CHAPTER ONE INTRODUCTION 1.1 Background to the Study
The issues of corporate governance have continued to attract considerable national and international attention over the years. The shocking accounting scandals of the 2001 perpetuated by Enron, Xerox, and WorldCom have placed the credibility of corporate financial reports under suspicion, and furthermore, eroding investors’ confidence. Thus, the issue of corporate governance has become paramount and centre of the agenda for both business leaders and regulators all over the world following the global financial crisis which has provided many illustrations of the collapse of corporate governance, consequently, the international regulators are hard at work to influence appropriate regulatory controls (Jegede, Akinlabi and Soyebo, 2013).
As a follow up to this, the Sarbanes-Oxley Act was enacted in 2002 to enhance corporate government mechanism which is viewed as the priority of financial revolution, in the expectation that governance mechanism may be reinforced,
public confidence retrieved, accuracy and reliability of financial information assured (Ming-Cheng, Hsin-chaing, I-cheng & Chun-feng, 2008).
Corporate governance is about putting in place the structure, processes and mechanisms that insure that the firm is being directed and managed in a way that enhances long term shareholder value through accountability of managers and enhancing firm performance (Jegede, Akinlabi and Soyebo, 2013). In other words, through such structure, processes and mechanisms, the well- known agency problem (which results from the separation of ownership from management and leads to conflict of interests within the firm) may be addressed such that the interest of managers can be aligned with those of the shareholders.
In Nigeria, It was discovered by the Securities and Exchange Commission (SEC) (a regulatory organ responsible for the supervision of corporations in Nigeria) in 2003 states that, poor corporate governance was one of the major factors in virtually all known instances of financial institutions’ distress in the Nigerian financial sector. It was also found that only about 40%
of quoted companies, including banks, had recognized codes of corporate governance in place (Ahmad & Kwanbo, 2012).
Consequently, in 2003, SEC in collaboration with the Corporate Affairs Commission released a code of corporate governance. Banks were expected to comply with the provisions of the code. In addition to that, banks were further directed to comply with the Code of Corporate Governance for Banks and Other Financial Institutions approved earlier in the same year by the Bankers’ Committee. However, in 2006, the consolidation of the banking industry necessitated a review of the existing code for the Nigerian Banks. A new code was therefore, developed to compliment the earlier ones and enhance their effectiveness for the Nigerian banking industry. Compliance with the provisions of the Code was mandatory.
The reforms carried out by the CBN in the banking sector as well as the code issued by the SEC were to bring about optimized corporate governance practices in the industry (Ahmad & Kwanbo, 2012). However, in 2008, the CBN and the Nigerian Deposit Insurance Company (NDIC) carried out a stress test in the banking industry. The stress test revealed some
unwholesome developments in the banking industry which were as a result of noncompliance with the corporate governance code by some banks (Ahmad & Kwanbo, 2012). This study therefore seeks to investigate the impact of corporate governance mechanism on the performance of banks.
1.2 Statement of the problem
The integrity of financial reporting has been a consistent concern among regulators and practitioners, especially after high-profile accounting scandals involving once well-respected companies such as Enron, WorldCom and Xerox (Zhou & Chen, 2004) and the Nigerian recapitalization exercise of the CBN in 2005. This has thus; rekindle the interest of researchers in recent years to examine the impact of corporate governance on the performance of firms (e.g. Macey and O’Hara, 2003; Levine, 2004; Adams and Mehran, 2008; Larcker, 2007; Caprio et al., 2007, Taiwo & Okorie, 2013; Mohammed, 2012; Akpan & Riman, 2012, Ajala, Amuda and Arulogun, 2012 and Obeten, Ocheni, & Sani, 2014).
Concerned about the dwindling loss of confidence by investors in commercial banks due to absence of good corporate
governance, the CBN in 2004 made it compulsory for all commercial banks to have sound corporate governance in their respective banks.
However, there are absence of consensus amongst empirical studies that seek to examine the relationship between corporate governance and firm’s performance especially as regards the Nigerian banking sector. This could be explained by the use of different corporate governance measures by different researchers in different economic environment. There is therefore need to examine relationship between corporate governance and performance of firms in a typical economic environment in Nigeria.
In the light of the forgoing, this present seeks to empirically examine the impact of corporate governance on the performance of commercial banks in Nigeria.
1.3 Objectives of the Study
The main objective of this study is to empirically examine the extent to which corporate governance mechanism affects the performance of commercial banks in Nigeria. This study
specifically seeks to accomplish the following specific objectives.
1. To examine the relationship between board size and the return on equity (ROE) of commercial banks in Nigeria. 2. To examine the relationship between audit committee
independence and the return on equity (ROE) of commercial banks in Nigeria.
3. To examine the relationship between size of audit committee and the return on equity (ROE) of commercial banks in Nigeria.
1.4 Research Questions
The study specifically seeks for answers to the following questions via findings.
1. To what extent is the relationship between board size and the return on equity (ROE) of commercial banks in Nigeria? 2. To what extent is the relationship between audit committee
independence and the return on equity (ROE) of commercial banks in Nigeria?
3. To what extent is the relationship between size of audit committee and the return on equity (ROE) of commercial banks in Nigeria?
1.5 Research Hypotheses
The following null hypotheses have been formulated for this study.
Ho1: There is no significant relationship between Board size the return on equity (ROE) of commercial banks in Nigeria.
Ho2: There is no significant relationship between audit committee and the return on equity (ROE) of commercial banks in Nigeria.
Ho3: There is no significant relationship between audit committee and the return on equity (ROE) of commercial banks in Nigeria.
1.6 Significance of the Study
The research provides management/owners of banks, shareholders and other stake holders with valuable information to reach a better understanding on the extent to which corporate governance impact on banks’ performance.
This study will also be of benefit to the regulatory bodies like the Security and exchange commission (SEC) and the central bank of Nigeria (CBN) in a way that it will avail them with
valuable insight on how sound corporate governance mechanism could turn to impact performance of firms in Nigeria thus re-engineering the need to strengthen corporate governance in banks.
In addition, the government will also be made to understand the need to strengthen regulatory agencies saddled with the responsibility of issuing sound corporate governance in Nigeria.
More so, the study will also be of immense important in the sense that it will add more statistical data to prior studies; this will help to serve as a reference point to students, researchers and the academia who desired to carry out further research on related topics.
1.7 Scope of the Study
The scope of this study covers all the 21 commercial banks quoted on the Nigerian stock exchange as at 2005. The scope in relation to time covers a period of 8 years (i.e. from 2005-2013). The choice of this period is due to the researcher’s belief that the period will provide findings that reflect current realities in the banking sector.
CHAPTER TWO LITERATURE REVIEW 2.1 Introduction
This chapter looks at review of related literature on the impact of corporate governance mechanism on banks’ performance. The chapter will focus on conceptual frame work, theoretical framework, an over view of corporate governance, importance of corporate governance in the Nigerian baking industry review of empirical works and summary of review.
2.2 Theoretical Frame Work
An understanding of corporate governance proceeds from an examination of a number of theories that attempt to explain the basis and rationale behind this management imperative. According to Anthony, (2007) these theories include the following: Agency theory, Stakeholders theory, Stewardship theory and Resource dependency theory. These theories are succinctly examined below:
2.2.1 Agency Theory
It is an acknowledged fact that the principal-agent theory is generally considered the starting point for any debate on the issue of corporate governance emanating from the classical thesis on the modern and private property by Berle and Means, (1932). According to this thesis, the fundamental agency problem in modern firms is primarily due to the separation between finance and management. Modern firms are seen to suffer from separation of ownership and control and therefore
are run by professional managers (agents) who cannot be held accountable by dispersed shareholders.
In this regard, the fundamental question is how to ensure that managers follow the interest of shareholders in order to reduce cost associated with principal agent theory? The principals are confronted with two main problems. Apart from facing an adverse selection problem in that they are faced with selecting the most capable managers, they are also confronted with a moral hazard problem; they must give agents (managers) the right incentive to make decisions aligned with shareholders interest.
In further explanation of the agency relationships and cost, Jensen & Meckling, (1976) describe agency relationship as a contract under which “one or more persons (agent) to perform some service on their behalf, which involves delegating some decision making authority to the agent”. In this scenario there exist a conflicting of interests between managers or controlling shareholders, and outside or minority shareholders leading to the tendency that the former may extract “perquisites” or
pursue new profitable ventures. Agency costs include monitoring expenditures by the principal such as auditing, budgeting, control and compensation systems, bonding expenditures by the agent and residual loss due to divergence of interests between the principal and the agent. The share price that (principal) pay reflects such agency costs. To increase firm’s value, one must therefore reduce agency costs. The following represent the key issues towards addressing opportunistic behaviour from managers within the agency theory:
2.2.2 Stakeholder Theory
One argument against the strict agency theory is its narrowness by identifying shareholders as the only interested parties, the stakeholder theory stipulate that a corporate entity invariably seeks to provide a balance between the interest of its diverse stakeholder in order to ensure that each constituency receives some degree of satisfaction (Abrams, 1951). The stakeholder theory therefore appears better in explaining the role of corporate governance than the agency theory by highlighting various constituents of a firm. Thus creditors, customers,
employees, banks, governments and society are regarded as relevant stakeholders.
Related to the above discussion, John and Senbet (1998), provide a comprehensive review of the stakeholder’s theory of corporate governance which points out the presence of many parties with competing interest in the operations of the firm. They also emphasis the role of non-market mechanism such as size of the board, committee structure as important to firm performance
Stakeholder theory has become more prominent because many researchers have recognize that the activities of a corporate entity impact on the external environment requiring accountability of the organization to a wider audience than simply its shareholders alone but exist within the society and therefore, has responsibilities to that society. One must however point out that large recognition of this fact has rather been a recent phenomenon. Indeed it has realized that economic value is created by people who voluntarily come together and corporate to improve every one’s position (Freeman et al, 2004
Critique of the stakeholder’s theory criticize it for assuring a single-valued objective (gains that accrue to the firm’s constitutions). The argument of Jensen (2001) suggests that the performance of a firm is not and other issues such as flow of information from senior management to lower ranks, inter-personal relations, working environment etc. are all critical issues that should be considered.
An extension of the theory called an enlightened stakeholder
theory was proposed. However, problems relating to empirical
testing of the extension have limited its relevance (Sanda et al, 2005).
2.2.3 Stewardship Theory
This theory, arguing against the agency theory posits that managerial opportunism is not relevant (Donaldson and Donaldson, 1991; Daris, Choorman and Donaldson, 1997;Muth and Donaldson, 1998).
According to the steward theory, a manager’s objective is primarily to maximize the firm’s performance because a manager’s need of achievement and success are satisfied when
the firm is performing well. One key distinguishing feature of the theory of stewardship is that it replace theory refers with respect for authority and inclination to ethical behaviour. The theory considers the following summary as essential for ensuring effective corporate governance in entity.
Board of Directors: the involvement of non-executive directors (NEDS) is viewed as critical to enhance the effectiveness of the boards activities because executive directors fully enhance decision making and ensure the sustainability of the business.
Leadership: Contrary to agency theory, the stewardship theory stipulates that the positions of CEO and boards chair should be concentrated in the same individual. The reason being that it affords the CEO the opportunity to carry through decision quickly without the hindrance of undue bureaucracy. We must rather point out that this position has been found to create higher agency costs. The argument is that when governance structures are effectively working, there should not be undue bureaucratic delays in any decision-making.
Board Sizes: Finally, it is argued that small board size should be encouraged to promote effective communication and decision-making. However, the theory does not stipulate a rule for determining the optimal board size and for that matter what constitute small.
Resource Dependency Theory: This theory introduces accessibility to resources, in addition to the separation of ownership and control, as a critical dimension to the debate on corporate governance.
Again the theory points out that organization usually tend to reduce the uncertainty of external influence by ensuring that resources are available for their survival and development. By implication, this theory seems to suggest that the issue of dichotomy between executive and non-executive directors is actually irrelevant. How then does a firm operate efficiently? To resolve this problem, the theory indicates that what is relevant is the firm’s presence on the boards of directors of the organizations to establish relationships in order to have access to resources in the form of information which could then be utilized to the firm’s advantage. Hence, this theory shows that
the strength of a corporate organization lies in the amount of relevant information it has at its disposal.
In the height of the foregoing analysis, it is clear that governance mechanism seeks to protect the interest of all stakeholders of a firm. In recent times, the structures of laws and accountability issues regarding corporate governance is changing world wide and directors are being held responsible every day for the success and failures of the companies the governance.
Corporate boards are responsible for major decisions like changing corporation by laws, issues of shares, declaiming dividends etc. this explains to some extent, the reason why discussions of corporate governance usually focus on boards. The board of directors is the “apex” of the controlling system in an organization and is there to ensure that the interests of shareholders are protected (Jensen 1993 and Short et al, 1998). It acts as the fulcrum between the owners and controllers of the corporation (Monks and Minow, 2001) and regarded as the single most important corporate governance mechanism (Blair,
managers of a company are accountable before the law for the company’s activities Oxford Analytical Ltd 1992: 7).
2.3 Conceptual Frame work
2.3.1 Concept of Corporate Governance
Corporate governance relates to relationship between firm’s various legitimate stakeholders. Corporate governance is about making certain that the company is directed appropriately for reasonable return on investments (Magdi and Nadereh, 2002). It is considered to be a process in which affairs of the firm are directed and controlled so as to protect the interest of all stakeholders (Sullivan, 2009). The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation such as, the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs (Uche, 2004 and Akinsulire, 2006).
Corporate governance is concerned with the processes, systems, practices and procedures that govern institutions. It is also concerned with the resolution of collective action problems among dispersed investors and the reconciliation of conflicts of
interest between various corporate claim holders, corporate governance rules can be seen as the outcome of the contracting process between the various principals or constituencies and the CEO (Becht et al, 2005).
There are other perspectives on corporate governance, the corporation’s perspective and the public policy perspectives. The corporation’s perspective is about maximizing value subject to meeting the corporation’s financial, legal, contractual, and other obligations. This perspective stresses the need for boards of directors to balance the interests of shareholders with those of other stakeholders: employees, customers, suppliers, investors, etc.
In order to achieve long term sustained value for the corporation. From a public policy perspective, corporate governance is about nurturing enterprises while ensuring accountability in the exercise of power and patronage by firms. The role of public policy is to provide firms with the incentives and discipline to minimize the divergence between private and social returns and to protect the interests of stakeholders. These two perspectives provide a framework for corporate
governance that reflects the interplay between internal incentives and external forces that govern the behavior and performance of the firm (Iskander, Magdi and Chamlou, 2000). 2.3.2 Overview of Bank Corporate Governance in Nigeria Effective corporate governance practices are essential to achieving and maintaining public trust and confidence in the banking system, which are critical to proper functioning of the banking sector and economy as a whole. Poor corporate governance may contribute to bank failures, which could lead to a run on the bank, unemployment and negative impact on the economy.
Effective corporate governance is likely to give a bank access to cheaper sources of funding through improving their reputation with rating agencies, customers and investors. The corporate governance landscape in Nigeria has been dynamic and generating interest from within and outside the country.
In 2003, the Securities and Exchange Commission (SEC) adopted a Code of Best Practices on Corporate Governance for publicly quoted companies in Nigeria. At the end of the consolidation exercise in the banking industry, the CBN in March
2006 released the Code of Corporate Governance for Banks in Nigeria, to complement and enhance the effectiveness of the SEC code. The three major governance issues that attracted the attention of the regulators are related party transactions, conflict of interest and creative accounting.
Globally, corporate governance practices in the banking industry have attracted special attention because of the importance of the industry to most economies. This led to the Organization for Economic Co-operation and Development (OECD) playing active role in defining guidelines for corporate governance in the banking industry through its Basel Committee on Banking Supervision.
According to the Basel Committee on Banking Supervision (2006), corporate governance from a banking industry perspective involves the manner in which the business and affairs of banks are governed by their boards of directors and senior management, which affects how they:
Set corporate objectives;
Meet the obligation of accountability to their shareholders and take into account the interests of other recognized stakeholders;
Align corporate activities and behaviour with the expectation that banks will operate in a safe and sound manner, and in compliance with applicable laws and regulations; and
Protect the interests of depositors.
The Basel Committee on Banking Supervision came up with the following principles, which are viewed as important elements of an effective corporate governance process.
Principle 1 – Board members should be qualified for their positions, have a clear understanding of their role in corporate governance and be able to exercise sound judgment about the affairs of the bank.
This is because the board of directors is ultimately responsible for the operations and financial soundness of the bank. In addition the board and individual directors can strengthen the corporate governance of a ban when they do the following:
Understand and execute their oversight role;
Approve the overall business strategy of the bank;
Avoid conflict of interest in their activities;
Commit sufficient time and energy to fulfilling their responsibilities;
Periodically assess the effectiveness of their own governance practices;
Avoid participation as the board of directors in day-to-day management of the bank.
For effective corporate governance boards are expected to function with specialized committees which include Audit committee, Risk management committee, Compensation committee, and Nomination/corporate governance committee. Principle 2 – The board of directors should approve and oversee the bank’s strategic objectives and corporate values that are communicated throughout the banking organization. This implies that the board must set the “tone at the top” and build a corporate culture that will drive good corporate
governance. The board of directors should ensure that senior management implements the agreed strategy of the bank and strategic policies and procedures designed to promote professional behavior and integrity in the bank.
Principle 3 – The board of directors should set and enforce clear lines of responsibility and accountability throughout the bank. This means that the authorities and key responsibilities of the board and senior management are very clear to avoid confusion.
Principle 4 – The board should ensure that there is appropriate oversight by senior management consistent with board policy. Principle 5 – The board should ensure that compensation policies and practices are consistent with the bank’s corporate culture, long-term objectives and strategy, and control environment.
Principle 6 – The bank should be governed in a transparent manner since transparency is essential for sound and effective corporate governance.
The Basel Committee recognizes that primary responsibility for good corporate governance rests with the board of directors and senior management of banks.
2.3.3 Corporate Governance Mechanism and Bank Performance Measures
Prior studies on the relationship between corporate governance mechanisms and corporate performance are seen to include various internal and external mechanisms, among which board size, board composition, board committees, CEO’s position-duality, CEO’s incentives and ownership interest, ownership concentration of insiders and outsiders, multiple directorships, debt financing, market for corporate control etc. are mentionable. However, this section of the chapter reviews only mechanism relevant to the scope of this study. These include: Board size, CEO duality, Audit committee independent, size of the audit committee, company size and debt financing
1. Board Size
Board size refers to the total number of directors on the board of any corporate organization. While a number of authors have
recommended large board size, there are others who believe that a small board size is the ideal thing for any firm that wants to sustain improved performance. Determining the ideal board size for organizations is very important because the number and quality of directors in a firm determines and influences the board functioning and hence corporate performance.
There is a convergence of agreement on the argument that board size is associated with firm performance. However, conflicting results emerge on whether it is a large, rather than a small board, that is more effective. For instance, while Yermack (1996) had found that Tobin’s Q declines with board size, and this finding was corroborated by those of Mak and Kusnadi (2005) and Sanda, Mikailu and Garba (2005) which showed that small boards were more positively associated with high firm performance. However, results of the study of Kyereboah-Coleman (2007) rather indicated that large boards enhanced shareholders’ wealth more positively than smaller ones.
Ogbechie, (2011) reveal that the average size of the boards of Nigerian banks is 14 directors, with the smallest having 8 directors and the largest 20 directors. A board size of 16
directors is the most popular. The Central bank of Nigeria (CBN) corporate governance code for banks operating in Nigeria recommend a maximum board size of 20 directors. All the banks are compliant. However, United Bank for Africa Plc has applied to the CBN for approval to increase their board size to 24.
2. CEO Duality
Separation of office of board chair and CEO Separation of office of board chair from that of CEO generally seeks to reduce agency costs for a firm. Kajola (2008) found a positive and statistically significant relationship between performance and separation of the office of board chair and CEO. Yermack (1996) equally found that firms are more valuable when different persons occupy the offices of board chair and CEO. Kyereboah-Coleman (2007) proved that large and independent boards enhance firm value, and the fusion of the two offices negatively affects a firm’s performance, as the firm has less access to debt finance. The results of the study of Klein (2002) suggest that boards that are structured to be more independent of the CEO are more effective in monitoring the corporate financial
accounting process and therefore more valuable. Fosberg (2004) found that firms that separated the functions of board chair and CEO had smaller debt ratios (financial debt/equity capital). The amount of debt in a firms’ capital structure had an inverse relationship with the percentage of the firm’s common stock held by the CEO and other officers and directors. This finding was corroborated by Abor and Biekpe (2005), who demonstrated that duality of the both functions constitute a factor that influences the financing decisions of the firm. They found that firms with a structure separating these two functions are more able to maintain the optimal amount of debt in their capital structure than firms with duality. Accordingly, they argued that a positive relationship exists between the duality of these two functions and financial leverage.
2. Audit Committee
Consistent with the agency theory, audit committee works as an additional control mechanism that ensures that the shareholders’ interests are being safeguarded. In consistent with the Cadbury proposal as to formation of audit committee, Central Bank of Nigeria and SEC have made it compulsory for all
banks to constitute a board’ audit committee consisting of a minimum of seven (7) members and it will hold at least three meetings in a year.
The committee will review the financial reporting process, the internal control system and management of financial risks, the audit process, conflicts of interest, infringement of laws etc. Thus, audit committee works as another internal control mechanism in the board structure, ‘the impact of which should be to improve the quality of the financial management of the company and hence its performance’ (Weir et al, 2002).
Although results of Klein (2002) and Anderson, Mansi and Reeb (2004) showed a strong association between audit committee and firm performance, Kajola (2008) found no significant relationship between both variables. This lack of consensus presents scope for deeper research on the impact of this corporate governance variable.
This means the total number of directors on the audit committee board. Bedard et al (2004) argue that it is important to increase the number of members of the audit committee to ensure more effective control of accounting and financial processes. Similarly Pincus et al (1989) show that firms with larger audit committees are expected to devote greater resources to monitor the process of “reporting” accounting and finance. In the same furrow, Anderson et al (2004) found that large size audit committees can protect and control the process of accounting and finance with respect to small committees by introducing greater transparency with respect shareholders and creditors which has a positive impact on the financial performance of the company.
4. The Independence of Audit Committee Members
The report of the Blue Ribbon Committee (BRC) considers independence as an essential quality of the audit committee in order to fulfill its oversight role. Indeed, this report argues that several recent studies have identified a correlation between the independence of the audit committee, the level of supervision and the level of fraud in the financial statements Several
previous studies use the percentage of outside directors to measure independence like Marrakchi et al (2001) and Bradbury et al (2006). In effect, these studies note that audit committees composed mostly or exclusively by outside directors are more independent than other committees.
Similarly, Klein (2002) shows that following the publication of the BRC, the NYSE and NASDAQ have changed their requirements concerning the audit committee. Indeed these amendments concern the obligation to establish at least three independent directors on the audit committee for listed companies. Bryan et al (2004) find that the independence of the audit committee has a positive influence on the quality of earnings.
In addition, in a study on the main characteristics of audit committees, Keasey et al (1993) show that the independence of the members of the audit committee is the most important criterion with effect on the reliability of financial statements. 4. Company Size
The size of company (proxied by total assets) is considered in this study as control variable to have a relationship with other
factors, for example, ‘there is a strong relationship between firm size and CEO compensation’ (e.g., Murphy, 1985). The literature is in harmony with this tendency. On average, larger companies are better performers as they are able to diversify their risk (Ghosh, 1998).
Furthermore, larger company has larger market share and market power in respect of customers and volume of investment. Larger firms have larger investor’s bases than smaller ones. Again, company size may be measured in different ways such as sales turnover, total assets, capital employed, etc.
In this study, total assets have been used as the measure of company size. Actually, to measure the magnitude of a company, total assets is such a determinant that may preferably be used than other measures as the accounting measure because sometimes a medium firm may have larger sales volume, for example, due to increase in assets turnover.
Debt financing or leverage may play a significant role in governance mechanisms especially in the banking sector for two unique characteristics of banks: Opacity and strong regulations. Due to opacity, depositors do not know the true value of a bank’s loan portfolio as such information is incommunicable and very costly to reveal, implying that a bank’s loan portfolio is highly fungible (Bhattacharya et al., 1998).
As a consequence of this asymmetric information problem, bank managers have an incentive each period to invest in riskier assets than they promised they would ex ante (Arun and Turner, 2003). The opaqueness of banks also makes it very costly for depositors to constrain managerial discretion through debt covenants (Capiro and Levine, 2002).
Referring different studies Haniffa and Hudaib (2006) assert that ‘debt forces managers to consume fewer perks and become more efficient to avoid bankruptcy, the loss of control as well as loss of reputation (Grossman and Hart, 1982).
Debt contracting may also result in improved managerial performance and reduced cost of external capital (John and Senbet, 1998). In short, debt may help yield a positive disciplinary effect on performance.
On the other hand, debt can increase conflicts of interest over risk and return between creditors and equity holders.’ Like other variables, relationship of gearing ratio with performance shows conflicting results in different studies.
Dowen (1995), McConnell and Servaes (1995), Short and Keasey (1999) and Weir et al. (2002) found a significant negative relationship between gearing and corporate performance. However, Hurdle (1974) found gearing to affect profitability positively.
2.3.4.2 Bank Performance Measures
A company’s operations and successfulness are integrally connected. Studies show that then concept of company’s performance is multidimensional. But the fact is that the company’s investors, shareholders and other stakeholders find
its successfulness in the financial performance. The financial performance measures can be divided into two major types:
1. Accounting- based measures (e.g., Return on Assets, Return on Equity, or Return on Sales), and
2. Market- based measures (e.g. Tobin’s Q ratio).
There has been extensive empirical research using different performance measures for examining the relationship between corporate governance and firms’ performance. There are some researches where either accounting-based measure or market-based measure has been used but some researchers have used both the measures. When both the measures have been used, almost all the researchers have found significant relationship with one measure but no relationship with other measures. This may be attributed for using different type of numerators and denominators used for calculating financial performance.
Different researchers argue differently in favour of their using measurement base. Some argue that if the capital market is unstructured and much volatile, Tobin’s Q ratios of different companies give misleading results. Accounting measures have been criticized on the grounds that they are subject to
manipulation, that they may systematically undervalue assets as a consequence of accounting conservatism and that they may create other distortions as well (Sanchez-Ballesta and Garcia-Meca, 2007).
Joh (2003) argues that accounting profitability is a better performance measure than stock market measures for at least three reasons. First, market anomalies may act as an impediment to all available information being reflected in the stock price. Second, a firm’s accounting profitability is more directly related to its financial survivability than is its stock market value. Finally, accounting measures allow users to evaluate the performance of privately held firms as well as that of publicly traded firms.
2.4 Review of Empirical Studies
There exist a plethora of studies that seek to examine the influence of corporate governance on firm’s performance. This section of the chapter examines some of these studies.
Yinusa and Babalola (2012) investigated the interaction between corporate governance mechanisms and capital structure decisions of Nigerian firms. Panel data methodology
was employed to analyse the data for the selected foods and beverages companies and the results show that corporate governance has important implications on the financing decisions. They concluded that corporate governance can greatly assist the food and beverages sector by infusing better management practices, effective control and accounting systems, stringent monitoring, effective regulatory mechanism and efficient utilization of firms’ resources resulting to improved performance if it is properly and efficiently practice.
Abdul-Qadir and Kwanbo, (2012) studied corporate Governance and Financial Performance of Banks in the post-consolidation era in Nigeria using data from the period 2006-2010. The study employed the use of t-test and ANOVA to test the three hypotheses formulated for the study. Findings revealed a significant impact of dispersed equity on the profitability of banks and an insignificant impact of board size on profitability. Mohammad, Islam and Ahmed, (2011) empirically investigated the influence of corporate governance mechanisms on financial performance of 25 listed banking companies in Bangladesh over the period 2003- 2011. Estimated results demonstrate that the
general public ownership and the frequencies of audit committee meetings are positively and significantly associated with return on assets (ROA), return on equity (ROE) and Tobin’s Q while Directors’ ownership and independent directors have significant positive effects on bank performance measured by Tobin’s Q.
Mohammed, (2012) in a related study investigated the Impact of Corporate Governance on Banks Performance in Nigeria. The study made use of secondary data obtained from the financial reports of nine (9) banks selected for a period of ten (10) years (2001- 2010). Data were analyzed using multiple regression analysis. Finding revealed that corporate governance positively affects performance of banks. The findings of the study further show that poor asset quality (defined as the ratio of non-performing loans to credit) and loan deposit ratios negatively affect financial performance and vice visa.
Ogbechie, (2011) studied corporate governance practices in Nigerian banks with regards to board characteristics, performance, culture and processes, and board effectiveness. The study also attempted to identify the level of compliance of
Nigerian banks to the Central Bank of Nigeria (CBN) code of corporate governance for banks operating in Nigeria. Empirical findings indicate that boards of Nigerian banks frequently undertake evaluation of their activities as a means of improving performance. It was also revealed that almost all the banks have been compliant with nearly all the Central Bank of Nigeria (CBN) corporate governance guidelines.
Cheng Wu, Chiang Lin, Cheng Lin and Chun-Feng, (2008) examined the impact of the corporate governance mechanism on firm performance. Return on assets, stock return and Tobin’s Q were the variables used in the regression model to measure firm’s performance. The empirical results indicate that firm performance has negative and significant relation to board size, CEO duality, stock pledge ratio and deviation between voting right and cash flow right. On the other hand, firm performance has a positive and significant relation to board independence and insider ownership.
Ahmad, (2003) investigated the impact of corporate governance on banking performance in Pakistan. The study measured efficiency of banks using Cobb-Douglas cost function
for the year 2000-2002. It is evident from the results that on average, overall efficiency remains about 82 percent throughout the period of analysis. However, it is observed that public ownership show lowest efficiency among all the groups i.e., 74 percent on average, which emphasizes on a competitive environment in the banking sector that may improve the efficiency of these institutions. Similarly, market share also affects the performance of banks negatively, suggesting that banks in a less competitive environment might feel less pressure to control their costs. Moreover, introduction of governance variables such as sound management and concentration have significant impact on banking efficiency. Omankhanlen et al (2013) investigated the role of corporate governance in the growth of Nigerian Banks. A multiple linear regression analysis involving ordinary least square was employed to test the hypotheses. The statistical significance of the variables was first determined using ANOVA statistics. The findings reveal that the problems of corporate governance in the Nigerian banking sector include: instability of board tenures, board squabbles, ownership crises, high level of insider dealings
While the weaknesses of corporate governance have been identified to include ineffective board oversight functions, disagreement between boards and management giving rise to board squabbles, lack of experience on the part of the Board of director’s members and weak internal control.
Adeyemi and Ajewole (2004) examine corporate governance issues and challenges in the Nigerian banking sector. Both primary and secondary sources of data were made use of. The primary data collected through the use of questionnaire were analyzed using simple descriptive statistics. Findings from the study showed that the Nigerian banking sector is yet to learn from the sad consequences of poor corporate governance of the period between 1994-2003 in particular.
Akpan and Riman (2012) examined the relationship between corporate governance and banks profitability in Nigeria. The study discovered that good corporate governance and not assets value determine the profitability of banks in Nigeria. Ayorinde et al (2012) examined the effects of corporate governance on the performance of Nigerian banking sector. The secondary source of data was sought from published annual
reports of the quoted banks. The Person Correlation and the regression analysis were used to find out whether there is a relationship between the corporate governance variables and firms performance. The study revealed that a negative but significant relationship exists between board size and the financial performance of these banks while a positive and significant relationship was also observed between directors’ equity interest, level of corporate governance disclosure index and performance of the sampled banks.
Onakoya (2011) examines the impact of corporate governance on bank performance in Nigeria during the period 2005 to 2009 based on a sample of six selected banks listed on Nigerian Stock Exchange market making use of pooled time series data. Findings from the study revealed that corporate governance have been on the low side and have impacted negatively on bank performance. The study therefore contends that strategic training for board members and senior bank managers should be embarked or improved upon, especially on courses that promote corporate governance and banking ethics.
Ganiyu and Abiodun (2012) examined the interaction between corporate governance mechanisms and capital structure decisions of Nigerian firms by testing the corporate governance and capital structure theories using sample of ten selected firms in the food and beverage sector listed on the Nigeria Stock Exchange during the periods of 2000 – 2009. Panel data methodology was employed to analyse the data for the selected foods and beverages companies and the results show that corporate governance has important implications on the financing decisions. Corporate governance can greatly assist the food and beverages sector by infusing better management practices, effective control and accounting systems, stringent monitoring, effective regulatory mechanism and efficient utilization of firms’ resources resulting in improved performance if it is properly and efficiently practiced.
Hoque et al (2012) empirically investigated the influence of corporate governance mechanisms on financial performance of 25 listed banking companies in Bangladesh over the period 2003-2011. Estimated results demonstrate that the general public ownership and the frequencies of audit committee
meetings are positively and significantly associated with return on assets (ROA), return on equity (ROE) and Tobin’s Q. Directors’ ownership and independent directors have significant positive effects on bank performance measured by Tobin’s Q. Chiang (2005) argues that as the independent directors are more specialized to monitor the board than the inside directors to run the business successfully by reducing the concentrated power of the CEO, it helps the company to prevent misuse of resources and enhance performance.
Krivogorsky (2006) also observes significant positive relationship between independent directors and performance of 81 European companies. In contrast, directors who are unrelated to the firm may lack the knowledge or information to be effective monitors. Yermack (1996), Agrawal and Knoeber (1996) and Bhagat and Black (1998) find a negative relationship between the proportion of independent directors and performance.
In conclusion, the review of prior studies has identified ten corporate governance characteristics that impact on firms’ performance, albeit with mixed evidence as to the direction of the relation.
Nevertheless, almost all this body of literature examined the relationship between corporate governance and firms’ performance during economically healthy periods without any financial distress.
As expected, the researchers differ on the extent to which corporate governance influences the performance of firms. Furthermore, each research study considered different set of factors and used variety of measurements to assess the performance of firms under investigation. Also most of these study focus on advance countries of Asia, Europe and America with Africa and Nigeria in particular receiving less research attention. This study therefore seeks to fill this gap that has hitherto existed in literature by empirically examining the impact of corporate governance mechanism on performance of commercial banks in Nigeria.
CHAPTER THREE
RESEARCH METHODOLOGY
3.1 Introduction
This chapter examines the methodology that will be utilized to reveal some statistical details about impact of corporate governance on bank’s performance in Nigeria. This chapter will mainly focus on the research design, the population and sample of the study, Sources of data collection, Techniques of
data analysis, definition of variable/model specification and weaknesses of the methodology.
3.2 Research Design
This study adopts the ex-post facto research design. This research design is adopted for this study because of its strengths as the most appropriate design to use when it is impossible to select, control and manipulate all or any of the independent variables or when laboratory control will be impracticable, costly or ethically questionable (Akpa and Angahar, 1999).
3.3 Population of the Study
A population is an aggregation of survey elements with common features or characteristics that are of interest to the researcher. The population of this study in view of the above definition covers all the 21 banks quoted on the Nigerian stock exchange as at 19th August 2014.
The sample is a subset of the population selected for the study or investigation. This study purposively selects six (6) commercial banks namely Zenith Bank Plc, Guarantee Trust Bank (GTB) Plc, First Bank Plc, Fidelity Bank Plc, Union Bank Plc, United Bank for Africa (UBA) Plc from the existing 21 banks to constitute the sample size of the study. The following criteria were taken into cognizance in the selection process.
The commercial banks selected were only those that survived the 2005 recapitalization exercise of the CBN without changing their identity.
The commercial banks selected for the study must be from the list of commercial banks that the CBN’s and World Bank’s ranking were adjudged to be the best performing banks in terms of strong and vibrant banks (Vanguard 3, July 2011).
3.5 Sources of Data Collection
This study adopts majorly the secondary kind of data in obtaining all the information there in. The financial statement of the six (6) sampled commercial banks from the period
2005-2012 forms the major sources of data for this study (e.g. see appendix I).
3.6 Techniques of Data Analysis
The following statistical tools will be employed in the analysis of data generated from the annual financial statement of the six (6) sampled commercial banks listed above: Descriptive statistics and multiple regression statistics. The multiple regression using the ordinary least squares (OLS) method was adopted for the analysis. The OLS method was preferred because it minimizes the errors between the points on the line and the actual observed points of the regression line by giving the best fit.
3.7 Definition of Variables
This study employed the following variables which are briefly explained below.
Return on equity (ROE): This is an accounting based performance indicator of companies. It measures the returns accruable to shareholders’ from their equity
Board size (BS): Board size refers to the total number of directors on the board of a bank.
Independence of the Audit Committee (IAC): This refers to the proportion of independent directors on the audit committee.
Size of Audit Committee: This is the total number of auditors that constitute the audit committee of a bank.
CEO Duality: This is a situation where one individual occupies the positions of CEO and at the same time the board chairperson of a company, thus increasing the concentration of power in one individual and undue influence of particular management and board members. CEO duality exists in a situation where the owner of the company in question still doubles as the chief executive officer (CEO) of the company.
3.8 Model Specification
The following model has been formulated to guide the researcher in the investigation.
ROE = α + β1 BS + β2IDA+ β3 SAC +u Where,
ROE = Return on Equity
BS = Board Size
IDA = independence of the Audit Committee Members
SAC = Size of the audit committee
α = alpha, which represents the model constant
β1 – β4 =Beta, representing the coefficients of variables used in the model.
u = is the stochastic variable representing the error term in the model. It is usually estimated at 5% (0.05) level of significance.
Decision Rule
This study shall accept and reject the null and alternative hypotheses using the following set criteria.
Accept the null hypothesis if the critical value of t at 0.05 level of significance in the t-table is greater than the calculated value.
Reject the null hypothesis if the critical value of t at 0.05 level of significance is less than the calculated value
3.9 Weaknesses in the Methodology
There is no methodology that has no inherent weakness. It is only left for the researcher to minimize them. The weakness of this study’s methodology is briefly discussed in subsequent paragraphs.
Over reliance on secondary data is another weakness of the methodology. Financial statements published do not have 100 %accuracy, so its reliability is not assured. The occurrence of inflation as well affects the secondary data.
Also as a weakness of the methodology is the erroneous assumption of the ability of linear and multiple regressions to validly project into the future past relationship whereas the relationship between the dependent and independent variables established is only valid across the relevant range.
Furthermore the model equations are only estimations of the independent value, the researcher cannot possibly account for
every factor that goes into each independent value, and there will always be some error (either pure error or lack of fit error) in a regression model.
The above weaknesses notwithstanding, the intent of the research may not be deterred as the error term included in the models specified above takes care of any information asymmetry either caused by inflation or reporting misfeasance. The researcher also made use of SPSS version 20 for windows application software to run the regression model for a more reliable result that reflect current realities in the banking sector and findings to meet all academic standards. Also the secondary data used in this study will be sourced from reliable source and human subjectivity will be suppressed to the barest minimum so as to enable the researcher have a result devoid of manipulation.
DATA PRESENTATION, ANALYSIS AND FINDINGS
4.1 Introduction
This chapter focuses on the presentation and analysis of data. In this regard, this chapter therefore presents findings from data analysis using the research method earlier explained in chapter three. This chapter will first present and analyse the data, test the hypotheses and interpret and discuss the findings of the study.
4.2 Data Presentation and Analysis
This section of the chapter presents and analyse the data extracted from the annual financial statement of the commercial banks sampled for the study (see appendix I for the raw data). Data analysis here was done with the aid of the statistical package for social science (SPSS version 20). As a reminder, this study has only one dependent variable: Return on equity (ROE), three independent variables: board size (BS), independence of audit committee (IDA), and size of the audit committee (SAC). The analysis of data is presented in the subsequent sections.
4.2.1 Data Validity Test
The researcher computed several diagnostic tests such as Durbin Watson test, variance inflation factor (VIF) and Tolerance statistics in order to ensure that the results of this study are robust. This is shown in table 4.1, 4.3 & 4.4.
The Durbin Watson statistics is estimated at 2.0 (see table 4.3) which is equal to the standard internationally recognized 2 (Gujarati, 2007). This thus indicates the absence of auto-correlation. The Durbin Watson statistics ensures that the residuals of the proceeding and succeeding sets of data do not affect each other to cause the problem of auto-correlation.
The Variance Inflation Factor (VIF) statistics for all the independent variables consistently fall below 2 (see table 4.4). This indicates the absence of multicollinearity problems among the variables under investigation (see Berenson and Levine, 1999). This statistics ensures that the independent variables are not so correlated to the point of distorting the results and assists in filtering out those ones which are likely to impede the
robustness of the model. There is no formal VIF value for determining presence of multicollinearity. Values of VIF that exceed 10 are often regarded as indicating multicollinearity, but in weaker models values above 2.5 may be a cause for concern (Kouisoyiannis, 1977: Gujarati and Sangeetha, 2007). Thus, this model exhibit low risk of potential multicollinearity problems as all the independent variables have a variance inflation factor (VIF) below 10 (Myers, 1990). This shows the appropriateness of fitting of the model of the study with the three (3) independent variables.
In addition, the tolerance values consistently lies between 0.945 and 0.996 (see table 4.4). Menard (1995) suggested that a tolerance value of less than 0.1 almost certainly indicates a serious collinearity problem. In this study, the tolerance values are more than 0.1; this further substantiates the absence of multicollinearity problems among the explanatory variables.
This section of the chapter presents in the table below the results of the correlation results between the dependent and explanatory variables.
Table 4.1: Correlations Result for All Variables
ROE BS IDA SAC
ROE Pearson Correlation 1 .310* .119 .300* Sig. (2-tailed) .030 .414 .036 N 49 49 49 49 BS Pearson Correlation .310* 1 -.050 .228 Sig. (2-tailed) .030 .732 .115 N 49 49 49 49 IDA Pearson Correlation .119 -.050 1 .026 Sig. (2-tailed) .414 .732 .861 N 49 49 49 49 SAC Pearson Correlation .300* .228 .026 1 Sig. (2-tailed) .036 .115 .861 N 49 49 49 49
*. Correlation is significant at the 0.05 level (2-tailed). Source: SPSS Version 20 output
Table 4.1 shows the Pearson product movement correlation for all the variables. Correlations result here is used as further check for data validity. These types of checks are necessary because high correlation cause problems about the relative contribution of each predictor to the success of the model (Guajariti, 2007). The correlation matrix above shows the
absence of multicollinearity among the explanatory variables as all the variables are very low with the highest correlation estimated at 0.310. This is less than 0.75 which is considered harmful for the purpose of analysis (see Gujarati and Sangeeta, 2007, Berenson and Levine, 1999).
4.2.3 Descriptive Statistics
This subsection of the chapter presents and analyses the descriptive statistics for both the dependent and independent variables. The results are presented in table 4.2 and explained subsequently.
Table 4.2: Descriptive Statistics for all Variables
N Minimum Maximum Mean Std. Deviation
ROE 49 11.62 39.45 22.6945 6.63261
BS 49 11.00 20.00 15.0000 2.09165
IDA 49 3.00 5.00 3.2449 .59619
SAC 49 5.00 6.00 5.8980 .30584
Valid N (listwise) 49
Source: SPSS Version 20 output
Table 4.2 presents the descriptive statistics for all the variables. N represents the number of paired observations and therefore the number of paired observation for this study is 49. The
performance of the selected commercial banks proxied by Return on equity (ROE) reflects a low mean of 22.7% with fluctuations of just 6.6. The maximum value during the period of observation is at 39.45, and the minimum value during the period of observation is at 11.62 while the maximum value of 39.45 indicates the highest ROE value from the sampled banks. This result implies that on average, shareholders of Nigerian commercial banks gets returns of 22.7% on their equity investment during the period under investigation. This reveals poor performance of the sampled commercial banks in terms of returns to the shareholders. The reason for this may be that, most firms make minimal profits and still pay taxes and other deductibles before declaring dividend to their owners.
The result of the descriptive analysis further reflects a mean of 15 in respect to the Board Size (BS) with a fluctuation of 2. This implies that on average, the number of persons who constitute the Board Size of commercial bank during the period under investigation is 15. The minimum and maximum mean stood at 11 and 20 respectively indicating that on average, the minimum number of persons that constitute the board size of commercial
banks is 11 and the maximum is 20 in the period under investigation.
The independence of audit committee of commercial banks in Nigeria reflects a mean of 3 persons with a standard deviation of 1. This implies that on average, the sampled commercial banks have at least three independent directors on the audit committee during the period under investigation. This is also in line with statutory requirements of the CBN. The minimum and maximum mean stood at 3 and 5 respectively. This indicates that on average, the minimum number of persons that constitute the independent members of the audit committee is 3 and the maximum is 5 in the period under investigation
Finally, the mean size of the audit committee (SAC) is estimated at 6 with a fluctuation of 0. This also implies that on average, the number of persons that constitute size of the audit committees of the sampled commercial banks is six (6) which is in line with statutory requirements of the CBN. The minimum and maximum mean stood at 5 and 6 respectively. This indicates that on average, the minimum number of persons that
constitute the size of the audit committee is 5 and the maximum is 6 in the period under investigation.
4.2.4 Regression Results of the Estimated Model Summary
This section of the chapter presents the results produced by the model summaries for further analysis.
Table 4.3: Model Summaryb
Model R R Square Adjusted R Square Std. Error of the Estimate
Change Statistics
Durbin-Watson R Square Change F Change df1 df2 Sig. F Change 1 .409a .167 .112 6.25047 .167 3.016 3 45 .040 2.034
a. Predictors: (Constant), SAC, IDA, BS b. Dependent Variable: ROE
Source: SPSS Version 20 output
Table 4.3 presents the summary of results for all the variables. From the model summary table above, the ‘R’ value
of 0.409 shows that there is a weak relationship between the dependent and independent variables. The R2 stood at 0.167.
The R2 otherwise known as the coefficient of determination
shows the percentage of the total variation in the dependent variable (ROE) that can be explained by the independent or explanatory variables (BS, IDA and SAC). Thus the R2 value of
0.167 indicates that 16.7% of the variation in the Return on equity (ROE) of commercial banks can be explained by the variation in the independent variables: (BS, IDA and SAC) while the remaining 83.3% (i.e. 100-R2) could be explained by other
variables not included in this model.
The adjusted R2 of 0.112% indicates that if the entire
population is considered for this study, this result will deviate from it by 5.5% (i.e. 16.7 – 11.2). This result implies that the performance of commercial banks in Nigeria herein measured by return on equity (ROE) is not very responsive to corporate governance mechanism herein measured by BS, IDA and SAC. This is why other factors account for most of the variation in performance of Nigerian commercial banks.
The results further reveals an F-statistics of 3.016 which indicate that the set of independent variables were as a whole contributing to the variance in the dependent variable and that there exist a statistically significant relationship at 0.040 (4.8%) between ROE and the set of predictor variables (BS, IDA, SAC) indicating that the overall equation is significant at 4.0% which is below 5% level of significance.
