African listed firms and four board characteristics. Therefore, future studies may consider other board attributes, unlisted firms and other institutional settings since this may shed more light on the relationship between board characteristics, sustainability reporting and earnings management.