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Running head: CORPORATE OWNERSHIP 1
The Impact Of Corporate Ownership On The Firm Performance In Nigerian Companies
CORPORATE OWNERSHIP 2
The Impact Of Corporate Ownership On The Firm Performance In Nigerian
Companies
Literature Review
Theoretical Framework
The underlining theory for this dissertation will be the agency theory. According to
Eisenhardt (1989) Agency Theory describes the relationship between principal and agent/s by
using the metaphor of a contract. As per the views of Eisenhardt agency theory is one that
suggests a relationship between the shareholders (or principals) and the management of
companies (executives). Shareholders are the ones who supply capital to the company
whereas management or the executives are the ones who spend the capital in such a way that
the company earns the profits expected by the shareholders. In short, both shareholders and
the management plays vital role in helping the company in developing in the right direction.
Agency theory is aimed to resolve any problem that can occur between the agent and
the principle, primarily because their goals and objectives might be entirely different. In the
context of corporate structure agency theory helps understand whether the shareholders that
own a significant part of the company are using their power to run the company without the
help of the agent. For example, in a study it was said that the CEO also acted as the chairman
and there was more than one of the same family member that had a place on the board, as a
result of this it had an adverse impact of the firm performance (Ehikioya, 2009). When more
than a member of the same family presents in a company board, the interests of that family
may get more importance rather than the interests of the company or the shareholders.
Furthermore, when a major shareholder acquires a firm, the concentration of
ownership on a particular individual may result. As a result of that the agency cost may
decrease (Ehikioya, 2009). Therefore, it is better for a company to have directors from
different families. Moreover, it is not for the best interests of the company to have two or
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more directors with any close relationships. When directors function independently without
any prejudices and biases, the company may develop in the right directions.
How does having an Ownership Structure impacts Firm’s Performance
According to Ahunwan (2003) the ownership structure can be divided into four major
groups: Group A, Group B, Group C and Group D. Group A represents the sectors that the
federal government and the state government take control. The government takes all the
revenue collected from the businesses while the business functions under Group A. Group A
business can be labelled as public sector business. In other words, all the people or the public
have equal shares in such businesses. The government owns and operates such business on
behalf of the people and the profits earned from such businesses will be delivered to the
public in the form of infrastructure development or through any other social service channels.
Group B has businesses that are co-owned by the federal government and the foreign
investors (Ahunwan 2003). For example, Nigerian oil sector is working under Group B
arrangement. In other words, Nigerian government and foreign companies have claims on
such businesses. Foreign companies help Nigerian government in the extraction and
purification of oil. These enterprises are listed in the stock markets.
Group C is concentrated with the rich people who have businesses and have enough
capital to inject into the business to make it grow to the next levels (Ahunwan, 2003). In
other words, Group C business is purely private business. Only rich people can operate such
businesses. Even though government may enforce some control over group C business,
majority of the policies and strategies of such businesses are determined by the private
people.
Group D are small businesses that are either owned by individual of family
enterprises characterised with low income and lack of capital for doing business (Ahunwan,
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2003). For example, there are many small scale industries in Nigeria which are owned and
operated by a group of people, mostly the members of a family. The decision making in such
business is done by the members of the group that owns the business.
Under corporate ownership, every member in the board is responsible for all the
activities that are taking place in the company. Moreover, every person in the company board
should work hard to improve the company performance of the company. At the same time, it
is possible for the major shareholders in corporate companies to exclude minority shareholder
from corporate management role, even if a representative is available in the board to
represent the minority group. A number of factors contribute to a well-arranged corporate
ownership among the proprietors. Mahoney & Roberts, (2004) argue that big boards are less
accurate and effective compared to a board with smaller number of members. When smaller
number of directors is present in a company board, it is easy for the CEO to make a
consensus while taking critical decisions. When more members are present in a company
board, the CEO would struggle to take a decision because of the contrasting opinions of the
board members.
Types of Business ownership
The legal ownership of business can be classified into three broad categories: sole
proprietorship, partnership and corporate ownership. In a sole proprietorship, the losses and
profits of a business are the sole property of the business owner. No other entities may have
any claims on such things. Moreover, there is no distinction made between personal and
business income, when a business functions under sole proprietorship. On the other hand, a
partnership is merely joint ownership; therefore, the losses and profits suffered by the
business will be shared among the partners. Personal liability of the profits and losses
suffered by such business depend on the amount of share hold by the partners. Both sole
proprietorship and partnership are simple arrangements that can be dissolved easily, without
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even a written contract. On the other hand, the operations of corporate ownership are much
more complex, than the sole proprietorship and partnership since it involves the creation of a
legal identity that separates its owners. Even if a single person owns all the shares of a
corporation, he or she is not personally responsible for it since corporation is a legal entity
rather than individual entity. Corporation is immortal in nature whereas individuals are
mortal in nature. In other words, a corporation may survive even after the death of its actual
owner (Corporate Ownership, 2014).
Relationship between Corporate ownership and corporate governance
There are many definitions for corporate governance. One of them defines corporate
governance as a coherent set of institutional arrangements that allow the enterprises to
function and to ensure the legitimacy of decision making and control whereas another one
defines it as a set of mechanisms having the effect of defining the powers and influencing the
decisions of leaders. A third definition describes corporate governance as a set of
mechanisms adopted by stakeholders to be represented and effectively assert their interests
(Boudabbous, 2014, p.8). According to Magdi and Nadereh (2002) corporate governance is
all about making sure that the business is runs well and investors get adequate returns. On the
other hand, OECD (1999) has defined corporate governance as the system by which business
corporations are directed and controlled. In any case, it is evident from the above definitions
that corporate ownership and corporate governance are connected in one way or another.
Bebczuk, (2005, p.3) conducted a study among 65 non-financial listed companies in
Argentina in 2003-2004, in order to know the relationship between corporate governance and
the ownership structure. He found that ownership appears to be quite concentrated at the
level of the largest ultimate shareholder, but separation of control and cash flow rights
prevails in less than half of the companies. According to Boudabbous (2014), corporate
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governance seeks to define the power of leadership and influence their decisions. In his
opinion, corporate governance follows different mechanisms in order to minimize the agency
costs resulting from conflicts of interest in situations of cooperation.
Relationship between Corporate ownership and the performances of companies
Brockman and Olson (2013, p.393) conducted a study to know more about the
relationship between corporate ownership and the performances of companies. Their findings
suggest that “the composition of ownership changes significantly with a decrease in
ownership concentration among inside equity holders, i.e. managers and directors who own
shares of the firm”. It should be noted that a company may have different types of
shareholders. Some of them could be the employees of the company (insiders) while the
others could be ordinary people (outsiders). When managers and directors of a company own
shares, it is quite possible that they will work hard to make the company profitable. In such
cases, managers and directors will get more salaries as well as dividends when the company
performs well. When the managers and directors do not have any share in the company, they
may not perform well since they get fixed salaries irrespective of the performances of the
company.
Concentrated ownership and its impact on the performance of a company
In concentrated ownership the majority shareholders are more powerful than the other
shareholders and they seem to get through with their decision. As per the views of Lemmon
and Lins (2003) concentrated ownership resulted in side-lining of the minority shareholders
by the majority shareholders of the company. Thus, concentrated ownership affects the
performance of a company performance both negatively and positively. In other words,
concentrated ownership helps majority shareholders to protect their interests at the expense of
the minority shareholders. It should be noted that the views, opinions and suggestions of the
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majority shareholders will get approval in the decision making bodies since it is easy for
them to get majority votes in such bodies.
According to Ehikioya (2009) the negative impact of concentrated ownership occurs
when the majority shareholders impose their strategies of doing business that is not well
researched. It will be difficult for the management of a company to put effective control on
all the operations of the company when improper strategies are implemented. The
implementation of improper strategies may result in crumbling of the company. Therefore, it
is necessary for the majority shareholders to implement only well researched strategies at the
first place of the company’s operations. Another drawback of concentrated ownership is
pointed out by Heflin and Shaw (2000). In their opinion, as the equity fraction held by
majority investors increases, the information-related component of the spread increases and
liquidity decreases. Shleifer and Vishny (1986) supported the arguments of Heflin and Shaw.
As per their views, majority shareholders help in the enhanced monitoring of management
and in increasing firm value. At the same time, they have the ability to reduce the liquidity of
the firm’s stock.
At the same time, the positive impact of concentrated ownership is the ability of this
ownership in providing better returns to majority investors as well as minority investors.
There are few people who have capacity of investing huge amounts. When the rich invests
more, the other shareholders also have the opportunity to gain more even though they less
investments in the company (Ehikioya, 2009). According to Ayyagari and Doidge (2010),
controlling majority shareholders or block holders in foreign firms capitalize on the increased
liquidity following a cross-listing to reduce the costs of unloading shares.
The Impact of Corporate Ownership on the Performance of Nigerian Companies
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Because of poor ownership structure and corporate governance, many of the Nigerian
public sector organizations such as NITEL, NNSL, NEPA, and NRC were either dead or
simply drain pipes of public resources, in the 1990’s. Majority of the manufacturing units of
these organizations were working below their capacity during this period. Not only
manufacturing units, but also service sector undertakings such as banks were also functioning
poorly in the 1990s. Many of the investors and shareholders have lost huge amounts of
money because of the poor performances of these public sector companies. It was difficult
for the government to stay idle while majority of the public companies in Nigeria were
collapsing. Nigerian government took a bold decision at the beginning of 2000, in order to
make drastic changes in the corporate governance of Nigerian public sector companies
(Kajola, 2008).
The government of Nigeria has introduced various institutional arrangements to
protect the interests of investors in the beginning of 2000. As part of these institutional
arrangements, the government has devised a “code of corporate governance best practices” in
November 2003. These institutional arrangements have defined: The roles of the board and
the management; Shareholders rights and privileges; and the role of the Audit Committee
(Kajola, 2008).
The government has given the right of selecting the CEO to the board of directors.
The CEO and the board of directors were given the responsibility of the day to day
management of the affairs of the firm. Moreover, it was the responsibility of the board of
directors to provide necessary leadership to the company. The CEO and the management on
the other hand will be responsible for the operations of the firm in effective and ethical
manner. Moreover, it was their responsibility of the CEO and the management to make
suitable business strategies based on the developments in the market. Above all, it was the
duty of the CEO to make sure that the financial reports are expected to comply with relevant
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statutory and professional pronouncements. Shareholders on the other hand were given the
right to communicate with the board at any time they like. Moreover, they were able to
appoint or remove any board member. It was the duty of the CEO and the board members to
clarify the doubts of the shareholders. The major responsibility of the audit committee was to
make sure that the company’s published financial reports are correct. It was the duty of the
audit committee to increase public confidence in the credibility of the company (Kajola,
2008). The above measures helped Nigerian public sector companies immensely and these
companies started to perform well after the introduction of the above institutional changes.
A study by Tsegbe and Herbert, found that foreign ownership has a positive impact on
the performance of Nigerian companies. Prior to the Nigerian Independence in 1960, foreign
ownership dominated the corporate structure in Nigeria (Tsegbe and Herbert, 2013). As a
result of that, Nigerian companies were well accustomed to foreign ownership. In other
words, Nigerian companies learned a lot in how to function effectively under foreign
ownership because of the colonial rule prior to 1960. It should be noted that foreigners have
cultivated many positive values and attitudes among the communities in which they rule. In
fact, Nigeria got lessons of civilization and modernism from the colonial rule. These
learnings helped Nigerian companies very much in increasing productivity and efficiency.
Foreign investors have ruthless management style that affects performance and
competitiveness of the business in the foreign countries. A company that is built by
foreigners bring profit to the individual and the country in which the company is located
(Loderer & Peyer, 2002). The foreign companies play a major role in the economy of the
country through helping the government in exploration of resources For example; foreign
companies have helped Nigeria in immensely in oil business. It should not be forgotten that
the technological advancements in Nigeria is negligible compared to that in western
countries. In fact Nigeria is importing technology from foreign countries. Oil drilling and
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purification are processes that require complicated technologies. Such technologies are
provided to Nigeria by foreign companies. In fact it is impossible for poor people to invest in
Nigerian oil sector because of the enormous money required for the investment in this sector.
That is the board of directors of the oil companies in Nigeria comprises of only the rich
people who have invested most in the industry (Ahunwan, 2002). It is evident that the
ownership structure contributes to the prosperity of the company. The only problem of the
concentrated ownership is that few people benefit from the oil business, and the poor remain
peripheral with regard to enjoying the benefits (Ehikioya, 2009).
Kajola, (2008, p.16) conducted a study among of twenty Nigerian listed firms
between 2000 and 2006 in order to examine the relationship between four corporate
governance mechanisms (board size, board composition, chief executive status and audit
committee) and two firm performance measures (return on equity, ROE, and profit margin,
PM), using panel methodology. He has identified a positive significant relationship between
ROE and board size as well as chief executive status. Moreover, he has concluded that the
board size should be reduced to a sizeable limit in order to help the company to perform
better. In his opinion, chief executive and the board chair should be occupied by different
persons in order to avoid the centralization of power on only one person.
Kajola’s findings were well supported by many scholars. Many studies have proved a
negative relationship between firm value and board size. In other words, when board size
increases, firm value decreases. Lipton and Lorsch (1992) pointed out that large boards are
less effective. In their opinion, when a board gets too big, it will be difficult for the CEO to
control and coordinate the activities and process of the company in the right direction.
Yermack (1996) also supported the arguments of Kajola. They also found a negative relation
between board size and profitability. Mak and Yuanto (2003) went one step ahead; they argue
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that firm valuation is highest when board has 5 directors. After conducting a study among
Nigerian firms Sanda et al (2003) also supported the arguments of Kajola.
Kajola’s findings are extremely significant in Nigerian business sector. Most of the
Nigerian firms have only one power centre; ie CEO. It is possible for the CEO to dictate the
functioning of the company. When a company has two or more power centres, it would be
difficult for the CEO to dictate the management of the company. Collective decisions will
takes place on such occasions and the company will be benefitted.
“In recent years, international economic pressures have induced Nigeria to adopt a
program of economic liberalization and deregulation. Advocates of the reforms tout their
potential not only for generating greater economic growth, but also for contributing to more
responsible corporate governance” (Ahunwan, 2002, p.269). The introduction of
globalization and liberalization has helped countries all over the world to liberalize their
economic principles in order to attract foreign direct investments as much as possible. Even
communist China has liberalized many of its economic policies in order to accumulate or
attract foreign direct investments. In fact, it is suicidal for countries to stay away from
liberalization at the moment. It is impossible for a developing country like Nigeria to keep a
blind eye towards foreign direct investments and still able to develop properly. At the same
time, responsible corporate governance is necessary for international companies while they
invest in a country like Nigeria. It should be noted that the business climate in Nigeria is
extremely different from that in other parts of the world. Corporate governance has little
importance in Nigerian business sector. However, it will be impossible for foreign companies
to invest in such countries where corporate governance is less respected. Therefore, it is
inevitable for a country like Nigeria to improve the climate for responsible corporate
governance in order to attract more foreign companies.
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Application of Agency theory in corporate governance
The agency theory is derived principally from the organizational economics and
management literatures. The major argument of this theory is that in structuring and
managing contract relationships, the separation of ownership and control can be
viewed as an efficient mode of economic organization within the nexus of contracts
perspective (Tsegba, and Herbert, 2013, p.24).
Agency theory stresses the importance of relationship between shareholders and
managers (Reference for Business, 2014). It is the duty of the managers to function in
accordance with the interests of the shareholders since the capital used for the business is
provided by the shareholders. In any business, investors should get adequate returns. The
implementation of institutional changes in Nigerian public companies by the government
helped the shareholders of those companies to get more benefits.
At times the agency conflicts may occur in the relationships between the shareholders
and the managers (Reference for Business, 2014). In other words, it would be difficult for the
managers to consider only the interests of the shareholders while taking decisions. For
example, corporate social responsibility and sustainable development are some of the major
topics in the corporate world. It would be difficult for the managers to neglect these things
and obey the instructions of the shareholders all the time. Ultimately, shareholders like to
maximize their returns from their investment. While strictly observing the principles of
corporate social responsibility and sustainable development, shareholders may not get the
expected returns from the business. “Indeed, agency theory is concerned with so-called
agency conflicts, or conflicts of interest between agents and principals. This has implications
for, among other things, corporate governance and business ethics” (Reference for Business,
2014)
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According to agency theory, corporate governance should lead to higher stock prices
and better long-term performance. There are many studies in support to the positive effects of
agency theory in the corporate governance. For example, the studies by Weiback (1988) and
Resenstein and Wyatt (1990) Mehran (1995) proved that firms perform better when the
number of board members will be less. Moreover, their studies proved that since managers
are better controlled by the CEO and board members, agency costs should be decreased while
agency theory is implemented in the corporate governance. The major reason for the poor
performances of many Nigerian companies is the poor management. If the CEO travel in one
direction and the managers travel in the other direction, the firm will not perform well.
Agency theory argues that the performance of better managed firms will be excellent
compared to the poorly managed firms. However, Pinteris (2002) argue that there are little
evidences to prove a positive association between corporate governance and firm
performance when agency theory is implemented in a firm. The findings of Pinteris stood out
since majority of the studies have supported the value of agency theory in corporate
governance and firm performances.
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