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Chapter Two
LITERATURE REVIEW
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1.0. Introduction
In the aftermath of the global financial crisis that began in 2008, banks around the
world have received the brunt of the blame for the crisis. The 2008 financial crisis was
highly linked by most economic articiants to bank oacity. !ome oliticians, financial
leaders, and certainly many in the general ublic have blamed banks for the crisis because of
the concern that they took on too much risk to the detriment of customers and countries they
were suosed to serve "#iang, $u % &iraorn, 201'(. The ercetion has grown that the
cororate governance of banks was so rela)ed in the years leading u to the beginning of the
crisis that rotecting stakeholders became secondary to attemting to generate as much
revenue and rofits as ossible "*dams, 2012(.
In the +nited ingdom, Prime -inister ordon /rown reuested a review to be
conducted for the cororate governance of banks in the +nited ingdom to determine the
roblems related to bank cororate governance, as well as recommend suggestions for how to
imrove bank cororate governance in the country "-ullineu), 2011(. The maor roblem
that led to the review to be conducted was the financial crisis that was considered to be as a
result of bank oacity. The review was thus e)ected to determine the effectiveness in risk
management in the banks and to determine the effects of cororate governance to
erformance and risks. The review was thus e)ected to address the roblem of the changing
atterns on banks boards and come u with recommendations on how imrovements could be
effected on the banks cororate governance
The recommendations that were ut forth from the alker 3eort included changes to
the comosition and role of the /oard of 4irectors of banks in the +nited ingdom such that
they are comrised of a broader range of eole from within and outside of the banks they
reresent, as well as take on a greater risk5management role as oosed to a sole focus on
revenue and rofit generation "#e/lanc, 2010(. 6rom the alker 3eort, uestions arise
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about the aroriate role of cororate /oards of 4irectors in reducing risk while also
enhancing erformance.
The chater takes to review the secific studies that have been carried out reviously
concerning cororate governance and the effects that it has on banks. /asel 7ommittee on
/anking !uervision, "201( argues that banks lay a vital role in the running of the
economy. 6or this reason, effective cororate governance becomes a critical factor in the
running and roer functioning of the banking sector and the economy as a whole. They are
determinants of the erformance of the economy as they determine the money suly and the
lending of money to the ublic. ithout roer regulation, the banks could adversely affect
the erformance of the economy as some eole may want to enrich themselves at the
e)ense of the economy. The banks thus serve a maor role in the economy as they serve the
role of intermediating funds from the savers to the deositors and incororate them in
activities that suort the enterrise and assist in economic growth. The bank governance
thus lay a maor role in the financial system of any given banks and the economy as a whole
"/asel 7ommittee on /anking !uervision, 201(. It is for this reason that the banks need to
adot cororate social resonsibility through the adotion of otimal cororate governance
structure. The study focuses on four main variables namely9 board si:e, board meeting
freuency, role duality and the number of number of non5e)ecutive directors in the business.
The chater will review the oinions of revious studies concerning the four variable and the
strengths and gas that e)ist in their studies. The review is thus done to investigate the
otimal structure for cororate governance that should be used and the effect that each of the
chosen structures has on the erformance and risk in the organi:ation. 4ifferent banks have
different cororate structures in terms of board si:e, number of non5e)ecutive directors and
roles duality and each structure has different risks that it faces. The review thus tries to
understand the role of board structure enhancing erformance and reducing risk. The
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cororate governance thus determines the allocation of authority and resonsibility within the
banks and in turn hels the board to set the banks strategyies and obectives, oerate banks
day to day business, establish control functions and rotect the interests of the deositors,
take into account the interest of the stakeholders and recogni:e the shareholders obectives
Bank opacity
*ccording to 6lannery, wan, % ;imalendran, "200( the urose of banks in the
economy differs from the urose of the other industrial firms. The difference of the
functions brings in the reason as to why the banks are usually subected to more strict
regulations than the other firms in the economy. !tringent regulations have been ut u to
control the banks< caital and risks "6lannery, wan, % ;imalendran, 200(. The urose of
the regulation of the banks is to hel revent systemic bank runs which are usually caused by
the inherent instability of banks. 6lannery, wan, % ;imalendran, "200( continue to argue
that the rationale behing banks regulation is mainly a cororate governance roblem.
=owever, given thast the investors lack information on how to monitors their investments, the
would be an increase in the adverse selection roblems and moral ha:ards. *s a result, banks
need to have a regulator to who should act as a monitor to the banks "6lannery, wan, %
;imalendran, 200(
>l5/annany, "2008( argues In the +nited ingdom
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negotiate bills of e)change and other credit instruments. 6inally, they rovide mechanisms
through which firms and governments can make ayments to each other "The 6inancial
3eort 7ouncil, 200@(.
To the economy, the banks are key role layers esecially in the suly of money. The
banks are institutions that are set u to hel imrove the allocation of funds. They allow for
funds transfers from one area to another thus heling to imrove the state of the economy in a
country. The banks can however, bring negative effects to the economy which would force
the economy to undererform. In an instance where banks choose to withhold funds and not
offer loans to both the ublic and other bank would mean that the free flow of money would
not be available thus the economy will be affected negatively ">l5/annany, 2008(.
iuliano, "200@( argues that to the economy, the banks also act as roviders of
liuidity through the issuance of demand deosits. *s a result, there is a great liability on the
banks side to that is usually evident in the balance sheet. /orrowers in such an instance are
e)ected to be more informed than the lenders in the issues concerning their investments.
iuliano, "200@( also argues that the banks are the lenders of last result to the economy. 6or
banks to effectively rotect their deositors and also hel to revent bank runs that usually
lead to moral ha:ards within the banks, then the deosit insurance becomes imortant
"iuliano, 200@(.
How the u!ine!!e! o" ank! a""ect! ri!k and per"or#ance can e percei$ed or de"ined
y di""erent !takeho%der!
/anks serves the welfare of all the stakeholders, it is imossible for a single bank to
obectively meet their demands "7larkson, 1AA(. The different stakeholders erceive
erformance and risks of banks different and thus each of the stakeholders takes to be art of
the bank
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identifies ways to hedge out risks while imroving erformance to hel attract more
customers and investors into the comany "*ndreas % Ballelado, 7ororate governance in
bankingC The role of board ofdirectors., 2008(.
&takeho%der'! per!pecti$e on per"or#ance and ri!k
*ccording to 4onaldson % Preston, "1AA?( reutation is an imortant factor as it
heavily influences the erformance of a bank through the si:e of its customers. The
erformance of the bank is reliant on the management of risks in organi:ation. It is for this
reason that erformance and risk are interrelated. -anaging the reutation of banks through
risk management and imrovement of the erformance reuires the banks to adot soft skills
like the anticiation of future trends and needs, understanding the reuirements of all the
stakeholders, listening to them and lanning to enable ositive action of the bank.
The shareholders of the banks are known to be risk averse yet they e)ect to have otimal
erformance. There is thus a collision between the shareholders and the directors as the
directors like taking risks to imrove on the erformance of the comany. The value of the
erformance that is affected by the si:e of risks that a bank takes is the difference between the
book value of the comany
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*ccording to #evine % #aeven, "200A( financial risks are other maor risks that banks
face. The financial risks involved in banks are in most cases related to the management of the
banks. Their weaknesses and the means through which they undertake their activities would
either increase or decrease the financial risks of the organi:ation "#evine % #aeven, 200A(.
*nna, Takeshi, % *igbe, "200A( argue that oor management in the banks would lead to
misaroriation of funds thus increasing the financial risks. !imilarly, the board of directors
is also determinants of the financial risks that an organi:ation faces. here the board of
directors do not work to ensure that the management they emloy are cometent then
financial risks are likely to accrue. The monitoring of the management by the board of
directors is vital as it also reduces the financial risks of the banks "*nna, Takeshi, % *igbe,
200A(.
*ccording to Plath % -ongiardino, "2010( asymmetry information risks could be
viewed as a situation whereby one of the arties involved in a given transaction osses more
information comared to the other thus making them suerior. *symmetry information in
banks can lead to either adverse selection or moral ha:ards which have negative imlications
in a bank. The banks may take advantage of the current economic conditions to increase the
interest rates for customers so as to rovide for the welfare of the shareholders through more
returns. The customers in such a case suffer due to lack of knowledge while the shareholders
and the banks enoy the benefits through imroved erformance "Plath % -ongiardino,
2010(.
>llul % Eerramilli, "2010( argues that the oerational risks in banks is the risk which
is associated with the administrative and oerational rocedures in banks. eaknesses in the
administration rocedures main through the adotion of weak controls and weak management
structures would mean that the oerational risks associated with businesses are high. Fther
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minor risks that should also be considered in banks include the market risks, insolvency risks,
strategic risks and liuidity risks ">llul % Eerramilli, 2010(.
The Hou!e o" Co##on! trea!ury co##ittee
The =ouse of 7ommons treasury committee was a committee that was tasked with
investigating into the root causes of the banking crisis and roosals to the government on
how to enhance the strategic obectives of the banking sector "The =ouse of 7ommons
Treasury 7ommittee, 200A(. *ccording to =ouse of 7ommons Treasury 7ommittee, "200A(
the the crisis was invoked by a number of factors among them low interest rates, e)cess
liuidity and lack of faith in innovation in the banking sector. There was also failure by the
regulatory authority to introduce suervisory systems that would have been designed to
rotect the ublic from systemic risks. The committee also argues out that the crisis led to the
collase of some banks like the nothern rock as they were forced into becoming lenders of
last resort in the system. Individuals flocked the banks to withdraw their deosits after
nothern rock was declared solvent. 6inally, the crisis also saw the merger between the #loyds
and =/F
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consideration, the shareholder engagement olicies, international cometitiveness and the
degree of rescritiveness "#eblanc, 2010(. 3eflecting the concerns that were raised through
the consultative rocesses made by alker, the following recommendations were raised.
7ororate governance should focus on the board si:e, its ualifications and the comosition.
GIn ractice, decisions on board si:e will deend on articular circumstances, including the
nature and scoe of the business of an entity, its organisational structure and leadershi style
"alker, 200A(.H They should ensure that the board has enough knowledge and understanding
on the affairs of the business to enable them to contribute effectively to the business. They
should rovide freuent training to the business to enhance develoment in the business. The
board should also rovide dedicated suort to both the e)ecutive and non e)ecutive directors
of the board esecially on the matters that are relevant to the activities of the business. The
suervisory rocess should give close attention to the balance of the board to enhance the risk
strategies that are rovided for by the board. alker in the alker review also recommends
that the board should be functions roerly and its erformance should be evaluated. The
none)ecutive directors should challenge and test any roosals ut forward on the strategies
suggested by the e)ecutive. ith the suort of the chairman and other seniors, the board
should ensure roer leadershi of the business and effectiveness in the various asects and
deartments of the bank. The board should also facilitate and encourage the directors
esecially in matters concerning the discussion and decision making "The alker 3eview,
200A(.
alker, "200A( also recommended that the shareholders should also understand their
institutional roles with include engagement and communication. The board should be made
aware of the material changes that the shareholders have made in due time. The institutional
shareholders should also reare a code of resonsibilities to hel govern the institutional
investors. alker also made recommendations on the governance of risk in that he roosed a
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board risk committee to be formed to hel advice the boar on all the current risks that the
business is e)osed to and the future risk strategies which they lan to undertake "alker,
200A(.
alker, "200A( also makes key contributions to the role of duality in the organi:ation.
=e argues that the 7>F also being the chairman of the board brings in both negative and
ositive imlications to the organi:ation. The division of the two roles to have different
eole in the two ositions would mean an increase in the views as they would be diverse
from the two eole while at the same time increasing the administrative costs. The alker
3eview, "200A( argues that the freuency of board meetings being held as has its own
imlications to the banks. Provided the board meetings conveyed rovide ositive resolutions
to hel imrove on the bank
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The first declaration of the credit crunch in the +nited ingdom was first made on
*ugust A, 200D "/eltratti % !tui:, 2012(. /eltratti % !tui:, "2012( argues that at this time, the
financial markets stalled since they lacked liuidity since the banks stoed lending to each
other. The crunch was caused by the failure of the institutions to manage the inherent
business risks together with the remuneration incentives of the directors. The management of
risks in the banks lacked influence and ower. 6inally, there were weaknesses in reorting for
both the financial transactions and for risks "/eltratti % !tui:, 2012(.
7ororate governance is all about the control and directing the different deartments of an
organi:ation to best achieve the interest of long5term erformance. The directors are
continuously suosed to work towards imroving the erformance of the banks and reduce
risks.
*ccording to the Turner 3eview, "200A( the credit crunch started as a result of the
collase of the #ehman /rothers global bank in 2008 and it almost brought down the
country
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funding as it made the bank suscetible to liuidity risks. *ccording to 6ranco % 4avid,
"200A( the +
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the lending activities of the banks, the caital for infrastrucuture develoment reduced. The
money sul in the economy of the +nited ingdom was also negatively affected since the
banks were not available to effectively rovide the economy with easy money suly otions.
*ll activities in the economy were thus adversely affected by the credit crunch "=su, 201'(.
E""ect! o" corporate )o$ernance on per"or#ance and ri!k
-ahfoudh % u, "2012( argues that cororate governance entails the means through
which banks sets targets to be imlemented by other stakeholders like the shareholders and
the emloyees to imrove on the erformance of the organi:ation "-ahfoudh % u, 2012(.
7ororate governance comrises of the board of directors of banks who are an imortant tool
in the develoment of the organi:ation, oortunity creation, leverage and management of the
banks. The board of directors, not necessarily the owners of the banks are the ones tasked
with roviding the organi:ation with a strong management to hel hedge out risks in the
banks as well as make imrovements on the erformance of the organi:ation. /y focussing
on cororate governance, the study targets to e)amine board meeting freuency, board si:e,
non e)ecutive directors on the board and role duality "-inton, Taillard, % illiamson, 2010(.
Board !i*e
In"%uence on per"or#ance
*ccording to -inton, Taillard, % illiamson, "2010( the si:e of the board is a maor
issue on the erformance and risk issues for the banks in the +nited ingdom. #arger boards
are more likely to ools resources together and thus encourage the information flow and
rocessing abilities. The bigger the si:e of the board, the more skilful they are and as a result,
there is an imroved decision making rocess. #arger boards allow for collective decision
making leading to the adotion of strategic decisions and actions into the banks to hel
imrove on their erformance "-inton, Taillard, % illiamson, 2010(. -ahfoudh % u,
"2012( argues that the larger boards are more likely to access and secure imortant resources
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from the environment around the banks and the different stakeholders. The larger boards
assist in develoing better board interlocking relationshis and create indeendence in the
decisions that are made for the organi:ation. The bigger boards are in most cases diverse in
their ideas and they tend to romote diversification of ideas for better services in the
organi:ation and as a result lead to better erformance in the banks. Therefore, there is a
ositive relationshi that e)ists between the si:e of the board and the erformance of the
banks.
4avid E. , "1AA( argues that different structures in the cororate governance systems
rovide differences in the board effectiveness to rovide roer governance. =e argues out
that there is an inverse relationshi that e)ists between the erformance of the board in terms
of board value and the board si:e "4avid E. , 1AA(. #iton % &ay, "1AA2( recommends that
for a board to achieve otimal erfornance for the business it sould comrise a ma)imum of
ten eole. =e argues that even if the board si:e was to increase, the e)ected benefits would
still be overweighed by the costs of remuneration and the seed at which the decisions are
made within the organi:ation "#iton % &ay, 1AA2(.
Eermack "1AA@( argues that the board si:e has its effects on the real value of the
comanies. The comanies with smaller si:es of the board of directors have great advantages
in rovide better value for the comanies as it ensures otimal resource utili:ation and easy
and fast flow of information in the organi:ation. The small board of directors ensures that the
gas within the organi:ation are easily identified and worked on to reduce the risks that the
businesses face "Eermack, 1AA@(. *dams % -ehran, "2008( argues that there is a negative
relationshi that e)ists betwen the erformance of the organi:ation and board si:e. The
cohesion that e)ists for small board allows the communication and cordination of costs to
reduce the director roblems. 6or large boards, the incentives for directors to manage
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information is lower as comared to the small boards. =owever, the si:e of the board is also
determined by the economic environment around the business "*dams % -ehran, 2008(.
In"%uence on ri!k
The bigger board are more likely to have control over the risks that face the
organi:ation thus imroving the erformance of the banks "-ahfoudh % u, 2012(. ith
otimal board si:e, the risks facing the organi:ation are reduced as the board effectively
manages both the reutation risks and the financial risks that face the organi:ation. The si:e
of the board brings in other costs related risks as such as the monitoring costs. The larger
board si:es will have to be monitored often as there may be other in the board that do not
rovide value for money yet they enoy the benefits ust like others in the board. Thus
according to Pathan % !kully, "2010( the board si:e is neatively related to the directors
monitoring costs thus may have an increase in risks faced by the organi:ation "Pathan %
!kully, 2010(.
#adio % ;estor, "200A( suorts this argument when he argues out that the norms of
most boardrooms never change. The norms create a dysfunctional board such that the to
managers are never criticised in their actions "#adio % ;estor, 200A(. !hort coming are thus
e)ected to be evident in such banks as only the ideas and oinions of the to managers are
taken into ractice thus increasing the risks that the organi:ation faces.
Board #eetin) "re+uency
In"%uence on per"or#ance
4uring and after the credit crunch crisis, the freuency of the board meetings was an
imortant characteristic of the banks in the +nited ingdom. *ccording to =udain % =aniffa,
"200@( the firms stock erformance ositively relates to the number of board meeting and the
freuency that the directors of the firms attended the meetings. The imortance of board
meetings is that it is a channel through which the directors can e)change knowledge and
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information concerning the activities of the firm and how best to tackle the weaknesses to
imrove on the erformance of the firms "=udain % =aniffa, 200@(.
+adiale, "2010( argues that the freuency of the board meetings strategically allows
for better erformance of the organi:ation as it encourages innovation and strategic
orientation through the flow of information when then board meets. The freuency of board
meetings encourage efficiency and effectiveness in the decision making rocess of the banks.
*s a result, high uality innovative decisions are made that imrove on the erformance of
the organi:ation and reduce the risks that the banks faces to enhance the imrovement of the
services offered. The advantage of the freuency of board meetings for banks is that it could
hel bring imrovements in the resource utili:ation. Ftimal resource utili:ation could mean
that there is increased erformance in the organi:ation while the costs incurred are greatly
reduced "+adiale, 2010(.
;ikos, "1AAA( argues that the number of board meetings held annually by the board is
inversely related to the value of the firm an increase in the freuency of board meetings in
organi:ation would mean that the organi:ation has been undererforming during the revious
years and the board seeks to address imortant issues that will imrove on the erformance.
The board meetings thus hel the directors to monitor the erformance of the organi:ation
and imrove on it where gas are identified ";ikos, 1AAA(.
In"%uence on ri!k!
=owever, there are also risks involved in the board meeting freuency. The more the
board meetings being held in the bank
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*dams, *lmeida, % 6erreira, "200?( argues that different individuals usually think
differently. ith different eole taking the ositions of chairman and 7>F, then more
diverse oinions are likely to be made to suort the erformance of the organi:ation
"*dams, *lmeida, % 6erreira, Powerful 7>Fs and their imact on cororate erformance,
200?(. 3enee % =amid, "2011( argues that different eole have different characteristic and
ualifications. =aving different eole in the two seats would arguably mean that better
decisions will be made and as a result, an increase in erformance for the organi:ation "3enee
% =amid, 2011(.
#inck, ;etter, % Eang, "2008( argues that revious studies conducted have not
e)licitly addressed the determinants of 7>F duality. The little that is already known ca
however be used to determine the role duality of 7>F and its effects on erformance. The
7>F osses secific knowledge that can be used esecially for the large and comle) banks.
In this case #inck, ;etter, % Eang, "2008( argues that the role duality hels the banks rea
maor benefits "#inck, ;etter, % Eang, 2008(.
In"%uence on ri!k
=udain % =aniffa, "200@( sees the duality as a concet that is not consistent with the
checks and balances of an organi:ation. =e continues to argue that duality is a concentration
of ower to one osition which in turn reduces the boards effectiveness to make decisions.
The managerial and monitoring decisions are fully made by the 7>F meaning that there are
weaknesses in the management team which may lead to reduced erformance for the
organi:ation and an increase in business risks. 4uality thus limits the indeendence of the
board as they are in most cases working under duress from the 7>F. eisbach, "1A88(
suorts the oinion that the other directors in the organi:ation are likely to be deendent as
their decisions are made from the decisions of the 7>F "eisbach, 1A88(.
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=afi:a % !usela, "2008( argue that the role duality should have a searation of owers that
allows for monitoring of the management. In such a case, the 7>F may not introduce over
ambitious lans as they will need to be aroved by the chairman of the board who must
consult with the rest of theboard members before comming into any conclusion "=afi:a %
!usela, 2008(.
3enee % =amid, "2011( however, argues that the si:e of the institution will determine
whether the institution should have different eole in the osition of chairman of the board
and that of the 7>F or the same erson. * small institution with different eole in the two
ositions would mean an increase in risks as oosed to the erformance benefits that would
be recorded "3enee % =amid, 2011(.
The nu#er o" non,e-ecuti$e director! on a oard
In"%uence on per"or#ance
*ccording to =iggs, "200'( the non e)ecutive directors of the board are imortant to
the banks as they rovide technological, technical and strategic assistance to the internal
e)ecutive directors. The non e)ecutive directors are vital as they offer effective monitoring to
the organi:ation. The non e)ecutive board usually act as mentors to the board as a whole and
are active articiants who hel in the develoment of strategies to be used in the business.
The effect that the number of non5e)ecutive directors has on the business could be viewed in
two dimensions "=iggs, 200'(. *ccording to here the erformance of the organi:ation is at
stake, the non5e)ecutive directors bring in new ideas and information into the board that is
used to enhance the erformance of the organi:ation. The more the number of non e)ecutive
members, the more the information gathered geared towards imroving the erformance of
the banks. =aving a big si:e of non e)ecutive directors would mean that the business would
benefit from the e)erience of the board thus would lead to an increase in the seed at which
the strategies of the comany are imlemented.
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Pablo % >leuterio, "2008( argue that the role of the directors is to ensure effective
management of finances and enhance erformance. The non5e)ecutive directors allow for
better management of resources and finances as they introduce their e)erience into the
board. The higher the number of non5e)ecutive directors, the higher the returns that are
e)ected as it hels the board to effectively manage its resources. "Pablo % >leuterio, 2008(.
In"%uence on ri!k!
*ccording to Iyala, "2011( the risks that are accomanied by the number of non5
e)ecutive directors on the board in the banking sectors are evident since they are not fully
involved in the affairs of the business. The non5e)ecutive directors do not invest enough time
into the business thus the business may have an increase in risks for more cost "*lmeida,
6erreira, % *dams, 200?(. The remunerations of the non5e)ecutive directors may not rovide
value for money as they may be aid for time that they did not serve the interest of the banks.
The more the number of non e)ecutive directors, the more the risks as some may not work as
they await the others to work thus the business incurs e)tra costs without any value for
money "!tewart, 2011(.
A)ency theory
alker, "200A( defines the agency relationshi as a relationshi in which a erson
who is the rincial engages or emloys another who is the agent to act on his behalf and it
includes being granted the authority to delegate and make decisions for the organi:ation
"alker, 200A(. *dams % 6erreira, "200D( argue that the agency theory is art of a bigger
toic of the cororate governance. It is a roblem that arises among the shareholders of the
business as they decide who is best suited to run the business. It is therefore, the roblem that
arises when the directors dictate how the comany is to be run whilst the shareholders own
the organi:ation "*dams % 6erreira, 200D(. 4emset:, !aidenberg, % !trahan, "1AAD( argue
that the directors may in most cases not act in the best interest of the shareholders and thus
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the agency theory was coined to consider the roblem and identify what best could be done to
revent the roblem "4emset:, !aidenberg, % !trahan, 1AAD(.
*ccording to -ay, "1AA?( mistrusts may occur between the agent and the rincial
and thus the rincial establishes roer incentives for the agent. !imilarly, the rincial may
limit the divergence of the agent by incurring monitoring costs that are made to hel limit the
oortunistic actions of the agent "-ay, 1AA?(. 4esite roviding these actions to reduce
divergence between the agent and the rincial, some divergence may still remain but could
be viewed as residual loss for the rincial "alker, 200A(. 4avidson % !ingh, "200'( argues
that the residual loss is the indirect additional agency costs that relates to directors urchasing
e)ensive materials for themselves at the e)ense of the shareholders. The costs that are
incurred by the shareholders in the agency relationshi include the remuneration ackages for
the managers, management costs that are incurred for the rovision of annual reorts,
committee activities and management analysis to risk. Fther costs likely to be incurred
include the monitoring costs and the bonding costs "4avidson % !ingh, 200'(
&takeho%der theory
*ccording to 6reeman, icks, % Parmer, "200( he term stakeholder is a term used
for organi:ations to refer to the grous that have legitimate claim on the organi:ation. The
stakeholder theory governs the organi:ational management and establishes business ethics
that address the morals necessary for roer running of the organi:ation. The stakeholders of
the organi:ation include shareholders, regulators, bondholders, and customers, savers,
borrowers and managers. >ach of the grous that comlete the stakeholders of the firm is
maor contributors in the interest of the firm. >ach of them rovides the firm with critical
resources necessary for the running of the firm "4emset:, !aidenberg, % !trahan, 1AAD(. The
stakeholders of a firm could be divided into both internal and e)ternal stakeholders. The
internal stakeholders include emloyees, shareholders and the managers while the e)ternal
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stakeholders include the suliers, regulators, customers, society among others "6reeman,
icks, % Parmer, 200(.
"4onaldson % Preston, 1AA?( argues that the stockholders or the shareholders rovide
the comany with the caital necessary to run the business. In return, the shareholders e)ect
the caital to be ma)imi:ed through rofit ma)imi:ation while reducing costs and risks. The
managers together with emloyees rovide the organi:ation with human caital
commitments, skills and time for the investments of the shareholder to bear fruits and reali:e
rofits. 7ustomers are among the most imortant art of the business as they suly revenue
to the organi:ation. In e)change to the revenue that is sulied to the organi:ation, the
customers e)ect value for money through goods and services rovided to them. The
creditors are a source of finance for the organi:ation. In e)change, the creditors e)ect the
loans that they rovide to be reaid to them as and when they fall due together with the
interest that has accrued to the loans. The suliers are the roviders of the inuts of the
organi:ation that are acuired at the lowest ossible rices and are acuired deending on the
buyers< demands "4onaldson % Preston, 1AA?(.
Who are the principa%! o" ank!
*ccording to the agency theory, the shareholders are the main rincials of banks. In
this case, the shareholders are considered to be the rincials as they delegate the business
duties to the directors who are considered to be the agents in the business. The arguments by
&ensen "2001( roose that shareholders ought to be the rincials of the banks due to a
number of factors. 6irst, the shareholders are the owners of the business in most cases, and
thus their interest should be considered first. !econdly, the shareholders are the reasons why
businesses come into e)istence and thus the reason why their interest should be served first.
ithout the business, other stakeholders would not have any control of the business thus
another vital reason behind &ensen
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*ccording to !aidenberg, !tahan, % 4amsets, "1AAD( the stakeholder
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incometent management. *ccording to Pathan % !kully, "2010( the board of directors is
resonsible for utting u mechanisms for internal controls. The internal controls are
imortant to the organi:ation as they are maor determinants of erformance and risk control
for the banks. eak controls would mean that the banks do not achieve their full otential
thus the board of directors become imortant role layers in the banks "Pathan % !kully,
>ndogenously !tructured /oards of 4irectors in /anks., 2010(.
*ccording to #iang, Pisun, % Pornsit, "201'( the structure of the board of governance
should be of otimal si:e and should meet regularly to ass on information and discuss on
issues concerning the banks. The structure of the board of directors is a determinant of
erformance and risks to the organi:ation. The structure of the board of directors is related to
cororate governance as the board needs to ensure that they act in accordance to the cororate
social resonsibilities. The welfare of all the stakeholders should be incororated in the
affairs of the comany and thus the structure of the board of directors should be made to
ensure its suorts their welfare "#iang, Pisun, % Pornsit, 201'(.
6inancials risks are likely to increase for oorly structured board of directors. The
management of the finances of the banks would be oor since the board of directors would
not be structured well to suort the monitoring of the management.
Corporate )o$ernance
7ororate governance is the system through which the organi:ations and controlled
and directed and it secifies the secific rights and resonsibilities of the organi:ation. The
cororate governance involves the establishment of a strong relationshi between both the
internal and e)ternal stakeholders of the organi:ation. It is therefore a design that forces the
management of the organi:ation centrali:e their activities on the welfare of all stakeholders.
7ororate governance with regards to banks entails the boards that are set u together with
the systems that are set to control the board. 7ororate governance with regards to banks
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Partial Title 2?
entails the systems ut in lace to ensure otimal erformance is achieved and that they
reduce all the tyes of risks that the banks face. In order to achieve resonsible cororate
governance for banks the cororate social resonsibility of the banks towards its stakeholders
should be considered. The cororate governance has often been shaing the olicies of their
comanies to achieve a wide range of environmental and social toics and resonsibilities.
Proer cororate governance means that there are strong structures and a comosition of well
behaved boards under scrutiny for their activities "*ndreas % Ballelado, 7ororate
governance in bankingC The role of board ofdirectors., 2008(.
&ay, &ohn, % ;ickolaos, "2002( in their article argue that according to the cadbury
reort, the strucuture of the cororate governance should consist of both thehe)ecutive and
non e)ecutive directors. The cudbury reort recommended that deending of the si:e of the
institution, there should be atleast three non e)ecutive directors and the osition of the
chairman of the board should be held by a different individual from that of the 7>F. The
division of both ositions in the board hels to imrove the the board
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organi:ation to hel deliver long5term success to the organi:ation. The concet of cororate
governance goes beyond the activities of the board of directors. The regulatory art of the
banks is an imortant obective of the cororate governance. 3egulation in the banks
enhances safety, stability and soundness in the activities of the organi:ation "637, 2010(.
>F74, "200( argues that cororate governance is a system that allows organi:ations
to remain cometitive in the changing world. they argue that cororate governance should be
adoted together with other innovative ractices to enable businesses meet the changing
demands and gras any new oortunities within the organi:ation. 7ororate governance is
also a concet that kees the management on their feet as it tasks the senior management with
the resonsibility of oerational management. The cororate governance thus deals with both
the internal and e)ternal structures of the firm and ensures that they rovide the firm with the
best risk management otions ">F74, 200(.
echani!#! o" corporate )o$ernance
eir, -cnight, % #iang, "2002( argues that effective cororate governance is an essential
art of a business. The cororate governance ensures that the business sets and achieves
strategically its goals. >fficient cororate governance effectively combines olicies, controls
and guidelines that that are aimed at achieving the needs of the stakeholders. 6or cororate
governance to be effective in the banks, it should be accomanied by a combination of
various mechanisms namely internal, e)ternal and indeendent audit. The internal
mechanisms are those that are aimed at achieving the obectives of the internal stakeholders
such as the emloyees, directors and the shareholders. The internal mechanisms ensure
smooth oerations through segregation of the different resonsibilities by the board of
directors "eir, -cnight, % #iang, 2002(. The internal mechanisms are the easiest for
banks to control and thus should be otimi:ed by the organi:ation. The stakeholders should
therefore bear their resonsibilities and ensure that they achieve the obectives of the banks.
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Partial Title 2D
4avidson % !ingh, "200'( argues that the e)ternal mechanisms are the controls that are
controlled from outside the organi:ation. The e)ternal mechanisms include the legal
comliance by the business and effective debt management from the creditors and suliers.
The banks have little control over the e)ternal mechanisms and thus in most cases leave it to
the control of the e)ternal mechanism. The indeendent audit on the other hand rovides for
cororation to ensure that the financial statements rovided reresent a fair value of the
bank
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shareholders aroach thus views the business as a legal instrument that comes into being
only for the ma)imi:ation of the interests of the shareholders. In most cases, the shareholders
aroach does not adhere to the rincial of the cororate social resonsibility and in most
cases other stakeholders of the business and the environment at large is neglected "-acey %
FJhara, 200'(. hen the shareholders aroach is ut into ractice, the management would
only focus on making rofits without considering the other stakeholders in the firm. If rofit
making is the comany
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Partial Title 2A
/er"or#ance
*dams, *lmeida, % 6erreira, "200?( erformance could be described as both ositive
and negative outcomes of a business. The erformance of businesses needs to be tracked to
ensure that they stay within that financial year lan. 6or the management of erformance to
be made effective, it reuires the consulted efforts of all the stakeholders of the business. The
management of erformance in the case of banks reuires a selection of goals, a union of the
methods of measurements relevant to the organi:ation to be measured against its goals and
regular intervention by the managers to imrove on the erformance to best achieve the goals
set. The main erformance management rocesses include financial lanning, modeling of
the business, oerational lanning and reorting analysis to strategically kee track of the
erformance indicators in banks "*dams, *lmeida, % 6erreira, Powerful 7>Fs and their
imact on cororate erformance, 200?(.
Ri!k!
illiamson, "1A88( argues that risks in general business refers to the ossibility of
businesses recording lowers rofits and at times even losses which could be due to
unforeseen business issues. *mong the uncertainties that are likely to bring about business
risks include changes in tastes and references of the consumers, cometition, obsolesce of
the roducts and services and changes in government olicies "illiamson, 1A88(. /lasko %
!inkey, "200@( argue that banks are in most cases in the business of service delivery and their
risks are likely to emerge either as internal risks or as e)ternal risks. The internal risks of
banks are those arising from events that take lace within the organi:ation such as
management skills and technology and thus are controllable. Fn the other hand, the e)ternal
risks are the risks that are taking lace outside the business remises and are in most cases
uncontrollable. !uch factors include the economic factors such as ricing ressure and market
risks and the olitical factors such as government olicies "/lasko % !inkey, 200@(.
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Partial Title '0
!inan % Phili, "200( argue that there is no other sector in the economy of any
country that faces more risks than the banking sector. It is so because the banks are tasked
with the duties of managing multile needs that are seemingly oosing each other. The
management of such duties leads the organi:ation to the management of two maor risks
namely the solvency risks and the liuidity risks. Poor management in the banking industry
would mean that there are more risks in the sector that may force the collase of different
bank "!inan % Phili, 200(.
Thierno, #aetitia, % *mine, "200A( focus their argument in the view of risk taking and
control of the banking sector. They argue that the searation of ownershi of the business
from control is an imortant means to reduce risks. The owners are in most cases lacking the
skill reuirements to control the business and thus should hire a board that has the skill
reuired. ith the searation of the two, the business decisions would be highly influenced
by the owners which would mean that irrational decisions are made and as a result, the risks
facing the business would increase immensely "Thierno, #aetitia, % *mine, 200A(
Conc%u!ion
The literature was undertaken to identify other eoles oinion on cororate governance and
the effects that it has on the banks. The study was aimed at roviding an otimal structure on
banks that are aimed at achieving the best erformance while reducing risks. The study also
weighs out between the stakeholders theory and the shareholders theory and concludes that in
as much as the welfare of the shareholders is the main reason why banks together with other
businesses come into e)istence, the welfare of the other stakeholders should also be
considered. The study however also resents gas as the four variables investigated on may
not offer a comlete investigation on cororate governance. Fther variables like the number
of women in the board, board indeendence and distinction between ownershi and control
are factors that influence the erformance and risks in banks.
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Partial Title '1
#ittle studies concerning the board structure and its effects to erformance and risks have
been conducted. It is therefore, hard to determine the best structure that should be adoted by
the banks to ensure best erformance and risks reduction. >ach tye of structure that has been
adoted for the board brings out its own advantages and disadvantages. /lasko % !inkey,
"200@( argue that ast erformance of the banks affects the structure of the board. The
findings in our study suort the idea that board structure is an imortant determinant of bank
erformance. iven that the board structure is relevant to the banks erformance, the
formulation of olicies regarding banks governance should be structured in such a way that
they benefit the organi:ation by increasing its erformance "/lasko % !inkey, 200@(.
The regulators should carefully reconsider some of the reuirements of being a bank
director to make the bank director market more cometitive and actively encourage ualified
directors to comete in the market. !imilarly, small boards tend to imrove bank
erformance. The study thus rovides evidence that the structure of the board for the banks
and consistent with its efficiency and erformance. 6urther study on board structure
determinants is necessary to enhance academic understanding of this subect.
Ta%e 1 &u##ary o" Literature Re$iewed
!tudy Bariables 6indings
-inton, Taillard, %
illiamson, "2010(
!i:e of the board and
erformance of the firm
#arger si:es of the board are
likely to ool resources
together and encourage the
8/9/2019 Case Study of the Uk Banking Sector
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Partial Title '2
flow of information.
Pathan % !kully, "2010(. !i:e of the board and risks
faced by the firm
larger board si:es will have
to be monitored thus
increasing the monitoring
costs and in return increasing
the financial risks
=udain % =aniffa, "200@( 6reuency of board meeting
and erformance of the firm
board meetings rovide a
channel through which the
directors can e)change
knowledge and information
concerning the activities of
the firm and how best to
tackle the weaknesses to
imrove on the erformance
of the firms+adiale, "2010( 6reuency of board meeting
and erformance of the firm
6reuency of board meetings
allow firms to be governed
making them relatively
rofitable and valuable to the
shareholders
*dams, *lmeida, % 6erreira,
"200?(
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of the firm
3ole duality allows for more
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imrove on erformance
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Partial Title ''
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