CHAPTER ONE:

INTRODUCTION

1.1 Background of the Study

Financial reporting quality is a crucial aspect of ensuring transparency, accountability, and trust in the operations of microfinance institutions (MFIs). The accurate and reliable presentation of financial information is essential for stakeholders, including investors, regulators, and donors, to make informed decisions and assess the financial health and performance of these institutions. However, the determinants of financial reporting quality in MFIs have received limited attention in the existing literature.  

Financial reporting quality refers to the extent to which financial statements accurately reflect an institution’s financial position, performance, and cash flows. In the context of MFIs, financial reporting quality plays a crucial role in building trust among stakeholders, attracting investment, and ensuring the sustainability of the microfinance sector (Armstrong and Ball, 2016; GutiérrezNieto et al., 2018). However, the unique characteristics of MFIs, such as their focus on serving financially vulnerable populations and their diverse ownership structures, can create challenges in maintaining high-quality financial reporting (Christen et al., 2013; Serbetci and Uyar, 2017). Several determinants influence financial reporting quality in MFIs. Regulatory frameworks and supervisory practices, including the level of enforcement, can significantly impact the quality of financial reporting (La Porta et al., 2013; Gutiérrez-Nieto et al., 2018). Internal governance mechanisms, such as the independence and expertise of the board of directors, internal control systems, and audit committees, also play a vital role in ensuring accurate and reliable financial reporting (Mersland and Strøm, 2014; Khan and Bano, 2016).

Financial reporting quality in recent decades has drawn the attention of many scholars as well as various management directors of different company around the globe as management of these different companies are solely responsible in preparing financial information that is capable of influencing decision makers by helping them to form predictions about the outcomes of present event or to confirm or correct prior expectations (Hassan, 2013). Good corporate governance is one of the most essential mechanisms in ensuring the achievement of goals and objectives of an organisation, meeting shareholders’ wealth, and preparing the quality of financial reporting. The role of corporate governance and financial reporting quality are amongst the most popular issues being investigated by researchers in the accounting field (Khalil & Ozkan, 2016)

Quality financial reports are crucial for the firm. The growth of information asymmetry causes friction between managers and shareholders as a result of disparities in managerial reports (Choi & Pae., 2011). Most often the poor level of financial quality reports prevents managers from doing their jobs, which results in mistakes and then leads to conflict among stakeholders (Choi & Pae., 2011). According to Juanda (2006) when operational management fails to provide financial reporting quality, this lack of transparency can create a breeding ground for misunderstandings and disputes between stakeholders. Moreover, the absence of clear communication channels between managers and employees can further exacerbate the problem, as it hinders the timely resolution of conflicts. 

Furthermore, quality financial report is strongly speculated to be one of the causes of investor distrust at a weak stock market. Its risk is associated with the inability to gain access to the information concerning the market situation, investee condition, and debts (Mendes et al., 2012). Quality of financial information is influenced by the risk of the company’s failure to obtain profits from creditors in the form of debt (Zamri et al., 2013). Financial reporting aims to provide quality financial information as a consideration for stakeholders (investors and creditors) as a source of corporate funding.

Micro financial institutions are different in size and characteristics. Examining their characteristics and the relationship with financial reporting quality had shed light on factors that could influence financial reporting quality. According Chen et al., (2019), internal control is a significant corporate governance mechanism that holds the accountability for leading and directing a business organisation and protecting the interests of all stakeholders. Internal control becomes the key player for the corporation in ensuring effective corporate governance to reduce information asymmetry, control insiders’ opportunism, and mitigate managerial incentives in earnings management practices and thus contribute to the integrity of the financial reporting (Chi et al., 2015). However, bringing out the determinants of financial reporting quality in Microfinance Institutions can be a complex issue which required special treatment. 

Moreover, another determinant of financial reporting quality in micro financial institutions is the level of financial expertise within the organisation. According to Uwuigbe et al., (2015) financial expertise is positively associated with financial reporting quality in micro financial institutions.

This is because individuals with financial expertise are more likely to understand the importance of accurate and complete financial reporting, and are better equipped to prepare high-quality financial reports. Firm size has been identified as a potential determinant of financial reporting quality in micro financial institutions. Larger micro financial institutions tend to have more resources, including financial and human capital, which can translate into better financial reporting practices (Uwuigbe et al., 2015). Uwuigbe et al., (2015) state that larger micro financial institutions are more likely to produce high-quality financial reports. However, this relationship may not hold true in all contexts, as Bokpin and Isshaq., (2009) argued that no significant relationship between firms’ size and financial reporting quality was found in their study.

The board independence in reporting financial quality has long been identified within the context of micro finance institutions, board independent means there are a significant proportion of independent non-executive directors. Non-executive directors are more effective in monitoring managers and protecting the interest of shareholders and thereby reducing agency problem (Hillman & Daziel, 2003). Independent directors on the board may improve earnings quality by mitigating managerial self-interest and by monitoring and controlling the production of financial statements by management. Accordingly, boards with more independent directors have a propensity for greater monitoring and are therefore expected to insist on greater earnings quality. Hence, we expect that board independence will improve earnings quality by limiting earnings management (Hillman & Daziel., 2003).

Thiruvadi & Huang., (2011), provides evidence that the presence of a female director on the audit committee constraints increasing negative (income-decreasing) discretionary accruals. They suggested that gender diversity on the board should be more emphasized as their presence may further enhance public confidence. Similarly, Orazalin, (2020) argued that companies with greater board gender diversity are more effective in constraining EM. They also indicate that companies with larger boards adopt a more restrained approach to EM practices. Arun et al., (2015) argued that firms with a higher number of female and independent female directors are adopting restrained EM practices. They made a distinction between complex (high debt) and simple (low debt) companies, and the outcomes revealed that female directors have a positive effect on the EM in simple companies. They suggest that female representation may enhance the functioning and efficiency of corporate boards and committees and, more generally, that executive gender may affect managerial behavior as a consequence might affect the financial reporting quality of the financial institution.

In the world perspective, inaccurate financial reporting quality have been witnessed with a view of hiding the financial loss, using or diverting funds and overestimating the value of assets with the company. However, in the United State of America, Canada, Mexico financial institutions must prepare financial information with higher quality. Financial reporting quality (FRQ) is the faithfulness of the information conveyed by the financial reporting process in these countries. It is generally accepted that certain characteristics of the financial institutions have an impact on the level and the quality of financial reporting disclosed (Moses et al., (2016).

In the United Kingdom, financial reporting quality is influenced by various determinants, including: Regulatory Framework: The Financial Reporting Council (FRC) plays a crucial role in setting accounting standards and regulations, ensuring compliance, and promoting high-quality financial reporting. The FRC’s oversight and enforcement contribute to the overall financial reporting quality in the UK. Also, the quality of audits conducted by independent auditors is a significant factor in financial reporting quality. The reputation and expertise of auditing firms, such as the “Big Four” (Deloitte, EY, KPMG, PwC), contribute to ensuring accurate and reliable financial reports. Furthermore, Strong corporate governance practices, including board independence, transparency, and accountability, are associated with higher financial reporting quality. The presence of independent directors and effective board oversight enhances the reliability of financial statements (Boubaker, et al., 2019).

In China financial reporting quality in China is influenced by several factors, the China Securities Regulatory Commission (CSRC) and the Ministry of Finance (MOF) have implemented various reforms to improve financial reporting quality. These reforms include enhanced disclosure requirements, stricter enforcement, and convergence with international accounting standards. Also, Auditor Independence and Professionalism: The quality of audits conducted by independent auditing firms, along with their adherence to professional standards, significantly impacts financial reporting quality in China and Effective corporate governance mechanisms, including the independence of boards, audit committees, and internal controls, are associated with higher financial reporting quality (Ding and Zhang., 2018).

In the Africa context, financial expertise has been identified as a crucial factor for financial reporting quality in micro financial institutions. Micro financial institutions with higher levels of financial expertise, such as those with dedicated accounting or finance departments or those that hire external accounting firms, are more likely to produce high-quality financial reports. Khlif and Samaha., (2017) found that micro financial institutions in Tunisia with higher levels of financial expertise had higher financial reporting quality than those with lower levels of financial expertise. In Nigeria, comparing the country to many other advanced jurisdictions, the quality of financial reporting is still poor. Micro financial institutions continue to suffered as micro financial institution in Nigeria frequently lament the lack of accessibility to or the unreliability of accessible financial expertise, poor auditor reputation (Oluchukwu and Somtochukwu 2013). According to Oluchukwu and Somtochukwu, (2013) board size, audit committee size, and auditor reputation positively affect financial reporting quality in Nigerian listed micro financial institutions. However, the level of corruption in the country negatively affects financial reporting quality.

In Kenya, the audit committee expertise is responsible for overseeing the financial reporting process, and its expertise is critical in ensuring the quality of financial reporting. In Kenya, the CBK requires banks to have an audit committee consisting of at least three non-executive directors, with at least one member having financial expertise King’ori, et al., (2017). According to King’ori, et al., (2017) audit committee expertise positively affects financial reporting quality in Kenyan financial institutions and expertise enhances the quality of audit committee oversight, which in turn improves the quality of financial reporting. Board independence, the size of the audit committee, and the reputation of the auditor all have a favorable impact on the quality of financial reporting in Kenyan listed companies. However, the degree of political meddling in financial reporting has a detrimental impact on the caliber of financial reporting.

In South Africa, financial reporting quality is an important aspect of the financial system as it helps in providing reliable and transparent financial information to stakeholders. Mabaso et al., (2018) found that board independence, audit committee expertise, and auditor reputation positively affect financial reporting quality in South African listed firms. However, the level of enforcement of accounting standards and the level of corruption in the country negatively affect financial reporting quality. Determinants of Financial Reporting Quality in South Africa according to Ofoegbu et al., (2019) audit committee expertise, auditor quality, and firm size has a great repercussion financial reporting quality in non-financial listed firms in South Africa. However, the level of external interference and the level of corruption in the country negatively affect financial reporting quality.

In Cameroon, financial reporting quality in Cameroon’s financial institutions is influenced by several determinants. These determinants can have either a positive or negative impact on financial reporting quality. One of the key determinants of financial reporting quality in Cameroon’s financial institutions is the level of board independence (Kueda et al., 2020). The board of directors plays a critical role in ensuring that the financial reports of the institution are accurate and reliable. A board that is independent and has a diverse range of skills and expertise is more likely to ensure that the financial reports are of high quality. According to Michael and Magang (2019) within the micro financial institutions in Cameroonian context, financial reporting quality is the expertise of the audit committee. The audit committee is responsible for overseeing the institution’s financial reporting process and ensuring that it complies with relevant regulations and standards. 

Closer home Bamenda, financial reporting quality in micro financial institutions are impacted by several financial institutional yardsticks such as firm size, gender diversity, and financial expertise. The reputation of the auditor is also an important determinant of financial reporting quality. A reputable auditor is more likely to provide an unbiased and accurate assessment of the institution’s financial reports. However, the poor quality of financial reporting in Bamenda financial institutions is, however, negatively influenced by political meddling and corruption. Political intervention can result in financial reports being manipulated for political purposes, while corruption can lead to money being misappropriated and financial reports being fabricated (Tchamyou et al., 2019). To completely comprehend the connection between these elements and the caliber of financial reporting in various circumstances, more study is required. However, there may be restrictions when evaluating gender, firm size, and financial knowledge as indicators of financial reporting quality, therefore care should be taken. It is crucial to take into account several elements that could affect the quality of financial reporting, such as company culture, the regulatory setting, and the caliber of accounting standards.

1.2. Statement of the Problem 

Financial reporting quality represents financial statements that provide accurate and fair information about underlying financial position and economic performance of an entity (Herath and Albarqi, 2017). This has not been the case as the worldwide increase in accounting scandals in the early 21st century has pointed to weakness in financial reporting quality. Such scandal has led to the collapse of Enron in 2001 and Worldcoms in 2002 (Shigyhan et al., 2023). However, developing economies are not left out of this scandal, as there are many institutions which have failed to live up to expectation. Most recently BICEC bank a subsidiary of BPCE in France scandal in 2015 in which 50 billion was embezzled (Fossung & Magang, 2019: Kueda et al., 2020). The collapsed or failure of some microfinance institution in Cameroon such as COFINEST which was one of the biggest microfinance institutions and her failure was accounted for by lack of transparency and accountability. Other microfinance institutions like FIFA, Dominion finance, Raven Green Finance and Global finance have also gone bankrupt due to poor financial reporting quality (Fotabong, 2012). This implies that the information provided by these institutions were not relevant, faithfully represented, comparable, verifiable, timely and understandable. These failures provide the need for a good financial reporting quality in microfinance institutions which handle savings of low-income earners in the society. 

However, larger firms turned to disclosed more information in their annual report because there are exposed to more scrutiny by investment analysis than smaller firms. However, result from previous study show that firm size significantly increases financial reporting quality (Macías & Muiño, 2011, Gjerde, et al., 2008). It failed to agree with the studies of Ogbebor et al., (2022), Agostino et al., 2011, Devalle et al., 2010; Stolowy & Jeny-Cazavan, 2001; Haller, 2002; Chua & Taylor, (2008) who concluded that firm size which equaly affect the board size, significantly reduces financial reporting quality. It is due to these debates over the years that necessitated the need to assess the effect of Board charateristic on the financial reporting quality of micro financial institutions in Bamenda City.

Beside Catalyst, (2011) argued that women are best manager and can do better than their male counter. This is not in agreement with Abdullah et al. (2021) who found that there is a significant negative relationship between female directors and the level of earning management as a proxy of financial reporting quality. It is based on this that necessitated the need to evaluate the effect of gender diversity on the financial reporting quality of microfinance in Bamenda City.

Most audit committee’s members of microfinance institutions focused more on their monetary power rather than their expertise, experiences and training Mubarak (2016). It is based on this that Mubarak (2016) concluded that non-executive directors in the audit committee have an insignificant effect on financial reporting quality. This concur with the findings of Oluchukwu and Somtochukwu (2013). Moses et al. (2016) who found audit committee to be a poor predictor for financial reporting quality. However, it does agree with Amah and Ekwe (2021) who state that, audit committee has a positive and significant effect on financial reporting quality. It is based on these arguments that necessitated the study in an attempt to analyze the effect of audit committee expertise on the financial reporting quality of micro financial institutions in Bamenda City.

Based on Bedard and Johnstone (2004), there is no clear-cut relationship between Internal Control and financial reporting quality. Besides Francis and Wang (2008) argues that the relationship between Internal Control and financial reporting quality is complex, and that the effectiveness of internal control depends on the specific context in which it is applied. This also agreed with McNichols and Stubben (2008) who argues that the relationship between internal control and financial reporting quality is not always positive.  This difference views have necessitated this study to examine the effect of internal control on the financial reporting quality of micro financial institutions in Bamenda City.

1.3 Research Questions

The research questions provide a framework and guideline through which substantial knowledge of the research study can be understood.

1.3.1 Main Research Question

The main research question of this study is; what are the effects of board characteristic on the quality of financial reporting in micro financial institutions in Bamenda City?

1.3.2 Specific Research Questions

We equally have the following specific research questions which include:

1. What is the effect of board independence on the financial reporting quality of microfinance in Bamenda City?
2. What is the effect of board size on the quality of financial reporting in microfinance in Bamenda city?
3. How does the frequency of board meetings affect the financial reporting quality in microfinance institution in Bamenda city?

1.4 Research Objectives of the Study

1.4.1 Main research Objective

The main objective of this study is to evaluate the effect of board characteristic on financial reporting quality of microfinance in Bamenda City.

1.4.2 Specific Research Objectives

1. To analysis the effect of board independence on financial reporting quality of microfinance in Bamenda City.
2. To evaluate the relationship of board size on financial reporting quality of microfinance in Bamenda City.
3. To evaluate the effect of frequency of board meeting on the financial reporting quality of microfinance institutions in Bamenda City.

1.5 Research Hypotheses

H_1: The board independence has a positive effect on the quality of financial reporting in micro financial institutions in Bamenda City.

H_2: The board size has a positive effect on the quality of financial reporting of micro financial institutions in Bamenda City.

H_3: The frequency  board meeting  has a positive effect on the quality of financial reporting of micro financial institutions in Bamenda City.