CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Corporate governance is concerned with the ways in which the providers of capital to corporations assure themselves of a return on their investment, and with the mechanisms through which shareholders exercise control over management so that their interests are protected. The G20/OECD Principles of Corporate Governance describe it as involving a set of relationships among a company's management, its board, its shareholders and other stakeholders. It also supplies the structure through which the objectives of the company are set, the means of attaining them are determined, and performance is monitored (OECD, 2023). On this view, good corporate governance should give the board and management proper incentives to pursue objectives that serve the company and its shareholders, and should make effective monitoring possible. An effective governance system, within an individual company and across an economy as a whole, helps to create the degree of confidence that a market economy needs in order to function properly (OECD, 2023). Corporate governance is therefore about what the board of a company does and how it sets the values of the company, and it is distinct from the day-to-day operational management of the company by full-time executives.

Research on corporate governance has been strongly influenced by agency theory. The primary reason for corporate governance is the separation of ownership and control and the agency problem that this separation creates. Agency costs arise in organizations where the owners (shareholders) are not the managers, because the interests of shareholders do not always match those of managers. Shareholders wish to maximize the value of the firm, whereas managers' objectives may also include greater consumption of perquisites and greater job security. Given the different attributes of the management-shareholder relationship, governance mechanisms such as managerial equity ownership, equity ownership by outside blockholders, executive compensation and compensation contracts can help align the interests of managers with those of shareholders and so reduce the agency problem. The board of directors also plays a central role in monitoring managers and limiting losses to shareholders, which is why it is regarded as one of the most important instruments for solving the governance problem. Recent Nigerian evidence is consistent with this view: in listed deposit money banks, board independence, audit committee independence, board size and board meetings have all been found to be significantly related to financial performance (Otekunrin, Doorasamy, Wright, Aregbesola & Omojola, 2024).

Since the mid-1980s, corporate governance has attracted a great deal of attention in both academic research and practice. Corporate scandals around the world, especially in Europe and America, involving Adelphia Communications, Arthur Andersen, Enron, HealthSouth, Tyco, WorldCom and Ahold, among others, set off a fresh round of debate on the effectiveness of corporate governance laws and shifted the spotlight to the board of directors. Comparative analyses of these cases identify ineffective boards, weak governance and control mechanisms, accounting irregularities, failures of auditors and dominant chief executives as recurring features (Soltani, 2014). In the wake of the scandals, the Sarbanes-Oxley Act of 2002 (SOX) was passed in the United States, and similar regulations followed in other jurisdictions.

Corporate governance has also moved to the front of the policy agenda of international bodies. The OECD promulgated its Principles of Corporate Governance in 1999 and revised them in 2004; they were revised again in 2015 and 2023 as the G20/OECD Principles (OECD, 2023). The European Association of Securities Dealers (EASD) issued Corporate Governance Principles and Recommendations in 2000, and the International Corporate Governance Network (ICGN) issued its Statement on Global Corporate Governance Principles in 2005, revising its 1999 version. The Basel Committee on Banking Supervision issued corporate governance principles for banks in 1999, revised them in 2006, and replaced them with a new set in July 2015 (Basel Committee on Banking Supervision, 2015). A major objective of these recommendations is to design an optimal board structure that prevents failure of the firm's governance and maximizes its financial performance.

In Nigeria, the Central Bank of Nigeria (CBN) responded to this trend in 2006 by establishing the Code of Corporate Governance for Banks in Nigeria Post Consolidation, which became effective in April 2006 because governance mechanisms in banks were notably weak (CBN, 2014). The major recommendations of the code include that the board should meet at least four times in a financial year; that the number of non-executive directors should exceed the number of executive directors; and that the size of a bank's board should not exceed twenty, among others. The rationale for these recommendations was to make the boards of commercial banks in Nigeria effective. The code was later revised in 2014 (CBN, 2014) and, with effect from 1 August 2023, was superseded by new corporate governance guidelines for banks (CBN, 2023). The study period of 2006 to 2010 nevertheless falls under the original 2006 code.

The recent global financial crisis, which also triggered a banking crisis in Nigeria, came as a surprise to practitioners and scholars, given the low level of integration of the Nigerian financial system with global financial markets. The CBN's investigation identified eight interrelated causes of the post-consolidation crisis: macroeconomic instability caused by large and sudden capital inflows; major failures in corporate governance at banks; a lack of investor and consumer sophistication; inadequate disclosure and transparency about the financial position of banks; critical gaps in the regulatory framework; uneven supervision and enforcement; unstructured governance and management processes at the CBN, together with weaknesses within the CBN; and weaknesses in the business environment (Bamanga, 2011). Failure in the corporate governance of banks was thus a principal factor in the financial crisis in Nigeria. The CBN injected N620 billion of liquidity into the banking sector and replaced the leadership of eight banks (Bamanga, 2011; Dikko & Alifiah, 2019). This raises an important research question: how effective are the recommendations of the Code of Corporate Governance for Banks in Nigeria Post Consolidation in promoting good corporate governance among Nigerian banks?

Corporate governance of banks matters for the banks themselves and for the whole economy. First, banks are themselves corporations, and sound corporate governance is essential for them to perform efficiently. Second, banks exert a strong influence on economic development, so their governance is crucial for growth and development (Ogundajo, Onakoya, Enyi & Siyanbola, 2019). Banks play a central role in mobilizing social savings and channelling them to the most productive projects, and bank lending is a major source of external finance for other firms, especially in developing and emerging economies. Sound governance of banks is essential if managers are to allocate social capital efficiently and strengthen the performance of the economy. Banks also play a critical role in the governance of other firms, as creditors or equity holders. It is therefore essential that banks themselves be soundly governed, so that they can exert effective governance over the firms they fund. The Basel Committee likewise stresses that good governance underpins robust risk management, public confidence and the safety and soundness of the banking system (Basel Committee on Banking Supervision, 2015).

Practitioners and academics alike suggest that the governance mechanisms of banks are key factors in bank performance. Research on governance issues in banks was long limited because earlier research concentrated on firms in the non-financial sector, and the volume of bank-specific work has only recently grown, notably for Africa (Kyei, Werner & Appiah, 2022; Otekunrin et al., 2024). This may be attributed to the peculiar nature of the governance problem in banks.

The nature of governance problems in banking differs from that in non-banking firms, and the literature gives several reasons why bank governance is peculiar. First, because of their special nature, banks have wider stakeholders. In addition to shareholders, the interests of depositors must be addressed, as must those of the regulators who ensure a sound financial system, so bank directors are accountable not only to shareholders but also to depositors and regulators (Basel Committee on Banking Supervision, 2015). Second, banks' high leverage, and the mismatch between the term structure and liquidity of their assets and liabilities, make their role in the economy very important. Third, agency problems are particularly serious in banks because they are informationally opaque, largely as a result of information asymmetries. Fourth, deposit insurance aggravates the situation by easing the moral hazard problem among bank shareholders and debt-holders: where deposits are insured, depositors have less incentive to monitor bank managers, and managers and shareholders may have added incentives to take more risk. Evidence that more generous deposit insurance schemes are associated with a higher likelihood of banking crises has been widely discussed. Finally, good bank governance is particularly important because it reduces the risk that taxpayers' funds will be used to resolve a crisis and helps to restrain connected lending.

Among the characteristics of the board, size, composition and activity have received special attention in the literature. An extensive body of empirical research has examined the effect of board size, board composition and the number of board meetings on firm performance, and the evidence remains inconclusive. It has been argued that a larger board is beneficial because it enlarges the pool of expertise and resources available to the firm, and Nigerian evidence for listed deposit money banks finds board size positively related to performance (Otekunrin et al., 2024). Others argue that a larger board impairs performance and that board effectiveness may decline as size increases. On composition, non-executive directors may be more motivated to monitor the chief executive, but they may also be less informed about the running of the business. On board activity, the frequency of meetings is often taken to indicate active monitoring. Contrary to this view, a study of 635 banks in 48 African countries between 2000 and 2016 found that more frequent board meetings were associated with lower performance in sub-Saharan Africa, though with higher performance in North Africa, possibly because boards meet more often after performance has deteriorated (Kyei et al., 2022). Studies of Nigerian deposit money banks have also examined the frequency and diligence of board meetings in relation to performance (Eluyela et al., 2018; Sanyaolu, Adejumo & Kadiri, 2020).

It is evident that most of the works reviewed used data from developed economies or from broad cross-country samples. This study presents evidence from Nigeria, one of the emerging markets of the world. Given the recent banking crisis in Nigeria and the revelation by the CBN that governance problems were a principal cause of the crisis, it becomes important to evaluate the effectiveness of the major recommendations of the Code of Corporate Governance for Banks in Nigeria Post Consolidation. This study sought to fill this important research gap by evaluating the impact of board size, board composition and board activity on the financial performance of banks in Nigeria, using a population sample of all the 24 commercial banks for the period 2006 to 2010.

1.2 Statement of the Problem

Less than a decade after the Enron scandal, the recent global financial crisis has raised many questions about the effectiveness of governance mechanisms in the banking industry. It has brought into focus the harmful consequences of poor governance principles in financial business. Poor corporate governance may contribute to bank failures, loss of market confidence, bank runs and liquidity crises, which can have broader macroeconomic implications such as contagion risk and damage to payment systems (Basel Committee on Banking Supervision, 2015). A bank that becomes less attractive for investment will soon lose employees and customers, and will become a candidate for acquisition.

For a developing country like Nigeria, corporate governance in the banking sector is of critical importance. This is evident in the recent banking crisis, one of the most serious the country has experienced. In 2009, following a banking system crisis largely caused by poor corporate governance practices, some Nigerian banks had to be rescued through the injection of N620 billion of liquidity by the CBN, and the leadership of eight banks was replaced (Bamanga, 2011; Dikko & Alifiah, 2019). This high-profile governance failure occurred after the CBN had adopted the Code of Corporate Governance for Banks in Nigeria Post Consolidation, which raises an important question about the effectiveness of the prescriptions of that code.

It has been established that Nigeria, like most developing economies, has weak market institutions, weak external governance laws and poor implementation of promulgated laws. Recent legal scholarship concludes that the CBN is statutorily the right regulator but functionally a poor enforcer of corporate governance in the banking sector, and recommends a governance framework suited to Nigeria's peculiar circumstances and business environment (Imaekhai, 2017). Effective corporate governance laws must therefore take the country's institutional specifics into account in making bank boards effective. Such laws should be informed by studies in the local jurisdiction, rather than by wholesale adoption of the recommendations of studies in developed economies. This study fills this important research gap by estimating the effectiveness of corporate boards in the Nigerian banking industry using Nigerian data. Specifically, it evaluated the recommendations of the Code of Corporate Governance for Banks in Nigeria Post Consolidation in enhancing bank board effectiveness in Nigeria.

1.3 Objectives of the Study

The overall objective of this study is to investigate empirically the impact of board effectiveness measures on the financial performance of banks in Nigeria within the five-year period 2006 to 2010. To achieve this objective, the study strives to accomplish the following specific objectives:

a. To determine the impact of board size on bank financial performance in Nigeria.

b. To investigate the relationship between board composition, defined by the proportion of non-executive directors, and bank financial performance in Nigeria.

c. To assess the impact of board activity, defined by the number of board meetings, on bank financial performance in Nigeria.

1.4 Research Questions

This study strives to provide answers to the following research questions:

a. What is the impact of board size on bank financial performance in Nigeria?

b. What is the impact of the proportion of non-executive directors on bank financial performance in Nigeria?

c. What is the impact of the number of board meetings on bank financial performance in Nigeria?

1.5 Research Hypotheses

In order to achieve the above objectives and provide answers to the research questions, the following a priori assumptions, stated in null form, are investigated:

a. Board size does not have a positive and significant impact on bank financial performance.

b. The proportion of non-executive directors does not have a positive and significant impact on bank financial performance.

c. The number of board meetings does not have a positive and significant impact on bank financial performance.

1.6 Scope of the Study

This study looks at the impact of board effectiveness measures (size, composition and functioning) on bank financial performance in Nigeria. It borrows extensively from previous work along these lines and makes use of three board structure variables: board size (the number of board members), the proportion of non-executive board members, and the number of board meetings. It also uses Tobin's Q as a proxy for bank financial performance.

The study covers 20 banks in Nigeria for the period 2006 to 2010, forming a panel data set for the five-year period. This period was chosen in order to eliminate possible bias caused by missing variables arising from the banking consolidation exercise, which ended in 2005. Data are collated from secondary sources, which include the annual reports of banks, the Nigerian Stock Exchange Factbooks, the annual reports of the Nigeria Deposit Insurance Corporation, and the Nigerian Stock Exchange Daily Official List.

1.7 Significance of the Study

The recent global financial crisis, which affected the Nigerian financial landscape, underscores the importance of good corporate governance in the country. This has been further emphasized by the proliferation of corporate governance principles and codes around the world (OECD, 2023; Basel Committee on Banking Supervision, 2015). In the Nigerian banking sector, it took the form of the Code of Corporate Governance for Banks in Nigeria Post Consolidation prescribed by the Central Bank of Nigeria. The prescriptions of the code drew extensively on those of developed economies, so its practicability and effectiveness in our jurisdiction remain in doubt. The lack of empirical research on the corporate governance of banks in Nigeria, especially on board effectiveness, also underlines the significance of this work. A study of this kind will therefore be significant to stakeholders and researchers alike in the following ways:

a. Shareholders

From the agency theory perspective, shareholders use the board to reduce agency costs and to align their interests with those of managers. The results of this study will help the shareholders of banking firms to understand the impact of board size, composition and functioning on bank performance. This knowledge will help shareholders to use their voting rights to insist on an effective board structure that enhances the value of the firm.

b. Regulators/Policy Makers

Good corporate governance imposes appropriate standards of conduct and regulates the relationships among bank boards, management and other stakeholders. It was on this basis that the Central Bank of Nigeria introduced the Code of Corporate Governance for Banks in Nigeria Post Consolidation in 2006 (CBN, 2014). The code leans heavily on established models of corporate governance that function in developed economies. Special attention must be given, through empirical investigation, to establishing codes that are tailored to the country's specific needs and that promote good corporate governance. The results of this research will therefore assist regulators and policy makers in reviewing the code and in making future recommendations, a need that remains relevant given the CBN's 2023 guidelines (CBN, 2023).

c. Academics/Researchers

This research will contribute to the current debate on corporate governance. It will add to the existing literature by providing evidence from the Nigerian banking industry and will be of great value to further studies on bank boards and financial performance in Nigeria.

1.8 Limitations of the Study

This research was subject to some limitations. One of them is the use of secondary data. Since the study relied exclusively on existing data sources, any error or mistake in the reporting of those data would affect the validity of the results. In addition, there is no central depository for all the required data, which put tremendous pressure on our financial resources. Financial constraint is therefore another limitation, given the volume of data required for a study of this magnitude.

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