The Impact of Governance Factors in the Financial Sector: An Investigation of UK Banks Listed in FTSE 100

 The Impact of Governance Factors in the Financial Sector: An Investigation of UK Banks Listed in FTSE 100

Abstract

The study explores the impacts of corporate governance factors on the banks’ financial performance listed in the FTSE 100 Companies Index. The study uses statistical tools to explore the variables in detail and establish a relationship between them under the United Kingdom context. The study uses four corporate governance factors; board composition/independent directors, the board size, CEO duality, and the board’s gender diversity and investigates their influence on the selected banks’ financial performance. The research has used a non-experimental explanatory study to assess governance factors and three firms’ financial performance between 2016 and 2019. The study obtained data from the financial reports and statements posted on the sampled banks. The data were coded and analyzed using descriptive statistics. The study used STATA and Excel to analyze the data. The correlation results showed the board size is positively related to ROE and ROA of the banks listed in the FTSE 100. The results also showed a positive relationship between board diversity and ROE and ROA at a 95% level of significance. The findings agreed with the conclusions of that gender-diverse boards are more cohesive and active. Lastly, they found a positive correlation between financial performance and separation of the office of the board’s chair and the CEO. Organizations should consider the studied variables to improve their performance. Firstly, the board size should reflect the size of the firms. Too big board size is costly, slow, and not cohesive, while too small boards may hardly satisfy their obligations. Banks listed in the FTSE 100 should also involve non-executive directors to enhance unbiased monitoring and control and reduce the conflict of interests. From the study, the banks listed in the FTSE 100 should pay particular attention to their board size, panel composition, diversity, and separation of the CEO and the board’s chair office.

CHAPTER ONE: INTRODUCTION

Background

Corporate governance is one of the critical factors influencing financial performance and banks and other financial institutions. Anwaar (2016) defines corporate governance as the factors that affect the institutional processes, including those that control and regulates the organization of the production and sales of goods and services. According to Mahrani and Soewarno (2018), corporate governance deals with the structures and processes through which firm members actively protect the shareholder’s interests.

The expansion of companies in both the merging and developed nations has increased corporate governance relevance. As the companies grow and expand, they employ the local people, use local raw materials, pay taxes, offer goods and services, and provide other services that benefit society. However, BAYERO (2019) shows that there has been a rise in corporation scandals. These scandals are attributed to “bad” corporate governance mechanisms. According to Kabir and Thai (2017), corporate scandals results incorporate a failure, which consequences can be felt in every aspect of society. For instance, corporate failure leads to job losses and loss of investors’ capital.

Moreover, corporate governance affects influence the interest of other stakeholders, affecting the corporation’s performance. For instance, society may boycott a firm’s products if it is discontented with the firm’s operations.  Consequently, Kabir and Thai (2017) show that companies modify their “usual governance and adopt social social-friendly geared towards satisfying different shareholders.”  Besides, studies have shown that investors are more willing to invest in organizations with better governance structure (Anwaar, 2016). This proves that corporate governance mechanisms affect the financial performance of the organizations.

Companies require investor’s funding to expand their projects. Ahmed and Che-Ahmad (2016) indicate that organizations with suitable corporate governance mechanisms can improve their firm’s value by 10% t0 12%. This results from investors’ investigation of corporate governance mechanisms before committing their funds to the companies. Firms with “undesirable” corporate governance mechanisms struggle to acquire loans.  For instance, before financiers extend loans to the firms, they look at the indicators like audit committees, shareholders, the board size, board duality, and board independence, among other factors related to an organization’s corporate structure. Consequently, organizations are adopting corporate governance mechanisms that are attractive to financiers and investors.

The financial success of organizations relies not only on the innovation, quality of management, and efficiency but also on compliance with corporate governance principles. Palaniappan (2017) shows that conformity with corporate governance standards increases the firm’s internal efficiency and improves its financial performance.  However, insufficient disclosure of the firm’s practices and lack of transparency reduces corporate governance mechanisms’ efficiency. Palaniappan (2017) shows that major corporate scandals and the worldwide financial crises have emphasized the importance of good corporate governance in improving the companies’ economic sustainability and ensuring better performance. The primary role of the administration is to facilitate efficient monitoring and the effective control of the businesses. Palaniappan (2017) shows that corporate governance’s essence lies in transparency and fairness in the firm’s operations and enhancing disclosures aimed at protecting all shareholders’ interests. According to Murwaningsari (2019), the corporate governance structures should enable the firm to make better decisions, hence improving its financial performance. A broader definition by Dzingai and Fakoya (2017) states that corporate governance outlines the relationships between the organization’s management, its board, its stakeholders, and its shareholders. Efficient corporate governance “ensures that corporations take into account the interests of a wide range of constituencies, as well as of the communities within which they operate and that their boards are accountable to the company and the shareholders (Wahudin and Solikhah, 2017)”

Corporate governance outlines the responsibilities of the auditors and the directors towards all the stakeholders. Wahyudin and Solikhah (2017) show that corporate governance is crucial as it increases shareholders’ confidence with the firm, improving the later’s financial performance.  Moreover, Corporate governance improves the firms’ relationship with its stakeholders, including the workers, suppliers, consumers, the external environment, and the community by ensuring that the company behaves responsibly towards the environment and the community. Therefore, safe for ensuring accountability, corporate governance also includes aspects of environmental and social responsibility.

Earlier, good corporate governance was not a compulsory legal requirement, and the companies voluntarily adhered to good leadership. However, Fiori, di, and Izzo (2016) show that due to corporate failures resulting from unethical acts corporate managers, most countries have outlined compulsory guidelines and norms to strengthen the framework of corporate governance. For instance, the United Kingdom outlined the Cadbury Committee Report in 1992. The report was followed by the Sarbanes Oxley Act of 2002 initiated by the united states. These acts acted as the initial development in the development of corporate governance regulations. The Acts were followed by the development of similar laws by other countries.

After the Enron financial crisis in Asia and WorldCom in the USA, Mansur and Tangl (2018) show that the corporate governance focus shifted from the traditional ground, which had agency conflicts to ethical issues like transparency, reporting, accountability, and disclosure. Following high-profile corporate scandals, there has been a public demand for corporate responsibility, triggering the academics, policymakers, and public and private sectors to ensure good corporate governance. For instance, Mansur and Tangl (2018) illustrate that the Sarbanes-Oxley Act was enacted in the united states to ensure that the board of directors adheres to the best practices of corporate governance like honesty reporting and disclosure. Good corporate governance upholds the principles of transparency, accountability, responsible management, and fairness. Addressing ethical corporate governance concerns through decision-making benefits the investors, consumers, employees, and the community.

However, the 2008 financial crisis triggered a debate on whether corporate governance affects (positively or negatively) the organization’s economic performance. This paper analyzes the corporate leadership mechanisms of the banks listed in FTSE100 companies.

A theoretical framework based on stewardship and stewardship theories will help in answering the research questions. The study will use corporate governance aspects like board composition, the executive board’s size, insider shareholder, and separation of roles between the CEO and the board’s chair. The research will use the firms’ return on assets and return on equity to measure performance.

Problem statement

Although numerous studies have attempted to establish the importance of good corporate governance on the organizations’ success, only a few studies have addressed the case of companies in the London stock exchange market, especially the banks listed in the FTSE 100 companies. There is an existing gap in studying the impacts of corporate governance factors on UK banks’ financial performance. This study aims to cover the gap and advise the banks on the advantage of corporate governance factors.

Research Justification

This investigation seeks to investigate the impacts of corporate governance practices on banks’ financial performance listed in the FTSE100 companies. The study overviews the organizations governance practises and their effects on the economic success of the specific organizations. The investigations also review the theories and the empirical frameworks affecting the companies’ financial performance mentioned above.

Study objectives

1. To investigate the effects of board size and independence the performance of UK banks listed in FTSE 100
2. To establish whether there is a connection between gender diversity and banks’ economic success listed in the FTSE 100.

• To determine the impacts of the separation of roles between the CEO and the board’s chair on the banks’ economic success listed in the FTSE 100.

Research questions

1. What are the effects of board size and independence the performance of UK banks listed in FTSE 100
2. Is there a connection between gender diversity and the economic success of banks listed in the FTSE 100.

• What are the impacts of the separation of roles between the CEO and the board’s chair on the banks’ economic success listed in the FTSE 100?

Research rational

Corporate governance practices are crucial tools in the management of big organizations.  Corporate governance includes constitutes of the different mechanisms aimed at improving the efficiency of the firm’s financial performance, including the structure of the ownership, size of the board of directors, the number of shares that can be owned by the largest shareholders, and CEO’s terms of work and remuneration. Therefore, it is necessary to comprehend the particular mechanisms and tools of corporate governance to ensure that the companies attain considerable financial performance results. Moreover, Anwaar (2016) shows that there has been a controversy on whether controlling the incentives and the corporate governance mechanisms improve financial performance. Further, there is a question on whether corporate governance parameters enhance an organization’s profitability when combined with other factors represented by the control variables.

According to Mansur and Tangl (2018), numerous studies attempted to answer the above questions, but the evidence presented was controversial. All studies showed that all the parameters had different influences on the organizations’ financial performance depending on the periods, explored samples, applied analytical method, and the employed variables. Therefore, this study attempts to elucidate the significance of the factors mentioned above in the UK banks where corporate governance practices have been widely distributed. Furthermore, the study employs the most recent data to explore the latest impacts of various corporate governance mechanisms on profitability. Lastly, the research sample includes banks from the FTSE100 index. In the author’s opinion, the United Kingdom’s largest companies (FTSE100) mostly reflect the regulatory power of corporate governance due to the volume of assets and the size of the companies mentioned above and their immense influence on the performance of the financial sector in the United Kingdom.

Structure of the research

The research is based on the investigation of corporate governance factors and their impacts on the banks’ financial success listed under FTSE100 companies. Chapter one of the research covers the introduction of the study’s background, problem statement, the rationale of the study, the study’s aim, reseach objectives, and the research questions. Chapter two explores the theoretical and conceptual frameworks of corporate governance and their effects on the organizations’ financial performance—Chapter three outlines the research methodology, data collection, and analysis techniques. Chapter four includes the data analysis, results, and discussion of the collected data—lastly, chapter five consists of summarizing research findings, conclusions, recommendations, and other research areas.

CHAPTER TWO: LITERATURE REVIEW

Introduction

This section reviews past literature connected to the area of the research. It discusses board composition, the structure of ownership, the other governance factors affecting companies, and their impact on financial institutions’ performance in the United Kingdom.

Theoretical Framework

Several theories form the basis of corporate governance. These theories are outlined in the subsequent sections.

Agency theory

According to Suteja et al. (2017), the principle-agent theory is usually the first point of controversies on corporate governance. According to Nuryana and Surjandari (2019), the modern firm’s main challenge lies in the separation between management and finance. Studies have uncovered that currently, firms suffer from ownership and separation of power, and the administrators (executive managers)  are not accountable to the entitled shareholders in the firms.

Agency theory outline mechanism to eradicate agency problems in the organizations. For instance, Lamichhane (2018) illustrates that the dividends mechanism limits the managerial intention of making overinvestment decisions that are usually financed by the internal cash flow. The executive incentive mechanism remunerates managers for serving the owners’ interests; the bonding mechanism minimizes the managerial moral hazard. This usually happens when the managers are not tied to the bankruptcy risk or the bond contract. According to Sathyamoorthi et al. (2017), the agency theory also outlines other owner’s efforts to reduce the agency cost of equity that usually arises from the moral hazard managers. These efforts include the owners’ intention to select competent and reputable board managers, the threat of firing, the risk of takeover, and direct intervention by the shareholders.

Stakeholder theory

The agency theory is limited in addressing corporate governance issues due to its narrowness. It describes the shareholders in the firms as the major interest groups of the organizations. The theory has become more famous. Many authors have acknowledged that the firm’s activities affect the macro environment, necessitating the firm’s accountability to a wider audience apart from shareholders only. For instance, Li et al. (2017) illustrated that companies are not the interests of shareholders only as they exist within the society; therefore, they are responsible to the community. Furthermore, Li et al. (2017) recognized that economic value arises from a group of people with common goals and objectives who work together to improve everyone’s position.

However, Sathyamoorthi et al. (2017) develop a critique of the theory because it assumes that the firm has a single-valued objective. Felício, Rodrigues, and Samagaio (2016)argue that stakeholders’ gains should only measure their performance. There is a need to consider other critical issues, including interpersonal relationships, information flow from the management to its subordinates, and working environment, among other topics.

Stewardship theory

Stewardship theory is a different management model from the agency theory, and it views managers as stewards whose aim is to serve the interests of the firms (Eisenberg, 2016). Steward theory principles are based on social psychology that addresses the executives’ behavior and conduct. Galal (2017) shows that steward behavior is collectivist and pre-organizational, with a higher utility relative to individualistic behavior. Moreover, the steward theory shows that stewards seek to achieve the objectives of the organization. Kota and Charumathi (2018) show that stewards balance the tensions between different interest groups and beneficiaries.

Moreover, stewards suggest a positive correlation between firms’ financial success and the managers’ excellent conduct. Basing on the theory, managers maximize the shareholder’s wealth, therefore improving an organization’s performance. According to Sobhy, Ehab, and Hussain (2017), stewards who successfully enhance a firm’s performance satisfy most of its stakeholders’ interests. Consequently, when stewards meet all stakeholders’ interests, they reduce the organization’s conflicts and tensions, hence improving its wealth.

When one person holds both the chief executive officer’s position and chairperson of a board position, then the power to determine strategies and fate relies on that person. Alatassi and Letza (2018) show that the stewardship theory supports a single person’s appointment for both positions and shows that the holders of the respective positions should seek to empower their subordinates and other stakeholders rather than monitoring and controlling them.

Lastly, the steward theory shows that to improve a firm’s performance, the organization should empower its managers and facilitate them with necessary instruments to achieve the organizational goals.

Resource development theory

The resource development theory is founded on the belief that the environment is the source of finite resources. The firms depend on scarce resources to run their operations efficiently and effectively. Improper control of the limited resources causes uncertainties among the firms operating in the respective environments.  According to Kanungo and Nayak (2017), firms must devise ways to benefit from these resources for their survival. The resource development theory indicates that the key to organizations’ success lies in its ordering capacity and resources (Zuva and Zuva, 2018). Therefore, good governance is an essential mechanism for mitigating critical aspects of environmental uncertainty in an organization.

The resource development theory further implies that the organizations’ corporate boards will reflect on their environment. The organizations should choose those directors to ensure the maximum provision of crucial resources for the firm.  The theory finally provides that the board of directors should constitute directors from diverse backgrounds to ensure that the organization can tap resources from the respective directors and improve its performance.

The theoretical perspective of Corporate Governance

The Board of Directors is a critical stakeholder in the management of organizations. Due to the significance of the BODs in the governance mechanisms, BODs have increasingly become responsible for the organization’s performance. Consequently. Most studies from diverse fields such as finance, economics, sociology, strategic management, law, and organizational theory focus (Bods Mandivhei 2019). According to Irawati et al. (2019), a firm’s performance depends on the degree of effectiveness of the Board of Directors’ roles.  Bansal and Sharma (2016) assert that these roles are numerous and essential.

Jemal (2019) shows that the directors’ significant duties are service, control, and resource dependence roles. First, service roles involve formulating initiating strategies and advising the executives on critical decisions of the firms. On the other hand, the resource dependence roles view the BODs as the facilitators of acquiring materials crucial for the organization’s success. Finally, the control role involves BODs monitoring managers, determining the executive’s remuneration, and hiring and firing executives.

Researchers have employed various theories, mostly the agency theory, to study the BODs. The Agency theory assumes that the BODs influence the opportunistic traits of the managers. Therefore, the BODs primarily control the systems in favor of the interests of the company’s shareholders. Bansal and Sharma (2016) argue that the board’s composition is critical for monitoring the managers and minimizing agency costs. Bansal and Sharma (2016) show that despite the executive directors having expertise, valuable knowledge, and specialized skills, independent directors need to bring new objective and independent ideas to the respective fields. Thus, agency theory suggests the need for external directors in a firm to oversee any self-centered manager’s interests and reduce agency costs (Esteban et al., 2017).

According to Suttipun (2018), BODs that consist of more than eight members in a firm tend to be defective. The board of directors’ large size reduces the effectiveness of coordination, decision-making, and communication, and they are most likely to have the CEO’s influence. Esteban et al. (2017) also assert that large boards are less cohesive and challenging incoordination, as there might numerous interactions and conflicts among members. Additionally, Esteban et al. (2017) show that CEOs usually make large BODs as the large boards enhance the dispersion of members’ power in the boardroom.

The resource dependence framework’s inherent goal is to maximize the interaction between the firms and the environment. Bansal and Sharma (2016) show that organizations need to access environmental resources as the vital issue of survival under the resource development theory’s scope. The resource development theory views organizations as open systems dependent on the other firms to provide necessary resources Li et al., (2017). According to Fiori, di, and Izzo (2016), the assumption holds that an organization’s financial success depends on the firm’s influence on the macro factors. BODs mainly administer the external dependencies of firms (Felício, Rodrigues, and Samagaio, 2016).

Corporate governance framework

Li et al. (2017) described corporate governance as systems that provide principles and guidelines to enhance appropriate execution of the executive responsibilities, satisfy the shareholders, and eliminate the challenges emanating from the moral hazard. It is worth noting that a unified and global corporate governance standard is not achievable. Bansal and Sharma (2016) show that institutional diversity characterizes corporate governance in European countries, including the United Kingdom.

The Size of the Board

The board of directors is a critical stakeholder in organizations, and they monitor the manager’s behaviors and advise the executives accordingly. With an increase in the board of directors’ size, there is a decline in the board’s efficiency and effectiveness. According to Esteban et al. (2017), the reduction in the efficiency emanates from the increased cost and difficulties in decision making, communication, and coordination on large groups.

They are limiting the board size to the optimum increase in the performance of an organization. Ahmed and Che-Ahmad (2016) show that the benefits emanating from the increased monitoring in large boards are outweighed by cumbersome decision-making and poor communication.  Researches on board size have a similar conclusion; a large board is defective in decision-making and more exposed to the CEO’s control.

Board composition

Moreover, the composition of board is a significant factor in governance and affects the firm’s routine operations hence generally affects the performance of organizations. Boards usually comprise of non-executive and executive directors. Anwaar (2016) argues that executive directors in a firm are dependent, and the non-executive directors should be independent. According to Fiori, di, and Izzo (2016), the board of directors should consist of at least a third of independent members to ensure unbiased control and effective monitoring. Suteja et al. (2017) show that they are essential in running an organization since they have the firm’s insider knowledge, unlike the non-executive directors; however, they can misuse the background and manipulate the organizations or transfer the wealth of other stakeholders to themselves. Effective boards should have members who are not the company’s shareholders or relatives to other board members to reduce conflict of interests.

A board with independent directors comprises of individuals with no association with the organization. The Independent panel has minimum chances of conflicting with the owner’s interests since the members have no material interest in the respective organizations. Moreover, Nuryana and Surjandari (2019) show that independent directors are essential in running a firm since the dependent or the executive directors may not have outside information that may be crucial for the firm’s benefit. Furthermore, independent board members are more efficient in advising the CEO as they are appointed on the board for the same reason, unlike the dependent who are employed in the organization for diverse reasons (Nuryana and Surjandari, 2019).

According to Esteban et al. (2017), board composition does not affect a firm’s financial performance. The finding resembled those of Li et al. (2017), who reported no connection between the board management and the firm’s performance. However, the research established that the independence of the board enhanced the board’s efficiency. Furthermore, Ahmed and Che (2016) reported that corporate boards dominated mitigates the agency problems through proper monitoring of the behavior of the managers of the firms.

However, the finding of past studies on the connection between the composition of the board and firms’ financial performance is inconsistent. Suteja et al. (2017) and Sathyamoorthi et al. (2017) found a positive correlation between the performance of a firm and board composition. For instance, Wahyudin and Solikhah (2017) and Nuryana and Surjandari (2019) reported an association between the executive’s ratio to non-executive directors and the financial performance of a financial institution. Bansal and Sharma (2016) further showed that an increase in non-executive directors’ numbers increased the firm’s performance in return on assets (ROA). Contrary, Esteban et al. (2017) found that outside directors harm the firm’s performance.

Li et al. (2017) reported a negative association between the increase in board independence and its value. However, Nuryana and Surjandari (2019) and Mansur and Tangl (2018) reported no significant connection between the board’s composition and its value. Based on the inconsistencies and the agency theory’s light, this study seeks to test whether the two variables are correlated.

Some studies argue that a higher proportion of non-executive directors in the firm’s boards reduces an organization’s agency cost. Mahrani and Soewarno (2018) and Jemal (2019) supports this notion by indicating that the increase in the proportion of the eternal directors in the corporate board reduces the negative impacts between an organization’s investment opportunities and the financial performance. However, Bansal and Sharma (2016) dispute the relationship by stating that between the external board member’s representation and the board performance. On the other hand, Fiori, di, and Izzo (2016) found a negative association between the external board members and the organization’s financial performance.

According to Dzingai and Fakoya (2017), a small corporate board has a higher market value. Furthermore, based on an event analysis, Li et al. (2017) assert that external directors’ appointment increases a firm’s value. This study also seeks to establish the relationship between the variables and advise the banks accordingly due to the contrasting findings on the effects onboard composition and the banks’ financial performance.

According to Outa and Waweru (2016), liberalization and globalization of the financial markets, corporate scandals, transparency of the organizations, and the increased demand of accountability by the stakeholders made the tasks and the roles of BODs the central aspect of the corporate governance debate. Suteja et al. (2017) show that BODs have various essential functions, including controlling the organization, ensuring service delivery, and devising a corporate strategy. The realization of the roles mentioned above relies on the boards’ features, which influences a firm’s performance.

This study concentrates on investigating the effects of the board composition, measured in terms of outsider director, affiliated director presentation, and insider director on the firm’s performance of the banks listed under FTSE 100 companies. BOD is undoubtedly the major decision-making organ of the firms listed in FTSE 100, and they are responsible for the performance of the respective organizations.

Gender diversity

Researchers have recently started investigating gender diversity’s impacts on corporate governance and financial performance (Salim, Arjomandi, and Seufert, 2016). Zhang, Chong, and Jia (2019) established a significant positive relationship between the board diversity (in terms of the ratio of women or/and minority races composition in the corporate board) and the organizations’ financial performance. Using data from US corporate firms, Orazalin, Mahmood, and Lee (2016) found that organizations with gender-diverse boards meet more frequently and give more pay-for-performance to the directors, improving the financial performance of the specific banks. Notwithstanding the above findings, there are limited empirical studies on the relationships between gender diversity and organizations’ financial performance. One of the reasons leading to limited studies on the above variables is the lack of a well testable theory involving the two variables. There is a need to study the influence of diversity on corporate performance and advice the respective firms accordingly.

Transparency and disclosure

Transparency is a crucial aspect of corporate governance. Nuryana and Surjandari (2019) show that transparency minimizes the information asymmetry between the financial stakeholders and the organizations’ management, thereby reducing the agency challenge in corporate governance. According to Sathyamoorthi et al. (2017), transparency in the banking context is broad. It refers to the quantity and the quality of information concerning the bank’s risks and its previous, current, and plans, actions, and decisions.

Insider shareholding and firm value

The primary argument to solve the challenge of the agency involves the use of insider shareholders. Several studies (Esteban et al., (2017), Li et al. (2017), and   Mansur and Tangl (2018)) have explored the influence of the insider shareholder on the reduction of the agency problem. However, the studies reported very conflicting results. For instance, Fiori, di, and Izzo (2016) found a significant relationship between the insider shareholder and the firm performance; Suttipun (2018) reported that there is a meaningful relationship between performance and ownership, while Felício, Rodrigues, and Samagaio (2016) did not find any linear relationship between the variables mentioned above.

The role of debt

Studies have linked debt owed to large creditors with the reduction of the agency problem. Anwaar (2016) shows that large creditors, just like the stakeholders, are interested in seeing the corporate management take performance improvement measures. For instance, Outa and Waweru (2016) found higher incidences of management turnover in Japanese firms in response to low performance in organizations with a principal bank relationship compared to those that do not. However, Mansur and Tangl (2018) show that another debt agency, another type of agency problem, arises when the conflict of interest emerges between the debt holders and the stockholders.

Financial performance in financial institutions

Financial soundness occurs when the banking system is stable, securing the depositor’s funds. Ahmed and Che-Ahmad (2016) show that whether a financial institution’s financial stability is unsatisfactory or strong varies from a bank to another. The external factors, including homogeneity of the bank businesses, lack of information by customers, the connection among financial institutions, and deregulation lead to bank failure. The camel framework constitutes of some useful measures to ensure financial performance as outlined below:

Capital Adequacy: Murwaningsari (2019) shows that capital adequacy influences how well an institution can cope with shocks to their balance sheet. The banks monitor their capital adequacy using the ration set by the banks for the global settlement. According to Nuryana and Surjandari (2019), banks measure their capital adequacy based on the relative risk weights assigned to various assets held off and the balance sheet items.

Asset quality: When a bank’s assets become impaired, they expose the bank’s solvency at risk. In response, banks are required to monitor the indicators of the quality of their assets in terms of exposure to certain risks. Mansur and Tangl (2018) show that credit risk is inherent in lending – which is the primary banking activity- and it arises when the borrowers fail to meet their obligations. Banks should monitor such risks to enhance their positive financial performance.

Earnings: Banks and other financial institutions’ sustainability depends on their abilities to earn adequate returns from their capital and assets. Nuryana and Surjandari (2019) indicate that good earnings performance enables a bank to remain competitive, expand its operations, and increase its capital base.

Liquidity: according to Sathyamoorthi et al. (2017), initially performing banks and other financial institutions may close due to low short-term liquidity management. Liquidity indicators need to contain funding sources and capture significant maturity mismatches. Bansal and Sharma (2016) indicate that an unmatched position may increase profits, but it also magnifies the risk of losses.

Measurement of financial support variables

Most studies acclaim that effective corporate governance improves a firm’s financial performance. Despite the widely accepted belief that good corporate governance improves a firm’s financial performance, some studies have established negative relationships between organizations’ financial performance and corporate governance. Bansal and Sharma (2016) have not found any connection between Mahrani and Soewarno (2018) variables. Researchers have given several explanations to account for these inconsistencies. Some researchers have argued that these inconsistencies emanate from the use of surveys or publicly available data as these sources are usually limited in their scope. Moreover, some have argued that the nature of performance measures could contribute to these inconsistencies.

Furthermore, BAYERO (2019) observes that “theoretical and empirical literature in corporate governance considers the relationship between corporate performance and ownership or structure of boards of directors mostly using only two of these variables at a time.”   For instance, Dzingai and Fakoya (2017) studied the relationship between board composition and financial performance while Wahyudin and Solikhah (2017) studied the correlation between managerial ownership and its performance.

To address the problems mentioned above, Sathyamoorthi et al. (2017) recommend that studies take a multivariate approach when testing the correlation between the firm’s governance and financial performance.  This study adds to the literature body by applying accounting-based and market-based performance measures like Tobin’s q and return on assets to test the correlation between the selected governance variables. Besides the board characteristics, the study will incorporate the intensity of the board activity, the audit committee activities, and the institutional shareholding features to explore governance. The study will combine the publicly available data and a survey to widen the governance variables’ scope.

Empirical studies on the effects of corporate governance on bank performance

studies have established causalities between the corporate governance factors and the organizations’ financial performance. However, some studies have shown a strong relationship, while others have found very weak connections between the variables mentioned above.  Similarly, Li et al. (2017) account that empirical evidence supports the hypothesis that large shareholders actively monitor the firms, and direct monitoring by the shareholders boosts firm performance.

Additionally, surveys of corporate governance by Esteban et al. (2017) and Fiori, di, and Izzo (2016) found that control is valued, which would not be the case if the large shareholders or block holders received similar benefits with the investors. Therefore, despite direct shareholder being an adequate substitute for compensation incentives, the institutional investors and the board’s monitoring is weak monitoring devices that should not be used as substitutes for direct monitoring.

In investigating the relationship between corporate governance, ownership, and banks’ economic performance, Dzingai and Fakoya (2017) reported that the regression results demonstrated some significant but economically irrelevant connection between corporate governance and operating performance. Another study by Felício, Rodrigues, and Samagaio (2016) examined the relationship between risk management, corporate governance, and Indonesian banks’ financial performance. The study found that bank ownership influences corporate governance and risk management. However, the study did not establish any linear relationship between corporate governance and bank financial performance.

Reliability of financial reporting

The reliability and accuracy of the management’s financial reports affect the investors’ and other stakeholders’ perceptions.  Safe for the experience of banks listed in FTSE 100 in the London Stock Exchange Market. Irawati et al. (2019) show that the stakeholders perceive the public listed financial firms’ financial reporting as more credible and transparent due to their subjection to more rigorous and stiffer scrutiny than the private companies. Due to inadequate scrutiny, Sathyamoorthi et al. (2017) argue that it is difficult to assure corporate governance’s financial reporting role in private organizations. External auditors and audit committees are the critical tools for ensuring the financial reporting corporate governance variable. However, there is limited empirical evidence around the variable, as mentioned above.

Existence of code of corporate governance

Ahmed and Che (2016) show that the increasing concerns over institutionalizing corporate governance mechanisms in banks and other financial institutions have led to the formulation of governance codes by voluntary industry associations and the regulatory agencies. However, clear evidence of what extent these UK banks listed have adopted the regulations mentioned above is or developed their firm-specific governance polices is still unknown due to the available data limitation.

Audit committee

The results of Kabir and Thai (2017) and Mansur and Tangl (2018) demonstrated the presence of a strong connection between the audit committees and the performance of the financial institutions. However, Nuryana and Surjandari (2019) found no significant association between the variables mentioned above. There is a need for more profound research to establish consensus on the relationship between audit committees and performance.

Board size

Research findings have agreed on the argument that there is an association between board size and financial performance. However, they are conflicts on whether it is a large or small board that is more efficient. For instance, Sathyamoorthi et al. (2017) found the Tobin’s Q reduces with a decline in board size while Bansal and Sharma (2016) and Mansur and Tangl (2018) showed that small boards were associated with higher performance. Besides, Outa and Waweru (2016) indicate that large panels are related to a positive influence on the shareholders’ wealth compared to smaller boards.

Separation of office of CEO and Board chair

Separation of the CEO’s office and the board chair aims at reducing the agency costs of a firm. Anwaar (2016) found a significant positive relationship between financial performance and the CEO’s separation and the board chair’s office. Kabir and Thai (2017) also reported that the firms were more valuable when they disintegrated the offices mentioned above. Furthermore, Ahmed and Che (2016) found that large independent boards improve the firm’s performance. The fusion of the CEO and the board chair’s office reduces the organization’s performance as it gets less access to debt finance. According to Ahmed and Che (2016), boards independent from the CEO’s influence are more reliable for monitoring the organizations’ financial process, improving the firms’ value.

Conclusion

In summary, studies have not consented to a general relationship between corporate governance and financial performance. However, empirical evidence demonstrates that, generally, the corporate ownership structure significantly influences economic performance. Moreover, weak corporate governance reduces the organizations’ financial performance (Li et al., 2017)

In general, corporate governance literature constitutes attributes like disclosure, trust, and transparency, among others. Further, disclosure and financial transparency enhance trust between the organization and the stakeholders, hence improving its economic performance. Capital adequacy, liquidity, and earnings are critical dimensions for assessing the financial performance of the banks. In conclusion, this literature forms the foundation for establishing the relationship between economic performance and corporate governance.

CHAPTER THREE: RESEARCH METHODOLOGY

Introduction

This section discusses the research design, the study population, sampling methods, data collection procedures, data collection tools, data analysis, and the study limitations

Research design

This research uses a non-experimental explanatory design to assess the impacts of corporate governance factors on banks’ financial success listed in the FTSE 100 companies. Fiori, di, and Izzo (2016) show that the explanatory research aims at establishing causal relationships between variables. According to Li et al. (2017), a descriptive non-experimental analysis is significant when the study tries to “explain how a phenomenon operates by underlying and identifying factors that cause a change in it when there is no manipulation of the independent variable.”

 Populations

The target population is the specific population of which statistical information is required. Jemal (2019) defines the population as a set of elements, services, events, groups of things, households, or people being studied. The study population constituted all seven banks listed in FTSE 100

Sample

The banks had to meet two conditions to be part of the sample of this study. First, the banks had to be part of the companies listed in the FTSE 100 companies index. Secondly, the annual reports of the banks had to be available to source the data.

The following seven banks were listed in the FTSE 100:

2. Standard Chartered.
3. Alliance & Leicester.
4. HSBC Holdings.
6. Royal Bank of Scotland.
7. Lloyds TSB Group.

However, the financial statement and reports of four banks were not available. Only three under-listed banks satisfied the second condition.

2. Royal Bank of Scotland.
3. HSBC Holdings.

The four banks that failed to meet the second condition were cut off from the study. The study analyzed the four banks’ data that met the two requirements for the period between 2016-2019, giving a combined total of 12 years.

Data collection procedures and instruments

The investigation utilized secondary data to assess the association between governance and bank’s economic success. The study obtained the data from the statements and reports published by the sampled banks.

Data collection procedures and instruments

The inclusion of data from a recent period would have been better; however, there was in the availability of data of all periods for the current period, compelling the study to use the period’s full available data between 2014-2018. The data collected included the number of internal and external directors, the number of male and female board members, and the CEO duality. The financial data included net income, total assets, and shareholders’ equity.

Data presentation and analysis

The independent valuables of the research were assessed in terms of decision making and board size/structure. The board’s roles were quantified in resource access, strategy, counsel, monitoring, and control. The study used risk management, committees, delegation, knowledge, and skills to measure boards’ effectiveness. The dependent variable constituted financial performance variables. The study measured the dependent variables in terms of return on assets and returned on equity.

The efficiency-value of money- was a proportion of actual revenue relative to actual expenditure. The study used a narrative approach of data analysis to provide insights into the corporate governance factors and their influence on the sampled banks’ financial performance.

The study utilized the panel multiple regression analysis and multiple regression. The investigation involved coding and analyzing the collected data using descriptive statistics to describe all variables using SPSS. The data coding involved reading through the financial reports and the selected banks’ statements to extract relevant information based on the pre-determined corporate governance indicators. The study used visual representations like graphs and charts to present the research findings. The graphical representation provided patterns that aided in identifying the trends.

Besides, the study used a regression model to assess the relative importance of each of the variables relative to financial performance. Esteban et al. (2017) assert that the regression model is used because of its ability to assess the nature of influence on the dependent variables by the independent variables.

Variables of the bank performance

Anwaar (2016) indicates that organizations’ performance I the primary objective of the shareholders’ interest. This study applied Return on Equity and the return on assets as the bank performance variable due to their relevance to the shareholders’ investment.

The return on the equity indicates the ratio of the organization’s profit relative to its total amount of the shareholder’s equity, and it is calculated as follows;

ROE = NI/ SE where

ROE represents the return on equity

NI represents the net income of the bank.

SE represents the shareholders’ equity.

According to Anwaar (2016), a firm with a higher return on equity has higher chances of generating cash internally than an organization with lower returns on equity.

The return on assets is the represents the ratio of the bank’s profit relative to its total assets, and it was calculated as follows;

ROA = NI/ TA where

ROA represents the return on assets

NI represents the net income of the bank.

TA represents the total assets.

Bank performance equation

The separation between the management has led challenges within the financial institutions due to the conflicting interests between the manager and the owners, necessitating a finding of the consensus to end the conflicts. Ahmed and Che (2016) show that studies have shown the need for organizations to adopt corporate governance mechanisms that reduce the disputes mentioned above to improve the firms’ financial performance due to the financial crisis.

The study formulated the performance equation as follows:

ROE= β0+β1 BS + β2 BC + β3 GD+ β4 CD + ε

Where:

BS: Board size

BC : Board composition/independence

GD: Gender diversity

CD: CEO duality

ε: Standard Errors

CHAPTER FOUR: DATA ANALYSIS AND INTERPRETATION.

 Introduction

The Chapter presents an analysis of the findings from the research conducted. The research established the financial performance of banks due to the effect of corporate governance. The study period covered in the study was from the year 2016-2019.

Descriptive statistics

The impact that corporate governance has on banks’ financial performance is extensively explained in this section. The test for various variables using ANOVA from the banks identified variables are board size, board independence, BGD, and CEO duality.

Table 4.1:  Descriptive Statistics

The table presents secondary data obtained drafted in the report showing financial performance from 2016 to 2019  of banks listed under the FTSE100 companies’ index of London stock exchange. The data collected was the Return on Assets calculated as percentage income returned of the total asset, the Return On Equity calculated as the net revenue returned in the capital employed percentage. Board size was quantified to the total number of directors of the indicated banks. The percentage of women on board in banks identified gender diversity; the non-executive directors identified board independency. Simultaneously, CEO Duality represented the dummy variables since, in some banks, the CEO and the chairperson might be one person.

 Impact of Board size, Board Independence, CEO Duality, and  Board Gender Diversity on ROA.

4.4.1 Correlation Analysis through Pearson formula.

Pearson correlation was analyzed was conducted to evaluated state the linear relationship between variables of research. This model determines the strength of the association of variables to the financial performance of the banks.

Table 4.2: Correlation matrix ROA

The result obtained in the table above are as follows: the correlation between ROA and the board size is relatively positive since a correlation of 0.08268 is identified after the correlation was determined, a negative correlation exists between Return On Asset and Board Independence since a figure of  -0.951 was obtained which explains a  negative correlation, Board Gender Diversity indicated a positive impact on the ROA since a correlation of +0.6024 was determined, and CEO duality negatively affect the ROA, since it showed a negative correlation of  -0.32462 hence Implying a poor relation between CEO duality and ROA of banks listed under the FTSE100 companies’ index of London stock exchange.

The result supports the finding of (Chopra 2007), which stated that it would lead to the financial institutions’ and entities’ poor performance if the board is more diversified. Also, finding the Board Independence is broadly diversified, leading to banks’ poor performance listed under the FTSE100 companies’ index of London stock exchange.

Data analysis

Data analysis involves transforming, cleaning, and modeling data to get the information used in a business entity’s decision-making. This is because the result in the data analysis will be based on making decisions.

Table 4.3 Test for significance.

From the summary above in table 4.3, the P-value is 0.002, which is much less than 0.05 significant level; hence, the null hypothesis is accepted since there is no systematic difference. This means a correlation between the bank’s financial performance listed under the FTSE100 companies’ index of London stock exchange and the predictor variables; therefore, this model should be used for analysis. Since the P-value is less than 0.05, then the model suit interpretation.

Table 4.4 ANOVA’

ANOVA tested the research data to experiment weather the findings are significant or not.

With the significant level being 0.91287, it indicates a 91% relationship of variables, and at a 5% level of significance, the model is much greater; hence the null hypothesis is accepted.

A simple correlation of R= 0.40824 implies a low correlation of the variables. The dependent variable’s total variation is R ² =0.166667, which indicates that 16.67% of correlations exist between variables.

The impact that Board size, Board Independence, CEO Duality, and Board Gender Diversity on ROE.

Table 4.3: Correlation Matrix ROE

The research found a positive correlation coefficient found in board size on Return On Equity, which is 0.770208, and the negative correlation of board independence on Return On Equity. Since its value is a negative figure of -0.56891, board gender diversity also affects the return on equity positively weak since it indicates a value of 0.277174. In contrast, CEO duality affects the return on equity relatively negative with a figure -0.96396. Therefore, the return on equity is determined mostly by the board size and board gender diversity. There is no systematic correlation of the variables; hence the null hypothesis should be rejected under this situation.

4.5.1 Graph 1: Impact of Corporate Governance on the ROE

The above graphical representation of the banks’ financial performance listed under the FTSE100 companies’ index of London Stock exchange and whose annual reports are published on data sources. The Return On Equity through the effect of other corporate factors such as board size, board gender diversity, board independence, and CEO Duality. The board size has a more significant impact on the banks’ performance than variables, which tend to have a smaller margin on the influence of banks’ performance. Higher bars represent higher financial performance on the return on equity.

4.5.2 Graph 2: Influence of the Corporate Governance on Return On Asset of the banks listed under the FTSE100 companies’ index of London Stock exchange and whose annual reports are published on data sources.

From the above graph, it is clear that the Return on Assets of banks’ financial performance is listed under the FTSE100 companies index of the London Stock exchange and whose reports are published on data sources annually. The board size has been positively influenced, which means that large board size leads to higher Return On Assets. On other factors, they also affect the return on assets relatively positive at a lower margin and, therefore, need to improve the corporate aspects.

 Finding interpretation

The study’s objective was to determine the effect of corporate governance on the banks’ financial performance listed under the FTSE 100 companies index on the London Stock exchange and whose annual reports are published on data sources.

The Board Size

Board size had a positive association on Return On Asset also on Return On Equity, i.e., 0.8261 and 0.770208. The banks listed under the FTSE100 companies’ index of London Stock exchange reports are published on data sources. This will enhance the return on equity positively. The result also states that the most efficient board is the one with small board members since they can easily monitor its management. From the findings, the ROA and ROE decreased when board size increased. When the board size increases, it led to a decline in the bank’s value. The board size also determines the complexity of the bank’s working environment. Though a large board size increases the quality of the decision, it is also likely that most members of the board might not involve in the decision-making process hence becoming challenging to make a strategic change (Zajac & Golden, 2001).

Board independence

A high ratio of independence board directors is related positively to return on asset and return on equity of banks listed under the FTSE100 companies’ index of London Stock exchange and whose annual reports are published on data sources. The board’s independence has a weak correlation with the ROA and ROE since it indicates a negative value of -0.95093 and – 0.56891. Hence, it implies that board independence needs to be adjusted to suit the banks’ running and performance.  Due to the increase of the board members’ independence, the promotion of ROE and ROA of the banks is enhanced.

4.6.2 Board of Gender Diversity

The most significant gender is the female gender at a 95% level of confidence. There existed a good relationship between Return On Asset. When female board members were promoted, it led to an increase in return on assets systematically. From the research, when women are promoted to director level, the banks’ performance increased as women are seen to be keen and ask questions rather than just nodding their heads. This is outlined from the test of the data findings were the board gender diversity was recorded to have influenced Return On Asset and Return On Equity with figures: 0.602464 and 0.277174, which are all positive figures making women more comfort people for directorial duties.

CEO Duality

The CEO duality relatively affects the return On assets and Return On Equity since a negative result was obtained from the research findings, which was -0.3246 on Return On Asset and -0.96396 on Return On Equity, indicating a negative relationship. Therefore, the Duality of the CEO’S influence the performance of the banks listed under the FTSE100 companies’ index of the London Stock exchange and whose annual reports are published on data sources. The finding from the research showed that the higher managerial officers would improve the efficiency of their work, and it would be the monitoring mechanism of the higher post in the banks.

.

CHAPTER FIVE:  SUMMARY, CONCLUSION, AND RECOMMENDATION.

 Introduction

This Chapter contains a summary of research findings, conclusions, policy recommendations, and future research areas. The research aimed to determine the influence that corporate governance has on banks’ financial performance listed in the FTSE100 companies’ index of the London Stock exchange. Their annual reports are published on data sources that covered four years, i.e., from the year 2016 to 2019.

The findings summary.

The reason for the research was to identify the correlation that exists between Board Size, Independence and Gender Diversity, and CEO Diversity against the Returns On Asset and Return On Equity. The ROA and the ROE represent the banks’ financial performance listed under the FTSE100 companies’ index of the London Stock exchange and whose annual reports are published on data sources. The analysis explains that at a 5% significance level, i.e., the P-value on the model is less than 0.05, which means it causes variation in the Return On Assets and Returns On Equity. Board Size indicated a positive correlation on the Return On Assets and the Return On Equity of banks listed under the FTSE100 companies’ index of London Stock exchange and whose annual reports are published on data sources. The positive change on board size, similarly influenced the Return On Asset and Return On Equity systematically; this is expressed in the analysis model. The correlation matrix results state that if the ratio of the independence of board members had a positive relationship on the Return On Assets and the Return On Equity. Then, there existed a positive correlation on female board directors’ promotion of the asset’s return since it was seen when female board members increased the banks’ financial performance. There were some aspects detected from CEO’S Duality, which also had a positive effect on financial performance, i.e., ROA and ROE, of the banks listed under the FTSE100 company Stockmembers’ independence and whose annual reports are published on data sources.

Conclusions

The investigation concludes that an increase in the board size decreases the performance of a financial institution. The board size reduces the effectiveness of the communication, cohesiveness, and decision-making process of an organization. Therefore, an increase in board size reduces the efficiency and the performance of banks listed in the FTSE 100.

Salim, Arjomandi, and Seufert (2016) found that the increase in board composition (non-executive directors) is positively related to the return on assets (ROA) and return on equity (ROE) of the banks listed in the FTSE 100. An increase in the number of external directors increases a financial institution’s performance since they effectively monitor the corporate managers.

The study also reveals that corporate board gender diversity has a positive association with ROE and ROA. An increase in board diversity (proportion of women to men) led to a rise in the financial variables mentioned above.

Concerning the effects of CEO duality on the listed banks’ financial performance, the study established that several aspects of the separation of the board’s chair and the CEO’s office positively influenced economic success. The study concludes that the separation of roles between the office of the chair and the CEO is essential in enhancing a firm’s financial performance.

Policy recommendations

Based on the findings, the study recommends that the listed banks and other financial institutions’ stakeholders consider corporate governance factors when electing board committees. These factors include the board size, board independence, and the ratio of the gender of the appointees. A board should have an optimum size, balanced in terms of gender and freedom to reduce conflicts among the stakeholders and improve financial performance.

Banks should be considerate of the board size when appointing board members. The board size should not be too big to reduce the cohesiveness between members and the effectiveness of communication and decision-making processes. However, the board size should not be too small to the extent that it does not satisfy its obligations. Board size should always reflect the size of the firm.

Concerning gender diversity, when selecting board members, the stakeholders should ensure the boards comprise women and the minority groups in terms of race and other factors. Having diverse boards ensures cohesiveness and increases board meetings’ frequency, hence expanding the board’s effectiveness. The increase in the effectiveness of the board enhances the financial performance of the board.

Corporate boards should also comprise of a significant number of non-executive board members. The study reveals that higher board composition reduces tensions and conflicts of interest, hence improving its financial performance. Besides, the study found non-executive directors enhance monitoring and control of the organization.

Lastly, the study suggests the separation of roles between the office of the director and the office of the CEO. The separation of functions between the two positions enhances proper monitoring of the organizations’ activities, hence improving an organization’s performance. Besides, the study found that CEOs in the firms where the board’s chair’s office are different are more likely to consult the relevant parties when making decisions rather than making them own. Proper consultation improves the quality of the decisions made, hence enhancing the performance of a firm.

 Limitations of the study and areas of further research

Safe from governance factors, financial institutions’ financial performance is also affected by economic factors like interest rates, inflation, and the level of the stock exchange market rates. Therefore, investigating the effects of corporate governance on the banks’ economic success listed in the FTSE 100 would have been more comprehensive if other factors influencing the financial services were considered.

The secondary data also reduced the effectiveness of the study. The analysis would have better if primary data were used to complement the secondary data. The use of primary and secondary data would ensure a better estimation of the impacts of the corporate governance factors on the financial sector.

The limited amount of time also limited the scope and depth of the research. The investigation would have been more in-depth if enough time was available to collect primary data using interviews and questionnaires.

Despite the limitations, the study established the association between different governance factors and the banks’ financial performance listed in the FTSE 100. In the future, researchers should carry out a similar study on other banks not listed on the FTSE 100. Future studies can also conduct the effects of governance factors on the banks’ financial performance recorded in the FTSE 100 using different variables. Furthermore, researchers should perform a comparative study on the impact of governance factors on the banks listed and unlisted in the FTSE 100.

Moreover, future studies should conduct similar research using both primary and secondary data to assess if they can establish any difference with this study. Future studies should also address the factors that increase corporate governance’s contribution to the performance of banks listed in the FTSE 100.

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