The association between audit quality, internal governance mechanisms and financial reporting quality : evidence from UAE

Abstract

The aim of this study is to investigate financial reporting quality in the United Arab Emirates (UAE) and the impact of audit quality and internal governance mechanisms (board of director including Royal family members and audit committee) on financial reporting quality. The study also tests whether internal governance mechanisms moderate the association between audit quality and financial reporting quality. Financial reporting quality in this study is measured by faithful representation and financial reporting timeliness. Faithful representation and financial reporting timeliness were proxied by earnings management, specifically discretionary accruals (DA), and total report lag (TRL), respectively. Three theories were applied to explain the hypotheses in this study namely, agency theory, resources dependence theory and elitism theory. The sample of the study consists of listed companies on the Abu Dhabi Securities Exchange (ADX) and the Dubai Financial Market (DFM) totalling 437 firm-years. This research’s study period was for eight years from 2011 to 2018, thus panel data were used in testing the hypotheses. Multivariate and hierarchical regressions were the main tests conducted to meet the research objectives of this study. The audit quality measures used in this study are audit size, audit fee, audit tenure and specialist auditor. The board of directors’ characteristics are royal family members on board, board size, frequency of board meetings, board meeting attendance, board independence and multiple directorships. Whereas audit committee’s characteristics are audit committee size, frequency of audit committee meetings, audit committee expertise and audit committee independence. Supporting elitism theory, the findings of the study showed that the existence of a Royal family member on the board of directors contributed towards deterring earnings management practices and expediting total report lag, hence enhancing financial reporting quality. In addition to royalty on board, audit committee expertise is found to be effective in hindering earnings management practices and shortening report lags. Moreover, board attendance and independence as well as audit committee size seem to promote timely financial reports. Then, in testing the moderating effect of board of directors and audit committee, generally, the findings showed that these internal governance mechanisms moderate the association between audit quality and financial reporting quality to a certain extent. The findings of this study could be of interest to investors and regulators as it reveals the financial reporting quality of listed companies in the UAE and the monitoring mechanisms, especially royalty on board, that are effective in augmenting the quality of financial reporting. This study should also be useful to future researchers as it has used and found support for elitism theory in accounting research. Furthermore, this study has extended the literature on corporate governance and financial reporting by testing the moderating effects of internal governance mechanisms on audit quality’s association with financial reporting quality, particularly in the context of the UAE.