CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
The issue of corporate governance and firm performance has dominated much of intellectual discussions in the last two decades. The discussions were not unconnected with the various corporate scandals that rocked giant corporations in the US and other parts of the world which have called to question the efficacy of the existing corporate governance structures in protecting shareholders’ interests (Hitt, Ireland and Hoskisson, 2009). As much as this issue is of much concern to the developed countries where most of the interests were generated, it is of utmost importance to developing countries as well. For instance, a good number of developing countries have turned in their economies to the influences of the market system, leading to the massive privatization and commercialization of state-owned enterprises while restrictions to foreign trade are been abolished or minimized. In this dispensation, corporate governance is viewed as crucial to the successes of these reforms; however, adequate attention has not been paid by researchers from developing countries at understanding the dynamics of corporate governance system in these developing countries’ economies.
For instance, Black, Jang, Kim, and Park (2010) analyzed the channels of the effect of corporate governance on firm value. They argue that good corporate governance contributes to increase in firm value by mitigating the deterioration of shareholder value from related-party transactions, by increasing the investment sensitivity to growth opportunity and by increasing the payout sensitivity to profitability. Similarly, Dahya, John, and McConnell (2007) report that firms with a higher proportion of independent directors have a higher Tobin’s q, and are less likely to engaged in related party transactions. Liu and Lu (2007) show that good corporate governance is associated with lower earnings management, and lower levels of tunneling.
Therefore, these results have provided another guidance and broad view for researchers who want to investigate corporate governance effect on shareholder value. The reason for which focus is on corporate payout policy and investment decision-making these days is because firm value and corporate performance are highly affected by these two managerial decisions. These two behaviors, along with the raising of capital, are the main financial decisions that bring reward for shareholders and decide a firm’s sustainability. Under information asymmetry, managers try to mitigate the conflict of interests between corporate insiders and shareholders (Easterbrook, 1984), and signal the firm’s value to external investors by paying dividends in order to decrease the cost of capital (Miller and Rock, 1985). Paying dividends decrease free cash flow that is considered as the main source of the private benefit of control of managers (Jensen, 1986). Proper investment decision-making improves firm value and corporate performance by increasing profitability and contributing to the firm’s growth in the long term (McConnell and Muscarella, 1985; Chan, Martin, and Kensinger, 1990; Chung Wright, and Kedia, 2003).
However, if managers over invest in negative NPV project to pursue the private benefit of control which is proportional to firm size, then this overinvestment could severely exacerbate the shareholders’ value (Jensen and Meckling, 1976). In summary, these two corporate decision-making is very important in shareholder point of view. Thus, corporate payout policy and investment decision-making may operate as the main channels by which the effect of corporate governance as internal control mechanism on firm value is enacted. Given the much attention that corporate governance and firm performance has received, an area of discussion that has received limited attention relates to the role of the interactive effect of performance and corporate governance on productivity growth of firms especially in developing countries (Byuan, Lee and Park, 2011).
Previous literature have documented that corporate governance mechanisms serves to reduce the extent of asymmetric information between corporate owners and managers; and also induces the managers to make efficient and rational decisions that maximizes shareholders wealth (Jensen and Meckling, 1976 Jensen, 1986; Weisback, 1988, Denis et al., 1997; Lemon and Lin, 2003).
It is very crucial to understand how corporate governance plays out in Nigeria because of the role ascribed to productivity growth by development agencies in the long run sustainable growth and development which is necessary for poverty reduction in this region. In the studies reviewed, the role of vertical integration in the model was conspicuously missing. Therefore, vertical integration is a crucial factor in the study of productivity growth of firms. Economic theory suggests that firms may embark on vertical integration when two or more of their production stages are technologically interdependent, this may result in significant cost-savings arising from technological economies of scale. More so, Arrow (1975) suggested that information asymmetry between upstream and downstream firms may necessitate vertical integration to improve resource allocation and reduce uncertainties from input supplies between two stages of successive production processes.
It is expected that this study will provide information on policy formulation and implementation as regards the role of corporate governance for the efficient performance of firms towards a private sector growth and poverty reduction in Nigeria.