CORPORATE GOVERNANCE AND FIRM PERFORMANCE: EMPIRICAL EVIDENCE FROM SELECTED LISTED COMPANIES IN NIGERIA
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
2.2.2.3Audit 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……………………………………………………………………….545.4 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 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.
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 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.
Shareholder: an individual or group who holds one or more shares in an organisation, and in whose name the share certificate is issued.
