AUDIT COMMITTEE CHARACTERISTICS AND FINANCIAL REPORTING QUALITY OF LISTED FIRMS IN NIGERIA
ABSTRACT
The study was designed to examine the extent to which financial reporting quality (FRQ) is influenced by audit committee characteristics. To achieve this objective, research questions and hypotheses were designed in line with four specific objectives. Relevant concepts were reviewed along with the review of empirical literature. The study was anchored on the stakeholder’s theory. In line with the aforesaid, secondary data were obtained from the financials of 74 listed non-financial firms in Nigeria. Relevant statistical tools were however employed to analyze the data and the hypotheses were tested using multiple regression technique along with the F-statistics. Based on the results from the analytical procedure of this study, it was observed that in testing the relationship between audit committee size and financial reporting quality, the computed value of F-stat is 3.97 with a corresponding p-value of 0.0201 implying that audit committee size (AUDCOMSIZE) has no significant influence on financial reporting quality of listed firms. Additionally, audit committee independence and audit committee diligence also recorded insignificant relationship with financial reporting quality of listed firms in Nigeria. The Boards of listed firms must continue to emphasize on the need for their respective audit committees to be diligent in the performance of their oversight functions.
TABLE OF CONTENTS
Cover Page - - - - - - - - i
Title Page - - - - - - - - ii
Declaration - - - - - - - - iii
Certification - - - - - - - - iv
Dedication - - - - - - - - v
Acknowledgements- - - - - - - - vi
Table of Content - - - - - - - - viii
List of Tables - - - - - - - - xi
Abstract - - - - - - - - xii
CHAPTER ONE: INTRODUCTION
1.1 Background of the Study - - - - - - 1
1.2 Statement of the Problem - - - - - - 5
1.3 Objectives of the Study - - - - - - 7
1.4 Research Questions - - - - - - - 7
1.5 Hypotheses of the Study - - - - - - 8
1.6 Scope of the Study - - - - - - 9
1.7 Significance of the Study - - - - - - 9
1.8 Limitation of the Study - - - - - - 11
1.9 Operational Definition of Terms - - - - - 13
CHAPTER TWO: LITERATURE REVIEW AND THEORETICAL FRAMEWORK
2.0 Introduction - - - - - - - 14
2.1 Audit Committee Attributes - - - - - 14
2.1.1 Audit Committee Size - - - - - 20
2.1.2 Audit Committee Independence - - - - - 22
2.1.3 Audit Committee Diligence- - - - - - 23
2.2 Financial Reporting Quality- - - - - - 23
2.3 Theoretical Framework - - - - - - 28
2.4 Empirical Review - - - - - - - 30
2.5 Summary and Gap of Study - - - - - 43
CHAPTER THREE: METHOD OF THE STUDY
3.0 Introduction - - - - - - - 44
3.1 Research Design - - - - - - - 44
3.2 Population of the Study - - - - - - 44
3.3 Sample Size and Sampling Technique - - - - 45
3.4 Method of Data Collection - - - - - - 45
3.5 Model Specification - - - - - - - 46
3.6 Method of Data Analysis - - - - - - 49
CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS
4.1 Presentation of Data - - - - - - - 50
4.1.1 Descriptive Statistics - - - - - - - 50
4.1.2 Correlation Analysis - - - - - - - 52
4.1.3 Other Diagnostic Test - - - - - - - 55
4.1.3a Results of Multicolinearity Test Using VIF - - - - 55
4.2 Test of Hypotheses - - - - - - - 56
4.2.1 Hypothesis One - - - - - - - 57
4.2.2 Hypothesis Two - - - - - - - 59
4.2.3 Hypothesis Three - - - - - - - 61
4.3 Discussion of Finding - - - - - - - 65
CHAPTER FIVE: SUMMARY OF FINDINGS, CONCLUSION AND
RECOMMENDATIONS
5.1 Summary of Findings - - - - - - - 68
5.2 Conclusion - - - - - - - - 69
5.3 Recommendations - - - - - - - 71
5.4 Suggestions for Further Studies - - - - - 72
References - - - - - - - - 74
Appendix I List of Sampled Companies - - - - 84
Appendix II Detailed Regression Output - - - - 85
LIST OF TABLES
Table 1: Summary of Descriptive Statistics of the Variables of the Study 50
Table 2: Result of Correlation Analysis 53
Table 3: Variance Inflator Factor Results for Independent Variables 55
Table 4: Results of Model I and Test of Hypothesis I 57
Table 5: Results of Model II and Test of Hypothesis II 59
Table 6: Results of Model III and Test of Hypothesis III 61
CHAPTER ONE
INTRODUCTION
Background of the Study
One of the main objectives of financial reporting is to provide high quality financial information about economic entities that is useful for economic decision making. The concept of financial reporting quality has attracted several researchers over the years given its importance to the accountancy profession generally and corporate reporting in particular (Nelson & Shukeri, 2011; Abbott, Parker & Peters, 2012; Ika & Ghazali, 2012; and Sultana, Singh & Van der Zahn, 2015). According to International Accounting Standard Board (IASB), (2008), high quality financial reporting is critical to investors and other stakeholders in making investment, credit and similar decision. Accounting earnings is a significant and important variable of financial reporting which is usually used as a yardstick of financial reporting quality.
As contained in the revised conceptual framework for financial reporting quality as an enhancing qualitative characteristics involving accounting information suggests that companies’ financial statements and their relevant audit reports is expected to provide a reliable input to potential investors, shareholders, creditors, employees, management, financial analysts, regulators and other stakeholders such that they do not lose their potentials of influencing the decisions of financial statements’ users. Financial reporting in general has been acknowledged as an essential area in accounting. Recognized as a very important area in accounting, the trustworthiness of financial reporting is seen to have influenced and provide reasonable assurance to a generality of users especially when financial statements (outcome of financial reporting) are audited (Hillison Watkins & Morecroft, 2004).
In order to improve the quality of financial reports of corporate entities, audit committee monitors the preparation and presentation of such financial reports. The audit committee is a committee which comprises of members of the board of directors saddled with the responsibility to assist their respective boards in fulfilling their oversight responsibility to stockholders, potential stakeholders, the investment community and others relating to the entity’s financial statements. Obviously it is the responsibility of audit committees to maintain free and open communication between the audit committee, the independent auditors, the internal auditors and the management of Companies (Salehi & Shirazi 2016). Audit committees are recognized as an effective and efficient means through which the certainty for a fraudulent financial report could be reduced. Audit committee can also be very effective not only in carrying out their objective oversight on the financial reports on the organization, but it also gives helping hands in order to set an ethical “tone at the top” (Locatelli,2002; Stein, 2003) for corporate entities. Traditionally, the major role of audit committees has been to examine and evaluate the integrity of the financials that are produced by the management. In recent times, this major role has extended beyond the annual financials to encompass the quarterly financial reports. Owing to this, audit committees are becoming more concerned on matters regarding to corporate reporting as contrasted with financial reporting.
According to Owolabi and Dada (2011), considering the total numbers of corporate collapses and failures, it is very important that audit committees is taken with more seriousness among corporate organizations. The audit committee serves as an intermediary between the external auditor and the board of directors; also it aids and facilitates the monitoring process by reducing information asymmetry between the external auditor and the board. In addition, Blue Ribbon Committee (1999) noted that as an important mechanism of corporate governance audit committee is responsible for the appointment of external auditors and oversees the audit process to ensure quality financial reporting. Therefore, an auditor’s independence and the quality of the financials are usually determined by the proper functionality of the audit committee.
Following the agitations to review the structures of corporate governance in Nigeria and in view of the importance attached to the institution of effective corporate governance, the Federal Government of Nigeria, through her regulatory agencies have come up with institutional arrangements to protect investors in Nigeria (Kajola, 2008). In this light, as contained in Company and Allied Matters Act (CAMA) CAP, C20, Law of the Federal Republic of Nigeria (LFN) 2004 Sec was the first attempt to provide for audit committee effectiveness. While, the second attempt was contained in the Code of Corporate Governance best practices issued by the Securities and Exchange Commission (SEC) in November, 2011. The two provisions listed above failed to help address the issue of audit committees in terms of financial expertise and hence failed to ensure quality of the financials. The failure was as a result of constant reports that surrounded the misappropriations of the financials which led to the removal of CEOs in some Nigerian banks (Ojeka, Owolabi and Kanu 2013). As at 2019 a new corporate governance code was issued with the hope of filling the gaps identified with previous codes. It is on this ground that this study sets out to ascertain the link between measures of audit committee characteristics and the financial reporting quality of companies.
Statement of the Problem
Financial reports are prepared in accordance with regulatory provisions and
deemed to provide relevant information to interested parties and/or stakeholders of organizations. It therefore behooves preparers of financial statements to ensure that financial reports provide truthful and accurate financial information to enable shareholders and other interested parties to make decision wisely. Lack of accuracy in financial reporting will lead shareholders and prospective investors to make wrong judgment about the organization. Incidentally, the heavy reliance on accounting numbers, being the yardstick of measuring the direction of business entity and serving as the decision base of different users of accounting information (Kothari, et al., 2000; Bello, 2010) has provided an incentive for managers to manipulate earnings to their own advantage. This manipulation that is not supposed to go unchecked by auditors has often led to the eventual collapse of firms of various sizes; thereby calling to question, the integrity of auditors and the efficiency of audit committees of firms.
No doubt, the credibility of financial information is vital to the growth of any economy. Auditors on their part are expected to be independent and objective in the discharge of their responsibilities (Adelaja, 2009), consequent on the notion that auditors provides key assurance in protecting the varying interests of shareholders (Gallegos, 2004). However, studies have traced one of the most vexing problems in the financial world today to the roles which audit committees of firms could play, to support the work of external auditors (O’Connor, 2006; Beatties & Fearnley, 2002). The oversight function of audit committees is therefore placed under scrutiny when businesses whose financial statements once showed no indication of any failure suddenly become bankrupt.
Prior studies (De Angelo, 1986; Jones, 1991; Dechow, Sloan, & Sweeney, 1995; Ashbaugh, et al., 2003; Semiu & Kehinde, 2011; Semiu & Johnson, 2012; Umar, 2012) have been conducted to examine how audit firm characteristics may possibly affect the quality of financial reporting. Although, these studies are largely based on data from the US and European nations, thereby reflecting trends and patterns in advanced economies; it is pertinent to note that empirical evidence on the effect of audit committee characteristics on financial reporting quality have remained scarce especially as it relates to Nigerian evidence. This situation thus creates an empirical which this current study is designed to fill. In this light, this study used three measures of audit committee characteristics to investigate their effects on the financial reporting quality of listed companies in Nigeria.
Objectives of the Study
The overall objective of the study is to examine the impact of audit committee characteristics on the financial reporting quality of selected listed service firms in Nigeria.
The specific objectives are to:
i. Examine the effect of audit committee size on financial reporting quality of listed companies in Nigeria.
ii. Assess the influence which audit committee independence exert on the financial reporting quality of listed companies in Nigeria.
iii. Assess the impact of audit committee diligence on the financial reporting quality of listed companies in Nigeria.
Research Questions
It is in view of the problems and the specific objectives of this study the following research questions are raised:
i. How does audit committee size affect the quality of financial reporting of listed companies in Nigeria?
ii. What is the relationship between audit committee independence and quality of financial reporting of listed companies in Nigeria?
iii. What effect does audit committee diligence have on the quality of financial reporting of listed companies in Nigeria?
Hypotheses of the Study
In line with the objectives of this study, the following hypotheses are formulated in null form;
H01: Audit committee size has no significant impact on the financial reporting quality of listed companies in Nigeria.
H02: Audit committee independence has no significant impact on the financial reporting quality of listed companies in Nigeria.
H03: Audit committee diligence has no significant impact on the financial reporting quality of listed companies in Nigeria.
Scope of the Study
This study focuses on audit committee characteristics and the quality of financial reporting, within the context on listed companies in Nigeria. The study covers the period after the issuance of the code of good corporate governance for insurance company, from 2011-2018. Financial reporting quality is represented by earnings quality which is proxied by absolute discretionary accruals of listed companies in Nigeria during the period covered by the study. On the other hand, audit committee characteristics covers audit committee size, audit committee diligence and audit committee independence. This study did not extend its scope to 2019 since at the time of gathering data in this study several firms had not made public the financial reports of 2019.
Significance of the Study
Financial reports are primarily designed to offer stakeholders and the generality of users the needed information that guides the decision-making process. This study is significant in light of the recent search by regulators for measures that could protect and improve the quality of the financials in the corporate world. It is also a response to the current call by the IAASB’s Framework for Audit Quality which, include raising awareness of the key elements of audit quality; encouraging stakeholders to explore different procedures on how to improve audit quality; and facilitating greater dialogue between key stakeholders on the topic (IAASB, 2013). Moreover, the IAASB framework for audit quality ascribed the major responsibility for performing quality audits to the auditors, and also emphasized that audit quality can be best achieved in a particular environment where other participants in the financial reporting supply chain gives their full support. Hence, this study is an effort towards such direction. The study is also significant as it focused on issues related to audit committee characteristics that are threatening the survival of audit committees of all sizes, on one hand and the going concern of corporate entities on the other hand. Therefore, the study is of importance in ensuring the credibility of financial information not only for the purpose of pointing the tendencies of corporate scandals, but most importantly the survival of their accounting and audit profession and the development of healthy financial and capital market. This study is of immense value to auditors, regulators, managers, professional accounting bodies, existing and potential shareholders and researchers. In contributing to existing literature and to fill some identified knowledge gap, this study is designed to analyze the link between audit committee characteristics (internal and external) and financial reporting quality of listed companies in Nigeria. The outcome of this study will therefore be useful to several stakeholders which include regulators and policy makers, companies’ management generally, corporate boards, researchers, professional accounting bodies among others.
The findings from the study could educate both existing and potential shareholders of selected and listed firms in Nigeria on the audit committee characteristics that improve the quality of financial reporting (with respect to audit committee characteristics). The study is also of great importance to researchers, as it provides empirical evidence on the relationships between audit committee characteristics and the quality of financial reporting on listed companies in Nigeria. This study also adds to the existing body of literature on audit committee characteristics and financial reporting quality among listed companies in Nigeria such that future researchers in this area will thus find this study useful as its outcome will serve as guide to further related researches.
Limitation of the Study
This study relied basically on secondary data which was obtained from 26 listed service firms in Nigeria. These companies were purposely selected because their stocks were actively traded on the floor of the Nigerian Stock Exchange during the study period. Also, companies that were not having consistent data set for all variables in the study period 2011-2018 were excluded and not included in this study sample. The generalization made therefore, may not be applicable on all the listed companies in Nigeria.
However, the above does not affect the outcome of this study because the listed companies cut across major industrial categories in the Nigerian Stock Exchange and include firms drawn from sector like conglomerate, consumer’s stables, energy, financial services, industrial goods and materials.
Operational Definition of Terms
The terms below have been defined in accordance with the context of their usage in this study.
· Audit: This is an independent examination that is carried out by qualified independent persons on financial statements or records of an entity to review the adequacy of internal control in accordance with the rules of the board or commission for the purpose of expressing an opinion on accuracy and completeness of such statements.
· Audit Committee: These are group of persons appointed by the company for the purpose of supervising the accounting and processes of the financials and stands as an intermediary between the board of directors and the external auditors.
· Financial reporting quality: The precision with which financial reporting conveys information about the firms operations or compliance of accounting standards of a particular country, or the extent to which the published financial statements and related disclosures capture the essence of the operations and financial position of the reporting entity.
· Financial statement: can be defined as a formal documentation of all financial related activities and position of a business, person or any other entity.
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