CORPORATE GOVERNANCE AND PERFORMANCE OF FINANCIAL INSTITUTIONS IN KENYA.

Author:Grace, Kamau
Position:Report - Statistical data
 
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INTRODUCTION

Over the last few decades, the business environment has evolved, registering innumerable developments. These key developments include how organizations are directed and controlled, the ownership and financing structure, aligning organization's strategies with environmental forces and stakeholder's engagement (Shleifer & Vishny, 1997; Dewji & Miller, 2013; Capital Markets Authority (CMA), 2015). Despite these advancements, organizations are still faced with challenges such as the separation of ownership and control (Jensen & Meckling, 1976; Shapiro, 2005). This separation leads to emergence of governance issues where the three main corporation's stakeholders interplay. These are shareholders, directors and management, creating the structure of corporate governance. Thus, corporate governance is a key driving force in a firm's performance. Corporate governance has been perceived from various dimensions. Dewji & Miller (2013) classified corporate governance components into internal and external aspects. Internal factors are under firm's control and include board composition, management remuneration structure, ownership concentration and debt level, while external components include market for corporate control, labor market and the regulatory framework. Other dimensions of corporate governance studied include board committees, skills and diversity (Narwal & Jindal, 2015; Van Ness et al., 2010).

The emergence of corporate scandals, stronger demand for accountability, transparency and performance in the global arena has placed corporate governance at the center of strategic management debate (Van der Walt et al., 2006). However, despite the role played by corporate governance in influencing firm performance, inconclusive empirical support has been recorded. This has led to immense interest for research both from scholars and practitioners (Shleifer & Vishny, 1997). However, the research findings have been diverse and inconsistent. According to Organization for Economic Cooperation and Development (OECD) (2004) corporate governance provides the structure through which objectives of a company are set and means for attaining those objectives, leading to higher performance. Similar accolades have been recorded by scholars, associating adoption of good governance to enhanced performance (Brown & Caylor 2004; Grove, Patelli, Victoravich & Xu, 2011). On the contrary, corporate governance has been linked with negative firm performance. For instance, Adams & Mehran (2011) reported no connection between corporate governance and corporation's performance. Further, Narwal & Jindal (2015) found corporate governance to have no significant influence on organizational performance. These inconsistencies have created greater impetus to further interrogate how these two variables interrelate.

Corporate governance is manifested through various dimensions. These include code of corporate governance, board independence, skills, size, committees experience and board diversity (Dewji & Miller, 2013; Narwal & Jindal, 2015). Whereas these components have been viewed as important in determining firm's level of adoption of corporate governance, minimal empirical support has been recorded. Besides, divergent findings have been recorded on how each of these dimensions contributes to firm performance (Letting et al., 2012; Adams & Mehran, 2011; Kiel & Nicholson, 2003). It is against this backdrop that this study sought to address the missing links on how these variables interact. The study sought to establish the influence of corporate governance on performance in Kenya's financial institutions as well as determine the independent influence of the various dimensions of corporate governance on performance of the institutions. The corporate governance dimensions that were considered in the study include code of corporate governance, board skills, independence, committees, board size and board diversity.

LITERATURE REVIEW

Our study was guided by the postulations of agency theory and stakeholder theory. Agency theory posits that organizations exist to maximize shareholders' wealth (Jensen & Meckling, 1976; Shapiro, 2005). Further, the theory supposes that agents are self-interested and acts for their own benefits at the expense of the principals (Adams, 2002). Thus, without governance control, managers are more likely to deviate from the interests of shareholders causing agency conflicts (Fama & Jensen, 1983). Agency theory contends that the main concern of corporations is how to write contracts in which agent's performance is measured and incentivized to act in the principal's interests (Jensen & Meckling, 1976). This is achieved when governance mechanisms mitigating the conflicts are put in place. Thus, corporate governance is viewed as key in bringing stakeholders interests into congruence, which leads to high performance. Despite the prominence of agency theory, it is criticized for the narrow view that managers are necessarily opportunistic actors and the stakeholders' interests are in conflict. To address the weaknesses of agency theory, stakeholders' theory is also adopted to compliment it by providing an alternative lens. Stakeholder theory postulates that successful organizations are judged by the ability to add value for all stakeholders (Donaldson & Preston, 1995; Freeman, 1984). In addition, firms that diligently seek to serve the interests of a broad group of stakeholders create more value overtime leading to high performance (Freeman, 1984; Harrison & Wicks, 2013).

Corporate governance is viewed as the system by which organizations are managed, objectives are set and achieved, risk is monitored and assessed and performance is optimized (Hamilton, 2003). As such, corporate governance is accomplished through established structures and practices. Structures identify distribution of rights and responsibilities among various corporate stakeholders. While governance practices involve board operations such as appointment, functioning, compensation and conflicts management (Aguilera & Jackson, 2003; Dewji & Miller, 2013; CMA, 2015). OECD (2004) recognizes best corporate governance practices to include formalizing governance policies, codes and guidelines, functioning of board of directors and relations with management, strengthening of shareholder rights, improving the control environment, transparency, disclosure and sustainability.

Numerous researchers concur that good corporate governance leads to high organizational performance (OECD, 2004; Amaoko & Goh, 2015; Castro, Aguilera & Arino, 2013; Letting, 2011). Brown & Caylor (2004) in their study established a positive relationship between corporate governance and firm performance. Grove et al. (2011) found a strong linkage between corporate governance and financial performance. Further, Letting (2011) observed adoption of corporate governance to significantly influence the level of firm's financial performance. Moreover, Schiehll et al. (2014) argue that the interplay between firm and country level governance mechanisms enriches understanding of comparative corporate governance across and within national systems. However, the positive link between corporate governance and firm performance has been challenged by other studies (Adams & Mehran, 2011; Cuervo-Cazurra & Aguilera, 2004). Further, other studies reported corporate governance to negatively affect performance in organizations (Narwal & Jindal, 2015). Furthermore, mixed findings have been reported on corporate governance and performance. Nippani et al. (2008) found board composition and bank size to significantly influence performance. However, audit committees, anti-takeover defense and executive compensation were found to have no association with firm performance.

To analyze corporate governance further, various dimensions have been interrogated to establish their independent influence to performance in firms. However, inconsistent and inconclusive empirical findings have been recorded. Board diversity was found to have no effect on organization's financial performance, with exception on board member's technical expertise (Letting et al., 2012). On the same vein, Bathula (2008) found board members level of education to be negatively related to firm performance. Further, the debate on board size attracted mixed reactions with contradictory empirical evidences linking it to performance. On the one hand, large board sizes were found to impact performance negatively (Nyamongo & Temesgen, 2013; Manini & Abdillahi, 2015). On the contrary, researchers contend that larger boards are beneficial and enhance resource accessibility to a firm (Daily et al., 2003). Yet, minimal empirical evidence has been recorded in support of this argument.

Board committees make recommendations to the board on various technical issues. While the committees have significant roles in board performance, studies report mixed findings on how they impact performance. Fratini & Tettamanzi (2015) found board committees to have no connection to firm performance. On the contrary, Carter, D'Souza, Simkins & Simpson (2007) observed audit, executive, remuneration and nomination committees to be positively associated with firm performance. For the...

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