ABSTRACT
This study investigates the
relationship that exists between corporate governance and firm performance of
some selected companies listed on the Nigerian Stock Exchange. The intent of
the study is to determine whether corporate governance mechanisms- CEO duality,
board size audit committee independence, and ownership concentration have an
impact on firm performance surrogated by return on assets (ROA); return on
equity (ROE), profit margin (PM). It provides empirical evidence for fifty two
(52) non-financial firms in Nigeria for a period of 2003 to 2008. The
Generalised Least Square (GLS) regression is employed to examine the
relationship existing between the variables. The results reveal that board
size, audit committee independence, ownership concentration have a significant
relationship with return on equity and profit margin. It is also observed that
CEO duality has no impact on firm performance. The advocacy is for the
Securities and Exchange Commission to
take into cognisance industry specific effects before formulating codes of
corporate governance that determine the characteristic of the audit committee
or the board structure. Proposition is also made for the Corporate Governance
Committee of companies to endeavour to do a regular appraisal of their corporate
governance compliance status so as to understand its effect on performance.
Keywords: Corporate
Governance, Firm performance, Agency Theory, Agency Costs
TABLE OF CONTENTS
PAGE
Certification………………………………………………………………………..iii
Declaration……………………………………………………………....................iv
Dedication ………………………………………………………………………....v
Acknowledgment………………………………………………….…………….....vi
Abstract……………………………………………………………….……………..vii
Table of Contents……………………………………………………………………..ix
List of Figures ……………………………………………………………………….xiv
List of Table ………………………………………………………………………....xv
Chapter One: Introduction………………………………………………………..….1
1.0 Background
to the study…………………………………………………………….....1
1.1 Statement
of Problem…………………………………………………………………..2
1.2 Objectives
of Study…………………………………………………………………….3
1.3 Research
Questions…………………………………………………………………......4
1.4 Hypotheses……………………………………………………………………………...4
1.5 Scope
of Study………………………………………………………………………….4
1.6 Significance
of Study…………………………………………………………………...5
1.7 Limitations
of Study…………………………………………………………………….6
1.8 Methodology……………………………………………………………………………6
1.9 Definition
of Terms…………………………………………………………………......7
Chapter Two: Literature Review…………………………………………………….….…….9
2.1 Introduction
………………………………………………………………………….….9
2.2 Conceptual
Framework………………………………………………………………....10
2.2.1 Agency
Concept……………………………………………………………………......10
2.2.2 Corporate Governance Mechanisms for Reducing
Agency Costs……………………..14
2.2.2.1 Board
Size……………………………………………………………………………...14
2.2.2.2 CEO
Duality…………………………………………………………………………....15
2.2.2.2 Ownership
Concentration………………………………………………………………17
2.2.2.3 Audit Committee
Independence………………………………………………………..18
2.2.3 Summary of Theory, Hypothesis
and Conceptual Model……………………………....19
2.3 Theoretical
Framework of Corporate Governance……………………………………....21
2.3.1 Stakeholder
Theory……………………………………………………………………...22
2.3.2 Stewardship
theory……………………………………………………………………...22
2.3.3 Resource Dependency Theory
(RDT)………………………………………………......22
2.3.4 Agency
theory…………………………………………………………………………...23
2.3.5 Assumptions of Agency
Theory………………………………………………………....24
2.3.6 Limitations of Agency
Theory…………………………………………………………..25
2.4. Measuring Firm Performance…………………………………………………………....26
2.5 Measuring
Control Variables………………………………………………………….…28
2.5.1 Company
Size……………………………………………………………………………29
2.5.2
Leverage……………………………………………………………………………….....28
2.6 Corporate
Governance and Performance Measures……………………………………...29
2.7 Methodological
Review………………………………………………………………….31
2.8 Corporate Governance Measures in Nigeria……………………………………………..32
2.8.1 The Role of the Board of
Directors, Chairman, and Chief Executive Officer…………..32
2.8.2 The Role of the Audit
Committee………………………………………………………..33
Chapter Three: Research Methodology …………………….………………………..……….34
3.1 Introduction………………………………………………………………………………34
3.2 Research
Design………………………………………………………………………….34
3.3 Population of Study……………………………………………………………………...34
3.4 Sample size and Sampling Technique………………………………………………..….34
3.5 Data Gathering Method…………………………………………………………………..35
3.5.1 Sources of
Data…………………………………………………………………………. 35
3.5.2 Instruments of Data
Collection……………………………………………………..……35
3.5.3 Validity and Reliability of
Instruments………………………………………………….35
3.6 Data Analysis Method…………………………………………………………………...36
3.6.1 Methods of
Data Analysis……………………………………………………………….36
3.6.2 Instruments for Data Analysis
(Including formulae) ……………………………………36
3.6.3 Model
Specification……………………………………………………………………...37
Chapter Four: Data Presentation and Analysis …………………………..………….…….. 39
4.1 Introduction……………………………………………………………………………..39
4.2 Data
Presentation………………………………………………………………………..39
4.2.1 Industry Based
Presentation…………………………………………………………….39
4.3 Data
Analysis …………………………………………………………………………....41
4.3.1 Summary
Statistics………………………………………………………………………41
4.3.2 Correlation
Analysis……………………………………………………………………..46
4.3.3 Econometric
Analysis……………………………………………………………………47
Chapter Five: Summary, Findings, Conclusion And Recommendations…………………..52
5.1 Introduction……………………………………………………………………………..52
5.2 Summary of Work Done………………………………………………………………...52
5.3 Findings………………………………………………………………………………….53
5.3.1 Theoretical
Findings……………………………………………………………………..53
5.3.2 Empirical
Findings……………………………………………………………………….54 5.4
Conclusion …………………………………………………………………………...….55
5.5 Recommendations…………………………………………..……………………………55
5.6 Suggestions
for Further Studies…………………………………………………….........56
References ……...……………………………………………………………………….58
Appendices …………………………………………………………………………………...…66
Appendix 1 Sample Companies and Their
Industries…………………………….…66
Appendix 11 Generalised
Least Square Regression Result Of Estimated Model (Fixed
Effects)
…………………………………………………………………68
LIST OF FIGURES
Figure
1: Corporate Governance, Agency Costs, and Firm performance: A Triangular Relationship………………………………………… 13
Figure
2: Conceptual Framework of Corporate Governance and Firm performance…… 20
Figure
3: Model showing the theoretical framework of corporate governance and firm
performance 26
Figure 4: Column Chart Showing Percentage of Sample Companies in
the Industry………….40
LIST OF TABLES
Table
1: Summary of Hypotheses ………………………………………………………………20
Table
2: Summary Statistics of
Variables……………………………………………………….42
Table 3: Summary
Statistics of Industries and Independent Variable ………………………….44
Table 4: Summary Statistics of Industries and
Dependent Variable …………………………...45 Table 5: Test for Multicollinearity
……………………………………………………………...46
Table
6: Generalised Least Square
Regression Result of Estimated Model……………………50
CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
The subject of corporate governance has spurred
research interests with respect to principal- agent relationship expropriation
in recent times especially with the existence of publicly quoted companies.
This is in corroboration with Claessens & Fan (2002) who opined that
corporate governance has received much attention in recent years.
Corporate governance reform has emerged as a critical
business issue, thrust on the world stage by a number of high profile corporate
failures (Strandberg, 2001). The prominent corporate accounting scandals of
Enron Corporation, World Com, Tyco, and Parmalat have led to contemporary
discussion on the best mechanisms for protecting stakeholder’s interest and
ensuring shareholders wealth maximisation. Also, in Nigeria the emphasis on the
need for corporate governance reform sprung up with the incidence of fraudulent
financial reporting as reported in the case of Cadbury Nigeria Plc. and the
recent crisis in the banking industry.
Abor & Biekpe (2005) intricately define corporate
governance as the process and structure used to enhance business prosperity and
corporate accountability with the ultimate objective of realizing long- term
shareholder value, whilst taking into account the interest of other
stakeholders. Kyereboah-Coleman (2007) argues that corporate governance is
represented by the structures and processes lay down by a corporate entity to
minimize the extent of agency problems as a result of separation between
ownership and control. Simply put, corporate governance in an organizational
context is the totality of the control, monitoring and directing mechanism
utilized by strategic management in the best interests of its stakeholders.
Firm performance is a concept that supports the
effective and efficient use of financial resources to achieve overall company
objectives which include both shareholders wealth maximisation and profit
maximisation objectives. It can be measured using long term market performance
measures and other performance measures that are non-market-oriented measures
or short term measures (Zubaidah et al, 2009). The measure of firm performance
employed in this study is from a non-market oriented perspective which is most
common and requires the use of accounting ratios which are the profitability
and investor ratios.
This study intends to contribute
to the few researches on the Nigerian environment as most of the researches on
firm performance and corporate governance which resulted in mixed outcomes were
conducted in the United States of America, the United Kingdom, Pakistan and
Malaysia (Ertugrul & Hegde, 2009; Jong, Gisper, Kabir, & Renneboog,
2002; Javid & Iqbal, 2009; Zubaidah, Nurmala, & Kamaruzaman, 2009). It
would also provide credible findings to support deliberations on this topical
issue.
1.2 Statement of Research Problem
The problem areas that spurred the interest in
researching on this topic are specifically the loss of confidence by the
investors on the capital market, the persistent agency problem and the
insolvency of large companies as a result of financial improprieties. These
issues are discussed more explicitly below.
Kajola (2008) asserts that financial scandals around
the world and the recent collapse of major corporate institutions in the USA,
South East Asia, Europe and Nigeria have shaken investors’ faith in the capital
markets and the efficacy of existing corporate governance practices in
promoting transparency and accountability. Good corporate governance is an
important step in building market confidence and encouraging more stable,
long-term international investment flows
(Bocean & Barbu, 2007). The loss of confidence by investors in the
capital market is therefore an indicator of poor corporate governance practice
in quoted companies (Oyebode, 2009). The shares of the listed companies on the
Nigerian stock exchange are gradually declining from a bullish state to a
bearish status. Shareholders have lost interest in trading on the stock
exchange because of the crash in share prices just as in the Cadbury Nigeria
Plc. case when it overstated its earnings and its shares were dealt a heavy
blow on the Nigerian Stock Exchange Market.
Also, the existence of the agency problem which
arises in a bid to intermediate between the interests of the managers and that
of the shareholders typically influences firm performance. It is for this
reason that Sanda, Mikailu, & Garba (2005) posits that for example, the
managers might take steps to increase the size of the company and, often, their
pay, although they may not necessarily raise the company’s profit, the major concern
of the shareholder.
The insolvency of large companies as a result of
financial improprieties has awakened discuss on the effect of corporate
governance on firm performance (Claessens, 2003; MENA-OECD Investment
Programme- Working Group 5, n.d). In the same vein, the predominance of sharp
practices by management and insider trading for the purpose of defrauding such
companies as a result of the need to satisfy some personal interest may also a
contributory factor to poor firm performance.
It is therefore believed that
examining the relationship between corporate governance mechanisms and firm
performance would attempt to address the problems as stated.
1.3 Objectives of Study
The objective of this study in a broad sense is to
measure the relationship between firm performance and corporate governance
mechanisms. The specific objectives of this study are thus as follows:
1. Ascertain
whether there is a negative relationship between board size and firm
performance.
2. Ascertain
whether or not the combination of the posts of the CEO and Chairman of the
board significantly enhances firm performance.
3. Investigate
whether there is a positive relationship between ownership concentration and
firm performance.
4. Examine
whether the independence of the audit committee affects firm performance
positively.
1.4 Research Questions
The study provides answers to the
following questions:
1. What
is the relationship between board size and firm performance?
2. To
what extent does the combination of the posts of the CEO and Chairman of the
Board affect performance?
3. How
does concentration of ownership affect firm performance?
4. What
relationship exists between the independence of the audit committee and firm
performance?
1.5 Hypotheses
The hypotheses that provide greater
insight into the research work are as follows:
H1: Board size has a negative significant relationship
with firm performance
H2: CEO duality does not significantly increase firm
performance
H3: Ownership concentration is positively related to firm
performance
H4: Audit committee independence has a positive significant
relationship with firm performance
1.6 Scope of Study
The focus of this study is to
employ panel data methodology to provide evidence on the relationship between
firm performance measures and corporate governance in Nigeria. The study
observes the most recent financial periods of some of the non-financial
companies listed on the Nigerian Stock Exchange. This includes fifty two (52)
selected listed non-financial companies.
Information is elicited from Annual Reports and
Accounts for a period of 6 years from 2003 to 2008. The list of selected
companies is contained in the appendix.
1.7 Significance of Study
The indispensability of this study lies in its
ability to fill an identified gap and contribute to existing researches in the
subject area.
The previous empirical studies conducted on the
Nigerian environment do not cover information elicited from the most recent
periods. The studies provide evidence from the period of 1996 to 2006 (Kajola,
2008; Sanda, Mikailu, & Garba, 2005), whereas this study provides evidence
from 2003 to 2008.
Most importantly, this study advances on Kajola
(2008) which is the most recent study in this area on the Nigerian Stock
Exchange known to the researcher. Kajola (2008) undergoes a limitation borne
from examining the relationship between only two performance measures – Return
on Equity and Profit margin on the corporate governance variables on twenty
(20) companies listed on the Stock Exchange. Whereas, this study makes use of a
larger sample size of fifty two (52) and examines the relationship between
three performance measures (Return on Equity, Return on Assets, and Profit
Margin) and four corporate governance variables .
As a result of the selection of sample companies from
different industries, an industry dummy variable is created so as to determine
whether or not peculiarity exists in the results of companies in same industry.
Also, company size and leverage are introduced as control variables in order to
determine their relationship with firm performance.
The intended purpose of bridging the discussed gaps
would not be achieved without this research lending its solutions and
methodologies to resolving the lasting conflict of interest between managers
and shareholders which has been tagged as the agency problem.
This study is beneficial to the
following categories of people:
Top
executives: this includes the CEO, Chairman and members of the board. It
would aid them in managing the issues arising from agency relationships. It
would also broaden their perspective on the aspects of corporate governance
that need to be enhanced that will result in improved firm performance.
Shareholders/
Investors: it would assist existing shareholders and potential investors to
make appropriate judgements as regards their investments and performance of the
companies in which they are stakeholders.
Regulators: it
would assist the regulators in promulgating better corporate governance regulations
that will be more encompassing and contribute effectively to enhancing firm
performance and resolving agency conflict.
Future
Researchers: they will be able to apply this research to carry out further
studies in the same area or related area by serving as a theoretical base for
the research to be carried out.
1.8 Limitations of Study
The constraints experienced in
carrying out this research are
1. Availability
of data: the inability to obtain data from a very large sample of the
population impairs the generalization of the findings to a certain extent.
2. Time
constraint: based on the fact that the researcher has to cope with other
academic activities and official assignments, there is insufficient time for
project work.
1.9 Methodology
This research employs panel data or longitudinal data
analysis which is a combination of cross sectional data analysis and time
series analysis.
The observations for the panel data analysis contains
two elements namely the cross sectional element denoted by subscript i and time series element denoted by
subscript t.
The population for this study has been defined as all
the companies quoted on the Nigerian stock Exchange which was three hundred and
twelve (213) as at 2008 (Okereke-Onyuike, 2009). A sample of fifty two (52)
non-financial companies has been selected based on random sampling technique
and the availability of the financial statements. The Annual reports and
Accounts of the listed companies contained in the sample examined cover a time
period of six (6) years which is from 2003-2008. This makes a total of three
hundred and twelve (312) observations applied in the panel data analysis.
The Ordinary Least Square Regression analysis is
applied to evaluate the effect of the performance measures on the corporate
governance mechanisms. The performance
measures are calculated using a set of financial ratios that are contained in
the annual financial reports and accounts of the selected companies. A test of
correlation is done to determine the associations between variables and also a
tabulated analysis of descriptive statistics.
The sources of data are basically secondary and they
are sourced from the Nigerian Stock Exchange Fact Book, Nigerian Stock Exchange
Annual, Annual reports and Accounts of companies.
1.10 Definition of Terms
Accounting
scandals: an event of an accounting nature that causes public outrage or
censure such as the understatement of profit, overstatement of assets.
Agency: fiduciary
relationship between two parties in which one (the “agent”) is obligated to the
other (the “principal”).
Audit
Committee: it is a body formed
by a company's board of directors to oversee audit operations and
circumstances. Besides evaluating external audit reports, the Committee may
evaluate internal audit reports as well.
Bearish: a stock market situation characterized by falling
stock-market prices.
Board of
Directors: A board of directors is a body of elected
or appointed members who jointly oversee the activities of a company or
organization. The body sometimes has a different name, such as board of
trustees, board of governors, board of managers, or executive board.
Bullish: a stock market situation characterized by rising stock
market prices.
Corporate
Governance: Corporate governance is the set of processes, customs,
policies, laws, and institutions affecting the way a company is directed,
administered or controlled.
Financial Reporting:
the presentation of financial information about an entity to potential
users of such information. The term usually refers to reporting to users
outside of the entity.
Insolvency: the
situation where entities cannot raise enough cash to meet its obligations, or
to pay its debt as they become due for payment.
Profit Margin:
It is a measure of operating efficiency and pricing strategy, the ratio is
usually computed using net profit before extraordinary items and taxes-that is,
net sales less cost of goods sold and Selling, General,
and Administrative (SG&A) Expenses. It is expressed as a
percentage and calculated as Net profit
divided by Sales.
Return on
Assets (ROA): ROA gives an idea as to how efficient management is at using
its assets to generate earnings. It is displayed as a percentage and calculated
as Profit after Tax/ Total Assets.
Return on Equity: Return on equity measures a corporation's
profitability by revealing how much profit a company generates with the money
shareholders have invested.
ROE is expressed as a percentage
and calculated as: Profit after tax /Shareholder's Equity. Stakeholders: persons with interest in an organisation such as its
owner, employees and creditors.
Shareholder: an
individual or group who holds one or more shares in an organisation, and in
whose name the share certificate is issued.
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