Corporate Governance Indicators and Firm Value

Corporate Governance Indicators and Firm Value

There are many definitions of corporate governance. Tricker (2000) defined it as “essentially the exercise of power over the modern corporation (large and small), holding company and subsidiary, listed and private.” In other words, Corporate Governance describes the process of decision-making and the process by which decisions are implemented (or not implemented) in a company. Hereby, private institutions conduct their affairs, manage resources, and guarantee the realization of peoples’ rights. Good governance accomplishes this in a manner essentially free of abuse and corruption, and with due regard to process, procedure and for the rule of law.

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According Wolfensohn (1999) former president of the World Bank, “corporate governance is about promoting corporate fairness, transparency and accountability.  Alo (2007) opined that corporate governance could be conceptualized as the manner as the manner in which power is exercised in the management of the resources of a corporation towards the realization of its goals, in terms of maintaining and increasing the value of shareholders as well as the satisfaction of other stakeholders.  In other words, corporate governance is being concerned with how a company is structured and controlled internally to ensure that the business is run lawfully and ethically with due regard to all stakeholders.
Smith (2002) sees corporate governance as a culture that has a common understanding of the roles of management and board, a culture of mutual respect that both parties must have for each other’s role. According to Mayer (2004), corporate governance is not solely concerned with the efficiency with which companies are operated in the interests of shareholders. It is also intimately related to company strategy and life cycle development.
It can be observed that there has been renewed interest in the corporate governance practices of modern corporations by shareholders and governments since early 2001 due to massive high-profile corporate bankruptcies, particularly due to the collapsed of a number of large firms such as Enron Corporation, Bank of Credit and Commerce International (BCCI), Rank Xerox, Tyco, Barings bank, Swiss Air, Parmalat, WorldCom, Adelphia Communications, AOL, Arthur Andersen, Global Crossing, Fannie Mae and Freddie Mac, and many others. In 2002, the US federal government passed the Sarbanes-Oxley Act, intending to restore public confidence in corporate governance.
In Nigeria, the examples of the corporate failures are better seen on what happened in the financial services sector some years back. The collapse of banks such as Allied Bank, All States Bank, Abacus Merchant Bank Nigeria Limited, Royal Merchant Bank Limited, Rims Merchant Bank Limited, Financial Merchant Bank Limited, Progress Bank Plc, and Republic Merchant Bank of Nigeria Limited no doubt exemplified the inadequacies of the time. Outside the banking sector, we also saw situations like “creative accounts” in which AP concealed debts well in excess of N20 billion, over valuation of the shares of Lever brothers, (Unilever), the fraudulent sale of shares involving Bonkolan Securities and others.
Though most corporate failures in many parts of the world have always been blamed on general economic recession, detailed and more focused researches on corporate failures have shown that whereas some companies that had been adjudged well established, strong and successful failed in times of economic recessions, some smaller ones survived. For instance,   Clutterbuck (1994) in his work showed that companies that failed shared some of the following characteristics:
(i)    Leadership of the company vested in an individual who combines the office of the Chairman and Chief Executive with domineering tendency.
(ii)    Persistent violation and non-compliance with internal control of the company by the Chief Executive.
(iii)    Optimistic (or even distorted) rather than prudential financial reporting.
(iv)    Irregular board meetings, often without adequate information given in advance.
(v)    Minimal disclosure in the accounts of the company.

It is the combination of these factors that undermine the capacity of a company to face the challenges of any economic downturn rather than the economic down turn itself.
Banking business started in Nigeria with the establishment of Elder Dempsteer in 1852. This was followed by the licensing of the African Banking Corporation from South Africa to commence banking business in Lagos in 1892. Since then, the banking industry in Nigeria had witnessed a tremendous growth in terms of the number of banks, bank branches, total capital reserves, total deposit liabilities, total assets, aggregate credit, total loans and advances and the profitability of the industry. The remarkable growth is indicative of the input of the banking sector to the economy.  The banks seems to have been relatively unaffected by the general downturn within the Nigerian economy while other industries in the economy are witnessing closures, the banking business remains relatively profitable until year 2002 (CBN, 2005).
Recent reports that most of the 25 banks that emerged in the post-consolidation era are hardly on solid health ground is sending spirals of shock across the nation’s financial landscape, demanding urgent stakeholders’ intervention (Sachs, 2007). Public consciousness was stirred around the health status of Nigerian banks. Operating in a global financial environment where a significant number of the world’s top players are losing grip, amid the pressures of global economic recession, there is a greater concern for the survival of the local institutions. The downturn witnessed by the Nigerian financial market has further increased apprehension among investors on the health status of the banks that constitute about 70 per cent of the nation’s stock market (Sachs, 2007).
Banks are the cornerstones, the linchpin of the economy of any country. Their relevance to the growth and development of the private sector and public institutions cannot be overemphasized. Given that case, not a few Nigerians are perturbed by recent foul-tasting comments and reports on the health conditions of the deposit money financial institutions. Many of the consolidated banks were reported to have infringed on relevant regulations bordering on capital adequacy, liquidity, credit limits, corporate governance, full disclosure, among others, between January 2005 (the beginning of the post-consolidation era) and December 2007.
Suspected deterioration in the financial health of some of the banks makes stakeholders worry with despondency about the nature and state of the Nigerian banking industry.  Given the importance of the need to safeguard depositors’ funds and shareholders investments, corporate governance for banking organizations is of great importance to the financial system and the economy. This development has led to the desire for new corporate governance codes that would make banks to be more transparent and accountable in the conduct of their businesses.
Bollard (2003) noted that risk management appears to be at the heart of most contemporary assessment of corporate governance themes  and that banks face a wide range of complex risks in their day-to-day business, including risks relating to credit, liquidity, exposure, concentration, interest rates, exchange rates, settlement, and internal operations. The nature of banks’ business – particularly the maturity mismatch between their assets and liabilities, their relatively high gearing and their reliance on creditor confidence creates particular vulnerabilities. The consequences of mismanaging their risks can be severe not only for the individual bank, but also for the system as a whole.
On proper assessment and management of risk, Bies (2003) suggested that before a company moves into new or higher-risk areas, the board of directors and management should receive assurances from internal audit that the tools are in place to ensure that the basics of sound governance will be adhered to. The audit committee should then actively engage the internal auditor to ensure that the bank’s risks assessment and control process over financial reporting are vigorous. Bies (2003) has identified two major types of risks faced by banks: operational risk and reputational risk. Operational risk has always been part of banking practice (Bies, 2003).  Reputational risks arise from inadequate or failed internal processes, people or systems or from external events. Such risks include employee fraud, customer lawsuits, failed information system conversions, etc.  This type of risk arises from customers and investors perceptions about the integrity of an organization (bank).

The CBN new code for the banking industry, is aimed at assisting boards of banks manage the challenges of balancing the conflicting interests of different stakeholders. Provisions of the new code that pertain to directors include:
a)    Prospective board members should have first degrees or their equivalents with appreciable experience/exposure. Candidates with lower qualifications but with experience may also be considered.
b)    Mandatory completion of CBN’s code of conduct forms once the appointments have been approved.
c)    Directors or significant shareholders should not borrow more than 10% of the bank’s paid up capital without the prior approval of the CBN. The Maximum credit to all insiders should not exceed 60% of a bank’s paid up capital.
d)    Chairmen of banks are prohibited from serving simultaneously as chairmen or members of board committees.
e)    No person is allowed to hold directorship in more than two banks.
f)    Disclosure of all insider related party transactions of banks in their financial statements.
g)    The responsibilities of the Chairman of the board should be clearly separated from that of the MD/CEO. No one person should combine the post of Chairman with that of the Chief Executive Officer of any bank.
h)    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.
i)    There should be, as a minimum, the following board committees in a bank: Risk Management, Audit Committee, and Credit Committee.
j)    The number of non executive directors should be more than that of executive directors subject to a maximum board size of 20 directors.
k)    At least two non executive directors should be “independent directors”.
l)    A committee of non executive directors should determine the remuneration of executive directors.
m)    Non-executive director’s remuneration should be limited to sitting allowances and reimbursable travel and hotel expenses.
n)    Non executive directors should not remain on the board of a bank continuously for more than 3 terms of 4 years each i.e 12 years.
o)    Regular training and education of board members is important.
p)    There should be annual Board and Directors’ review/appraisal by an outside Consultant. The review report is to be presented at the bank’s AGM.
q)    Any director whose facility or that of his/her related interest remains nonperforming for more than one year should cease to be on the board of the bank and could be blacklisted from sitting on the board of any other bank.
r)    The practice of anticipatory approvals by the Board Committees should be limited strictly to emergency cases only and ratified within one month at the next committee meeting.
s)    The Board Credit Committee should have neither the chairman of the Board nor the MD as its chairman.
t)    All insider credit applications pertaining to directors and top management staff (AGM and above) and parties related to them, irrespective of size should be sent for consideration/ approval to the Board Credit Committee
u)    Where directors and companies/entities/person s related to them are engaged as service providers or suppliers to banks, full disclosure of such interest should be made to the CBN.
v)    The Board Credit Committee should be composed of members knowledgeable in credit analysis.
Basel, (1999) on his part identified the following practices as critical elements in any good corporate governance process:
a)    Establishing strategic objectives and a set of corporate values that are communicated throughout the banking organization;
b)    Setting and enforcing clear lines of responsibility and accountability throughout the organization;
c)    Ensuring that board members are qualified for their positions, have a clear understanding of their role in corporate governance and are not subject to undue influence from management or outside concerns;
d)    Ensuring that there is appropriate oversight by senior management;
e)    Effectively utilizing the work conducted by internal and external auditors, in recognition of the important control function they provide;
f)    Ensuring that compensation approaches are consistent with the bank’s ethical values, objectives, strategy and control environment;
g)    Conducting corporate governance in a transparent manner.
There is hardly any issue in recent times that has moved from the periphery to the centre as quickly and decisively as corporate governance. This is not only within policy circle but even Academia has also intensely focused on corporate governance (La Porta et al, 1998).  However, despite the growing literature in the field as opined by Shleifer and Vishny (1997), very little attention has been focused on the issue of the corporate governance in the banking industry. As Shleifer and Vishny (1997) argue in their work, there has been very little research done on corporate governance outside the United States, apart from a few developed countries, such as Japan and Germany.  Das et al (2007)  observed that this is particularly strange in light of the fact that a significant amount of attention has been paid to the role that banks themselves play in the governance of other sorts of firms” (Macey and O’Hara 2003).
According to Das et al (2007) corporate governance of banks especially in developing economies is important for the following reasons:
(i)    Banks have an overwhelmingly dominant position in developing economy financial systems, and are extremely important engines of economic growth (King and Levine, 1993; Levine 1997).
(ii)    Financial markets are usually underdeveloped, banks in developing economies are typically the most important source of finance for the majority of firms.
(iii)    Banks in developing countries are usually the main depository for the economy’s savings.
(iv)    Many developing economies have recently liberalized their banking systems through privatization/disinvestments and reducing the role of economic regulation. Consequently, managers of banks in these economies have obtained greater freedom in how they run their banks.

Caprio and Levine (2002) and Das et al (2007) pointed out; two inter-related features of financial intermediaries affect corporate governance as follows:
(i)    Banks are more opaque, which intensifies the agency problem. Due to greater information asymmetries between insiders and outside investors, in banking, it is (a) more difficult for equity and debt holders to monitor managers and use incentive contracts; and, (b) easier for managers and large investors to exploit the private benefits of control, rather than maximize value.
(ii)    Banks are heavily regulated and this frequently impedes natural corporate governance mechanisms. For instance, (a) deposit insurance reduces monitoring by insured depositors, reduces the desirability of banks to raise capital from large, uninsured creditors with incentives to monitor and increases incentives for shifting bank assets to more risky investments; and (b) regulatory restrictions on the concentration of ownership interfere with one of the main mechanisms for exerting corporate governance around the world: concentrated ownership.
La Porta et al (1999) study corporate governance patterns in 27 countries and conclude that “the principal agency problem in large corporations around the world is that of restricting expropriation of minority shareholders by the controlling shareholders”. Waba (2006) reported that Ogbechie (2006) examined the key corporate governance issues in the management of public companies which covers broad areas of traditional corporate governance prescriptions such as Board Disclosure; Board Composition; Board Committees; Strategy Committee and Remuneration Issues.
Some recent studies have attempted to explore the issue of corporate governance in banking organisations. Boubakri et al (2003) examine the corporate governance features of newly privatized firms in Asia and documents how their ownership structure evolves after privatization. The results suggest that, on the one hand, privatization leads to a significant improvement in profitability, while, on the other hand, it creates value for shareholders. Joh (2003) presents evidence on corporate governance and firm profitability from Korea before the economic crisis and finds that the weak corporate governance system offered few obstacles against controlling shareholders expropriation of minority shareholders. In fact, weak corporate governance systems allowed poorly managed firms to stay in business and resulted in inefficiency of resource allocation, despite low profitability over the years. Anderson and Campbell (2003) investigate corporate governance activity at Japanese banks. The results indicate that there does not exist any relation between bank performance and non-routine turnover of bank presidents, in the pre-crisis (1985-90) period, although there is an observed significant relationship between turnover and performance in the post-crisis (1991-96) period.
In another study, Reddy (2001) had recommended that the positions of chairman and managing director in public enterprises would be needed to be vested in one person as against the popular view for the private sector. This is in order to protect the interests of the organization. The major challenge in progressing to good corporate governance is to build essential knowledge on relevant laws, duties and responsibilities, financial analysis, strategy, business ethics and effective decision-making. However, Kohli (2003) stressed that corporate governance has to be perceived and understood in a much broader spectrum, encompassing all players involved in the business, instead of restricting it only to board and executive management. Das et al (2007) argue that a company having better corporate governance is quoted at a premium in the bourses than those with weak corporate governance practices. Jalan (2000) has examined the issue of corporate governance in public versus private banks and thereafter.
Spong and Sullivan (2007) reported that Glassman and Rhoades (1980) compared financial institutions controlled by their owners with those controlled by managers and found that the owner-controlled institutions had higher earnings. Allen and Cebenoyan (1991) found that bank holding companies were more likely to make acquisitions that added to firm value when they had high inside stock ownership and more concentrated ownership. Cole and Mehran (1996) discovered higher stock returns at thrifts that had either had a large inside shareholder or a large outside shareholder. These studies thus offer some support for the hypothesis that stock holdings provide an incentive to run a bank better and achieve higher earnings for its stockholders.
Das et al (2007) examined corporate governance in terms of the link between CEO turnover and corporate performance as well as the implications of the concentrated ownership that is common in many emerging and developed markets. Specifically, they examine the relationship between turnover of bank chairmen (who they term as chief executive officer or CEO) and bank performance using the approach adopted by Kaplan (1997) and more recently, employed by Gibson (2003). The results of the study revealed that Irrespective of whether which measure of bank performance is considered, lagged value of the performance measure has a significant influence on CEO turnover. In other words, bank performance does impinge upon CEO turnover. It also found that SIZE negatively and significantly impact CEO turnover, suggesting that bigger banks tend to have lower probability of rotation of CEOs.
A number of studies have also examined possible relationships between ownership and risk taking. Saunders, Strock and Travlos (1990) looked at a group of large, publicly traded banking organizations and found a higher level of risk in organizations where the managers and directors had higher ownership stakes, much as might be expected under principal-agent theory.  Das et al (2007) have also reported on studies that have looked at risk measures derived from stock prices such as Anderson and Fraser (2000), Brewer and Saidenberg (1996), Chen, Steiner and Whyte (1998), Demsetz, Saidenberg and Strahan (1996), Demsetz and Strahan (1997), and Knopf and Teall (1996), but have not come to consistent conclusions on the effect of inside ownership on bank risk taking. Several of these studies also explored the influence of outside shareholders on bank risk. For instance, Cebenoyan, Cooperman, and Register (1999) found reduced risk levels at thrifts with large outside investors, and Knopf and Teall (1996) found the same type of relationship in thrifts with institutional investors, thus indicating that such shareholders may be protecting their investments by monitoring bank management.
According to Ciancanelli et al (2009) though there is a great deal of empirical research on corporate governance, very little of it concerns the behaviour of owners and managers of banks. In addition, there is no clear theoretical path between governance as a microeconomic concept and regulation as a macroeconomic concept. There is, therefore, little guidance as to the conceptual framework that is suitable to understanding governance in banks.
This lack of guidance creates a strong theoretical motive for research on these issues. Therefore by defining a conceptual framework appropriate to governance in banks, it is possible to contribute to the further development in the area of banking, so that governance is understood as an integral part of the microeconomic foundations of what is called systemic risk in the banking literature (OECD, 1995; Davis, 1995; Lindgren, Garcia and Saal, 1996)
Ciancanelli et al (2009) further argue that developing models of corporate governance in banking requires that we understand how regulation affects the principal’s delegation of decision making authority (Jensen and Smith, 1984) and what effects this has on the behaviour of their delegated agents. (Freixas and Rochet, 1997)
It is accepted that each country has a specific sort of corporate governance and diverse methods of corporate control as result of its history, economic and business culture. (Ciancanelli and Reyes, 1999; Ciancanelli and Scher, 1999; Prowse, 1994). Therefore, it follows that there is not one “best” type of corporate governance. At the same time, one can say that all corporations, whatever the particular forces that constrain their behaviour, act in light of both internal and external rules. The latter emanate mainly from the legal system, regulation and codes of conduct. (Cadbury, 1998) Of these the government and regulatory bodies are deemed to play a transcendental role in corporate governance. (Charkham, 1995)
The observed forms of corporate governance of banks emerge in the course of their operations as entities having to respect the private interest of owners, on the one hand, and the public interest in the overall stability of the system, on the other hand. (Visentini, 1997) Thus, if one accepts that the banking regulatory framework is one of the most important external forces in shaping the behaviour of banks, a theory of corporate governance needs to address the integration of both internal and external forces in order to attain an optimal balance of public and private interests.

The board has been defined as the relationship between the shareholders of the firm and the management delegated with undertaking the day-to-day operations of the organization (Stiles and Taylor, 2001). Several researchers have identified the key functions of the board as strategic, controlling (monitoring managers and accountability), institutional (building links with investors and stakeholders), approval of a core philosophy and mission, maintenance of legal and ethical practices, communication with shareholders, and review (Riana, 2008; Zahra and Pearce, 1989; ICC, 2009). The responsibilities of the board of directors of any company are explicitly stated by the statutory framework of the country in which the company operates. The corporation’s by-laws and its declaration of board values and charter for the country in which the corporation operates serve as a guiding principle of the role and fiduciary duties of the board.
Board structures are not uniform across countries (Hopt and Leyens, 2004; Keenan, 2004). There is a diversity of ownership structures around the world. Most notably, company law in France, Germany, the Netherlands and China requires and/or allows listed firms to adopt a two-tier board (as opposed to a unitary board) composed of a Board of Management (or decision-making unit) and a Supervisory Board (or monitoring unit). For example, in Germany the supervisory board (Aufsichtsrat) is by law composed of independent or non-executive directors and includes employee representatives 50% in companies with more than 2000 employees (Aguilera, 2005). The dual-board structure, strongly embedded in some national systems, is currently being questioned. For instance, the EU allows new firms registering under European statutes (societas europea) to choose between one or two-tiered systems (Hopt, 2002). A comparative perspective highlights the immense power, charm, and leadership given in the US corporate governance system to the chief executive officer (CEO), who usually also exercises the role of chairman of the board. In fact, in the USA, the split of these two roles is generally perceived as a transitional arrangement or a sign of weakness, particularly in the case of new outside CEOs (Khurana, 2002).
One of the challenges facing modern corporations in Nigeria may stem from lack of qualifications of corporate board members. According to the Central Bank of Nigeria (2006), many board members may lack the requisite skills and competencies to effectively contribute to leadership of modern corporations. The board needs a range of skills and understanding to be able to deal with various business issues and have the ability to review and challenge management performance. It needs to be of sufficient size and have an appropriate level of commitment to fulfill its responsibilities and duties. There are issues about the appropriate mix of executive and non-executive directors. The key roles of chairperson and CEO should not be held by the same person (CBN, 2006).

The current literature on corporate governance structure has stressed the agency problem where ownership is dispersed and shareholders have a passive role. Professional managers have a strong independence and cross incentives through bonus shares payments. This implies that they have incentives to disclose information when a company’s investments succeed but they also tend to hide information when there are significant losses. This figure usually applies to big American corporations and British publicly traded firms where legislation forbids individual stakes greater than 25%. In theory, a controlling shareholder can affect minority shareholders’ rights and firm performance in two opposite ways. Shleifer and Vishny (1997) argue that ownership concentration is, along with legal protection, one of two key determinants of corporate governance. Large shareholders can benefit minority shareholders because they have the power and incentive to prevent expropriation or asset stripping by managers. In this vein, ownership concentration can be viewed as an efficient governance mechanism. On the other hand, large shareholders can collude with managers to expropriate minority shareholders’ benefits, which is called tunneling (Johnson et al., 2000) and described as one of the central agency problems in countries with relatively poor shareholder protection (La Porta et al., 1999; 2000). Morck et al. (2000) also discuss how controlling shareholders may pursue objectives that are at odds with those of minority shareholders. Therefore, the relationship between ownership concentration and firm efficiency is a complicated issue. When ownership of shares is widely dispersed, increasing ownership concentration is likely to mitigate the free-rider problem and enhance firm efficiency. However, when the fractional ownership of the largest shareholder exceeds a certain threshold, increasing ownership concentration raises the likelihood of tunneling and decreases firm efficiency.
In Nigeria, a more prevalent constraint arises from restricted competition in the market for goods and services. Impediments to competition are diverse, ranging from anti-competitive practices by firms to policy restrictions on ownership and entry (Khemani and Leechor, 1999). Often, entry barriers are disguised as regulations supposedly designed to serve or protect the “public interest.” These policies usually give owners profits in excess of competitive returns. Such profits, however, come from distorted prices in the form of a hidden tax on consumers. The lack of competition also accentuates ownership concentration. Owners of incumbent firms have an incentive to retain control of profitable operations. They may choose to remain a private firm or may go public, but without giving up control, by retaining a controlling stake or issuing non-voting shares (Khemani and Leechor, 1999).

Shareholders’ rights vary from country to country. For example, in North America, shareholders’ rights tend to be more developed than other nations and there are standard for the purchase of any common stock (Investopedia, 2009). Shareholders rights are included in corporations’ laws and stock market rules and regulations. Share holders rights are crucial for the protection of investors against poor management. Protection of shareholders rights including minority shareholders rights has been become a challenge for developing and implementing effective corporate governance system in many developing countries. For instance, one of the major issues of corporate governance in Nigeria is the lack of protection of minority shareholders’ rights. Although there are laws in Nigeria that were intended to protect minority shareholders’ rights, these laws are not strictly enforced (BrabnersChaffeStreet, 2003).
Nigeria has adequate laws that are designed to protect shareholders’ rights and ensure good corporate governance. However, these laws are often ignored because shareholders are generally unaware of the rights that they have as a shareholder. Experts such as BrabnersChaffeStreet (2003) have argued that the greater the shareholding of an individual, the greater are his/her rights and the greater is his/her power within the company. This is so not only because the larger the shareholding the more likely it is to represent a controlling interest. It is then logical to expect that minority shareholders would be expected to play a lesser role on how the firm is governed.

According to the OECD (2004) corporate governance principles, to ensure an efficient corporate governance structure, it is essential that an appropriate and efficient legal, regulatory, and institutional foundation be established upon which all market participants can rely in establishing their private contractual relations. The OECD (2004) principles of corporate governance state that a corporate governance framework will typically comprise elements such as legislation, regulation, voluntary commitments, and business practices that are based on a country’s specific circumstances such as history and tradition. However, as new experiences accrue and business circumstances change, the content and structure of this framework may need to be adjusted (OECD, 2004).
In Nigeria, there are legal and regulatory systems in place to protect the rights and obligations of shareholders, rules and regulations for conducting business, and penalties for violations of these regulations (Okeahalam and Akinboade, 2003). As previously mentioned, one of the major laws regulating business conduct and operations in Nigeria is the CAMD (1990). However, the problem of supervision and enforcement of such laws and processes still remains a major issue hindering effective implementation of corporate governance. Judicial and administrative means of supervision have not been successful in bringing the type of changes necessary to implement effective corporate governance. Researchers have shown that the regulatory process should consist of setting the rules, creating standards of monitoring compliance, and enforcement of those rules and standards (Otobo, 1997; Okeahalam and Akinboade, 2003).

In response to recent corporate governance scandals, governments have adopted a number of regulatory changes. One component of these changes has been increased disclosure requirements.
For example, the Sarbanes-Oxley Act (sox) adopted in response to Enron, WorldCom, and other public governance failures required detailed reporting of off-balance-sheet financing and special purpose entities. Also the issue of transparency and disclosure was highlighted by The Cadbury
Report (1992) which argued that a major barrier to the flow of relevant information is the risk of opportunism inherent to the manager’s influence in the firm, which is referred to as an incomplete or distorted disclosure of information and calculated efforts to mislead, distort, obfuscate or otherwise confuse the public and shareholders. A credible disclosure is vital for allocation of resources. For example, the lemons problem arises where investors cannot distinguish between good and bad ideas; they will value both good and bad ideas at an average level (Healy and Papelu, 2001).
A credible disclosure solves the lemons problem in which a bad security can appear to be as valuable as a good one. The adverse selection avoidance, disclosure, and transparency, should therefore lower the firm’s cost of capital by the impact of skeptical investors (Lundholm and Van Winkle, 2006).
Investors typically view a well-governed company as one that is responsive to requests from investors for information on governance issues (Okeahalam and Akinboade, 2003). In an African country like Nigeria, an independent board of directors remains a challenge, not only for the government but also for those with whom such enterprises contract because of shortage of skills and lack of familiarity with board functions and fiduciary responsibilities.

According to the World Bank’s (2003) report on corporate governance, most developing and transition economies have failed to enforce laws, rules, and regulations regarding corporate governance consistently and evenly. This failure was perhaps not anticipated by the OECD principles, which implicitly assume that countries have an efficient legal and regulatory framework in place and those courts and securities regulators have the means and capabilities to enforce it. Practices such as self-dealing and insider trading are widespread. Such offenses mostly go unpunished, even if stiff penalties apply in theory (World Bank, 2003). According to the report, auditing is another major area of weakness in corporate governance enforcement. Most countries delegate the setting of accounting and auditing standards to the accounting association (World Bank, 2003). However, professional associations usually lack the means to impose effective sanctions on their members. Auditors have been given unqualified opinions, certifying that the accounts audited provide a true and fair picture despite the many defects noted. The penalties for such behavior are minor and enforcement is generally lax.
In Nigeria, the capacity to support the implementation of good corporate governance is undermined by the existence of weak monitoring and enforcement. Government departments and independent regulators responsible for monitoring corporate governance do not as yet fulfill their roles as overseers. Many are generally weak and subject to external influence by politicians and lawmakers. Community watchdog organizations such as consumer bodies are not well developed in Africa (Botha, 2001). There is a need for legislative overhaul or decree that establishes a regulatory agency and indicates its functions, including its enforcement powers (Otobo, 1997).

Over the years, Nigeria as a nation has suffered a lot of decadence in various aspects of her national life, especially during the prolonged period of military dictatorship under various heads. The political and business climate had become so bad that by 1999 when the nation returned to democratic rule, the administration of Obasanjo inherited a pariah state noted to be one of the most corrupt nations of the world.
Most public corporations, such as NITEL, NNSL, NEPA, and NRC were either dead or simply drain pipes of public resources, while the few factories that were merely available were working below capacity. The banks with their super profits were collapsing in their numbers, leaving a trail of woes for investors, shareholders, suppliers, depositors, employees and other stakeholders. It was as a result of the messy state of the nation then that led to the government to make a bold step in initiating the corporate governance evolution.
In view of the importance attached to the institution of effective corporate governance, the Federal Government of Nigeria, through her various agencies have come up with various institutional arrangements to protect the investors of their hard earned investment from unscrupulous management/directors of listed firms in Nigeria. These institutional arrangements, provided in the “code of corporate governance best practices” issued in November 2003 are briefly discussed hereunder.
(i)    The roles of the board and the management
(ii)    Shareholders rights and privileges
(iii)    The role of the Audit Committee.

2.24.1    The Roles of the Board of Directors
i)    The business of a firm is managed under the direction of a board of directors who delegates to the CEO and other management staff, the day to day management of the affairs of the firm.
(ii)     The board sees to the appointment of a qualified person as the CEO and other management staff.
(iii)     The directors, with their wealth of experience, provide leadership and direct the affairs of the business with high sense of integrity, commitment to the firm, its business plans and long- term shareholder value.
(iv)     The board provides other oversight functions.
The CEO and Management
They are responsible for:
(i)     Operating the firm in an effective and ethical manner.
(ii)     Preparing the strategic plans and annual operating plans and budgets for the board’s approval.
(iii)     The integrity of the firm’s financial reporting system that fairly presents its financial position. The financial reports are expected to comply with relevant statutory and professional pronouncements.
(iv)    Establishing an effective system of internal controls to give reasonable assurance that the firm’s books and records are accurate, its assets safeguarded and applicable laws complied with.

2.24.2    Shareholders Rights and Privilege
(i)     The board of the firm should have effective communication with shareholders to enable them understand the business, risk profile, financial condition and the operating performance of the firm.
(ii)     Shareholders should be involved in the appointment and removal of directors and auditors.
(iii)     Opportunity should be given to shareholders to ask questions about the direction of the firm and especially on the remuneration policy of key executive members and board members, which should be linked to performance.
(iv)     Shareholders holding at least 20% of the issued capital of a firm should, as far as possible have a representative on the board, except they are disqualified by the virtue of their being in competing business with the firm or they have other conflicts of interest.
(v)     There should be at least one director on the board representing the minority shareholders.

2.24.3    The role of the Audit Committee
The Companies and Allied Matters Act, 1990 states that a public limited liability company should have an audit committee (maximum of six members of equal representation of three members each representing the management/ directors and shareholders) in place. The members are expected to be conversant with basic financial statements. The committee has the following objectives:
(i)    Increasing public confidence in the credibility and objectivity of published financial statements.
(ii)    Assisting the directors, especially the non- executive directors, in meeting their responsibilities of financial reporting.
(iii)    Strengthening the independent position of a firm’s external auditors by providing an additional channel of communication.
The committee is expected to perform the following functions:
(a)    Provision of oversight functions on effective internal control, reliable financial reporting, which must comply with regulatory requirements and corporate code of conduct. This function is being exercised on behalf of shareholders.
(b)    Review not only external’s auditors’ reports but also, the report of the internal auditor.
(c)    Maintain a constructive dialogue with external auditors and the board in order to enhance the credibility of financial disclosures.
The following regulations were in place before the introduction of the governance code:
(i)    Companies and Allied Matters Act (1990): It prescribes the duties and responsibilities of managers of public limited liability companies.
(ii)    Investment and Securities Act (1999): It requires the Securities and Exchange Commission to regulate and develop the capital market, maintain orderly conduct, transparency and sanity in order to protect investors.
(iii)    Banks and Other Financial Institutions Act (1991): It requires the Central Bank of Nigeria to register and regulate the banks and allied institutions.
(iv)    The Nigerian Accounting Standards Board Act (2003): It empowers the NASB to enforce compliance with Statement of Accounting Standards issued by it by all the public limited liability companies.
(v)    The Insurance Act (2003): It empowers the Nigerian Insurance Commission to register and regulate the insurance business in Nigeria.
The above regulations and the code of corporate governance are the yardsticks, which guide the operations of limited listed companies in Nigeria. The level of compliance with the above clearly distinguishes a well- governed firm from others.

There are many factors or variables that may constitute yardsticks by which corporate governance can be measured in an organization. Some of these mechanisms are briefly discussed below.
2.25.1    Board Size
Limiting board size to a particular level is generally believed to improve the performance of a firm because the benefits by larger boards of increased monitoring are out weighed by the poorer communication and decision making of larger groups.
Empirical studies on board size seem to provide the same conclusion: a fairly clear negative relationship appears to exist between board size and firm value. Too big a board is likely to be less effective in substantive discussion of major issues among directors in their supervision of management.
Lipton and Lorsch (1992) argue that large boards are less effective and are easier for the CEO to control. When a board gets too big, it becomes difficult to coordinate and for it to process and tackle strategic problems of the organisation. Yermack (1996), using data from Finland and Liang and Li (1999), with Chinese data, also find negative correlation between board size and profitability.
Eisenberg, Sundgren and Wells (1998) and Mak and Kusnadi (2005) also report that small size boards are positively related to high firm performance.
Mak and Yuanto (2003) using sample of firms in Malaysia and Singapore, find that firm valuation is highest when board has 5 directors, a number considered relatively small in those markets.
In a Nigerian study, Sanda et al (2003) report that firm performance is positively correlated with small, as opposed to large boards.

2.25.2    Board Composition
Enhanced director independence, according to Young (2003) is intuitively appealing because a director with ties to a firm or its CEO would find it more difficult to turn down an excessive pay packet, challenge the rationale behind a proposed merger or bring to bear the skepticism necessary for effective monitoring.
The proponents of agency theory say that corporate governance should lead to higher stock prices or better long-term performance, because managers are better supervised and agency costs are decreased. However, Gompers and Metrick (2003) submit that the evidence of a positive association between corporate governance and firm performance may have little to do with the agency explanation.
Empirical studies of the effect of board membership and structure on firm value or performance generally show results either mixed or opposite to what would be expected from the agency cost argument. Some studies find better performances for firms with boards of directors dominated by outsiders (see Weiback 1988, Resenstein and Wyatt, 1990 Mehran, 1995 and John and Senbet 1998), while Weir and Laing (2001) and Pinteris (2002) find no such relationship in terms of accounting profit or firm value. Also, Forsberg (1989) find no relationship between the proportion of outside directors and various performance measures.
In the same vein, Hermalin and Weisbach (1991) and Bhagat and Black (2002) find no correlation between the degree of board independence and four measures of firm performance, controlling for a variety of other governance variables, including ownership characteristics, firm and board size and industry. They find that poorly performing firms were more likely to increase the independence of their board. Mac Avoy, Dana, Cantor and Peck (1983), Baysinger and Butler (1985) and Klein (1998) find that firm performance is insignificantly related to a higher proportion of outsiders on the board. Thus, the relation between the proportion of outside directors and firm performance is mixed.
Studies using financial statement data and Tobin’s Q find no link between board independence and firm performance, while those that used stock returns data find a positive relationship. In the case of a sample of 228 small, private firms in China Liang and Li (1999) report that the presence of outside directors is positively associated with higher returns on investment.

2.25.3    Audit Committee
Klein (2002) reports a negative correlation between earnings management and audit committee independence. Anderson, Mansi and Reeb (2004) find that entirely independent audit committees have lower debt financing costs.

2.25.4    CEO Status
Several studies have examined the separation of CEO and chairman of the board, positing that agency problems are higher when the same person occupies the two positions. Using a sample of 452 firms in the annual Forbes Magazine rankings of the 500 largest USA public firms between 1984 and 1991, Yermack (1996) shows that firms are more valuable when the CEO and the chairman of the board positions are occupied by different persons. However Liang and Li (1999) do not find a positive relation on the separation of the position of CEO and board chair.

There are several well-developed theoretical perspectives that are available to researchers to aid them in exploring the issues of corporate governance. These theories include: managerial hegemony theory, agency theory, stewardship theory, and resource dependence theory. A succinct review of each of them is as follows: Managerial hegemony theory advocates that boards of directors are just statutory additions which are dominated by the management; boards play only a passive role in strategy or directing the corporation (Mace, 1971; Vance, 1983; Lorsch and Maclver, 1989). Agency theory is built on the premise that there is an agency relationship wherein the principal delegates the work to the agent and involves risk sharing and conflict of interest between the two. Implicit in it is the belief that the agent will be driven by self-interest rather than a desire to maximize the profits for the principal. The board, as an intermediary, is expected to resolve such conflict of interest and minimize
the agency costs. Some see the board’s role of control as also encompassing a role in strategy. At variance with the notion of the agent being driven by self-interest, as advocated by the agency theory, stewardship theory postulates that managers are motivated by a desire to achieve and gain intrinsic satisfaction by performing challenging tasks. Proponents of this theory argue that managers need authority and desire recognition from peers and bosses. Thus, their motivation transcends mere monetary considerations. The role of the board of directors in matters of strategy is seen as contributing to this managerial perspective. Finally, the interaction of the board with the environment can be a source of strategic information and the resource dependence theory derives its insight from the fact that board members are also members of the boards of other firms, and this creates a web of linkages to competitors and other stakeholders. Linkages which are also created with the firm’s external environment help access important resources and create buffers against adverse external changes (Riana, 2008).

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