22 Afro-Asian J. Finance and Accounting, Vol. 2, No. 1, 2010Copyright © 2010 Inderscience Enterprises Ltd.Corporate governance mechanisms and firms’ financial performance in NigeriaAhmadu U. Sanda*, Aminu S. Mikailu andTukur GarbaDepartment of Economics,Usmanu Danfodiyo University,Sokoto, NigeriaE-mail: ahmaduus@yahoo.comE-mail: amikala2001@yahoo.comE-mail: ttukurus@yahoo.com*Corresponding authorAbstract: This paper investigates the effects of certain corporate governancemechanisms on the performance of firms listed on the Nigerian StockExchange. Based on a sample of 93 firms for the period 1996 through 1999, ourresults show an optimal board size of ten, favour concentrated over diffusedownership, and support separation of posts of CEO and chair. Moreover, whiledirector shareholding is found to be an insignificant factor affecting firmperformance, the results show expatriate CEOs performing better than theirlocal counterparts. We need to err on the side of caution as sampling selectionwas based on data availability rather than any probability criterion.Keywords: corporate governance; agency theory; stakeholder theory;concentration effect; director shareholding effect; Nigeria.

Reference to this paper should be made as follows: Sanda, A.U., Mikailu, A.S.and Garba, T. (2010) ‘Corporate governance mechanisms and firms’ financialperformance in Nigeria’, Afro-Asian J. Finance and Accounting, Vol. 2, No. 1,pp.22–39.Biographical notes: Ahmadu Umaru Sanda is a Senior Lecturer in Economics,at Usmanu Danfodiyo University, Sokoto (UDUS) Nigeria. His researchinterest is in corporate governance and asset pricing. He has to his creditpublications in Asian Academy of Management Journal, Capital Market Reviewand Malaysian Management Review, amongst other journals.Aminu S. Mikailu is the Former Vice-Chancellor at UDUS, a Professor ofManagement Accounting and Finance with research interest in taxation, fiscalpolicy, corporate governance and Islamic finance. He has published in manyjournals, including the Nigerian Journal of Accounting Research, The NigerianJournal of Renewable Energy and Journal of Public Administration and LocalGovernment.Tukur Garba is a Senior Lecturer in Economics at UDUS. His main researchinterest is in development economics, financial economics and quantitativeeconomics. His work has been published in a number of journals including TheNigerian Journal of Accounting Research, Maiduguri Journal of Arts and

Social Sciences and Journal of Research and Development in Africa.Corporate governance mechanisms and firms’ financial performance 231 IntroductionCorporate governance is concerned with ways in which all parties interested in thewellbeing of the firm (or stakeholders) attempt to ensure that managers and other insiderstake measures (or adopt mechanisms) that safeguard the interests of the stakeholders. Atypical firm is characterised by numerous owners having no management function, andmanagers with no or little equity interest in the firm. The free-rider problem associatedwith diffused ownership of equity tends to prevent any shareholder from taking unilateralaction to bear the costs of monitoring the managers, who may pursue interests thatconflict with those of the shareholders.A significant amount of literature has developed on agency theory and how corporategovernance mechanisms might help resolve the conflicts. Much of the literature has beenbuilt upon the theoretical works of Ross (1973), Jensen and Meckling (1976) and Fama(1980). The stakeholder theory has been popularised in the works of John and Senbet(1998) and an extension of it, enlightened stakeholder theory, has been propagated byJensen (2002). For the stakeholder theory, concern should go beyond the traditionalmanagement-shareholder relationship to include all other stakeholders (such asemployees, government, creditors). Jensen (2002) criticises the traditional stakeholder

theory, arguing that in the presence of tradeoffs and conflicts, the theory offers no clearguidance on how to resolve such conflicts.This research aims to examine the relationship between certain measures of corporategovernance mechanisms [such as those suggested by John and Senbet (1998) and Monksand Minow (1995)] and firms’ financial performance in a developing stock exchangesuch as Nigeria where there is a yawning gap between theory and evidence. In morespecific terms, our objective is to examine how enterprise performance may be affectedby director shareholding, outside directors, board size, ownership concentration, CEOduality, foreign CEOs and leverage.A short look at the views of eminent scholars might provide a clue to the significanceof this study. Metrick and Ishii (2002) maintain that corporate governance increases firmefficiency. Grosfeld (2002) support this view, arguing that corporate governance helpsthe process of privatisation. By promoting efficiency and investment, corporategovernance helps the development of the stock market, which Demirguc-Kunt andLevine (1996) associate with improved macroeconomic growth.The rest of this paper is structured into nine sections. Section 2 gives an overview ofthe regulatory framework. Sections 3 and 4 are devoted to theoretical framework andliterature review respectively, while Section 5 lists out the hypotheses of the study. Themethodology is outlined in Section 6, while Section 7 deals with the type and sources of

data. After presenting the results in Section 8, we discuss them in Section 9, beforeproviding a concluding remark in Section 10.2 Regulatory frameworkThe Nigerian Stock Exchange came into being in 1960, but started operations with fewerthan ten stocks in 1961. Since then, the market has remained small, compared to whatobtains in other countries. According to Standard and Poor’s (2000) by 2003 marketcapitalisation for the entire market stood at US$2,940 million, equivalent only to 2%,24 A.U. Sanda et al.1.1% and 0.9% of that of Malaysian, South African and South Korean stock exchangesrespectively.Emenuga (1998) argues that the market suffers from other problems, with liquidity ofthe market averaging only 2%, compared to the average of Taiwan (174.9%) and SouthKorea (97.8%). The weak regulatory framework contributes to this situation. TheSecurity and Exchange Commission (SEC) was established in 1979, and the Securitiesand Investment Act in 1999. Thus the stock exchange operated for almost two decadeswithout a regulatory organ, and for another two with a regulatory organ weakened by theabsence of a comprehensive legal document to assist in the discharge of its regulatoryduties. From the works of Klapper and Love (2002), Dean and Andreyeva (2001) andGarcia and Liu (1999), we know that weak regulatory environment could havedeleterious consequences for corporate governance and firm performance.3 Theoretical framework

Agency problem posits that in the presence of information asymmetry the agent is likelyto pursue interests that may hurt the principal (Ross, 1973; Fama, 1980). This constitutesthe theoretical framework upon which this paper is based. The theory has helped provideinsights not only into the problems arising between management and shareholders butalso between management and a wider class of stakeholders. The stakeholder theory [seeJohn and Senbet (1998) for a comprehensive review] and the related enlightenedstakeholder theory developed by Jensen (2002) constitute important extensions on theapplications of the agency problem. Jensen (2002) finds faults in stakeholder theory sincethe multiplicity of objective functions that it recognises “violates the proposition that asingle-valued objective is a prerequisite for purposeful or rational behaviour by anyorganization” [Jensen, (2002), p.237). The enlightened stakeholder theory has animportant advantage in that it offers a simple criterion to enable managers decide whetherthey are protecting the interests of all stakeholders: invest a dollar of the firm’s resourcesas long as that will increase by at least one dollar the long term value of the firm.4 Literature reviewFinance literature suggests that both market and non-market mechanisms can beemployed to help resolve the agency problem between managers and other stakeholders.The market mechanisms are of two broad categories – managerial labour market (whichrewards good managers, and punishes poor-performing ones) and the market for

corporate takeover. Fama (1980) asserts that a firm can be viewed as a team, whosemembers realise that in order for the team to survive, they must compete with otherteams, and that the productivity of each member has a direct effect on the team and itsmembers. However, owing to problems associated with poison pills, takeover bids mightbe thwarted (Demsetz and Lehn, 1985). Thus, corporate governance mechanisms arebeing trumpeted as a means of reducing the agency problem, since market mechanismsmay not by themselves resolve it.Empirical works abound on the mechanisms aimed to help reduce the agencyproblem. Abstracting from other dimensions of corporate governance (such as incentiveCorporate governance mechanisms and firms’ financial performance 25schemes) we focus on five mechanisms – insider shareholding, board composition, boardsize, ownership concentration and debt. For each of these aspects of corporategovernance, we provide albeit briefly a review of important literature. The literature onrelationship between insider shareholding and firm performance has produced mixedresults. Empirical evidence on the relationship between insider shareholding and firmperformance is mixed: DeAngelo and DeAngelo (1985) report positive relationship;McConnell and Servaes (1990) and Nor et al. (1999) document a curvilinear relationship;Loderer and Martin (1997) find no significant relation; and Yeboah-Duah (1993)supports a linear relation.

The role of outside directors has been recognised in the literature. The Sarbane-OxleyAct in the USA, and Cadbury Committee Report (1992) in the UK and Bhagat andBlack (2001) all emphasise its importance in enhancing enterprise performance. Yet, thepicture emerging from empirical evidence is rather blurred as both the magnitude anddirection of the relationship are often contested. Weisbach (1988), Mehran (1995) andPinteris (2002) provide evidence showing a positive effect of outside directors on firmperformance. However, John and Senbet (1998) caution that despite the appeal of outsidedirectors, the empirical evidence from the works of Fosberg (1989) is rather mixed, withno clear picture emerging. Several other works such as Hermalin and Weisbach (1991),Bhagat and Black (1999, 2001), Yermack (1996), Metrick and Ishii (2002) and Weir andLaing (2001) report no significant relation between outside directorship and firmperformance.Since the role of foreign investment has been acknowledged as an importantdeterminant of firm performance, we consider the nationality of a chief executive as animportant aspect of corporate governance that needs be investigated for its impact onenterprise performance. Echoing the results of Laing and Weir (1999), Estrin et al. (2001)test whether foreign firms perform better than domestic ones, using a panel data set onBulgaria, Romania and Poland, 1994–1998, reporting that foreign firms perform betterthan domestic ones.

Board size is another corporate governance variable commonly investigated for itsimpact on enterprise performance. Reviewing the works of Monks and Minow (1995),Yermack (1996) seems to support small boards, arguing that large boardrooms tend to beslow in taking decisions, and hence can be an obstacle to change. This is consistent withthe works of Lipton and Lorsch (1992) who find evidence in support of small firms,arguing specifically for an optimal board size of ten.The fourth element of governance mechanism examined in this study is ownershipconcentration. Wruck (1989) suggests the tendency for firm performance to rise at lowlevels of ownership concentration and to fall after a point as additional levels ofconcentration may be harmful (for example through the prevention of takeover) and hugeenough to offset the positive effect of monitoring. Shleifer and Vishny (1997) review theworks of Gorton and Schmid (1996) which supports a positive effect of block holders onenterprise performance. The evidence is inconclusive. Renneboog (2000), Demsetz andLehn (1985) and Holderness and Sheehan (1988) find a weak association betweenperformance and ownership concentration. In contrast, Mørck et al. (1988) supports thetendency for firm performance to rise at low levels of concentration and to fall at higherlevels.Another variable being examined for its effects on firm performance is leverage.Large creditors, like large stakeholders, also have interest in seeing that managers

26 A.U. Sanda et al.take performance-improving measures. Referring to the works of Kaplan and Minton(1994) and Kang and Shivdasani (1995), Shleifer and Vishny (1997) support thisview. John and Senbet (1998) offer an explanation as to why the problem of debtagency tends to persist. According to them, debt holders are entitled to claims and thesehave the tendency to rise at low levels of firm performance, and to remain constantbeyond a certain level of that performance. Thus, good performance benefits thestockholders more than it does debt holders, but this is not true when performance is verylow. In fact as the firm moves towards bankruptcy, equity holders face the risk of losingonly their shareholdings, passing the burden of such bankruptcy to the debt holders.Taken together, these outcomes encourage managers working to protect the interest ofequity holders to embark upon risky, high-return projects. In order to ensure theprotection of the interest of creditors, the literature suggests that they be represented onthe board of the firm.5 Hypotheses of the studySeven hypotheses are tested in this study. Stated in the null, we hypothesise that thereis no significant relationship between firm performance and each of the following:insider shareholding, outside directors, size of the board, ownership concentrationand leverage. Two other hypotheses are tested: first we propose no significantdifference in mean performance of firms run by foreign CEOs and those by local

ones; second we hypothesise that average performance is not significantly differentin firms with CEO serving as chair, compared to firms in which the two roles areseparated.6 MethodologyIn this section, we present in Table 1 variable definition and measurement, and thenproceed to specify the models estimated in this paper.Table 1 Variable definitions and measurementVariable MeasurementPE ratio Price-earning ratio, measured as ratio of share price to earning per shareROA Return on assets, measured by expressing net profit as a proportion of totalassetsROE Return on equity, measured by expressing net profit as a proportion ofvalue of equityQ Modified Tobin’s Q obtained by dividing year-end market capitalisation bythe book value of total assetsDIRSHARE Director shareholding, measured by expressing total number of sharesowned by directors of firm as a proportion of outstanding shares of the firmBOARDSIZE Board size, measured by taking the total number of members of the boardof directors of a firmOUTSIDE Outside directors: measured by taking the number of outside directors as aproportion of board sizeCorporate governance mechanisms and firms’ financial performance 27Table 1 Variable definitions and measurement (continued)

Variable MeasurementCONCENT Ownership concentration, measured by dividing the proportion of sharesowned by the largest shareholders by the number of those largeshareholdersDebt Leverage, measured by expressing debt as a proportion of share capitalFIRMSIZE Firm size, obtained by taking the natural logs of total assetsCEOSTATUS CEO duality, a dummy variable, taking a value of 0 for firms with CEOserving as chairman, and 1 otherwiseDIRSHSQUARE Quadratic term, obtained by squaring the values of director shareholdingBDSZSQUARE Quadratic term for board size, obtained by squaring board sizeCEOFOREIGN Foreign CEO, a dummy variable taking a value of 0 for firms withNigerian CEOs, and 1 otherwiseCONCENTSq Quadratic term, obtained by squaring the values of ownership contrationΣDji Sectoral dummies representing all sectors but one, in order to avoid thedummy-variable trapThe models estimated in this paper are given below:i 0 1 i 2 i3 I 4 i iFIRMPERFORM a a DIRSHARE a BOARDSIZEa OUTSIDE a CONCENT μ= + ++ + + (1)i 0 1 i 2 i3 I 4 i iFIRMPERFORM b b DIRSHARE b BOARDSIZEb OUTSIDE b CONCENT μ

= + ++ + + (2)i 0 1 i 2 i3 I 4 i 5 iFIRMPERFORM DIRSHARE BOARDSIZEOUTSIDE CONCENT FIRMSIZEφ φ φφ φ φ μ= + ++ + +(3)i 0 1 i 2 i3 i 4 i5 i 6 i7FIRMPERFORM OUTSIDE DIRSHAREDIRSHSQUARE BOARDSIZECEOSTATUS BDSIZESQUARECONλ λ λλ λλ λλ= + ++ ++ ++ CENTi +λ8FIRMSIZEi +mi(4)i 0 1 i 23 i 4 i5 6 i7FIRMPERFORM OUTSIDE DIRSHAREiDIRSHSQUARE BOARDSIZECEOFOREIGN STATUSBDSIZESQUδ δ δ

δ δδ δδ= + ++ ++ ++ i 8 i9 i iARE CONCENTFIRMSIZE mδδ++ +(5)i 0 1 i 2 i3 i 4 i5 6 i7FIRMPERFORM OUTSIDE DIRSHAREDIRSHSQUARE BOARDSIZECEOFOREIGN STATUSBDSIZESQUϕ ϕ ϕϕ ϕϕ ϕϕ= + ++ ++ ++ i 8 i9 i 10 i iARE CONCENTCOCENTSQ FIRMSIZE mϕϕ ϕ+

+ + +(6)28 A.U. Sanda et al.i 0 1 i 2 i3 i 4 i5 6 i7FIRMPERFORM OUTSIDE DIRSHAREDIRSHSQUARE BOARDSIZECEOFOREIGN STATUSBDSIZESQUθ θ θθ θθ θθ= + ++ ++ ++ i 8 i9 i 10 i j ji iARE CONCENTCOCENTSQ FIRMSIZE Dθθ θ θ μ++ + +Σ +(7)i 0 1 i 2 i3 i 4 i5 6 i7FIRMPERFORM OUTSIDE DIRSHAREDIRSHSQUARE BOARDSIZECEOFOREIGN STATUSBDSIZESQUθ θ θθ θ

θ θθ= + ++ ++ ++ i 8 i9 i 10 i11 i j ji iARE CONCENTCOCENTSQ FIRMSIZEw Debt Dθθ θθ μ++ ++ +Σ +(8)The results obtained from the estimation of equations (1) to (8) above are given inTables 2 through 9 respectively. It is important to emphasise that except in equation (8),each of the seven other equations was estimated four times, one each for the fourmeasures of performance (ROA, ROE, PE ratio, and Q).7 Data and data collectionThe population for this study comprises all firms listed on the Nigerian Stock Exchangeover the period 1996 through 1999. As at the time when the data set was being collected,there were no more than 150 firms listed on the Nigerian Stock Exchange, but 93 of themhad complete data on the variables specified in our models. Therefore sampling selectionwas based on data availability, not probability. However, the sample covers all sectors of

the exchange, and all the major firms are represented in the sample. For this reason thesample has a good representation of the population and the conclusions derived from thisstudy may be relevant to the entire population.8 ResultsTable 2 shows the results obtained from estimation of equation 1.Most coefficient estimates are insignificant. We suspected problems from the data,and therefore took logarithmic transformation of the variables and reestimated the model,reporting the results in Table 3.In Table 3, a clear pattern seems to emerge. One, director shareholding is negativelyrelated to performance, and is significant in two out of four cases Two, board size issignificant in just one out of four cases. Three, outside directors bear negative (butinsignificant) coefficient estimates in all the four specifications. Third, ownershipconcentration is significantly positively related to performance, in three out of four cases.A chief limitation of the results in Table 3 is that they do not control for firm size.Table 4 does so.Corporate governance mechanisms and firms’ financial performance 29Table 2 Coefficient estimates for equation (1)Dependent variableROA ROE TOBIN Q PE ratioDirector shareholding –.00597 (–1.23) –.026 (–.348) –0.00001 (–1.062) –.069 (–1.1)Board size .036 (.577) –.562 (–.571) .0038 (5.7)*** .423 (.497)Outside directors –.0977 (–1.66)* .948 (1.029) –.0027 (–3.95)*** .14 (.18)

Ownership concentration .0055 (1.459) .0039 (.066) - .011 (.215)R2 0.05 0.01 0.12 0.02F 2.33* 0.36 11.78*** 0.66Note: Significant at 10% (*); 5% (**); 1% (***).Table 3 Coefficient estimates for equation (2)ROA ROE Q PE ratioDirector shareholding –.058 (–1.064) –.0341 (–.640) –.19 (–5.1)*** –.064 (–2.7)***Board size .044 (.713) .202 (3.35)*** .0289 (.634) .0429 (1.574)Outside directors –.879 (–1.551) –.264 (–.479) –.31 (–.769) –.075 (–.296)Ownership concentration .0157 (2.348)** .0136 (2.100)** .0159 (3.32)*** –.0019 (–.678)R2 0.07 0.09 0.25 0.07F 2.10** 3.89*** 12.69*** 2.86**Note: Significant at 10% (*); 5% (**); 1% (***).Table 4 Coefficient estimates for equation (3)ROA ROE Q PE ratioDirectorshareholding–.1155 (–2.223)** –.0307 (–.562) –.2587 (–7.414)*** –.0725 (–2.997)***Board size .1843 (2.907)** .1941 (2.913)*** .163717 (3.767)*** .060589 (2.025)**Outsidedirectors–.760 (–1.449) –.2705 (–.490) –.2376 (–.681) –.0887 (–.348)Ownershipconcentration.01489 (2.412)** .0136 (2.100)** .014714 (3.546)*** –.0022 (–.760)Total assets –.527 (–5.324)*** .0311 (.299) –.4871 (–7.264)*** –.06584 (–1.411)R2 0.21 0.09 0.44 0.09

F 8.44*** 3.11*** 24.16*** 2.70**Note: Significant at 10% (*); 5% (**); 1% (***).Three points emerge from the results in Table 4. One, director shareholding issignificantly negatively related with performance in three out of four cases. Two, boardsize bears positive relationship with performance and is significant in half of the cases.Three, outside directorship is not statistically significant in any of the four specifications.Finally, ownership concentration is significant is three out of four regressions. Table 5shows the results intended to examine the effects of non-linearity.30 A.U. Sanda et al.Table 5 Coefficient estimates for equation (4)ROA ROE Q PE ratioOutsidedirector–.166984 (–.248) .484363 (.692) –.434273 (–1.017) –.258913 (–.813)Directorshareholding–.1163 (–2.259)** –.0262 (–.490) –.241464 (–.149)*** –.072582 (–2.976)***Directorshareholdingsquares–.00781 (–.331) –.0050 (–.204) –.002968 (–.195) –.006714 (–.611)Board size .515857 (1.006) .5979 (1.121) 1.1880 (3.383)*** –.142838 (–.553)CEO status .8247 (1.692)* 1.04 (2.052)** –.105101 (–.341) –.279897 (–1.271)Board sizesquares

–.0193 (–.669) –.023 (–.781) –.0576 (–2.949)*** .011829 (.825)Concentration .4933 (2.586)*** .5287 (2.66)*** .60574 (4.886)*** –.028144 (–.318)Total assets –.547 (–5.43)*** .0058 (.056) –.4736 (–7.151)*** –.058268 (–1.215)R2 0.23 0.13 0.5 0.11F 5.84*** 2.95*** 18.26*** 2.12***Note: Significant at 10% (*); 5% (**); 1% (***).Table 6 Coefficient estimates for equation (5)ROA ROE Q PE ratioOutsidedirector.670 (1.020) 1.06 (1.517) –.118 (–.260) –.329 (–.984)Directorshareholding–.074 (–1.476) .028 (.525) –.2198 (–6.165)*** –.049 (–1.920)*Directorshareholdingsquares–.005 (–.208) –.0041 (–.175) –.0049 (–.314) –.0148 (–1.310)Board size –.348 (–.574) .132 (.205) .9357 (2.175)** .180 (.580)CEO foreign 1.76 (6.453)*** 1.71 (5.879)*** .5396 (2.783)*** –.033 (–.229)CEO status 1.53 (3.319)*** 1.63 (3.330)*** .154 (.483) –.3003 (–1.325)Board size sq .03 1 (.925) .005 (.150) –.044 (–1.828)* –.0073 (–.421)Concentration –.127 (–.634) –.104 (–.490) .40 (2.812)*** –.056 (–.549)Total assets –.477933 (–5.09)*** .090546 (.908) –.445569 (–6.583)*** –.028 (–.578)R2 0.39 0.28 0.5 0.07

F 10.52*** 6.44*** 15.62*** 1.13Note: Significant at 10% (*); 5% (**); 1% (***).As may be seen in Table 5 the measures of board independence, namely outside directors,is not significant; the other measure, namely, CEOSTATUS, is significant in 2 out of 4cases and in both of those cases the dummy variable has a positive coefficient estimate,suggesting the need for separation of offices of CEO and chairman. Third, ownershipconcentration is significantly positive in three out of four cases. The results on Q,presented in Column 3, require a close examination in view of certain peculiarities. Fiveout of eight variables are significant at 1% level. In particular, both measures of boardCorporate governance mechanisms and firms’ financial performance 31size are significant, with the quadratic one having a negative sign. Taking partialderivatives and solving for optimal values gave results suggesting an optimal value ofboard size of ten. Beyond this level a negative relationship is predicted to set in.Table 6 is specifically intended to test whether or not foreign CEOs perform betterthan local ones. In three out of four cases, the coefficient estimate of the Foreign CEOdummy variable is positive and significant at 1% level, implying that firms with foreignCEOs tend to perform better.Ownership concentration: a double edged sword?Next, we include a quadratic term for ownership concentration in order to test for theeffect of non-linearity. The results are given in Table 7. We focus attention on one

measure of ownership performance – Q – for a couple of reasons. Except for this measureof performance, the parameter estimates for the other measures are not stable, tending towander rather erratically. From the results, seven of the nine parameter estimates aresignificant at 1%, with the adjusted R2 computed at 55.6%. We also observe a statisticallysignificant non-linear relationship between ownership concentration and firmperformance.Table 7 Coefficient estimates for equation (6)Dependent variableRegressorsROA ROE Q PE ratioOutsidedirectors–0.095 (–0.151) 0.723 (1.167) –0.469 (–1.208) –0.142 (–0.459)Directorshareholding–0.089 (–1.704)* –0.018 (–0.357) –0.237 (–7.27)*** –0.072 (–2.87)***Directorshareholdingsquares–0.0 (–0.441) –0.004 (–0.189) 0.0015 (0.106) –0.0068 (–0.603)Board size 0.36 (0.676) 0.35 (0.656) 1.045 (3.120)*** –0.08 (–0.319)Board sizesquares–0.006 (–0.214) –0.005 (–0.172) –0.0455 (–2.438)** 0.007 (0.507)ExpatriateCEOs

1.436 (5.55)*** 1.444 (5.7)*** 0.57 (3.506)*** 0.068 (0.530)CEO status –0.737 (–1.633) –1.04 (–2.3)** 0.246 (0.885) 0.28 (1.352)Ownershipconcentration0.791 (0.428) 2.32 (1.27) 4.355 (3.680)*** 2.037 (2.268)**Ownershipconcentrationsquares–0.123 (–0.431) –0.36 (–1.27) –0.61 (–3.33)*** –0.325 (–2.348)**Total assets –0.527 (–5.3)*** –0.022 (–0.232) –0.556 (–8.96)*** –0.065 (–1.350)R2 0.346 0.261 0.553 0.042F 9.401*** 6.62*** 19.811*** 1.636Note: Significant at 10% (*); 5% (**); 1% (***).32 A.U. Sanda et al.Accounting for industry variationsThe relationship between firm performance and governance mechanisms might well varyfrom one sector of the exchange to another. To address this issue, 13 dummy variableswere included and the results shown in Table 8. The automobile sector showed a betterlevel of performance than the textile, conglomerate, insurance, construction andpackaging sectors of the exchange.Table 8 Coefficient estimates for equation (7)Dependent variableRegressorsROA ROE Q PE ratioOutside directors –1.064 (–1.306) –0.66(–0.810) –1.44(–3.26)*** .226(0.544)Directorshareholding

–0.065 (–0.896) –0.03(–0.411) –0.19(–4.78)*** –0.077(–2.1)**Directorshareholdingsquares0.05(1.597) 0.03 (0.957) 0.039(2.25)** –0.003(–0.179)Board size –0.18 (–0.264) –0.499(–0.71) 1.33(3.23)*** .252 (0.63)Board sizesquares0.02 (0.555) 0.04(1.106) –0.065(–2.92)*** –0.011(–0.5)Expatriate CEOs 1.35 (3.9)*** 1.315(3.4)*** .25(1.16) .213(1.04)CEO status –0.98(–1.47) –0.65(–0.97) .629(1.74)* –0.326(–0.96)Ownershipconcentration–0.005(–0.003) 1.504(0.731) 3.79 (3.32)*** 2.565 (2.39)**Ownershipconcentrationsquares0.049(0.16) –0.229(–0.73) –0.5(–3.18)*** –0.42(–2.6)**Total assets –0.73(–4.6)*** –0.005(–0.032) –0.59(–6.68)*** –0.14(–1.71)*Banking –1.41(–1.87)* –1.447(–1.92)* –0.779(–1.85)* .628 (1.56)Breweries –1.49(–1.4) –1.711(–1.62) .135(0.2) .436(0.82)Building –2.15(–2.6)*** –1.80(–2.2)** –1.077(–2.43)** .248(0.610)Conglomerates –2.34(–2.59)** –2.079(–2.3)** –2.22(–4.6)*** .292(0.67)

Construction –2.34(–2.56)** –1.233(–1.3) –1.185(–2.4)** –0.104(–0.22)Food andbeverages–1.05(–1.338) –0.22(–0.3) –0.03(–0.078) .230(0.59)Health –2.41(–2.13)** –1.46(–1.29) –0.8(–1.357) .659(1.11)Industrial –3.54(–3.6)*** –1.99(–2.0)** 0.06 (0.112) .653(1.29)Insurance –1.63(–2.32)** –0.64(–0.9) –1.35(–3.48)*** 0.0784(0.22)Packaging –3.98(–4.4)*** –2.19(–2.4)** –1.669(–3.43)*** .376 (0.81)Petroleum –0.82(–0.92) .168 (0.19) .589(1.24) 0.087(0.20)Textiles –3.15(–3.1)*** –1.7(–1.64) –1.43(–2.54)** –0.586(–1.03)R2 0.48 0.379 0.741 0.099F 7.161*** 5.083*** 19.2*** 1.663**Note: Significant at 10% (*); 5% (**); 1% (***).Corporate governance mechanisms and firms’ financial performance 33A second result is that despite the extension of the model, the nature of the relationshipbetween board size and firm performance has remained unchanged, with the resultspredicting an optimal size of ten board members.A more interesting insight offered by the inclusion of sector dummies into theregression analysis is concerning the relationship between firm performance andgovernance variables, notably ownership concentration and director shareholding. As inthe previous results, statistically significant relationship is found between firmperformance and the two governance variables mentioned above. Given the negative

coefficient estimate of the quadratic term for the concentration variable, performance ispredicted to rise within a certain range and fall thereafter. In contrast, given the positivesign of the coefficient estimate for the quadratic term for director shareholding, it ispredicted that beyond a certain level of director shareholding, further ownership of sharesby directors would lead to improvements in performance. This will sound ratherperplexing, for the literature suggests a limit within which such a positive relationshipcan be expected to hold.Do the results therefore run counter to theoretical expectation? To answer thisquestion we refer to the coefficient estimates of the two quadratic terms in the model. Anegative coefficient estimate for the quadratic term for ownership concentration implies a∩-shape for the relationship between concentration and firm performance. Taking partialderivatives and solving for optimal values we obtained results implying that beyondownership concentration of 32.46%, a negative relationship will set in. By the sametoken, a positive coefficient estimate for the quadratic term for director shareholdingimplies a U-shaped relationship between director shareholding and firm performance.Taking partial derivatives and solving for optimal values we obtained results indicatingthat beyond director shareholding of 8.94%, a positive relationship is predicted betweenfirm performance and director shareholding. In view of this, we propose that there is alimit to which this relationship might hold, although the U-shaped nature of the function

suggests otherwise. As directors own more and more shares, this will increase ownershipconcentration. If the level of director shareholding continued to rise and thereby causedthe level of ownership concentration to rise beyond the threshold of 32.46%, would therelationship between director shareholding still be positive in view of the U-shapednature of the function?The answer depends on whether performance is falling (due to concentrationeffects) faster than it is rising (due to director shareholding effect). Looking at thecoefficient estimate of the two quadratic terms, the absolute value for that ofconcentration is higher than that of director shareholding. Thus, after ownershipconcentration of 32.46%, the negative effects of it will outweigh the positive effect ofdirector shareholding. Hence the negative effects of concentration seem to preventdirector shareholding from having an unlimited range within which to exhibit a positivecorrelation with performance. These results are tentative and further investigation isrequired to address these and related issues. Such issues include for example the need toestimate the level of director shareholding required to raise the level of ownershipconcentration to the threshold level.Effects of leverageThe regression analysis was also extended to incorporate two new elements in Table 9.34 A.U. Sanda et al.Table 9 coefficient estimates for equation (8)Dependent variable – QOutside directors 2.052 (3.116)***

Director shareholding .177 (1.827)*Director shareholding squares –0.02105 (–0.668)Board size –2.074 (–3.023)***Board size squares .121 (3.122)***Expatriate CEOs 3.125 (4.686)***CEO status –2.017 (–2.659)***Ownership concentration 4.817 (2.514)**Ownership concentration squares –1.028 (–3.712)***Total assets –1.292 (–9.318)***Debt .446 (7.176)***Banking 1.958 (2.951)***Breweries –1.144(–1.345)Building 5.023 (5.664)***Conglomerates 3.015 (3.784)***Construction –.902 (–1.164)Industrial 1.107 (1.836)*Insurance 0.05269 (.128)Packaging 1.498 (2.465)**Petroleum –.134 (–0.204)Textiles 1.255 (0.783)R2 0.919F 46.533***Note: Significant at 10% (*); 5% (**); 1% (***).The first was the need to consider leverage in the computation of Q and the second was toinclude debt as a control variable. A number of important changes in the results emergedin terms of significance and signs of the parameter estimates. Although CEO statusremained significant with the expected negative sign, a significant positive effect wasobtained for outside directors. Moreover, the measure of leverage turned out to besignificant and with positive sign, a finding running in support of our a priori expectationof a positive sign for the linear measure of debt.

9 Results discussionResults are discussed in accordance with the seven hypotheses presented in Section 5 ofthis paper.The first hypothesis seeks to examine the effect of director shareholding on firmperformance. The results are significant in 15 out of 25 regressions, indicating a negativerelationship between director shareholding and firm performance. These results are notCorporate governance mechanisms and firms’ financial performance 35consistent with the theoretical expectation of a positive relationship proposed byDeAngelo and DeAngelo (1985). An explanation for this unexpected finding may befound in a recent work by Sanda et al. (2008) who report that in Nigeria, there is evidenceof a significant concentration of shares in a network of family holdings, with such familycontrol producing governance structures in which many members of the same family sitaround a family-related CEO or chairman. In addition, Morck and Yeung (2003) arguethat such ownership structures tend to produce governance structures that could causeexpropriation of minority shareholders by the dominant family holdings.The second hypothesis seeks to examine the effects of outside directors on enterpriseperformance. The results are not significant in 23 out of 25 regressions, implying that thenull hypothesis is not rejected. Although supporting the earlier works of Fosberg(1989), Hermalin and Weisbach (1991) and others, our results are inconsistent with the

results reported in the works of Wesisbach (1988), Mehran (1995) and Pinteris(2002) who report significant positive relationship between the two variables. Theabsence of a significant relationship reported here may be a pointer to the need forrethinking the governance structures of firms quoted in Nigerian Stock Exchange.Both theory and empirical results alluded to earlier on suggest that outside directors areexpected to contribute to significant performance improvement. That this is not thecase in Nigeria may be indicative of a tendency for CEO or management to gainsignificant control of the board, including the outside directors, making them unable toexercise the sort of control required of them. Additionally, if the CEO has direct orindirect influence in the appointment or renewal of appointment of board members, evenoutside directors might be forced to compromise their independence. As in this case,often a lack of significant result could be an important finding. It means thatoutside directors are not effective in promoting the interest of the firm. This raises theissue of the need for the regulatory authorities in Nigeria to examine more closely theneed to review the code of corporate governance in ways that will ensure that outsidedirectors are more effective in checking the affairs of managers as a means of raising firmperformance.The third hypothesis examines the effect of board size on performance. Our resultsappear to uphold the predictions of the theory – within a certain range, there is a positive

relationship operating between board size and firm performance. Our results show anoptimal board size of ten, a finding consistent with the predictions of Yermack (1996). Arecent study by Sanda et al. (2008) shows that most firms listed on the Nigerian StockExchange report board size of less than ten even over the period of this study (1996 to1999). This suggests that Nigerian boardrooms are operating below the size that isoptimal for effective promotion of enterprise performance.The fourth hypothesis tests the effects of ownership concentration on performance.The coefficient estimates are positive and significant in 15 out of 25 regressions.Moreover, they show a negative coefficient estimate for nearly all the quadratic terms forownership concentration. These findings are in conformity with Wruck (1989) and otherswho predict that within a certain range of ownership concentration, a positive relationshipwith performance would be expected. Our finding may be a reflection of weak legalsystem in Nigeria since according to Coffee (1999) such a system may not protect theinterest of minority shareholders, leading to more concentrated ownership structures.Moreover, where agency problem is prevalent, concentrated ownership structures couldbe a reflection of shareholder response for curbing the excesses of management.36 A.U. Sanda et al.The fifth hypothesis examines the effects of CEO duality. A major shortcoming ofthis test is that there is hardly any literature to suggest the nature of this relationship. Our

test is based on Nigeria’s code of corporate governance which recommends separation ofthe roles of CEO and chair. The results show that in 5 out of 17 regressions, CEOsseparating the two roles perform better than those combining them. Only in 2 out of 17regressions was the reverse result found.The sixth hypothesis tests the effects of CEO nationality on firm performance. It wasfound that in 9 out of 17 regressions, foreign CEOs perform significantly better than localones. By testing this hypothesis and reporting that foreign CEOs perform better than localones, this should help to justify policy to attract foreign investors as well as to supportcapacity development efforts for local CEOs.Finally, our results show significant positive relationship between leverage andenterprise performance, a finding that leads to the rejection of the null hypothesis. Thereare several possible explanations. One, where corporate governance structures are weak,creditors could take on the monitoring role of management in order to enable the processof loan recovery. This result is consistent with an aspect of the literature cited in thispaper concerning the finding [reported in Kaplan and Minton (1994) and others] thatlarge creditors have the capacity to monitor managers in order to raise enterpriseperformance. In the same vein, finance and economics literature suggests a link betweenfinancial development and economic growth. Such literature pays additional emphasis onthe capital market since it has the capacity to generate long term funds badly needed for

investment. A positive relationship between debt and performance could actually be areflection of the weakness of the country’s capital market, resulting in over reliance onthe banking system for funds to support enterprise growth.All in all, it could be surmised that the results have offered important insights into therelationship between corporate governance variables and firms’ financial performance inNigeria. To the extent that we have provided policy implications emanating from thesefindings, we are content that these results have enabled us to achieve a modest objectiveof our study – gaining additional understanding of the sort relationship between a set ofgovernance variables and enterprise performance in Nigeria.10 ConclusionsIn this paper, we set out to examine the relationship between enterprise performance anda set of corporate governance variables since it is widely realised that a weak corporategovernance structure could engender problems that could have significant ramificationson all stakeholders including government, employees, and above all, shareholders. Insummary, the story emerging from this research is that unlike the findings in othercountries, but in keeping with the outcomes of other researches, outside directors arefound to make no significant contribution to firm performance, and that directorshareholding may actually hurt the enterprise. Another aspect of the results is concerningthe finding that both ownership concentration and board size exhibit a significant

non-linear relationship, helping to raise performance within a certain range, but causing itto fall beyond an optimal level. It is striking to note that while foreign CEOs are found toperform better than local ones, firms having a chief executive serving as chairman arefound to record lower levels of performance compared to firms in which the two roles areseparated. That leverage is found to show significant positive relationship withCorporate governance mechanisms and firms’ financial performance 37performance could be indicative of conscious efforts by major creditors (such as banks)to take on a monitoring responsibility in ways that help to enhance firm performance.These results have helped to enable the achievement of this research’s broad objective ofattempting to understand the nature of the relationship between corporate governance andthe performance of firms listed on the Nigerian Stock Exchange.A couple of caveats need be mentioned at this stage. One, as mentioned in apreceding section, the sample was selected based on data availability, but since itaccounted for more than half of listed firms and was drawn from all the sectors, thesample is broadly representative of the population through which it was drawn. Furtherresearch based on the adoption of a probability criterion in sampling selection is howevercalled for in order to ascertain the extent to which the conclusions emerging from thisresearch could be regarded as representative of the entire population of firms listed on the

country’s stock exchange. A second limitation is concerning the method of statisticalanalysis, which relied on the standard OLS regression rather than on the more robust,quintile regressions or even panel data analysis. These limitations suggest the need forfuture research thata uses the entire population of firms on the stock exchange since most of them nowmaintain electronic copies of the statement of accountsb adopts other methods of econometric techniques of data analysis such as fixed andrandom effects regression that are necessary in the analysis of panel data.AcknowledgementsThe authors are grateful to African Economic Research Consortium (AERC) for financialsupport, anonymous reviewers for useful comments and Paul Collier, Lemma Senbet andother participants of the Finance and Resource Mobilisation Group at the AERC meetingsheld in December 2001, May 2002 and November/December 2003 in Nairobi. All errorsare our own.ReferencesBhagat, S. and Black, B. (2001) ‘The non-correlation between board independence and long-termfirm performance’, Journal of Corporation Law, Vol. 27, pp.231-271.Bhagat, S. and Black, B. (1999) ‘The uncertain relationship between board composition and firmperformance’, Business Lawyer, Vol. 54, pp.921–963.Cadbury Committee Report (1992) Report on the Financial Aspects of Corporate Governance, Gee

Publishing, London.Coffee, J.C. (1999) ‘Privitization and corporate governance: the lessons from securities marketfailure’, Journal of Corporation Law, Vol. 25, pp.1–39.Dean, J.W. and Andreyeva, T. (2001) ‘Privatisation, ownership structure and companyperformance: the case of Ukraine’, Journal for Institutional Innovation, Development &Transition, Vol. 5, pp.62–72.DeAngelo, H. and DeAngelo, L. (1985) ‘Managerial ownership of voting rights: a study of publiccorporations with dual classes of common stock’, Journal of Financial Economics, Vol. 14,No. 1, pp.33–69.Demirguc-Kunt, A. and Levine, R. (1996) ‘Stock market development and financial intermediaries:stylized facts’, The World Bank Economic Review, Vol. 10, No. 2, pp.291–231.38 A.U. Sanda et al.Demsetz, H. and Lehn, K. (1985) ‘The structure of corporate ownership: causes and consequences’,Journal of Political Economy, Vol. 93, No. 6, pp.1155–1177.Emenuga, C. (1998) ‘The Nigerian capital market and Nigeria’s economic performance’,Proceedings of the One-day Seminar of the Nigerian Economic Society, 21 January.Estrin, S., Konings, J., Zolkiewski, Z. and Angelucci, M. (2001) ‘The effect of ownership andcompetitive pressure on firm performance in transition countries: micro evidence fromBulgaria, Romaia and Poland’, Paper Presented at LICOS, K.U. Leuven; a Phare AceWorkshop on Competition policy in Romania, 7 August.

Fama, E.F. (1980) ‘Agency problems and the theory of the firm’, Journal of Political Economy,Vol. 88, No. 2, pp.288–307.Fosberg, R. (1989) ‘Outside directors and managerial monitoring’, Akron Business and EconomicReview, Vol. 20, pp.24–32.Garcia, V.F. and Liu, L. (1999) ‘Macroeconomic determinants of stock market development’,Journal of Applied Economics, May, Vol. 2, No. 1, pp.29–59.Gorton, G. and Schmid, F. (1996) Universal Banking and Performance of German firms, NationalBureau of Economic Research, Working Paper No. 5453.Grosfeld, I. (2002) ‘Exploring the link between privatization and other policies in transition’, PaperPresented at ‘Beyond Transition’ Conference, organized by Centre for Analysis of SocialExclusion, London School of Economics, FALENTY, 12–13 April.Hermalin, B.E. and Weisbach, M.S. (1991) ‘The effects of board composition and directorincentives on firm performance’, Financial Management Winter, Vol. 20, No. 4, pp.101–112.Holderness, C. and Sheehan, D. (1988) ‘The role of majority shareholders in publicly heldcorporations’, Journal of Financial Economics, Vol. 20, pp.317–346.Jensen, M.C. (2002) ‘Value maximization, stakeholder theory, and the corporate objectivefunction’, Business Ethics Journal, Vol. 12, No. 2, pp.235–256.Jensen, M.C. and Meckling, W.H. (1976) ‘Theory of the firm: managerial behaviour, agency costsand ownership structure’, Journal of Financial Economics, Vol. 2, pp.305–360.

John, K. and Senbet, L.W. (1998) ‘Corporate governance and board effectiveness’, Journal ofBanking and Finance, Vol. 22, No. 4, pp.371–403.Kang, J. and Shivdasani, A. (1995) ‘Firm performance, corporate governance and top executiveturnover in Japan’, Journal of Financial Economics, Vol. 38, No. 1, pp.29–58.Kaplan, S. and Minton, B. (1994) ‘Appointment of outsiders to Japanese boards: determinants andimplications for managers’, Journal of Financial Economics, Vol. 36, No. 2 pp.225–258.Klapper, L.F. and Love, I. (2002) ‘Corporate governance, investor protection, and performance inemerging markets’, World Bank Policy Research Working Paper, World Bank PolicyResearch Working Paper No. 2818.Laing, D. and Weir, C.M. (1999) ‘Governance structures, size and corporate performance in UKfirms’, Management Decision, Vol. 37, No. 5, pp.457–464.Lipton, M. and Lorsch, J.W. (1992) ‘A modest proposal for improved corporate governance’,Business Lawyer, November, Vol. 48, No. 1.Loderer, C. and Martin, K. (1997) ‘Executive stock ownership and performance: tracking fainttraces’, Journal of Financial Economics, August, Vol. 45, No. 2, pp.223–255.McConnell, J.J. and Servaes, H. (1990) ‘Additional evidence on equity ownership and corporatevalue’, Journal of Financial Economics, Vol. 27, No. 2 pp.595–612.Mehran, H. (1995) ‘Executive compensation structure, ownership and firm performance’, Journalof Financial Economics, Vol. 38, No. 2, pp.163–184.

Metrick, A. and Ishii, J. (2002) ‘Firm-level corporate governance’, Paper Presented at GlobalCorporate Governance Forum Research Network Meeting, April.Monks, R.A.G. and Minow, N. (1995) Corporate Governance, Basil Blackwell, Cambridge.Corporate governance mechanisms and firms’ financial performance 39Mørck, R., Schleifer, A. and Vishny, R.W. (1988) ‘Management ownership and market valuation:an empirical analysis’, Journal of Financial Economics, Vol. 20, Nos. 1–2, pp.293–315.Morck, R. and Yeung, B. (2003) ‘Agency problems in large family business group’,Entrepreneurship: Theory and Practice, Vol. 27 No. 4, pp.367–382.Nor, F.M., Said, R.M. and Redzuan, H. (1999) ‘Structure of ownership and corporate financialperformance: a Malaysian case’, Malaysian Management Review, Vol. 34 No. 2, pp.44–48.Pinteris, G. (2002) Ownership structure, board characteristics and performance of Argentinebanks’, Working paper, University of Illinois, Fall.Renneboog, L. (2000) ‘Ownership, managerial control and governance of companies listed on theBrussels stock exchange’, Journal of Banking and Finance, Vol. 24, No. 12, pp.1959–1995.Ross, S. (1973) ‘The economic theory of agency: the principal’s problem’, American EconomicReview, Vol. 63, No. 2, pp. 134–139.Sanda, A.U., Garba, T. and Mikailu, A.S. (2008) ‘Board independence and firm financialperformance: evidence from Nigeria’, Paper Presented at the Economic Development inAfrica Conference, organised by the Centre for the Study of African Economies, Department

of Economics, University of Oxford, England, 16–18 March.Shleifer, A. and Vishny, R.W. (1997) ‘A survey of corporate governance’, Journal of FinancialEconomics, Vol. 52, No. 2, pp.737–783.Standard and Poor’s (2000) Emerging Stock Markets Fact Book, New York, USA.Weir, C.M. and Laing, D. (2001) ‘Governance structure, director independence and corporateperformance in the UK’, European Business Review, Vol. 13, No. 2, pp.86–95.Weisbach, M. (1988) ‘Outside directors and CEO turnover’, Journal of Financial Economics,Vol. 20, Nos. 1–2, pp.431–460.Wruck, K.H. (1989) ‘Equity ownership concentration and firm value: evidence from private equityfinancings’, Journal of Financial Economics, Vol. 23, No. 1, pp.3–28.Yeboah-Duah, K. (1993) ‘Stock ownership and the performance of the firm in Malaysia’, CapitalMarket Review, Vol. 1, pp.83–108.Yermack, D.L. (1996) ‘Higher market valuation of companies with a small board of directors’,Journal of Financial Economics, Vol. 40, No. 2, pp.185–211.