The relationship between board structure and

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ABSTRACTKenya has characteristics of board structures and ownership concentration similar to those found in most countries. Firms in transition economies are characterized by high degree of ownership concentration. Empirical studies suggest that ownership concentration is related to firms’ corporate governance, financing and investment policies. Ownership for most firms is distributed among institutional investors and retail investors; with ownership concentrated mainly to institutional investors. The ownership can also be categorized into state ownership and public ownership. The type of ownership structure of a firm ultimately affects the board structure categorized in this study as type 1 board, whose members directly own equity shares in the firm; type 3 board, where the board members do not hold any equity shares in the firm whose board they sit on; and type 2 which is a blend between the two extremes, whose some members own equity shares and some do not hold any equity shares.This study reviews empirical literature related to the relationship between board structure and financial performance. The effectiveness of boards of directors, including board type, board composition, board size, and aspects of board leadership including duality and board busyness are addressed using a number of theories of corporate governance: agency theory, resource dependency theory, entrenchment and convergence of interests theory.The study was motivated by the fact that one could imagine a simple causal structure such that board structure directly influences financial performance and thus the firm value. Type 1 boards would be motivated in ensuring that the entity’s financial performance is enhanced while type 3 board members may not be motivated to ensure better financial performance. Type 2 boards that is a combination of the two extremes may be considered the control variable. The study focused on whether empirical literature exists to support these thoughts.This study explored literature related to the issues above to determine any theories and empirical studies carried out in the past. It has established gaps in knowledge, research and methodological problems related to board structures and financial performance.

Text of The relationship between board structure and

  • The Relationship Between Board Structure and Financial Performance

    BY

    NEBERT OMBAJO MANDALA

    D80/61102/2011

    An Independent Study Paper Submitted in Partial Fulfillment of the Requirements for the Degree of Doctor of Philosophy in Business Administration

    (Finance)

    School of Business University Of Nairobi

    January, 2013

    ombajom@yahoo.com/+254722421422

  • iii

    DECLARATION

    THIS INDEPENDENT STUDY PAPER IS MY ORIGINAL WORK, AND HAS NOT BEEN PRESENTED FOR THE AWARD OF A DEGREE IN ANY OTHER UNIVERSITY. SIGNED DATE . NEBERT OMBAJO MANDALA THIS INDEPENDENT STUDY PAPER HAS BEEN SUBMITTED FOR EXAMINATION WITH MY APPROVAL AS THE UNIVERSITY SUPERVISOR. SIGNED DATE .. ... PROFESSOR ERASMUS KAIJAGE SCHOOL OF BUSINESS, UNIVERSITY OF NAIROBI.

  • iv

    DEDICATION

    To my precious wife Doreen and daughter Leila, for giving me a new purpose for living and a

    renewed zeal to excel.

    To my late Dad and Mum Mr. David Mandala and Mrs. Beliah Mandala, for laying the

    foundation for my academic advancement and outstanding achievements.

  • v

    ACKNOWLEDGEMENTS First and foremost, I would like to express my deepest gratitude and appreciation to my

    supervisor, Professor Kaijage without whom I would not have achieved this. His guidance,

    encouragement and support were of great value. He gave me a push to go on at a time when I

    almost despaired.

    Special thanks also go to all my friends, particularly those in my PhD class. Their

    contribution throughout my study period is highly appreciated.

    Most importantly, I thank God the Almighty for giving me life, health and the ability to

    undertake this journey.

  • vi

    ABSTRACT

    Kenya has characteristics of board structures and ownership concentration similar to those

    found in most countries. Firms in transition economies are characterized by high degree of

    ownership concentration. Empirical studies suggest that ownership concentration is related to

    firms corporate governance, financing and investment policies. Ownership for most firms is

    distributed among institutional investors and retail investors; with ownership concentrated

    mainly to institutional investors. The ownership can also be categorized into state ownership

    and public ownership. The type of ownership structure of a firm ultimately affects the board

    structure categorized in this study as type 1 board, whose members directly own equity shares

    in the firm; type 3 board, where the board members do not hold any equity shares in the firm

    whose board they sit on; and type 2 which is a blend between the two extremes, whose some

    members own equity shares and some do not hold any equity shares.

    This study reviews empirical literature related to the relationship between board structure and

    financial performance. The effectiveness of boards of directors, including board type, board

    composition, board size, and aspects of board leadership including duality and board

    busyness are addressed using a number of theories of corporate governance: agency theory,

    resource dependency theory, entrenchment and convergence of interests theory.

    The study was motivated by the fact that one could imagine a simple causal structure such

    that board structure directly influences financial performance and thus the firm value. Type 1

    boards would be motivated in ensuring that the entitys financial performance is enhanced

    while type 3 board members may not be motivated to ensure better financial performance.

    Type 2 boards that is a combination of the two extremes may be considered the control

    variable. The study focused on whether empirical literature exists to support these thoughts.

    This study explored literature related to the issues above to determine any theories and

    empirical studies carried out in the past. It has established gaps in knowledge, research and

    methodological problems related to board structures and financial performance.

  • vii

    TABLE OF CONTENTS

    DECLARATION ................................................................................................................. iii DEDICATION ..................................................................................................................... iv ACKNOWLEDGEMENTS................................................................................................... v ABSTRACT ........................................................................................................................ vi 1.0 INTRODUCTION ...................................................................................................... 1

    1.1 Statement of the Problem ..................................................................................... 3 1.2 Objectives of the Study ........................................................................................ 5 1.3 Corporate Governance ......................................................................................... 5 1.4 Ownership Structure ............................................................................................ 6 1.5 Financial Performance Measures ......................................................................... 7 1.6 Outline of the study ............................................................................................. 8

    2.0 THEORETICAL REVIEW ...................................................................................... 10 2.1 Agency Theory .................................................................................................. 10 2.2 Competing Theories .......................................................................................... 14 2.2.1 Convergence-of-interests Theory ....................................................................... 14 2.2.2 Entrenchment Theory........................................................................................ 15

    3.0 EMPIRICAL REVIEW ............................................................................................ 17 3.1 Introduction ....................................................................................................... 17 3.2 Corporate Governance and Financial Performance............................................. 17 3.3 Board Structure and Financial Performance ....................................................... 18 3.4 Board Composition and Firm Performance ........................................................ 24 3.5 Ownership Structure, Corporate governance and Financial Performance............ 26 3.6 Corporate Governance and Bankruptcy.............................................................. 31 3.7 Corporate Governance Variables and Performance ............................................ 32 3.8 Board Size and Firm Performance ..................................................................... 34 3.9 Board Composition and CEO performance ........................................................ 35 3.10 Research Gaps ................................................................................................... 36 3.11 Conceptual Framework ...................................................................................... 39

    4.0 CONCLUSIONS AND RECOMMENDATIONS..................................................... 41 REFERENCES ................................................................................................................... 42

  • 1

    1.0 INTRODUCTION

    Kenya has characteristics of board structures and ownership concentration similar to those

    found in most countries. Ownership for most firms is distributed among institutional

    investors and retail investors; with ownership concentrated mainly to institutional investors.

    The ownership can also be categorized into state ownership and public ownership. The type

    of ownership structure of a firm ultimately affects the board structure categorized in this

    study as type 1 board, whose members directly own equity shares in the firm; type 2 board,

    where the board members do not hold any equity shares in the firm whose board they sit on;

    and type 3 which is a blend between the two extremes, whose some members own equity

    shares and some do not hold any equity shares.

    Agency problems have in the recent past become an integral part of the modern-day

    corporation, owing to the widening separation of ownership and control responsibilities,

    growing business diversification and segmentation across industries, business lines, and

    investor emphasis on near-term performance and return outcomes. Financial scandals further

    lead to the question of whether firms are being run in the best interests of stakeholders. The

    board of directors and the executive management have the control responsibilities for the firm

    while the owners may not be able to offer adequate supervision or accountability, particularly

    in companies with widely dispersed ownership. Agency conflicts (conflicts that arise from

    the separation of ownership and control) may not be fully resolved effectively through

    corporate governance systems hence managers may not act to maximise the returns to

    shareholders unless appropriate governance structures are implemented in the large

    corporations to safeguard the interests of shareholders (Jensen and Meckling 1976).

    Agents or managers may not always act in the best interest of shareholders when the control

    of a company is separate from its ownership. Herbert (1959)

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