Internal Control Systems and Financial Reporting Quality: The Moderating Role of Firm Leverage in Non-Financial Firms Listed on the Nairobi Securities Exchange

Abstract

This study examined whether firm leverage moderates the association between internal control systems and financial reporting quality among non-financial firms listed on the Nairobi Securities Exchange (NSE). Financial reporting quality is essential to investor confidence and effective capital-market oversight, yet internal control systems may not deliver uniform outcomes across firms facing different financial pressures. The study used a positivist philosophy, a deductive approach and an explanatory longitudinal panel design. Secondary data were drawn from annual reports, audited financial statements and corporate-governance disclosures for 26 firms selected from a population of 39 non-financial listed firms that met the stated continuous-listing and data-availability criteria, covering 2010–2025 (416 firm-year observations). Internal controls were operationalised through an Internal Control Disclosure Index (ICDI) based on the five COSO components; leverage was measured as total liabilities divided by total assets; and financial reporting quality was proxied by the inverse of discretionary accruals estimated using the modified Jones model. Fixed-effects panel regression with firm-clustered robust standard errors showed a positive association between the ICDI and reporting quality (β = 1.497, p < .001) and a positive direct association between leverage and reporting quality (β = 0.566, p < .001). The interaction term was negative and statistically significant (β = −1.767, p < .001), indicating that the positive association between disclosed internal controls and reporting quality weakened as leverage increased. The study recommends that regulators, boards and lenders should assess internal-control disclosures alongside leverage exposure. This study provides evidence on how internal controls affect financial reporting quality, accountability, and the reliability of financial information.