CHAPTER ONEINTRODUCTION

1.1 Background of the Study

The audit committee is a critical component of a Company’s corporate governance structure, responsible for overseeing the internal audit function and ensuring the integrity of financial reporting (Cohen et al., 2013). One of the means through which the management of an organization communicates its effectiveness and efficiency to shareholders is through audited financial reports. The audited financial report is an assurance given to the shareholders that the financial reports reveal the true financial state of the organization. Through this, shareholders make an informed decision about their investments. Perception of audit quality can vary depending on the individual assessing it. Users, auditors, regulators and other stakeholders in the financial reporting process may have very different views as to what constitutes audit quality, which will influence the type of indicators one might use to assess audit quality.

 Nuraddeen & Hasnah, (2015) regarded audit quality as the ability of auditors to identify and bring to light material misstatements and manipulations in reported net income. Asiriuwa et al., (2018) observed that in the light of audit quality, an auditor is expected to ascertain a material problem within an organization’s accounting system and also to reveal such problem. Deductively, this means that the work of an auditor is in two folds; to determine and to report. These two processes must be appreciated in the quest for audit quality. For an auditor to discover a violation of the accounting system, he must be qualified and capable. More so, for an auditor to report on financial issues, he must also be capable (integrity and independence). Thus, an unqualified auditor or an incapable auditor may not be able to produce quality audits.

Audit committee is one of the major operating committees of companies’ board of directors that is in charge of overseeing financial reporting and disclosure (Bansal & Sharma, 2016). An audit committee assists the board of directors to fulfill its corporate governance and overseeing responsibilities in relation to an organization’s financial reporting, internal control system, and risk management system as well as its internal and external audit functions. Its role is to provide advice and recommendations to the board within the scope of its terms of reference. In Nigeria, section 359(3) and (4) of the Companies and Allied Matters Act requires every public traded firm to establish an audit committee. It is part of their responsibility to assist in the oversight of the integrity of the company’s financial statements, compliance with legal and other regulatory requirements, assessment of the qualification of independence of external auditors and performance of the company’s internal audit function as well as that of external auditors (Nasser, 2015). It is also meant to establish an internal audit function and ensure that there are other means of obtaining sufficient assurance of regular review or appraisal of the system of internal controls in the company, oversee management’s process for the identification of significant fraud risks across the company and ensures that adequate prevention, detection, and reporting mechanisms are in place.

In Europe, a German payment processing company (Wirecard) collapsed in 2020. The company’s auditor, EY, was found to have failed to properly audit Wirecard’s financial statements, which led to the company’s collapse. Wirecard was founded in 1999 and quickly became one of the world’s largest payment processors. The company processed payments for millions of businesses and consumers around the world. In 2019, Wirecard’s financial statements were audited by EY. EY issued an unqualified audit opinion, which means that it found no material misstatements in Wirecard’s financial statements. However, in 2020, it was revealed that Wirecard’s financial statements had been inflated by billions of euros. EY was heavily criticized for failing to detect the fraud. The collapse of Wirecard prompted regulatory modifications in Germany, illustrating the pivotal role of independent and adequately equipped internal audit departments in detecting and preventing corporate fraud (Amadeo, 2021).

In Asia, the Toshiba scandal in 2015 serves as a prominent example of corporate malfeasance. Toshiba inflated its profits by $1.2 billion over a span of seven years, driven by the imperative to meet excessively ambitious financial targets. The internal audit department proved ineffective due to a lack of autonomy and insufficient resources, thereby enabling the perpetuation of the fraudulent activities. This case underscores the significance of a robust and autonomous internal audit function in detecting financial misrepresentation and thwarting the escalation of fraud within an organization (Lee & White, 2017).

In the United States, the Enron scandal in 2001 stands as one of the most infamous instances of corporate deceit. Enron manipulated its financial statements through intricate accounting practices to conceal debt and inflate profits, culminating in a catastrophic financial downfall. The internal audit department at Enron was compromised due to its close affiliation with the external auditor, Arthur Andersen, resulting in a substantial conflict of interest. This lack of independence facilitated the perpetuation of the fraud. The Enron scandal led to staggering financial losses for investors and catalyzed the enactment of the Sarbanes-Oxley Act, which bolstered corporate governance and audit regulations in the U.S. (Deakin, 2005).

The case of Revlon, an American cosmetics company that filed for bankruptcy in 2022. The company’s auditor, Deloitte, was sued by Revlon’s creditors for failing to properly audit the company’s financial statements. Revlon’s creditors allege that Deloitte failed to properly audit the company’s financial statements in a number of ways, including:  Failing to properly review Revlon’s inventory and accounts receivable, failing to obtain sufficient evidence to support Revlon’s claims about its revenue and expenses, failing to properly assess the risk of fraud at Revlon. However, Deloitte’s negligence allegedly led to Revlon’s creditors losing billions of dollars. (Mehta, 2022). The Revlon bankruptcy is a reminder of the importance of maintaining independence and skepticism. Auditors must be independent of the companies they audit and they must be skeptical of the information that management provides them. They must also be willing to challenge management and to ask tough questions.

In Africa, the Steinhoff scandal in 2017 epitomizes a prime example of internal audit deficiencies leading to substantial corporate malpractice. Steinhoff International, a South African retail giant, overstated its profits by nearly $7 billion due to deceptive accounting practices. The internal audit function exhibited weakness, lacking both the authority and resources to challenge the financial transactions of senior executives. Management’s lack of support further compromised the internal audit function’s capacity to uncover or prevent fraudulent activities. The collapse of Steinhoff precipitated a significant plummet in its stock value and triggered investigations across multiple nations, raising concerns about corporate governance standards in South Africa Odendaal, (2018).

In Cameroon, the SONARA scandal in 2020 laid bare substantial weaknesses in internal audit mechanisms at the country’s national oil refinery. Billions of CFA francs were misappropriated due to feeble internal audit controls and a lack of independence in the audit function. Internal auditors were unable to effectively supervise financial operations or question management decisions, thereby enabling widespread corruption and financial mismanagement to persist within the organization. Another recent case involved the collapse of a major Cameroonian bank (World Bank. 2020). The bank’s auditors had repeatedly warned the bank’s management that the bank was taking on too much risk, but the management ignored the warnings. As a result, the bank eventually collapsed, and the government was forced to bail it out. These cases illustrate the importance of having an effective audit committee team.

Statistics from the Public Company Accounting Oversight Board (PCAOB) reveal that a significant number of audit deficiencies are related to auditors’ failure to adequately address risks, indicating potential issues in the auditors’ ability to maintain independence and objectivity (PCAOB, 2022). These findings underscore the need for a research to investigate the relationship between audit committee characteristics, as well as its impact on audit quality and corporate governance. A study by (Cohen et al, 2010) on 108 Israeli organisations found that strong audit committee oversight led to an increase in the effectiveness of internal audit functions across various countries. This highlights the global recognition of the importance of audit committee characteristics in improving audit quality. (Abbott et al, 2010) found that 83% of audit committees with greater independence and expertise have higher internal audit quality. The study was conducted on 492 non-regulated Big 5 audited firms that filed proxy statements with SEC in the period from February 5th 2001 to June 30th 2001. Another study by (Carcello et al., 2011) revealed that, audit committees with at least three members have better internal audit quality compared to those with fewer members. A study conducted by Beasley (1996) found that the presence of independent audit committee members was linked to increased internal audit effectiveness, with 63% of organizations reporting improved audit quality due to these characteristics. This underscores the importance of robust governance structures in enhancing the reliability of financial reporting and internal controls.

A report by the African Development Bank (2020) indicated that about 70% of financial institutions in sub-Saharan Africa have strengthened their audit committees, which contributed to an enhancement in internal audit quality. This reflects a growing recognition of the vital role of audit committees in ensuring transparency and accountability within the financial sector.  In Cameroon, a study by Njeuma, (2023) found that only 45% of small and medium sized enterprises in the Northwest and Litoral regions have established effective audit committees. Among those with audit committees, 70% reported improvements in internal audit quality, suggesting a direct link between the characteristics of audit committees and the quality of internal audits. This indicates a significant opportunity for enhancing governance practices within Cameroonian financial institutions Furthermore, the study highlighted that institutions with audit committees that meet regularly (at least quarterly) experienced an increase in the perceived quality of their internal audits.\

1.2 Statement of the Problem

Over the years, there has been an increasing argument on the relevance of auditors to satisfy the true and fair view of financial reports. In the opinion of Akhidime, (2015), the argument is based on the collapse of companies that are declared fit and solvent by auditors before their sudden downfall. For example, the Enron scandal, and others as mentioned in the introduction. Since the Enron Corporation’s scandal in 2001 in the United States, there have been consistent moves for better quality and consistency of accounting and accurate reporting to protect the interest of the stakeholders (see for example, the SarbanesOxley Act introduced in the United States in 2001). This is because financial reporting is an important element in the corporate structure, by relieving a fundamental asymmetry information between managers/directors and providers of finance. The limited access to managerial information causes the providers of finance such as shareholders and debt holders, to be forced to rely on the financial reporting. Looking at the collapse these companies only makes us to question the effectiveness of audit committee characteristics. Past researchers have carried out their research regarding the relationship between audit committee characteristics and internal audit quality, and stated their opinion while equally giving room for further research to fully understand the relationship. Audit Committee acts effectively in order to limit the agency problems arising from the separation of ownership and control Jensen et al (1976). It is vital for an audit committee to inspect the preparation of financial statements, manage the risk and follow internal control systems.

Many studies have been carried out in the past and recent years seeking to know to what extend the characteristics of audit committee affect the financial performance of organizations in different countries. These studies have continually been revealing different results and so coming to conclusions as to how the audit committee characteristics influences, affects or impacts financial performance has greatly dependent on several factors. This can affect the organization’s performance that benefits from the return via the exploitation of human and financial resources, namely shareholders, managers, creditors, employees, customers, suppliers and the government. The presence of an audit committee causes the reliability of financial reports to improve financial performance. Our choice of the audit committee’s characteristics focuses on audit committee independence, the size of the audit committee, and the audit committee meetings, audit committee financial expertise, and audit committee gender.

Arguments have been on the rise as concerns the role of the independent audit committee members in monitoring the performance of their firms which is important and helpful in achieving the shareholders’ objective represented by maximizing their wealth Anderson et al., (2004); Adams & Ferreira, (2009). The findings of Alzeban & Sawan, (2015) found that independence of audit committee members influences the implementation of internal audit recommendations. Also, Sharhan & Bora, (2020) Indicated that Audit committee independence significantly influences audit quality. Moreover, in their study, Hussein et al, (2020) highlighted that audit committee independence has a unique and significant impact on audit quality. Dare et al. (2021), observed that independent audit committees contribute significantly to audit quality in the Nigerian oil sector. Similarly, Vadasi et al. (2021) found that audit committee independence positively influenced the professionalization of internal audit functions among firms listed on the Athens Stock Exchange. See et al. (2020) also reported a positive influence of independent directors on audit quality in their study of Malaysian listed firms. Also, Asiriuwa et al. (2018), highlighted independence as a key attribute of effective audit committees in enhancing audit performance. Additionally, Barua et al. (2010) linked audit committee independence to increased investments in internal auditing, suggesting that independent committees are more likely to support rigorous and well-resourced internal audit functions. However, Xie, et all (2013), found no significant relationship between audit committee independence and firm performance, Also, Osevwe-Okoroyibo & Emeka-Nwokeji (2021) found no significant relationship between audit committee independence and firm performance. Furthermore, Waweru & Riro (2013) found no significant relationship between audit committee independence and effectiveness.

Saudi corporate governance requires firms to have an audit committee with a minimum of three and a maximum of five members. Previous studies like Krishnan, (2005) highlighted the effect of the audit committee size on financial performance. The presence of a large audit committee provides a strong oversight, improves the governance quality, and promotes the disclosure and the transparency degree Anderson et al. (2004).  Other studies stated that the larger the audit committees’ sizes, the less adjusted the results would be Cornett et al., (2009). The resource dependency theory argued that as the audit committee size increases, the committee becomes more effective because more diverse knowledge and expertise are brought to the meetings (Buallay & Al-Ajmi, 2020). It is well stated that a larger audit committee is more likely to scrutinize firms’ financial reporting process, thus having higher chances of mitigating financial fraud (Al-ahdal & Hashim, 2020). However, some other studies found a negative association between the governance issues and the audit committee size Krishnan, (2005). Based on the stakeholder theory, a large audit committee generates more delegation of power among members. Nevertheless, this habit creates neglect and delay of duty, which causes more opportunistic behavior within the audit committee. The audit committee size and the number of audit committee meetings were negatively correlated and associated with the performance gaps Anderson et al, (2004). In the same sense, agency theorists suggested that larger groups are associated with high conflicts and lesser cohesion, resulting in weak corporate governance (Jensen, 1993).

It is argued that a smaller audit committee size tends to be more effective in monitoring companies’ financial reporting (Fariha et al., 2021; Klein, 2002). Some empirical studies found a negative link between audit committee size and financial performance (Fariha et al., 2021; Musallam, 2020). Another study found that the audit committee size systematically influenced the downward management of revenues (Cornett et al., 2009). Likewise, Xie et al. (2003) reported that small audit committees tend to be more participatory, since they are characterized by a higher oversight capacity than larger audit committees.

The audit committee meetings signify the level of audit committee activities and is assumed to be a significant attribute for effective monitoring (Vafeas, 1999). Studies have shown varying results as to how audit committee meetings impact organizational performance. A considerable body of the literature reported that micro financial institutions with higher audit committee meetings have fewer reports of financial fraud (Abbott et al., 2004). Studies like Shahkaraiah & Amiri, (2017) focused on the effect of the number of meetings on the financial performance. Giving more importance to the effect of this character in the precision of the audit committee quality and questions the impact of the number of meetings held by the audit committee on financial institutions’ financial performance. Also, Al-Matari et al. (2014) showed an insignificant relationship between the number of audit committee meetings and the firm performance.

It has been argued that the qualifications of the audit committee members play a significant role in enhancing the performance of the firms (Abbott & Parker, 2002). The experience includes covering accounting estimates, accruals, provisions, preparation of financial statements, and auditing financial information. Bilal et al. (2018) gave the implication of the need to have at least two financial experts within the audit committee and the obligation of its strengthening. Ashari & Krismiaji, (2020) found a positive relationship between audit committee financial expertise and financial performance. While the Aldamen et Al., (2011) concluded on their positive contribution to the performance of firms. Also, a higher proportion of financial experts in the audit committee positively impact firms’ financial performance (Kallamu & Saat, 2015; Chaudhry et al., 2020). However, Tanyi &S Smith (2015) concluded that the excessive engagement of audit committee members had a negative and significant impact on the supervision quality and the financial information quality. Krishnan (2005) discovered the presence of managers’ work experience, the tendency of management to commit fraud, the permanence of auditors, and financial stress indirectly associated with the audit committee that may have an impact on internal control. In the same sense, Abbott et al. (2004) revealed the presence of a negative relationship between audit committee financial expertise and errors detected in the financial statements. Thus, audit committees whose members have financial expertise, are more likely to be exposed to the impacts of internal control problems (Krishnan, 2005).

The concerns regarding the quality of financial reporting have raised questions regarding the effectiveness of the monitoring mechanism of companies. Fama (1980) suggests that the credibility and transparency of financial reporting of a company depends upon the monitoring mechanism of the company itself. Effective corporate governance mechanisms safeguard the rights of investors in getting true and fair information of the company (Rahman and Ali, 2006). One high-level governance device, which has been discharged in ensuring the quality of financial reporting, is the audit committee. This is because board of directors often delegates the responsibility for oversight of the financial statement reporting process to an audit committee (Beasley, 1996). What has been an issue of greater interest among academicians, investors and regulatory bodies are the effectiveness of audit committees in performing their functions. This is due to the fact that even though the formation of an audit committee is mandatory, their effectiveness as a governance mechanism may still be questionable. Moreover, from studies conducted in other countries, there have been sufficient evidence to conclude that the presence of an audit committee alone does not assure that the committee will perform their duties as expected.

Despite the increasing recognition of the vital role played by audit committees in enhancing corporate governance and financial oversight in other countries, there exists a notable gap in the understanding of the specific characteristics that define effective audit committees within the context of public limited companies in the Northwest, Littoral and central regions of Cameroon. The unique nature and challenges of the operations of public limited companies may necessitate a tailored set of characteristics for audit committees to positively impact financial performance. This gap in knowledge poses a significant challenge for stakeholders, including regulators, practitioners, and policymakers, as it hinders the development of targeted strategies to optimize the effectiveness of audit committees in public limited companies. Addressing this gap is crucial for fostering sustainable financial practices and ensuring the long-term success and stability of public limited companies in the Northwest and Littoral regions of Cameroon.

With all the arguments surrounding the audit committee characteristics in different countries and audit quality, this thesis will seek to sort out the effect of the audit committee characteristics and its effect on the audit quality of public limited companies in the Northwest and Littoral regions of Cameroon.

1.3 Research Questions

1.3.1 Principal Research Questions

What is the effect of audit committee characteristics on the internal audit quality of public limited companies in the Northwest, Littoral and Central regions of Cameroon?

1.3.2 Specific Research Questions   

1. What is the effect of audit committee independence on the internal audit quality of public limited companies in the Northwest, Littoral and Central regions of Cameroon?
2. What is the effect of audit committee size on the internal audit quality of public limited companies in the Northwest, Littoral and Central regions of Cameroon?
3. What is the effect of audit committee meetings on the internal audit quality of public limited companies in the Northwest, Littoral and Central regions of Cameroon?
4. What is the effect of audit committee financial expertise on the internal audit quality of public limited companies in the Northwest, Littoral and Central regions of Cameroon?
5. What is the effect of the audit committee gender on the internal audit quality of public limited companies in the Northwest, Littoral and Central regions of Cameroon?

1.4 Research Objectives

1.4.1 Principal research Objectives

To investigate the effect of audit committee characteristics on the internal audit quality of public limited companies in the Northwest, Littoral and Central regions of Cameroon1.4.2 Specific Research Objectives

1. To analyse the effect of audit committee independence on the internal audit quality of public limited companies in the Northwest, Littoral and Central regions of Cameroon
2. To examine the effect of audit committee size on the internal audit quality of public limited companies in the Northwest, Littoral and Central regions of Cameroon
3. To determine the effect of audit committee meetings on the internal audit quality of public limited companies in the Northwest, Littoral and Central regions of Cameroon
4. To evaluate the effect of audit committee financial expertise on the internal audit quality of public limited companies in the Northwest, Littoral and Central regions of Cameroon
5. To evaluate the effect of audit committee gender on the internal audit quality of public limited companies in the Northwest, Littoral and Central regions of Cameroon