Assessment of the Moderating Effect of Earnings Quality on the Relationship between Idiosyncratic Risks and Stock Return Volatility amongst NSE-Quoted Firms in Kenya

Abstract

Nairobi Securities Exchange has shown a decline in performance for almost a decade now. Statistics reveal that NSE 20 Share Index declined from 5,046 points recorded in the year 2014 to 1,672 points recorded in the year 2022. The cause of volatility in the Bourse is not clear, though past studies have attributed it to idiosyncratic risks, such as capital expenditure, financial gearing, profitability and earnings quality. However, empirical evidence shows conflicting results on the effect of financial gearing and volatility of stock returns. Similarly, past studies on the effect of capital expenditure, profitability and earnings quality on the volatility of stock return have yielded weak relationships. Thus, this study sought to examine the moderating effect of earnings quality on the relationship between Idiosyncratic Risks and Stock Return Volatility amongst NSE-quoted firms in Kenya. Results revealed that earnings quality had a significant moderating effect on the relationship between capital expenditure, financial gearing and profitability on the volatility of stock returns at the NSE (CAPIT:β = 0.224471, p = 0.0000; DCR: β = -0.268377, p = 0.0000; AER: β = 0.101095, p = 0.0000; EPS: β = -0.020479, p = 0.0002; P_E: β = -0.023141, p = 0.0004; ROE: β = -0.061298, p = 0.0254). The findings further indicate that earnings quality has a positive moderating effect on the overall model and the relationship, increasing R² from 70.8197% to 82.0373%. The study concludes that earnings quality positively moderates the relationship between capital expenditure, financial gearing and profitability on the volatility of stock returns at the NSE. It is recommended that NSE-listed firms should optimize their capital expenditure, use more internal sources of finance and focus more on wealth maximization objectives to reduce the volatility of stock returns. Also, the study recommends that NSE-listed firms should put mechanisms in place to improve their accrual quality to reduce the volatility of returns.