The Effect of Corporate Governance Mechanisms on Firms’ Financial Performance: Evidence from Selected Commercial Banks in Ethiopia

Abstract

Corporate governance has become subject to the development agenda of most developed and developing countries economy, due to the fact that corporate governance structure of a firm has critical impact on its financial performance. Corporate governance mechanisms emerge to tackle agency problems in ensuring that shareholders’ funds are not expropriated or wasted on unprofitable activities. The results of most research studies reveal that, well governed firms have been noted to have higher firm performance than poor governed firms. However, there are different researchers who opposed this idea as they have found mixed results on the relationships between different variables of corporate governance and financial performance. Research studies on this issue in developing countries; especially in Ethiopia remained an ignored area from empirical research. Thus, this study examined the effect of corporate governance mechanisms on firms’ financial performance on the selected commercial banks in Ethiopia by taking a sample of 6 commercial banks starting from the year 2003 up to 2009. This study used return on asset, return on equity and operating profit margin as dependent variables to measure financial performance of commercial banks and board size, board independence, frequency of board meetings, chief executive officer duality, audit committee and board ownership as independent variables to express quantitatively corporate governance mechanisms. In addition, firm size, financial leverage and firm growth rate were used as control variables, which are specific to commercial banks and general to the economy as a whole. The researcher used both correlation analysis and pooled panel data regression models of cross-sectional and time series data for analysis. The results provide evidence that board size is negatively and significantly related with all the three indicators of financial performance- return on asset return on equity and operating profit margin. Audit committee and financial performance indicators-return on asset and return on equity is negative and statistically significant, but it is not significant with operating profit margin. Board independence, chief executive officer duality and board ownership are positively and significantly related with all the three financial performance indicators. However, frequency of board meetings is not statistically significant with all the three financial performance indicators.

Keywords: Corporate Governance Mechanisms, Agency Problem, Firms’ Financial Performance and Commercial Banks.

DOI: 10.7176/RJFA/10-21-05

Publication date: November 30^th 2019