Corporate Governance And Firm Performance: An Empirical Evidence From Selected Listed Companies In Nigeria
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
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:
- Ascertain whether there is a negative relationship between board size and firm performance.
- Ascertain whether or not the combination of the posts of the CEO and Chairman of the board significantly enhances firm performance.
- Investigate whether there is a positive relationship between ownership concentration and firm performance.
- Examine whether the independence of the audit committee affects firm performance positively.
1.4 Research Questions
The study provides answers to the following questions:
- What is the relationship between board size and firm performance?
- To what extent does the combination of the posts of the CEO and Chairman of the Board affect performance?
- How does concentration of ownership affect firm performance?
- What relationship exists between the independence of the audit committee and firm performance?
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:
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.
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.
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.
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
An event of an accounting nature that causes public outrage or censure such as the understatement of profit, overstatement of assets.
Fiduciary relationship between two parties in which one (the “agent”) is obligated to the other (the “principal”).
It is abody 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.
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.
A stock market situation characterized by rising stock market prices.
Corporate governance is the set of processes, customs, policies, laws, and institutions affecting the way a company is directed, administered or controlled.
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.
The situation where entities cannot raise enough cash to meet its obligations, or to pay its debt as they become due for payment.
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 soldand 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.
An individual or group who holds one or more shares in an organisation, and in whose name the share certificate is issued.
Summary, Findings, Conclusion and Recommendation
This research work is structured and brings to the fore the relationship between corporate governance and firm performance in selected listed companies in Nigeria.
This chapter includes the summary of the focal point of the study, research findings, conclusions recommendation, and suggestions for further studies.
5.2 Summary of Work Done
Corporate governance discuss has spurred research interests with respect to principal- agent relationship expropriation in recent times especially with the existence of publicly quoted companies.
There has been contemporary argument (Chen, Chen, & Wei, 2004; Sanda, Mikailu, & Garba
2005; Biswas & Bhuiyan, 2008; Darren 2010) that restricting agency conflicts and resulting agency costs is a potential channel through which corporate governance may impact on firm performance. It follows that internal corporate governance mechanisms are a means to curb agency costs and reduced agency cost would increase firm performance.
The study lends its solutions and methodologies to resolving the lasting conflict of interest between managers and shareholders which has been tagged as the agency problem by measuring the relationship between corporate governance and frim performance. A conceptual model is developed based on a review of theoretical and empirical literature.
Four hypotheses are formulated to provide better insight into the research. The hypotheses are tested using Generalised Least Square Regression testing for Fixed Effects. Other preliminary analysis including descriptive statistics and correlation are contained in the study to aid the robustness of findings.
The research findings are categorised into both theoretical and empirical findings which forms the basis for recommendations and suggestions for further studies.
5.3.1 Theoretical Findings
The theoretical perspectives of corporate governance have been discussed with a focus on agency theory. However, agency theory appears to be the mother theory of corporate governance from which other theories have sprung up, it still suffers some limitations. One of the limitations is that the stewardship attribute of agents is not taken into cognisance. The theory does not also recognise the existence of other stakeholders’ asides the shareholders.
In measuring the effect of corporate governance on firm performance certain findings as regards the theoretical framework are as follows:
- The sample companies prefer larger boards to increase firm performance because of the benefits of harnessing several human resource skills and input. This agrees with the resource dependency theory that proposes that board be comprised of directors with various skill and inputs that can take the company to where it ought to be.
- As regards a combination of the roles of Chief Executive Officer and Chairman of the board, the performance measure determines what theory is supports increase in performance. The study observes that the relationship between CEO duality, profit margin and and return on assets supports stewardship theory. The negative association between CEO duality and return on equity agrees with agency theory that it is better to separate the offices for adequate checks and balances.
- The concentration of director ownership does not necessarily have an effect on firm performance of the sample companies as against the theory of agency.
- A better independent audit committee does not result in improved firm performance in the sample companies. Whereas, agency theory presupposes that the more independent an audit committee, the enhanced the performance.
5.3.2 Empirical Findings
The study provides empirical evidence on the relationship between corporate governance and firm performance using regression analysis. The findings are discussed as follows:
The corporate governance measures except for from CEO duality have a significant relationship with firm performance but the signs vary. Some signs are positive while others are negative.
Be that as it may, board size has shown a positive significant relationship with profit margin and return on equity. While a negative relationship is observed with profit margin and return on assets. Inferably, the higher the board size, the greater the firm performance.
Also, combination of the position of the Chief Executive Officer and the Chairman of the board reflects a positive insignificant relationship with profit margin and return on assets. CEO duality also shows a negative insgnificant relationship with return on equity. This suggest that CEO duality has no impact on performance though the relationship is both positive (profit margin and return on assets) and negative (return on equity).
The study equally observes that the concentration of directors ownership shows a negative relationship with the firm performance measures. The relationship is significant with profit margin and return on equity but insignificant with return on assets. It then implies that the concentration of directors ownership has a negative and significant effect on firm performance as regards profit margin and return on equity.
Furthermore, audit committee independence has a negative significant relationship with firm performance based on profit margin and return on equity. The relationship of this corporate governance proxy with return on assets is negative and insignificant.
As regards the control variables, the size of the company depicts a positive insignificant relationship with profit margin and return on equity but a negative insignificant relationship with return on asset. The relationship between leverage and firm performance is observed to be insignificant with the three performance measures but positive with profit margin and return on assets and negative with return on equity.
Finally, it is typically observed that returns on asset did not turn out any significant relationship with the corporate governance measures. While return on assets appears to be the least efficient performance measure, return on equity appears to be the most efficient. Also, in evaluating the corporate governance measures, CEO duality is found to be the weakest. The combination or separation of the position of Chief Executive Officer and Chairman is generally found not have any impact on any of the three performance measures.
Corporate governance is a pertinent contemporary issue because of the prominence of corporate scandals mostly arising from creative accounting, and other financial misappropriations. The companies listed on the Nigerian Stock Exchange are guided by the Securities and Exchange Commission Code of Corporate Governance developed in October 2003. The corporate governance mechanisms complied with by companies is specified in this code of best practices. In order to curb agency cost which could be monetary and non- monetary and increase firm performance, corporate governance indices are identified. The effect of these corporate governance mechanisms on accounting based measures of firm performance is observed. The concentration of director ownership is quite low at an average of 4% and has an inverse relationship with the performance measures. The average board size is found to be 9 which is in concordance with the Securities and Exchange Commission Code of Corporate Code of Corporate governance. The audit committee is on the average 49% independent which results in an impact on performance based on return on equity and profit margin.
In attaining deeper insight into the relationship between corporate governance and firm performance and also into the research findings, the study makes some propositions to that effect.
Importantly, industry specific effects should be taken into consideration before formulating codes of corporate governance that determine the characteristics of the audit committee or the board structure. The Securities and Exchange Commission should take into cognisance this condition in formulating a code of corporate governance.
In addition, the Corporate Governance Committee of companies should endeavour to do a regular appraisal of their corporate governance compliance status as it affects performance. This is because the study is able to identify that corporate governance has an impact on firm performance.
Conclusively, diminishing profits should be investigated because it is apparent that there are scenarios were profits keep reducing till they eventually turn to losses. The performance indicators used in the study, measure below 10 % on the average which indicates poor performance and increasing agency costs.
5.6 Suggestions for Further Studies
This study has evaluated the relationship between corporate governance and firm performance and has opened up areas that further research can be executed.
For adequate generalisation of findings, the sample size could be increased and the time horizon can be expanded.
The financial institutions (banking, insurance and others) were not incorporated in the study because of the peculiarity of their financial statement and industry. Future researches should study the financial institutions collectively for the purpose of comparison.
There are a plethora of corporate governance measures that could be tested for their relationship with performance as this study only looks at four measures. Other performance indicators can be tested especially incorporating market based measures rather than only accounting based measures. A more efficient measure for capturing return on assets should be devised because of the large proportion of total assets relative to profit.
In measuring the effect of audit committee characteristic on firm performance, the financial expertise of the audit committee members should be taken into consideration rather than only just their independence. Or better still; a more robust measure of audit committee independence should be created.
Also, the control variables can be increased to include company age, auditor type, and growth of the company. The size of the company can also be captured using the logarithm of the book value of total assets or the number of employees in the company.
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