Impact Of Corporate Governance On The Profitability Of The Nigerian Banking Sector

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Abstract

Corporate governance has, in recent times, raised a great deal of concern due, largely, to massive corporate failures in the domestic and global arena. Governments have in response to rising cases of financial distress taken both pro-active and reactive measures to achieve stability in the sector. However, notwithstanding government interventionist roles, stability of banking operations remains suspect. This study seeks to empirically determine the effect of corporate governance on the profitability of banking sector in Nigeria. Return on equity (ROE) and return on assets (ROA) were adopted as proxies for banking sector profitability while capital adequacy ratio (CAR), liquidity ratio (LQR) and ratio of non-performing loans to total loans (NPL) were adopted as proxies for corporate governance. Inflation rate was introduced as a control variable. Empirical evidence from the study shows significant impact of corporate governance on the profit performance of the Nigerian banking sector. We recommend that the regulatory authorities (CBN, NDIC and SEC) should diligently exercise their oversight functions to ensure strict compliance, by the banking sector, to extant regulations on corporate governance so as to consolidate, or possibly, improve on the gains of the initiative. 

 

Introduction

As a concept, corporate governance connotes the processes involved in the discharge of the mandate of governance in corporate entities (Okafor, 2011). It refers to the process through which an organization is governed and controlled. Corporate governance codes define the relationship between company management, their boards and their shareholders as well as require that management and directors carry out their duties within a framework of accountability and transparency (Adeola, 2003).

 

Corporate governance has become a topical issue because of its immense contributions to the growth of modern economies where the private sector plays a key role in the growth process. Absence of good corporate governance is often blamed for the woeful performance of business entities. Developed private sector-driven economies with history of established corporate governance structures consistently record high and predictable growth rates. Thus low economic growth rates that characterize developing nations are often attributed to low level of corporate governance practices in these economies.

 

There is substantial evidence of a positive link between firm performance and corporate governance. See for example, Ahmed and Hamdan (2015), OECD (2009), Gompers et al (2003), Claessen et al (2002). Shleifer & Vishny (1997), Haris and Raviv (1988), Fama and Jensen (1983), Jensen and Merkling (1976), Williams (2000), Drobetz et al (2003), Hussain et al (2000), Gemmil & Thomas (2004), etc. However, notwithstanding the avalanche of empirical support for positive effect of corporate governance on firm performance, studies like Hutchinson et al (2002) and Bathala & Rao (1995) find evidence of negative relationship between them while others like Park & Shin (2003) and Singh & Davidson (2003) did not establish any relationship.

In spite of conflicting evidence for corporate governance as a major driver of corporate performance, it is widely acknowledged that lax or inadequate corporate governance practices promote corporate failures. The OECD (2009), for instance, attributes the 2007 global financial crisis to failures and weaknesses of corporate governance structures. Similarly, the 2009 banking crisis that led to the 2010 banking reforms in Nigeria was attributed to weak corporate governance structures in the affected banks (Sanusi, 2009).

The increasing necessity for entrenchment of good corporate governance, in banks and other financial institutions, is underscored by the wave of financial scandals that led to the collapse of the world’s giant financial institutions early in this millennium. These corporate failures have been largely attributed to corporate governance failures in these institutions (see for example, Zandi, 2009; Lahart, 2009; Faber, 2009). It is also argued that the transition of global economies from public to private ownership of business equally makes the emphasis on corporate governance more compelling. Adeola (2003) explains that as an economy transits from state ownership of business concerns to a market-based one, the only assurance that the populace will realize the gains of the liberalization exercise is institution of sound corporate governance practice. This may explain why prominent instances of governance-related corporate failures that shook the corporate world at the turn of the century are traced to the US, a known example of a market-oriented economy and they include Enron (2001), Worldcom (2002), Arthur Anderson (2002), etc. A 2003 survey by SEC cited by the CBN (2006) shows that poor corporate governance was identified in most known cases of distress in financial institutions in Nigeria.

Market economies are often characterized by liberalization of banking operations and promotion of competition thereby making banking operations more market-driven. The liberalized banking environment poses some major challenges particularly in the areas of manpower and regulatory capacity. For instance, a direct consequence of liberalizing the conditionalities for entry into banking business is a sharp increase in the number of licensed banks. To fill the gap created by rapid increase in the number banks in the system, unqualified and incompetent applicants are often recruited while the supervisory and regulatory functions of the Central Bank are longer effectively discharged leading to inefficiencies in corporate governance.

Efficient corporate governance system in the banking sector promotes the integrity of bank management which defines the quality of banking services delivery and influences the overall performance of the sector. Three major codes of corporate governance have been issued to regulate governance-related issues in Nigerian banking by the SEC (2003) and CBN (2006 and 2010). These codes aim at enhancing the integrity of bank management and its capacity to spur growth of the economy through quality-oriented banking services delivery.  

 

To underscore the need for corporate governance as a veritable tool for improved banking sector performance in Nigeria, this study seeks to examine the extent to which the performance of the sector is affected by major indicators of corporate governance. Return on equity (ROE) and return on assets (ROA) were adopted as proxies for profitability while capital adequacy ratio (CAR), liquidity ratio (LQR) and ratio of non-performing loans to total loans (NPL) were adopted as proxies for corporate governance. Inflation was introduced as control variable. Data on these variables covering the period 2003-2015 were analyzed using the technique of the ordinary least squares.   

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