effect of board diversity and audit committee …

International Journal of Business Management and Processes

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International Journal of Business Management and Processes (IJBMP) Vol 5. Issue No.4. March,

2021. PP 14-33. ISSN 2616-3209

EFFECT OF BOARD DIVERSITY AND AUDIT COMMITTEE ACTIVITIES ON

FINANCIAL REPORTING QUALITY AMONG FIRMS LISTED IN NAIROBI

SECURITIES EXCHANGE

Dickson Kipchumba Singoei1, Patrick Kibati2 & Symon Kiprop3

1&2. School of Business, Kabarak University, Kenya

3. Faculty of Arts and Social Sciences, Egerton University, Kenya

Corresponding Author’s Email: [email protected]

Abstract

Globally, firms are currently facing issues related to corporate governance thus facing some challenges that

include unreliable financial reporting. This is despite them having board of directors who are mandated to oversee

ethical running of organizations. The link between board diversity and financial reporting quality of firms has

attracted the attention of numerous scholars. However, some of the studies have so far been done in different

sectors and locations and have reported conflicting results. Hence, there is need to conduct a study to establish

how board members’ diversity affect Financial Reporting Quality(FRQ) among firms listed in Nairobi Security

Exchange(NSE) in Kenya. The purpose of this study was to investigate the effect of board diversity and audit

committee activities on FRQ of firms listed in NSE. The study objectives were on variables education and age

diversity and their effect on FRQ. It was anchored on Resource Dependency Theory and the Upper Echelon

Theory. The study employed a longitudinal research design. Census approach was used for all the 40 firms that

remained consistently listed between 2011 and 2017. The data was collected using data collection sheet. Random

Effect Model proved to be consistent under the Haussmann test and thus was used to analyze panel data. The

study found a negative significant moderating effect of audit committee activities on the relationship between age

diversity and FRQ. It was also found that a positive significant moderating effect of audit committee activities

existed between education diversity and FRQ.

Key Words: Age Diversity, Audit Committees Activities, Board Diversity, Education Diversity, Financial

Reporting Quality

Introduction

Financial reporting is a requirement for firms by the international financial reporting standards

(IFRS) and many regulatory agencies across the globe. It is a pre-requisite in evaluating a firm’s

performance by various stakeholders (IFRS, 2016). Profits are significant for a company,

however, through accrual accounting, earnings management and adoption of aggressive

accounting methods, if companies generate little money from the profits, they may face

financial risks despite being profitable, (Lee, Strong, Khan & Wang, 2012).

However, Quality of financial reporting have for a long time been underestimated. This has led

to collapse of international firms which had indicated positive financial performance. This was

evidenced by Treadway Commission Report of 1987 in U.S.A which addressed the issue of

fraudulent company financial reporting resulting to Sarbanes –Oxley Act (SOX) due to a

significant fall of reputable firms like WorldCom and Enron in U.S.A (Miller, 2017). The trend

was replicated across the globe as evidenced by the collapse of Parmalat Company in Europe

in 2003, Chuo Aoyama in Asia, JCI and Randgold in South Africa, Cadbury Company in

Nigeria (Muriuki, Iravo & Wanyama, 2018). Besides, the importance of proper corporate

supervision has been pointed out in the corporate scandals of the high-profile organizations

being centered by both embezzlement and fraudulent cases.

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Effect of Board Diversity and Audit Committee Activities on Financial Reporting Quality among

Firms Listed in Nairobi Securities Exchange


The collapse of several international economies prompted regulatory officials to reform

corporate governance measures worldwide during the global financial crisis of 2008.

Pargendler (2016) asserts that there has been an outcry from the public for improvement in

monitoring of corporate activities. In line to that, corporate boards have been known for the

role they play in providing a conciliatory option between markets and governments for

organizational supervision reasons (Pargendler, 2016). It has been discovered that the incidents

of bribery, fraud, and corruption are widespread. The research also found that companies with

homogeneous board memberships, for instance, only have male members or board members

are old or young only, suffer from a higher level of government-related scandals (Skroupa,

2017). Studies have revealed that sound governance of the board not only decreases the

negative implications of earnings management but also the probability of error-related financial

reporting (Dionne, 2017).

Board diversity is a key to enhancing corporate governance practices in an organization (Wang,

2015), as diversity in the board room fosters better decision making and brings about

innovation in an organization. Some of the features of a diversified board include gender, age,

educational and functional background, industry experience or exposure and nationality

(Wang, 2015). Sirnidi, Gul and Tsai (2011) opined that the best board is a mix of individuals

with different skills, knowledge, information power and readily available to contribute his/her

time professionally. It is noteworthy, that the cost of a diversified board is quite expensive as

its high cost may impede on the organization's performance (Wang, 2015), and this could also

affect its financial reporting quality.

Theoretically, age diversity in the management of an organization is directly related to

financial reporting quality principles. The relationship between age diversity and quality

financial reporting has been investigated in many studies. Hambrick and Manson's theory

(1984) showed that the characteristics of senior managers have an effect on their judgment and

the company outcomes. Younger people are by definition biologically and ethically distinct

from older people. Gibbons and Murphy (1992) recognized that age determines behavior and

benefits. The priority of younger managers, according to Joos et al., (2003), is mainly on future

safety. Sundaram and Yermack (2007) confirmed that the financial reporting system has a

beneficial correlation between age and ethical behavior. Mudrack (1989) conducted an

investigation into the factors affecting the ethical conduct of the organization. The study found

older CEOs to be more vulnerable to conventional customs and culture, and therefore more

ethical.

Talbi (2014) conducted a study on the relationship between the chief executive officer (CEO)

age and the standard of financial reporting on a sample of listed US companies (S&P1500)

over the period 2000-2009. The study estimated FRQ based on manipulations of operating

revenue accounting, unusual cash transfers, and discretionary anomalous expenses. The study

found a positive link between the CEO age and actual revenue management. The link had a U-

shaped nature equal to 48 years of inflection, but it was not monotonous. That is to indicate

that if board of directors is made up of young managers, real earnings will increase. Therefore,

when the manager is young, we expect real profit management to boost and decrease when the

manager is aging.




Why should a director's educational diversity affect organizational success and the consistency

of financial reporting? For the obvious reason, education level is a proxy for knowledge and

intellect and smarter management can provide better strategic direction for a company's team,

which will have a beneficial result on the firm’s performance (Kumar, 2013). Some works

demonstrate that a more competent Board of Directors is well placed to improve enterprise

performance and capable of carrying out discrete tasks such as the appointment of the CEO,

compensation and incentives package for managers, merger and purchasing activities or the

defense against a tender for take-over. An additional reason was that more educated managers

would advise on advanced methodologies to improve corporate performance. Graham and

Harvey (2005) have demonstrated, for instance, that financial-based chief finance officers

(CFOs) are more likely to employ methodologies in carrying out the capital budgeting and in

estimating capital costs.

Directors’ education may be positively linked to his / her social capital. That is, managers with

greater education backgrounds have more personal connections with other managers and

representatives, which can enhance the financial disclosure performance of the company. This

applies in particular to businesses in pre-phases which need the connection between the

company and external assets (Kumar & Zattoni 2013). Hambrick and Mason (1984) set the

foundations for the explanation of the connection between the contextual features of top

echelons and the result of the organization. The writers asserted that corporate results, policies

and effectiveness reflect the principles and behavioral foundations of strong players.

According to Ruzaidah and Takiah (2014), the more regular audit committees meet, the better

the FRQ since there is an opportunity to track the management activities in the session more

quickly and efficiently. Although there is no indication of the nature of the work done by the

number of sessions during the meeting, it is found that the audit committee is less likely to be

a good monitor without a meeting or with a few meetings (Wang, Cheng & Xiao, 2014). Abbott

(2000) found that corporations that meet at least twice a year for audit committee activities are

less likely to be prosecuted for misleading or false reporting. The actions of the audit committee

affect the revenue, management and expectations of the investors. Klein (2002) found that

significant increases in irregular accruals are followed by cuts in Audit Committee operations.

Bedard, Chtourou and Courteau (2014) surveyed a total of 100 firms in the finance sector to

examine the connection between the efficacy of the audit committee and the financial reporting

standard. Consequently, data were obtained using both primary and secondary methods and

analyzed using SPSS. Study results indicated that the features of the audit committee had a

positive effect on the quality of the financial reporting. Cheng and Wang (2016) further

investigated the connection between the activities of the audit committee between Shanghai

listed companies and the Shezhen stock corporations. Results of the study showed that

meetings of the audit committee played a positive and important role in the handling of

revenues. Xie et al., (2003) found that the enhanced audit committee operation is associated

with reduced earnings management levels as a result of the number of committee conferences.

Bryan, Liv, and Tiras (2014) argued that regular audit committee meetings have increased the

accountability and reliability of reported revenue and thus improved the quality of revenues. It

is often expected that members of the commonly-meeting audit committee will be more

effective in carrying out monitoring activities than otherwise.




Khalif and Samaha (2016) argue that the general consensus in the literature is that periodic

meetings between the audit committee and the Chief Internal Auditor (CIA) result in an

improved internal audit function and eventually enhance the quality of financial reporting and

thus improve the organization's efficiency. The BRC Report (1999), the Treadway Commission

(1987) and the Toronto Stock Exchange Committee on Corporate Governance (TSECCG,

1994) have outlined the significance of such a session by saying that a direct channel from the

audit committee to internal audit facilitates the examination and assessment of certain

problems.

In addition, Mazlina (2005) disclosed that frequent meetings between the audit committee and

internal auditor could give the audit committee access to information and expertise on

appropriate accounting and auditing problems. In addition, the Institute of Internal Auditors

(IIA, 1993) argues that it should meet with the chief internal auditor at least four times a year

in order for an audit committee to be efficient. Mazlina (2005) backed this argument by finding

an important beneficial connection between the frequency of audit committee/internal auditor

sessions and financial reporting quality. Literature (e.g., Goodwin, 2003; Raghunandan et al.,

2001; Scarbroughet al., 1998) also examined the impact of audit committee independence on

relationships between audit committee and internal audit.

The notion of board diversity and board structure in Kenya has achieved prominence as it has

in other nations, according to Nyoka (2018). A number of private firms, state corporations,

banks and other financial institutions collapsed in the 1980s and 1990s; some were listed in the

Nairobi Securities Exchange. The collapse and subsequent delisting of Uchumi Supermarkets

Limited from the NSE in 2006 and the 2004 Kenya Meat Commission, the collapse of a number

of non-listed medium-sized businesses such as Kenya Bus Services Limited (2005), are just a

few local instances. Evidence is accessible to demonstrate that most of the State Corporations

and Limited Companies ' failure instances were due to the management board's systematic

failures.

Aifua and Embele (2019) carried out a study in Nigeria on the effect of the board's

characteristics on the quality financial reporting of manufacturing firms. The study used board

independence and expertize as board diversity variables but the current study analyzed age and

education diversity. Oluoch (2014) examined Demographic diversity in top management team,

corporate voluntary disclosure, discretionary accounting choices and financial reporting quality

in Commercial state corporations in Kenya. This study concentrated on Commercial state

corporations only while the current study encompasses all the listed companies in NSE.

From the studies reviewed, it is clear that restricted surveys have assessed the impact of all

recognized elements of board diversity on the quality of financial reporting among NSE listed

companies in Kenya. This creates a gap in understanding that this research intended to bridge

by assessing the impact of board diversity and audit committee activities on NSE-listed

companies’ financial reporting quality and so, the study attempted to address the question of

what impact does board diversity and audit committee activities have on financial reporting

quality of NSE-listed firms?.




Research Hypotheses

The study tested the following hypotheses;

H01: There is no significant effect of the board of directors’ age diversity on financial

reporting quality among firms listed in Nairobi securities exchange.

H02: There is no significant effect of the board of directors’ education diversity on financial

reporting quality among firms listed in Nairobi securities exchange.

H03: There is no significant moderating effect of Audit committees’ activities on board

diversity and financial reporting quality among firms listed in Nairobi securities

exchange.

Theoretical Framework

This paper was informed by Upper Echelon Theory (UET) and resource dependence theory.

UET is primarily a theory of information processing, with managers acting based on the

situations they face based on their filtered perception. Consequently, board characteristics

connected with their ability to process information are anticipated to play a significant part in

a company's strategic results (Dollinger, 1984). Therefore, if individual features have a bearing

on organizational outcomes, it is realistic to think that there is an enhanced need to investigate

the features of the boards on the execution of the policy and the effect on the quality of

organizational performance and financial reporting.UET claims that a high level of education

among managers is associated with open-mindedness, data processing capacity, and ongoing

change handling. They, therefore, have more knowledge and are in a position to handle data

and decision-making (Hambrick & Mason, 1984). Hambrick and Mason (1984) argue that

firms with younger managers may experience more significant development than firms with

older managers because older managers prevent taking risky approaches, while younger

managers are inclined to make risky decisions. In this context, the theory suggests that younger

members are more likely to be prepared to bear more danger and to undertake substantial

structural modifications to enhance the company's future opportunities, while older members

prefer investments that provide fast payback (Antia et al., 2010; Nakano & Nguyen, 2011;

Horvath & Spirollari, 2012). Therefore, this theory is relevant in this research as it is linked to

the variables of the study age and educational level diversity.

Resource dependence theory views Board of Directors (BoD) as assets to a firm’s performance

and delivering of Financial Reporting quality. Ferreira (2011) and Campbell and Mínguez-

Vera (2008) have shown that these assets are their skills and knowledge. The various

heterogeneities of board members are more likely to bring diverse perspectives and experience

in reaching solutions to challenges about resources imposed from the external environment to

the firm. Furthermore, the approach emphasizes that various boards have access to a wider

resource pool that strengthens the network of a company with its internal setting and provides

it access to fresh links and resources (Pfeffer and Salancik 1978; Daily et al. 2003; Campbell

and Mínguez-Vera 2008; Ferreira 2011).




The increase in the number of professional contacts offers channels for internal company

collaboration and support and allows a company to handle its connections with third parties

more efficiently (Pfeffer and Salancik 1978; Campbell and Mínguez-Vera 2008). Ferreira

(2011) adds that it is particularly important to increase the amount of economic and political

links because it can assist company’s access government investment funds, negotiate with

regulators or win public agreements. Therefore, the theory of resource dependency inherently

illustrates the advantage of board diversity for corporate governance and leadership, which may

increase the quality, efficiency and social disclosure of income of corporations.

Hypotheses Development

The activities of the audit committee are the number of meetings/ conferences that the audit

committee holds. Activities of the audit committee guarantee transparency of leadership and

accountability to stakeholders (BRC, 1999). The total number of sessions of the audit

committee is an indication of the efficiency of the audit committee. Users of financial

statements view fewer meetings as an indicator of less engagement and lack of time to

supervise the process of financial reporting. Xie et al. (2003) showed that enhanced audit

committee activity is associated with decreased rates of earnings management as a result of the

number of committee meetings. Bryan, Liv, and Tiras (2004) argued that frequently meeting

audit committees enhance the transparency and openness of recorded income and thus enhance

the quality of income. Members of the audit committee that meet frequently are often

anticipated to be more effective in carrying out monitoring duties than otherwise. Zhou, Zhang,

and N. Zhou (2007) used the number of conferences and meetings to determine whether the

frequency has an impact on the quality of financial reporting and findings revealed a positive

correlation.

According to Ruzaidah and Takiah (2004), the more regular audit committees meet, the better

the FRQ (Financial reporting quality) since there is an opportunity to track the management

activities in the session more quickly and efficiently. These studies consider meeting frequency

as a proxy for the operation of the audit committee. While the amount of sessions may not

provide any indication of the extent of the job performed during the conference, it is observed

that the audit committee is less likely to be a successful monitor without any meeting or with a

few number of meetings.

Beasley et al., (2000) found out that the activities of audit boards are closely linked to FRQ, as

fraud in financial statements is more probable to occur in companies with fewer activities of

the audit committee. However, distinct findings were revealed in other researches such as one

by Lin et al., (2006) which did not report any proof of a connection between the activities of

the audit committee and the restatements of earnings. Xie et al., (2003) also discovered no

proof of a significant connection between the level of discretionary accruals and the operations

of the Audit Committee.

In reference to the Agency Theory, Bedard and Gendron (2010) asserted that the existence of

activities of audit committee is more probable to influence efficient monitoring of the conduct

of management. This is because the activities of the Audit Committee (AC) do not have a

financial or personal connection with management and are therefore more likely to be

independent and objective from the impact of management. Consequently, AC activities of the

Audit Committee have more chances to regulate and decrease the possibilities for management




to withhold any information for self-advantage (Allegrini and Greco, 2011). Consequently, an

AC with activities of audit committee was designed to guarantee the quality and transparency

of the process of financial reporting, which in turn decreases the asymmetry of information

(Allegrini and Greco, 2011; Li et al., 2012).

It therefore seems reasonable to argue that efficient monitoring of AC activities of the Audit

Committee is considered to further motivate management to be accurate in production of

precise information (Haniffa and Cooke, 2002). Akhtaruddin and Haron (2010) and Patelli and

Prencipe (2007) discovered that more voluntary disclosure is associated with the activities of

audit committee.

Zainal (2009) discovered that, owing to their varied background, qualities, features, and

knowledge, a greater percentage of independent non-executive directors improve the quality of

financial reporting, which may improve decision-making processes. Non-executive directors

are considered to be in a better place to meet their monitoring role than executive directors

because they are independent and concerned with keeping their reputation. In line with this

proposal, it is anticipated that there will be a favorable connection between the quality of

financial reporting and the percentage of non-executive audit committee managers. Ameer et

al., (2010) found that companies with external directors are anticipated to have better financial

reporting than companies with majority of internal executive and associated non-executive

directors who are part of the audit committee.

Despite the fact that board diversity has received a lot of research attention worldwide as

evidenced by the literature reviewed, no study has been carried out on board diversity and the

moderating variable audit committee activities; it hasn’t been widely researched in Kenya.

Most of the reviewed researches focused on board diversity and its effect on financial reporting

quality only without focusing on activities of the audit committee. Thus, this study

hypothesized that;

H01: There is no significant moderating effect of Audit committees’ activities on board

diversity and financial reporting quality among firms listed in Nairobi securities

exchange.




Limitation of the Study

This study may have endured a variety of constraints. First, for 7 years, the study was limited

to secondary data collection. The study focused on 40 companies that were continually listed

in the NSE for the entire period of the study in Kenya. Secondly, the study relied solely on two

readably specific features of board members: age, education and the actions of the audit

committee as a moderator to address the issue of how the diversity of board members and audit

committee operations impact the consistency of financial reporting. This is therefore a

constraint as there are other aspects of board members that can affect the quality of Financial

Reporting. This research concentrated only on companies listed in the NSE, thus limiting the

generalizability of results to other industries.

Methodology

The study adopted positivism research philosophy and employed longitudinal research design.

Researchers following the perspective of positivism are of the opinion that the natural scientist's

philosophical position emphasizes working with observable social reality for generalization

(Saunders, 2016). In addition, findings of the study can be replicated because board diversity

should be isolated and that observations should be repeatable to confirm the findings reached.

The study sampling frame consisted of all firms listed in NSE for a seven-year period that is,

between 2011-2017.Finally, 280 firm-yearly data of 40 firms listed in NSE formed the sample

size. Data collection sheet was employed for collection of data. The research relied on

secondary sources that were obtained by evaluating the contents of the financial reports of the

40 registered companies in NSE.

Measurement of Variables

Dependent Variable

Financial Reporting quality was measured using two measures; Earning Value Relevance and

reliability/faithfulness. According to Francis (2005), stock returns is a proxy of earning value

relevance and are considered to be an insightful indicator on the pay-off system of interest to

capital suppliers, as well as an extremely summarizing accounting statistic of financial data. At

the same time, it is understood that value-relevance collects data accuracy and increases

revenue accuracy as a measure of free cash flow.Therefore,stock returns is a function of

Earning per share and the change in earning per share. The resultant residuals from the model

measure that part of the dependent variable that is not explained by the independent variables

which in this case the financial reporting quality. Similarly, the study measured financial

reporting quality by reliability/faithfulness using a model developed by scholars Kim and Cross

(2005). In particular, cash flows from operating activities and accruals are set at time t as the

independent variables, while at t+1 cash flow as the dependent variable representation.

Reliability is described as the capacity of the two autonomous factors to explain working

money flows in t+1. Since residuals in a regression model takes into account those factors not

explained by the variables in the model, it shows then that the higher the value of residuals, the

less reliable are the cash flows and thus lower financial reporting quality. The study further

aggregated the two Financial Reporting Quality Metrics into a summary index to optimize the

sample information content and tradeoff between the aforementioned measures and also that

there is no generally agreed FRQ measurement technique. This was done by summing the

residuals from the two regression models used to measure the financial reporting quality, and

then getting the mean. The integration of the two measurements into an index has the benefit




of reducing the consequences of the measurement errors in the individual financial reporting

quality behavior. The aggregation procedure for corporate governance measures was justified

by Dechow et al., (2010).

Independent Variables

Age Diversity A standard deviation of the age of all board members was measured since the

study is concerned with the spread of the age of directors rather than with the range between

the youngest and the oldest director (Dagsson, 2011, McIntyre et al., 2007).

Education diversity was measured as the standard deviation of proportion of directors with

certificate, Diploma, Degree, Masters and PhD levels of education, (Chen & Zhang, 2014).

Moderating Variable The moderating variable which is Audit Committee Activity (ACA) was measured as the

number of yearly meetings conducted by the audit committee (Tian, 2009; Chen et al., 2006).

Analytic model and Model specification

A panel data has been used to evaluate the hypotheses using hierarchical regression model. In

hierarchical regression analysis, only some of the variables are utilized simultaneously across

every stage. At every step R² was computed to indicate the incremental alteration with the

addition of the most recently entered predictor and was exclusively related with the predictor.

The benefit of using hierarchical regression through a series of F-tests is to regulate the

integration of variables, each phase of the interactive method approaches the determination of

the true value of each variable's contribution. The coefficient of determination, R2, measures

that part of the total variance of Y that was explained by understanding the value of X. The

study hypotheses was tested in three stages using multiple regression analysis and hierarchical

moderated regression as modelled by Barron and Kenny (1986) as shown below

𝐹𝑅𝑄𝑖𝑡 = 𝛽0𝑖𝑡 + 𝛽1𝑖𝑡𝐶 + 𝜀…………………… 1

𝐹𝑅𝑄𝑖𝑡 = 𝛽0𝑖𝑡 + 𝛽1𝐴𝐷𝑖𝑡 + 𝛽3𝐸𝐷𝑖𝑡 + 𝜀………………………… 2

𝐹𝑅𝑄𝑖𝑡 = 𝛽0𝑖𝑡 + 𝛽1𝐴𝐷𝑖𝑡 + 𝛽3𝐸𝐷𝑖𝑡 + 𝛽5𝐴𝐶𝐴𝑖𝑡 + 𝜀………………… 3

𝐹𝑅𝑄𝑖𝑡 = 𝛽0𝑖𝑡 + 𝛽1𝐴𝐷𝑖𝑡 + 𝛽3𝐸𝐷𝑖𝑡 + 𝛽5𝐴𝐶𝐴𝑖𝑡 + 𝛽6𝑎𝐴𝐷𝑖𝑡 ∗ 𝐴𝐶𝐴𝑖𝑡 + 𝛽6𝑐𝐸𝐷𝑖𝑡 ∗ 𝐴𝐶𝐴𝑖𝑡 + 𝜀…………… 4

The point of interest is whether Model 3 explains the DV better than Model 2 by comparing

the coefficient of determination. Above all, the resultant p values explain the significance of

moderation on each of the independent variable.

Descriptive statistics

Descriptive statistics for the dependent, independent and test variables are presented in Table

1. The result shows that age diversity has the highest mean of 10.55, while financial reporting

quality had the lowest mean of -0.04. Furthermore, board education diversity was at a mean

of 5.59 and the audit committee activities at a mean of 3.66. Moreover, financial reporting

quality was at a mean of -0.04 with firm size at a mean of 2.32.The director’s age diversity

influences its management decision making for instance a board with directors of different age

gaps will make good and informed decision because it cuts across all directors both old and

young and both experienced and inexperienced. In fact Oba (2014) in his study found that age

of the board members significantly had an effect on the Quality of financial reporting such that




old board members were likely to have more experience than young ones thus older directors

are likely to deliver a higher quality of financial reporting. As presented in table 1, the study

therefore deemed it important to establish the board age diversity of the targeted firms.

Educated directors play an instrumental role in ensuring that there is better management of the

firm and better decision making that protect the shareholders interest. Sharma, (2016) showed

that education has a positive impact on reporting on financial performance. It is therefore

necessary to ascertain the trends in board education diversity during the study period. The

manner in which firms run their financial activities is mainly influenced by the audit committee

activities. Al-Shaer, Salama and Toms (2017) implied a favorable and substantial connection

between all firms ' audit committee meetings, review operations, and the quality of financial

reporting. For instance, firms with a robust audit committee ensure financial reports are done

correctly in adherence with companies and government laws. It is against this backdrop that

the study found it important to establish the trends of audit committee meetings. On average,

the maximum numbers of meetings were 9 and a minimum of 1.

Table 1: Summary table of Variables

descriptive for standard deviation

measure descriptive for

actual means

Stats N Min Max Mean p50 Sd skewness Kurtosis Mean Sd

Ad 280 9.3 19.72 10.55 10.18 1.35 3.51 20.27 52.64 3.84

Ed 280 0.44 27.22 5.59 0.84 8.68 1.61 4.02 11.85 17.80

Aca 278 1 9 3.66 4 1.57 0.5 3.47

Fs 280 -0.27 51.34 2.32 0.16 4.36 5.45 57.97

Roa 275 0 11.16 5.2 6.69 3.19 -0.76 1.9

Frq 280 -8.4 1.45 -0.04 0.09 0.74 -6.43 63.96

Source: Research Data, (2021)

Diagnostics Tests

For the Jarque-Bera Test, if the p-value is lower than the Chi (2) value then the null hypothesis

cannot be rejected. It can therefore be concluded that the residuals are normally distributed. As

per tests of this study, the chi (2) is 0.609 which is greater than 0.05 meaning that the null

hypothesis cannot be rejected. The implication is that there is no violation of the normal

distribution assumption of error terms as the residuals are coming out to be normal.

Multicollinearity is a phenomenon whereby high correlation exists between the independent

variables. It occurs in a multiple regression model when high correlation exists between these

predictor variables prompting questionable assessments of regression coefficients. This leads

to strange outcomes when attempts are made to decide the degree to which the independent

variables explain the changes in the outcome variable (Creswell, 2014).

The outcomes of Multicollinearity are expanded standard errors of evaluations of the Betas,

which means diminished reliability, quality and misleading results. Multicollinearity test was

used to check whether high correlation existed between one or more variables in the study with

one or more of the other independent variables. Variance inflation factor (VIF) measured

correlation level between the predictor variables and estimated the inflated variances due to

linear dependence with other explanatory variables. A common rule of thumb is that VIFs of




10 or higher (conservatively over 5) points to severe multi-collinearity that affects the study

(Newbert, 2008). The results of the VIF test ranged between 1.25 and 2.87. All the variables

are less than 10, thereby; the model does not suffer from multicollinearity problems.

To conduct the heteroscedasticity test, this study used Breusch-Pagan test for

heteroscedasticity. The findings indicated that Chi2 (1) was 0.19 which was more than p value

of 0.05 revealing that null hypothesis was not rejected suggesting that assumption of constant

variance was not violated.

Autocorrelation in panel data can be detected using several tests such as the Baltagi-Wu test,

Durbin Watson test and the Breusch-Godfrey test. According to Drukker (2003), these tests

employ many specification assumptions such as individual effects types, need for non-

stochastic repressors and inability to work in the presence of heteroscedasticity. Drukker (2003)

further argues that the autocorrelation test of Wooldridge (2002) does not have such limitations

and can also deal with unbalanced panel data with and without gaps in the observations. By the

p-values in this analysis, the null hypothesis was rejected at the 5% significance level, which

means that there is no autocorrelation in the data.

Unit Root Test

A time- series is said to be stationary if its mean and variance are constant over time (Gujarati,

2004). Thus, the series tend to drift around its mean due to the limited variance. The series can

be of a stochastic nature (randomly determined) or a deterministic nature (displaying a trend).

In contrast a nonstationary time–series or a random walk model is one where the mean and

variance continually change over time and has a simple correlation coefficient between the X

variable and its lagged variable which is influenced by factors other than solely the length of

the lag between the two (Studenmund, 2011).In the field of economics and finance, time related

or seasonal shocks in one-time period may strongly influence subsequent periods. This current

study applied Fisher and Phillips and peru test. The following hypothesis was considered for

this test.

Null hypothesis (Ho): All panels contain unit root.

Alternative hypothesis (H1): At least one panel is stationary.

Looking at the p-values in the test, the null hypothesis was rejected at all conventional 5%

significance levels for all the variables of the study, which means that there is no unit root in

the data. This implies that the means and variances in the data do not depend on time, hence

the application of OLS can produce meaningful results (Gujarati, 2012).

Correlation Results

Correlation statistics is a method of assessing the relationship between variables/factors. The

results regarding the correlation results were summarized and presented in table 2. Pearson

correlation results in the table showed that board age diversity is negatively related with

financial reporting quality with a Pearson Correlation coefficient of r =-0.681 which is

significant at p < 0.01. Also, the correlation results indicated that board education diversity is

positively related with financial reporting quality as shown by a coefficient of r = 0.252 which

is significant at p< 0.01.




Furthermore, audit committee activities is positively related with financial reporting quality,

with a coefficient of r = 0.409 which is significant at p < 0.01.Besides, return on asset (ROA)

is positively related with financial reporting quality, with a coefficient of r = 0.143 which is

also significant at p < 0.05 while firm age was negatively correlated with financial reporting

quality, with a coefficient of r =-0.144 which is also significant at p < 0.05.

Table 2: Correlation Results

FRQ AD ED ACA ROA FS

FRQ 1

AD -.681** 1

ED .252** -.237** 1

ACA .409** -.329** .259** 1

ROA .143* -.149* -.172** .127* 1

FS -.144* .166** .290** -.128* -.783** 1

** Correlation is significant at the 0.01 level (2-tailed).

* Correlation is significant at the 0.05 level (2-tailed).

Key

FRQ = Financial Reporting Quality

AD = Age Diversity

ED = Education Diversity

ACA = Audit Committee Activities

ROA = Return on Asset

FS = Firm Size

Hypotheses Testing

Moderation implies that causal relationship between two variable changes as a function of the

moderator variable. Moderation is said to exhibit if the amount of variance accounted for with

the interaction is significantly more than the variance without the interaction and coefficient of

the interaction term is different from zero (Hayes, 2013).

To test the moderation effect of depth of outreach the study used hierarchical regression model

(baron and Kenny, 1986). The effect of dependent variable such as financial reporting quality

was regressed on controls, exogenous variables and interactions terms. Hierarchical regression

method was used by entering variables in lump of variables for control and exogenous variables

including the moderator as well as each of the interaction terms and observing their results.

The findings were analyzed and interpreted in order to evaluate whether the determinants of

financial reporting quality had an effect on audit committee activities and thus the model 1

presented the dependent and controls variables, model 2 presented the dependent, controls and

independent variables, model 3 presented the dependent, controls, independent and moderator,

while model 4 presented controls, independent and moderation with interactions to test the

hypothesis.




Baron and Kenny argued that increase in R change indicate significant model.

Based on the study findings in Table 3, R squared within from random effect increased from

58% to 65% (R2Δ = 7%) after moderating the relationship between board diversity and

financial reporting quality of firms in NSE by audit committee activities.

It can be seen from Table 3 that there is a negative and significant moderating effect of the

audit committee's activities on the relationship between the board age diversity and the

financial reporting quality (=β -0.33, p= 0.01<0.05)) hence the null hypothesis was rejected.

In addition, the audit committee's activities have a positive and significant moderating impact

on the relationship between the diversity of board education and the financial reporting quality

(β = 0.19, ρ =0.01<0.05) hence the null hypothesis was rejected.

Table 3: Regression Analysis Results for moderation

Model 1 Model 2 Model 3 Model 4

FRQ Coef. (Std. Err.) Coef. (Std. Err.) Coef. (Std. Err.) Coef. (Std. Err.)

_cons (-1.94(.09)** (-0.04(.04) 1.35(.79) 5.02(2.18)**

FS (-0.03( 0.01(.05) (-0.02(.04) (-0.03)

ROA 0.09(.07) (-1.60(.21)** 0.01(.05) 0.04(.05)

AD (-1.60(.33)** (-1.55(.21)** (-1.15(.27)**

ED 1.00(.38)* 0.08(.04) (-0.12(.08)*

ACA 0.30(.11)** (-2.89(1.27)*

AD_ACA (-0.33(.12)**

ED_ACA 0.19(.05)**

R-sq:

Within 0.02 0.57 0.58 0.65

Between 0.02 0.38 0.43 0.48

Overall 0.02 0.54 0.56 0.63

R-sqΔ 0.55 0.01 0.07

F stat 2.87 50.71 45.67 38.65

Prob> F 0.06 0.00 0.00 0.00

sigma_u 0.51 0.40 0.38 0.37

sigma_e 1.26 0.85 0.84 0.77

Rho 0.14 0.19 0.17 0.19

Housman test

chi2(6) 0.122 .6.01 6.93 6.44

Prob>chi2 0.01 0.04 0.02 0.01

**significant at 0.01 level; *significant at 0.05 level; Figures in parenthesis are t –statistics;

Source: Research Data (2021)

Results and Discussion of Findings

The main objective of this study was to evaluate the effect of board diversity and audit

committee activities on financial reporting quality among firms listed in NSE.This was a

moderation approach.




Generally, from the above analysis of moderation, the findings showed that audit committee

activities weaken the relationship between age diversity and financial reporting quality as

shown by (β=-0.33, p=0.01<0.05). This was supported by Mustafa and Meier (2006), as they

found that the proportion of independent audit committee members as well as the average

tenure of audit committee members in both random and matched models was substantially and

negatively related to the level of property misappropriation in publicly owned companies.

On the other hand, audit committee activities strengthens the relationship between education

diversity and financial reporting quality as shown by coefficients, (β=0.19 p=0.01<0.05). The

findings were in support of Raghunandan & Rama (2004) who recorded that excellent audit

committees may influence auditor-related perceptions of shareholders, especially in

circumstances where shareholders may perceive an enhanced auditor danger.

Graphical representation of moderation on a Modgraph

To show antagonistic and enhancing moderating effect, the study used modgraph as

recommended by (Jose, 2008). In order to understand the nature of the interaction of audit

committee activities on the relationship between determinants of financial reporting quality

(board age diversity and board education diversity), Aiken & West (1991) suggested that the

moderated results be presented on a moderation graph. Further-more, he indicated that it is

insufficient to conclude that there is interaction without probing the nature of that interaction

at different levels of the moderator. Therefore, the significance of the coefficient of audit

committee activities was assessed at low, medium and high levels of board age diversity and

board education diversity.

Figure 1: Modgraph for Moderating Effect of audit committee activities on the

Relationship between board age diversity and financial reporting quality




According to the above graph, fig1 indicates decreasing moderating effect, thus at high level

of age diversity, financial reporting quality is low with all levels of audit committee activities.

However, as age diversity decreases financial reporting quality decreases with all levels of audit

committee activities but the decrease is high with high levels of audit committee activities

compared to low levels of audit committee activities.

Figure 2: Modgraph for Moderating Effect of audit committee activities on the

Relationship between board education diversity and financial reporting

quality

The examination of the graphical plots from figure 2 shows an enhancing moderating effect,

thus under high level of board education diversity, financial reporting quality is high with all

levels of audit committee activities. However as education diversity increases, financial

reporting quality increases with all levels of audit committee activities but the slope raises

drastically in all levels of audit committee activities.

Conclusion and Recommendations

The moderation findings in this study indicated that the use of audit committee activities as a

moderator weakens the relationship between board age diversity and financial reporting

quality. However, an audit committee activity strengthens the relationship between board

education diversity and financial reporting quality.

The study found that the more the number of audit committee meetings is held, the more

negatively financial reporting quality is affected by age diversity. It is a recommendation of

this study that for a board that is not age diversified, the audit committee should meet

frequently. It was also found that the more the audit committee meets in an education

diversified board, the higher the financial reporting quality of the firm. Therefore, it is

recommended that for a board that is education diversified, the audit committee should be

meeting more frequently as this improves the quality of financial reporting.




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