Abstract
Corporate governance has become subject to the development agenda of most developed and developing countries economy, due to the fact that corporate governance structure of a firm has critical impact on its financial performance. Corporate governance mechanisms emerge to tackle agency problems in ensuring that shareholders’ funds are not expropriated or wasted on unprofitable activities. The results of most research studies reveal that, well governed firms have been noted to have higher firm performance than poor governed firms. However, there are different researchers who opposed this idea as they have found mixed results on the relationships between different variables of corporate governance and financial performance. Research studies on this issue in developing countries; especially in Ethiopia remained an ignored area from empirical research. Thus, this study examined the effect of corporate governance mechanisms on firms’ financial performance on the selected commercial banks in Ethiopia by taking a sample of 6 commercial banks starting from the year 2003 up to 2009. This study used return on asset, return on equity and operating profit margin as dependent variables to measure financial performance of commercial banks and board size, board independence, frequency of board meetings, chief executive officer duality, audit committee and board ownership as independent variables to express quantitatively corporate governance mechanisms. In addition, firm size, financial leverage and firm growth rate were used as control variables, which are specific to commercial banks and general to the economy as a whole. The researcher used both correlation analysis and pooled panel data regression models of cross-sectional and time series data for analysis. The results provide evidence that board size is negatively and significantly related with all the three indicators of financial performance- return on asset return on equity and operating profit margin. Audit committee and financial performance indicators-return on asset and return on equity is negative and statistically significant, but it is not significant with operating profit margin. Board independence, chief executive officer duality and board ownership are positively and significantly related with all the three financial performance indicators. However, frequency of board meetings is not statistically significant with all the three financial performance indicators. Keywords: Corporate Governance Mechanisms, Agency Problem, Firms’ Financial Performance and Commercial Banks. DOI : 10.7176/RJFA/10-21-05 Publication date: November 30 th 2019
Highlights
IntroductionBackground of the StudyAccording to the report of UNESCAP (2007), the definition of governance is defined as the process of decision making by which decisions are implemented or not implemented in corporate business firms. Berghe and Ridder (1999) acknowledged that corporate governance needs to put in place the structures and processes which make it possible for a business firm to pursue its strategy effectively to improve its financial performance.In 1997, Shleifer and Vishny defined corporate governance mechanisms as follows: “Corporate governance mechanisms are ways to reduce the agency costs, where they attempts to minimize two types of agency conflicts: first, the conflicts between shareholders (owners) and managers; second, the conflicts between controlling majority shareholders and minority shareholders” (Shleifer & Vishny, 1997, p. 737).The need for corporate governance arises from the potential conflicts of interest between stakeholders such as chief executive officers, board members and shareholders within the business organizations
The following part of the analysis enables the researcher to identify the possible determinant factors of corporate governance mechanisms that affect banks’ financial performance and to analyze the way in which dependent variables are related with independent variables
The purpose of this study is to investigates the effect of corporate governance mechanisms on firms’ financial performance on selected commercial banks in Ethiopia using three financial performance indicators as dependent variables and six corporate governance mechanisms as independent variables
Summary
Background of the StudyAccording to the report of UNESCAP (2007), the definition of governance is defined as the process of decision making by which decisions are implemented or not implemented in corporate business firms. Berghe and Ridder (1999) acknowledged that corporate governance needs to put in place the structures and processes which make it possible for a business firm to pursue its strategy effectively to improve its financial performance.In 1997, Shleifer and Vishny defined corporate governance mechanisms as follows: “Corporate governance mechanisms are ways to reduce the agency costs, where they attempts to minimize two types of agency conflicts: first, the conflicts between shareholders (owners) and managers; second, the conflicts between controlling majority shareholders and minority shareholders” (Shleifer & Vishny, 1997, p. 737).The need for corporate governance arises from the potential conflicts of interest between stakeholders such as chief executive officers, board members and shareholders within the business organizations. According to the report of UNESCAP (2007), the definition of governance is defined as the process of decision making by which decisions are implemented or not implemented in corporate business firms. Berghe and Ridder (1999) acknowledged that corporate governance needs to put in place the structures and processes which make it possible for a business firm to pursue its strategy effectively to improve its financial performance. The need for corporate governance arises from the potential conflicts of interest between stakeholders such as chief executive officers, board members and shareholders within the business organizations. In their study of 2007, Imam and Malik (2007) acknowledged that potential conflict of interest between stakeholders within the business firms usually arises from the following two reasons. Corporate governance used to scale back agency issues in a very business firm to confirm that shareholders’ investment isn't expropriated on unprofitable activities
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