THE RELATIONSHIP BETWEEN CORPORATE GOVERNANCE PRINCIPLES AND FINANCIAL PERFORMANCE OF INVESTMENT BANKS IN THE NAIROBI SECURITIES EXCHANGE

ABSTRACT 

Corporate governance is an area that has grown rapidly in the recent years as an emerging issue due to the global corporate scandals and collapse of big companies. The corporate governance principles hence adopted by any corporate entity affects the firm’s ability to respond to the content and context in which it operates and its overall performance. The purpose of this study was to assess the relationship between corporate governance principles and financial performance of investment banks in the Nairobi Securities Exchange. The objectives of the study were to investigate the relationship between corporate governance principle aspects (board composition, CEO duality, board size principles) and ROA of investment banks in the Nairobi Securities Exchange. The study used a descriptive research design where primary data was collected from the seven investment banks in the Nairobi Securities Exchange in Nairobi County using a questionnaire issued to the managers while secondary data was in the form of published financial statements. Statistical Packages for Social Sciences (SPSS) was used by the researcher to facilitate the analysis and interpretation of data and the results obtained was presented using tables, frequencies, graphs and charts for easy interpretation. The correlation results indicated that the corporate governance principles (CEO duality and Board composition) had a strong negative correlation on financial performance in investment banks while board size had a weak negative correlation on financial performance in investment banks. The regression analysis showed that CEO duality, board composition, board size and their combined contribution had a significant effect on the financial performance in investment banks. 

The study recommends that investment banks operations were to be governed through a clear management structure that enhances security of shareholder wealth and sustainability of the organisation. This is to be achieved by continually reviewing regulations regarding management governance structures so as to assure transparency in limiting CEO duality thus assuring legitimacy in the firm performance. The board members in investment banks should entail a pool of diverse skills and expertise to enhance innovative ways in steering business performance. This could be enhanced through independent recruitments from a pool of experts and the pre-allocation of equitable balance in the boards and the board member number should be maintained on an optimal basis of five or less. The study purpose thus requires institutions to invest in the optimal operationalization of the corporate governance focused in this study.

CHAPTER ONE 

INTRODUCTION 

Background of the study 

Corporate governance entails a set of relationships between a company’s management, its board, its shareholders and other stakeholders. It further provides the structure through which the objectives of the company are set and the means of attaining those objectives and monitoring performance. Therefore, the attainment of the objectives and monitoring performance has wider implications that are critical to economic and social well-being. This is through the provision of the requisite incentives and performance measures to achieve the predetermined business success as well as to enhance the stewardship of the resources through transparency to ensure the equitable distribution of the resulting wealth (OECD, 2009). 

The corporate governance principles hence adopted by any corporate entity affects the firm’s ability to respond to the content and context in which it operates and its overall performance. It is thus evident that well governed firms perform better to a greater extent than poorly governed ones hence the need of appropriate corporate governance principles. A sound corporate framework benefits firms through greater access to financing, lower cost of capital, better financial performance and more favourable treatment of all stakeholders. They argue that weak corporate governance leads to poor firm financial performance and risky financing patterns (Claessens et al., 2002). 

Corporate governance has been a major policy reform and discussion in Kenya for over a decade evidenced by corporate governance guidelines issued by the Capital Markets Authority and supported by private sector initiatives, including widespread director training, improving governance across listed companies. Revived privatization, performance contracts, vetting of state officers, establishment of independent commissions and other reforms have placed increasing emphasis on the corporate governance of state corporations, which continue to play a major role in the economy. Kenya recognizes the value of good governance as demonstrated in the constitution in Chapter 2 article 10 (1) on National Values and Principles of Governance commits all persons, state organs and any other parties to the national values, good governance being one of the values (Capital Markets Authority, 2014). 

Investment banks entail financial institutions that deal mainly with corporate and retail customers with specialisation in securities markets activities including underwriting, trading, asset management, advisory activities and corporate restructuring such as mergers and acquisitions. They thus play a vital role in assisting mid-market businesses maximize value. The key success factor for the development of such investment banks in the developed world has been their access to capital in their own right, thus enabling them to make the guarantee in the first place. However, the existence of major scandals in these developed countries in the past brought about the much needed corporate governance for institutions to incorporate (Marks, 2012). 

Enron, one of America’s largest energy corporations incurred tremendous financial losses as a result of arrogance, greed and foolishness from the top management to the bottom of the pyramid. The hiding of financial losses of the trading business and other operations through a market to market practice was designed to make the company appear to be more profitable than it really was .In South East Asia, Refco one of America’s largest futures brokers defrauded investors in the firm’s initial public offering by hiding hundreds of millions of dollars in loans to another company. This was spearheaded by the CEO(Chief Executive Officer) in a company he had control in a scheme to hide as much as 545 (five hundred and forty five) million dollars having cleverly repaid the money just before routine audits (Seabury, 2011). 

In Kenya, Francis Thuo and Partners went under in early 2007, marking the first of a series of stockbroker failures that were largely blamed on weak management and fraudulent selling of investors’ shares by the intermediaries. Nyagah stockbrokers were put on statutory management in 2008 after failing to meet its financial obligations. In addition, a forensic audit done by PricewaterhouseCoopers (PwC) revealed that the firm might have gone down with about Shs1.3billion of public funds through the diversion of funds by management, fraud by the staff, occurrences of collusion by other stockbrokers in the NSE and even office of the regulator (CMA, 2014). 

An RBA (Retirement Benefits Authority) report in 2012 disclosed that NSSF (National Social Security Fund) had investments in shares through Discount Securities amounting to over Sh. 15 billion which was a thirty-four per cent of NSSF assets. Discount Securities, which was one of the brokers, disbursed the funds used in the purchase of shares in more than 80 nominee accounts through which it invested NSSF money in the stock market. NSSF issued cheques to the broker to facilitate the purchase which on calculation was worth more than Sh15 billion whereas the share certificates issued were worth Sh.14.3 billion. This culminated to the broker facing criminal charges for non-delivery of share certificates worth more than Sh1 billion as well as failing to pass on dividends payable to NSSF worth over Sh100 million. 

The financial sector in Kenya has in the recent past been subjected to corporate governance credibility over management and supervision of the banks in this sector. This has been evidenced by the cases of bank failures from Dubai, Imperial, National and Chase banks. The auditors and regulators of these institutions colluded through the misrepresentation of the financial position so as to make the institutions to be deemed profitable, evade tax and under report debt. The financial results show the financial soundness of the company which is crucial in determining the investor and employee confidence thus the cover up of the malpractices in such information constituted to their tumbling down (Achuka, 2016). 

Corporate governance has therefore emerged as a major policy concern for many developing countries following the financial crisis in Asia, Russia, and Latin America. The collapse of Enron suggests that even the highly industrialized countries such as the U.S. are not immune to the disastrous effects of bad corporate governance. Studies have shown that low corporate governance standards raise the cost of capital, lower the operating performance of industry, and impede the flow of investment (Gatamah, 2004). 

In light of the size of the Kenyan economy and its vision in the blueprint of Vision 2030, it will take financial institutions like investment banks to provide the backing for large IPO (Initial Public Offer) and bond issues. Strong corporate governance will thus be indispensable to resilient and a vibrant capital market as an important instrument of investor protection since business enterprises that do not prosper lead to employment decline, tax revenue falls and invariable economic growth hindered. Good corporate governance, therefore, becomes a prerequisite for national economic development (Dave, 2009). 

Statement of the problem 

The financial scandals around the world and the recent collapse of major financial institutions in USA, South East Asia and Kenya have shaken investors’ confidence in the capital markets. Capital Markets Authority of Kenya (CMA) the regulatory body in the capital market has key interests on the shareholders who invest in the quoted companies so as to determine the value for the investment is maximised. Corporate governance therefore, receives high priority on the agenda of policymakers, financial institutions, investors, companies and academics (Heracleous, 2001). 

Corporate governance has received much attention in the academic literature with a number of studies having sought to investigate the relation between corporate governance mechanisms and financial performance (Berglof & Thadden, 1999). Most of the studies have shown mixed results without a clear-cut relationship. A study by Becht et al. (2002) indicated that corporate governance practices positively influences the profitability of the organization while MacAvoy and Millstein (2003) found that board composition does not have any effect on financial performance. Further, the limited studies in the area have focused mainly on developed economies. It is therefore crucial to examine the relationship in the context of a developing economy. 

Studies done locally regarding corporate governance have majored on public institutions, the private institutions and the listed companies. Maulu (2014) carried out a study on the relationship between corporate governance and financial performance of stock brokerage firms and investment banks in Kenya. The findings were that a relationship exists between different aspects of corporate governance practices and financial performance with firms having bigger boards reporting better results than those with small ones and that no significant relationship between ownership structure, information disclosure and frequency of meeting with financial performance of firms. Ada B. (2013) conducted a study on the relationship between corporate governance practices and dividend pay-out of commercial banks in Kenya. The findings were that 72.7% of dividend pay-out in the commercial banks was positively related to corporate governance practices that had statistically significant values. Miring’u, A. and Muoria, E. (2011) carried out a study to examine corporate governance effects on the performance in commercial state corporations in Kenya. It was identified that a positive relationship exists between Return on Equity (ROE) and board size and board compositions of all state corporations. 

None of these studies have focused on the relationship between board composition, board size and CEO duality and Return on Assets (ROA) of investment banks in the NSE. Investment banks occupy a special place due to their centrality in the transmission of monetary policy and the functioning of the payment and settlement systems. There is need to determine whether corporate governance principles influence their financial performance. Therefore based on the limited empirical data and the great exposure of such institutions in the financial sector this study sought to provide more empirical data in Kenya.

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Item Type: Kenyan Topic  |  Size: 67 pages  |  Chapters: 1-5

Format: MS Word  |  Delivery: Within 30Mins.

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