Exploring How Audit Quality Bridges the Link between Board Audit Committee Financial Expertise and Financial Reporting Quality: Empirical Evidence from Kenyan Commercial Banks

Abstract

Financial reporting quality (FRQ) within the banking industry is of particular interest due to the importance of transparency, market confidence and financial stability. Banks are particularly prone to FRQ issues due to the high level of estimation within the accounting process such as loan loss provisions (LLP). In addition, low FRQ may mask risk and pose a threat to financial stability. This study sought to establish the mediating effect of audit quality on the relationship between board audit committee financial expertise and financial reporting quality (FRQ) among banks in Kenya. Anchored on Agency Theory, Stakeholder Theory and Resource Dependence Theory, the study adopted a positivist philosophy and an explanatory longitudinal panel research design. Secondary data were obtained from audited financial statements, annual reports, external audit reports and Central Bank of Kenya publications covering 2015–2024, and all analyses were based on this full balanced panel of 330 observations. Financial reporting quality was measured using absolute discretionary loan-loss provisions derived from a bank-specific loan-loss-provision model, with lower values indicating less reporting discretion and higher financial reporting quality. Audit quality was proxied by external audit fees. Mediation was tested using the Sobel test. The mediation results demonstrated that audit quality mediate the relationship between financial expertise (indirect β = 0.008, p < 0.05), meeting frequency (indirect β = 0.007, p < 0.05), independence (indirect β = 0.005, p < 0.05) and size (indirect β = 0.005, p < .05) and financial reporting quality. The study recommends that banks and regulators should strengthen substantive board audit committee financial expertise and engagement between Board Audit Committees and external auditors. The findings have the potential to provide policymakers and regulators with information highlighting the significance of strong audit board committee in the process of enhancing financial reporting quality. Keywords: Quality Audit, Audit Fees, Dimensions of Board Audit Committee, Quality of Financial Reporting, Discretionary Loan-Loss Write-offs, Mediation, Kenyan Banks