Abstract:
Earnings management has attracted recent research discourse due to the financial
scandals that emanate from compromised quality of financial reports and untrue firm
values. Opportunistic managers use their discretion to make financial reporting choices
that maximize their own utilities at the expense true economic reflection of the firm.
This practice has been depicted to have an adverse implication on the shareholders as
it misleads them on the true value of their investment which eventually affects their
decision making. In its quest to address this pertinent issue, the study sought to
investigate the moderating role of CEO power on the relationship between corporate
governance mechanism and earnings management. The study’s specific objectives were
to determine the effects of audit committee’s; independence, meeting frequency,
financial expertise, blockholder ownership and institutional ownership on earnings
management, as well as to assess the moderating role of CEO power on each of the
relationships. A positivism research paradigm was adopted in the study. The research
was guided by agency, entrenchment and stakeholder theories. Explanatory research
design and a panel approach was used to conduct a survey of listed firms at the NSE
that met the inclusion criteria. The study population comprised of 65 listed firms out of
which the research focused on the 35 firms that were consistently in operation during
the study period between 2004 and 2017, resulting in a total of 490 firm-year
observations. Secondary data obtained from the financial reports were analyzed using
both descriptive and inferential statistical techniques. Corporate governance
mechanism was found to have a significant effect on earnings management with its
effects moderated by CEO power. The study results specifically indicate a negative and
significant effect of audit committee’s; independence (β= -0.813, ρ<0.05), meeting
frequency (β= -0.028, ρ<0.05), financial expertise (β= -2.064, ρ<0.05), and blockholder
ownership (β= -1.778, ρ<0.05) on earnings management, while institutional ownership
(β= 2.952, ρ<0.05) indicated a positive and significant effect. CEO power moderates
the relationships between; audit committee’s independence (β=0.214, ρ<0.05,
ΔR 2 =2.83%), meeting frequency (β= -0.087, ρ<0.05, ΔR 2 =1.7%), financial expertise
(β=0.144, ρ<0.05, ΔR 2 =0.1%), blockholder ownership (β= -0.079, ρ<0.05,
ΔR 2 =1.22%), institutional ownership (β= -0.101, ρ<0.05, ΔR 2 =0.7%) and earnings
management. Corporate governance mechanisms specifically the audit committee
attributes and shareholder activism present monitoring mechanisms that aid in
constraining earnings management. More independence, higher financial expertise and
a higher level of activity which is indicated by the meeting frequency is desirable in
reducing earnings management. Blockholders play a crucial role in monitoring
managerial activities, and therefore increased blockhoder ownership structure reduces
earnings management to a greater extent due to their activism. The findings further
supports agency theory propositions which suggests monitoring mechanisms as a
measure to reduce divergence of interests in the firm. Institutional investors who were
found to increase earnings management due to their transient nature. It is therefore in
the best interest of the firm for institutions to refrain from pressurizing management for
higher short-term performance, but instead focus on the long-term prosperity of the
firm. Based on the study findings, CEO power reduces the effectiveness of audit
committee attributes and blockholders in constraining earnings management. It is
therefore recommended that corporate governance mechanisms should be allowed to
operate without undue influence of the CEOs.