THE EFFECT OF CREATIVE ACCOUNTING ON SHAREHOLDERS’ WEALTH IN LISTED COMPANIES IN KENYA BY MUNENE JULIA W. D63/72769/2014 A RESEARCH PROJECT SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE AWARD OF THE DEGREE OF MASTER OF SCIENCE IN FINANCE, SCHOOL OF BUSINESS, UNIVERSITY OF NAIROBI 2016 DECLARATION I declare that this research project is my original work and has not been presented to any University or institution of higher learning for a degree or any other award. Sign ________________________________________ Date __________________ Munene Julia W. Reg. No.: D63/72769/2014 This project has been submitted with our approval as the university supervisors Signed ________________________________ Date___________________ Mr. Murage Dominic Lecturer, School of Business Signed ________________________________ Date ___________________ Dr. Lishenga J. Senior Lecturer, School of Business ii ACKNOWLEDGEMENT My heartfelt thanks to God Almighty for his guidance and protection in my academic work. My profound appreciation goes to my supervisor, Mr. Murage Dominic for his untiring guidance through this exercise. I also acknowledge all the Lecturers at School of Business, University of Nairobi for their indirect and direct role towards the success of this research project. Lastly but not least, many thanks to my colleagues for always being there for me. May God bless you all abundantly. iii DEDICATION This work is dedicated to my parents; Nyaguthie and Munene and my brothers Muriithi and Mugera. I also dedicate this work to Mr. Felix and Titus for their unwavering support and encouragement all through in my academic drive. I also dedicate this work to IBVM Loreto sisters and Vincentian priests for their moral and spiritual support, have done a great deal in me reaching this far. May the Almighty God bless you abundantly. Many thanks. iv ABSTRACT The creative accounting practices are prevalent and attributed to bad corporate governance. Accountants apply strategies that enhance creative accounting by using profit eroding mechanisms which lead to drastic consequences. These include corporate scandals and collapse both international and locally as in the case of WorldCom and Enron. In Kenya, there are companies that over-report their financial performance to meet targets and please ever demanding shareholders. This highlights the existence of creative accounting. The current trend in the Kenyan investment is that companies indicating an increase in shareholders wealth attract more investment and thus increasing share capital. Various methods can be used to influence shareholders wealth as a way of attracting future investment; some may be legal or illegal. This study used a diverse research design; cross-sectional and explanatory research designs were adopted for primary data and time-series for collecting secondary data. This study therefore adopted mixed research design to ensure that the data collected and analyzed addresses the objectives of the study. The study comprised 64 companies listed on the NSE. The target population was comprised of all listed companies in Kenya. 35 questionnaires were distributed for this study but only 25 respondents provided their responses on time thus getting 71.4% response rate. The data was measured using frequency tables, weighted means, standard deviations and percentages and depicted using tables and bar charts as shown in the following sections. The period of study was from 2010 to 2015.The period acted as a pointer with regard to the recent financial crises. The researcher found that the independent variables explain 64.3% of the variance in the shareholders wealth. It’s very clear that these independent variables influence to a large extent the growth of shareholders wealth. It is therefore sufficiently to conclude that these variables significantly influence the growth of shareholders wealth given the unexplained variance is only 35.7%. The study recommends that local investors should embrace shareholder value concept as an excellent model for value creation to increase insider trading meant to boost investor confidence and sense of security as guaranteed by mutual interests in growth in shareholder value. Further research should be carried out on other employees who could be involved in creative accounting therefore indirectly affecting shareholders wealth. v TABLE OF CONTENTS DECLARATION............................................................................................................... ii ACKNOWLEDGEMENT ............................................................................................... iii DEDICATION.................................................................................................................. iv ABSTRACT ....................................................................................................................... v LIST OF TABLES ......................................................................................................... viii LIST OF FIGURES ......................................................................................................... ix LIST OF ABBREVIATIONS .......................................................................................... x CHAPTER ONE: INTRODUCTION ............................................................................. 1 1.1 Background of the Study ........................................................................................... 1 1.1.1 Creative Accounting Concept ............................................................................. 3 1.1.2 Shareholders’ Wealth ......................................................................................... 5 1.1.3 The Relationship between Creative Accounting and Shareholders’ Wealth ...... 7 1.1.4 The Nairobi Stock Exchange .............................................................................. 8 1.2 Research Problem ...................................................................................................... 9 1.3 Research Objective .................................................................................................. 12 1.4 Value of the Study ................................................................................................... 12 CHAPTER TWO: LITERATURE REVIEW .............................................................. 14 2.1 Introduction ............................................................................................................. 14 2.2 Theoretical Review ................................................................................................. 14 2.2.1 Agency Theory ................................................................................................. 14 2.2.2 The Information Theory ................................................................................... 15 2.3 The Determinants of Shareholders’ Wealth ............................................................ 16 2.3.1 Dividend pay-out policy ................................................................................... 17 2.3.2 Earnings after Tax and Interest ......................................................................... 17 2.3.3 The movement in Share Prices ......................................................................... 18 2.3.4. Market Forces .................................................................................................. 18 2.4 Empirical Review .................................................................................................... 19 vi 2.5 The Conceptual Framework .................................................................................... 23 2.6 Summary of Literature Review ............................................................................... 25 CHAPTER THREE: RESEARCH METHODOLOGY ............................................. 26 3.1 Introduction ............................................................................................................. 26 3.2 Research Design ...................................................................................................... 26 3.3 Population................................................................................................................ 27 3.4 Sample Design......................................................................................................... 27 3.5 Data Collection ........................................................................................................ 28 3.6 Validity and Reliability of Data .............................................................................. 28 3.7 Data Analysis .......................................................................................................... 29 3.7.1 Analytical Model .............................................................................................. 29 CHAPTER FOUR: DATA ANALYSIS, FINDINGS AND INTERPRETATION ... 31 4.1 Introduction ................................................................................................................. 31 4.2 Data Findings .............................................................................................................. 31 4.3 Discussions of Research Findings .............................................................................. 42 CHAPTER FIVE: SUMMARY, CONCLUSION AND RECOMMENDATIONS .. 43 5.1 Introduction ................................................................................................................. 43 5.2 Summary ....................................................................................................................