How Corporate Governance Affects Bank Performance

Abstract

Effective corporate governance practices are essential to achieving and maintaining public trust and confidence in the banking system and also critical to bank performance. Good corporate governance should facilitate efficient, effective and entrepreneurial management that can deliver shareholder value over the long term. Corporate governance of banks is important since commercial banking operations are not as transparent as other firms. The opaqueness of bank’s balance sheets and income statement makes it very costly for depositors to constrain managerial discretion and they cannot know the true value of the bank’s loan portfolio as such information is incommunicable and very costly to reveal. This project looks at how corporate governance affects bank performance, since good corporate governance shall ensure that strategic goals and corporate values are in place and communicated throughout the bank. Sound corporate governance therefore creates an enabling environment that rewards banking efficiency, mitigates financial risks, and increases systematic stability. A good working relationship between the board of directors, management and other stakeholders in any given bank would result in increased efficiency, throughput and profits. Companies with better corporate governance have better operating performance than those companies with poor corporate governance. It is also believed that good corporate governance helps to generate investor goodwill and confidence. The researcher identified basically two different models of the firm concerning the impact of corporate governance on performance, the shareholder model and the stakeholder model. The shareholder model describes the formal system of accountability of senior management to shareholders while the stakeholder model describing the network of formal and informal relations involve the corporation. This study was to establish if there was a relationship between corporate governance practices and commercial bank performance in Kenya. The population of the study was

the 45 banks licensed by the Central Bank of Kenya as at the end of 2010. The study adopted a census study approach because of the small population and the banks are easily assessable. Secondary data was collected from the published financial reports. Two methods of data analysis were employed, the descriptive analysis which provides some averages of relevant variables and the regression analysis to establish a relationship between the corporate governance variables (independent variables) and firm performance (the dependent variable) over the period of study. From the study the researcher concludes that the Board should be involved in the selection and appointment of senior executives, the board should also put systems in place for identifying, monitoring and managing the organization’s risk profile. Given the increasing complexity of business today, there is need for the financial reports to include more comprehensive information as investors rely on information they receive from companies in making their investment decisions. Failures in corporate governance practices have aggravated incidences where management manipulates financial reports for different purposes hence making it difficult for the stakeholder to build confidence in them. By examining the existing relationships between the directors, management, shareholders, and the other stakeholders, the study recommends that existing boards setbacks need to be addressed in order to improve the corporate governance in banking institutions in Kenya. The researcher concludes that corporate governance practices (directors’ effectiveness, management effectiveness, shareholder protection, disclosure and transparency) have a positive relationship with bank performance. Amongst other success factors to overall bank performance, this study attributes 20.7% of these to corporate governance practices. Therefore banks should embrace adequate corporate governance practices in order to increase financial performance.