Project Topic – IMPACT OF BOARD CHARACTERISTICS ON NIGERIAN QUOTED FIRMS

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CHAPTER ONE

INTRODUCTION

1.1         Background of the Study

Corporate boards are by definition the internal governing mechanism that shapes firm governance, given their direct access to the two other axes in the corporate governance triangle: managers and shareholders (owners). In today’s volatile corporate environment, corporate boards are very important for smooth functioning and strategic policy making of the organizations. Boards are expected to perform different functions, for example, monitoring of management to mitigate agency costs (Eisenhardt, 1989:57-74; Shleifer and Vishny, 1997:737-783; Roberts, McNulty and Stiles, 2005:5-26), hiring and firing of management (Hermalin and Weisbach, 1998:96-118), provide and give access to resources (Hillman, Canella and Paetzold, 2000: 235-255; Hendry and Kiel, 2004: 500-520), grooming CEO (Vancil, 1987:43-71) and providing strategic direction for the firm (Tricker, 1984:201-219; Van der Walt and Ingley, 2001: 174-185, Kemp, 2006: 56-73). Boards also have a responsibility to initiate organizational change and facilitate processes that support the organizational mission (Hill, Green and Eckel, 2001: 28-32; Bart and Bontis, 2003: 361-381).

In addition, the boards seek to protect the shareholder’s interest in an increasingly competitive environment while maintaining managerial professionalism and accountability in pursuit of good firm performance (Ingley and Van der Walt, 2001: 174-185; Hillman and Dalziel, 2003: 383-396; Hendry and Kiel, 2004: 500-520; McIntyre, Murphy and Mitchell, 2007:547-561). The role of board is, therefore, quite daunting as it seeks to discharge diverse and challenging responsibilities. The board should not only prevent negative management practices that may lead to corporate failures or scandals but also ensure that firms act on opportunities that enhance the value to all stakeholders. To understand the role of board, it should be recognized that boards consists of a team of individuals, who combine their competencies and capabilities that collectively represent the pool of social capital for their firm that is contributed towards executing the governance function (Carpenter and Westphal, 2001: 639-600; Lynall, Golden, and Hillman, 2003: 416-431;Vera-Munoz, 2005: 115-127). As a strategic resource, the board is responsible to develop and select creative options in advancement of the firm.

Research on corporate board is influenced mainly by Agency Theory. Agency Theory argues that where there is separation of management and ownership, the manager (i.e. agent) seeks to act in self-interest which is not always in the best interests of the owner (i.e. principal) and departs from those required to maximize the shareholder returns. This agency problem can be set out in two different forms known as adverse selection and moral hazard (Eisenhardt, 1989:57-74; Barkema, and Gomez-Mejia, 1998:135-147). Adverse selection can occur if the agent misrepresents his ability to perform the functions assigned and gets chosen as an agent. Moral hazard occurs if the chosen agent shirks the responsibilities or underperforms due to lack of sufficient dedication to the assigned duties. Such underperformance by an agent, even if acting in the best interest of the principal, will lead to a residual cost to the principal (Jensen and Meckling, 1976:305-360). These costs resulting from sub-optimal performance by agents are termed as agency costs.

1.2         Statement of Problem

While it is clear that boards have a crucial responsibility towards strategy, every board does not participate equally in strategic decision making. Some boards are considered ‘passive’ while others are considered ‘active’, based on their invo lvement in strategic decision making process. Corporate governance literature demonstrates a swing from passive school of the 1970s and 1980s to the active school prevalent over the last ten years”. Proponents of the active school suggest several roles for the boards.

It is generally believed that the effectiveness of a board depends on its active participation in the strategic decisions of the firm. Agency theory opened a new strand of argument, which posits that it is not enough for a board to actively participate in strategic decision making, but, that the quality of that decision depends on how effective the firm has resolved its agency problem.

Based on this, most scholars have advocated for a corporate board that constitute majorly of outside directors. This has generated raging debate among scholars and practitioners on the effect of outside directors or board characteristics on critical decisions of firms.

Most studies used data from developed economies like United States of America, United Kingdom among others. Considering the volatile nature of emerging economies and the rate of corporate failure, it has become imperative to investigate the effect of board characteristics on critical decisions of the firm. This study is poised to fill this important research lacuna.

1.3         Objectives of the Study

The thrust of this study is to investigate the impact of board characteristics on Nigerian quoted firms. In order to give this proper attention, the study will pursue the following specific objectives.

1. To examine the effect of board characteristics on Chief Executive Officer’s (CEO’s) total compensation.
2. To investigate the effect of board characteristics on CEO’s incentive pay out of total compensation.
3. To ascertain the effect of board characteristics on firm’s unrelated diversification.
4. To examine the effect of board characteristics on firm’s research and development expenditures.
5. To determine the effect of board characteristics on the firm’s debt intensity.
6. To examine the effect of board characteristics on the firm’s CEO turnover.

1.4         Research Questions

To achieve the above objectives, this study will provide answers to the following questions.

1. What is the effect of board characteristics on CEO’s total compensation in Nigeria?
2. What is the effect of board characteristics on CEO’s incentive pay out of total compensation in Nigeria?
3. What is the effect of board characteristics on the level of firms’ unrelated diversification in Nigeria?
4. What is the effect of board characteristics on the intensity of firm’s research and development expenditures in Nigeria?
5. What is the effect of board characteristics on firm’s debt intensity in Nigeria?
6. What is the effect of board characteristics on CEO turnover in Nigeria?

1.5         Research Hypotheses

In line with the objectives of the study and the research questions, the study presents the following research hypotheses;

1. There is a significant negative effect of board characteristics on CEO’s total compensation.
2. There is a significant positive effect of board characteristics on CEO’s incentive pay out of total compensation.
3. There is a significant negative effect of board characteristics on the level of firms’ unrelated diversification in Nigeria.
4. There is a significant positive effect of board characteristics on the intensity of firm’s research and development expenditures in Nigeria.
5. There is a significant positive effect of the board characteristics on firm’s debt intensity in Nigeria.
6. There is significant positive effect of board characteristics on firm’s CEO turnover in Nigeria.

1.6         Significance of the Study

The impact of board characteristics on Nigerian quoted firms has received serious interest among scholars and practitioners. However, the bulk of theoretical and empirical stand points are based on studies in developed economies. Given the high rate of corporate failure in Nigeria and the global quest for corporate governance compliance, it has become imperative to empirically investigate how the composition of corporate boards influences the critical decisions of the firm. In Nigeria, such studies are scant based on the author’s knowledge. Thus, this study will act as a spring board for understanding how the total number of non-executive directors promotes or fail to promote the critical decisions of the firm.

The outcome of this study is expected to benefit policy makers, such as government and its agencies, in the formulation of corporate governance codes that will be tailored towards resolving corporate governance problems in our local context, instead of depending on studies from developed economies that may not take into cognizance the peculiar nature of Nigerian corporate environment. This study will also serve as a spring board to academicians that will want to undertake further research along this line, most especially, with regard to Nigeria with paucity of data and literature on corporate governance, especially from an empirical point of view.

1.7         Scope of the Study

This study covered all companies that are quoted on the floor of the Nigerian Stock Exchange. Specifically, there are 35 classification of industrial groups, including foreign listing, emerging markets, and memorandum quotations and 212 firms quoted firms in Nigeria as at 2009 (NSE Fact book, 2009). The study proposes to use 212 quoted Nigerian firms, without excluding any sector.

The data set for the study will include CEO’ total compensation, CEO incentive pay, total number of a company’s unrelated diversification, research and development expenditure, debt component in a company financial structure, number of times any firm has changed its CEO, total number of non-executive directors and total board size.

1.8         Limitation of the Study

A study of this nature, being carried out in the present economic, political and social conditions, is faced with a number of limitations.

Time: Due to the limited time given for the study, the researcher could not get all the required information needed for the study.

Finance: Financial constraint was also among the major constraints that the researcher encountered in the course of this study.

Attitude of the Respondents: Often, most respondents of the different companies were unwilling to cooperate, for fear of disclosing the true position of the company’s activities. Others were apprehensive of the researcher’s intention, suspecting that the researcher may disclose their organization’s secrets to the public.

These limitations notwithstanding, the findings of the research still remain valid

1.9         Definition of Terms

Board of Directors: Companies and Allied Matters Act 1990, defines board of directors as persons appointed by the company to direct and manage the business of the company (section 44). In this study, board of directors is the chief executives, managers and non-executive directors who have control of the company, subject of course to the ultimate authority of the shareholders in a general meeting.

Board characteristics: This is a ratio of non-executive (outside) directors to total board size. It categorizes corporate board members into outside directors and inside directors while placing the analytical spotlight on outside directors.

Non-Executive Directors (Outside Directors): These are board members who are not involved in the day to day running of the company. They only attend board of directors meeting and are paid sitting allowance. Their appointment is supposedly based on their tract records. Amongst the non-executive directors are at least two independent directors who do not have any form of business relationship with the company.

Critical Decisions: Critical decisions of a firm are those decisions that are important to the survival of a firm. Such decisions are taken by the board of directors. These discrete decisions involve potential conflict of interest between the management and shareholders. In this study, the critical decision include; CEO’s total Compensation; CEO incentive pay; firm unrelated diversification; research and development expenditure; debt intensity; and CEO turnover.

Directors: These are board members who are involved in the day to day running of the company. They occupy dual position by function as employees of the company as well as board member. By the dictate of corporate governance laws in Nigeria, these set of directors are expected to be on the minority because they are entrenched and beholden to the CEO.

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Project Topic – IMPACT OF BOARD CHARACTERISTICS ON NIGERIAN QUOTED FIRMS