Correlation between Earnings Management and Financial Distress among Selected Firms in Kenya

Abstract Background This paper evaluates the link between earnings management and financial distress among listed firms in Kenya. Earnings management is the use of accounting practices to prepare financial statements that portray a company's business activity and financial status in an unrealistically favorable manner. On the other hand, financial distress is when an organization's revenues or income no longer satisfy its financial obligations, resulting in bankruptcy and possible dissolution. Results The assessment compares the modified Jones score, which is commonly used to measure discretionary accruals, with Altman’s Z score, which measures the degree of financial distress. The earnings management and financial distress. The selected firms under this study are known to be financially distressed as per the publicly available information. The hypothesis tests express whether a correlation exists between earnings management and financial distress. The result also highlights the level of significance of the effect of earnings management on financial distress. Conclusion The study concludes that there is some moderate probability that a financially distressed firm is likely to practice earnings management. On the other hand, there is a moderate likelihood that firms that practice earnings management may face financial distress at some point. Earnings management is not necessarily practiced to camouflage financial distress, but that does not mean that it cannot happen. On the other hand, financial distress is not an indicator of earnings management and vice versa.