Abstract

Abstract This study investigates the effect of corporate governance on the performance of commercial banks in Nigeria, and the determination of governance effect on profitability of banks. This came as a result of the fact that corporate governance has been relied on statements which do not represent a true situation of the strength of banks. Four research hypotheses were formulated based on these variables -capital adequacy, asset base, policy shift, investment, liquidity ratio, inflation and their relationship with profitability. Descriptive research design was used for this study. Data were obtained from published annual reports and account of the selected commercial banks and the publication of Central Bank of Nigeria. Ordinary Least Square (OLS) technique was used to estimate the variables using multiple linear regression models. The result of the analysis revealed that the estimation of capital adequacy, asset base, policy shift, investment, liquidity ratio and inflation are prime determinants of corporate governance. The findings revealed that the profitability of banks increased within the years under review as assets base of the banks increased. It further shows that as policy shift and investment increases profitability of banks also increases. Consequently, it was recommended that the regulatory authority should restructure their regulatory framework and strengthen their supervisory capacity to ensure a smooth working relationship with banks, prevent distress and failure in the post-consolidation era. Finally, there should be a provision of heavy sanctions for those that violate banking regulation and other laws that guide bank business. Key Words: Corporate Governance, Performance, Commercial Banks, Capital, and Profit Understanding the problem Banks are ordinarily catalytic and developmental institutions, for a developing economy like ours. The issue in Nigeria however, is that they are not too effective and efficient in their functions. In fact, large non-performing insider related loans and advances have been identified as one of the major problems, in virtually all known instances militating against the performance of commercial banking activities in Nigeria. Agene (1999: 64) posits that poor credit administration, lack of transparency and accountability as well as the tendency for banks to engage in 'window-dressing' financial statements, led to a large overhang of non-performing loans in many banks. In the same vein, bad corporate governance has hindered the attainment of corporate objectives and economic growth in the banking sector and the economy in general. This has also led to the loss of public confidence and loss of customers' funds in the banking industry; it is generally believed that bad corporate governance is the "Achilles heels" of many corporations in both rich and poor nations. This is particularly true of Nigeria where corruption is endemic (Financial Standard, Sept 3, 2007: 56). Furthermore, Oluyemi (2007:26) noted that bad corporate governance such as fraud and forgeries, unprofessional conduct and customer's disloyalty tends to reduce shareholders wealth, leading to a weak and unreliable banking sector. Many owners and directors abuse or misuse their privileged position by engaging in self-serving activities. Corporate governance in the banking industry has been complex, when new generation banks streamline corporate governance issues as their main policy thrust, other banks have generally ignored the issue of bringing to the fore strategic corporate governance philosophies, making clear understanding of the issues at stake to be vague. Moreover, several banks in Nigeria have relied on profitability, liquidity, asset quality and capital adequacy as criteria for measuring performance, yet there exist other crucial performance variables l i k e 58 Research Centre for Management and Social Studies investment, policy shift and inflation. Furthermore, the relationship between corporate governance and performance of banks has not been adequately considered even within the banking industry. In fact, the effects of corporate governance on bank performance have not been subjected to vigorous empirical analysis. Corporate governance and performance issues have relied on statements which do not represent a true situation of the strength of the banks. It is in this vein that this study intends to identify what actually is the effect of corporate governance on bank performance in Nigeria. What actually is the code of corporate governance and how it works will be made clearer in this study. Objectives of the study The general objective of this study is to determine the effect of corporate governance on the performance of commercial banks in Nigeria while specifically pursuing the following objectives, to: identify the existing corporate governance structures in the banking system; determine the relationship between corporate governance and bank performance overtime; analyze the effects of corporate governance on capital adequacy of banks overtime; determine the relationship between corporate governance and investment overtime and make recommendations. Research questions The following research questions are pertinent for this study: a There is significant relationship between corporate governance, assets, investment and capital adequacy within the period under review. Significance of the study Financial scandals have shaken investors' faith in banks as well as capital markets and the efficacy of existing corporate governance practices in promoting transparency and accountability. Corporate governance faces the challenges of unprofessional conduct, fraud and forgeries, weak internal control measures, non implementation of penalty measures by regulatory and legal frame work among others. These afore-mentioned problems have affected the relative performance of the banking sector; leading to inefficiency and reduced profit margin. This has also reduced the inflow of foreign direct investment in the banking sector. Secondly, the 'supposed' findings of the study should be seen to benefit the industry through improvement on corporate governance vis-a -vis capital adequacy, investment, assets base and profitability. The study shall also promote and improve good corporate governance practice in governmental outfits. The organizations that will benefit from the study are the Securities and Exchange Commission (SEC), the Nigerian stock exchange (NSE), Corporate Affairs Commission (CAC), Chartered Institute of Bankers of Nigeria (CIBN), Institute of Chartered Accountants of Nigeria (ICAN), Institute of Directors (IOD), financial institutions Training centre etc. Other stake holders that shall benefit from this study are the policy makers in government and those in the banking sector as well as the shareholders, employees and the general public; especially at 59 Research Centre for Management and Social Studies this period that the banking industry is undergoing unprecedented turn around in banking reforms and restructuring. Finally, it is intended to contribute to knowledge and further the frontiers of knowledge in the area of corporate governance performance; concepts, principles and processes to make informed decisions in the academic and business world. Students will also find this work relevant and will ginger them for further studies. Scope of the study This study is meant to cover all commercial banks operating in Nigeria, with the study span being 1980 -2007 (28 years #25 billion In studying the effect of corporate governance on commercial banks, the researcher uses time series data that required information from several years to establish a defined trend. So in choosing from the twenty five existing banks, fifteen commercial banks have been randomly selected and used for the study. Theoretical framework The theoretical framework upon which this study is based is agency theory, which posits that in the presence of information asymmetry the agent (in this case, the director and manager) is likely to pursue interests that may hurt the principal, or shareholders (Rose, 1999:7; Fame, 1983:21). Agency theory suggests that the firm can be viewed as a nexus of contracts (loosely defined) between resource holders. An agency relationship arises whenever one or more individuals, called the principals, hire one or more other individuals, called agents, to perform some services and then delegate decision-making authority to the agents. However, this has implications for, corporate governance, business ethics, among other things. Agency theory suggests that, in imperfect labour and capital markets, managers will seek to maximize their own utility at the expense of corporate shareholders. At first the theory was applied to the relationship between managers and equity holders with no explicit recognition of other parties interested in the well-being of the firm. Subsequent research efforts widened the scope to include not just the equity holders but all other stakeholders, including employees, creditors, government, debtors etc. This approach, which attempts to align the interests of managers and all stakeholders come to be regarded as the stakeholders' theory. The stakeholders' theory has been a subject of some investigation; John and Senbet (1998:371) provide a comprehensive review of corporate governance, with a particular focus on stakeholders' theory. The authors noted the presence of many parties interested in the well-being of the firm and that these parties often have competing interests .While equity holders might welcome investments in high yielding but risky projects, for example, such investment might jeopardize the interests of debt holders especially when the firm is teetering on the edge of bankruptcy. In an article extending the stakeholder theory, Jenson (1976:325) also recognizes the multiplicity of stakeholders. He concurs with John and Senbet (1998:386) that certain actions of management might have conflicting effects on various classes of stakeholders. This implies that the managers have a multiplicity of objectives functions to optimize, something that Jenson sees as an important weakness of the stakeholders theory "because it violates the proposition that single-valued objective is a prerequisite for purposeful or rational behaviour by any organization" (Jenson,1993:10). In search of a single valued objective function that conforms to rationality, Jenson suggest a refinement of the stakeholder theory-the enlightened stakeholders' theory. This Theory offers at least two advantages. First, unlike the earlier version with multiple objectives, the modified form of the theory proposes only one objective that managers should pursue: the maximization of the long-run value of the firm .If the interest of any major stakeholder was not protected, the objective of long-run value maximization would not be achieved. A second, related appeal of the enlightened stakeholder theory is that it offers a simple criterion to enable managers to decide whether they are protecting the interests of all stakeholders: invest a dollar of the firm's as long as that will increase by at least one dollar the long-term value of the firm. There is an important caveat; however, Jenson cautions that the criterion may be weakened by the presence of a monopoly situation or externalities. The simplest albeit highly impractical way to solve the agency problems is to eliminate the separation between ownership and control in a company. However, the separation of ownership and control is to benefit of the company as its represents the optimal competitive response to the formation of the company's ownership structure. Regulatory model to capital adequacy of commercial banks in Nigeria Another theory on which this work is based on is the regulatory model. This is known as capital cushion theory. The idea of capital cushion as a contingency was mentioned by Barnes and Blanco (2000) in Offiong (2006:52). In this case, banks would maintain this cushion to prevent the stochastic capital ratio from reaching values below the permitted minimum in order to avoid sanctions. When regulatory guidelines exceed market requirement, the regulation is binding and the bank is operating in the regulatory model. Otherwise the bank is operating in the market model. Regulation of capital base provides a close control of all banks by the government or i t s authorized agencies. Banks must meet minimum capital requirements before they can be chartered and they must uphold the minimum required capital throughout their whole corporate life. As a need for the regulatory authorities to uphold the minimum capital requirements, ten industrial nations came together and adopted a regulatory framework called the Basle Accord. The Basle Accord I framework, presumes that a bank's minimum capital requirement is linked by a formula to its credit risk as determined by the composition of assets. The greater the credit risk the greater the required capital (Kock and Macdonald, 2000: 128). This framework is based on the credit mode. It was discovered that the Basle Accord I presumes a linear relationship between a bank's assets and its capital and this can be linked to the portfolio diversification and Slusky's theory (Osota, 1994:49). The portfolio diversification theory upholds that a firm should invest in both low and high risk assets; and this means that financial assets acquired by banks should have a combination that yields maximum return but not at the detriment of a bank's capital base. The Basle Accord I according to Onoh (2006: 258) makes it clear that carrying the most risky assets implies the provision of huge capital cover at the expense of profitable investment opportunities. In Nigeria as in other countries, the monetary authorities specify from time to time subject to economic dictates; the minimum capital requirement for licensed banks in the system. Banks failure has convinced government of the necessity of establishing minimum capital requirements for insured banks. The binding rules on minimum capital for banks generally, is that banks should have a sound capital to give reasonable assurance of the maintenance of a protection to depositors as well as other creditors (Oluyemi, 2007:53-59). However, banks supervisors', as agents of the public, try to maximize society's welfare by choosing capital ratios representing the optimal trade off among the three objectives of bank regulation. These are to protect depositors, to promote a stable money supply by preventing financial panic; and to foster an efficient and competitive banking system that facilitates financial intermediation (Mitchell, 1984:26). Generally, the regulation of bank capital in Nigeria started when the first banking ordinance was enacted in 1952. This became necessary because of rampant bank failures, which characterized 61 Research Centre for Management and Social Studies the 1892-I952 free for all banking era in Nigeria. The main causes of the failure during this period were attributed to under capitalization and inefficient management of financial resources (Mbat, 2000: 49). This ordinance provided that banks have a minimum of #50,000 as authorized capital and at least #25, 000 as paid up capital. Expatriate banks were however supposed to show evidence that they had #200, 000 paid up capital. Banks were also mandated to put aside 20% of their profits as reserves as well as make provision for bad and doubtful debts. These requirements were meant to help strengthen banks (Mbat, 2001: 42 -43). In 1958, another ordinance that increased the paid up capital for indigenous banks to #50, 000 and raised that of expatriate banks from #200, 000 to #400. 000 came into existence. It also increased the level of profit to be transferred to reserve fund from 20% to 25% (Osubor, 1984: 302). In 1969, the banking Act raised minimum paid up capital for indigenous banks to N 600,000 and for expatriate ones to N1.5 million (Ekezie, 2002: 98). A good innovation of the Act was that commercial banks should maintain a ratio of 1: 1 0 between paid up capital plus reserves and total deposit liabilities (Mbat, 2001:46). However, between 1988 and 1991 three increases in bank capitals were recorded (Onoh, 2006: 109), In February 1988, paid up capital was increased to N 5 million for commercial banks. This went up eight months later in October 1989 to N10 million. In October 1989 and February 1991 the capital base was increased to N20 million and N50 million respectively (Adimorah, 1988: 105). Research methodology Once a problem is identified in any research effort, the researcher's next task is to determine the type of research design he would use to enable him analyze and interpret his data to solve the problem at hand. As a result, decision has to be made as to the procedures to be adopted to collect, analyze and interpret the data. These could be referred to as design decision or commonly called research methodology. Balsley and Clover (1988: 38) defined research design as the plan, structure and strategy of investigation conceived by a researcher, so as to obtain answers to research questions and control variances. The plan is the overall scheme or programme of research. Consequently, the study on the effect of corporate governance on the performance of commercial banks in Nigeria is aimed at doing a thorough investigation on ways of improving the performance of banks through various structures and mechanisms. Nevertheless, the research design adopted in this study is empirical and exploratory in nature. Materials explored were from published and unpublished works, reports, journals, reviews and magazine; as well as financial statements of the selected banks. Sources of data The data for this research were collected from secondary sources. They include financial statements and of the selected banks for a good number of years. Also extensive and intensive library research 62 Research Centre for Management and Social Studies was carried out in order to obtain data for this study. This provided an avenue for establishing a sound critical and analytical framework for the study. The secondary data of the selected banks had been extracted from their annual reports and statements of accounts, although other sources include: a. Publication of the central bank of Nigeria (Bullion) for various years. b. Annual reports and statement of accounts of Nigeria deposit insurance cooperation (NDIC). c. Publication of federal office of statistics, namely annual abstract of statistics (various issues) Techniques of data analysis The analytical tool used in this study is the ordinary least squares (OLS) regression analysis. This was used to estimate the relationship between profitability and Assets, as well as the relationship between dividends per share and profitability, earnings per share and investments. Four hypotheses were estimated using the OLS model. Model Specification: The implicit form of the equation or model is given as: Y i = f (x 1 , x 2 , x 3 , x 4 , x 5 x 6 ) Where: Y i = Profitability of banks at a time t x 1 = Capital adequacy at a time t x 2 = Asset base at a time t x 3 = Policy shift at a time t x 4 = investment at a time t x 5 = liquidity ratio at a time t x 6 = Inflation at a time t It is expected that dy i /dx 1, dy i /dx 2 , dy i /dx 3 , dy i /dx 4 , dy i /dx 5 , dy i /dx 6 < 0. The criteria used in selecting the lead equation include the conformity of the signs of the regression coefficient with economic theories, the coefficient of multiple determinations (R 2 ), and the significance for the model, F -test and that of the coefficient of the independent variables through the t -test. The statistical significance of the coefficients and F -test were tested at 1%, 5% and 10% respectively. Data presentation, analysis and discussion of findings This section of the study through data analysis discusses the performance indicators of banks; the relationship between profitability of banks and capital adequacy, asset base, policy shift, investment, liquidity as well as inflation of banks. To test the time series properties of the variables employed for the estimation of our models, the stationarity test was conducted .Augmented Dickey Fuller (ADF) test was employed to determine the order of integration of the variables in the model and this is done to determine whether the series follow a non-stationary pattern. According to Nyong (2005:145), when the series are non stationary, the use of orthodox method of estimation such as ordinary least square will lead to the acceptance of meaningless result. As such, when the series are non-stationary around the mean, we adopt the traditional practice of differencing the series which leads to stationarity which allows the researcher to adopt the conventional econometric methods which explains the long-run relationships. The unit root results which indicate the order of integration of each of the variables is presented in Integrated of order 1 ( I ) . This implies that the null hypothesis of non stationarity for all the variables is rejected. Given the unit root properties of the variables, we proceed to establish whether or not there is a long run relationship among the variables in the equation using ordinary least square method. In Data presentation The trend of asset base in Liquidity ratio as indicated in Inflation was also considered by the study as a performance indicator for banks. Data analysis Profitability ratios of banks are highly affected as more money in circulation tends to affect banks propensity to mop-up savings. However, the estimated coefficient for liquidity ratio has a negative sign. Though this result is significant at 1 per cent it is inconsistent with economic theory. This is in line with research work carried out by Akpan (2006: 65). Hence it obvious that for the period under review the liquidity ratios of the banks were low relative to their profitability ratios as a result of high cost of operational expenses insider loans and lack of proper risk management Discussion of findings Based on the foregoing analysis it was discovered that a direct relationship exist between profitability of banks and asset base, policy shift and investment of banks. In order words as this variable increased as shown in It was also observed that an inverse relationship exists between profitability and capital adequacy, liquidity and inflation. This means that when these variables increase, the profitability of the industry will reduce; despite the fact that profitability has a direct relationship with 66 Research Centre for Management and Social Studies liquidity according to economic theories. The inverse relationship between liquidity and profitability observed in this study could be attributed to the fact that most Nigerian Banks experience high cost of operational costs, insider loans and lack of proper risk management. This finding is in corroboration with Okoli (2006:15) who found out that when a bank has high operational cost and unable to manage it risk asset there is a tendency of being insolvent. The finding of this study is also in line with Akpan (2006:50) who noted that there exist a negative relationship between profitability and inflation. This is because during inflationary period the profitability ratios of banks arc highly affected as more money in circulation tends to affect banks propensity to mop-up savings. Summary and Conclusion The study is concerned with the effect of corporate governance on the performance of commercial banks in Nigeria. The profitability ratio was used as dependent variable. While capital adequacy, asset base, policy shift, investment ratio, liquidity ratio and inflation rate were used as independent variables. The ordinary least square method was the estimation technique. The empirical evidence presented in the last section of the study show the following quantitative and deductive results: 1. The prime determinants of corporate governance of commercial banks are capital adequacy, asset base, policy shift, investment, and liquidity ratio as well as inflation rate. .3. In this study, we have adopted both the economic criteria and statistical criteria for accepting or rejecting the null hypothesis. However, the coefficients of asset base, policy shift and investment have a direct relationship with profitability while capital adequacy, liquidity ratio, and inflation have inverse relationship with profitability Based on the findings of the study as contained in the data analysis, the following were obtained: Capital adequacy, asset base, policy shift, investment, Liquidity and inflation are among the variables determining corporate governance of commercial banks. It is believed that from the analysis so far, Finally, this research work discusses the principles and mechanisms of corporate governance; the relationship between corporate governance and bank's performance ;the stakeholders theory; the banks responsibility in ensuring corporate governance, and corporate governance legislature, Recommendations Based on our findings, the following recommendations are put forward.