CORPORATE GOVERNANCE AND

BANK PERFORMANCE IN NIGERIA

AMIENYARU ENOBAKHARE

Research report presented in partial fulfilment

of the requirements for the degree of

Masters of Business Administration

at the University of Stellenbosch

Supervisor: Daniël Malan

Degree of Confidentiality: A December 2010

ii

DECLARATION

By submitting this research report electronically, I, Amienyaru Enobakhare, declare that the

entirety of the work contained therein is my own, original work, that I am the owner of the

copyright thereof (unless to the extent explicitly otherwise stated) and that I have not

previously in its entirety or in part submitted it for obtaining any qualification.

A. Enobakhare September 2010

Copyright © 2010 Stellenbosch University All rights reserved

iii

ACKNOWLEDGEMENTS

I give my sincere thanks and gratitude to almighty God for seeing me through this research

period as well as the MBA programme. Also I appreciate the words of encouragement and

emotional support from my family Mr. And Mrs E P Enobakhare, Dr. Egbe , Etinosa,

Oghomwen, Ibude and Iriagbonse. I also thank my study leader Daniel Malan for his

guidance, inputs and patience with me. Finally I will say a big thank you to Cynthia Swarts for

her tremendous support through out the programme.

iv

ABSTRACT

The purpose of this study was to determine the relationship between corporate governance

and the profitability of banks in Nigeria. This has been done in line with previous studies in

other parts of the world where it was discovered that the corporate governance culture of a

firm does have an effect on its profitability.

The corporate governance variable employed in this study was that of ownership. Four types

of ownership were used as the independent variables, namely board ownership, Institutional

ownership, foreign ownership and government ownership. Whilst the dependent variables

employed were return on assets (ROA) and non performing loans ratio (NPL). Information on

banks’ return on assets and non performing loans was generated from year end financial

statements and yearly bank reviews from a Nigerian based research firm called Agusto and

Company. Also the banks’ ownership variables information was also pooled from financial

reports, the Agusto report on banking industry as well as bank websites.

A descriptive statistic data was generated to review the trend of banks’ return on assets and

non-performing loan performance indicators, whilst a Pearson correlation table was generated

to review the correlation between the ownership variable and the performance of banks.

The results generated were found to be similar to what has previously been done. This study

makes a significant contribution to research by exposing the importance of corporate

governance, a concept which has been neglected in the Nigerian corporate world. Finally it

provides further justification to do further research in this area in the Nigerian banking and

corporate environment.

v

Table of contents

Page

Declaration ii

Acknowledgements iii

Abstract iv

List of tables Error! Bookmark not defined.

List of figures viii

List of acronyms ix

CHAPTER 1 INTRODUCTION 1

1.1 INTRODUCTION 1

1.2 DEFINITION 1

1.3 CONCEPT OF COPORATE GOVERNANCE IN THIRD WORLD COUNTRIES 4

1.4 THE NIGERIAN ECONOMY 5

1.4.1 The Nigerian Banking Industry 7

1.5 STATEMENT OF PROBLEM 9

CHAPTER 2 LITERATURE REVIEW 10

2.1 INTRODUCTION 10

2.2 AGENCY THEORY 10

2.3 STAKEHOLDER THEORY 12

2.4 STEWARDSHIP THEORY 13

2.5 RESOURCE DEPENDENCY THEORY 13

2.6 ORGANISATIONAL THEORY 14

2.7 BOARD OF DIRECTORS 14

2.8 BOARD CHARACTERISTICS AND STRUCTURE 14

2.8.1 Board structure 15

2.8.2 Board size 15

2.8.3 Board leadership 15

2.8.4 Board composition 16

2.8.5 Board diversity 16

2.9 CORPORATE GOVERNANCE IN NIGERIAN COMPANIES 16

2.9.1 Corporate governance for banks operating in Nigeria 18

2.10 CODE OF BEST PRACTICES ON CORPORATE GOVERNANCE 21

vi

2.10.1 Equity ownership 22

2.10.2 Organisational structure 22

2.10.3 Quality of board membership 23

2.10.4 Board performance appraisal 24

2.10.5 Reporting relationship 24

2.10.6 Industry transparency and disclosure requirements 24

2.10.7 Risk management 25

2.10.8 Role of auditors 26

2.11 PROCESS AND PROBLEMS OF CORPORATE GOVERNANCE IN THE NIGERIAN BANKING INDUSTRY 27

2.11.1 Environmental pressure 28

2.11.2 Instability of tenure 29

2.11.3 Government action 29

2.11.4 Board/management relationship 29

2.11.5 Executive chairmanship/vice chairmanship 30

2.11.6 Ownership crisis 30

2.11.7 Insider dealings 31

2.11.8 Quality of bank directors 32

2.12 PRE-REQUISITES FOR EFFECTIVE CORPORATE GOVERNANCE IN NIGERIA 32

2.12.1 Knowledge 32

2.12.2 Information 33

2.12.3 Strong management team 33

2.12.4 Power 33

2.12.5 Auditors 34

2.12.6 Motivation 35

2.12.7 Time 36

2.13 CORPORATE GOVERNANCE AND FIRM PERFORMANCE 36

CHAPTER 3 RESEARCH DESIGN AND METHODOLOGY 40

3.1 INTRODUCTION 40

3.2 INSTITUTIONAL OWNERSHIP 40

3.3 FOREIGN OWNERSHIP 41

3.4 BOARD OWNERSHIP 42

3.5 GOVERNMENT OWNERSHIP 43

3.6 RESEARCH DESIGN AND METHODOLOGY 44

vii

3.7 VARIABLE MEASUREMENT 45

3.8 INDEPENDENT VARIABLES 45

3.9 DEPENDENT VARIABLE 47

3.10 RESEARCH MODEL 47

3.11 DATA 48

CHAPTER 4 RESULTS 51

4.1 INTRODUCTION 51

4.2 DEPENDENT VARIABLE (NON-PERFORMING LOANS AND RETURN ON ASSETS – PERFORMANCE INDICATORS) 51

4.3 DESCRIPTIVE STATISTICS 51

4.4 DEPENDENT VARIABLE: RETURN ON ASSETS 53

4.4.1 Institutional ownership 53

4.4.2 Foreign ownership 53

4.4.3 Board ownership 54

4.4.4 Government ownership 54

4.5 DEPENDENT VARIABLE: NON-PERFORMING LOANS RATIO 55

4.5.1 Institutional ownership 55

4.5.2 Foreign ownership 55

4.5.3 Board ownership 56

4.5.4 Government ownership 56

CHAPTER 5 SUMMARY, CONCLUSION AND RECOMMENDATIONS 57

5.1 INTRODUCTION 57

5.2 CONCLUSION 57

5.3 RECCOMENDATIONS 58

5.4 FOR FUTURE RESEARCH 59

REFERENCES 61

Appendix 1: Performance descriptive statistics: Return on assets and non-performing loan ratio 64

Appendix 2: Banks Return on Assets Ratio 65

Appendix 3: Non-performing loan ratio 66

Appendix 4: Ownership Variables 67

Appendix 5: Summary output: return on assets 68

Appendix 6: Summary output: non performing loans 69

viii

LIST OF FIGURES

Page

Figure 1.1 GDP Growth per cent 6

Figure 2.1 Ownership structure of Nigerian banks 30

Figure 2.2 Functions of corporate governance 35

ix

LIST OF ACRONYMS

AGM Annual General Meeting

BGL BGL Services Limited

BOD Board of Directors

BOFID banks and other financial institutions decree

CBN Central Bank of Nigeria

CCO Chief Compliance Officer

CEO chief executive officer

ECA Economic Commission for Africa

GDP Gross Domestic Product

IT Information Technology

MD/CEO managing director/chief executive officer

NDIC Nigerian Deposit Insurance Corporation

NPL non performing loans

OECD Organisation for economic corporation and development

OLS Ordinary Least Square

PAT profit after tax

ROA return on assets

SEC Security Exchange Commission

SPV Special Purpose Vehicle

UK United Kingdom

US United States

1

CHAPTER 1

INTRODUCTION

1.1 INTRODUCTION

This chapter basically introduces the concept of corporate governance by analysing the

importance thereof and reviewing different definitions from scholars. A brief history of the

concept is discussed with specific reference to cases like that of Enron and the role played

by the neglect of corporate governance. In addition, since this thesis is based on Nigerian

banks it became imperative to briefly discuss the Nigerian economy and the current trend

of the banks. Finally the chapter addresses weaknesses of implementing corporate

governance in Africa in the past and addresses the need for the continent to strengthen its

governance culture which ultimately will lead to its economic growth and development.

1.2 DEFINITION

Why should an issue such as corporate governance become so important that institutions

world wide are not only adhering to its policies but also setting up units within the

organisation to look at it? Does it affect the corporate profitability of organisations giving

that the main focus is on corporations’ ways of acting? Then the big puzzle is that if

corporate governance does not directly affect the bottom line, it must be value adding

since it is embraced by institutions world-wide.

The issue of corporate governance has shown strong significance in the corporate world

given the rate at which multinationals have closed doors as a result of their acts. These

are organisations that were termed world class and assumed to act in line with acceptable

ethical standards. Amongst these organisations was the fall of Arthur Anderson with its

role in the tragic Enron story. Other examples of organisations that have either gone down

or suffered loss of income as a result of the way they have acted, are Worldcom, Shell in

Nigeria and the more recent incidence of the Indian telecommunications firm.

This now brings us to the issue of corporate governance. What exactly does this term

mean since business is naturally affected by the people and culture where it operates.

Does it mean something in a certain country while it means an entirely different thing

somewhere else? However, before proceeding with definitions, a brief history of the

concept is necessary.

2

The history of corporate governance dates back to the 19th Century when state corporation

laws enhanced the rights of corporate boards without unanimous consent of shareholders.

This was done in exchange for statutory benefits like appraisal rights and was believed to

make corporate governance more efficient. Early debates came up after the wall street

crash of 1929 where legal scholars like Adolf Augustus Berle, Edwin Dodd and Gardiner

C. Means questioned the changing role of the modern corporation.

These debates have become much stronger and with increased globalisation another

major cry has been on the issue of labour exploitation from foreign multinationals. All

these, amongst others, have brought about a continued high call for the modern

corporation to act in acceptable ways when its operations are carried out in different

countries where they exist. However this is in line with the issue that effective corporate

governance has been identified to be critical to all economic transactions especially in

emerging economies (Dharwardkar et al., 2000).

The concept of corporate governance has been defined in many ways by scholars world

wide. The president of World Bank, J. Wolfensohn, defines corporate governance as

promoting fairness, transparency and accountability. While scholars like Shleifer and

Vishny define corporate governance as that concept which deals with the ways in which

suppliers of finance to corporations assure themselves of getting a return on their

investment.

Another school of thought does have a view that seems to have caught up in some cycles.

This group defines corporate governance as the way in which directors and auditors

handle their responsibilities towards shareholders. In simple terms it also explains

corporate governance as ways of bringing the interest of investors and managers into line

and ensuring that firms are run for the benefit of investors (Mayer, 1997).

A broader and more acceptable definition is that corporate governance as a subject, as an

objective, or as a regime is to be followed for the good of shareholders, employees,

customers, bankers and indeed for the reputation and standing of our nation and its

economy (Maw et al., 1994: 1).

Finally the OECD in 1999 defined corporate governance principles as the system by which

business corporations are directed and controlled. The pillars of good corporate

governance have been known to shareholder rights, transparency and board

accountability. Corporate governance is also very much concerned with board structure,

executive compensation and shareholder reporting. There is a general assumption that the

3

board is responsible for managing the business and the company’s trading future. Hence,

the likelihood of a link between good corporate governance and corporate profitability.

This concept is relatively new in Africa when compared to developed places like Europe

and America. However, it has taken hold in Africa with corporate Africa embracing its

principles in line with the different regulating bodies. Nevertheless it is of importance to

note that good economic and corporate governance are fundamental preconditions for the

renewal of Africa. It certainly matters to Africa because African countries contribute to

macro-economic stability, enhance a government’s ability to implement development and

reduce poverty with scarce resources.

Much of the crisis in the emerging economies has led to the issue of corporate governance

being given the required attention. The East Asian crisis and recent corporate scandals,

both those perpetrated by the private investors and governments at large, have given

more prominence to this concept. Much research has been done on these issues in the

United States (US) and the United Kingdom (UK) with some degree of neglect being

experienced in Africa. This lack of adequate research in the field of corporate governance

in some aspects of Africa has been a major source of concern. However, there is a

gradual change in this trend. Some landmark achievements have been made in this field

over the last decade with one of them been the setting up of a corporate governance unit

in Stellenbosch, South Africa.

Guidelines for enhancing corporate governance in Africa were set up by the Economic

Commission for Africa (ECA). However, it is not a one size fits all, which means that

individual best practices should be identified for countries. This also means that each

African government should identify those components and mechanisms that provide a

good fit with its circumstances and will enable it to have good corporate governance. In

view of this the journal on good corporate governance in Africa by the economic

commission for Africa suggests relevant codes and standards that African countries should

give priority to which will enable the continent to be on the right path to achieving these

values.

The importance of good corporate governance cannot be overlooked in the present day

economy as it seems to flow into all spheres of the economy. This includes both the

private and public organisations. A major influence is that which it has on the attraction of

private investment through globalisation. Africa’s leaders recognise that globalisation can

facilitate much needed inflows of private investment and transfers of technology, in

4

addition to increasing access of their countries’ exports to world markets. Africa as a

continent has yet to fully tap into globalisation and although it has its controversial aspects,

it is still well known that globalisation also has positive angles to it.

The negative perception of the continent as a result of its poor governance culture has

been one of the reasons for its inability to effectively attract adequate foreign direct

investments, including capital flows. This further reiterates the importance of good

corporate governance in the continent.

In a country like Nigeria the issue of corporate governance has been one that has brought

about serious debates both from international and domestic institutions. It has been

addressed as one of the major factors that has led to a reduction in capital flows and

subsequent slow economic growth in the country. This is believed to be attributed to the

long military rule experienced by the country. However, with the advent of democracy in

May 1999, there has been a steady trend towards implementing good governance

structures both in public and private sectors.

A major sector where there has been a loud cry for good corporate governance values is

that of banking. The importance of banks in any economy cannot be understated

especially with the recent world financial crisis. The Nigerian financial sector has

experienced many changes over the last two decades which included bank distress and

reforms of major financial institutions.

There was the issue of weak corporate governance and institutional capacity which

needed to be addressed if the banking consolidation that took place in 2005 was to be

successful. This saw the Apex bank, central bank of Nigeria, coming up with a corporate

governance code for Nigerian banks which was to be effective from 3 April 2006. In this

code Nigerian banks were mandated on corporate governance values which should be in

line with the industry standard and will help to further strengthen the sector. The big

question being asked is how well these banks are acting in line with the corporate

governance codes from the Apex bank. Also, if they are acting in line with these laid down

rules, has it had a positive impact on the firm’s profitability?

1.3 CONCEPT OF COPORATE GOVERNANCE IN THIRD WORLD COUNTRIES

As stated previously, corporate governance has taken a stronger foothold in developed

countries when compared to emerging economies. Opinions differ on the content,

boundaries and relevance of the theory of corporate governance in the third world because

5

of the underdevelopment, unstructured and informal nature of the economies (Yahaya,

1998). However, the issues of good corporate governance can not be overlooked in this

part of the world because of its perceived role in development and economic prosperity.

In line with the recent trend where most African countries have decided to formalise their

economy, the clamour for good corporate governance has increased. This is also in line

with recent policies in other African countries. A major theory of corporate governance that

is of utmost importance in Nigeria is ownership structure. Most companies are either family

owned or major shares are held by a few investors. Ultimately this leaves control of the

firm within a small group of people. These theories will be discussed in the next chapter.

The theories are agency theory, stakeholder theory, stewardship theory and resource

dependency theory.

1.4 THE NIGERIAN ECONOMY

Nigeria, also named the Federal Republic of Nigeria, is a country located in West Africa.

The country is bordered by the Republic of Benin in the West, Cameroon in the east while

in the northern part is the country called Niger. Nigeria is the most populous black nation

and eighth most populous country in the world. It has a population of 140 million people

with about 250 ethnic groups. It is highly diverse in terms of culture and religion, which

tends to play a role in the way business is being conducted.

Nigeria is rich in natural mineral resources especially crude oil, and termed the 12th largest

producer of petroleum, 8th largest exporter and has the 10th largest proven reserves. The

country’s macro-economic performance for the last 12 months has been mixed with the

GDP growth rate hitting an estimated figure of 6.8 per cent (BGL financial monitor). The

non-oil growth was at 9.5 per cent while the oil sector declined by 4.5 per cent. Crude oil

plays a major role in Nigeria’s economy, accounting for 40 per cent of GDP and 80 per

cent of government spending. Agriculture used to be the country’s largest source of foreign

exchange, however, with the discovery of crude oil there was a total neglect of this sector.

A country that used to provide food for its citizens as at 1960 and provided about 98 per

cent of the nation’s consumption suddenly became an importer of food and agricultural

produce.

The country took on foreign debt to finance structural developments in the 1970’s during

the oil boom. Unfortunately many of these infrastructural projects that these funds were

taken for were inefficient and funds were grossly mismanaged by corrupt leaders. In the

1980’s when the world experienced the oil glut, Nigeria was unable to service its loans

6

which resulted in its defaulting of the loans. This incident led to the nation servicing only

the interest portions of its loans.

With the election of a democratic government in 1999 which had amongst its top priorities

to free the nation of all outstanding debt, things began to turn around. Fortunately, after a

long campaign by the nation’s democratic leaders, it was finally agreed with Paris club

creditors that Nigeria should repurchase its debt at a 60 per cent discount. The other 40

per cent debt was paid off using the profit from oil sales.

The payment of the above debt led to the availability of about $1.15billion which will now

be channelled into poverty alleviation programmes. This payment of debt has also helped

the nation to a great deal by resulting in positive signs of economic growth. Nigeria then

recorded a GDP real growth rate of 6.4 per cent (2007 est.), GDP purchasing power parity

of $296.1billion and per capita GDP purchasing power parity of $2,100. Currently Nigeria

has an unemployment rate of 4.9 per cent (2007 est.), a labour force of about 50.13 million

and has recorded an inflation rate of 5.4 per cent in 2007. However, the year on year

inflation for 2008 stood at 14.6 per cent while core inflation (non-food) was 9.2 per cent.

Figure 1.1: GDP Growth per cent

Source: BGL Research

The country has set goals for itself and it has forecasted double digit growth which has not

been met yet. However, given an improvement in the country’s economy, critics have

questioned how realisable and sustainable these developments will be, given the low level

of corporate governance in the country. Also, other critics have argued that corporate

governance only relates to corporations. In hindsight, the growth of corporations ultimately

plays a role in a country’s economic growth.

7

Many economic reforms have been made by the present administration of President Musa

Yaradua who was elected in May 2007. The nation hopes these economic reforms are

implemented quickly and in a transparent manner so that the nation’s economy can

experience more growth. The International Monetary Fund forcasted that the economy

would grow by 9 per cent in 2008 and 8.3 per cent in 2009. However, the overdependence

on crude oil, which is a major factor for the country’s tremendous growth, still poses a

serious threat to the long-term growth sustainability.

1.4.1 The Nigerian banking industry

The major function of banks both in a developed and developing economy is to act as a

financial mediator between the region of surplus and deficit. The Nigerian financial sector

of the economy has experienced many changes over the last two decades which include

the distress and reforms of some major financial institutions.

There was an initial crisis in the mid 90’s (1994–1995) that saw the distress of about five

banks while a further escalation of the crisis was noticed in the late 90’s (1997–1998) with

another 26 banks closing shop. All of this happened under the military rule of the late

dictator, General Sanni Abacha, as the then president of the country.

Fortunately with the advent of the democratic government in May 1999, the financial

sector, especially the banks, started to stabilise. The market did not witness any more

crashes but there was still a major constraint in the financing capabilities of the banks

which was as a result of their minimum required capital base by the central Bank of

Nigeria. The capital base required by before 2005 was approximately US$17million. As a

result of this the 89 banks could not compete internationally and were unable to fund large

ticket transactions. In June 2005, the Central Bank of Nigeria (the Apex bank) announced

that all banks were given till end of the year to increase their capital base to a minimum of

about $210million. This new policy resulted in a major change in the banking sector which

saw a flight to capital market to raise funds. Those that were not successful in raising the

new minimum required capital via public offers had to merge with other banks or be

acquired. This new trend resulted in a dramatic reduction in the number of banks from 89

to 25 in 2005 and subsequently 24 in 2007 as a result of the merger between a South

African and a local bank.

It is important to note that prior to 2005 the Nigerian banking system could not deliver on

these defined roles. This was attributed to a couple of reasons, namely low aggregate

banking credit to the domestic economy (18.4% as percentage of GDP), systemic crisis

8

where banks were frequently out of clearing inadequate capital base and over dependence

on public sector funds. Other reasons include the payment system that encouraged cash-

based transactions, low banking/population density, poor corporate governance and the

oligopolistic structure that had 10 out of 89 banks accounting for over 50 per cent of total

banking system assets (Ogbechie & Koufopoulos, 2009: 87).

This new minimum capital base has helped the local banks to compete internationally as

well as comfortably finance large investments in the country and beyond. Presently the

country’s 24 banks are referred to as mega banks because of their financial strength,

presence in other African countries and in financial hubs around the world such as London

and New York. This is contrary to the initial belief that Nigerian banks are inferior

compared to foreign banks, despite the fact that much still needs to be done (African

Review of Business & Technology, 2005).

The main purpose of the recapitalisation exercise, according to the Central Bank of

Nigeria, was to establish a banking system that will rapidly drive Nigeria’s economic

growth and development. Also, this was to ensure the integration of the Nigerian banking

system into the global financial system. Finally, the Central Bank of Nigeria also targets a

local bank to feature in the top 100 banks in the world within the next 10 years and in the

long term to make Nigeria Africa’s financial hub (Ogbechie & Koufopoulos, 2009: 90).

The outcome of the above transformation has been impressive with asset base

experiencing a 277 per cent growth between 2003 and 2007. By February 2008 11 banks

had over $1billion in tier 1 capital and had operations in 16 African countries and in seven

countries outside Africa. Twenty one of these banks are listed on the Nigerian stock

exchange accounting for about 60 per cent of market capitalisation in 2008.

Nevertheless, it goes without doubt that the banking system is one that is built on trust and

public confidence. This makes it important to employ good corporate governance practices

in the industry. The banking sector is very important for the country’s economic growth as

a result of mobilisation of funds, allocation of credits to various sectors of the economy,

payment and settlement systems, and the implementation of monetary policy. An effective

corporate governance practice is therefore essential to maintain public trust and

confidence in the banking system. This in turn will determine the profitability of these

institutions.

9

1.5 STATEMENT OF PROBLEM

In view of the above, it is important to note that Nigeria’s neglect of core issues, which

have been regarded as a nation’s building blocks, has had a negative impact on the

country. Amongst these issues were proper rules and regulations from all governing

bodies, especially the banking sector. This lack of respect for rule of law also impacted

negatively on the way business was done, subsequently affecting corporate governance.

Presently Nigerian banks are regarded as big banks and have been able to weather the

recent economic storm so far. However, there is a cry for full disclosure of their activities

especially their exposure to the capital market. This will reveal which banks comply with

corporate governance measures that have been set by the Apex bank.

In view of the above, the research question in this study is to test if there is a relationship

between corporate governance and banks’ performance. Taking it a step further,

ownership structure is the arm of corporate governance which is being used to test the

relationship with banks operating in Nigeria. The research question follows what has been

done in other countries, both developed and developing economies, where ownership

structure is broken down further to board ownership, institutional ownership, foreign

ownership and government ownership.

10

CHAPTER 2

LITERATURE REVIEW

2.1 INTRODUCTION

This chapter addresses the various variables of corporate governance such as agency

theory, stewardship theory, board ownership and so on. Afterwards a review of the

corporate governance and its effects as seen from past research conducted by scholars in

the Nigerian business environment is analysed. A more focussed analysis is further seen

on the relationship between corporate governance and Nigerian banks; that is steps taken

by the Central Bank of Nigeria, securities and exchange commission as well as the

Nigerian deposit insurance corporation. The focus is on past corporate governance

measures and whether they have been adhered to by the banks. However, the concept

also poses as a challenge to Nigerian banks, hence its review in this chapter and a look at

the pre-requisites for effective corporate governance in the Nigerian banks. Finally, this

chapter addresses the core of this research which is the relationship between corporate

governance and a firm’s performance. A review of past research has been analysed as

well as the corporate governance variables which have been employed to reach the

various conclusions. Hence, this has formed a basis for the intention to research and

determine whether this relationship exists in Nigerian banks.

2.2 AGENCY THEORY

Many theories have emerged to highlight the objective of the firm and how it should

respond to its obligations. This concept has a long history, but in a formal sense it

originated in the early 1970s. Those that influenced this theory include property-right

theories, organisation economics, contract law and political philosophy The most

prominent is the agency theory in the corporate governance literature. This theory revolves

around an individual referred to as the principal who hires another individual (the agent)

and delegates decision making authority to the agent (Jensen & Meckling, 1976). The

agency relationship in business is between stockholders and managers. It also spans to

the relationship between debt holders and stockholders. This relationship comes with

conflict normally termed agency conflicts or conflicts of interest between the principals and

the agents.

According to this theory, the fundamental agency problem in modern firms is due to the

separation between finance and management (Coleman, 2008: 3). It is believed that

11

modern firms suffer as a result of separation of the ownership which invariably results in

the firm being run by professional managers. These professional managers of agents

cannot be held accountable by the dispersed shareholders.

The fundamental problem is how the managers follow the interest of the shareholders to

ensure that cost is reduced. Also, the principals are confronted with a couple of problems,

amongst which are: how to select the most capable manager and also ensure that

managers are given the right incentive to take decisions that are aligned with

shareholders’ interest. Also, the challenge that the managers might extract prerequisites

(or perks) out of other sources leading them to be less concerned about the overall welfare

of the firm, is possible. They advertently become less interested in other profitable new

ventures as a result of their selfish needs.

The cost of the above is known as agency cost. It is the cost borne by shareholders to

encourage managers to maximise shareholder wealth rather than act in their own self

interest. This theory is most associated with a seminal 1975 Journal of Finance paper by

Michael Jensen and William Meckling. They insinuated that corporate debt and

management equity levels are influenced by the agency cost. Agency costs have been

divided into three major types. One of them is cost spent on managerial activities such as

audit cost while the second is expenditures to structure the organisation in way that will

limit undesirable managerial behaviour. This includes appointing non executive directors,

business restructuring and restructuring management hierarchy. Finally, opportunity cost is

incurred when restriction by shareholders limits the ability of managers to take actions that

positively impact shareholders’ wealth.

It is therefore important to reduce agency cost to increase firm value. A way of ensuring

that firm value is preserved is by the composition of a board of directors. The board of

directors should constitute more non-executive directors. This will ensure that they are

unbiased in their judgements, reduce conflict of interest and ensure the board’s

independence in monitoring and passing fair judgement (Coleman, 2008: 3).

Also, the issue of CEO duality can help in reducing agency cost, namely increasing firm

value. Separating the positions of chief executive officer (CEO) and board chairperson will

help spread power and reduce undue influence of management and board members.

12

2.3 STAKEHOLDER THEORY

This theory centres on the issues concerning the stakeholders in an institution. It stipulates

that a corporate entity invariably seeks to provide a balance between the interests of its

diverse stakeholders in order to ensure that each interest constituency receives some

degree of satisfaction (Abrams, 1951). However, there is an argument that the theory is

narrow (Coleman, 2008: 4) because it identifies the shareholders as the only interest

group of a corporate entity. However, the stakeholder theory is better in explaining the role

of corporate governance than the agency theory by highlighting different constituents of a

firm (Coleman, 2008: 4).

In an original view of the firm the shareholder is the only one recognised by business law

in most countries because they are the owners of the companies. In view of this, the firm

has a fiduciary duty to maximise their returns and put their needs first. In more recent

business models, the institution converts the inputs of investors, employees, and suppliers

into forms that are saleable to customers, hence returns back to its shareholders. This

model addresses the needs of investors, employers, suppliers and customers. Pertaining

to the scenario above, stakeholder theory argues that the parties involved should include

governmental bodies, political groups, trade associations, trade unions, communities,

associated corporations, prospective employees and the general public. In some scenarios

competitors and prospective clients can be regarded as stakeholders to help improve

business efficiency in the market place.

This theory has become prominent because researchers have realised the actions of a

corporate impact on the external environment. These actions require accountability of the

entire institution to a wider and more sophisticated audience than just its shareholders. In

view of this, another school of thought proposed that companies are no longer an

instrument of shareholders alone but exist within the society and hence its responsibilities

to the community from which it operates (McDonald & Puxty, 1979). This is in line with

people coming together collectively to increase economic value in an organisation or firm.

Further to the above, stakeholder theory was criticised (Jensen, 2001) for assuming a

single valued objective. Invariably the performance of a firm should not be measured by

the gains to shareholders. It should offer soft issues such as flow of information from

senior management to junior management, interpersonal working relationships, working

environment and so on.

13

2.4 STEWARDSHIP THEORY

This theory links the success of firms with that of the managers. It tends to argue against

the agency theory which posits that managerial opportunism is not relevant. This theory

stipulates that a manager’s objective is first to maximise the firm’s performance because a

manager’s need of achievement and success are met when the firm is doing well

(Coleman, 2008: 4). This theory addresses the issue of trust which the agency theory

refers with respect for authority and inclination to ethical behaviour.

A fall out of this theory is that it attacks the following areas for effective corporate

governance in an organisation. The areas include board of directors and leadership issues

in a firm. Under the board of directors, it is believed that the involvement of the non

executive directors is important in enhancing the board activities. This is so, because the

executive directors have complete knowledge of the firm’s operations. Complete

participation of non executive directors enhances decision making and ensure

sustainability of the business.

Under leadership this theory is contrary to that of the agency theory. Stewardship theory

supports the idea that CEO and board chair should be the same individual. This is to

ensure that decisions are taken quickly and promptly which is believed to impact positively

on the firm (Donaldson & Davis,1991: 49-64).

Finally, this theory stipulates that small board sizes should be encouraged to enhance

effective communication and decision making. Nevertheless, the theory does not stipulate

how an optimal board size should be determined.

2.5 RESOURCE DEPENDENCY THEORY

This theory addresses the availability of resources of the firm to the general public.

However, this is in addition to the separation of ownership and control within the firm.

Availability of resources of the firm ensures that the organisation is protected from

uncertainty of external influences. The theory also postulates the presence of firms’ board

of directors in other organisations. This helps in building relationships between

organisations in order to have access to resources in the form of information which can

then be utilised to the advantage of the firm.

14

2.6 ORGANISATIONAL THEORY

This theory recognises the peak of organisation structure as the sit of the chief executive

officer. Given this stance, the theory goes further to say that the board of directors is a

mere imposition and is not completely relevant. It is given that most decisions will be taken

by the CEO and the board of directors will have to go in accordance. This theory draws its

application from lower developed countries organisation structures. Most of these

organisations have ownership and control stemmed together because they are mainly

small businesses and their size do not warrant the type of corporate democracy witnessed

in big multinationals like Mobil, Barclays and so on (Yakasai, 2001: 2).

2.7 BOARD OF DIRECTORS

Looking at the above theories, there is no doubt that the essence of corporate boards

cannot be underplayed in the issues of corporate governance in a firm. This is in relation to

the direction in which the structure of laws and accountability has moved in recent times. It

has become more glaring that given the wrongful acts of corporates, directors are being

held responsible for the success and failures of the companies they govern. This is

because the board of directors is the “apex” of decision making in an institution. Also, they

ought to monitor the activities of top management ensuring that the interest of

shareholders, general public and regulations are complied with (Jensen, 1993).

The board of directors is the single most important corporate governance mechanism

(Blair, 1995) and regarded as the institution where the managers of a company are

accountable before the law of a company’s activities (Coleman, 2008: 6). Further research

has shown that the board of directors is effective in monitoring managers. In addition to

this, it is believed that more non-executive directors on the board will increase its

monitoring capabilities. Amongst other functions of the board is to select, evaluate and, if

necessary, replace the CEO based on performance.

2.8 BOARD CHARACTERISTICS AND STRUCTURE

In line with a previous study that has been done in Nigeria, the effect of board

characteristics on corporate governance in the Nigerian banking industry was researched.

The variables employed under the board characteristics included board structure, board

size, board leadership, board composition and board diversity.

15

2.8.1 Board structure

This has drawn a lot of attention in the field of economics, finance and strategic

management and its effect on the organisation. The board structure refers to how the

organisation is structured in terms of the board of directors. Its major focus is on size and

the division of labour between the board chair and the managing director/chief executive

officer (MD/CEO) and finally the composition (Ogbechie & Koufopoulos, 2009: 92).

2.8.2 Board size

This can be simply defined as the total number of directors that a corporate organisation

has on its board. It goes without doubt that the number and quality of directors in a

company has an effect on how well the board functions, hence its performance. Given this,

it becomes a challenging task to determine the ideal board size for an organisation.

The possibility of a large board has the likelihood of more knowledge and skills at their

disposal. Also, a large board size might also help to reduce the effect of an authoritative

and dominant CEO. It is believed that the board becomes more effective in carrying out its

duties as more directors are recruited into the board.

However, another school of thought believes that large board sizes pose more harm than

good for the corporate institution. There is the view that the larger the board size, the more

difficult it becomes to control and hence achieve results. Also, large boards are more

prone to formation of fractions, thereby delaying decision making processes (Ogbechie &

Koufopoulos, 2009: 92).

2.8.3 Board leadership

This is another key component of the board structure as the leadership tells the direction

of board meetings, hence the outcomes. In the Nigerian corporate world, an independent

structure exists where two different individuals serve in the roles of CEO and board

chairman. A scenario where these two roles are held by an individual who brings about the

theory of CEO duality. CEO duality can lead to accumulation of power in one person

thereby vesting all powers on a single individual even if the outcome will be negative.

However, another school of thought does not accept the superiority of the separation of

power. From their own perspective they see it as a crisis measure for distressed

companies. This was shown in a study by Dobrzynski (1991). Also, stewardship theory

proposes that joint structure leadership provides cohesive company leadership that

16

eliminates doubt of the individual leading the organisation (Ogbechie & Koufopoulos, 2009:

95).

2.8.4 Board composition

The board composition is used to denote the difference between the directors within the

company and those brought from outside the company. It is simply the percentage of

outside directors currently sitting on the board. The directors within the company are those

that are also managers or current officers in the firm while outside directors are normally

referred to as non executive directors; because they do not partake in the day to day

running of the company. It is also believed that outside directors contribute more to a firm’s

growth as a result of their independence from the firm’s management. Also they normally

have an unbiased view given their origin coupled with their experience (Ogbechie &

Koufopoulos, 2009: 96)

2.8.5 Board diversity

In the global marketplace a company that employs a diverse workforce is better positioned

to understand the market in which it does business and hence has the capability to thrive

in such environments. The term diversity refers to a mixture of men and women, people

from different age brackets, people with different ethnic groups and racial backgrounds.

Scholars have emphasised the importance of improved board diversity as a result of the

different perspectives from board members. It is believed that by corporate governance

scholars that board have either a direct or indirect effect on the firm. Though board

diversity might be a constraint according to Goodstein; nevertheless it goes without doubt

that for boards to be effective there is need for diverse perspective (Ogbechie &

Koufopoulos, 2009: 99).

2.9 CORPORATE GOVERNANCE IN NIGERIAN COMPANIES

The Nigerian corporate world is one that has increasingly come under scrutiny, both

domestically and on the international scene. The core issues hover round the board of

directors, responsibilities of members, roles of directors and the use of independent

auditors. The challenge with most companies in Nigeria is that the management mark their

own scripts, score themselves distinctions and sing their praises. However, to equity

owners the fantastic financial reports are engineered, as the effects are not felt in the real

economy.

17

The above has been one of long dispute between the general public and the banking

community. The argument has been that, despite the impressive results posted by the

banks (profit after tax [PAT] got as high as 1000%), no real effect has been felt on the real

economy which spans across manufacturing, agriculture, mining, and the real estate

sector amongst others. All these have done nothing but give credence to the above

speculation that the results might actually have been doctored (Yakasai, 2001: 241).

It gets more difficult when a comparison is made between unstructured private limited

liability and public liability companies. While the private companies are known for their

simplicity, effective management, innovation and creating wealth, the public liability

companies are associated with lethargy, nonchalance and lack of personal touch due to

the legal separation of ownership and control.

In Nigeria the conventional wisdom that shareholders determine board membership and

influence corporate direction is false. This is as a result of the fact that individual

shareholders are unable to exercise any influence unless they pose sufficient

shareholdings and influence. However, some blue chip companies go the extra mile to

ensure that their shareholders are carried along in making corporate decisions. This is

done through various meetings, published materials, videos of AGM’s, shareholders

forums and so on (Yakasai, 2001: 241).

Corporate governance in the private sector is of general interest, however, the Nigerian

public has taken a keen interest in that of the banks operating in the Nigerian bank

landscape. This is in view of the banks’ published figures and their dominance in the

Nigerian stock exchange. Another major reason is that most economies world wide have

migrated to a money and exchange economy. The basic instrument to facilitate

international trade and exchange is money. Apparently these banks happen to be the

custodian of these financial instruments. As a result of this sensitive role their corporate

governance is of keen interest to government, depositors, shareholders and the general

public.

Nevertheless, these stated bodies all have different interest in these financial institutions.

The general public and government do look forward to a safe, sound and stable banking

system while the depositors are more interested in returns on deposits and the quality of

service being rendered. Simply put: the government looks for safety of the banks, while

shareholders are concerned about their profitability. It is essential to take another

stakeholder group, the employees, into consideration. The workers are interested in

18

sustained employment through the continued existence and profitability of their employer-

banks.

Given the above diverse interest from stakeholders, governance in Nigerian companies

and banks has become political and volatile. Also, the governance of Nigerian banks has

been claimed to be centrally located in the hands of the board of directors (BOD) (Yakasai,

2001: 241). Given the multiplicity in any bank, this increases the role of the BOD of any

Nigerian bank. With all these in sight, there are strict laws in appointing people to be BOD

in banks and it is different from other private institutions in the country (NDIC).

To satisfy the numerous and diverse interests of bank shareholders, general public and

regulatory bodies; the bank’s BOD are mandated to have some core responsibilities. One

of the most important is the development of corporate vision, mission and business

strategy. This is to ensure that all members are on the same page regarding the bank’s

focus. This also goes further to comply with the Central Bank of Nigeria’s corporate

governance code that demand members of bank’s BOD to be knowledgeable enough to

contribute meaningfully to the bank’s affairs (CBN code). A fallout of this is another

responsibility which is to monitor and supervise that the bank’s strategic goals for effective

results and deliverables to shareholders are met.

Also, given that BOD is the highest oversight body, it must be satisfied that adequate

information, control and audit systems are in place. This is in addition to its responsibility of

corporate compliance with legal and ethical standards imposed by the law and the bank’s

own statement of values. Another key responsibility is to manage crisis and ensure a

proper risk management system (Yakasai, 2001: 242). This in turn will ensure that good

loans are extended, thereby guaranteeing the safety of depositors’ funds.

The responsibilities stated above are amongst what a bank’s BOD should have, however

there are no laid down rules on how these tasks should be performed. Nevertheless, one

of the surest ways is to ensure that the board is composed of people of integrity, good

judgement, with knowledge and experience to help the bank in achieving its strategic

goals.

2.9.1 Corporate governance for banks operating in Nigeria

After the bank consolidation in 2005, it became imperative for tightening of their activities

by a regulatory body, Central Bank of Nigeria (CBN). The outcome of this was the release

19

of a code of corporate governance for Nigerian banks post consolidation. This was

released and became effective on 3 April 2006.

The code started by stating the importance of corporate governance and also retention of

public confidence. This was given the role of the finance industry given its mobilisation of

funds, allocation of credit to the needy sectors of the economy, the payment and

settlement system and the implementation of monetary policy.

The essence of the code became more important as a result of the outcome by the

security exchange commission (SEC). The report published in April 2003 revealed that

corporate governance was at a rudimentary stage with only about of 40 per cent with a

recognised code of corporate governance in place. Specifically in the financial sector, poor

corporate governance was identified as a major factor in virtually all identified reasons for

the failure of financial institutions in the past. Also, without doubt, it was known that the

ongoing consolidation will bring about challenges, especially on issues bordering on IT,

culture and integration processes. The code from CBN also identified that two-thirds of

mergers failed world wide as a result of challenges posed by personnel integration, IT

integration, corporate culture and management squabbles. The report further stated that a

standardised code of corporate governance will help in addressing such issues.

Nevertheless it is important to state that prior to this code of corporate governance from

CBN, the Nigerian Securities and Exchange Commission released a code of best practices

on corporate governance for public quoted companies. Banks were expected to adhere to

these as well as a corporate governance code from the bankers’ committee.

In the post consolidation corporate governance code released by CBN, weaknesses and

challenges of corporate governance in Nigeria banks were identified and explained in

details. This was to ensure that all institutions involved reviewed it to see where they erred

in order to ensure measures to be taken to reduce and eliminate such weaknesses.

Amongst the weaknesses listed are ineffective board oversight, disagreement between

board and management, overbearing influence of chairman or MD/CEO and weak internal

control measures. Other weaknesses highlighted, included non-compliance with laid down

control measures, non-compliance with rules and laws from regulatory authorities, passive

shareholders, lending abuses and excess of one obligor limit and having sit tight directors.

Sit tight directors in this case refer to directors that fail to make meaningful contributions in

meetings or in the affairs of the banks.

20

The challenges listed in code were to address existing ones and those that are likely to

occur after the banking consolidation. A major challenge was the technical incompetence

of board and management to effectively redefine, re-strategise, and restructure in the

areas of corporate identities, new business acquisitions, branch consolidation, expansion

and product development.

Another challenge was that of the relationship amongst the directors. This is bound to

arise in boardroom squabbles especially in institutions that were formerly one man or

family owned. The new idea of contending with new directors, especially in the areas of

making decisions, will pose as a challenge in these new institutions. An offshoot of the

above challenge will be that of the relationship between staff and new management. The

work environment might become strained as a result of changes in work policies.

Examples of this include changes in pay structure, changes in reporting lines and

knowledge gaps between the existing staff and the new ones.

The major reason for the consolidation exercise was to ensure that banks increase that

capital base, thereby giving them the capacity to fund large ticket transactions. Hence in

meeting this new requirement it becomes imperative for the banks to have proper risk

management structures in place. This will help to manage the risk of these institutions as

the level of risk will be more than the institutions have ever seen. This poses a serious

challenge to the banks’ post consolidation and will need to be given serious attention. The

management of risk in transparent and ethical manners will have an effect on the banks’

governance.

Another challenge that appeared is ineffective merger of the banks after the general

process. It is believed that scenarios where an investment bank merges with a commercial

bank are not properly implemented and might result in a situation where both institutions

will still run parallel, especially if both managing directors are in charge of the various

banking units. Inadvertently this will pose as a challenge for the institution as a whole.

Given the number of banks involved in the consolidation process, coupled with the amount

involved, the tendency to have an average of three different banks merging to bring about

a new entity is high. The outcome will be an institution that will have options regarding

choice of IT and different accounting systems. The use of technology will increase to

power the new consolidated business. This will definitely need to be well managed to

ensure efficient operations and quality of service. An offshoot of this challenge is an

inadequate management capacity. Given the challenge stated above, it becomes

21

imperative for the level of management capacity to increase to ensure the effective running

of the new big banks.

According to the corporate governance code released by the Central Bank of Nigeria

(2006), issues concerning insider loans and transparency were also raised as challenges.

It was stated that if consolidation failed to achieve transparency through diversification of

bank ownership; it will result in other negative aspects of the bank operations. Amongst

the effects will be insider related trading and rendition of false returns. Rendition of false

returns to regulatory authorities and concealment of information to bank examiners will

mean early detection of troubled banks.

A major challenge in a bigger bank will be that of getting the right choices given the very

diverse interest involved. A good example is an audit committee which ought to comprise

of both directors and shareholders. The outcome of this is selection of people without the

necessary skills and expertise to handle such a task, thereby making the committee

ineffective. This might also reflect in operational controls as a result of the larger size of

the institution.

Finally, the disposal of surplus assets and use of such funds will pose a challenge in the

post consolidation of these banks. After the consolidation, branches that are too close will

have some disposed to reduce operational cost and increase efficiency. Assets such as

cars, computers and other assets will also be disposed off. These items can be sold for

prices lower than their market value, which is wrong. The income from such sales should

be properly recognised and not used in boosting profits to cover operational losses and

inefficiencies.

2.10 CODE OF BEST PRACTICES ON CORPORATE GOVERNANCE

The CBN corporate governance code went a step further by focussing on best practices of

corporate governance in the sector. These were termed as initiatives that will promote

good corporate governance post consolidation in the Nigeria banking system. Some of

these principles are as listed below.

i. Carefully crafting out the banks overall strategic objective, its corporate values with

clear lines of responsibility and accountability.

ii. The bank’s management team should be proactive and committed to the above

goals. They should also function in line with the corporate strategy to have a clear

sense of direction and achievement.

22

iii. The board of directors should be committed and carry out its oversight function in a

professional manner. Also, the board should be well constituted to ensure

meaningful contributions in meetings.

iv. Given the creation of new entities there is bound to be dispute among the different

stakeholders of the bank. In view of this it is imperative that the institution should

have measures in place to resolve disputes that arise amongst board, management

and staff of the bank.

v. The new entities will be large corporations and a clear succession plan will have to

be in place. Shareholders need to be responsive, enlightened and responsible.

vi. Another challenge should be that the bank should ensure they have an effective

and efficient audit committee of the board. Also the auditors should be of high

integrity, independence and competent. These auditors should include both internal

and external auditors.

2.10.1 Equity ownership

Another issue that came up in the CBN study was that of the bank’s ownership structure

prior to consolidation. The present practice, pre consolidation, poses a challenge as a

non-restrictive equity holding. This has led to serious abuses by individuals and family

members as well as government in the management of banks. Given this unhealthy

scenario and to encourage private sector-led economy, the code stipulated that holdings

by individuals and corporate bodies should be more than that held by government. The

code also noted that individuals who form part of management of banks in which they also

have equity holdings will be compelled to manage the companies better. In view of this it is

right to say that the code favoured board ownership in these banks.

The above positions were further streamlined regarding positions individuals and

government can take in these banks. It was stated that government’s direct and indirect

holdings in any bank should be limited to 10 per cent by the end of 2007. The CBN stated

in the code of corporate governance, post consolidation, that any equity holding exceeding

10 per cent by an investor is subject to confirmation.

2.10.2 Organisational structure

Historically in the Nigerian banking sector a major source of conflict has been in the

structure of the organisation where the board ask for senior positions to be able to

23

exercise undue power. Given this, a major issue under the organisational structure was on

executive duality. Amongst the issues raised was that the chairman and MD/CEO roles

should be clearly separated. This will ensure that no one has unfettered powers of

decision making by occupying the two positions at the same time. The position of the

executive vice chairman is no longer recognised in the new structure. In the earlier section

under equity ownership it was noted that individuals and family members held large stakes

in the banks, leading to unhealthy lending practices. To fight this trend it was then

resolved that no two members of the same extended family should occupy the position of

chairman and that of chief executive officer or executive director of a bank at the same

time.

2.10.3 Quality of board membership

The board of the banks has been a long standing issue where it is stated that the board

should be effective and composed of qualified people that are conversant with its oversight

functions. The CBN further stated that these people should be knowledgeable in business

and financial matters for them to be considered to be on the board. Given that the right

people have been selected, it is imperative that there should be regular training and

education of board members. To make this more tenable, it is important that the banks

should budget for it at the start of the financial year.

With the capability of the board in place it is important for the board to have necessary

powers to chart the bank in the right direction. A major concern is for the board to have the

powers to hire consultants that will advise it on the way forward for the bank.

The code also looked at the composition of the board of directors to other directors; this is

to ensure that the board is not skewed to one direction and thereby influencing decisions

taken. The code stated that the number of non-executive directors should be more than

that of executive directors. This is subject to a maximum board size of 20 members. The

board should comprise of a minimum of two non-executive directors who must have been

appointed based on merit. They should not represent any shareholder group and also

have no business interest in the bank. This is to ensure that they give a fair and outside

opinion on the affairs of the bank.

Taking it a step further, the remuneration for the non executive directors should be limited

to sitting allowances, directors’ fees as well as hotel expenses. Finally, there should be a

fixed tenor for the bank’s board which should be not more than three terms of four years

24

each (12 years). This should also include top bank executives as they should have a clear

succession plan for them.

2.10.4 Board performance appraisal

It goes without doubt that the board should be appraised to see if all set targets and

deliverables are met. The need for board performance reviews and appraisals to ensure

exceptional performance was stated as a necessity in the code of corporate governance

post consolidation by the Central Bank of Nigeria. However, for the board performance to

be properly appraised, a couple of steps need to be taken. The first step is to determine

the skills, knowledge and experience of board members. And having ascertained this to be

in order, the next step will be to define the company future strategic goals, strategic

objectives and the critical success factors needed to achieve this. With all these in place

the board should ensure it works as a team to achieve its goals with a periodic review or

self assessment. This can be done annually, preferably by an outside consultant with the

report being presented at the AGM while the CBN is sent a copy.

2.10.5 Reporting relationship

The reporting relationship is very key in an organisation, including the banking sector, as

to a large extent it determines the degree of transparency and disclosure that will occur.

Given the importance of this, it became important for the corporate governance code to

highlight that the structure of any bank should show clearly acceptable lines of

responsibility and hierarchy. Also, all designated officers should be aware that they will be

held accountable for duties and responsibilities attached to the offices they occupy. This

will further ensure that people are focussed and regulatory matters taken seriously and

adhered to.

2.10.6 Industry transparency and disclosure requirements

The stakeholders of the banking sector are immensely important and it goes without doubt

that their confidence in the institutions says a lot about the corporate governance

structures in place. Therefore, to ensure that stakeholder confidence is retained, the issue

of transparency and disclosure must be complied with according to regulatory

requirements.

A major point to note here is the issue concerning related party transactions. Where the

board directors or other bodies related to them are engaged as service providers or

suppliers to the bank, disclosure should be made to all parties involved including the CBN.

25

Another key issue in attracting and retaining stakeholder confidence is that regarding

disclosure of company financial reports. The code requires the chief executive officer and

chief finance officer of the banks to certify on all reported financial reports that they have

reviewed the reports. Their signatures will also specify that, based on their knowledge, the

report does not contain any untrue statement of a material fact. Also, the financial

statements and reports fairly represent the financial conditions and results of the banks for

the period that have been covered. Falsifying reports will attract a fine and six months

suspension of the bank CEO for a first time offender. However, in the case of a

reoccurrence, a removal and blacklisting of the CEO will be the case. Also, all staff

connected will be referred to professional bodies for disciplinary actions.

The code went further to analyse all loans given to directors and related parties, stating

that the practice of anticipatory approvals by board committees should be limited strictly to

emergency and should have a lifeline of one month after which it should be ratified. Also,

any director whose loan or related interest loans are non-performing for more than one

year should cease to be on the board of the bank. If the facility in question is not

regularised within a period, the person will be blacklisted from being on the board of any

other bank.

In addition to monitoring compliance with money laundering requirements, bank chief

compliance officers should also monitor the implementation of the corporate governance

code. The banks should encourage whistle blowing by staff to ensure strict adherence to

rules and regulations. An easy way of ensuring whistle blowing will be by the enactment of

a special medium such as special email or hotline to both the bank and CBN. With this in

place, a means of monitoring should be enacted which is basically the CCO making

monthly returns on compliance and corporate governance status to CBN. Finally, it was

mandated that the CEO and CCO should certify each year that no code in the corporate

governance was breached in the course of business.

2.10.7 Risk management

The past bank failures were highly attributed to a lack in their risk management units, and

therefore the code of corporate governance post consolidation for Nigeria specified what

was needed from this unit. Firstly, the risk management committee should establish

policies for risk oversight and management. It was stated that banks should have a risk

management framework in place as well as a unit which will be lead by a senior executive

of the bank. This new unit will run according to the directives of the board of risk

26

management. Given this it becomes important for the internal control system to be well

documented and designed to achieve a high degree of bank operations. Also, the system

should be structured to ensure that the reliability of financial reporting and compliance with

rules and regulations from all levels in the bank are in place. To ensure that the above

codes are monitored, external auditors are mandated to report to CBN on the bank’s risk

management culture.

2.10.8 Role of auditors

2.10.8.1 Internal auditors

In the Nigerian banking system there exist the internal and external auditors. The internal

auditors are staff of the banks that have been recruited to monitor the affairs of the various

branches and units of the bank on a day to day basis. These groups of staff ought to be

largely independent, highly competent and people of integrity. Given the responsibility of

the unit, the code specified that the head of this unit should not be less than an assistant

general manager and should be a member of a professional body. In terms of reporting

style, the AGM should report directly to the board audit committee, however, a copy of the

report should be sent directly MD/CEO of the bank. Also, on arrival of CBN examiners,

these quarterly reports should be made available to them.

The combination of the board audit committee was also an issue for the code. It was

stated that members of the board audit committee should be non executive directors and

ordinary shareholders. These people should normally be appointed in annual general

meetings. Amongst the appointed people should be the chairman of the committee and

also all members should be knowledgeable in internal control measures.

Finally, these groups of people will act as an intermediary between the external auditor

and the bank. Hence, amongst their duties will be to ensure that the bank’s financial

reporting is of acceptable standards and that the bank has adhered to all rules and

regulations of CBN.

2.10.8.2 External auditors

External auditors play a key role in the issue of banks in Nigeria and therefore deserve the

focus and attention they presently receive. Firstly, the appointment of the external auditors

will a task to be approved by CBN; one advantage of this is to ensure that the relationship

between these auditors and the banks is not compromised as this might lead to ethical and

27

governance issues. Regarding tenor, the external auditors are only allowed to work with

the banks for 10 years. Afterwards a break of 10 years is required before the auditor can

come back to audit the bank.

If CBN doubts the work done by the external auditors, quality assurance auditing should

be engaged by the CBN. If the results from this team support the fact that the auditors

have erred, then they will be blacklisted from auditing banks and other financial institutions

for a time frame to be determined by the CBN.

In order to avoid conflict of interest, it is advisable that an audit firm should not provide

services to a bank in some scenarios. On such scenario is if one of the bank’s top officials

was employed by the firm and worked in the bank’s audit during the previous year. Finally,

the external auditors should not provide any of the services, namely bookkeeping for the

banks, valuation services, actuarial services, internal audit outsourcing as well as human

resource functions.

2.11 PROCESS AND PROBLEMS OF CORPORATE GOVERNANCE IN THE NIGERIAN

BANKING INDUSTRY

In Nigeria, the Companies and Allied Matters Act of 1991 places great responsibility in the

hands of BOD. However, this is further strengthened by Nigerian deposit insurance

corporations placing additional rules guarding the activities of bank directors. In Nigeria,

bank governance can be seen from three perspectives, namely:

i. Composition in terms of competence, knowledge, experience and business

network. The usual practice is to look for highly qualified and experienced people

with business connection. The search can be first conducted in-house amongst staff

members and if not successful then an outside search is resorted to. It is important

to note that this is seen in the big and medium sized banks; however, for the new

generation banks recruitment is done on ownership, family members and allies.

ii. Tenure of board members, organising and running the board entails first and

foremost to determine the ratio of executive to non-executive directors. In Nigeria

the big banks normally have bigger board members when compared to the smaller

generation banks. The table below illustrates the ratio of executive to non-executive

directors. Also, there should be a clear distinction between the board chairman and

MD/CEO, and the frequency of meetings should be agreed upon.

28

The present situation is one where the big banks hold frequent meetings whereas

the smaller banks dislike holding meetings. They prefer using the time in marketing

for deposits which is probably partially due to the fact that they have less loan

portfolio size.

The tenure of board members should be agreed upon and should include issues

such as , age limit, knowledge and experience of intending board members. Finally,

the maximum number of tenures for directors should be agreed upon – that is,

where the contract is renewable.

iii. Action is necessary in terms of responsibility, commitment, performance indicators,

monitoring and evaluation. The general trend in most organisations is for duties to

be delegated to senior management who in turn process it and present it to the

board of directors. In line with this very few questions are asked, which is where the

knowledge of the board members becomes key and comes into question. However,

one key performance indicator is the bank’s profitability which the board should take

seriously, as this is used at AGMs to judge their own performance.

Given the above as the process for a board of directors, it is important to also note the

peculiarity of the banking business in Nigeria. This peculiarity poses some problems which

will be discussed briefly.

2.11.1 Environmental pressure

Given the present business environment, pressure normally comes from two sources,

namely from family and close allies and from the underground or informal sector (Yakasai,

2001: 243). It is a norm to find friends and relatives putting pressure on board members for

favours. These favours may span across awarding contracts, employment of under-

qualified candidates and extending of loans without proper risk management practices

adhered to.

The other pressure can emanate from a number of sources. A major one is compromising

ethics for business relationships. These are situations where the bank is forced to part with

a certain amount of money to get business. These kinds of acts adversely affect the bank’s

corporate governance which ultimately impacts negatively on the country (Yakasai, 2001:

243).

29

2.11.2 Instability of tenure

The BOD constitutes a serious part of good decision making in any organisation. Given its

sensitive nature, it is important that the members’ tenure be stable to ensure that ideas are

cultivated and implemented, otherwise the institution on its own becomes unstable. In the

early 1990s, the Nigerian private sector experienced high volatility in dissolving the board

members. This was particular with industries that were operating in the strategic sectors

such as petrochemical and banking industries.

The federal government, however, divested from the banking industry in 1993 and there

has been an improvement in the erstwhile public banks in which board dissolution was

high. It is important to note that an unstable board breeds insecurity of board members

which might lead to them having a different focus such as enriching themselves through

any means within the shortest possible period. The effect of instable boards results in the

lack of a strategic goal being developed for the bank which subsequently leads to

ineffectiveness in the day to day running of the bank. All these will lead to a reduction in

profitability of the bank’s bottom line.

2.11.3 Government action

This problem emanates from two schools of thought, namely government’s interference in

the appointment of incompetent personnel as a result of affirmative action and quota

system in the country (Yakasai, 2001: 244). This ultimately leads to compromising

recruiting standards and gives forth to staff that are incompetent which invariably impacts

negatively on the bank’s overall performance.

Also, it is believed that government agencies such as the NDIC and CBN are interested in

ensuring stability, safety and soundness of banks but their actions prove otherwise. This is

particularly the case when a bank’s huge exposure to the government and its parastatals

has not been properly addressed, leading to the crisis such as in 1998. The issues were

then resolved with the payment of only principal amounts and the interest payments were

waived. This kind of interference leads to a decline in profit line, bearing in mind that the

probability of government also recruiting some members of directors is present.

2.11.4 Board/management relationship

It is paramount for the relation between the BOD and bank’s management team to be

mutual and complimentary to flag a good message to the investing public. However, the

supervisory role of the BOD cannot be compromised. Given this, there is bound to be

30

conflict if the BOD engages in the day-to-day operations of the bank rather than in policy

and strategic issues. This was witnessed in the 1990s amongst the big four banks at the

time. The consequence of such conflicts is that the governance of the banks will suffer

because the boards will waste their energies on operational and tactical problems. Also,

there will be rivalry amongst the two groups where one will see the other as a foe; leading

to divergent opinions and behaviours.

This was the case in state owned banks in the 1990s and even carried over to the year

2000 when the banks had been privatised.

2.11.5 Executive chairmanship/vice chairmanship

This is a scenario where the chairman/vice chairman of the board is not satisfied with

moderating the excesses of the managing director of the bank. The chairman then seeks

to be executive chairman of the bank so he/she could sit over the judgment of his/her

activities. This observation has also exposed the moral issue on the expected

transparency, accountability and police role of the chairman/vice chairman (Yakasai, 2001:

245).

2.11.6 Ownership crisis

At various points, there has been conflict over ownership structures of the Nigerian

banking institutions. This scenario has played out in the private as well as government

owned banks. In government owned banks, the board was dissolved by the Ministry of

Finance Incorporated which held shares in trust for the government, while at private owned

banks throwing of chairs and punching at board meetings and annual general meetings

was the case.

31

Figure 2.1: Ownership structure of Nigerian banks

The consequence of such a crisis is the instability that accompanies such boards. When

such crisis persists, the regulatory authorities such as CBN will be forced to come in by

instituting an interim management board (Yakasai, 2001: 245). However, it is important to

note that ownership crisis can also evolve as a result of a forceful takeover of one bank by

another. In scenarios like this, the CBN is always called in to resolve such issues. This is

synonymous with the recent ownership structure that ensued between Bank PHB and

Spring Bank of Nigeria Plc.

2.11.7 Insider dealings

Like all other industries where raw materials are converted into finished and processed

goods for clients, the banking sector is not excluded from this process. The sector’s raw

materials comprise of the depositor’s funds which are in its custody. These raw materials

or funds are used to create risk assets which are then repaid with interest to the share

holders and depositors.

Without doubt the creation of these risk assets, which bring forth the loan/advances portion

of the balance sheet, comprises an important part of the bank’s balance sheet. Given this

importance, it is imperative for bank directors to disclose all related borrowings as

stipulated by the banks and other financial institutions’ decree (BOFID). This also extends

to scenarios where bank directors create companies to borrow money or grant loans to

relatives or close allies that are not worthy of it. These acts were amongst those that led to

the banking crisis in the mid 90s. Also, history is replaying itself in the country where some

banks are being indicted for indiscriminate lending to capital market players as well as the

32

downstream petroleum sector. The origination of this is a fragile governance structure and

neglect of laid down rules which will lead to loss of profit, thereby reducing the bank’s

performance. The proportion of private owners in Figure 2.1 gives credence to the high

rate of insider trading that took place in the country.

2.11.8 Quality of bank directors

There is no doubt that there is a high correlation between board performance and quality

of directors. Evidence in the 90s revealed that this was compromised and unfit persons

were appointed to boards of banks. The consequence of this was the director’s lack of

capacity to contribute at board meetings. However, occasionally when they did, such

contributions were either below par or not relevant at all (Yakasai, 2001: 246). The

outcome of this was a negative effect on quality issues of governance and leadership by

the board, a situation that further worsened the remaining fragile reputation of bank

directors.

2.12 PRE-REQUISITES FOR EFFECTIVE CORPORATE GOVERNANCE IN NIGERIA

To categorically state factors that will ensure good corporate governance in the Nigerian

banking system will be a huge task. However, given the present operating environment, it

is essential to explore some factors that are capable of affecting the governance

environment.

In a research by Yakasai (2001) it was agreed that the board is the ultimate governing

body responsible for the growth of the bank. In view of this, given the level of importance

required from this body; it goes without saying that there are some qualities which should

be inherent in board members (Yakasai, 2001: 247). These factors should include the

following: knowledge, information, strong management, power, independence and time.

2.12.1 Knowledge

Considering the complexity of our financial system which has made the banking industry

more complicated, it is important to have people of high qualities at the helm of affairs.

These directors should be from diverse and complementary backgrounds, have knowledge

and experience, and should network. It is advisable that each board member should have

expertise in more than one area of specialisation so that the membership will not be

unskilled. This will ensure that knowledge from board members is broad and deep enough

to match the demands facing the industry (Yakasai, 2001: 247).

33

In addition to the above, regular evaluations of board members have to be carried to

determine the right mix. This exercise will also ensure that knowledge gaps, level of

professional competence and academic background requirements are continuously met.

This same approach should be employed in all other committees within the organisation. It

will ensure that things are done properly and help in strengthening the risk profile of the

banking institutions.

2.12.2 Information

Information is without doubt the key for board members to be able to work effectively and

timely, given the spate of events in this present day financial system. Board members

should have an open door policy to ensure information is received from employees,

shareholders, customers, regulators and fellow colleagues. The sources of this information

should be well processed to ensure that boards are not acting on rumours which will

inadvertently go against the initial intention.

2.12.3 Strong management team

It is imperative to have a management team with relevant knowledge and entrepreneurial

spirit, core cultures and values for the organisation. However, the board should create an

enabling environment for this management team to exhibit entrepreneurial traits. It is these

managers that provide a clear sense of direction for the entire organisation since they

have a perfect understanding of the internal structures of the bank.

2.12.4 Power

The essence of power in a board cannot be under-estimated. However, there must be a

balance between a supervisory tier and executive tier of the board A body can be effective

if it has the authority to make decisions and to ensure top management approves and

implements them. One of the most important ways to ensure separation of powers is to

separate the offices of the chairman and chief executive officer.

It is, however, paramount to note that with the presence of power, the next requirement is

the knowledge base of its members. This is so, because, to ensure effective use of board

power, a clear sense of direction should be present. However, a clear sense of direction is

a function of the inherent capabilities of board members. Given all these, it becomes

essential that in bringing in new members, there should be a transparent process where

skills set and conflict of issues matters will be looked into (Yakasai, 2001: 248).

34

A simple test to indicate if the board has value will include asking questions like: Does a

balance of power exist between the executive and non executive directors? Who controls

the agenda of the meeting? Does the board have a clear sense of direction? Also: Can the

board call the executive directors to order when boundaries are overstepped? Affirmative

responses to these questions will indicate that the board has power (Yakasai, 2001: 248).

2.12.5 Auditors

In the Nigerian banking landscape, internal auditors as well as external auditors exist. The

internal auditors are staff members with the entire unit reporting to the chief executive

officer. The essence of internal auditors is to review internal audit trails and ensure the

level of exceptions are reduced, depending on when external auditors come to audit the

bank. They also help to reduce fraud and keep an eye on staff in up country branches,

ensuring that the bank’s culture is preserved and adhered to.

The role of external auditors cannot be over-emphasised given the assumption about

shareholders’ willingness and ability to scrutinise the bank’s affairs and call erring board

and management to judgement (Yakasai, 2001: 248).

The appointment of external auditors is a requirement by the Central Bank of Nigeria in

accordance with statutory provisions of Acts establishing the roles of corporate affairs

commissions, companies and allied matters, Central Bank of Nigeria, other banks and

other financial institutions (Yakasai, 2001: 248). Given all these, the major role of auditors

– both internal and external – is to ensure that one of the functions of corporate

governance, which is accountability, is adhered to, because shareholders, both

institutional and small shareholders, do not have the luxury of time to do it themselves.

35

Accountability

Direction Supervision

Executive Action

Figure 2.2: Functions of corporate governance

Source: Corporate Governance is a Third World country with particular reference to Nigeria

2.12.6 Motivation

Similar to other spheres of business, motivation has remained a key factor in the

deliverables and outputs of employees. This is the case with board of directors of banks.

The right incentives and perks should be in place to align bank directors’ interest with

those of stakeholders they represent. These stakeholders include shareholders,

employees and customers (Yakasai, 2001: 249).

The reward system is an effective means that can be used to influence the performance

and motivation of bank directors. Although the reward system usually extends beyond the

amount of money paid, it should also include share options for board members.

A downside to this exists where intending board members turn their focus to the monetary

benefits they will get from being nominated. In view of this, it is important that after an

attractive package has been offered, the nominating committee should have suitable

nominees who will be concerned about the challenges and not the financial gains.

36

2.12.7 Time

This issue relates to two options, one of which is the utilisation of time in board meetings

and tenures associated with board members. Regarding the issue of tenures of board

members, it is essential to have staggered retirements which will ensure the presence of

knowledgeable and experienced directors at any point in time. This adds to the credibility

and efficiency of the board in duly executing its functions.

The other issue of time is more delicate, as it deals with the importance for board

members to be very intelligent and experienced people, as stated above. However, it is

also important that board members prepare properly for meetings so that meetings focus

on crafting and execution of corporate strategies (Yakasai, 2001: 249).

2.13 CORPORATE GOVERNANCE AND FIRM PERFORMANCE

Considering the current economic conditions, it has become paramount to cite the

importance of the financial sector for economic growth (Nada, 2004). However, a lot of

reasons have been named for the failure of banking institutions world-wide. Amongst these

reasons was the quality of corporate governance in the banking institutions. It is a general

belief that good corporate governance enhances a firm performance. However, there have

been some studies that have gone against this notion. For this reason it is inconclusive or

inconsistent to say that corporate governance and firm performance are directly correlated.

In a study by Akyereboah-Coleman (2008), the effect of corporate governance on

performance of firms in Africa was carried out. The data used was drawn from 103 firms in

Africa over a five year period from 1997–2001. These firms cover a range of sectors which

included the industrial, manufacturing, mining, agriculture and services sectors. The study

employed return on assets and Tobin’s Q as its performance measures. This research

employed the use of market and accounting based performance measures to ensure that

a clear relationship between corporate governance and performance can be arrived at.

Some results from the study contradict past research, while others conformed to past

findings. The contradicting data included studies that have shown that a long tenure does

not augur well for firm performance. This was drawn on the basis that the CEO spends

energy and time building an empire to control. It was also discovered that board activity

intensity had a negative relationship with return on assets and a weak positive relationship

with Tobin’s Q. The board activity intensity was measured by the frequency of board

37

meetings. It is worthy to note that this confirms past research that high frequency of board

activities is always as a result of corporate problems (Coleman, 2008: 16).

The conclusion of the research was to further emphasise the importance of corporate

governance in firms. It states that it constitutes the organisational climate for the internal

activities of a company. However, the research was not targeted towards a particular

industry, but covered a wide range of sectors. Also, it was targeted at African companies

giving more credence to the positive side of good corporate governance in the African

corporate world. A key feature of the research was the results from the regression which

showed that the direction and extent of impact of corporate governance is dependent on

the performance measure being examined (Coleman, 2008: 20). The results showed that

large boards enhance corporate performance and when they are dominated by non-

executive directors, the firm’s value is enhanced. Also, CEO duality does not significantly

impact on Tobin’s Q, the market based performance measure used. It, however, does

have a negative relationship with firm profitability.

Finally, the study concluded by stating that for enhanced performance, the positions of

CEO and board chair should be held by different persons and that firms should be

encouraged to maintain relatively independent audit committees. It was suggested that a

broader spectrum of variables should be employed, however, the result of the research

should not be compromised.

A study conducted in the Middle East and North Africa also shows that there is a

relationship between corporate governance and bank performance (Nada, 2004). This

study research used data from 249 banks from 20 countries in the above stated region.

The corporate governance parameter used was ownership structure and findings were

related to past research. It was discovered that foreign banks are significantly better

performers than all sample groups. However, government owned banks were discovered

to perform poorly when compared to the others.

A similar research using ownership structure was conducted on Indian banks (De, 2003).

However, the performance indicators used were accounting measures which comprised of

return on assets, net interest margin and operating cost ratio. The outcome of the study

showed there is a significant positive relationship between return on assets and private

ownership, but the research also showed that there is no significant relationship between

return on assets and ownership variables.

38

An empirical analysis was also carried out in Kenya, between the relationship of corporate

governance and bank performance (Barako & Tower, 2007) This research was done using

return on assets and non performance loans as the dependent variables. However, the

independent variables used were the ownership structure of the banks. The research was

to empirically examine the relationship between ownership structure and bank

performance (Barako & Tower, 2007: 139). The areas reviewed under the ownership

structure included the following: proportion of board ownership, level of foreign ownership,

institutional and government ownership.

The ordinary least square model was applied as a multivariate test to assess the influence

of each of the independent variables on performance. In line with past work done, the

result of the OLS regression provides strong support for the proposition that ownership

structure influences bank performance. The level of board ownership, foreign and

government ownership was seen to be associated with performance of financial

institutions in Kenya. (Barako & Tower, 2007: 140). A compelling result of the research is

negative relationship between state ownership and bank performance on the performance

indicators used. This goes to show that government ownership of banks has a negative

impact on the bank’s performance in Kenya.

Another fall out of this research is its acceptance of entrenchment hypothesis, which says

that board ownership of financial institutions increases conflict of interest between owners

and borrowers. It also spills into the risk taking nature of the financial institution concerned.

The impact of this is the inability of managers to take good and decisive decisions resulting

in the creation of substandard risk assets and invariably low performance.

The performance indicators; return on asset and non performing loans showed that

institutional shareholders have no significant influence on financial performance of banks

(Barako & Tower, 2007: 140). This is contrary to findings in the Western economies, where

institutional investors have spurred changes especially in promoting sound corporate

governance; the reverse is the case in Kenya’s financial system.

Finally, the ordinary least square of the research shows that there is a positive relationship

between foreign ownership and bank performance. However, this is in line with previous

research findings and with the general belief that local banks are influenced by policies

and procedures of the parent companies, which may provide a better basis for evaluating

and mitigating risks. However, this is not to say that local banks with sound corporate

governance cannot do as well as its peers with foreign owners.

39

Another impediment to corporate performance is the agency theory, between the

principals (owners) and the agents (managers). It is believed that managers have

additional information about the firm when compared to the owners. This is as a result of

the insider information which is available to the managers. The outcome of this is that

owners are faced with the challenge of managers not acting in their best interest (Jensen

& Meckling, 1976).

Relating the above scenario to a bank is complicated as a result of the various parties

involved. Conflict of interest exists between the shareholders and depositors as well as

between shareholders and the managers of the bank. The risk in banks is being adopted

by the bank’s managers to increase the company’s share price and this is usually contrary

to the risk appetite levels of the depositors or shareholders. Given this, it is therefore

correct to state that corporate governance in banks should encapsulate all stakeholders

involved – that is, from the depositors to employees to shareholders.

Other studies have also been done in other parts of the world where little or no correlation

was found between firm performance and corporate governance. In a study conducted on

the emerging markets of Ukraine and Russia (Rachinsky, 2007) the financial ratios used

were return on assets, return on equity and net interest income. The conclusion of the

research was that there was no significant relationship between good governance and

performance in Russia. However, in the case of Ukraine, a slight relationship was found

between governance and performance. Nevertheless, the research further claims that

there might be some shortcomings which were stated as being related to accuracy of the

financial data and unreliable governance data. Also, the sample of banks used was rated

from bad to less bad rather than bad to good and finally the report states that the sample

was small and perhaps insufficient to generate strong statistical significance.

40

CHAPTER 3

RESEARCH DESIGN AND METHODOLOGY

3.1 INTRODUCTION

This study has been done in line with past research that has been carried out in

developing economies, with specific emphasis on Africa. It is also in line with an earlier

stated study, “Corporate Governance and Bank Performance, Does Ownership Matter?

Evidence From The Kenyan Banking Sector” by Dulacha and Greg. The focus was on

ownership structure. The ownership structure parameters were board ownership, foreign

ownership, institutional ownership and government ownership. The dependent variable

used in this study was the bank’s return on assets (ROA) and its non performing loan to

total advances (NPL) ratio. The independent variable was the corporate governance

variables.

A more recent study was done by Kyereboah-Coleman (2008) with the focus on

companies in various parts of Africa. The study also looked at a correlation between

corporate governance and the firm’s performance. While that of Kenya specially

researched banks in Kenya, the latter researched a broad range of companies in Africa.

The parameters used were board size, board independence, board activity intensity, CEO

duality, CEO tenure and audit committee. The final parameter used, which had a similarity

with the former, was institutional ownership. In both studies, institutional ownership was

termed to have a positive relationship with firm performance.

The dependent variable that was employed here also had similarity with that of Kenya. It

included return on asset (ROA) and Tobin Q. A careful analysis of this method would

reveal that a non performing loan ratio is an important tool in measuring how profitable a

bank will be, because a bank can only be profitable if its risk assets are performing and of

acceptable standards. Given that this research is a focus on banks in Nigeria, return on

assets and non performing loan ratio have been employed as the dependent variables.

Nevertheless, the independent variables will comprise of parameters from both studies.

3.2 INSTITUTIONAL OWNERSHIP

A firm’s ownership structure dictates its governance; past research has shown that

governance does have an effect on the profitability. It can be stated that a firm’s ownership

structure should have an effect on its performance, given its ties with its corporate

governance (Barako & Tower, 2007: 136).

41

It is believed that when the bulk ownership of a firm lies in hands of a few, the possibility of

equitable treatment of all stakeholders is likely (Coleman, 2008: 11). These groups or

institutions help to monitor the operations of the firm given their relatively high level of

investment. The fallout of the above is that institutional shareholders have greater

incentives to monitor corporate performance than scattered smaller groups. It is believed

that institutional shareholders help to resolve free ride problems commonly associated with

corporations where shares are widely held (Barako & Tower, 2007: 136).

In view of the above, it can be stated that institutional shareholder activism causes

changes in governance structure, which also results in a significant increase in

shareholders’ wealth. It is also important to note that institutional ownership is measured

by percentage volume held by institutions. Institutions in the Nigerian context will be

referred to as companies formed to have shareholdings in these banks as there is a high

likelihood of this form of ownership.

Based on the foregoing, the following hypothesis is set up:

ROA ratio – Hypothesis 1a: The presence of a bank’s institutional ownership is positively

associated with the bank’s profit, based on its ROA.

NPL ratio – Hypothesis 1b: The presence of a bank’s institutional ownership is negatively

associated with the level of non-performing loans.

3.3 FOREIGN OWNERSHIP

Much research has been done on firm performance with foreign ownership used as a

variable. The results have, however, been inconsistent with some research showing a

strong correlation and others not showing any relationship. A good example was seen in

the studies cited by Nada which indicated that foreign owned banks are less efficient than

the domestic ones. The shortcoming of this research, also stated by Nada, is that this

research was conducted mainly in the developed economies while neglecting developing

countries. It is, however, important to note that in these developed economies the

domestic banks are highly regulated, and older and more sophisticated than the foreign

banks.

Nevertheless, another research was conducted by Claessens and Demirguc-kunt in 2000

and 1999 respectively, stating that foreign owned banks report significantly higher interest

margins and higher net profitability than domestic banks. A lot of reasons are attributed to

the good performance of foreign ownership in comparison to domestic ownership.

42

These reasons include prudent management of risks as influenced by the policies of the

parent company, and strict focus on profitability to maximise shareholders’ wealth creation

capacity. This can be compared to domestic banks which suffer from inefficiencies, outside

interference and the possibility of not focussing on maximising returns. All these affect the

company’s earnings and its capacity to grow (Barako & Tower, 2007: 136).

It is also believed that foreign banks have superior ability to diversify risks and render

services to multinational clients that domestic banks may not be able to offer, especially in

developing economies. It therefore almost follows that with entrants of foreign banks or

investors into an economy, there is the likelihood that domestic banks will tend to

strengthen their local systems in line with what is obtainable overseas so that they can

compete effectively.

Based on the foregoing, the following hypothesis is set up:

ROA ratio – Hypothesis 2a: The higher the proportion of a firm’s foreign ownership, the

higher the profit; based on the return of assets ratio.

NPL ratio – Hypothesis 2b: The higher the proportion of a firm’s foreign ownership, the

lower the level of the non performing loans.

3.4 BOARD OWNERSHIP

Board ownership, simply defined, means a scenario where owners form part of the

management of the company. This scenario of owner-managers in organisations is

believed to be beneficial to the organisation because of the high probability that their

interest is more aligned to that of the stakeholders. However, it is important to note that

board ownership varies between banks and companies due to their difference in operating

models.

The agency theory which states that there is positive association between managerial

ownership and financial performance because of the convergence between managers and

owners’ interest is in line with research by Jensen and Meckling (1976). It is thus possible

to deduce that Board ownership has a positive relationship with firm performance (Barako

& Tower, 2007: 135).

Other research has also been done in different sectors which further signifies the positive

relationship between board ownership and firm performance. A major example was the

43

study by Palia and Lichtenberg (1999) using a sample of 255 manufacturing firms between

the period 1982–1993.

However, the above scenario might not be applicable in the case of banks, because of the

difference in the ownership structure and stakeholders involved. It is believed that with

increased board ownership, there might be greater conflict of interest with the depositors

and shareholders (Barako & Tower, 2007: 136). In a research in the Argentinean banking

industry, it was reported that high board ownership stake led to higher loan portfolio risk.

This higher loan portfolio invariably leads to a higher degree of non-performing loans in the

bank’s portfolio. In work that was carried out by Pinteris (2002), agency conflict between

bank owners and bank depositors was identified as amongst the causes of this negative

relationship. To further add to the above research is the work done by Fogelberg and

Griffith (2000) and Hirsschey (1999), which further correlates the results from the

Argentinean banking study.

In view of the above, the following hypothesis is set up:

ROA ratio – Hypothesis 3a: The higher the level of a firms board ownership, the lower the

profit using return on assets ratio.

NPL ratio – Hypothesis 3b: The higher the level of a firm’s board ownership, the higher the

level of non-performing loans.

3.5 GOVERNMENT OWNERSHIP

Government ownership of banks has many perspectives from different groups of people

which also affects the outcome or possible results of the banks. Two common

perspectives from past research include those from the development side and the political

side (Barako & Tower, 2007: 137). It is believed by past research that this kind of

ownership is prevalent in countries with low levels of per capita income productivity. This is

in line with research conducted by Rafael la Porta, Florencio Lopez-De-Silanes and Andrei

Shleifer (2002).

The development theorists are of the opinion that government ownership of banks

increases the chances of allocating credit to long-term socially desirable projects that

otherwise may not get private funding. This optimistic view is associated with Alexander

Gerschenkron who focussed on the necessity of financial development for economic

growth.

44

However, the political theorists believe that when government own banks, they are used to

fund projects that are politically inclined and not that which is desired. To further explain

the point of the political theorist, government ownership of banks creates an avenue for

promoting and propagating political patronage that adversely affects performance of these

institutions (Barako & Tower, 2007: 137). Past research has shown that government

ownership of banks impacts negatively on the banks’ performance. Examples of research

that proved this include studies done by Barth, Caprio and Levine (2002). A study

conducted in Argentina banks by Allen et al. (2002) also strongly confirms that government

ownership is associated with poor performance.

Based on the foregoing, the following hypothesis is set up:

ROA ratio – Hypothesis 4a: There is negative relationship between a firm’s government

ownership and bank profitability performance.

NPL ratio – Hypothesis 4b: There is positive relationship between a firm’s government

ownership and bank performance measured as non-performing loans.

3.6 RESEARCH DESIGN AND METHODOLOGY

The sample of this study was drawn from the financial institutions operating in Nigeria’s

financial system with the licence to carry out banking activities. Nevertheless, a couple of

criteria had to be used for the banks that will be included in the research report. The

conditions include the following:

i. Banks must have been in existence for the period under review which is 2003–

2008. It is important to note that, as a result of the consolidation that took place in

2005/2006, an important criterion will be to include banks that scaled the

consolidation process. Also, for the banks that came up as a result of the merger,

the financial ratios of the most dominant bank in the group prior to merger before

opting for the post consolidation figures will be used.

ii. All relevant information on ownership and performance must be available for the

period under review. The performance is in relation to banks that have consistently

published their annual financial reports for each year under review; while those that

have not published theirs will be excluded from the research.

45

3.7 VARIABLE MEASUREMENT

In the research report, two dependent variables were looked at, namely return on assets

and ratio of non-performing loans of the banks. Return on assets was selected because of

its relative use in past research work in determining how profitable a bank or firm is. A

good example in the case of banks is the research on bank performance and corporate

governance by Barako and Tower (2007). Also, in more recent research work by Coleman

(2008), where a study of corporate governance and firm performance was carried out with

emphasis on African firms; return on assets was also employed to determine how

profitable a firm was. To further buttress the reason for opting for the return on assets

ratio, is that it is a clear indication of how well banks are able to utilise their raw materials

which in this case is the cash deposits from depositors and equity from stakeholders.

A major determinant of a bank’s profitability is its level of non-performing loans in its

portfolio. Non-performing loan ratio is the total non-performing loans to total advances from

the bank. It determines how stable a bank is (Barako & Tower, 2007: 137) and also the

degree of impaired assets in a bank’s custody. This ratio goes further to indicate the

strength and expertise of a bank’s risk management structure. It indirectly reveals a bank’s

lending behaviour, which is connected to the bank’s corporate ownership and controls. It is

therefore important to use the non performing loan ratio as it has a direct relationship to

the bank’s corporate governance system and invariably its performance.

3.8 INDEPENDENT VARIABLES

The independent variable used in this research report is investigation of the corporate

governance mechanism which is the ownership structure. Under the ownership structure

the categories of variables studied are: level of board ownership, foreign ownership,

institutional ownership and government ownership.

In past research done, institutional ownership was defined by scenarios where a clearly

identifiable body owns a certain percentage of the shareholding of its total share value. In

the study done by Barako and Tower on the banking sector, a minimum holding of 30 per

cent shareholding was used as the criteria for identifying institutional shareholders.

However, it is believed that there is an absence of strong institutional investors in the

Nigerian banking industry (Ogbechie & Koufopoulos, 2007: 118). This is also believed to

make it impossible for these people to influence the decisions of the banks. Nevertheless,

for the purpose of this research, and given the peculiarity of the Nigerian banking

shareholding, a system has been adopted to look for individual investors or registered

46

companies that have relatively large shareholding compared to other shareholders. This

has been adopted as this group of individuals or companies do possess the ability to steer

the decisions of the banks, thereby acting like institutional investors. Nevertheless, in

circumstances where it is apparent that institutional investors are present, the study will

opt for what was done in prior research.

Under the government ownership, this will include banks where the Nigerian government

has shares. The Nigerian government in this context includes the three tiers of

government, namely local government, state government and federal government. To

further align this research to the Nigerian context, government ownership has been

extended to include apparent cases of related ownership. This is a scenario where people

in government or strongly related parties, such as family members, own stakes in these

banks. This has been adopted as a result of the possibility of influence of the bank’s

decisions from such parties due to their relative high positions in the society. A careful

review of this ownership brings to light the use of special purpose vehicles by government

to own substantial stakes in banks. Where this is discovered, it will be assumed that the

SPV ownership is taken as government ownership.

Using foreign ownership variables, has been termed as Nigerian banks in which foreigners

own a substantial amount of shareholdings. This group of people can either be individuals

or corporations. To further extend this foreign ownership structure, multinational

subsidiaries of foreign banks have been included and those owned by other foreign

organisations operating within the Nigerian financial landscape.

Due to the peculiarity of the banking industry and how it has evolved in the Nigerian

environment, there undoubtedly exists a strong relationship between a bank’s performance

and board ownership. Most banks in Nigeria were built around a few people that raised the

initial sum to set up the banks. Also, during the economic boom in 2005 where most banks

came to the market to raise capital, these investors still retained a substantial amount of

their shareholding. In addition to this, most of these board members also partake in the

day to day running of the companies, given their high vested interest. In this research

report the board ownership variable will be taken as the proportion of board shareholding

to the total value of shares of the banks. This information was extracted from the bank’s

financial year statements, the Agusto report on banking and the Nigerian stock exchange

website.

47

3.9 DEPENDENT VARIABLE

In line with past research done, the performance measures used were non performing

loans to total loans and return on assets. These ratios were used in the research done on

corporate ownership and control in the Kenyan banking system by Barako and Tower

(2007). These variables were also used in research done by Claessens (2000) and

Mahajan (1996).

To get a proper view on the ratio used, it is imperative that the meanings are explained

which further buttress the reasons they were chosen. In the Nigerian context, non-

performing loans are loans that have defaulted in one way or the other – either in not

paying principal or interest due within a stipulated period. However, it should be noted that

this should be in line with the terms on the offer letter. Generally a loan is termed to be

substandard where interest or principal is over 90 days past due, but not more than 180

days past due. In this scenario, a minimum provision of 10 per cent is required under the

prudential guidelines. However, the term doubtful loans refers to scenarios where interest

and/or principal is over 180 days past due but not more than 360 days past due. Given

these circumstances, a minimum provision of 50 per cent is required under the prudential

guidelines. Finally, when a loan is termed as a lost loan, it is when interest and/or principal

is over 360 days past due. For this a 100 per cent provision is required under the

prudential guidelines. This is line with the Nigerian banking industry standard and was

recently published by Agusto & Co. (2008). In summary, the non performing loan ratio

used in this study shows a cumulative loan loss provision as a percentage of gross loans

and advances.

A bank’s return on assets ratio is defined as the net profit before tax divided by the

average total net assets of the bank. It defines how profitable a bank is as well as returns

that are derived from the total assets that have been extended to its clients. It is imperative

to note that a bank’s assets comprise not only of its fixed assets, but also the loans that

have been advanced which will be referred to in this study as risk assets. However, the

bank’s liability comprises primarily of shareholders’ funds and liabilities generated from

customers.

3.10 RESEARCH MODEL

This study has tried to determine any correlation between the bank’s performance and

ownership structure in the Nigerian banking sector. Given the number of independent

variables, a multi regression model was used to analyse the data and relationship between

48

the variables. This tests the influence of each of the independent variables on the

performance ratios, which is the dependent variable. The test is based on the statistical

model below and is line with what was done in the Kenyan banking system by Barako and

Tower (2007).

PERFit = β0 + β1BODOWN + β2FOROWN + β3GOVOWN + β4INSOWN

where:

PERFit = Performance of bank i at time t, which is measured as ratio of return on assets

and ratio of non-performing loans

BODOWN = Proportion of board ownership to total shareholding

FOROWN = Ratio of foreign ownership stake to total shareholding

GOVOWN = In banks were it exists, it was taken as a percentage of shareholding held by

the government or a related party to the entire shareholding of the company

INSOWN = This was taken as the ratio of shareholding held by institutions to the total

number of shares outstanding in the bank

3.11 DATA

The data used for this research primarily comprises of non-performing loan ratio to total

advances and return on assets. This was collected for six years from the bank’s individual

annual report obtained from their registrars and bank offices. A yearly bank report from

Agusto & Co was also used in the compilation of the data given their track record and

expertise in this field.

Also, the independent variables used comprise of ownership variables of corporate

governance. Under the ownership variable, the following areas were reviewed: board

ownership, institutional ownership, government ownership and foreign ownership. The

data used in deriving the above parameters were collected from the various companies’

annual reports. The shareholding figures were analysed and the data extracted. The

ownership structure was calculated as a percentage of its value to the number of shares

outstanding. An example is the case of United Bank of Africa for its board ownership. It

was discovered that the board members’ total number of shareholding summed up to

1 131 627 863 units. This was then divided by the total number of shares outstanding on

the stock exchange giving rise to a value of 0.0524. The total number of shares

49

outstanding for all quoted companies is available on the website of the Nigeria Stock

Exchange.

In analysing the data, it was discovered that government participation in banks was

minimal with only three banks identified as institutions where the government had

presence. The banks are Wema Bank, Skye Bank and Finbank. The means of government

ownership in Finbank is direct, as the Rivers state government directly owns six per cent of

the bank. However, in the case of Wema Bank and Skye Bank, government vehicles are

used to own shares in these banks. While Ibile Holdings, which is an investment company

belonging to the Lagos State Government, owns 12.36 per cent of Skye Bank; Odua

Group, which is primarily owned by government from the Western part of Nigeria, has 9.76

per cent shareholding in Wema Bank.

In a past study, it was stated that the Nigerian banking industry does not have large

institutional shareholders. What this study did, was to group any institution or individual

under institutional ownership if it is regarded as “other significant shareholders”. These

institutions do have a large stake in the banks and this study reckons their activities to be

likened to that of institutional investors. However, in cases where these “other significant

shareholders” were clearly identified and it is beyond doubt that they cannot function as

institutional investors, they were excluded. A good example is that of Odua Group’s

interest in Wema Bank, where it was addressed as other significant shareholders. Behind

Odua Group is the Western government, and hence our categorisation under government

ownership for this research.

Another key feature that stood out in the ownership structure of Nigerians banks is that the

ownership structure was skewed towards certain categories. Whilst Board ownership was

highly prevalent due to the fact that most of these institutions are closely held by a few

number of people, foreign ownership was practically non-existent. However, it was noticed

that Standard Chartered Bank had 100 per cent foreign ownership, while Citibank had

82.63 per cent foreign ownership and Platinum Habib Bank had 15.29 per cent foreign

ownership from Habib Bank Limited of Pakistan.

The dependent ratios where calculated on a bank by bank basis using their annual

financial reports. Return on assets (ROA) and the non performing loan (NPL) ratios were

obtained for the period under study. However, in compiling the above information, only

banks that were in existence for the entire study period were taken. This was done

because prior to the consolidation in 2005, Nigeria had a total of 89 banks, and post

50

consolidation, it came down to 25. Further consolidation also took place which brought the

total count of banks to 24. However, two banks were excluded from this research as a

result of their inability to make public their annual financial reports for the period under

study.

After the banking consolidation the bank’s capital base has experienced an astronomical

growth from a minimum amount of two billion naira to twenty five billion naira. The effect of

this was an increase in their working capital, hence their ability to create more risk assets,

which will subsequently lead to an increase in the bank’s performance. Given this, it is

important to watch out for this in the data analysis, as the probability of a jump in the

performance ratios exists from prior 2005 and post 2005.

51

CHAPTER 4

RESULTS

4.1 INTRODUCTION

The data used for this research was pooled from recognised research firms and the bank’s

annual report which was obtained from the respective registrars. After compiling this data,

a descriptive analysis was carried out on the return on assets (ROA) and non performing

loans (NPL) ratios. This was to ensure that the mean, median and standard deviation of

this data was analysed as well as the impact of the ownership variables on the

performance ratios. The trend revealed from the descriptive analysis as well as the

regression model results ought to depict a general trend of the Nigerian banking industry.

Finally, from the regression model, it was determined if a relationship exists between

ownership and banks’ performance in Nigeria.

4.2 DEPENDENT VARIABLE (NON-PERFORMING LOANS AND RETURN ON

ASSETS – PERFORMANCE INDICATORS)

These performance indicators have been chosen since they are the common tools for

assessing banks’ performances. Additional reasons why they were chosen is because of

their employment in similar past research reports. In Nigeria, non-performing loans in the

books of a bank is a critical factor as revealed in the recent financial crisis. The impact of

the recent global financial crisis affected 10 Nigerian banks as a result of the high degree

of non-performing loans on their books; which led to them being under receivership from

the Central Bank of Nigeria.

As a result of the above, the Central Bank requested full provision of non-performing loans

by the banks. The provision requirement ensured that the banks’ capital became

significantly impaired and in some cases completely eroded. Without the injection of

liquidity by the Nigerian Central Bank, those banks would have collapsed unveiling

significant losses for investors and depositors alike. Nevertheless, the impact of this has

been a freeze in credit from the banks, leading to excess liquidity and steep decline in

interest rates in the inter-bank market.

4.3 DESCRIPTIVE STATISTICS

Appendix 1 presents the summary of the two performance indicators, i.e. return on assets

(ROA) and non performing loans (NPL) in the regression model. The data shows that for

52

the period under review, the mean of return on assets was relatively stable with a value of

4.08 and 3.69 in 2003 and 2008 respectively. However, the slight drop in the mean can be

neglected and attributed to the possible increase of bad loans as a result of increased

lending. Also, analysing the maximum return on assets for each year showed a gradual

increase from 7.90 to 9.30 in 2003 and 2008 respectively. However, it is important to note

that the ROA went as high as 12.40 in 2007. The likely effect of this is the banking

consolidation of 2006. This led to an increase in the banks’ capital base hence increasing

their risk appetite which subsequently led to increased profitability.

The overall standard deviation for the return on assets gave a value of 2, that is from

recording a value of 2.09 in 2003 to 1.78 in 2008. The stability of this return on assets for

the period under review indicates that return on assets was relatively stable for this period.

However, a slight increase in ROA was noticed for the years included in the study.

The average non-performing loan ratio for the period under review was 12.05 against the

industry average of 5.6 per cent in 2008. The mean of NPL nearly halved from 15.81 per

cent in 2003 to 8.62 per cent in 2008. However, it is important to note that this is a huge

drop from the 2004 figure of 19 per cent. Also reviewing the yearly figures for the banks in

the population sample, the NPL was 23.84 per cent in 2008 from a 2003 figure of 43.70

per cent. This high distortion from industry average is as a result of the banks that were

included in the research report.

Also, the reduction in NPL ratio from 2003 –2008 can be attributed to a couple of factors.

Amongst this is the increased risk management measures embraced by the banks due to

the expansion in their loan books after their 2006/2007 capitalisation. It should be noted

that bank capitalisation had been significantly enhanced by 2008 following the 2007

consolidation in the industry.

The standard deviation for NPL showed significant volatility within the period 2003–2008

with an overall figure of 10.57. The disparity in the NPL of the banks shows that an

industry standard for risk assets is lacking. This means that while risk management

improved and is considered adequate in some institutions, it is less so in other institutions.

It also means that certain banks are more exposed to loan defaults than others.

53

4.4 DEPENDENT VARIABLE: RETURN ON ASSETS

4.4.1 Institutional ownership

Institutional ownership was used to set up the null hypothesis that the bank’s institutional

ownership is positively associated with bank’s return on assets (ROA). However, from the

table ROA shows a weak positive association with institutional ownership with a correlation

coefficient of 0.008. This is consistent with hypothesis 1a and research done in the Kenyan

banking system, which posits that the presence of a bank’s institutional ownership is

positively associated with the bank’s profit based on its ROA.

The result above can be associated with the fact that the presence of institutional

ownership is not a sole predictor of profitability, but rather the management acumen of the

bank is a more accurate predictor of the return on assets. Another reason might be the

past Central Bank governor’s stance against foreign ownership of Nigerian banks, where

the foreign ownership would have given raise to higher institutional ownership and hence

the capability of improving the bank’s performance. The hypothesis that the presence of

the bank’s institutional ownership is positively associated with the bank’s profitability in the

Nigerian banking sector, is accepted.

4.4.2 Foreign ownership

Under this dependent variable, the hypothesis drawn states that foreign ownership is

positively associated with return on assets in line with past studies. From the results, the

correlation coefficient gives a value of 0.032.The correlation coefficient of 0.03 suggests a

weak positive association between profitability based on return on assets and percentage

of foreign ownership. This is consistent with hypothesis 2a which states that the higher the

proportion of a firm’s foreign ownership, the higher the profit; based on the return of assets

ratio. Most foreign owned banks have declared profits in the period when the locally owned

counterparts were declaring losses on account of huge provisions compelled by the CBN.

This might be attributed to the lending behaviour of foreign owned banks with a focus on

wholesale banking and blue chip companies with low default rates. The foreign owned

banks have been known to operate lean structures with few branches and have shifted

their focus from retail banking, which is perceived to have a higher degree of risk, long pay

back periods as well as high default rate in loan repayments. All these would have further

aided foreign bank’s profitability in line with the set hypothesis. Hence, the hypothesis is

accepted that the higher the proportion of a firm’s foreign ownership, the higher the

54

profitability of the banks. However, it is important to state that the weak correlation might

be due to the few number of banks with foreign ownership in Nigeria.

4.4.3 Board ownership

Hypothesis 3a states that the higher the level of a firm’s board ownership, the lower the

profitability based on return on assets, that is the relationship is negatively related. The

results from the data analysis show a correlation coefficient of 0.015 between the board

ownership of Nigerian banks and their return on assets. The above figures depict a weak

positive correlation in the Nigerian banking sector.

A significant number of Nigerian banks have strong board ownership. Most local banks

were either family owned or registered as limited companies before subsequently

participating in public offers and hence getting listed on the Nigerian Stock Exchange.

However, majority share holding is still believed to lie in the hands of few individuals, even

after the public offers and listing. Also, these owners still affect how business is done in the

banks, hence having a negative influence in creating of risk assets. Bad risk assets also

have a negative effect on the bank’s profitability which is measured in this study using

return on assets ratio.

The weak positive correlation leads to the rejection of the null hypothesis. It is suggested

that the higher the percentage of board ownership, the more profitable the bank is using

the return on assets ratio. A likely explanation to this is the possible effect of the bank’s

managers, given that they also own the bank. Hence, the likelihood of ensuring their

business is profitable in all situations.

4.4.4 Government ownership

Hypothesis 4a states that there is a negative relationship between a firm’s government

ownership and a bank’s profitability based on return on assets. From the data, the

relationship gives a correlation coefficient of –0.15 in line with the hypothesis. From the

data table, it was noticed that government ownership in banks was limited to only three

banks, namely Wema Bank, Finbank and Skye Bank. Further buttressing the correlation

coefficient, two of these banks failed the recently conducted stress test conducted by the

Central Bank of Nigeria in 2009. However, the government ownership in Skye Bank is

indirect and being held by a third party (Ibile Holdings) for the government.

Hypothesis 4a is not rejected despite the fact the correlation coefficient of –0.15 is weak.

Other factors, such as those stated above, have aided in further confirming the

55

relationship. This relationship between government ownership and banks’ profitability

seemed to have been noticed by the CBN, hence the new law limiting government

ownership in Nigerian banks to 10 per cent stake after the consolidation.

4.5 DEPENDENT VARIABLE: NON-PERFORMING LOANS RATIO

4.5.1 Institutional ownership

Hypothesis 1b states that the presence of a bank’s institutional ownership is negatively

associated with its level of non-performing loans; that is, the higher the percentage of

institutional ownership, the lower the degree of non-performing loans and vice versa. The

study gives a correlation coefficient of 0.073 between the institutional ownership and non

performing loans ratio in the Nigerian banking context. In line with past studies, it is

expected that institutional ownership styles will enforce stricter risk management structures

to ensure that risk assets created are of acceptable standards and good quality hence

increasing the bank’s profitability. This is mainly done by reducing the amount of

provisioning the bank might witness as a result of good quality assets.

However, the analysis has shown a positive correlation between institutional ownership

and non performing loans in banks. A likely explanation of this is that the institutional

shareholders of these banks are represented by individuals not skilled in the act of

banking, hence their inability to contribute positively to the quality of risk assets being

created.

4.5.2 Foreign ownership

Under the foreign ownership variable, Hypothesis 2b states that the higher proportion of

this ownership, the lower the level of non-performing loans hence depicting a negative

relationship. The correlation coefficient from the data gives a figure of –0.02 showing a

weak negative correlation. This indicates that foreign ownership leads to a reduction in

non-performing loans in the Nigerian banking context, hence Hypothesis 2b is not rejected.

It is believed that foreign owned banks have the necessary risk management expertise to

ensure that the percentage of non-performing loans is reduced as much as possible. The

analysis has gone further to prove this correct, despite the fact that the correlation is weak.

This weak correlation might be as a result of the few foreign banks operating in the

industry and present in the data.

56

4.5.3 Board ownership

Hypothesis 3b in this study theorises that the higher the level of a firm’s board ownership,

the higher the level of non-performing loans, hence suggesting a positive relationship. In

line with this, this study reveals a weak positive association with a figure of 0.089 between

both variables. The correlation coefficient signifies a weak correlation which is consistent

to the hypothesis being postulated hence Hypothesis 3b is not rejected.

Several Nigerian banks have significant board ownership just as several of the banks have

huge non-performing loans portfolios, as revealed by a recent CBN enquiry into the books

of the banks. However, it is important to state that this was only recently made known to

the public in 2009. Nevertheless, the data has further shown that an increase in board

ownership leads to an increase in non-performing loans of the banks. In addition, factors

such as risk management and poor lending practices would have accounted for the level

of non-performing loans in Nigerian banks.

4.5.4 Government ownership

Hypothesis 4b states that there is positive relationship between a firm’s government

ownership and bank performance measured as non-performing loans. Data from this

study revealed a correlation coefficient of 1.53 signifying a positive relationship between a

bank with government ownership and the level of its non-performing loans. Hence,

Hypothesis 4b is not rejected.

The above relationship shows that as government ownership in a bank increases, so also

its level of non-performing loans which negatively affects its profitability. This hypothesis is

in line with what was done in past research and also applies to the Nigerian banking

environment. To further buttress this point, the recent bank crisis in Nigeria showed that

banks with government ownership, such as Finbank and Wema Bank, were faulted for a

high level of non-performing loans after the CBN carried out its audit test. This shows that

this hypothesis also applies in the Nigerian banking sector as it does in other countries.

57

CHAPTER 5

SUMMARY, CONCLUSION AND RECOMMENDATIONS

5.1 INTRODUCTION

Corporate governance will continue to have relevance to firms, as it constitutes the

balance of power with which the organisation is directed (Yakasai, 2001: 249). Corporate

governance not only places the organisation in an acceptable light with the public, but also

affects other core areas of business such as profitability. Whilst company profitability is

key, also important is how a company is viewed by the public, which ultimately affects the

patronage it attracts from the public - its bottom line. This chapter reviews the results of the

previous chapter and suggest areas of further research in this field and the likely positive

effects on the performance of the firm.

5.2 CONCLUSION

The essence of this study is to determine the effect of corporate governance using

ownership structure on a bank’s profitability. Four ownership styles were used, namely

institutional ownership, foreign ownership, board ownership and government ownership.

Under each ownership, two hypotheses were set up against return on assets and non

performing loans.

This gives rise to a total number of eight hypotheses that were set up. From these eight

hypotheses, two were rejected in line with past research, while the other six were not

rejected. However, it is important to state that the correlations were weak as a result of

limitations in the amount of data available.

The institutional ownership showed a weak positive correlation with return on assets in line

with previous studies. This is likely as a result of the fact that most shareholders with huge

numbers of units take interest in the profitability of the banks. However, the data was

conflicting as it also showed that institutional shareholders also lead to an increase in the

bank’s non-performing loans.

On foreign ownership, the hypothesis against return on assets and non performing loans

was not rejected. While this research will agree with the results from the hypothesis that

foreign ownership does impact a bank’s profitability positively, the Nigeria banking system

is also in line with other research where foreign ownership reduces the percentage of non-

58

performing loans. This might not be unconnected to the fact that foreign owned banks

have more robust risk management units.

Board ownerships are the most prevalent in the Nigerian banking system. Data results

showed a weak positive correlation with return on assets. Hence, it was rejected while the

hypothesis on non-performing loans was not rejected. A possible explanation of this is

that since majority shares are owned by single entities or individuals; their risk asset

creation decisions are normally influenced by this group to suit their needs, hence the

negative impact on banks’ risk assets.

The negative impact of board ownership on non-performing loans proved to be true as a

result of findings from the recent bank crisis. The recent stress test conducted by the

Central Bank of Nigeria (2009) revealed that most banks with a high percentage of board

ownership also had high levels of non-performing loans. However, the annual financial

statement has been altered, showing lesser values of non-performing loans against what

is truly obtained.

Government ownership was found to be negatively associated with returns on assets and

positively associated with non performing loans, hence not rejecting Hypothesis 4a and 4b.

This was found to be in line with past studies done. However, the impact of government

ownership on banks seemed to have been already discovered in the Nigerian banking

system, as the CBN recently made public that government stakes in any Nigerian bank

should be limited to a 10 per cent holding. An additional reason for this is to reduce

mismanagement of banks by government officials.

In conclusion, the study has been able to show that the Nigerian banking sector is affected

by the level of corporate governance culture being embraced. The corporate governance

variable was ownership styles and proved to have an impact on a bank’s profitability. It has

also been proved in the Nigerian context that the ownership style of the banks is bound to

have an effect on the banks’ profitability. Also, a fall out of this research is that it further re-

emphasises that the past bank crisis in Nigeria must have been fuelled by ignoring

corporate governance measures in the day to day running of the banks.

5.3 RECCOMENDATIONS

The Nigerian banking industry has been characterised by the bank crisis, as stated earlier

in this study. In 2008, while the global economy was in recession, the then governor of

CBN stated that the Nigerian economy was insulated from this recession as a result of non

59

exposure or ties to the global economy. However, this statement proved to be wrong, as

the year 2009 brought the realities of how connected the Nigerian economy was with the

global economy.

This effect became apparent on assumption of the new CBN governor, Sanusi Lamido

Sanusi, in 2009. On assumption of office, he pledged that he will ensure banks fully

disclosed the contents of their loan books. To ensure this was done, he embarked on a

stress test which saw 10 banks affected. Amongst the banks affected were Intercontinental

Bank and Oceanic Bank, which were amongst the big four banks. It is important to note

that these banks had a higher percentage of board ownership due to the original

ownership during incorporation.

These banks had high levels of non-performing loans and in some instances had their

entire capital wiped out by unhealthy lending practices. This further reinforces the results

on the effect of board ownership on a bank’s profitability. However, the new CBN governor

discovered that these banks had poor corporate governance measures, which were further

buttressed by the falsification of their past financial statements.

The above led the CBN reforms on the banking industry. Amongst these reforms was the

reduction of the banks’ CEOs tenure to a period of 10 years. This is to ensure that CEOs

do not become too strong and adversely affect the decision making process of the banks’

lending practises. Hence, board ownership seems to be amongst the top corporate

governance factors affecting Nigerian banks.

5.4 FOR FUTURE RESEARCH

Corporate governance culture has been neglected for a long time in the Nigerian corporate

environment. However, a recent trend has revealed that for corporate success and

economic growth it can no longer be neglected. To further explore the relationship

between corporate governance and a bank’s profitability, CEO tenure can also be tried.

Analysing the impact of a CEO’s tenure on the bank’s profitability will help to determine if

the CBNs recent stance on the bank’s chief executive was necessary and if it will have a

positive effect on return on assets.

Also, since the most prevalent form of ownership is board ownership, it will be important to

confirm if board size has any correlation on profitability of banks in Nigeria. Finally,

anaylsing the impact of board activity, intensity on the bank’s profitability will also be

helpful in the Nigerian banking sector.

60

The banking sector is of great importance to every economy due to its function of

intermediation. However, other sectors of the economy are equally important, as they also

contribute to the country’s economic growth. Hence, it is also suggested that the variables

used in this research, as well as those suggested, can also be tried on other sectors to

evaluate their impact on the firm’s profitability in the Nigerian context. This will further

throw more light on corporate governance culture in the Nigerian corporate world.

61

REFERENCES

African Review of Business and Technology. 2005. Nation with a new image, March.

African Review of Business and Technology. 2007. Radical policies reform Nigeria’s

banks, February.

Agusto & Co. 2008. Banking Industry Report.

Barako, D.G. & Tower, G. 2007. Corporate governance and bank performance: Does

ownership matter? Evidence from Kenyan banking sector.

Berger, A.N, Clarke, R.G., Cull, R., Klapper, L. & Udell, G. 2005. Corporate governance

and banks performance: A joint analysis of the static, selection and dynamic effects of

domestic, foreign and state ownership. Journal of banking & Finance.

CBN/NDIC. 1995. Distress in the Nigerian Financial Services Industry.

Central Bank of Nigeria. 2006. Code of corporate governance for bank in Nigeria post

consolidation.

Dyck, A. 2000. Ownership structure, legal protections and Corporate Governance.

Ebhodaghe, J.U. 1994. Boardroom management practices and distress in the banking

system. NDIC quarterly.

Fama, E.F. & Jensen, M.C. 1983. Agency problems and Residual Claims. Journal of Law

and Economics.

Fama, E.F. 1980. Agency problems and theory of the firm. Journal of Political Economy.

FGN. 1991. Banks and Other Financial Institutions Decree.

FGN. 1991. Companies and Allied matters Decree.

Ford, N. 2005. Banking on the People. African Business, October.

Franks, J. & Mayer, C. 2000. Ownership and control of German Corporations. Review of

Financial Studies.

Ikelegbe, A. 2001. Civil society, oil and conflict in the Niger delta region: Ramifications of

civil society for a regional resource struggle. Journal of Modern African studies.

Jensen, M. & Meckling, H. 1976. Theory of the firm: Managerial behaviour agency cost

and ownership structure. Journal of Financial Economics.

62

Jensen, M. 2001. Value maximization, shareholders theory and corporate objective

function. Journal of Applied Corporate Finance.

Kolo, A. 2007. Impact of Nigeria’s bank consolidation on shareholder’s return.

Kyereboah-Coleman, K. 2008. Corporate governance and firm performance in Africa: A

dynamic panel data analysis. Studies in Economics and Econometrics.

Love, I. & Rachinsky, A. 2007. Corporate governance, ownership and bank performance in

emerging markets. Evidence from Russia and Ukraine.

Micco, A., Panizza, U. & Yanez, M. 2004. Bank ownership and performance.

Nigeria Deposit Insurance Corporation. 1991. Annual reports and statement of accounts.

Nigeria Deposit Insurance Corporation. 1991. Pocket Guide for Bank Directors.

Ohara, M. & Macey J.R. 2003. The corporate governance of banks. Economic Policy

Review.

Oyejide, T.A. & Soyibo, A. 2001. Corporate governance in Nigeria.

Shleifer, A., Lopez-De-Silanes, F. & La Porta, R. 2002. Government ownership of banks.

Journal of Finance.

Umoh, P.N. 1994. The problems of corporate governance in the Nigerian banking industry.

Versi, A. 2007. Nigeria’s Grand Plan. African Business, August.

Yahaya, M.I. 1998. Corporate governance in Nigeria: Private sector perspective.

Yakasai, G.A. 2001. Corporate governance in third world country with particular reference

to Nigeria.

[Online] Available: http://en.wikipedia.org/wiki/Corporate_governance Accessed: 21

November 2008.

[Online] Available: http://www.encycogov.com/WhatIsGorpGov.asp Accessed: 26

February 2009.

[Online] Available: http://www.encycogov.com/WhatIsGorpGov.asp Accessed: 21

November 2008.

[Online] Available: http://en.wikipedia.org/wiki/McKinsey Accessed: 21 November 2008.

[Online] Available: http://en.wikipedia.org/wiki/Fortune_Magazine Accessed: 21 November

2008.

63

[Online] Available: http://en.wikipedia.org/wiki/Business_Week Accessed: 21 November

2008.

64

APPENDIX 1:

PERFORMANCE DESCRIPTIVE STATISTICS: RETURN ON ASSETS AND

NON-PERFORMING LOAN RATIO

Maximum Minimum Mean Std. Dev.

Panel A

Overall RoA 12.40 0.30 3.70 2.00

By Year

2003 7.90 0.40 4.08 2.09

2004 6.90 0.80 3.53 1.80

2005 9.80 1.10 3.53 2.00

2006

2007 12.40 1.50 3.70 2.41

2008 9.30 0.30 3.69 1.78

By ownership

Board 7.90 0.30 3.41 1.55

Foreign 12.40 1.40 4.95 2.70

Institutional 7.90 0.30 3.22 1.54

Government 6.20 1.20 3.16 1.48

Panel B

Overall NPL ratio 46.60 0.30 12.05 10.57

By Year

2003 43.70 - 15.81 11.77

2004 31.00 - 11.58 9.65

2005 43.70 0.30 13.67 12.18

2006

2007 46.60 1.20 10.14 10.64

2008 23.84 1.01 8.62 8.03

By ownership

Board 46.60 1.00 12.55 10.88

Foreign 24.10 0.30 9.66 7.59

Institutional 46.60 1.00 13.32 11.72

Government 46.60 3.20 14.70 12.38

Performance descriptive statistics: Return on Assets and Non-Performing Loan Ratio

65

APPENDIX 2:

BANKS RETURN ON ASSETS RATIO

2004 2005 2006 2007 2008

ROA ROA ROA ROA ROA Avg. ROA

Access 4.7 3.3 1.4 2.80 4.16 3.27

AFRIBANK 0.9 1.1 1.1 2.90 4.40 2.08

Bank PHB 5.4 2.2 2.80 3.30 3.43

CITIBANK 5.4 4.7 5.5 7.70 5.60 5.78

DIAMOND 0.4 3.1 3.2 2.70 2.59 2.40

Ecobank 2.7 1.4 3.2 3.50 3.40 2.84

ETB 7.9 5.2 5.2 6.00 6.00 6.06

FCMB 1.7 6.1 2.6 3.40 3.96 3.55

Fidelity Bank 1.29 2.00 1.34 3.10 3.10 2.17

Firstbank 3.8 0.8 3.8 2.90 2.77 2.81

Firstinland 1.29 2.13 2.6 2.70 0.30 1.80

GTB 4.9 3.9 3.6 3.00 3.79 3.84

IBTC 7.3 3.9 9.8 4.00 4.70 5.94

INTERCONT 4.8 6.9 4.4 3.90 3.28 4.66

Oceanic 6.2 5.3 3.8 2.70 2.75 4.15

Sterling 1.39 1.23 1.32 2.80 2.60 1.87

Stanchart 5.1 1.4 4.2 12.40 9.30 6.48

UBA 2.1 3.6 2.3 1.50 3.59 2.62

UBN 3.1 2.4 2.9 2.60 3.28 2.86

WEMA 4.3 2.7 1.2 1.80 1.80 2.36

ZENITH 4.1 2.4 3.1 2.50 2.91 3.00

66

APPENDIX 3:

NON-PERFORMING LOAN RATIO

2004 2005 2006 2007 2008

NPL NPL NPL NPL NPL Avg. NPL

Access 10.9 7.1 9.8 8.80 2.16 7.75

AFRIBANK 25.9 31 31.9 15.50 12.10 23.28

Bank PHB 9.6 9.6 8.7 6.10 2.10 7.22

CITIBANK 17.3 17.1 23.1 5.50 19.30 16.46

DIAMOND 10.2 7.1 5.7 6.60 4.27 6.77

Ecobank 24.1 15 15.9 3.10 9.30 13.48

ETB 16.7 24.7 20.9 18.80 18.80 19.98

FCMB 25 8.5 7.8 3.20 2.74 9.45

Fidelity 2.11 2.34 14.49 8.10 8.10 7.03

FirstBank 35.4 26.6 23.5 2.90 1.01 17.88

Finbank 8.2 7.23 23.34 46.60 23.40 21.75

GTB 2.8 2.8 2 1.90 1.20 2.14

IBTC 3.1 1.4 2.9 14.20 12.20 6.76

INTERCONT 19.9 6.2 6 4.70 3.50 8.06

Oceanic 9.1 6.1 5.3 3.20 3.20 5.38

STERLING 43.7 34.2 43.7 23.60 8.90 30.82

Stanchart 0 0 0.3 1.20 1.10 0.52

UBA 8.5 3.9 3.5 4.20 3.58 4.74

UBN 23.4 23.3 18.2 14.80 23.84 20.71

WEMA 14.6 17 28.8 23.00 23.00 21.28

Non Performing Loan Ratio

67

APPENDIX 4:

OWNERSHIP VARIABLES

Board ownership Foreign Ownership Institutional Ownership Government Ownership

1 Access 18.3 0 16 0

2 Afribank 0.7 0 27.75 0

3 Bank PHB 34.6 15.29 0 0

4 Citibank 2.64 82.63 0 0

5 Diamond 15.7 0 24.08 0

6 Ecobank 0.48 0 71.3 0

7 ETB 26.08 0 64.28 0

8 FCMB 5.13 0 35.09 0

9 Fidelity 7.36 0 0 0

11 Firstbank 4.66 0 5.6 0

10 Finbank 16.16 0 6 6

12 GT Bank 7.14 0 10.91 0

13 IBTC 0 0 0 0

14 Intercontinental 26.67 0 0 0

15 Oceanic 6.08 0 41.84 0

16 Sterling 22.53 0 23.9 0

18 Stanchart 0 100 0 0

20 UBA 0.05 0 0 0

21 Union 0.93 0 0 0

23 Wema 0.29 0 9.76 9.76

24 Zenith 8 0 26.26 0

Ownership Variables

68

APPENDIX 5:

SUMMARY OUTPUT: RETURN ON ASSETS

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.68363

R Square 0.46735

Adjusted R Square 0.334188

Standard Error 1.154187

Observations 21

ANOVA

df SS MS F Significance F

Regression 4 18.70138 4.675345 3.509629 0.030704

Residual 16 21.31437 1.332148

Total 20 40.01575

CoefficientsStandard Error t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%

Intercept 3.119793 0.477211 6.537551 6.84E-06 2.10815 4.131436 2.10815 4.131436

Board ownership 0.014539 0.025167 0.577685 0.571518 -0.03881 0.06789 -0.03881 0.06789

Foreign Ownership 0.032215 0.010139 3.177367 0.005849 0.010722 0.053709 0.010722 0.053709

Institutional Ownership 0.008083 0.012865 0.628257 0.538701 -0.01919 0.035356 -0.01919 0.035356

Government Ownership -0.14968 0.10887 -1.37481 0.18814 -0.38047 0.081119 -0.38047 0.081119

Return on Assets

69

APPENDIX 6:

SUMMARY OUTPUT: NON PERFORMING LOANS

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.471773

R Square 0.22257

Adjusted R Square 0.028212

Standard Error 8.517738

Observations 21

ANOVA

df SS MS F Significance F

Regression 4 332.3324 83.0831 1.145155 0.371043

Residual 16 1160.83 72.55186

Total 20 1493.162

CoefficientsStandard Error t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%

Intercept 9.170779 3.521752 2.604039 0.019183 1.704999 16.63656 1.704999 16.63656

Board ownership 0.089083 0.185728 0.479641 0.637973 -0.30464 0.482808 -0.30464 0.482808

Foreign Ownership -0.01955 0.074824 -0.26131 0.797188 -0.17817 0.139067 -0.17817 0.139067

Institutional Ownership 0.072782 0.094944 0.766574 0.454497 -0.12849 0.274054 -0.12849 0.274054

Government Ownership 1.532243 0.803447 1.907086 0.074627 -0.17099 3.235475 -0.17099 3.235475

Non performing loans