Effect of Good Corporate Governance
OBJECTIVES OF THE STUDY
The general objective of this study is to discuss the effect of Corporate Governance on banks performance.
The specific objectives of the study are to:
- Determine the extent to which commercial banks in Nigeria complied with the Central bank of Nigeria code of corporate governance.
- Evaluate the effect of banks’ compliance to CBN code of corporate governance on the performance of banks in Nigeria.
REVIEW OF RELATED LITERATURE
Keasey and Wright (1993) defined corporate governance in terms of “structures, process, cultures and systems that engender the successful operation of organizations”. The topicality of corporate governance has manifested in diverse definitions depending on the interests and individuals involved. Cadbury (2000) defined “corporate governance as being concerned with holding the balance between economic and social goals and between individual and communal goals. The corporate governance framework is there to encourage the efficient use of resources and equally to require accountability for the stewardship of those resources. The aim is to align as nearly as possible the interests of individuals’ corporations and society.” Similar finding is expressed by Orham and Dumus (2009). OECD (1999) posits that corporate governance is “the system by which business are directed and controlled. The corporate governance structures specifies the distribution of rights and responsibilities among different participants in the corporation such as the board, managers, shareholders and other stakeholders and spell out the rules and procedures for making decisions on corporate affairs by doing this, it also provides the structure through which the company objectives are set and the means of attaining these objectives and monitoring performance”. Corporate governance is concerned with the intrinsic nature, purpose, integrity and identity of the institution with a primary focus on the entity’s relevance continuity and judiciary aspect. Governance involves monitoring and overseeing strategic direction, socioeconomic and cultural content externalities and constituencies of the institutions.
From the perspective of the banking sector Srivastava and Srivastava (2010) are the view that corporate governance involves the manner in which the business and affairs of individual institutions are governed by their board of directors and senior management with depositors standing out clearly as the most important stakeholder. An essential feature of a corporation is the separation of ownership from management. To this end, the shareholders (owners) delegate decision making rights to managers to act on their behalf. However, this separation of ownership from control implies a loss of effective control by shareholders over managerial decisions. Thus, the primary objective of corporate governance is to attempt an alignment of the managerial incentives with those of stakeholders. This is to check the tendency of selfishness by managerial employees especially the top ones to ensure that delegated decisions making powers are not abused to the detriment of shareholders and other stakeholders.
The major elements of corporate governance are good board practices, control environment, transparent disclosure, well defined shareholder rights and board commitment. Although, corporate governance can be defined in a variety of ways, generally, it involves the mechanisms by which a business enterprise organized in a limited corporate form is directed and controlled. It usually concerns mechanisms by which corporate managers are held accountable for corporate conduct and performance. Several codes have been developed as a guide to corporate governance; however, the best guide to global corporate governance was developed. The Organization for Economic Cooperation Development (1999) principle of corporate governance is as shown below;
- The rights of shareholders: the corporate governance framework should protect shareholders rights
- The equitable treatment of shareholders: the corporate governance framework should ensure the equitable treatment of all shareholders including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights.
- The role of stakeholders in corporate governance: the corporate governance framework should recognize the rights of stakeholders as established by law and encourage active cooperation between corporations and stakeholders in creating wealth, jobs and the sustainability of financially sound enterprises.
- Disclosure and transparency: the corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation including the financial situation, performance, ownership and governance of the company.
- The responsibilities of the board: the corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board and the boards accountability to the company and the shareholders.
Corporate Governance in Banking Sector
The narrow approach of corporate governance views the subject as the mechanism, through which shareholders are assured that managers will act in their interests. Shleifer and Vishny (1997) defined corporate governance as the methods by which suppliers of finance control managers in order to ensure that their capital cannot be expropriated and that they earn a return on their investment.
External Corporate Governance Mechanism
In common practices, depositors rely on the government role in protecting their bank deposits from expropriating management. It might encourage economic agents to deposit their funds into banks because a substantial part of the moral hazard cost is guaranteed by the government. In other words, even if the government may explicitly provide deposit insurance, bank managers probably still have an incentive to opportunistically increase their risk-taking, however it will bear the government’s expense. This moral hazard problem can be restored through the use of economic regulations such as asset restrictions, interest rate ceilings, reserve requirements, and separation of commercial banking from insurance and investment banking. The effects of these regulations limit the ability of bank managers to over-issue liabilities or divert assets into high-risk ventures. Thus, the special nature of banking requires not only a broader view of corporate governance but also government intervention through regulation and supervision in order to restrain the expropriating management behavior in banking sector. In this view, managers and owners are subject to the regulation.
In general, the literature on bank regulation emphasizes the stated purpose of regulation as that of maintaining the integrity of the market system. Recent attention is more focused on the role of government in the financial sector; government’s participation as the owner of financial intermediaries, government’s intervention in pricing and allocating credit, and government’s role in regulating and supervising financial intermediaries. Regulation is commonly associated with the resolution of market failure in provision of the public good of financial stability. The characteristic limitations imposed are not concerned with market structure per se (for examples barriers to entry or power of market monopoly). Instead, the constraints imposed by bank regulators in many countries attempt the opposite action. Ciancanelli and Gonzales (2000) state that in banking sector the regulation and regulator represent external corporate governance mechanism.
In the conventional literature on corporate governance, the market is the only external governance force with the power to discipline the agent. The existence of regulation means there is an additional external force with the power to discipline the agent. The force is quite different from the market. This implies that the power of regulation has different effects to those produced by markets. Bank regulation represents the existence of interests different from the private interests of the firm. As a governance force, regulation aims to serve the public interests, particularly the interests of the customers of the banking services. An agent of the public interest, the regulator, also enforces regulation itself. This agent does not have a contractual relationship either with the firm’s principal or with the banking organisations because of different interests from the principal Ciancanelli and Gonzales (2000).
The research design adopted for this research was ex-post facto. The adoption of this research design was based on the reason that the study relied on historic data obtained from the annual reports from 2010 – 2014. Therefore, the event under investigation had already taken place and the researcher did not control or manipulate the variables.
The focal variables considered for the study include general compliance to CBN code of corporate governance, which was derived from the summation of actual board size, actual board composition, audit committee representation, power separation and board diversity of banks in Nigeria, and the bank’s profit after taxation. The dataset were also sourced from the website of ten (10) commercial banks in Nigeria comprising of annual observations ranging from 2010 – 2014.
Nature and Sources of Data
The secondary data used in this study were extracted from the bank’s published annual reports from 2010 – 2014.
The Central Bank of Nigeria being the apex regulatory organ of the Nigerian banking industry maintains a list of deposit money banks currently operating in the Nigerian banking industry. Hence our population of study consisted of all the banks currently operating in Nigeria as adopted from the official website of the Nigerian Central Bank totalling 20 banks (see appendix 1 for details).
DATA PRESENTATION AND ANALYSIS
The research work aimed at accessing bank’s compliance to central bank of Nigeria code of corporate governance. The focal variables considered for the study include best practice code of corporate governance, actual board size, actual board composition, audit committee representation, power separation and board diversity of banks in Nigeria. The dataset sourced from the website of ten (10) commercial banks in Nigeria were annual observations ranging from 2010–2014.
For orderly presentation and description of the data used, the variables were presented in tables.
Although the data were secondary and retrieved from individual bank’s website, they were transcribed into probity form to allow for econometric analysis. Best practice was transcribed form the CBN codes of corporate governance as it relates to the independent variables (board size, board composition, audit committee, power separation and board diversity). The independent variables were transcribed as explained in table 4.1. (See Appendix III).
SUMMARY, CONCLUSION AND RECOMMENDATIONS
Corporate performance is an important concept that relates to the way and manner in which financial, material and human resources available to an organization are judiciously used to achieve the overall corporate objective of an organization. Unfortunately, corporate governance has become a major concern to both the public and the private sector of the Nigerian economy as the financial services industry has experienced fluctuating fortunes leading to high profile cases of corporate failure and consequent near loss of public confidence for the past two decades. The lack of effective corporate governance in Nigeria has worked to the decrement of shareholders and created a class of stakeholder who has lost interest in the banking system. Furthermore, poor corporate governance was identified as one of the major factors in virtually all known instances of financial institutions distress in the country, and hence the CBN enactment of a code first in 2006.
The study set out to appraise Nigerian banks compliance to the CBN code of Corporate Governance as well as its effect on banks performance. The study specifically considered Nigerian commercial banks’ compliance to CBN code for board size, board composition, audit committee, power separation and board diversity. The study then examined the effect of commercial banks’ compliance level on their performance (profit). The study employed a panel data ordinary least square and analysis of variance to appraise commercial banks’ compliance to CBN best practice code and the extent to which it affected their profit performance.
Nigerian commercial banks’ compliance to CBN best practice for board size was statistically insignificant. Therefore, commercial banks in Nigeria were up till the date of this study non-compliant with the CBN best practice for board size. The same was discovered for board diversity, audit committee, and power separation as the f-statistics evidenced in analysis of Variance showed a significant variance between the Nigerian commercial banks’ observed practices and the best practice code as dictated by the Central Bank of Nigeria (CBN). Nonetheless, Nigerian commercial banks significantly complied with the CBN best practice code for commercial banks’ board composition. This was evidenced in the analysis of variance as the f- calculated was less than the f- critical, signifying very little variance between commercial banks’ observed practices and the CBN best practice code for corporate board composition.
It was discovered that some Nigerian commercial banks had lesser board size than the best practice of a minimum of 20 persons in the board (Noncompliance with best practice code for board size). However, most banks followed the best practice of having 2 non-executive independent directors and more non-executive directors than the executive directors (compliance with best practice code for board composition). Considering the audit committee, a few commercial banks had exclusive board audit committee and separate statutory audit committee, which indicate a stronger audit team, while the other majority has just the statutory audit committee, comprised of three board directors and three shareholders. It was further discovered that members of the audit committees did not take seriously attendance to audit committee meetings. Most times, the statutory audit committee meeting held once a year just to read and approve the annual financial statement and accounts. Attendance to board committee meetings were considered significant compliance to best practice code on a premise that more good heads are better than fewer one. Fraud cases and errors may easily be detected by more than fewer directors or shareholders and there may be more than fewer meetings necessary for the early detection of fraud and errors.
All banks failed in compliance to best practice for board diversity, as they always had more males on the board than females. Sometimes, there were only males on the board and no female. There was never a case where there equal representative of males and females or where there were more females than males. Looking at the power separation, while different directors headed various committees, the representing membership was highly limited considering the size of the board.
Quantitatively, the Cronbach’s alpha test for reliability of transcribed data of commercial banks’ observed practices showed to be 67.8% (0.678). Although the commercial banks’ compliance to best practice regarding most of the code of corporate governance were insignificant. When tested on the banks’ profit after tax, it had significant effect. The group unit root test (best unit root test for panel data) showed that the aggregated variables of commercial banks’ observed practices and the banks’ profit after tax was stationary, qualifying the use of the variables for ordinary least square (OLS) analysis. Furthermore, the correlation test showed that both variables had 77.68% relationship with each other. This proved a strong and direct relationship with each other. The correlation test between commercial banks’ observed practices and best practice code showed that board composition (76.55%), board size (69.5%), and power separation (56%) was positive and strong. The rest were below 40% (weak) but positively related to best practice code.
The residual of the variables used for OLS analysis was not normally distributed. Nevertheless, the coefficient of determination (R2) was 60.35% (0.60348), indicating that 60.35% of the variation in the commercial banks’ profit after tax can be attributed to the variation in aggregated commercial banks’ observed practices (LNCOMP). The variables were logged o make the residual of the data used for OLS analysis homoscedastic. Panel data variables are normally heteroscedastic and therefore must be logged in order to make the residual have a constant variance. Furthermore, serial correlation was not identified in the model. Therefore, the result of this ols analysis can be used for forecasting and recommendation based on the result can be relied upon for policy formulation.
Therefore compliance to CBN code of corporate governance has direct and strong relationship with commercial banks’ profit after tax and observed commercial banks’ practices has direct relationship with the best practice, it is important for commercial banks in Nigeria to significantly comply with CBN best practice code of corporate governance in order to further strengthen their determination of the profit after tax of Nigerian commercial banks. The researchers strongly believe that compliance to CBN code of corporate governance by Nigerian commercial banks will save the financial sector from distress in Nigeria.
In conclusion, the direct relationship between general compliance to CBN code of corporate governance and profit of commercial banks will boost the profitability of the commercial banks, and early detection of fraud cases and errors in the financial statements.
The following recommendations were drawn from the study;
- The Central Bank of Nigeria should strictly monitor on an annual bases, commercial banks’ compliance to the code of corporate governance, especially board size, audit committee, board diversity, power separation.
- Therefore, a percentage (1%) increase in commercial banks’ general compliance with the CBN code of corporate governance causes profit after tax to increase by 3.53%, commercial banks’ general compliance to the best practice CBN code of corporate should be raised by 24.54% in order to reach the desired level of commercial banks’ profit after tax in Nigeria.
CONTRIBUTION TO KNOWLEDGE
This study contributed to our knowledge on commercial banks compliance with Central Bank of Nigeria code of corporate governance and its effect on Bank performance.
The result of the study contributed the body of empirical literatures in that the success achieved in this subsector will be applied on the other sectors.
This study will help to spur Central Bank of Nigeria into monitoring the commercial bank compliance with Central Bank of Nigeria code of corporate governance in order to achieve the desired levels of profitability for the commercial banks in Nigeria.
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