THE EFFECT OF CORPORATE GOVERNANCE ON THE PROFITABILITY OF COMMERCIAL BANKS
An international wave of mergers and acquisitions has swept the banking industry as boundaries between financial sectors and products have blurred with good corporate governance, which will strengthen and upgrade the institution to survive in an increasingly open environment. In Nigeria, the central bank unveiled new banking guidelines designed to consolidate more competitive and be able to operate in the global market. Despite all its attempts, the central bank of Nigeria disclosed that after the consolidation in 2006, 741 cases of attempts, fraud and forgery involving N 5.4 billion were reported. In the light of the above, this research examined the relationships that exist between governance mechanisms and financial performance in the Nigeria consolidated banks. And also to find out if there is any significant relationship between the level of corporate governance disclosure index among Nigeria banks and their performance.
1.1 BACKGROUND OF THE STUDY
Globalization and technology have continuing speed which makes the financial arena to become more open to new products and services invented. However, financial regulators everywhere are scrambling to assess the changes and master the turbulence (Sandeep, Peter and Lilicaro 2002:9). An international wave of mergers and acquisitions has also wept the banking industry in line with these changes the fact remains unchanged that there is the need for counties to have sound resilient banking systems with good corporate governance. This will strengthen and upgrade the institution to survive in an increasingly open environment (Qi Whand Zherg 2000; Koke and Renneboog, 2002 and Kashif 2008).
Given the fury of activities that have affected the efforts of banks to comply with the various consolidation policies and the antecedents of some operators in the system, these are concerns on the need t strengthen corporate governance in banks. This will boost public confidence and ensure efficient and effective functioning of the banking system (soludo, 2004). According to Heidi and Maleen (2003:4) banking supervisors have strong interest in ensuring that there is effective corporate governance at every banking organization. As opined by Mayes Haline and Aorno (2001), changes in bank ownership during the 1990s and early 2000s substantially altered governance of the world’s banking organization.
The fundamental question is how do these changes affect bank performance?
It is therefore necessary to point out that the concept of corporate governance of banks and very large firms have been a priority on the policy agenda in developed market economies for over a decade. Further to that, the concept is gradually worming itself as a priority in the African continent. Indeed, it is believed that Asion crisis and the relative poor performance of the corporate sector in Africa have made the issue of corporate governance catelphrase in the development debate (Berglof and Von-Thedden, 1999).
Several events are therefore responsible for the heightened interest in corporate governance especially in both developed and developing countries. The subject of colleges of high profile companies, Enron, the Houston, Texas based energy giant and Worldcoon the telecom behemoth, schocked the business world with bott the scale and age of their unethical and illegal operations. These organizations seemed to indicate only the tip of a dangerous iceberg, while corporate practices in the US companies came under attack it appeared that the problem was for more widespread large and trusted companies from Permalat in Italy to the multinational newspaper.
Group Hollinger Inc, Adephia communication company Global crossing limited and Tyco international Limited, revealed significant and deep-rooted problems in their corporate governance. Even the prestigious New York stock Exchange had to remove its direction (Dick Grasso) amidst public outrage over excessive compensation (La Porta, Lopez and Shleiger 1999).
In developing economies, the banking sector among other sector has also witnessed several cases of collapses, some of which include the Alpha Merchant Bank Ltd Savannah Band Plc, society General Bank Ltd (all in Nigeria). The continental Bank of Kenya Ltd and trust Bank of Kenya among others (Akpan, 2007), In Nigeria, the issue of corporate governance has given the front burner status by all sectors of the economy. For instance, the securities and exchange commission (SEC) set up the peterside committee on committee also set up a sub-committee on corporate governance for banks and financial institution in Nigeria. This is in recognition of the critical role of corporate governance in the success or failure of companies (Ogbechie 2006:6). Corporate governance refers to the processes and structures by which the business and affairs of institutions are directed and money in order to improve long term shareholders value by enhancing corporate performance and accountability, while taking into account the interest of other stakeholders (Jenkinson and Meyer, 1992). Corporate governance is therefore, about building credibility ensuring transparency and accountability as well as maintaining an effective channel of information disclosure that will foster good corporate performance.
Jensen and Meckling (1976) acknowledged that the principal agent theory which was also adopted in this study is generally considered as the starting point for any debate on the issue of corporate governance. A number of corporate governance mechanisms have been proposed to ameliorate the principal agent problem between managers and their shareholders. These governance mechanisms as identified in agency theory include board size board compositions CEO pay performance sensitivity, directors ownership and shareholders right (Gomper, Ishii and Metrick, 2003). They further suggest that changing these governance mechanisms would cause managers to better align their interest with that of the shareholders thereby resulting, in higher firm value. Although, corporate governance in developing economies has recently received a lot of attention in the literature Lin (2000); Carter Colin and Lorseh (2004); Stainkourona, Moria, Maria – Eleni. Agoraki, Manthos and Panaqiotis (2007); Mc Connell, Servers and Lins (2008) and Bebeluk, cohen and Ferrell (2009), yet corporate governance of banks in developing economies as it relates to their financial performance has almost been ignored by resrachers (Caprio and Levine (2002); Ntim (2009), Even in developed economies, the corporate governance of banks and their financial performance has only been discussed recently in the literature (Macey and Ottan, 2001).
The few studies on bank corporate governance narrowly focused on a single aspect of governance, such as the role of directors or that of stock holders while omitting other factors and interaction they may be important within the governance framework. Feasible among these few studies it eh one by Adams and Mehran (2002) for a sample of a US companies, where they examined the effects of board size and composition on value. Another weakness is that such research is often limited to the longest activity traded organizations. Many of which show little variation in their ownership performance as market value.
In Nigeria, among the few empirically feasible studies on corporate governance are the studies by Senda and Markailn and Gorba (2005)and Ogbechie (2006) that studied the corporate governance mechanisms and firms and firms performance. In order to address these deficiencies, this study examined the role of corporate governance in financial performance of Nigerian banks unlike other prior studies, this study is not restricted to the framework of the organization for economic cooperation and development principles, which is based primarily on shareholder sovereignty. It analyzed the level of compliance of code of corporate governance in Nigeria banks with the Central Banks post consolidated code of corporate governance neglected the operating performance variable as priorities for performance, this study employed the accounting operating performance variables to investigate the relationship if any, that exists between corporate governance and performance of banks in Nigeria.
1.2 STATEMENT OF THE PROBLEM
Banks and other financial intermediaries are at the heart of the worlds recent financial crises, the deterioration of their asset portfolios largely due to distorted credit management, was one of the main structural sources of the crisis (Fries, Neven and Seabright, 2002; Kashif, 2008 and Sanusi, 2001), to a large extent this problem was the result of poor corporate governance in countries banking institutions industrial groups. Schjoedt (2000) observed that this poor corporate governance, in turn, was very much attributable to the relationship among the government, banks and big business as well as the organizational structure of business.
In some countries (for example Iran and Kuwait) banks were part of larger family. Controlled business groups and are abused as a tool of maximizing the family interests rather than the interst of all shareholders and other stakeholders. In other cases where private ownership concentration was not allowed, the banks were heavily interred with and controlled by the government even without any ownership share (Williamson, 1970; Zahra, 1996 and Yeung, 2000) understandably in either case, corporate governance was very poor. The symbolic relationship between the government or political circle banks and big business also contributed tot eh maintenance of late prudential regulation, weak bankruptcy codes and poor corporate governance rules and regulations (Das and Ghosh, 2004; Bai, Liu, Ln, Song and Zhag, 2003).
In Nigeria, before the consolidation exercise the banking industry had about 89 active players whose overall performance led to sagging of customer’s confidence. There was lingering distress in the industry. the supervisory structures were inadequate and there were cases of official recklessness amongst the managers and directors, while the industry was notorious for ethical abuses (Akpon, 2007). Poor corporate governance was identified as one of the major factors in virtually all known instances of bank distress in the country. Weak corporate governance was seen manifesting in form of weak internal control system, excessive risk taking override of internal control measures, absence of or no-adherence to limits of authority, disregard for cannons of prudent lending absence of risk management processes. Insider abuses and fraudulent practices remain worrisome features of the baking system (Soludo 2004b). This view is supported by the Nigeria security and exchange commission (SEC) survey in April 2004, which show that corporate governance was at a rudimentary stage, as only about 40% of quoted companies including banks had recognized codes of corporate governance in place. This as suggested by the study may hinder the public trust particularly in the Nigerian bans if proper measures are not put in place by regulatory bodies.
The Central Bank of Nigeria (CBN) in July 2004 unveiled new banking guidelines designed to consolidate and restructure the industry through banks more competitive and be able to play in the global market requires accountability transparency and respect for the rule of law. In section one of the code of corporate governance for banks in Nigeria post consolidation (2006). It was stated that the industry consolidation poses additional corporate governance challenges arising from integration processes, information Technology and culture.
Code further indicate that two thirds of mergers world-wide failed due to inability to integrate personal and systems and also as a result of the irreconcilable difference in corporate culture and management, resulting in Board of management squabbles.
Despite all these measures, the problem of corporate governance still remains un-resolved among consolidated in Nigeria bank, thereby increasing the level of fraud (Akpan, 2007) see Appendix 2. Akpan (2007) further disclosed that data from the National Deposit insurance Commission report (2006) shows 741 cases of attempted fraud and forgery involving N5.4 billion. Soludo (2004b) also opined that a good corporate governance practice in the baking industry is imperative of the industry is to effectively play a key role in the overall development of Nigeria.
The cause of the recent global financial crisis have been traced to global imbalances in trade and financial sector as well as wealth and income inequalities (Goddand 2008) more importantly caprio. Leaven S Levine (2008) He opined that there should be a revision of bank supervision and corporate governance reforms to ensure that deliberate transparency reduction and risk mispricing are acted upon.
Furthermore, according to Samsi (2010), the current banking crisis in Nigeria, has been linked with governance malpractice within the consolidated banks which has therefore become a way of life in large parts of the sector. He further opined that corporate governance in many banks failed because boards ignored these practices for reasons including being misled by executive management, participating themselves in obtaining use. Secured loans at the expense of depositors and not having the qualification to enforce good governance on bank management.
The boards of directors were further criticized for the decline in shareholders wealth and corporate failure. They were said to have been in the spotlight for the fraud cases that had resulted in the failure of major corporation, such as Enron, Worldcom and global crossing.
The series of widely publicized cases of accounting improprieties recorded in the Nigerian baking industry in 2009 (For example Oceanic Ban, Intercontinental Bank, Union Bank, Afri Bank, Fin Bank, and Spring Bank) were related to the lack of vigilant oversight functions by the boards of directors, the board relinquishing control to corporate managers who pursue their own self-interests and the board being remiss in its accountability to stakeholders (Vadiale 2010). Inan (2009) also confirmed that in sme cases, these bank directors equity ownership is low in other to avoid signing blank share transfer forms to transfer share ownership to the bank for debt owned banks, he further opined that the relevance of non-executive directors may be watered down if they are bought over since, in any case, they are been paid by the banks they are expected to oversee.
As a result, various corporate governance reforms have been specifically emphasized on appropriate changes to be made to the board of directors in terms of its composition, size and structure (Abidin, Komal and Jusoff, 2009).
It is in the light of the above problems, that this research work studied the effects of corporate governance mechanisms on the financial performance of banks in Nigeria and also reviewed the annual reports of the listed banks in Nigeria to find out their level of compliance with the CBN (2006) post consolidation code of corporate governance. The study also finds out if there is any statistically significant difference between the profitability of the health and the rescued banks in Nigeria as listed by CBN in 2009. Finally, it went further to investigate if the banks with foreign directors perform better than those without foreign directors.
1.3 OBJECTIVE OF THE STUDY
Generally, this study seeks to explore the relationship between internal corporate governance structures and firm financial performance in the Nigerian banking industry. However, it is set to achieve the following specific objectives.
1a. To examine the relationship between board size and financial performance of banks in Nigeria.
1b. To find out if there is a significant differences in the financial performance of banks with foreign directors and banks without foreign directors in Nigeria.
- To appraise the effect of the proportion of non-executive directors on the financial performance of banks in Nigeria.
- To investigate if there is any significant relationship between directors equity interest and banks financial performance of banks in Nigeria.
- To empirically determine if there is any significant relationship between the level of corporate governance disclosure and the financial performance of banks in Nigeria.
- To investigate if there is any significant difference between the profitability of the healthy banks and the rescued banks in Nigeria. 1.4 RESEARCH QUESTION
This study addressed issue relating to the following pertinent questions emerging within the domain of study problems.
1a. To what extent (if any) does board size affect the financial performance of banks in Nigeria?
1b. Is there a significant difference in the financial performance of banks with foreign directors and banks without foreign directors in Nigeria?
- Is the relationship between the proportion of non-executive directors and the financial performance of listed banks in Nigeria statistically significant?
- Is there a significant relationship between directors and equity holdings and the financial performance of banks in Nigeria?
- To what extent does the level of corporate governance disclosure affect the performance of banks in Nigeria
- To what extent (if any) does the profitability of the healthy bank differ from that of the rescued banks in Nigeria? 1.5 SIGNIFICANCE OF THE STUDY
This study is of immense value to bank regulations investors, academics and other relevant stakeholders. By introducing a summary index that is better linked to firm performance than the widely used G. Index. The study provides future researchers with an alternative summary measure. This study provides a picture of where banks stand in relation to the codes and principles on corporate governance introduced by the Central Bank of Nigeria. It further provides an insight into understanding the degree to which the banks that are reporting on their corporate governance have bee compliant with different sections of the codes of best practice and where they are expecting difficulties. Boards of directors will find the information of value in bench making the performance of their banks against that of their peers. The result of this study will also serve as a data base for further researchers in this field of research. 1.6 SCOPE OF THE STUDY
Generally, banks occupy an important position n the economic equation of any country such that its (good or poor) performance invariably affects the economy of the country. Poor corporate governance may contribute to banks failures, which can increase public costs significantly and consequences due to their potential impact on any application system. Poor corporate governance can also lead markets to loose confidence in the ability of a bank to properly manage its assets and liabilities, including deposits which could in turn trigger liquidity crisis.
From the preceding discussions, it is evident that the question of ideal governance mechanism (board size, board composition and directors equity interest) is highly debatable. Since performance of firms, as identified by Dlas and Goh (2004), depends on the effectiveness of these mechanisms, there is a need to further explore this area. Although researchers have tried to find out the effects of board size and other variables on the performance of firms they are mostly in context of developed markets. To the best of the researcher’s knowledge based on the literature reviewed, only few studies were found in the context of Nigerian banks. Due to neglect of banking sector by other studies and with radical changes in Nigerian banking sector. In last few years, present study aims to fill the existing gap in corporate governance literatures.
Studies on bank governance are therefore important because banks play important monitoring and governance role for their corporate clients to safeguard their credit against corporate financial distress and bankruptcy. An expose by Prowse (1997) shows that research on corporate governance applied to financial intermediaries especially banks is indeed scarce. This shortage is confirmed in Oman (2001); Goswami (20010; Lin (2001) Malherbe and Segal (2001) and Arun and Turner (2002). They held a consensus that although the subject of corporate governance in developing economies has recently received a lot of attention in the literature, however, the corporate governance of banks in developing economies has been almost ignored by researchers. The idea was also shared by Caprio and Levine (02001). Macey and Ohara (2002) shared the same opinion and noted that even in developed economies the corporate governance of banks has only recently been discussed in the literature. To the best of the researchers knowledge, apart from the few studies by Caprio and Levine (2002), Peek and Rosengren (2000) on corporate governance and bank performance. Every little or no empirical studies have been carried out specifically on this subject especially in developing economies like Nigeria. A similar study carried out in Nigeria was by Sanda, Mukailu and Garba (2005) wehre they looked at corporate governance and the financial performance of nonfinancial firms. This scarcity of research effort demands urgent intervention, which therefore justifies the importance of this study, which intends to provide guidance in corporate governance of banks. Furthermore, banks are very opaque which makes the information asymmetry and the agency problem particularly serious (Bierja, 2007). This also necessitates the study on bank governance. 1.7 LIMITATION OF STUDY
Considering the year 2006 as the year of imitation of post consolidation governance codes for the Nigerian baking sector, this study investigates the relationship between corporate governance and financial performance of bank. The choice of this sector is based on the fact that the baking sectors stability has a large positive externally and banks are the key institutions maintaining the payment system of an economy that is essential for the stability of the financial sector. Financial sector stability, in turn has a profound externality on the economy as a whole. To this end, the study basically covers the 21 listed banks out of the 24 universal banks operation in Nigeria till data that met the N25billion capitalization dead-line of 2005. The study covers these banks activities during the post consolidation period. i.e. 2006-2008. The choice of this period allows for a significant lag period for banks to have reviewed and implemented the recommendation by the CBN post possible to obtain the annual reports of 2009/2010 since they are yet to be published by many as all the time of this research.
Furthermore we focused only on banking industry because corporate governance problems and transparency issues are important in the banking sector due to crucial role in providing loans to non-financial firms, in transmitting the effects of monetary policy and in providing stability to the economy as a whole. The study therefore covers four key governance variables which are board size, board composition, director’s equity interest and governance disclosure level. 1.8 DEFINITION OF TERMS
This study made use of secondary data in establishing the relationship between corporate governance and financial performance of the 21 banks listed in the Nigeria stock exchange. The secondary data is obtained basically from published annual reports of these banks. Books and other related materials especially the Central Bank of Nigeria bullions and the Nigeria stock exchange fact Book for 2008 were also reviewed.
In analyzing the relationship that exists between corporate governance and financial performance of the studied banks, a panel data regression analysis method was adopted. The Pearson correlation was used to measure the degree of association between variables under consideration. However, the proxies that were used for corporate governance are; board size, the proportion of non executive directors, directors’ equity interest and corporate governance disclosure index. Proxies for financial performance of the banks also include the accounting measure of performance; return on equity (ROE) and return on asset (ROA) as identified by Firest Rand Banking Group (2006). To examine the level of corporate governance disclosure of the sample banks, the content analysis method was used. Using the content analysis, a disclosure index is developed for each bank using the Nigerian post consolidation code and the organization for economic cooperation and development (OECD) code of corporate governance as a guide. This was used alongside with the papers prepared by the secretariat for the nineteenth and the twentieth session of International Standards of Accounting and Reporting (ISAR); entitled “Transparency and Disclosure Requirements for Corporate Governance and “Guidance on Good Practices in Corporate Governance” respectively.
The student test was used in analyzing the difference in the performances of the healthy banks and the rescued banks. It was also used to determine if there is any significant difference in the performance of banks with foreign directors and that of banks without foreign directors.
THE EFFECT OF CORPORATE GOVERNANCE ON THE PROFITABILITY OF COMMERCIAL BANKS