Implications Of Poor Corporate Governance Practice On Banking System Stability In Nigeria
The broad objective of this study is to investigate the implications of poor corporate governance practice on the banking system stability in Nigeria. Specifically, the study sought to; examine the effect of board composition on the banking system stability in Nigeria; to evaluate the effect of board size on the banking system stability in Nigeria; to ascertain the effect of bank size on the banking system stability in Nigeria. To achieve these objectives, ex-post facto research design and panel regression analysis were adopted. The dependent variable is non-performing loan to total assets and the independent variables are board composition, board size, bank size, and net income; the data generated from individual bank audited financial reports were analyzed using panel regression models. With respect to the analyses done, the following findings were made at 5 percent level of significance, the study accepted the first alternate hypothesis that board composition has no significant effect on banking system stability in Nigeria. For the second hypothesis, the study accepted the second null hypothesis and rejected the alternate hypothesis that board size has significant effect on banking system stability in Nigeria.
The study rejected the third hypothesis which states that bank size has no significant effect on banking system stability in Nigeria. The implication of these findings is that when the composition of the board increases, it affects the banking system stability so much as it increases the allowances to be paid thereby increasing the expenses to be incurred by banks. It was also seen that stability of the banking system does not really rely on the size of a bank.
Higher number of non- executive independent directors promotes rational decisions and creates value for the shareholders. The role of independent directors is very important and improves the value of a bank as it shows that they can monitor the bank and help the managers to take unbiased decisions. Based on the above findings, it was recommended that the regulatory and supervisory authorities should monitor banks closely to ensure that banks comply with the corporate governance codes especially when it has to do with board size since it has a significant effect on stability of the banking system and board of directors should ensure the implementation of existing regulation such as lending exposure to an individual and make corporate governance practices a priority for the banks.
1.1 Background to the Study
Corporate Governance is the system by which corporations are directed and controlled (Rezaee, 2009). The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation such as; boards, managers, shareholders and other stakeholders and spells out the rules and procedures and also decision making assistance on corporate affairs (Magdi and Nadereh, 2002). By doing this, it also provides the structure through which the company objectives are set, the means of obtaining those objectives and examining the value and the performance of the firms. Effective corporate governance is considered as ensuring corporate accountability, enhancing the reliability and quality of financial information, and therefore enhancing the integrity and efficiency of capital markets, which in turn will improve investors’ confidence (Rezaee, 2009).
Corporate governance involves a system by which governing institutions and all other organizations relate to their communities and stakeholders to improve their quality of life. (Ato, 2002). It is therefore important that good corporate governance ensures transparency, accountability and fairness in reporting. In this regard, corporate governance is not only concerned with corporate efficiency, but also relates to a much wider range of company strategies and life cycle development (Mayer, 2007). It is also concerned with the ways parties (stake holders) interested in the wellbeing of firms ensure that managers and other insiders adopt mechanisms to safeguard the interest of the shareholders. (Ahmadu and Tukur, 2005). Corporate governance is based on the level of corporate responsibility a company exhibits with regard to accountability, transparency and ethical values. Corporate governance has also been defined by Keasey et al (1997) to include, “the structures, processes, cultures and systems that engender the successful operation of organizations”. The definition could therefore be centered on how the organization relates with other stake holders within an environment. Therefore, corporate governance describes how companies ought to be run, directed and controlled (Cadbury Committee, 1992). It isabout supervising and holding to account those who direct and control the management.
Corporate governance is an important effort to ensure accountability and responsibility and a set of principles, which should be incorporated into every part of the organization. Though it is viewed as a recent issue, there is, in fact, nothing new about the concept. Corporate governance has been in existence as long as the corporation itself – as long as there has been large–scale trade, reflecting the need for responsibility in the handling of money and the conduct of commercial activities (Metrick and Ishii, 2002). Corporate governance has succeeded in attracting a great deal of interest as it focuses not only on the long-term relationship, which has to deal with checks and balances, incentives for managers and communications between management and investors but also on transactional relationship, which involves dealing with disclosure and authority (Tandelilin et al. , 2007).
The challenge of corporate governance could help to align the interests of individuals, corporations and society through a fundamental ethical basis. This it will fulfill the long-term strategic goal of the owners, which, after survival may consist of building shareholder value, establishing a dominant market share or maintaining a technical lead in a chosen sphere (Yetman,2004). It will certainly not be the same for all organizations, but will take into account the expectations of all the key stakeholders, in particular: considering and caring for the interests of employees, customers and suppliers, stockholders and debt holders, state and local community, both in terms of the physical effects of the company’s operations and the economic and cultural interaction with the population. The outcome of a good corporate governance practice is an accountable board of directors who ensures that the investors’ interests are not jeopardized (Hashanah and Mazlina, 2005).
Desai and Yetman (2004), identified two areas of agency problems that make human ability to make allocative decision imperfect; the cognitive and behavioral limitations. The cognitive limitation is hidden information, also known as bounded rationality. This prevents investors from knowing a priori whether the managers, whom they have employed as their agents, allocate resources in the most efficient manner. The behavioral limitation, also known as opportunism, is hidden action that reflects the productivity, inherent in an individualistic society of managers as agents to use their positions for resources allocation to pursue their own selfish interest and not necessarily the interest of the firm’s principals. This makes it very crucial and important to study the existence of the influence of corporate governance on the performance of firms
1.2 Statement of 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 (Sanusi, 2010). 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 remained a worrisome feature of the banking system (Soludo, 2004). The problem of corporate governance still remains un-resolved among consolidated Nigerian banks, thereby increasing the level of fraud (Akpan, 2007). 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 (Sanusi ,2010)
1.3 Objectives of the Study
The main objective of this study is to ascertain the impact of corporate governance on performance in Nigerian commercial banks. To achieve this, the research is focused on the following specific objectives:
- Examine the conceptual framework of corporate governance in commercial banks in Nigeria.
- Determine the extent of corporate governance practices in operation in the banking sector
- Ascertain the impact of Board Size on corporate performance.
- Determine how the level of independence of directors influences the returns of banks.
- Ascertain the factors that affect the levels of governance adopted.
1.4 Research Questions
The study will attempt to answer the following research questions:
- To what extent do commercial banks in Nigeria practice and adhere to corporate governance principles?
- Does the size of a board have an impact on the corporate performance of banks in Nigeria?
- What influence does the level of independence of boards have on bank’s performance?
- What are the reasons that make firms adopt different levels of governance under the same level of investor protection?
1.5 Research Hypotheses
- H0: There is no significant relationship between the size of a board and firm performance in the banking sector in Nigeria
- H1: There is a significant relationship between the size of a board and firm performance in the banking sector in Nigeria
- H0: Level of board independence has no impact on firm performance in the banking sector
- H1:. Level of board independence impacts on firm performance in the banking sector
1.6 Significance of the Study
The purpose of this study would be to critically examine, and understand while analyzing the adherence to corporate governance in the Nigerian Commercial banking sector. The outcome of this research is anticipated to contribute to existing body of knowledge. In addition; the study would highlight the regulatory and institutional factors which may affect the adoption, sustainable observation and practices of good corporate governance by banks in Nigeria.
Since the corporate performance of banks and other financial intermediaries is crucial for efficient resource allocation, at the micro and macro levels, this study would show the importance for banks themselves to put in place sound corporate governance. In fact, no one single factor contributes more to institutional problems, capable of precipitating crisis, than the lack of effective corporate governance (Lawal, 2009).
1.7 Scope of the Study
This study investigated corporate governance and its impact on performance commercial banks in Nigeria. The choice of this sector is based on the fact that the banking sector’s stability has a large positive externality and banks are the key institutions maintaining the payment system of an economy that is essential for the stability of the financial sector (Achua, K,2007). Financial sector stability, in turn has a profound externality on the economy as a whole. To this end, the study basically covered five of the commercial banks operating in Nigeria till date that met the N25 billion capitalization dead-line of 2005. The study will cover these banks’ activities during the post consolidation period i.e. 2006- 2012.
1.8 Definition of Key Terms
Is the totality of practices and principles by which a company’s board of directors provide a framework for achieving a company’s objectives. It encompasses every aspect of Management from the conceptualization of plans to the evaluation of performance and disclosure of such performance.
Is developing a strategy to accomplish specific objectives set to achieve organizational performance.
Is the ability of an organization to fulfill its mission through sound management, strong governance and a persistent rededication to achieving results.
Is the effectiveness of all efforts geared towards set objectives, measured as a relationship between the amount of output produced and the amount of input used to produce that output.
Is the result of activities of an organization or investment over a given period of time.
Is an individual, group, or organization that owns one or more units of shares in a company and who partakes in the financial prosperity or otherwise of the company.
A person, group or organization that has an interest or concern in an organization.
Summary of Findings, Conclusion and Recommendations
The objective of this chapter is to discuss the findings, reach conclusion and make necessary recommendations from all the qualitative and quantitative analysis presented in chapter four.
The chapter is structured into five sections as follows: section 5.1 summarises the research objectives and the analysis, section 5.2 covers the conclusion while section 5.4 covers the sections for recommendations
5.1 Summary of Work Done
This study made use of secondary data in analyzing the relationship between corporate governance and financial performance of the 21 banks listed in the Nigerian Stock Exchange. The secondary data was obtained basically from published annual reports of the selected banks. Relevant data for the study were retrieved from the Nigerian Stock Exchange Fact Book for 2008 and corporate websites of the reviewed banks.
The Pearson Correlation and regression analysis were used to find out whether there is a relationship between the variables to be measured (i.e. corporate governance and banks’ financial performance) and also to find out if the relationship is significant or not. However, the t-test statistics was used to establish if there is any significant difference between the profitability of healthy and rescued banks and also if a difference exist in the profit of banks with foreign directors and those without. The proxies that were used for corporate governance are; board size, proportion of non executive directors on board and directors’ equity holdings. Accounting measure of performance (return on equity and return on asset) as identified by First Rand Banking Group (2006) were used as the dependent variable. Decisions were later taken based on return on equity.
However, in examining the level of corporate governance disclosures of the sampled banks, a disclosure index was developed using the CBN post consolidation code of best practices and guided by the papers prepared by the UN secretariat for the nineteenth session of ISAR (International Standards of Accounting and Reporting, 2001), entitled “Transparency and disclosure requirements for corporate governance” and the twentieth session of ISAR (2002), entitled “Guidance on Good Practices in Corporate Governance Disclosure”) for the banks under study. Using this post consolidation code of best practices, issues in corporate governance disclosure are classified into 5 broad categories: Financial disclosures, non-financial disclosures, annual general meetings, timing and means of disclosure, and best practices for compliance with corporate disclosure. Under all these broad and subcategories, a total of 45 issues were considered (See Appendix 4).
With the help of the list of disclosure issues, the annual reports of the banks were examined and a dichotomous procedure of content analysis was followed to score each of the disclosure issue. Each bank was awarded a score of ‘1’ if it appears to have disclosed the concerned issue and ‘0’ otherwise. The score of each bank was totaled to find out the net score of the bank. A corporate governance disclosure index (CGDI) was then computed. Furthermore, the t- test was used to establish if there is any significant difference in the profitability as recorded by the cleared banks as identified by CBN
From the analysis above, the study therefore conclude that there is no uniformity in the disclosure of corporate governance practices made by banks in Nigeria. Though they all disclose their corporate governance practices, but what is disclosed does not conform to any particular standard. The banks do not disclose in general how their debts are performing, by providing a statement that expresses outstanding debts in terms of their ages and due dates. This is however done for insider-related debts in some banks. The insider-related debts are expected to form an insignificant part of the debts of the banks and so may provide an adequate picture of the risk profile of the banks.
Disclosures on directors’ remuneration do not provide sufficient details that would enhance any meaningful analysis. This makes it difficult for anyone to judge the adequacy or otherwise of directors’ remuneration. Similarly, disclosures about employees are scanty. They do not provide sufficient details that would enable anyone to do any meaningful analysis for the assessment of the adequacy or otherwise of their remuneration, vis-à-vis the number in each category of staff.
Despite the requirements of stock exchange and government regulators, certain bank managers still disclose selectively, especially when the monitoring and enforcement of disclosure requirements are not strict in Nigeria.
Furthermore, the study conclude that a negative relationship exist between bank performance, board size and proportion of non executive directors. That is, a reasonably strong correlation exists between poor performance and subsequent increase in board size and independence. While a percentage increase in return on equity can be explained by directors’ equity interest and the governance disclosure level.
5.4 Recommendations and Implication of Study
Based on the findings of this research, we therefore present the following recommendations which will be useful to stakeholders.
- Efforts to improve corporate governance should focus on the value of the stock ownership of board members, since it is positively related to both future operating performance and to the probability of disciplinary management turnover in poorly performing banks.
- Proponents of board independence should note with caution the negative relationship between board independence and future operating performance. Hence, if the purpose of board independence is to improve performance, then such efforts might be misguided. However, if the purpose of board independence is to discipline management of poorly performing firms or otherwise monitor, then board independence has merit. In other to have proper monitoring by independent directors, bank regulatory bodies should require additional disclosure of financial or personal ties between directors (or the organizations they work for) and the company or its CEO. By so doing, they will be more completely independent. Also, banks should be allowed to experiment with modest departures from the current norm of a “supermajority independent” board with only one or two inside directors.
- Steps should also be taken for mandatory compliance with the code of corporate governance. Also, an effective legal framework should be developed that specifies the rights and obligations of a bank, its directors, shareholders, specific disclosure requirements and provide for effective enforcement of the law.
- In this study, all the disclosure items were given same weight which helps to reduce subjectivity; however, authority may place higher emphasis on certain elements of governance. Some aspect of governance may be considered to be a basic component or prerequisite to implementing others and thus should be given more weight.
- Finally, there is the need to set up a unified corporate body saddled with the responsibility of collecting and collating corporate governance related data and constructing the relevant indices to facilitate corporate governance research in Nigeria.
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