Chief Executive Officer Compensation, Earnings Management, Audit Quality and Value of Listed Firms at the Nairobi Securities Exchange

Abstract

The overarching aim of a firm is to increase owners’ wealth. This aspect is reflected through augmented firm value – and management has a responsibility to periodically report to the shareholders on how well resources entrusted to them were effectively used to generate value. However, firm value depends on among other aspects, the level of chief executive officer compensation, earnings management and audit quality. This research sought to determine the link between chief executive officer compensation and value of firms trading shares at Nairobi Securities Exchange. The effect of audit quality and the influence of earnings management on the association between Chief Executive Officer pay and company value were also tested. The study was anchored on the agency theory and adopted a positivist research approach/philosophy. A descriptive longitudinal research design and secondary data retrieved from annual audited financial reports of 46 companies that consistently traded shares at the Nairobi Securities Exchange over a 10-year period (2011-2020) were used. Diagnostic tests to verify the appropriateness of the data for descriptive and inferential analysis using multiple linear regression with Statistical Package for Social Sciences 25 and Stata were conducted. It was found out that Chief Executive Officer compensation negatively and significantly influences firm value while earnings management has an intervening role on the link amid Chief Executive Officer compensation and firm value. Audit quality was proxied by auditor’s industry specialization and audit fees. The findings suggest moderation effect of audit quality on the association between Chief Executive Officer pay and company value. There was also a significant joint influence of Chief Executive Officer compensation, earnings management and audit quality on value of companies at the Nairobi Securities Exchange. These findings expand the growing literature on scholarly debate about Chief Executive Officer compensation, earnings management and financial reporting quality. The findings corroborate the theoretical propositions of agency, signaling, efficient market hypothesis and management entrenchment theories. Regarding policy implications, institutions such as the Nairobi Securities Exchange, Central Bank of Kenya, Insurance Regulatory Authority and Capital Markets Authority can develop and implement strategies that enhance transparency and fairness in financial reporting, effectiveness and accountability in utilization of company resources and proper screening of companies’ operations prior to listing on the securities exchange. This study is vital as it extends literature on determinants of firm value by establishing the moderating and intervening influences of the quality of audits and earnings manipulation respectively – on the association between Chief Executive Officer compensation and company value. The study enriches existing research in the area of financial reporting quality, earnings management, not only in Kenya but even for cross national and global studies. The findings in this research support the agency, signaling, managerial entrenchment and efficient market hypothesis theories since information asymmetry, which can be exasperated by earnings manipulation and divergent interests between Chief Executive Officers and shareholders, leads to mispricing of shares and inaccuracy in firm valuation. This study contributes to knowledge by emphasizing optimal contractual agreements between management and Chief Executive Officers. In addition, earnings management and audit quality are noted as vital determinants of firm value that regulators, investors and other stakeholders should assess when making their economic decisions. Besides, it expands the knowledge on the efficient market hypothesis, signaling and management entrenchment theories in light of wealth creation for the shareholders.