Impact of corporate governance on the financial performance of deposit money banks

CHAPTER ONEINTRODUCTION1.1 Background to the studyIt has become a worldwide dictum that the quality of corporate governance makes animportant difference to the soundness or unsoundness of banks. Thus, effective corporategovernance   practice   incorporates   transparency,   openness,   accurate   reporting   andcompliance with statutory regulations among others. Historically, antecedents indicatethat financial  crisis is  a direct  consequence  of lack of good  corporate governance  inbanks;   invariably   one   of   the   sources   of   instability   in   the   banking   sector   is   lack   orinadequate of corporate governance.Wherever   a   power   is   exercised   to   direct,   control   and   regulates   activities   that   affectpeople, there is need for good exercise of such power. For corporate entities, particularlypublic  liability   companies,   the  exercise   of  power   over  the  enterprise’s   direction,   thesupervision and control of executive actions, concern for the effect of the enterprise onother parties and especially the environment, the acceptance of a fiduciary duty to beaccountable, constitute the quintessential of corporate governance.The banking distress of last decades has posed many challenges to corporate governancein banking industry. Bank distress can be associated to lack or avoidance of code ofethics   and   professionalism.   Odozi   (2007)   expound   this   posting   that   “ethics,   like,corporate governance,  transparency, and  accountability etc., is a  cliché that  has been

abused and misused”. The failure of banks in Nigeria, as elsewhere, has been largely due,not   merely   to   inadequate   corporate   governance   or   leadership,   but   to   a   failure   ofprofessional ethics as manifested in numerous instances of creative accounting practices,professionals insensitive internal control and risk management position being seriouslycompromised or even colluding with fraudster. Financial scandals around the world and the recent collapse of major corporate institutionin the USA has brought to fore, once again the need for the practice of good corporategovernance, which is a system of managing the affairs of corporations with a view toincreasing shareholders’ value and meeting the expectations of other stake-holders.For the financial institutions, the retention of public confidence through the enthronementof   good   corporate   governance   remains   of   almost   importance   given   the   role   of   theindustry in the mobilization of fund, the allocation of credit to the deficit sectors of theeconomy,   the   payment   and   settlement   system   and   the   implementation   of   monetarypolicy.Universally, there is a grounds well of interest in corporate governance. Particularly, theneed   to   implement   good   corporate   governance   in   the   banking   sector   becomes   moreapparent after the Asian financial crisis. This has been largely event-driven in the sensein that it is in response to scandals and unexpected crisis, which in some cases abruptlyterminated the existence of large corporate entities. The failure of Johnson Matheys bank,Bank   of   credit   and   commerce   international,   Polly   peck,   world   com   and   Enron

incorporation  are   cases  in  point.  The  failure  of   these  institutions  has   been  traced  toseveral lapses associated with poor corporate governance including conflicts of interestof corporate governors. Corporate governance has in recent time’s assumed heightened importance requiring thatboards and management of companies’ exhibit greater transparency and accountability intheir business conduct. The just concluded consolidation of the Nigeria banking industrymakes the institution of corporate governance a sine qua non in the industry. With thenumerous number of banks that emerged from the ashes of the erstwhile eighty-ninebanks being publicly quoted, corporate governance should in fact take the Centre stage inthe in the management of these banks. Hence, effective corporate governance requires aclear understanding of the respective role of the board and of senior management andtheir relationships with others in the corporate structure. The relationships of the board ofmanagement with stockholder should be characterized by “integrity” their relationshipswith   employees   should   be   characterized   by   “fairness”   their   relationships   with   thecommunities   in   which   they   operate   should   be   characterized   by   commitment   tocompliance and good corporate citizenship. Anya (2003).On the other hand, bank like many other economic organizations are expected to generateprofit through effective and efficient utilization of resources (inputs) to create sound assetportfolio (output) and ensure continuity. The position of bank therefore in the nation isseen as the oil of the engine of economic development through financial intermediation

and advisory services. Banks makes profit from the spread between interest charged ondeposit and loan interest rate. These differentials ought to compensate adequately for theinvestors contribution and the service provider as well, if corporate governance has to beused as yardstick in determining bank performance.Bank performance therefore, could be seen in term of how the management operates orthe result of their actions. In view of the later, performance could be seen in terms of theabsolute profits, rate of return, earnings per share, the quality of asset portfolio, level ofliquidity and net contribution to the economic development of the nation, performancehowever is not determined by inputs alone but is also dependent on the environmentwithin which the bank operates.  This environment is referred to as “PESTLM” comprising of Political, Economic, SocialCultural,   Technology,   Legal   and   Marketing.   The   level   of   bank’s   performance   isdetermined on how the institution can positively influence these environmental factorsand effectively survive in a driven competitive environment.In the last two decades, development in Nigeria financial sector have reinforced the needfor greater concern for corporate governance in financial institutions in the country. Therole   of   corporate   governance   on   banking   performance   relating   to   economic   growthcannot be over-emphasized. Banks are the pivot of modern economy, the repository ofpeople’s wealth and  suppliers  of credit which  lubricates the engine  of  growth of theentries economy Ebnodagne (1997).

The upsurge in the number of financial intermediaries following deregulation and thenumber of a significant number of the institutions with attendant agony suffered by manydepositors/   customers   and   the   systematic   stress   to   the   economy,   all   underscore   theimperative   for   greater   concern   for   corporate   governance   in   financial   intermediariesespecially mainstream banks. For instance, between 1994 and 1995 five banks failed andhave their licenses revoked by the central bank of Nigeria (CBN) due to distress. Hence the kernel of this study is to examine The impact of corporate governance onperformance of deposit money banks in Nigeria.1.2 Statement of the problemBanks and other financial intermediaries are at the heart of the world’s recent financialcrisis.   The   deterioration   of   their   asset   portfolios,   largely   due   to   distorted   creditmanagement, was one of the main structural sources of the crisis (Fries, Neven and Seabright, 2002; Kashif, 2008 and Sanusi, 2010). To a large extent, this problem was theresult of poor corporate governance in countries’ banking institutions. Schjoedt (2000)observed that this poor corporate governance, in turn, was very much attributable to therelationships among the government, banks and big businesses as well as organizationalstructure of businesses1. In  Nigeria,   before the   consolidation  exercise,   the  banking  industry  had  abouteighty-nine   active   players   whose   overall   performance   led   to   sagging   of

customers’   confidence.   There   was   ungearing   distress   in   the   industry,   thesupervisory structure was inadequate and there were cases of official recklessnessamongst the officials and directors, while the industry was notorious for ethicalabuses (Akpan, 2007). Poor corporate governance was identified as one of themajor factors in virtually all known instances of bank distress in the  country.Weak   corporate   governance   was   seen   manifesting   in   form   of   weak   internalcontrol   systems,   excessive   risk   taking,   override   of   internal   control   measures,absence to non- adherence  to limits of authority, absence of risk managementprocesses, insider abuses and fraudulent practices remain a worrisome feature ofthe banking system (Soludo, 2004).This view is supported by the Nigerian Security and Exchange commission (SEC) surveyin April 2004, which shows that corporate governance was at a rudimentary stage, asonly   about   40%   of   the   quoted   companies   including   banks   had   recognized   codes   ofcorporate governance  in place. This, as suggested by the may hinder the public trustparticularly in the Nigerian banks if proper measures are not put in place by regulatorybodies.The   Central   Bank   of  Nigeria  (CBN)   in   July   2004   unveiled   new   banking   guidelinesdesigned to consolidate and restructure the industry through mergers and acquisitions.Despite   this   measure,   the   problem   of   corporate   governance   still   remains   unresolvedamong consolidated Nigerian banks, thereby increasing the level of fraud. (Akpan, 2007)

further disclosed that data from the National Deposit Insurance Corporation report (2006)shows 741 cases of attempted fraud and forgery involving #5.4 billion. Soludo (2004)also   opined   that   a   good   corporate   governance   practice   in   the   banking   industry   isimperative, if the industry is to effectively play a key role in the overall development ofNigeria.Various corporate governance reform has been specifically emphasized on appropriatechanges   to  be   made  to   the   board  of   directors   in  terms   of  its   composition,   size  andstructure. The study seeks to examine the impact of corporate governance mechanisms onthe financial performance of deposit banks in Nigeria.1.3 Research QuestionsThis study addressed issues relating to the following pertinent questions emerging withinthe domain of study problems.(i) What   is   the   relationship   between   the   board   size   and   the   financialperformance of deposit money banks in Nigeria?(ii) Is   there   a   significant   relationship   between   board   composition   and   thefinancial performance of deposit money banks in Nigeria?(iii) Is there any significant relationship between directors’ equity interest andthe financial performance of deposit money banks in Nigeria?1.4 Objectives of the Study

This   study   aims   to   examine   the   relationship   between   internal   corporate   governancestructures   and   firm   financial   performance   and   firm  financial  performance   of  depositmoney banks in Nigeria. However, it is set to achieve the following objectives:(i) To examine the relationship between board size and the financial performanceof deposit money banks in Nigeria(ii) To investigate if there is a significant relationship between board compositionand financial performance of deposit money banks in Nigeria(iii) To determine if there is any significant relationship between directors’ equityinterest and the financial performance of deposit money banks in Nigeria