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. 

1.2       Statement of Problem

The puzzle remains whether corporate governance reinforces performance of organizations or if corporate governance can be considered as a substitute for firm performance. If they were complements, the impact of performance would be greater in firms with efficient governance structures. It is also argued that poor corporate governance has often led to low productivity in most manufacturing firms (Byuan, Lee & Park, 2011). The key research problem is centered on whether corporate governance assists in enhancing productivity of firms in Nigeria as well as maximizing shareholders wealth. Byuan, et. al; (2011) hold that given the much attention that corporate governance and firm performance have received, an area of discussion that has received limited attention relates to the role of corporate governance on productivity growth of firms especially in developing countries.

Demsetz and Lehn (1985) and Adams, Hermalin and Weisbach (2010) in their review emphasized that part of the key problem to overcome is that a firm’s choice of governance structure is endogenous, and great heterogeneity in firm performance within the same industry remains a puzzle and challenge to economics. The problem of corporate governance arises from the separation of ownership and control of business organizations. This separation puts the executive decision making in the hands of the managers who are not owners. Hence, managers tend to act in ways that are inconsistent with value maximization objective expected by firm owners. Part of the problem according to Alchian (1950), Stigler (1958), Hart (1983), Shleifer and Vishny (1986), Schmidt (1997) is the agency problem between owners and managers.

A major concern of corporate governance therefore is to ensure that interests of managers and investors are aligned such that the flow of external finance into the firm is guaranteed and also that investors are fairly remunerated. An effective corporate governance structure thus has an incentive to reduce agency problem and promote productivity growth of firms resulting from separation of ownership and control in modern businesses as pointed out by Berle and Means (1932), Jensen (1986).

Also, Alchian (1950), Stigler (1958) and Machlup (1967) posit that good corporate governance induces more effort from managers to minimize costs, hence, the critical challenge is that the reduction in profits effects on corporate governance. On the one hand, it reduces the amount of internal financing available to invest in new projects, and hence, increases the need for external financing. But the main reason outside investors provides external financing to firms is to receive control rights in exchange (Shleifer and Vishny, 1997), which increases the need for good governance. On the other hand, the reduction in profits increases managers’ effort to maximize firm value (or minimize costs) which decreases the need for good governance.

The problem above is that corporate governance which enhances external financing needs to be consistent. No wonder, Doidge, Karolyi & Stulz, (2007) argue that the benefit of good governance is access to stock markets on better terms. A firm with good governance should be able to access external financing at lower cost and thus not need stronger governance. Consequently in countries with good governance, firms should have lower need for stronger governance when they face more intense competition. In contrast, in countries with weak governance, firms should have greater need for stronger governance in the face of more intense competition. The latter effect corresponds largely to developing countries, where firms invest less in corporate governance, while the former effect is more characteristic of developed countries. Aghion and Howith (1997) and Aghion et al (1999) proposed a model in which good corporate governance (measured by financial pressure) affects firm’s productivity. On the contrary, Holmstorm and Milgrom (1994) analyse initiative and various incentive mechanisms as complimentary in a multi-task principal agent framework. This effect is thus what this study sought to investigate in Nigeria, hence, this study sought to examine the impact of corporate governance on performance of Nigerian firms.