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.