Concept Of Corporate Governance

Published Date: 02 Nov 2017

2.1 Introduction

This chapter discusses information from similar studies which have carried out in the area of corporate governance. The specific areas covered include: the concept of corporate governance, theoretical review, empirical review, link between corporate governance and organization performance, indicators of effective corporate governance mechanisms and the conceptual framework

2.2 Concept of Corporate Governance

Corporate governance is the international term associated with the trend towards greater corporate responsibility and the conduct of business within acceptable ethical standards. Transparency, accountability and openness in reporting and disclosure of information, both operational and financial, are internationally accepted to be vital to the practice of good corporate governance. Corporate governance is concerned with holding the balance between economic and social goals and between individual and communal goals -the aim is to align as nearly as possible the interests of individuals, corporations and society (World Bank, 1999). The object of good corporate governance is attained when institutions demonstrate their public accountability and conduct their business within acceptable ethical standards. This demonstration will take the form of effective financial reporting, both internally and externally, and the unqualified encouragement of public debate in respect of such financial reports.

According to McCord (2002), corporate governance refers to the manner in which the power of an organization –whether private or public- is exercised with the objective of obtaining increasing stakeholders’ value. Governance is the manner in which power is exercised in the management of economic and social resources for sustainable performance and development (McCord, 2002). In today’s world, governance has assumed critical importance in the socio-economic and political systems because it is seen as a contemporary practice which all organizations must embrace.

Governance is therefore a vital ingredient in the maintenance of dynamic balance between the need and equality in a productive society. When applied to the public sector, the term governance refers to efforts geared towards promotion of efficient, effective and sustainable development that contributes to welfare of society by creating wealth, employment and solution to the emerging challenges such as poverty, devastating effects of HIV Pandemic and among others. It also recognizes and protects citizens’ rights with an approach based on the democratic ideals, legitimate representation and participation (Njoya, 1999).

Corporate governance is concerned with the processes, systems, practices and procedures as well as the formal and informal rules that govern institutions, the manner in which these rules and regulations are applied and followed, the relationships that these rules and regulations determine or create, and the nature of those relationships (Cochran and Warwick, 1998). It also addresses the leadership role in the institutional framework. Corporate Governance, therefore, refers to the manner in which the power of a corporation is exercised in the stewardship of the corporation's total portfolio of assets and resources with the objective of maintaining and increasing shareholder value and satisfaction of other stakeholders in the context of its corporate mission. According to Oman (2001) corporate governance implies that companies not only maximize shareholders wealth, but balance the interests of shareholders with those of other stakeholders, employees, customers, suppliers, and investors so as to achieve long-term sustainable value. From a public policy perspective, corporate governance is about managing an enterprise while ensuring accountability in the exercise of power and patronage by firms.

Effective corporate governance in the public sector means that public officials must demonstrate compliance with the following six characteristics: they are composed of people with the knowledge, ability and commitment to fulfill their responsibilities; they understand their purpose and whose interests they represent; they understand the objectives and strategies of the departments or organization; they understand what constitutes reasonable information for good government and do everything possible to obtain it; once appropriately informed, they are prepared to ensure that the department’s objectives are met and that operational performance is never less than satisfactory; and they fulfill their accountability obligations to those whose interests they represent by regularly and adequately reporting on their department’s activities and effectiveness (King, 2002). According to MCCG (2000), corporate governance goes beyond the financial and regulatory aspects of governance and advocated for an integrated approach to good governance in the interests of a wide range of stakeholders having regard to the fundamental principles of good financial, social, ethical and environmental practice.

A dominant feature of business since 1994 has been the emergence of information technology in all its facets, as a key driver of business strategy and decisions. The proliferation of cheap, accessible communication via the internet has facilitated a potent form of information exchange across all spectrums of society. Information technology has now become an integral part of internal controls and reporting information. At the same time, there are fiduciary implications because of the electronic formation of contracts, the integrity of electronic communications, the retention of records etc. Consequently, directors need to ensure that the necessary skills are in place for them to discharge their responsibility for internal controls. While technology can be used to improve reporting and transparency, directors must be aware of the blurring of organizational barriers as a consequence of e-business (Carlin and Meyer, 2002).

Principles of Good Corporate Governance

The commonwealth Heads of Government (1997) noted that good corporate governance must have a code of practice establishing standards of behavior and public organizations should strive to secure greater transparency and reduce corruption. The principles of good corporate governance are designed to assist organizations to formulate own specific and detailed codes of best practice.

According to the World Bank (2004) corporate governance principles can be summarized into four broad categories including; those focusing on economic management, those concerned with structural policies, social inclusion policies and equity, public sector management and institutions. The specific principles include; leadership, Board appointment criteria, strategy and values, structure and organization, corporate performance, viability and financial sustainability, corporate compliance, corporate communication, accountability, corporate culture and internal control procedures.

2.2.2 Corporate Governance and organization performance

Corporate governance is a multi-faceted subject. An important theme of corporate governance deals with issues of accountability and fiduciary duty, essentially advocating the implementation of guidelines and mechanisms to ensure good behaviour and protect shareholders (Schilling, 2003). Corporate governance is a concept that involves practices that entail the organization of management and control of companies. It reflects the interaction among those persons and groups, which provide resources to the company and contribute to its performance such as shareholders, employees, creditors, long-term suppliers and subcontractors (Brownbridge, 2007).

Another key focus is the economic efficiency view, through which the corporate governance system should aim to optimize economic results, with a strong emphasis on shareholders welfare. There are yet other sides to the corporate governance subject, such as the stake holder’s view, which calls for more attention and accountability to players other than the shareholders (for example, the employees or the environment) (Shivdasani and Zenner, 2004). Recently there has been considerable interest in the corporate governance practices of modern corporations, particularly since the high-profile collapses of large U.S. firms such as Enron Corporation and Worldcom (Klapper and Love, 2003).

The argument has been advanced time and time again that the governance structure of any corporate entity affects the firm's ability to respond to external factors that have some bearing on its performance. In this regard, it has been noted that well governed firms largely perform better and that good corporate governance is of essence to firms. The subject matter of corporate governance has dominated the policy agenda in developed market economies for sometime especially among very large firms. Subsequently, the concept is gradually warming itself to the top of policy agenda in the Africa continent. Indeed, it is believed that the Asian crisis and the seemingly poor performance of the corporate sector in Africa have made the concept of corporate governance a catchphrase in the development debate (Brown Bridge, 2007).

It is believed that good governance generates investor goodwill and confidence. Again, poorly governed firms are expected to be less profitable. Claessens et al. (2003) also points that better corporate framework benefits firms through greater access to financing, lower cost of capital, better performance and more favorable treatment of all stakeholders. They argue that weak corporate governance does not only lead to poor firm performance and risky financing patterns, but are also conducive for macroeconomic crises like the 1997 East Asia crisis. Other researchers contend that good corporate governance is important for increasing investor confidence and market liquidity (Donaldson, 2003).

Performance can be defined as the capability of an entity to produce results in a dimension determined apriori (Laitinen,2002).Measuring and improving performance is a key to ensuring the successful implementation of organization strategy (Laitinen, 2002).

Becht et al., (2002) identifies a number of reasons for the growing relevance of corporate governance, which includes the world -wide wave of privatization of the past two decades, the pension fund reform and the growth of private savings, the takeover wave of the 1980s, the deregulation and integration of capital markets, the 1997 East Asia Crisis, and the series of recent corporate scandals involving firms such, as Enron and WorldCom in the USA and elsewhere. Developing countries are now increasingly embracing the concept knowing it leads to sustainable growth. Indeed/ corporate governance in Kenya is now gaining some level of recognition with very little work in the area even in the well-regulated institutions and sectors.

Several studies have been done to the effect of corporate governance structure and firm's performance. One argument is that a strong corporate governance mechanism, could lead to a high performance (Sanda et al., 2005). It will help to promote a firm's performance and protect public interests. Nam et al., (2002) found that corporate governance should lead to better performance since managers are better supervised and agency costs are decreased. Poor corporate governance on the other hand is a fertile ground for corruption and poor financial performance. Brown and Caylor (2004) found that organizations with weaker corporate governance perform poorly compared to those with stronger corporate governance in terms of service provision.

2.3 Public Sector Governance

Public sector governance encompasses the policies and procedures used to direct an organization’s activities to provide reasonable assurance that objectives are met and that operations are carried out in an ethical and accountable manner. In the public sector, governance relates to the means by which goals are established and accomplished. It also includes activities that ensure a government’s credibility, establish equitable provision of services, and assure appropriate behavior of government officials — reducing the risk of public corruption. Kings Report (1994) identifies performance of audit committees as a key element of governance of all kinds of organizations. The report further notes that Audit committees must subscribe to a code of practice and members with skills to provide for objective evaluation of their performance.

According to the United Nations report (2007), reducing the cost of government by downsizing, outsourcing and improving government efficiency, is but one of the challenges faced by governments worldwide in their effort to maximize value for citizens. In their quest to achieve this, they have among others tried to implement policies and initiatives to promote transparency and accountability in public administration, and policies which foster an environment of trust in the private sector. The report further notes that public administration is a constituent pillar of governance.

Fundamentally therefore, public sector governance is about the nature and quality of three principal relationships: between citizens and politicians, between politicians as policy makers and the bureaucracy (those responsible for providing public goods and services), and between the bureaucracy as delivery agents and the citizenry as clients When the rule of law is weak, the risk of state capture is high. State capture "refers to actions of individuals, groups, or firms… in the public and/or private sectors to influence the formation of laws, regulations, decrees, and other government policies to their advantage, through the illicit and nontransparent provision of private benefits to politicians and/or civil servants" (World Bank, 2000) and is a serious problem in many developing countries (Kaufmann, 2003). Governance should not be reduced to government, as the three aspects of governance are interdependent in a society. Indeed, social governance provides a moral foundation, while economic governance provides a material foundation, and political governance guaranties the order and the cohesion of a society (Nzongola-Ntalaja, 2003).

Governments as part of good governance should provide a stable political and economic environment. Government policies throughout the world should aim to promote fiscal responsibility, remove barriers to competition, ensure a legal framework for property rights and regulatory oversight, and ensure transparency of the law and policies. Good governance is an essential component of the millennium development goals [MDGs], because "good" governance establishes a framework for fighting poverty, inequality, and many of humanities’ other shortcomings (United Nations, 2007).

Thus, governance is the process whereby a society makes important decisions, determines whom they involve, and how they render account (Graham, Amos, Plumptre 2003). As a process, it comprises complex mechanisms, processes, relationships, and institutions through which citizens and groups articulate their interests, exercise their rights and obligations, and mediate their differences (Cheema, 2005).

Policies that supply public goods are guided by principles such as human rights, democratization and democracy, transparency, participation and decentralized power sharing, sound public administration, accountability, rule of law, effectiveness, equity, and strategic vision (Cheema 2005). The Human Development Report issued in 2002 insists on "good" governance as a democratic exigency, in order to "(rid) societies of corruption, (give) people the rights, the means, and the capacity to participate in the decisions that affect their lives and to hold their governments accountable for what they do" (Nzongola-Ntalaja 2002). "Good" governance promotes gender equality, sustains the environment, enables citizens to exercise personal freedoms, and provides tools to reduce poverty, deprivation, fear, and violence (Cheema, 2005). The UN views good governance as participatory, transparent and accountable. It encompasses state institutions and their operations and includes private sector and civil society organizations. In practice, such principles should translate into "strengthening democratic institutions" (Nzongola-Ntalaja, 2002) by free, fair and frequent elections, a representative legislature, some judiciary and media independence from the State, the guarantee of human rights, transparent and accountable institutions, local governments that possess decentralized authority, a civil society which sets priorities and defends "the needs of the most vulnerable people" (Cheema, 2005).

2.3.1 Corporate Governance in developed Economies.

There are many differences in corporate governance issues between developed and emerging economies. Many emerging economies have state –owned or state-controlled commercial enterprises that dominate the economy and therefore have a significant effect on attracting investment, financing growth, and establishing reliable business practices in a developing country. Developed markets tend to interpose on governance issues from different perspectives, giving the idea and the implementation of corporate governance greater weight in comparison to emerging economies. Developing countries, in contrast, may have governance rules in place, but enforcement is inconsistent and selective.

2.3.2 Corporate Governance in Emerging Economies

Emerging economies are ‘low-income, rapid-growth countries using economic liberalization as their primary engine of growth’ (Hoskisson et al., 2000). Institutional theory has become the predominant theory for analysing management in emerging economies (Hoskisson et al., 2000; Wright et al., 2005). As an example, seven of the eight papers published in a recent special issue of the Journal of Management Studies on strategy in emerging economies utilized institutional theory (Wright et al., 2005). Institutions affect organizational routines (Feldman and Rafaeli, 2002) and help frame the strategic choices facing organizations (Peng, 2003; Peng et al., 2005). In short, institutions help to determine firm actions, which in turn determine the outcomes and effectiveness of organizations (e.g. Heath et al., 2007).

However, the institutions that impact such organizational actions in emerging economies are not stable. Furthermore, the formal institutions that do exist in emerging economies often do not promote mutually beneficial impersonal exchange between economic actors (North, 1994). As a result, organizations in emerging economies are to a greater extent guided by informal institutions (Peng and Heath, 1996). The theories used by researchers often implicitly assume that the institutional conditions found in developed economies are also present in emerging economies. Clearly, this is not the case in emerging economies and as a result the organizational activities can differ considerably from those found in developed economies (Wright et al., 2005). In many developing countries, state owned enterprises make up a disproportionate segment of the economy and suffer from a myriad of management and performance issues that limit their effectiveness and the role they are expected to play in generating growth.

To illustrate, in the case of corporate governance, emerging economies typically do not have an effective and predictable rule of law which, in turn, creates a ‘weak governance’ environment (Dharwadkar et al., 2000, p. 650; Mitton, 2002). This is not to say that emerging economies have no laws dealing with corporate governance. In most cases, emerging economies have attempted to adopt legal frameworks of developed economies, in particular those of the Anglo-American system, either as a result of internally driven reforms (e.g. China, Russia) or as a response to international demands (e.g. South Korea, Thailand). However, formal institutions such as laws and regulations regarding accounting requirements, information disclosure, securities trading, and their enforcement are either absent, inefficient, or do not operate as intended. Therefore, standard corporate governance mechanisms have relatively little institutional support in emerging economies (Peng, 2004; Peng et al., 2003). This results in informal institutions, such as relational ties, business groups, family connections, and government contacts, all playing a greater role in shaping corporate governance ( Peng and Heath, 1996; Yeung, 2006).

For threshold firms, the transition to professional management is always difficult. Yet it is even more difficult in emerging economies because of the weak institutional environment and it is common for even the largest firms to still be under the control of the founding family. In essence, these firms attempt to appear as having ‘crossed the threshold’ from founder control to professional management. But the founding family often retains control through other (often informal) means (Liu et al., 2006). Indeed, publicly-listed firms in emerging economies have shareholders, boards of directors, and ‘professional’ managers, which compose the ‘tripod’ of modern corporate governance (Monks and Minnow, 2001). Thus, even the largest publicly-traded firms in an emerging economy may have adopted the appearance of corporate governance mechanisms from developed economies, but these mechanisms rarely function like their counterparts in developed economies.

In short, the corporate governance structures in emerging economies often resemble those of developed economies in form but not in substance (Peng, 2004). As a result, concentrated ownership and other informal mechanisms emerge to fill the corporate governance vacuum. While these ad hoc mechanisms may solve some problems, they create other, novel problems in the process. Each emerging economy has a corporate governance system that reflects its institutional conditions. However, there are a number of similarities among emerging economies as a group; conflicts between two categories of principals are a major issue.

2.4 Theoretical Review

Neuman (2006) defines a theory as a system of interconnected ideas that condense and organize knowledge about the world. The agency theory and the stewardship theory are the main theories underlying the concept of corporate governance.

2.4.1 Agency theory

This theory rests on the assumption that the role of organizations- whether public or private is to maximize the wealth of their owners or shareholders (Blair, 1995). The agency theory holds that most businesses operate under conditions of incomplete information and uncertainty. Such conditions expose businesses to two agency problems namely adverse selection and moral hazard. Adverse selection occurs when a principal cannot ascertain whether an agent accurately represents his or her ability to do the work for which he or she is paid to do. On the other hand, moral hazard is a condition under which a principal cannot be sure if an agent has put forth maximal effort (Eisenhardt, 1989).

According to the agency theory, superior information available to professional managers allows them to gain advantage over owners of firms. The reasoning is that a firm’s top managers may be more interested in their personal welfare than in the welfare of the firm’s shareholders (Berle and Means, 1967). Donaldson and Davis (1991) argue that managers will not act to maximize returns to shareholders unless appropriate governance structures are implemented to safeguard the interests of shareholders. Therefore, the agency theory advocates that the purpose of corporate governance is to minimize the potential for managers to act in a manner contrary to the interests of shareholders. Proponents of the agency theory opine that a firm’s top management becomes more powerful when the firm’s stock is widely held and the board of directors is composed of people who know little of the firm. The theory suggests that a firm’s top management should have a significant ownership of the firm in order to secure a positive relationship between corporate governance and the amount of stock owned by the top management (Mallin, 2004). Wheelen and Hunger (2002) argue that problems arise in corporations because agents (top management) are not willing to bear responsibility for their decisions unless they own a substantial amount of stock in the corporation. The agency theory also advocates for the setting up of rules and incentives to align the behaviour of managers to the desires of owners (Hawley & Williams, 1996).

In summary, the idea of agency theory can be attributed to Coase (1937) but the ideals of the theory have not only been applied in the private sector but also in public enterprises. The citizenry as stakeholders are increasingly demanding for accountability and transparency from the people elected as leaders and those employed to serve in the public owned enterprises. These has led to demands such as putting in place stringent laws and regulations to guide operations of public sector employees and establishing systems to ensure that checks and balances are properly addressed. This has been extended to governments where the public demand for services anchored under the principles of transparency, ethics and realization of value for money.

2.4.2 Stewardship theory

The stewardship theory, also known as the stakeholders’ theory, adopts a different approach from the agency theory. It starts from the premise that organizations serve a broader social purpose than just maximizing the wealth of shareholders. The stakeholders’ theory holds that corporations are social entities that affect the welfare of many stakeholders where stakeholders are groups or individuals that interact with a firm and that affect or are affected by the achievement of the firm’s objectives (Donaldson & Preston, 1995; Freeman, 1984). Successful organizations are judged by their ability to add value for all their stakeholders. Some scholars consider the natural environment to be a key stakeholder (Starik & Rands, 1995; Dunphy et al., 2003). Stakeholders can be instrumental to corporate success and have moral and legal rights (Donaldson & Preston, 1995; Ulrich, 2008). When stakeholders get what they want from a firm, they return to the firm for more (Freeman, 1984; Freaman & McVea, 2001).Therefore, corporate leaders have to consider the claims of stakeholders when making decisions (Blair, 1995) and conduct business responsibly towards the stakeholders (Manville & Ober, 2003; White, 2009). Participation of stakeholders in corporate decision-making can enhance efficiency (Turnbull, 1994) and reduce conflicts (Rothman & Friedman, 2001).

According to Kaptein and Van Tulder (2003), corporations adopt reactive or proactive approaches when integrating stakeholders’ concerns in decision making. A corporation adopts a reactive approach when it does not integrate Stakeholders into its corporate decision making processes. This results into a misalignment of organizational goals and stakeholder demands (Mackenzie, 2007). Some authors attribute scandals such as those of Enron and WorldCom to the failure to consider stakeholder concerns in decision making. In summary, the stewardship theory suggests that organizational leaders, acting as stewards, are more motivated to act in the best interests of the organization rather than for their own selfish interests. The application of this theory is gaining root in the public sector where the citizens being stakeholders are demanding for servant leadership. The notion that public office exist for one to enrich himself is fast changing to that of service to the public.

2.4.3 Theoretical Model

Non- financial

MeasuresIn attempting to apply the aforementioned theories of corporate governance, Wraikat (2010) researching of information technology governance role in enhancing public sector performance in Jordan discussed the various issues as shown in Figure 2.1

Performance

IT Governance

Accountability

Transparency

Financial measures

Predictability

Participation

Figure 2.1: IT Governance Model

Source: Wraikat (2010)

As shown in Figure 2.1, Wraikat expressed that accountability, transparency, predictability and participation were the main determinants of IT governance in Jordan’s public sector which in turn led to performance. The performance comprised of financial and non- financial measures.

2.5 Empirical Literature Review.

Previous empirical studies have provided the nexus between corporate governance and firm performance (Claessens et al. 2002; Klapper and Love, 2002; Gompers et al. 2003; and Sanda et al. 2003). Others (like Bebchuk and Cohen, 2004; Becht et al, 2002) have shown that well-governed firms have higher firm performance. The main, characteristic of corporate governance identified in these studies include board size/ board composition, and whether the CEO is also the board chairman.

There is a view that larger boards are better for corporate performance because they have a range of expertise to help make better decisions, and are harder for a powerful CEO to dominate. In recent times on the contrary, emphasis has geared toward smaller boards. Jensen (1993) and Littlefield et al (1992) contend that large boards are" less effective and are easier for a CEO to control. The reason is that when a board get too big, it becomes difficult to co-ordinate and process problems. Klapper and Love (2002) examine corporate governance and performance in a sample of firms in 14 countries, most of which are developing economies.

John and Senbet (1998) provide a comprehensive review of the Stakeholder theory of corporate governance. The main issue raised in the theory is the presence of many parties with competing interests in the operations of a firm. They also emphasized the role of non-market mechanisms such as the size of the board, committee structure as important to firm performance; Jensen (1993) critiques the Stakeholder theory for assuming a single -valued objective. They thus, propose an extension of the theory called an enlightened stakeholder theory. However, problems relating to empirical testing of the extension have limited its relevance and applicability in a modern day corporate entity (Sanda et al., 2003).

Corporate governance ratings are foreseen to help attract and retain capital in the stock market. This is because financial markets operate on the basis of investors' confidence, which can be enhanced with the continuing practice of good, fair and transparent corporate behavior. The ratings are expected to have an impact on companies' credit ratings. As such, poor corporate governance rating would affect the agency's credit rating for a company while conversely; those with high ratings could be better rewarded. Companies with better corporate governance ratings would see higher profitability and productivity as good governance involves improved processes and systems as well as enhancement of trust and accountability.

Previous researches use available ratings developed by rating agencies. For example, Bauer et al. (2004) analyzed the relationship between different governance standards measured by the Deminor Corporate Governance Ratings and stock returns, firm value and operating performance for most firms included in the FTSE Eurotop 30. Deminor is a rating which evaluates approximately 300 different governance criteria per firm, which can be attributed to four broader categories that are: Rights and duties of shareholders; Range of takeover defence; Disclosure on corporate governance; and Board structure and functioning.

Besides that, there are researches that use self-developed rating generally constructed using recommendations and suggestions contained in Code of Corporate Governance. In Korea, Black et al. (2003) report evidence on the relationship between corporate governance and the market value of Korean public firms. Comparing prior studies that use other corporate governance index such as S&P and CLSA ranking, the corporate governance index used in the study is based on responses to objective questions on a 2001 survey by the Korea Stock Exchange, reducing the problem of omitted corporate governance variables in the construction of index. The index is composed of six sub-indices, based on a total of 39 separate elements. Quite similar study is done by Beiner et al. (2004) using data from Switzerland. The dependent variables in their study are corporate governance index and additional variables of control mechanism; ownership structure, board characteristics, and leverage. This provides comprehensive description of firm-level corporate governance for a broad sample of firms listed in Swiss Stock Exchange (SWX). The corporate governance index is mainly based on the recommendations and suggestions contained in the Swiss Code of Best Practice.

The same analysis is done in German by Drobetz et al. (2004) who developed corporate governance rating (CGR) based on responses on questionnaires sent out to all firms in the four principal segments of the German stock exchange. The survey questions are constructed based on the German Corporate Governance Code and other ratings such as Deminor Ratings, and were tested from a legal and regulatory perspective by Deutsche Borse AG. It managed to collect 30 governance proxies under five categories from 253 listed firms. Equal weighting scheme is used for the different proxies in order to be transparent and also to allow easy interpretations.

Mohanty (2002) differentiates firms with good and poor governance by developing a corporate governance index in a way, which is quite distinctive from others. Instead of looking at the process of governance, the measures of corporate governance are based on observation to the outcome of good corporate governance. The index is developed based on the definition by SEBI committee report which defines the objective of corporate governance as the maximization of shareholder's wealth by keeping in mind the interests of other stakeholders. Thus, if a firm has got appropriate corporate governance in practice, it must get reflected in how the firm deals with its seven types of stakeholders.

The association between quality of corporate governance and firms' profitability is quite major focus in corporate governance studies, but one cannot predict much on the direction as prior literatures show mixed results. Jensen and Meckling (1976) have proven that better-governed firms might have more efficient operations, resulting in a higher expected future cash-flow stream. In Brown and Caylor (2004), the result of the Pearson Correlations used in the study provides evidence that all measures of return except for one-year return; and all measures for profitability are significantly positively correlated with the CGQ scores that represent quality of corporate governance. Klapper and Love (2003) that use return on assets as measure for performance found evidence that firms with better governance have higher operating performance. Contrast results are seen in Gompers et al. (2003), Beiner et al. (2004) and Bauer et al. (2004). According to Cho and Kim (2003), company would enhance their corporate governance when the company's performance is poor because changes in corporate governance structure are expected to bring out positive result on their performance.

2.6 Relationship between Corporate Governance and Organizational Performance

Although there is a growing focus on governance issues, such as specific board composition configuration or board leadership structure, the results are unclear with respect to firm performance (Dalton et al., 1998). Many studies that demonstrate positive relationships between variables of interest from the four sets of board attributes and firm’s performance, when meta-analytically reviewed, show negative relationships and no statistically significant relationship at all (Dalton et al., 1998). For example, Hunter and Schmidth (1990, p. 29) have suggested that "conflicting rustles in the literature may be entirely artificial". There is no actual population of relationships at all. For example, a meta-analysis of 54 empirical studies of board composition and 31 empirical studies of board leadership structure and their relationship to financial performance, by Dalton et al. (1998, p. 269), concluded that these and other analyses "relying on firm size, the nature of financial preference indicators and various operationalization’s of board composition, provide little evidence of a systemic governance structure and financial performance relationships".

Similarly, the analysis of 40 years of data from 159 studies, carried out by Dalton and Daily (1999), concluded that there is no clear evidence of a substantive relationship between board composition and financial performance, irrespective of the type of performance indicators, the size of the firm or the manner in which board composition is measured. For example, a board could be completely independent and, at the same time, fail in its expertise, counsel and resource-dependency roles (Dalton and Daily; 1999). On the other hand, a board dominated by inside and affiliated directors could fall short in its ability to monitor and control (Daily and Dalton, 1994; 1999). Hence, reliance on the independence of board members or any one dimension of board roles and attributes will not ensure high levels of corporate financial performance, especially if it is at the expense of other director roles (Johnson et al., 1993; Dalton and Daily, 1999).

However, the key thing to note is that corporate governance compliance shows real confidence in the future and in the high growth prospects of your business. Corporate governance compliance makes organization more attractive because it is visibly managed and directed (Knell, 2006). The recent developments provide ample evidence that inadequate corporate governance standards in certain organizations could contribute to their failure. The inadequate governance standards in the corporate sector, raises the risk profile of companies and exposes the organization and especially lending institutions to greater potential default. The adherence to formal (or mandated) corporate governance practices are particularly crucial for banks and financial institutions as weak or inadequate corporate governance standards invariably result in ineffective risk management and ultimately to financial instability (Singh 2005). In the case of banks and financial institutions, the developments in one of them may trigger systematic consequences. The essence of formal corporate governance in financial institutions, are therefore, the responsibilities of the board and its independent committees for providing adequate checks and balances, transparency and disclosures, robust risk management systems, risk containment procedures, early warning systems and prompt corrective actions to avoid default (Singh 2005).

According to agency theory, good corporate governance should lead to higher stock prices or better long-term performance, because managers are better supervised and agency costs are decreased. Poor corporate governance on the other hand is fertile soil for corruption and corruptive symbiosis between business and political circles (Manyuru, 2005).

A comprehensive and integrative review of the corporate governance contribution to company performance research suggests a tendency, amongst scholars, to search for universal associations between board attributes, board roles and company performance (Zahra and Pearce, 1989; Maassen, 1999). Zahra and Pearce (1989), reviewing 22 empirical studies in their construction of an integrative model of a literature review identifying variables of board attributes and board roles in relation to firm’s performance, identify a number of shortcomings in previous research and urge cautious interpretation of results on board roles and attributes. Using the same constructs of board roles and attributes for measuring impact on firm’s performance, Maassen’s (1999) empirical study of the USA, UK and the Netherlands listed companies came to similar conclusions. Moreover, both studies concluded that there is an over-focus on the financial dimensions of company performance, with some attention being given to systemic performance and very little attention being paid to social dimensions of company performance (Zahra and Pearce, 1989; Maassen 1999).

Performance refers to the extent to which organization’s goals and objectives are achieved efficiently and effectively. Performance can take many forms depending on who and what the measurement is intended for. Different stakeholders require different performance indicators to enable them make informed decisions. Environmental and social groups are keen in following actions that the company undertakes with regards to corporate social responsibility; shareholders will be interested in viability, growth in profitability market share and turnover (Brown et al., 1997). Governments and multilateral agencies are interested by expected social and economic benefits to micro entrepreneurs, such as increases in employment and income levels.

2.7 Critical review

The content, format and frequency of reports depend on who needs the information and for what purpose. For example shareholders will be more interested in profitability, growth, return on investment and continued financial stability of the institution (Manyuru 2005). Governments and multilateral agencies are interested with the expected social and economic benefits to micro entrepreneurs, such as increases in employment and income levels.

Moreover, there are various measures of performance including financial and non-financial measures. Most of these measures make use of the financial statements. Financial statement analysis seeks to evaluate management performance in several areas including profitability, efficiency and risk (Reily and Brown, 1997). Microfinance performance can take many forms depending on what the stakeholders are interested in. Different stakeholders require different performance indicators to enable them make informed decisions.

Recent years have seen growing push for transparency in microfinance; this has seen an increasing use of financial and institution indicators to measure risk and performance of MFIs. For the purpose of this research project four indicators namely market share, turnover or disbursement, portfolio quality, and profitability are proposed as measures of microfinance performance. These are considered to be the most important indicators as they provide reasonable overview of the business volume, performance, risk and the financial condition of microfinance institution.

2.8 Public Sector Performance and Corporate Governance

The performance of the Public Sector largely defines the nature of service provision and general development of the area under jurisdiction of the public entity. The effectiveness of corporate governance in the public sector and its performance can be measured using a number of broad variables including; efficiency of operations, the quality of service delivery, transparency and accountability and risk management Performance can be defined as the capability of an entity to produce results in a dimension determined a priori (Laitinen,2000). Measuring and improving performance is key to ensuring the successful implementation of organization strategy (Laitinen, 2002). Effective performance against goals and standards in corporate plan, business plans, service delivery plans and individual performance are all intertwined in the governance system. Performance in any organization is the capability to achieve its objectives. There are two aspects which are taken into consideration when measuring performance of any organization; financial measures which mainly discuss the profit that an organization can achieve and non-financial measures which discuss measures other than financial that organization may achieve such as customer satisfaction and quality enhancement.

2.9 Factors influencing Performance of Public Sector organizations

According to the Asian Development Bank (1998) the most important pillars of corporate governance in the public sector are; efficiency, transparency/accountability, risk management and service delivery.

2.9.1 Efficiency

Public service consumers require services to be delivered in such away that they minimize costs including the time taken to be accorded the services. This can be possible if the systems and procedures used by public institutions are well structured with proper reporting mechanisms. According to Oman (2001) corporate governance implies that organizations not only maximize shareholders wealth, but also balance the interests of shareholders with those of other stakeholders including; employees, customers, suppliers, and investors so as to achieve long-term sustainable value.

From a public policy perspective, corporate governance is about managing an enterprise while ensuring cost containment and timely execution of activities in the exercise of power and patronage by public entities. Effective corporate governance in the public sector means that public officials must demonstrate compliance with the following six characteristics: they are composed of people with the knowledge, ability and commitment to fulfill their responsibilities; they understand their purpose and whose interests they represent; they understand the objectives and strategies of the departments or organization; they understand what constitutes reasonable information for good government and do everything possible to obtain it; once appropriately informed, they are prepared to ensure that the department’s objectives are met and that operational performance is never less than satisfactory; and they fulfill their accountability obligations to those whose interests they represent by regularly and adequately reporting on their department’s activities and effectiveness (King, 2002). Consequently, governments need to ensure that the necessary skills are in place for them to execute their work activities effectively and efficiently. Qualities of staff in the key positions also contribute significantly in governance mechanisms that support a performance –based culture in an organization.

2.9.2 Risk Management

Risks are uncertainties that can impinge on an organization’s ability to achieve its objectives and can result in many interdependent outcomes both negative and positive. According to ALARM (1998) effective corporate governance mechanisms must assist an organization in mitigating possible risks so as to achieve the intended performance targets. Corporate governance practices in the public sector must enable a public entity to have direction, authority and oversight management so as to overcome probable risks. The CIPFA report (1994) notes that risk management requires a holistic and integrated approach and is one of the keystones to achieving effective corporate governance. The report further notes that risk management provides a means of improving strategic, operational and financial management practices in the public sector. It also helps to maximize opportunities and minimize loss, service disruption and bad publicity which might accrue to a public entity. ALARM (2000) notes that effective corporate governance requires that risk management be integrated to policy, planning and operational management strands in an organization. It must be imbedded into the culture of the organization. Singh (2005) notes that effective corporate governance practices provide adequate and robust risk management systems and risk mitigation procedures including early warning systems which assist an organization to take prompt actions before situations get out of hand.

Fone et al (2000) explains that it is impossible for an organization to achieve effective corporate governance without effective risk management. This implies that public sector operators must put in place strategies which will ensure proactive identification and mitigation of risks as part of their corporate governance concerns. Solace et al (2000) argues that while risk management is part of good corporate governance practices, organizations can only strive to manage risks in the most appropriate way rather than to eliminate them since the latter is impossible. They suggest various ways of managing risks including; transferring them to third parties, sharing risk, contingency planning and withdrawal from unacceptably high risk ventures.

2.9.3 Service Delivery

Public entities like other organizations are expected to provide quality services in a timely and cost effective manner. Service delivery is therefore one of major hallmarks of effective corporate governance. Fundamentally therefore, public sector governance is about the nature and quality of three principal relationships: that between citizens and politicians, between politicians as policy makers and the bureaucracy (those responsible for providing public goods and services), and between the bureaucracy as delivery agents and the citizenry as clients .When the rule of law is weak, the risk of state capture is high. State capture "refers to actions of individuals, groups, or firms in the public and/or private sectors to influence the formation of laws, regulations, decrees, and other government policies to their advantage, through the illicit and nontransparent provision of private benefits to politicians and/or civil servants (World Bank, 2000).

The Commonwealth Heads of Government (1997) noted that good public sector corporate governance must have a code of practice establishing standards of behavior and that public organizations should strive to provide quality services and minimize malpractices such as corruption. According to the World Bank (2004) corporate governance principles can assist public institutions in improving service delivery through better economic management and equity in resource allocation and utilization.

2.9.4 Transparency and Accountability

Effective corporate governance mechanisms must contribute towards transparency and accountability. Singh (2005) explains that corporate governance provides adequate checks and balances, transparency and disclosures which are necessary for accountability. Effective corporate governance requires commitment and openness especially from top management and is more than just putting in place structures such as committees and reporting mechanisms to achieve desired results. Donald (1999) explains that better public sector governance requires a strong commitment by all participants to effectively implement all elements of corporate governance. This includes having a framework which is people oriented, effective communication, and systematic approach to corporate management; emphasize corporate values and ethical conduct and relationships with citizens and public clients.

Public actors and those in leadership should provide citizens and the general public with complete confidence regarding decision making processes and actions of public sector agencies in managing their activities. Bob (2001) explains that being open through meaningful consultation with stakeholders and communication of complete, accurate and transparent information leads to effective and timely action thus enhancing the process of scrutiny which help to ensure that public entities are fully accountable and therefore central to good governance. The Canadian Joint Committee on Corporate governance (2000) argued that transparency is a much better approach than attempting to regulate behavior if one is seeking to build a healthy governance culture.

2.9.5 Policy Implementation

Public sector operations are guided by a set of laws which are promugulated by governments. These laws are implemented through policies formulated and pursued by public entities. Good corporate governance practices can only be pursued by public enterprises if they are grounded on appropriate codes and other rules.

2.9.6 Organization Politics

Public entities are generally centers for political and power play. The nature of politics will therefore determine the success of programmes and activities being pursued by these entities. Politics characterized by issues and principle will positively affect the execution of corporate governance practices in public sector institutions.

2.9.7 Work Culture

Culture is a set of beliefs, perceptions and norms being pursued by an organization. Any organization grounded on a culture which is progressive will assist in achieving good corporate governance.

2.9.8 Work Environment

The environment in which employees operate directs affects service delivery and the execution of programmes and activities. Good corporate governance can be achieved if the work environment is devoid of incidences such as negative attitude to work corruption and nepotism. A conducive work environment characterized by freedom of expression and thought, teamwork and respect among employees will positively impact on the effectiveness of good corporate governance.

2.10 Conceptual Framework

Independent Variables moderating Variables Dependent Variable

Performance.

- Value for taxes

- Satisfaction with services rendered

- Cost reduction

- Eradication of corruption and unethical practices

- Faster services

- improved relations with the public

- Provision of relevant services

Efficiency

Transparency & Accountability

Policy implementation

Organization structure

Politics

Work Culture

Work Environment

Risk Management

Service Delivery

2.10 Chapter summary

While the evidence that better corporate governance is associated with better outcomes from the perspective of countries and firms is mounting, there is still a suspicion that this relationships is due to other factors and merely reflects that better countries and better firms have better performance and better corporate governance (practices), but there is no causal relationship from corporate governance to performance. As such there is need for more evidence on how corporate governance reforms can lead to improvements in performance. And, most importantly, as also highlighted by the practitioners at the conference, there remain many puzzles on the lack of reforms by countries. And it is also surprising that many corporations have not yet adopted better corporate governance practices. It remains hard to introduce the legal and institutional changes which would enhance good governance, support efficient financial markets and protect minority shareholders. And many corporations do not see the rewards, in part because the domestic institutional environment and financial markets do not yet sufficiently support corporate governance. The reason that many emerging markets do not yet take steps to achieve the economic advantages should be sought in their political systems.