Audit Attributes and Financial Reporting Quality of Listed Manufacturing Firms in Nigeria: The Moderating Effect of Audit Committee Financial Expertise
By Jibril Adamu
Bayero University Kano, Nigeria Being A PhD Accounting Colloquium to be presented at The 11th Accounting &
Finance Research Association International Conference to be Held On November 1-3, 2021, Kings University College, Accra, Ghana
Background to the Study
Financial reporting is a two-party transaction in which the issuers of the financial reports provide the users with information therein, use for their financial decisions. The potential users of financial reports vary widely and include creditors, suppliers, financial analysts, government authorities among others. The issue of financial reporting quality is of prime concern not only to the final users but for the whole society as it affects economic decisions. The increasing arguments as it relates to financial reporting quality have been adduced to the negative perception and reception of accounting information by users, this was verified by the most evident way in a series of global financial reporting scandals, corporate failures, collapses of organisations (Enron, WorldCom, Lehman Brothers, Fortis, Oceanic Bank, Cadbury
Nigeria Plc, Sokoto cement, Benue cement,
Oando oil Plc, Arik airline, Sky Bank among others) and the economic conditions created by the recent economic recession (Asiriuwa, Aronmwan, Uwuigbe & Uwuigbe 2018).
Corporate governance mechanisms have been introduced to aid investors, in terms of aligning the interests of managers with those of shareholders that endorse the reliability and integrity of financial reports (Bala, Amran & Shaar, 2019). Some of these corporate governance mechanisms are external auditors which is an external corporate governance mechanism and audit committee which is an internal corporate governance mechanism. Agency theory proposes that the primary duty of the audit committee is to ensure that managers act in the best interests of shareholders, agency theory postulates that, due to the separation between management and owners, investors need protection as managers have agendas that differ from those of investors and that they might not, therefore, always perform in the shareholders’ best interests (Fama & Jensen, 1983; Jensen & Meckling, 1976). To combat this, there is a need to hire independent auditors to offer their independent opinions on the truth and fairness of firms’ financial reports and this agrees with theory of inspired confidence. However, regulators and investors have
frequently questioned the role played by
both external auditors and audit committee because several recent financial scandals and failure of most of these corporations audited financial reports have been confirmed to be illusive or not in tune with the economic reality of the failed organisations (Bratten, Causholli, & Omer, 2019; Jerry & Saidu, 2017).
One of the critical roles of independent auditors is that, they assure confidence to financial statements users about the reported information. Audit services have been critical to financial reporting quality since industrial revolution (that is, separation of ownership from management). However, the ability of auditors or audit firm to provide high audit quality capable of producing high financial reporting quality is attributed to some certain features of the audit firm; these features are auditor independence, audit compensation, audit firm type or size, auditor’s tenure, audit communication, joint audit services, audit report lag, auditor’ specialization among others (Nwanyanwu, 2017; Jerry & Saidu, 2017; Asiriuwa, et al. 2018; Bala, et al. 2019). This study will limit itself to the following generic audit attributes as documented and validated in the extant literatures as having explanatory power to the variation in financial reporting quality and they are;
audit firm size, audit fee, auditors’ tenure,
joint audit, audit report lags and audit communication (Defond & Zhang, 2014; Bala, et al. 2019; Hasan & Rahman, 2019; Huang, 2019; Almarayeh, Aibar-Guzman, & Abdullatif, 2020).
Section 404(1-7) of Companies and Allied Matter Act, 2020 stipulates establishment of Audit committee in a public company which is saddle with functions of monitoring and overseeing the financial statements. Also, the committee assists the firm in maintaining the goal and objectives of meeting the shareholders’ wealth and increasing the investor confidence in the financial reporting quality. Audit committee is to oversee the integrity of financial statements, the efficiency and effectiveness of internal control system and monitoring of both internal and external auditors (Defond & Zhang, 2014). The existence of audit committee members could help to balance different views of management and external auditor and to provide improved financial reporting (Eyenubo, Mohammed, & Ali, 2017).
The efficacy of audit committee in monitoring the financial reporting practices relies on audit committee members with accounting and financial expertise (Dussii & Boulila, 2018). Consistent with the agency theory, the existence of audit committee members with accounting and
financial knowledge improves committee
efficacy in executing monitoring responsibilities (Chen & Komal, 2018). Audit committee members who are experts in accounting and financial disciplines are more vigilant in identifying irregular accounting and auditing practices compared to members who are lacking in these areas (Alkilani, et al., 2019). Premised on the above, there is a need to employ a more advance technique to examine the direct and interactive influence of audit committee financial expertise on audit attributes in relation to financial reporting quality, this is because it has been adduced that the complementary functions of audit committee concerning audit quality proxies by audit attributes are complex, it goes beyond a direct relationship and it warrants further research to fully explore the interacting impact of audit attributes and audit committee financial expertise on financial reporting quality.
Manufacturing firms listed on the Nigerian Stock Exchange were worst hit by the protracted economic recession that threatened most business in Nigeria in 2016, at the end of the year the sector recorded 26.37% negative returns (Nnorom, 2017). Quality of financial reports would have signalled economic shocked caused by the recession and investors planned adequately,
Manufacturing firms in Nigeria were also
hit negatively by the global pandemic (corona virus) recently witness in Nigeria in 2020 which occasioned closure and disruption of businesses as a result the need to conduct a research on this sector of economy on financial reporting quality.
Statement of the Research Problem Financial reports are supposed to provide relevant information to stakeholders of an organization. It is thus important that financial reports provide truthful and reliable financial information to enable shareholders and other interested parties to make decision wisely (Bala, et al., 2019). Lack of relevancy and reliability in financial reporting will lead shareholders and other stakeholders to make wrong judgment about the organization. Incidentally, the heavy reliance placed on accounting numbers as it measures the direction of business entity as well as decision base by different users of accounting information has provided an incentive for managers to manipulate earnings to their own advantage (Jerry & Saidu, 2017). This manipulation that is not supposed to go unchecked by auditors and audit committee has often led to the eventual collapse of firms of various sizes. However, regulators and investors have frequently questioned the role played by both external auditors and audit committee
because several recent financial scandals
and failure of most of these corporations audited financial reports have been confirmed to be illusive or not in tune with the economic reality (Bratten, et al., 2019; Jerry & Saidu, 2017).
The empirical evidence on the impact of financial reporting quality as a matter of fact been at extreme ends and largely inconclusive in the literature, while some studies observed significant relationship between variables employed to explain financial reporting quality others observed no significant relationship. The polarity in empirical findings interestingly is a common denominator for both studies undertaken in developed economies and those undertaken for emerging markets (Hasan, Kassim, & Hamid, 2020). A number of studies have been conducted both in advance economy and emerging economy on the relationship between audit attributes and financial reporting quality. Notable among the studies are: Semiu and Kehinde (2011); Semiu and Johnson (2012); Shehu (2012); Renkas, Goncharenko and Olena (2016) Eyenubo, et al. (2017); Jerry and Saidu (2017); Nwanyanwu (2017); Al-Dmour, Abbod and Al-Qadi (2018); Alkilani, et al. (2019); Abdulrahman, et al. (2020); Abubakar, Usman, Anuforo and Alhaji (2021) among others.
Despite the unanimity in the literature that financial reporting quality is an attribute to be encouraged, the findings with respect to the explanatory variables of financial reporting quality have been at polarity and this suggests to us that the issues surrounding the explanatory variables of financial reporting quality are far from been resolved, there is a need to employ a more advance technique to examine the direct and interactive influence of audit committee financial expertise on audit attributes in relation to financial reporting quality, this is because it has been adduced that the complementary functions of audit committee concerning audit quality proxies by audit attributes are complex, it goes beyond a direct relationship and it warrants further research to fully explore the interacting impact of audit attributes and audit committee financial expertise on financial reporting quality, which no researcher has done to the best of our knowledge in Nigeria, particularly in quoted manufacturing sector our main domain.
Audit communication and audit report lag are audit attributes which are dearth in extant literature in explaining financial reporting quality in Nigeria. Studies in advanced economy have found a significant positive relationship with financial reporting quality (Almarayeh, et al., 2020;
Daferighe & George, 2020). Limited studies have used these variables in explaining variation in financial reporting quality in emerging economy like Nigeria, to the best of researcher’s knowledge no study has employed these variables in Nigeria and this necessitated their inclusion in this study.
Therefore, this study will distinguishes itself from prior studies in many aspects, among which are: first, the study introduces audit committee financial expertise to moderate the relationship between audit attributes and financial reporting quality which to the best of researcher’s knowledge no work has been done in this area, as such the study will contributes to three streams of literatures, audit attributes literature, financial reporting quality literature and audit committee financial expertise literature, by providing up to date empirical evidence on impact of audit attributes and financial reporting quality moderated by audit committee financial expertise in an emerging economy like Nigeria. Secondly, the study will introduce two audit attributes’ variables in addition to the ones studied in the literature; audit communication and audit report lag in explaining variation in financial reporting quality, limited studies have used these variables and those studies that use the variables are in advanced economy.
Objective of the Study
The main objective of this research work is to examine the interactive relationship between audit committee financial expertise and audit attributes on financial reporting quality of listed manufacturing firms in Nigeria. The study specifically seeks to examine the:
- impact of audit attributes (audit firm size, audit fee, auditor tenure, join audit, audit communication and audit report lags) on financial reporting quality of listed manufacturing firms in Nigeria;
- Moderating effect of audit committee financial expertise on the relationship between audit attributes and financial reporting quality of listed manufacturing firms in Nigeria.
Gap in Empirical Work
Based on the review of related previous studies, the following gaps are established. one, most of the previous studies reviewed on audit attributes and financial reporting quality were carried out in the developed countries and developing countries outside Nigeria. The studies include Ahmad, et al. (2016), Aritonang (2018), Amin, et al.
(2018), Ozcan (2019), Sumiadji, et al. (2019) conducted their research in Indonesia; Heydari (2015), Ashtiani, et al.
(2016), Rad, et al. (2016) in Tehran; Houqe, et al. (2015) in India; DeAngelo (1981), DeFond and Francis (2005), Defond and Zhang (2014), Reynolds amd Francis (2004), Zerni, et al. (2012), Bratten, et al. (2019), Horton, et al. (2021) in United State of America; Almomani (2015), Nawaiseh (2016), Alkilani, et al. (2019),
Almarayeh (2020), Qawqzeh, et al. (2020) in Jordan; Pham, et al. (2017), Khauh and Khuong (2018) in Vietnam; Yasser and Soliman (2018), Chariri and Januari (2017) in Egypt; Tontiset and Kaiwinit (2018), Komolsakulchai (2015), Piyawiboon (2015) in Thailand; Nawafly and Alarussi (2019), Hasan, et al. (2020) in Malaysia; Zandi, et al. (2019), Waris, et al. (2020) in Pakistan; Gul, et al. (2003) in Australia; Xiao et al. (2020) in China; Francis, et al. (2009), Marmousez (2009), Velte and Azibi (2015) in France and Lesage, et al. (2011) in Demark.
Two, among the few studies conducted in Nigeria, none of the studies employed audit communication and audit report lag in explaining the variation in financial reporting quality in Nigeria (Semiu & Johnson, 2012, Umar, 2012, Dangana, et
al., 2016; Farouk, et al. 2019; Abdulrahman, et al. 2020). This study if completed will be among the first study to provide empirical evidence on the variation in financial reporting quality using those
proxies as audit attributes proxies.
Three, of all the studies reviewed, on audit committee attribute (financial expertise), none used it as a moderator on the relationship between audit attributes and financial reporting quality, they only employed it either as independent variable or control variable in explaining variation in financial reporting quality in their studies, this study will be among the pioneer study to provide empirical evidence and the relationship between audit attributes and financial reporting quality moderated by audit committee financial expertise in Nigeria particularly list manufacturing firms.
Proposed Conceptual Framework
This study will adopt correlation research design to examine the impact of audit attributes on financial reporting quality of all listed manufacturing firms in Nigeria. The choice of correlation research design is informed by its effectiveness in studying the relationships as well as the impact of one variable on another, thus, consistent with the objective of this study.
The population of the study will comprise all listed manufacturing firms on the floor of the Nigerian Stock Exchange as at 31st December, 2020 for a period of ten years (2011 to 2020).
Source: Researcher Compilation 2021.
Baron and Kenny (1986) Three Hierarchical Multiple Regression Model will be adopted to test for moderation. The models are presented as follows:
Multiple Regression Model (Before inclusion of moderating variable)
EQDD = ∝it + β1AFZEit + β2AFEEit + β3ATNRit + β4JADTit + β5ACOMit + β6ARLit + β7FSZEit + β8FLEVit + β9FPRFit
+ µit (i)
EQDD = Earnings quality by Dechow and Dechev
AFZE = Audit firm size AFEE = Audit fee ATNR = Audit tenure JADT = Joint audit
ACOM = Audit communication ARL=Audit report lag FSZE=Firm size
FLEV=Firm leverage FPRF=Firm profitability µ = error term
β1 - β5 = Beta coefficient
it = period i and time t
∝it = the constant
Multiple Regression Model (with inclusion of moderating variable)
EQDD = ∝it + β1AFZEit + β2AFEEit + β3ATNRit + β4JADTit + β5ACOMit + β6ARLit + β7ACFXit + β8FSZEit + β9FLEVit
+ β10FPRFit + µit (ii)
ACFX=Audit committee financial expertise
Hierarchical Multiple Regression Model (After inclusion of moderating variable) EQDD = ∝it + β1AFZEit + β2AFEEit + β3ATNRit + β4JADTit + β5ACOMit + β6ARLit +β7AFZEit*ACEXit + β8AFEEit*ACEXit + β9ATNRit*ACEXit + β10JADTit*ACEXit + β11ACOMit*ACEXit
+ β12ARLit*ACEXit + β13FSZEit + β14FLEVit + β15FPRFit