Earnings Quality and Stock Returns of Commercial Banks Listed on the Nairobi Securities Exchange in Kenya
Abstract
The banking sector accounts for 40.3% of Kenya's Nairobi Securities Exchange (NSE) market capitalization, yet the relationship between earnings quality and stock returns remains underexplored despite the sector's systemic importance. During 2017-2023, NSE-listed banks experienced negative mean stock returns (-0.67%) with substantial volatility, operating within a context of regulatory interventions and economic uncertainty. This study analyzed the relationship between earnings quality dimensions (persistence, predictability, and volatility) and stock returns for 11 commercial banks listed on the NSE from 2017 to 2023. Anchored on agency theory, signaling theory, and efficient market hypothesis, the study employed a descriptive correlational design using secondary data from audited financial statements and NSE records. Data was analyzed through descriptive statistics, correlation analysis, and panel regression with fixed effects models and robust standard errors. Results revealed that individual earnings quality attributes had statistically insignificant direct effects on stock returns; earnings persistence had a positive but insignificant effect (coefficient = 0.0976, p = 0.540), earnings predictability exhibited a negative but insignificant relationship (coefficient = -0.0544, p = 0.651), and earnings volatility showed low positive but insignificant impact (coefficient = 0.0004, p = 0.840). However, their joint effect was statistically significant (F(3,10) = 16.32, p = 0.0004), explaining 6.98% of within-bank stock return variation. The study found significant mean reversion (30.7% correction) in stock returns and exceptional temporal stability in earnings persistence (97.31%). The study recommends comprehensive earnings quality policies addressing multiple dimensions simultaneously, holistic improvement programs for bank managers, alternative analytical frameworks for investors exploiting mean reversion patterns, and enhanced regulatory disclosure requirements with early warning systems based on earnings quality patterns.
Keywords: Earnings Quality, Earnings Persistence, Earnings Predictability, Earnings Volatility, Stock Returns, Nairobi Securities Exchange (NSE), Commercial Banks.
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