Financial Instability Red Flag and Fraud Risk Detection: The Moderating Role of Board Independence in Listed Financial Institutions in Nigeria

Abstract

The persistence of fraudulent financial reporting among Nigerian financial institutions, despite regulatory reforms and corporate governance codes, motivates this study, which examines the effect of the Financial Instability Red Flag on fraud risk detection, the direct effect of board independence on fraud risk detection, and the moderating role of board independence on the financial instability fraud risk detection relationship. Financial instability, an accounting red flag recognised under ISA 240 Paragraph A35, reflects deteriorating financial condition arising from excessive debt obligations and is proxied by total liabilities divided by total assets. The study adopted a quantitative approach and an ex post facto research design, anchored on positivist philosophy, using panel data drawn from the audited annual reports of 42 listed Nigerian financial institutions from 2014 to 2024 (462 firm-year observations). Fraud risk detection was measured with the Dechow F-Score model, while board independence was measured as the proportion of independent directors to total board size. Data were analysed using descriptive statistics, correlation analysis, and panel regression, with firm size as a control variable. Findings show that Financial Instability Red Flag had a negative and statistically insignificant effect on fraud risk detection under the direct-effect model, but became positive and statistically significant once board independence and interaction terms were introduced. Board independence had a negative and statistically significant direct effect on fraud risk detection when first introduced as a moderator, but this effect became negative and statistically insignificant once the interaction terms were added; board independence also did not significantly moderate the financial instability-fraud risk detection relationship. The study concludes that financial instability is a context-dependent red flag whose fraud-signalling strength is sensitive to governance-model specification, while board independence, though theoretically expected to strengthen monitoring, has not translated into a consistent, statistically significant direct or moderating safeguard within Nigerian financial institutions. Regulators and boards should therefore strengthen financial stability monitoring and empower independent directors with stronger risk oversight mandates.