FINANCIAL DETERMINANTS OF AGGRESSIVE ACCOUNTING PRACTICES: EVIDENCE FROM FIRMS LISTED ON THE NAIROBI SECURITIES EXCHANGE, KENYA

Abstract

In emerging markets, where businesses frequently have low financial resources and relatively weak institutional supervision, aggressive accounting techniques continue to undermine the credibility of financial reporting. This study examined firm-specific determinants of income smoothing practices among firms listed at NSE, Kenya. The study looked specifically at the effect that it had on profitability, financial leverage, liquidity and operational efficiency on earning management behavior. The research was reliant on the Positive Accounting Theory, Trade-off Theory, Credit Risk Theory, Pecking Order Theory and Risk and Return Theory. The study employed a mixed-source quantitative design. 279 finance professionals from 55 listed companies provided primary data, and audited financial statements from 2019 to 2023 provided secondary data. Descriptive statistical techniques were employed to analyze the data as well as Pearson correlation, multiple regression, fixed effects panel regression and diagnostic tests. The findings indicated that financial leverage (β = 0.270, p < .001) and profitability (β = 0.472, p < .001) were the most significant determinants of income smoothing practices, and liquidity had a positive but less significant effect (β = 0.173, p < .001). Operational efficiency did not significantly affect earning management (β = 0.014, p =.670). The regression model explained 64.1% of the variation in aggressive accounting practices (R² = 0.641), which is a substantial explanatory power. The results imply that financing pressures and falling profitability are the main incentives for managers to use aggressive accounting in emerging capital markets. In addition to adding to the existing body of knowledge, regarding the quality of financial reporting by offering empirical data from a developing African economy. The results indicate that in order to enhance the early detection of earning management practices, authorities should include financial distress indicators into risk-based surveillance systems.