CEO characteristics, audit committee financial expertise and fraudulent financial reporting among listed manufacturing firms in East Africa

Abstract

Fraud-related losses affect both small businesses and large corporations. According to the 2020 PwC Kenya Global Economic Crime and Fraud Survey, Kenyan firms have lost a total of Ksh.5.5 billion in the last 24 months due to fraudulent financial reporting. Therefore, this study sought to evaluate the effect of CEO’s characteristics on fraudulent financial reporting and the moderating role of audit committee financial expertise on the relationship between CEO’s characteristics and fraudulent financial reporting of listed manufacturing firms in East Africa. Specifically, the study assessed the effect of CEOs; tenure, age, compensation and shareholding on fraudulent financial reporting and the moderating role of audit committee financial expertise on the relationship between CEO’s characteristics and fraudulent financial reporting. The study was anchored on the Fraud Pentagon, upper echelon and agency theories. Explanatory research design and longitudinal research design was employed in this study where secondary panel data was obtained through content analysis from audited financial statements spanning from 2007 to 2021. The study targeted listed manufacturing firms in East Africa during the study period and only firms that met the inclusion and exclusion criteria were retained. After applying the inclusion/exclusion criteria only 15 manufacturing firms formed the study population. Data was analysed using descriptive and inferential statistics with the significance of each independent variable being tested at 95% confidence level. The random effect regression results showed that CEO age (β1 = -.433, p=.004<.05) and CEO shareholding (β4 = .171, p=.002<.05) had negative and significant effect on fraudulent financial reporting in manufacturing firms in East Africa. However, CEO compensation (β3 =.892, p=.000<0.05) had positive and significant effect on fraudulent financial reporting. Audit committee financial expertise had a buffering interaction effect on the relationship between CEO age (β=-079; p=.000<.05), CEO compensation (β=-.149; p=.000<.05) and fraudulent financial reporting, while audit committee financial expertise had enhancing interaction effect on the relationship between CEO shareholding (β= .020; p=.026<.05) and fraudulent financial reporting. Thus, the study concluded that manufacturing firms with CEOs with older age and higher CEO shareholding have low probability of engaging in fraudulent financial reporting, while firms with CEO with higher compensation have high probability of engaging in fraudulent financial reporting. Based on the findings, the study recommends that manufacturing firms should have older CEOs as compared to young CEOs, should increase CEOs shareholding in the company, should ensure that the audit committee has financial expertise and should reduce CEOs compensation in order to alleviate fraudulent financial reporting in manufacturing firms in East Africa. Since the study focused on listed manufacturing firms in East Africa only; hence, future studies could incorporate other companies such as banks, agricultural allied listed firms and construction allied firms so that the findings provide an overview status of adoption and application of CEO characteristics to fraudulent financial reporting. The study used Beneish M-Score model of examining the fraudulent financial reporting. Future research could employ different measure for fraudulent financial reporting such as the F score model