The Role Of External Auditors In Corporate Governance

Project and Seminar Material for Accountancy / Accounting

The Role Of External Auditors In Corporate Governance


External Auditors is a key factor of efficient corporate control systems. Companies around the world have been required by their various corporate regulations to have audit committee which primarily is to ensure the integrity of financial reporting and the audit process by ensuring that the external auditor is independent, objective and does a thorough job. An effective audit committee practice is for good corporate governance. It ensures that the statement of affairs presented by the agent is accurate or rather that the report can be trusted and also to ensure that the performance reported is aligned with the goals of the principal. This fact necessitated the need for this work as the study examines the effect of audit committee characteristics and firm’s performance on some listed banks in Nigeria. The study found out that there is no positive relationship that exists between audit committee size and a firm’s performance. furthermore, the study revealed that there is a positive relationship between audit committee financial literacy and the firm’s performance.

Chapter One


1.1 Background to the Study

The role of audit committee is of much interest to regulators and the general public. Earlier, the role of the audit committee was to oversee companies financial reporting and discourse for such quoted companies. However nowadays the role of audit Committee has became very pronounced party due to the numerous economic events that have affected the stability of the financial markets and investors confidence at large.

Section 334 (1) requires corporate directors to prepare the annual financial statement in line with extant laws. This is usually affirmed by the statutory auditors who audit the books of account. The credibility of such auditors report is enhanced through the audit committee of such corporate organizations. According to Lindsell (1992), the audit committee is a Mechanism of corporate governance to check the quality, credibility and objectivity of financial reporting it performs an oversight function in the financial reporting process and communicates to users through a report in the financial statement.

Given the vital roles of audit committee, listed companies required to include in their annual reports a summary of activities carried out by their audit committees (Madawaki, 2013). For audit committee to perform its role, the members must be independent, have good financial knowledge; expertise enough and amongst others. In terms of independence, Davidson, Godwin-stewart and Kent (2005) specifically noted that independent audit committee members are more objective and likely to handle possible deficiencies in the manipulation of financial reports. They noted further, that financial reporting quality improved greatly in the year audit committee is farmed. It suggests that the role of audit committees is integral to quality financial reporting. Companies establish audit committee to help improve quality of financial reporting practices and earnings (Ramsay, 2001).

Several studies have examined the relevance of audit committee in corporate financial reporting in Nigeria (Okoye and Cletus, 2010, Owolabi and Ogbechia, 2010). Madawaki (2013) noted that none explored the association between the role audit committee in relation to financial reporting. In filling this research gap, this study attempts to make a key contribution to the current literature on the role of audit committee to financial reporting quality specifically. In other words, this study makes a bold attempt to critically examine the role of audit committee in financial reporting in Nigeria.

1.2 Statement of the Research Problem

Nigeria is currently experiencing a paucity of research in this direction of the role of audit committee in financial reporting (Madawaki, 2013). Abbott and Parker (2000), Krishsnan (2005) assert that audit committees have been in existence for decades. However, there are criticisms of the practices and roles of audit committees and their relevance in financial reporting (Enofe, Aronmwan and Abadua, 2013). They suggest that the inclusion of the role of audit committee and the reports of the external auditors lead to information overloads. Given these deficiencies, a question worth answering is audit committees still have a major role to play in ensuring quality financial reporting. This again, is in addition of the persistent collapse of firms.

Audit Committees are by reference to relevant sections of CAMA 1990 expected to bridge the expectation gap in providing a means by which the opinion expressed by auditors on a firm’s financial statement can be seen to be unbiased and independent. It is argued that the presence of Audit Committees is likely to lead to unnecessary rift between shareholders and directors as well as management and auditors in terms of quality financial reporting. Also, were the managing director is a very influential member in the board and succeeds in hijacking authority from others, the audit committees would have no choice but to dance to this tune, given the composition of the audit committees of equal number of directors and representatives of the shareholders of the company subject to a maximum of six (6) members, thus implying audit committee will not effectively and positively impact on financial reporting. From the view point of prior researchers, this makes the appointment of the committee unnecessary (Klein, 2002). In view of the above, the study intends to find answers to the following questions:

  1. Does the financial literacy of audit committee members enhance financial reporting in Nigeria?
  2. How does the frequency of meetings and audit committee members enhance financial reporting in Nigeria?
  3. What is the effect of multiple directorships of audit committee on financial reporting in Nigeria?

1.3 Objectives of the Study

The basic objective of this stud among others is to evaluate audit committees and financial reporting in Nigeria. The objectives of this study are divided into two, general and specific objectives. The general objective is the evaluation of the impact of audit committee on the quality of financial reporting in Nigeria. However, the specific objectives are:

  1. To examine if the financial literacy of audit committee members enhance financial reporting in Nigeria.
  2. To ascertain if the frequency of meetings of audit committee enhance financial reporting in Nigeria.
  3. To determine the effect of multiple directorships on financial reporting in Nigeria.

1.4 Hypotheses of the Study

The following hypotheses have been formulated to serve as a base for this research:

The study formulated and developed for testing the following hypotheses:

H1: Audit committee size has a positive relationship with firm performance.

H2: Audit committee financial expertise has positive relationship with firm performance.

H3: The frequency of audit committee meetings has a positive relationship with performance.

H4: Greater independence of the audit committee is associated with higher firm performance.

1.5 Scope of Study

This research work is an empirical study on audit committee and financial reporting in Nigeria for the period 2012 cut across fifty (50) quoted firms from varying industries on a cross sectional basis.

1.6 Significance of the Study.

One major questions remains unanswered empirically in research, and that is does the inclusion of the report of audit committee in the financial report have any effect on the decisions users would makes? Answering this question informed the justification of this study. The importance attached to a study of this nature is that it seeks to examine the role of audit committee in financial reporting in Nigeria.

The study will indeed contribute to the existing debate on the importance or otherwise of including the audit committee report in financial reports. The management team of companies stands to benefit from this study as this work will reveal if the role of audit committee report in the financial statement add value to decision making or is just an item of more cost.

Future researchers are expected to benefit largely from the outcome of the study.

The result of this study will be very useful not only to other researchers in this area of study but also to corporate bodies in Nigeria as it will help them understand the role that audit committees play in improving and ensuring an effective internal control system, corporate governance and ultimately, a sound and reliable financial reporting framework.

1.7 Limitations of the Study

The limitation encountered in the course of the study includes:

Inadequate empirical research materials extensively dealing on the subject matter in Nigeria is relatively scanty to afford the researcher an adequate insight.

The problem of smallest of the sample size where the data where extracted from posed a major limitation.

There is problem generalizing the outcome of the study to what may have happened in terms of effectiveness of the audit committee of the selected companies on financial reporting in Nigeria in prior years since this study is majorly a cross-sectional one.

Chapter Five

Summary, Conclusion and Recommendation

5.0 Introduction

It is important to reiterate that the objective of this study was to examine the effect of audit committee characteristics and firm performance on some listed banks in Nigeria. In the preceding chapter, the relevant data collected for this study were presented, critically analyzed and appropriate interpretation given. In this chapter, certain recommendations made which in the opinion of the researcher will be of benefits in examining the effect of audit committee characteristics and firm performance on some listed banks in Nigeria.

5.2 Summary

This study was undertaken to examine the effect of audit committee characteristics and firm performance on some listed banks in Nigeria. The study opened with chapter one where the statement of the problem was clearly defined. The study objectives and research hypotheses were defined and formulated respectively. The study reviewed related and relevant literatures. The chapter two gave the conceptual framework, empirical and theoretical studies. The third chapter described the methodology employed by the researcher in collecting both the primary and the secondary data. The research method employed here is the descriptive survey method. The study analyzed and presented the data collected in tables and tested the hypotheses using the time series method. While the fifth chapter gives the study summary and conclusion.

5.3 Conclusion

The overall aim of this research is to advance an understanding of the relationship between the audit committee characteristics and the firm performance represented by the ROA, ROE and Tobin’s Q.

Inconsistent with the first hypothesis specifically H1 that states there is a positive relationship between the audit committee size and firm financial performance as measured by ROE, ROA and Tobin’s Q, the results showed that there is a negative but not significant relationship with ROE, ROA and Tobin’s Q; this implies that the audit committee size cannot influence firms‟ financial performance.

Consistent with this study’s expectation, audit committee financial expertise results showed a positive significant relationship with ROE, ROA, and Tobin’s Q which is supported by (Rashidah and Fairuzana, 2006), that reflects that as audit committee financial expertise increase, the firm financial performance will increase, which is acceptable and consistent with the formulated study hypothesis H2.

This study finds that audit committee meetings is positively and significantly associated with ROE, positive insignificant with ROA and Tobin’s Q, which is consistent with this study’s argument, and accepts hypothesis H3.
Hypothesis H4 predicts that audit committee independence is positively associated with the firm financial performance. The positively signed coefficient and the insignificant relationship with ROE, and significant with ROA and Tobin’s Q showed in the results reject this study’s argument and hypothesis.

As for the control variable firm size, shows a negative insignificant relationship with ROE, ROA, and Tobin’s Q. This result opposes claims in prior studies that higher firm performance is associated with larger sized firms. Firm age showed a significant negative relationship, while firm leveraged showed a positive but not significant relationship with ROE, ROA and Tobin’s Q.

5.4 Recommendations

In line with the findings and Conclusion of the study, the following recommendations are proffered:

  1. The inability of audit committee size to enhance financial performance may be as a result of the problem of one size fits all. This ability of board members to take a quality decision and perform proper monitoring is more important than just their numbers, emphasis should be laid by Securities and Exchange Commission on quality of time spent by the board members in deliberation rather than their numbers.
  2. The audit committee composition is expected to be three members from the executive and three members from the shareholders. Therefore, the number of outside members of audit committee should be increased to an average of sixty-five percent (65%) for the listed firms in Nigeria.
  3. The audit committee is expected to meet at least four times in a year implying that they could meet beyond four times a year. From the findings of the study, the quality of time and decisions taken during meetings should be more of emphasis by the management rather than the number of times the committee should meet in a year.
  4. The members of the audit committee should highly be composed of members with knowledge of finance in order to make them effective which will affect financial performance positively. At least 45% of audit committee members should be financially literate.

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