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,
Patel and Lilicare, 2002:9). An international wave of mergers and acquisitions
has also swept the banking industry. In line with these changes, the fact
remains unchanged that there is the need for countries 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,
Wu and Zhang, 2000; Köke 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,
there are concerns on the need to strengthen corporate governance in banks.
This will boost public confidence and ensure efficient and effective
functioning of the banking system (Soludo, 2004a). According to Heidi and Marleen (2003:4),
banking supervision cannot function well if sound corporate governance is not
in place. Consequently, banking supervisors have strong interest in ensuring
that there is effective corporate governance at every banking organization. As
opined by Mayes, Halme and Aarno (2001), changes in bank ownership during the
1990s and early 2000s substantially altered governance of the world’s banking
organization. These changes in the corporate governance of banks raised very
important policy research questions. 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 warming itself as a priority in the
African continent. Indeed, it is believed that the Asian crisis and the
relative poor performance of the corporate sector in Africa have made the issue
of corporate governance a catchphrase in the development debate (Berglof and
Von -Thadden, 1999).
Several events
are therefore responsible for the heightened interest in corporate governance
especially in both developed and developing countries. The subject of corporate
governance leapt to global business limelight from relative obscurity after a
string of collapses of high profile companies. Enron, the Houston, Texas based
energy giant and WorldCom the telecom behemoth, shocked the business world with
both 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 far more widespread. Large and trusted companies from Parmalat in
Italy to the multinational newspaper group Hollinger Inc., Adephia
Communications 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 director (Dick
Grasso) amidst public outcry over excessive compensation (La Porta, Lopez and
Shleifer 1999).
In developing economies, the banking sector
among other sectors has also witnessed several cases of collapses, some of
which include the Alpha Merchant Bank Ltd, Savannah Bank Plc, Societe Generale
Bank Ltd (all in Nigeria), The Continental Bank of Kenya Ltd, Capital Finance
Ltd, Consolidated Bank of Kenya Ltd and Trust Bank of Kenya among others (Akpan,
2007).
In Nigeria,
the issue of corporate governance has been 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 corporate governance in public
companies. The Bankers’ Committee also set up a sub-committee on corporate
governance for banks and other financial institutions 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 therefore refers
to the processes and structures by which the business and affairs of
institutions are directed and managed, in order to improve long term share
holders’ value by enhancing corporate performance and accountability, while taking
into account the interest of other stakeholders (Jenkinson and Mayer, 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 composition, CEO pay performance
sensitivity, directors’ ownership and share holder right (Gomper, Ishii and
Metrick, 2003). They further suggest that changing these governance mechanisms
would cause managers to better align their interests 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); Goswami
(2001); Oman (2001); Malherbe and Segal (2001); Carter, Colin and Lorsch (2004);
Staikouras, Maria-Eleni,
Agoraki, Manthos and Panagiotis (2007); McConnell,
Servaes and Lins (2008) and Bebchuk, Cohen
and Ferrell (2009), yet corporate governance of banks in developing economies
as it relates to their financial performance has almost been ignored by
researchers (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 O’Hara, 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 interactions that may be important within the governance framework.
Feasible among these few studies is the one by Adams and Mehran (2002) for a sample of 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 largest, actively traded organizations- many
of which show little variation in their ownership, management and board
structure and also measure performance as market value.
In Nigeria,
among the few empirically feasible studies on corporate governance are the studies
by Sanda and Mukailu and Garba (2005) and Ogbechie (2006) that studied the
corporate governance mechanisms and firms’ performance. In order to address these deficiencies, this study examined the
role of corporate governance in the 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 analysed the level of compliance
of code of corporate governance in Nigerian banks with the Central Bank’s post
consolidated code of corporate governance. Finally, while other studies on
corporate governance neglected the operating performance variable as proxies
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.
1.1 Statement of Research Problem
Banks and other
financial intermediaries are at the heart of the world’s recent financial
crisis. 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, 2010). To a large extent, this problem was the result of poor corporate
governance in countries’ banking institutions and industrial groups. Schjoedt
(2000) observed that this poor corporate governance, in turn, was very much
attributable to the relationships among the government, banks and big
businesses as well as the organizational structure of businesses.
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 interests of all shareholders and other
stakeholders. In other cases where private ownership concentration was not
allowed, the banks were heavily interfered 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
symbiotic relationships between the government or political circle, banks and
big businesses also contributed to the maintenance of lax prudential
regulation, weak bankruptcy codes and poor corporate governance rules and
regulations (Das and Ghosh, 2004; Bai, Liu,
Lu, Song and Zhang, 2003).
In Nigeria,
before the consolidation exercise, the banking industry had about 89 active
players whose overall performance led to sagging of customers’ 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 (Akpan,
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 systems, excessive risk taking, override of internal control
measures, absence of or non-adherence to limits of authority, disregard for
cannons of prudent lending, absence of risk management processes, insider
abuses and fraudulent practices remain a worrisome feature of the banking
system (Soludo, 2004b). This view is supported by the Nigeria Security and
Exchange Commission (SEC) survey in April 2004, which shows that corporate
governance was at a rudimentary stage, as only about 40% of quoted companies
including banks had recognised codes of corporate governance in place. This, as
suggested by the study may hinder the public trust particularly in the Nigerian
banks 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 mergers and acquisition. This
was to make Nigerian banks more competitive and be able to play in the global
market. However, the successful operation 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 Nigerian post consolidation
(2006), it was stated that the industry consolidation poses additional corporate
governance challenges arising from integration processes, Information
Technology and culture. The code further
indicate that two-thirds of mergers world-wide failed due to inability to
integrate personnel and systems and also as a result of the irreconcilable
differences 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 Nigerian banks, 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 banking industry is
imperative, if the industry is to effectively play a key role in the overall
development of Nigeria.
The
causes of the recent global financial crises
have been traced to global imbalances in trade and financial sector as well as
wealth and income inequalities (Goddard, 2008). More importantly, Caprio,
Laeven & Levine (2008) opined that there should be a revision of bank
supervision and corporate governance reforms to ensure that deliberate
transparency reductions and risk mispricing are acted upon.
Furthermore,
according to Sanusi (2010), the current
banking crises 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 un-secured loans at the expense of
depositors and not having the qualifications 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 corporations, such as
Enron, WorldCom and Global Crossing.
The series
of widely publicized cases of accounting improprieties recorded in the Nigerian
banking industry in 2009 (for example, Oceanic Bank, 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 (Uadiale,
2010). Inan (2009) also confirmed
that in some 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 debts owed 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, Kamal 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 healthy 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.
1.2 Objectives
of 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 difference in the financial performance of banks with
foreign directors and banks without foreign directors in Nigeria
2)
To appraise the effect of the proportion of non-
executive directors on the financial performance of banks in Nigeria.
3)
To investigate if there is any significant
relationship between directors’ equity interest and the financial performance
of banks in Nigeria.
4)
To empirically determine if there is any
significant relationship between the level of corporate governance disclosure and
the financial performance of banks in Nigerian.
5)
To investigate if there is any significant difference
between the profitability of the healthy banks and the rescued banks in
Nigeria.
1.3
Research Questions
This study
addressed issues relating to the following pertinent questions emerging within
the domain of study problems:
1a) To what extent
(if any) does board size affect and 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.
2) Is the
relationship between the proportion of non-executive directors and the
financial performance of listed banks in Nigeria statistically significant?
3) Is there a
significant relationship between directors’ equity holdings and the financial
performance of banks in Nigeria?
4) To what
extent does the level of corporate governance disclosure affect the performance
of banks in Nigeria?
5) To what extent
(if any) does the profitability of the healthy banks differ from that of the
rescued banks in Nigeria?
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