Preventive Internal Controls and Earnings Quality: Evidence from Firms Listed at the Nairobi Securities Exchange
DOI:
https://doi.org/10.53819/81018102t70117Abstract
Financial statements aid a wide range of users in economic decision-making, and the usefulness of the income statement depends on the quality of the earnings it reports. Reported earnings among firms listed at the Nairobi Securities Exchange (NSE) have fluctuated considerably over time, raising the question of whether the strength of preventive internal controls explains this variability. This study evaluated the effect of preventive internal controls on the earnings quality of NSE-listed firms. Anchored on agency theory and the rational expectations (inspired confidence) theory, the study adopted a descriptive causal design based on cross-sectional regression analysis. A census of the 63 NSE-listed companies was targeted; after pilot testing with 6 firms, 46 of the remaining 57 (80.7%) provided usable responses. Primary data on preventive controls were collected via a five-point Likert-scale questionnaire covering segregation of duties, staff rotation, compulsory leave, and physical/access controls, and converted into a Preventive Controls Indicator Ratio (PCIR). Secondary data on earnings persistence (EPER), the proxy for earnings quality, were drawn from audited annual financial statements. Diagnostic tests confirmed normality, linearity, homoscedasticity, and the absence of serious multicollinearity. Both bivariate and multivariate regressions showed that preventive internal controls were positively and significantly associated with earnings quality (bivariate: β = 0.7324, t = 21.308, p < 0.001; multivariate: β = 0.6836, t = 2.469, p = 0.018), leading to rejection of the null hypothesis. The study concludes that preventive internal controls are strongly associated with the reliability of earnings, consistent with a role in shaping it reported by NSE-listed firms and recommends that boards and audit committees institutionalize and continuously strengthen segregation of duties, staff rotation, and access controls as a deliberate earnings-quality safeguard.
Keywords: preventive internal controls; earnings quality; earnings persistence; agency theory; Nairobi Securities Exchange.
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