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
1.1 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.
1.2 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.
1.3 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.
1.4 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?
1.5
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.
1.6 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.
1.7 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.
1.8 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.
1.9 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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