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IOSR Journal of Business and Management (IOSR-JBM) e-ISSN: 2278-487X, p-ISSN: 2319-7668. Volume 16, Issue 11.Ver. II (Nov. 2014), PP 86-112 www.iosrjournals.org Effect of Corporate Governance on Performance of Sugar Manufacturing Firms in Kenya: A Case of Sugar Manufacturing Firms in Western Kenya Philip naftali mbalwa , Henry Kombo , Lydia Chepkoech , Shadrack Koech , 2 3 4 Paul Mbiti Shavulimo , 1,Department of Economics, Egerton University, P.O. Box 536, 20115 Egerton, Kenya 3Department of Business Studies, Kabarak University, private Bag 2017, Nakuru, Kenya Department of Business, Egerton University, P.O. Box 536, 20115 Egerton, Kenya 5Department of Business, Kenya Methodist University, P.O. Box 2265, Nyeri, Kenya Abstract: Corporate governance is increasingly becoming important in organization as an approach of improving performance. Corporate governance is the system through which organizations are directed and controlled. It is concerned with transparency, accountability and power relationship within and outside the organization. There has been an increasing importance in corporate governance in organizations in recent years. Some studies have argued for a positive relationship while others argued that there is a negative relationship between corporate governance and organizational performance. This study sought to determine the effect of corporate governance on organizational performance of sugar manufacturing firms in western Kenya. The research employed correlation survey design. The population of the study constituted of eleven sugar manufacturing firms in Western Kenya. A convenience sample of sugar manufacturing firms in Western Kenya was used for the study. Primary data was collected using structured questionnaires. Descriptive statistics was used to summarize the data. Pearson’s correlation coefficient was used to determine the relationship between corporate governance and organizational performance of sugar manufacturing firms, multiple regression analysis was used to determine the effect of corporate governance on organizational performance. Findings revealed that the corporate governance practices were positively related to the performance of sugar manufacturing firms in western Kenya, although not very strongly (r = 0.587, p < 0.05). This means that the corporate governance practices which involve board characteristics, board size, Top management characteristics and Shareholders communication policy and Continuous disclosure had an impact on the performance of Sugar firms in Western Kenya. The study recommended that there are other factors which influence performance of sugar manufacturing firms such as trade liberation and government intervention which normally introduce new variables that have an effect on the performance of Sugar firms in Western Kenya. The study also recommended areas of further research. Key Words: Corporate governance, Performance, Sugar firms I. Introduction 1.1 Background of the Study The concept of corporate governance began to be used and spoken about more commonly in the 1980s (Parker, 1996) but it originated in the Nineteenth Century when incorporation was being advocated for as a way of limiting liability (Fletcher, 1996; Vinten, 2001). Adams (2002) perceives creation of the registered company to be the real starting point for any discussion on corporate governance. The issues associated with corporate governance have assumed multifarious dimensions with wide implications, especially for profit-oriented business organizations. There has been growing interest in corporate governance in recent times that it has become an issue of global significance. The main reason for the search for a universal understanding of the indicators, drivers and mitigating instruments of corporate governance has been heightened in recent times by the spectacular failure of top organizations including Enron, WorldCom, Tyco, Adelphia, Arthur Anderson, Lehman Brothers, Freddy Mac, Fanny Mae, Goldman Sachs, Marconi, Northern Rock, Parmalat and Yukos (Duke & Kankpang, 2011). In most corporate organizations, conflict of interest is a pervasive phenomenon which characterizes relationships between and among the various stakeholders. Conflict exists at many levels and in varying degrees of intensity. For instance, it is commonly observed between the majority and minority shareholders, and between the internal organizational controllers and some of the external stakeholders. Sugar industry ensures food security improves rural lives and provides sustainable livelihoods for millions of Kenyans, but it also has to suffer heavy government intervention. The industry is under constant threat of collapsing due to perennial challenges. The major crises the sub-sector is currently experiencing include liberalization and increasing competition from cheap sugar imports, poor industry policies and structures www.iosrjournals.org 86 | Page Effect Of Corporate Governance On Performance Of Sugar Manufacturing Firms In Kenya: A Case that fail to address basic problems that would assist in recovery and continued government intervention that has resulted in mismanagement of the industry (Mwakio, 2009). The reasons for poor corporate governance are found throughout the world which is mostly coupled with fraudulent acts and other major malpractices. They include irregularities in accounts, non-compliance with law, nepotism, non-merit based system and exploitation of minority shareholders (Love, 2011). Sugar firms have also had their share in corporate frauds and scandals. However the government has taken strides to reduce such malpractices and their effects on corporate environment. Governance is all about encouraging corporate sector to be accountable, fair, transparent and responsible as spelled out by the World Bank president. Companies today have established the concept of corporate governance which is characterized by major components that include company polices, rules and regulations, board of directors, role of CEO and chairman, stock holders, creditors, institutional investors and regulators reporting and maintaining overall transparency,fairness and accountability about the business operations (Nwakioke, 2009). The World Bank, in 1999, states that corporate governance comprises of two mechanisms, internal and external corporate governance. Internal corporate governance, giving priority to shareholders‟ interest, operates on the board of directors to monitor top management. On the other hand, external corporate governance monitors and controls managers‟ behaviors by means of external regulations and force, in which many parties involved, such as suppliers, debtors (stakeholders), accountants, lawyers, providers of credit ratings and investment bank (professional institutions). Consequently, corporate governance mechanism has been a crucial issue discussed again (Pham et al., 2007). Poor corporate governance has been a problem in the sugar industry. For efficiency and profitability of the industry, the reform process should be geared towards developing and implementing policies that will ensure that the principles of good corporate governance are instilled and maintained. This will ensure competitiveness and sustainability of the industry business enterprises and attract investment (Kenya Sugar Board, 2009). 1.1.1 Corporate Governance Effective corporate governance was identified to be critical to all economic transactions especially in emerging and transition economies (Banerjee et al., 2009). However, at varying levels of agency interactions, market institutional conditions reduced informational imperfections and facilitated effective monitoring of agents which impinged on the efficiency of investment. Likewise, corporate governance assumed the centre stage for enhanced corporate performance. What then is corporate governance? Corporate governance is the system through which organizations are directed and controlled. It is concerned with transparency, accountability and power relationship within the organization. The purpose of corporate governance is to ensure that the organization is managed in the long term interest of the shareholders (Joe, 2007). Corporate governance can also be referred to as set of rules and procedures that ensure that managers do indeed employ the principals of value based management. The essence of corporate governance is to make sure that the key shareholder objective-wealth maximization is implemented (Rashid,2008). It is concerned with the relationship between the internal governance mechanisms of corporations and society‟s conception of the scope of corporate accountability (Low, 2006). Keasey et al, (1997) included „the structures, processes, cultures and systems that engender the successful operation of organizations. Scholars argue that corporate governance is represented by the structures and processes laid down by a corporate entity to minimize the extent of agency problems as a result of separation between ownership and control (Fama, 1980). It must also be indicated that different systems of corporate governance will embody what are considered to be legitimate lines of accountability by defining the nature of the relationship between the company and key corporate constituencies. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation such as; boards, managers, shareholders and other stakeholders and spells out the rules and procedures and also decision making assistance on corporate affairs (Duke & Kankpang, 2011). By doing this, it also provides the structure through which the company objectives are set and the means of obtaining those objectives and examining the value and the performance of the firms. The improvement of corporate governance practices is widely recognized as one of the essential elements in strengthening the foundation for the long-term economic performance of countries and corporations (Kyereboah, 2007). The term corporate governance relates to how corporations, firms, organizations etc. are owned, managed and controlled. Moshe (2006) stress that corporate governance is about ensuring that the business is running well and investors receive a fair return. Cremers and Nair (2005) asserts that core corporate governance institutions respond to two distinct problems, one of vertical governance (between distant shareholders and managers) and another of horizontal governance (between a close, controlling shareholder and distant shareholders). www.iosrjournals.org 87 | Page Effect Of Corporate Governance On Performance Of Sugar Manufacturing Firms In Kenya: A Case 1.1.2 Organizational Performance Measuring and analyzing organizational performance plays an important role in achieving organizational goals. The performance is usually evaluated by estimating the values of qualitative and quantitative performance indicators (Maharm & Anderson, 2008). It is essential for a company to determine the relevant indicators, how they relate to the formulated company goals and how they depend on the performed activities. Measuring firm performance using accounting ratios is common in the Corporate Governance literature Maham and Anderson (2008) in particular, return on capital employed, return on assets, and return on equity. Similarly, economic value added can be as an alternative to purely accounting- based methods to determine shareholder value by evaluating the profitability of a firm after the total cost of capital, both debt and equity are taken into account (Mazumbar, 2006). In this study, Market share, Growth in sales, profit and output in sales were used to measure organizational performance. Corporate governance promotes reduction of waste on non-productive activities such as shirking, excessive executive remuneration, perquisites, asset-stripping, tunneling, related-party transactions and other means of diverting the firm‟s assets and cash flows. It also results in lower agency costs arising from better shareholder protection, which in turn engenders a greater willingness to accept lower returns on their investment. The firm ultimately ends up enjoying higher profits as it incurs lower cost of capital. Importantly, firms become more attractive to external financiers in direct proportion to a rise in their corporate governance profile. Finally, managers become less susceptible to making risky investment decisions, and focus more on value-maximizing projects that generally facilitate organizational efficiency. The ultimate outcomes of these corporate governance benefits are generally higher cash flows and superior performance for the firm (Love, 2011). 1.1.3 Sugar Industry in Kenya The sugar sub-sector is mainly concentrated in the western part of Kenya. These include the populous provinces of Nyanza, Western and parts of Rift valley. Potential also exists in the Eastern and Coastal belts (Sucam, 2003). Shortly after independence in 1963 the government set up Muhoroni (1966), previously East African Sugar Company Ltd in 1961; Chemelil (1968); Mumias (1973); Nzoia (1978); South Nyanza (1979). Miwani Sugar, started in 1922 as private investment, was taken over in 1970. Private investment include: West Kenya Sugar, Soin Sugar Company, Kibos Sugar and Allied Industries Ltd, Butali Sugar Company and Busia Company. Of the private investments only Butali and West Kenya are presently in operation, the rest are proposed or at varying stages of construction. At present, both Miwani and Muhoroni are under receivership; only the latter is operational. According to Kenya Sugar Board (2005), the state stake holding in the industry is: Miwani Sugar (49%); Muhoroni (82.78%); Chemelil (97.64%); Nzoia (98.87%); South Nyanza (99.79%). The government has divested in Mumias and Miwani, currently retaining 20 percent in the former, also the sole firm presently listed at the Nairobi Stock Exchange. The large government ownership makes the industry prone to state and political interference (Sucam, 2003). The industry is one of the largest contributors to the agricultural Gross Domestic Product, directly and indirectly supporting and estimated 6 million Kenyans (20% of the Kenyan population), produces over 500,000 metric tonnes of sugar for domestic consumption (saving the economy in excess of US$250 million or Kshs. 20 billion in foreign exchange annually), GOK (2006). The prominence of the sugar industry in Western Kenya has prompted the growth of regulatory and other industry affiliated bodies. The government oversees the sub-sector principally through the Ministry of Agriculture (MoA) and the Kenya Sugar Board (KSB), the latter being made of representatives from the state, sugar companies, farmers‟ organization and general industry. The industry has over 150 smaller, artisanal „jaggerries‟, competing for cane with the regular factories (Harding, 2005). Other related industries are: Agro- chemical and Food Company Limited started in the early 1980s with some government stake holding.. This scenario has stimulated growth of rural infrastructure in feeder roads, transport services, spurring economic, educational, medical and other social services and the expansion of other rural facilities, all vital to western Kenya‟s economic well-being. This desire was expressed in the Sessional Paper No. 10 of 1965 on African Socialism and its Application to Planning in Kenya. Despite these investments, self-sufficiency in sugar has remained elusive over the years as consumption continues to outstrip supply. Total sugar production grew from 368,970 tonnes in 1981 to 520,404 tonnes in 2007. Domestic sugar consumption increased even faster, rising from 324,054 tonnes in 1981 to 741,190 tonnes in 2007. The main industry organ is the Kenya Sugar Board. KSB was established to regulate, develop and promote the sugar industry; coordinate the activities of individuals and organizations in the industry and; facilitate equitable access to the benefits and resources of the industry by all interested parties. KSB has 12 members and renewable tenure of three years. Another key player is the Minister of Agriculture who imposes levies on domestic and imported sugar, Special Development Levy (SDL), makes the regulations and appoints the SAT members in consultation with the Attorney General. The stakeholders in the industry include farmers, the government, sugar factories, and out-grower institutions like the Kenya Sugarcane Growers Association www.iosrjournals.org 88 | Page Effect Of Corporate Governance On Performance Of Sugar Manufacturing Firms In Kenya: A Case (KESGA), Kenya Sugar Research Foundation (KESREF), importers, financial institutions, transporters, consumers and lobby groups like Sugar Campaign for Change (SUCAM). Unfortunately, not all of them have been involved in the due processes and most of them have not been represented. This has resulted in a small group making decisions that affect the entire industry. This is occasioned by political interference. The performance of the sugar industry has continued to be quite dismal. Kenya therefore continues to live off its legacy of being self-sufficient in terms of sugar production. According to sources from the Mumias Sugar Company, current production stands at 520,000 metric tonnes and consumption which has increased steadily over the last years at 740,000 leaving the country with a deficit of 220,000 metric tonnes. From the list of registered millers and jaggeries provided by the KSB, Muhoroni and Miwani Sugar Company are currently under receivership. Muhoroni Sugar has been under receivership for the last four years Ramisi Sugar Factory collapsed in 1988 although plans are underway to revive it. According to the agricultural manager of the company sanctioned by the government to revive Ramisi, commercial growing of cane at the Kiscol project, was expected to commence by June 2010, while it was anticipated that the factory was to be fully operational by 2011. In terms of production arrangements, most Sugar companies typically have a factory, human resources, agriculture and finance department. The factory department has recently been split up into quality control and engineering in a number of the factories such as Chemelil. The sugar companies also maintain nucleus estates to ensure there is enough supply of cane. Out growers‟ scheme on the other hand covers individuals or private sugar–cane farmers. Despite the existence of nucleus estates, sugar companies still complain of sugar cane shortage a problem which has also contributed to the production gaps in the industry. 1.2 Statement of the Problem Corporate governance is increasingly becoming important in organizations as an approach of improving organizational performance. Lack of sound corporate governance has led to poor performance of organizations throughout the world as well as suppressing sound and sustainable economic decisions. Economic crisis that hit the South East Asian stock markets in 1997-1998 was partly due to weak corporate governance in the region. Several studies demonstrated varying positive relationships between corporate governance and organizational performance in quoted companies in Nigeria. Some other studies have however argued against a positive and negative relationship between corporate governance and firm performance. Empirical literature has revealed inconsistent findings regarding the relationship between corporate governance and organizational performance. Given the inconsistency reported in Kenya and the fact that little studies have been done in Kenya on sugar firms and few have been done elsewhere, this study sought to determine the effect of corporate governance on performance of Sugar manufacturing firms in Kenya. 1.3 Objectives of the Study The overall objective of this study was to examine the effect of corporate governance on performance of sugar manufacturing firms in Kenya. The specific objectives of the study were to: i. Determine the effect of Board characteristics on the performance of firms. ii. Determine the effect of top management characteristics on performance of firms. iii. Determine effect of stakeholder communication on performance of firms. iv. Determine joint effect of Board characteristics, top management characteristics and stakeholder communication on performance of firms. 1.4 Research Hypotheses This study sought to test the following hypotheses: H 1:ard characteristics positively affect organizational performance. H 2 Top management characteristics positively affect organizational performance. H Stakeholder‟s communication positively affects organizational performance. 3: H 4 Combined levels of Board characteristics, top management characteristics and stakeholder communication positively affect organizational performance. 1.5 Significance of the Study Organizational corporate governance has some financial implication and thus it is imperative to keep track of such activities. The study is important to scholars in management and hence will contribute positively to the academic knowledge. The study will also be important to management practitioners and will contribute to the existing literature in the field of strategic management and other management courses. The study revealed that corporate governance practice affects the organizational performance of the sugar industry and that relationship exists between corporate governance and the organizational performance. The findings of the study will therefore be very useful to give a general picture of what corporate governance elements affect the performance of sugar industry. The study will be a basis of reference and will www.iosrjournals.org 89 | Page Effect Of Corporate Governance On Performance Of Sugar Manufacturing Firms In Kenya: A Case activate more research in the study area by academicians and the business community in Kenya and the world. 1.6 The Scope and Limitation of the Study 1.6.1 Scope of the Study This study was conducted to determine effect of corporate governance on performance of sugar manufacturing firms. Aspects looked into were Board characteristics, top management characteristics, shareholder communication characteristics, market share, sales growth, profit and output in units. This study used a sample drawn from the top management in various Sugar companies and only focused on sugar manufacturing firms in Western Kenya and Nyanza. 1.6.2 Limitations of the Study The study was limited to nine public and private sugar manufacturing firms in Kenya. Additionally, respondents were unwilling to provide information for fear that the information was sensitive. Besides, these respondents considered certain information as classified and confidential, and were unwilling to share the information. The researcher, therefore, took the necessary steps and measures to ensure that proper communication was made on the purpose of the study and assured the respondents of confidentiality of information provided. 1.7 Operational Definition of Terms Corporate governance: Corporate governance is the system through which organizations are directed and controlled. It is concerned with transparency, accountability and power relationship within the organization Firm performance: This refers to measurements of performance such as accounting ratios, return on capital employed, return on assets and return on equity. Stakeholders’ interests: This refers to the Structure that specifies the distribution of rights and responsibilities among different participants in the corporation such as; boards, managers, shareholders and other stakeholders and spells out the rules and procedures and also decision making assistance on corporate affairs. Sugar manufacturing firms: These are all those industries concerned with processing sugarcane into sugar Sugar industry: These are firms concerned with processing sugarcane stokes into sugar, molasses. Board Size: is the number of directors on the board. Board independence: is measured as the percentage of directors who are unaffiliated with the sample firm. Shareholder: somebody who owns one or more shares of a company‟s stock. Stakeholder: a person or group with direct interest, involvement or investment in something, e.g. the employees, stockholders, and customers of a business concern II. Literature Review 2.1 Introduction of the chapter Corporate governance is a necessary ingredient for the firm performance as well as the overall growth of the economy of the country (Brava et al., 2006). There was a virtual explosion of interest in corporate values under headings like shareholder value (Olson 2008; Copeland, 2005; Pinto, 2006), stakeholder value (Freeman, 1984), customer value (Kanellus & George, 2007). Large and new value systems were marketed as general solutions applicable to all kinds of businesses, which attracted little interest among academic researchers (Rajan & Zingales, 2000). The World Bank, in 1999, stated that corporate governance comprises of two mechanisms, internal and external corporate governance. Internal corporate governance gave priority to shareholders‟ interest and enabled the board of directors to monitor top management. On the other hand, Cremers and Nair (2005) asserted that external corporate governance monitored and controlled managers‟ behaviors by means of external regulation and force, in which many parties were involved, such as suppliers, debtors (stakeholders), accountants, lawyers, providers of credit ratings and investment bank. Corporate Governance is about ensuring accountability of management in order to minimize downside risks to shareholders and about enabling management to manage enterprise in order to enable shareholders to benefit from upside potential of firms (Keasey & Wright, 1993). Mercus (2006) extended an agency perspective on governance and suggested that particular blend of incentives, authority relations and norms of legitimacy in founder firms interacted with the external environment which affected the nature and pace of learning and capability development. The corporate governance structure specified the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders and other stakeholders and spelled out the rules and procedures for making decisions on corporate affairs. It also provided the structure through which the company objectives were set, means through which those objectives www.iosrjournals.org 90 | Page Effect Of Corporate Governance On Performance Of Sugar Manufacturing Firms In Kenya: A Case were attained as well as monitoring performance (Abor & Adjasii, 2007). Corporate governance is important because it promotes good leadership within the corporate sector. Corporate governance has the following attributes; leadership for accountability and transparency, leadership for efficiency, leadership for integrity and leadership for respect and the rights of all stakeholders, (Govannini, 2009). Lack of sound corporate governance has enabled bribery, acquaintance and corruption to flourish as well as suppressing sound and sustainable economic decisions (Verma et al., 2006). In general, corporate governance is considered to have significant implications on the growth prospects of an economy, because best practice reduces risks for investors, attracts investment capital and improves the performance of companies (Spanos, 2005). In Sri Lanka, effective corporate governance was considered as means of ensuring corporate accountability, enhancing the reliability and quality of financial information, hence enhancing the integrity and efficiency of capital markets, which in turn improved investor confidence (Rezaee, 2009). The main reason for emerging economies to consider introducing corporate governance was their need to build investor confidence to attract foreign and local investment and expand trade (Abhayawansa & Johnson, 2007). International donor agencies such as the IMF and World Bank indirectly influenced developing countries to improve their corporate governance mechanisms and regulatory infrastructure (Nanakioke, 2009). The adoption of corporate governance was also stimulated by the belief that the economic crisis that hit the South East Asian stock markets in 1997-1998 was partly due to weak corporate governance in the region (Mobius, 2002). This resulted in governance reforms in the emerging markets to restore investor confidence by providing a secure institutional platform on which to build an investment market (Maharm & Anderson, 2008). 2.2 Theories of Corporate Governance This study was based on two theories, the shareholder model and stakeholder model. Having a clear understanding of different models provided insights that were based on in identifying good corporate governance practices. 2.2.1 Shareholder model The identification of the separation of ownership and control as a source of conflicting interests between owners and managers can be traced back to Berle and Means (1932). Macus (2008) argued that whereas an agent (manager) acts on behalf of the principle (owner), differing objectives of the owners and managers, incomplete information on the managers‟ behavior, and incomplete contracts gave rise to the principle-agent problem. Particularly, incomplete contracts as a source of agency problems have been discussed by many authors such as, Fama and Jensen (1983) and Hart (1995). Much conventional corporate governance thinking was focused on arrangements to solve the agency problem and ensure the firm was operated in the interests of the owners (shareholders and creditors). In line with this thinking Rezaee (2009) described “corporate governance as the way a company is managed, monitored and held accountable”. There has been a great deal of critique relating to this „conventional‟ view of corporate governance. Firstly, this perspective overlooked the diversity of the stakeholders within the principal-agent relationship and thus ignored the game around an enterprise, which was performed by multiple stakeholders with varying degrees of conflicting interests among themselves. Secondly, this perspective focused too narrowly on the bilateral contract between owners and managers, and ignored the interdependencies and interactions among stakeholders. It was also criticized for treating managers as opportunistic agents that were driven by individual utility maximization. Opponents of the shareholder model stressed that the interests of all the stakeholders‟ was accounted for. If the emphasis was solely on shareholder value maximization, there were externalities that were imposed on other stakeholders of the corporation. This critique is the foundation of the corporate governance stakeholder model advocated by many theorists. 2.2.2 Stakeholder Model Stakeholders in a corporation include suppliers, employees, customers, governmental bodies, political groups, trade associations, trade unions, communities, associated corporations, prospective employees, prospective customers and the general public. Various stakeholder models were advocated by scholars. Allen (2005) suggested that corporate governance concerns arrangements to ensure that firms are operated in a way that society‟s resources are used efficiently, and that competition and reputation should also be included as mechanisms to deal with, in addition to the conventional ones. The model used by Allen suggested that when managers and employees reach full consensus and cooperate, the Pareto efficient outcome can be achieved. Allen‟s model however, is too simple to be used for analyzing complex realities, especially when the role of different stakeholders is to be considered. Rashid (2008) advocated that corporate governance consists of institutions that induce or force management to internalize the welfare of stakeholders. Based on this approach, a stakeholder model was designed in such a way that there was a broader mission of management, and www.iosrjournals.org 91 | Page Effect Of Corporate Governance On Performance Of Sugar Manufacturing Firms In Kenya: A Case management in turn was sharing control with stakeholders. The former suggests that management should aim at maximizing the sum of stakeholders‟ benefits, and incentive systems should then be designed with the purpose of achieving this aim. In this model, control is shared between stakeholders in the form of generalized co-determinations. This model is more elaborately designed, but it is based on the assumption of optimal contracting among stakeholders. This assumption is however considered unrealistic as there is a range of institutional setting restrictions on the contracts among stakeholders, for example, government intervention is an important factor that is prevalent in many emerging economies. 2.3 Corporate Governance Corporate governance provides a firm foundation for the development of economies. A good corporate governance mechanism improves the health of the corporate sector, thus enhancing national competitiveness. Corporate governance mechanisms consist of a combination of economic and legal institutions that ensure the flow of external financing to the firm, aligns the interests of owners (investors) with managers and other stakeholders, and guarantees a return to investors. Board governance is one of the important controls in managing the firms operations (Fama 1980; Fama & Jensen 1983). Previous studies by Western researchers (Anderson & Reeb 2003; Miller & Breton-Miller 2006; Villalonga & Amit 2006, Amran & Ahmad 2009, Samad et al., 2008) found mixed findings on corporate governance mechanisms and firm performance. Liu (2005) identified various corporate governance mechanisms. These include: board size, board composition, audit committee, CEO status, board independence and transparency and accountability. Larger organizations often use corporate governance mechanisms to manage their businesses because of their size and complexity. Publicly held corporations are also primary users of corporate governance mechanisms. Larger organizations often use corporate governance mechanisms to manage their businesses because of their size and complexity. Publicly held corporations are also primary users of corporate governance mechanisms (Vitez, 2011). The literature suggests that both market and non-market mechanisms could be used to promote the alignment of interest of managers and stakeholders. The managerial labour market and the market for corporate takeover exerted pressures both within and outside the firm in order to achieve such an alignment of interest. Fama (1980) asserted that a firm can be viewed as a team, whose members realize that in order for the team to survive, they must compete with other teams, and that the productivity of each member has a direct effect on the team and its members. Thus, within the firm, each manager has the incentive to monitor the behavior of other managers, whether subordinates or superiors. Secondly, Fama (1980) argued that the firm was in the market for new managers and the reward system was based on performance in order for it to attract good managers or even to retain existing ones. Demsetz and Lehn (1985) provided an explanation for the weakness of the market induced mechanisms as a means of protecting stakeholder interests. They observed that the free rider problem tended to prevent any of the numerous owners of equity from bearing the cost of monitoring the managers. Empirical works on the mechanisms aimed to help reduce the agency problem. Abstracting from other dimensions of corporate governance they focused on various mechanisms, board composition, board size, independence of chief executive officer, Audit committee, Transparency and accountability, Shareholders communication policy and Continuous disclosure 2.3.1 Board Characteristics Board characteristics comprises of Board of directors, Board size, Board composition and Independence of the Board. 126.96.36.199 Board of directors A board of directors is a corporate governance mechanism that protects the interests of a company‟s shareholders. The shareholders use the board to bridge the gap between them and company owners, directors and managers. The board is often responsible for reviewing company management and removing individuals who do not improve the company‟s overall financial performance. Shareholders often elect individual board members at the corporation‟s annual shareholder meeting or conference. Large private organizations may use a board of directors, but their influence in the absence of shareholders may diminish (Vitez, 2011). 188.8.131.52 Board Size Limiting board size to a particular level is generally believed to improve the performance of a firm because the benefits by larger boards of increased monitoring are outweighed by the poorer communication and decision making of larger groups. Empirical studies on board size provided the same conclusion; a fairly clear negative relationship appeared to exist between board size and firm value. A big board is likely to be less www.iosrjournals.org 92 | Page Effect Of Corporate Governance On Performance Of Sugar Manufacturing Firms In Kenya: A Case effective in substantive discussion of major issues among directors in their supervision of management. Scarborough et al, (2010) argued that large boards are less effective and are not easier for the CEO to control. When a board gets too big, it becomes difficult to coordinate and for it to process and tackle strategic problems of the organization. Empirical evidence on the relationship between board size and performance was mixed; hence bigger board having representation of people with diverse backgrounds was expected to bring diversified knowledge and expertise to the board. Yoshikawa and McGuire (2008) contended that by increasing the number of directors, the pool of expertise available to the firm increases and so larger boards are likely to have more knowledge and skills at their disposal as compared to smaller boards. Further, Forbes and Milliken (1999), and Goodstein, Gautam, and Boeker (1994) provided evidence that larger boards reduced the domination by the CEO. Pearce and Zahra (1992), and Dalton, Daily, Ellstrand, and Johnson (1998) reported positive association between board size and performance. Kathuria and Dash (1999) investigated the relationship between the size of the board and firm performance for 504 Indian firms. Jenson (2010) indicated that a value relevant attribute of corporate boards is its size. Organizational theory indicated that larger groups took relatively longer time to make decisions and therefore, more input time Cheng (2008). Empirical studies have shown that limiting board size to a particular level is generally believed to improve the performance of a firm (Lipton and Lorsch, 1992, Yermack, 1996, Sanda et al., 2005, Eisenberg et al., 1998).There was a convergence of agreement on the argument that board size is associated with firm performance. However, conflicting results emerged on whether it is a large, rather than a small board, that is more effective. For instance, while Yermack (1996) had found that Tobin‟s Q declines with board size, and this finding was corroborated by those of Mak and Kusnadi (2005) and Sanda, Mikailu and Garba (2005) which showed that small boards were more positively associated with high firm performance. However, results of the study of Kyereboah-Coleman (2007) further indicated that large boards enhanced shareholders‟ wealth more positively than smaller ones. Separation of office of the chair of the board from that of CEO generally seemed to reduce agency costs for a firm. Kajola (2008) found a positive and statistically significant relationship between performance and separation of the office of the chair of the board and CEO. Yermack (1996) equally found that firms are more valuable when different persons occupy the offices of board chair and CEO. Kyereboah-Coleman (2007) proved that large and independent boards enhanced firm value, and the fusion of the two offices negatively affected a firm‟s performance, as the firm had less access to debt finance. From a sociological point of view, a larger board of directors was beneficial and increased the collection of expertise and resources accessible to a firm (Dalton et al., 1999). Boards with too many members led to problems of coordination, control, and flexibility in decision-making (Jiangb et al., 2006). Large boards gave excessive control to the CEO and harming efficiency (Eisenberg et al., 1998; Fernandez et al., (1997). Furthermore, Jensen (2009) argued that as board size increases, boards‟ ability to monitor management decreases due to a greater ability to avoid an increase in decision-making time. Similarly, Hermalin and Weisbach (2007) argued that the consensus among the economic literature was that a larger board could weaken firm performance. Empirical studies on board size provided a similar conclusion: a fairly clear negative relationship appeared to exist between board size and firm value. Too big boards are likely to be less effective in substantive discussion of major issues among directors in their supervision of management. Research studies on higher market value of companies from Finland and China by Yermack (1996) and Liang and Li (1999), found a negative correlation between board size and profitability. Similarly, Mak and Yuanto (2003) using sample of firms in Malaysia and Singapore, found that firm valuation is highest when board size is small. Study of Nigerian firms by Sanda et al., (2003) reported that firm performance was positively correlated with small, as opposed to large boards. Finally, Mak and Kusnadi (2005) also reported that small size boards were positively related to high firm performance. Overall, the findings were consistent with the notion that a large board was characteristic of weak corporate governance and limiting board size to a particular level was believed to improve the performance of a bank as the benefits by larger boards were outweighed by the poorer communication and decision making of larger groups. These arguments suggested that large board size affected banks‟ performance negatively. In specific terms, the results of Klein (2002) and Anderson, Mansi and Reeb (2004) showed a strong association between internal audit committee and firm performance, whereas Kajola (2008) found no significant relationship between both variables. This lack of consensus presented scope for deeper research on the impact of this corporate governance variable. Regarding board size, there was a convergence of agreement of its association with firm performance. However, conflicting results emerged on whether it was a large, rather than a small board, that was more effective. For instance, while studies conducted by Yermack (1996), Mak and Kusnadi (2005), and Sanda, Mikailu and Garba (2005) found that small boards were more positively associated with high firm performance, Kyereboah-Coleman (2007) found that larger boards enhanced shareholders‟ wealth more positively than smaller ones. www.iosrjournals.org 93 | Page Effect Of Corporate Governance On Performance Of Sugar Manufacturing Firms In Kenya: A Case 184.108.40.206 Board Composition Board composition has been claimed as a key factor in allowing the board to act as a guardian of the principal‟s interests. Inside directors have access to information that is relevant to assessing managerial competence and the strategic desirability of initiatives. In that sense they are better able to discriminate legitimate or illegitimate causes of organizational misfortune. However, insider directors usually do not make exhaustive evaluation of the strategic decision processes since they are influenced by the CEO. Enhanced director independence, according to (Young 2003, Young et al., 2008) is intuitively appealing because a director with ties to a firm or its CEO finds it more difficult to turn down an excessive pay packet, challenge the rationale behind a proposed merger or bring to bear the skepticism necessary for effective monitoring. The proponents of agency theory said that corporate governance led to higher stock prices or better long-term performance, because managers were better supervised. However, Gompers and Metrick (2003) submitted that the evidence of a positive association between corporate governance and firm performance had little to do with the agency explanation. Empirical studies on the effect of board membership and structure on firm performance generally showed results either mixed or opposite to what was expected from the agency cost argument. Some studies found better performances for firms with boards of directors dominated by outsiders (Cornett et al., 2008; Ravina & Sapienza, 2009) while Weir and Laing (2001) and Pinteris (2002) found no such relationship in terms of accounting profit or firm value. Also, Forsberg (1989) found no relationship between the proportions of outside directors and various performance measures. Adams et al, (2010) Bhagat and Black (2006) found no correlation between the degree of board independence and four measures of firm performance. Bhagat and Black (2006) found that poorly performing firms were more likely to increase the independence of their board. Mac Avoy, Dana, Cantor and Peck (1983), Baysinger and Butler (1985) and (Klein 1998, Rezaee 2009) argued that firm performance was insignificantly related to a higher proportion of outsiders on the board. Thus, the relation between the proportion of outside directors and firm performance is mixed. 220.127.116.11 Boards Independence Board independence was considered crucial because outside directors were considered as true monitors‟ who could discipline the management and improve firm performance (Duchin et al., 2010). Nank and Bruce (2009) argued that a board is more independent if it has more non-executive directors (NEDS). As to how this relates to firm performance, empirical results have been inconclusive. In one breath, it was asserted that executive (inside) directors are more familiar with a firms activities and therefore are in a better position to monitor top management. On the other hand, it‟s contended that NEDS may act as professional referees to ensure that competition among insider‟s stimulated actions consistent with shareholders value maximization. Gokam and Simba (2009), asserted that the presence of non-executive directors in the board, would make the board more independent and an independent board could be better placed to make independent decisions and help safeguard the interests of all the stake holders, particularly the rights of minority shareholders. The issue of board independence stems from the concern to protect shareholder interests from managerial opportunism. Independence is critical to ensuring that the Board of Directors fulfills its objective of oversight role and holds management accountable to shareholders (Psaros & Seamer, 2009). Having majority of independent directors (outsiders) on the board will counterbalance the power of the CEO in decision-making and provide assurance to shareholders. As for the relation between board independence and firm performance, if outside directors are independent and have professional ability, they could be more objective to make decisions and monitor managers. Empirical research on the state of corporate governance by Bebchuk and Weisbach (2009), Ravina and Sapienza, (2009) Corroborated that the higher ratio of independent directors led to better firm performance. Corporate governance is a necessary ingredient for the firm performance as well as for the overall growth of the economy of the country (Alon Brava et al., in 2006). 2.3.2 Top Management Characteristics Top Management characteristics in this study focused on Audit committee, Independence of Chief Executive Officer, Director‟s Professional Qualification, Transparency and Accountability 18.104.22.168 Audit committee Corporate structure should include an audit committee composed of independent directors with significant exposure on financial transactions. The size and effectiveness of the Audit Committee could be an indicator of the seriousness attached to issues of transparency and sends the right signal to the public who then develops confidence in the organization (Watts & Zimmermon, 2007). Klein (2002) reported a negative correlation between earnings management and audit committee independence. Anderson, Mansi and Reeb (2004) found that independent audit committees had lower debt financing costs. The audit committee is established with the aim of enhancing confidence in the integrity of an organization‟s processes and procedures www.iosrjournals.org 94 | Page Effect Of Corporate Governance On Performance Of Sugar Manufacturing Firms In Kenya: A Case relating to internal control and corporate reporting including financial reporting. Audit Committee provides an „independent‟ reassurance to the board through its oversight and monitoring role. Among many responsibilities the boards entrust the Audit Committee with the transparency and accuracy of financial reporting and disclosures, effectiveness of external and internal audit functions, robustness of the systems of internal audit and internal controls, effectiveness of anti-fraud, ethics and compliance systems, review of the functioning of the whistleblower mechanism. (Kalam, 2006) Audit Committee may also play a significant role in the oversight of the company‟s risk management policies and programs. (Ertugrul & Hedge, 2009). Although results of studies by Klein (2002) Anderson, Mansi and Reeb (2004) showed a strong association between audit committee and firm performance, Kajola (2008) found no significant relationship between both variables. This lack of consensus presented scope for deeper research on the effect of corporate governance on organizational performance. 22.214.171.124 Independence of Chief Executive Officer Separation of office of the chair of the board from that of CEO generally seeks to reduce agency costs for a firm. Kajola (2008) found a positive and statistically significant relationship between performance and separation of the office of the chair of the board and CEO, Scarborough et al. (2010) equally found that firms were more valuable when different persons occupied the offices of the chair of the board and CEO. Kyereboah- Coleman (2007) proved that large and independent boards enhanced firm value, and the fusion of the two offices negatively affected a firm‟s performance, as the firm had less access to debt finance. The results of the study of Klein (2002) suggested that boards that were structured to be more independent of the CEO were more effective in monitoring the corporate financial accounting process and therefore more valuable. Fosberg (2004) found that firms that separated the functions of the chair of the board and CEO had smaller debt ratios (financial debt/equity capital). The amount of debt in a firms‟ capital structure had an inverse relationship with the percentage of the firm‟s common stock held by the CEO and other officers and directors. This finding was corroborated by Abor and Biekpe (2005), who demonstrated that duality of the both functions constituted a factor that influenced the financing decisions of the firm. They found that firms with a structure separating these two functions were more able to maintain the optimal amount of debt in their capital structure than firms with duality. Accordingly, they argued that a positive relationship existed between the duality of these two functions and financial leverage. Separation of these two offices was however sharply challenged by Mangena and Chamisa, (2008), who found that shareholders‟ returns were maximized when there was duality. 126.96.36.199 Director’s Professional Qualification Director‟s educational background and competency contributed positively to the success of firms (Castillo & Wakefield, 2006). Nevertheless, companies faced a challenge in searching for qualified directors to sit on the board A survey by Ernst and Young showed that many firms in Europe and America struggled to find qualified directors (Hartvigsen, 2007). Raber (2005) claimed that there was no shortage of qualified directors, but stringent laws and rules pertaining to directorship and litigation by shareholders made directors to be more careful in accepting their job. Nowadays, firms can no longer be satisfied with directors who simply make technical appearance (Berube, 2005). Firms seek qualified directors, together with their expertise. A report by Christian and Timbers in New York reflected the tough competition for recruiting qualified outside directors (Hartvigsen, 2007). 188.8.131.52 Transparency and Accountability Managers‟ accountability to shareholders is an important objective of corporate governance. Corporate governance is concerned with how a company is directed, controlled and managed, so as to ensure that there is an effective framework for accountability of directors to owners. Accountability is enhanced when the roles and responsibilities are clearly articulated in a program charter, memorandum of understanding, or partnership agreement and when these agreements work out such issues as to whom and for what purposes the members of the governing body are accountable to the program or the organization (Ridley, 2009).Stakeholder participation in the formulation of these agreements and their public disclosure also strengthens the accountability of program governance. All persons in leadership positions should uphold high standards of ethics and professional conduct over and above compliance with the rules and regulations governing the operation of the program (Albuquerque & Wang, 2008). Members of the governing, executive and advisory bodies, as well as members of the management team, must exercise personal and professional integrity, including the avoidance of conflicts of interest. Program‟s decision-making, reporting, and evaluation processes should be open and freely available to the general public (Berglof & Claessens, 2006). www.iosrjournals.org 95 | Page Effect Of Corporate Governance On Performance Of Sugar Manufacturing Firms In Kenya: A Case 2.3.3 Stakeholders’ Communication Characteristics Shakeholder Communication Policy formed part of Corporate Governance Principles and Best Practices framework. 184.108.40.206 Stakeholders’ Communication Policy The accuracy and reliability of the financial reports issued by management affected the perception of the firm by all other stakeholders and prospective investors (Nwadioke, 2009) The Zenith Company was to develop a Shareholder Communications Policy so as to promote effective communication with shareholders. The Shareholder Communication Policy formed part of Corporate Governance Principles and Practices framework. It was to develop a Continuous Disclosure Policy to ensure that it complied with the Corporations Act and the ASX Listing Rules (RCG Corporation Limited, 2009). The Zenith Company Secretary had primary responsibility for ensuring that implementation and enforcement of the Policy had been given full support and cooperation of the Board. The Continuous Disclosure Policy formed part of Corporate Governance Principles and Practices framework. The Company recognized the value of providing current and relevant information to its shareholders. The Disclosure Officers had the primary responsibility to communicate with shareholders. Information was communicated to shareholders through: - Continuous disclosure to relevant stock markets of all material information; Periodic disclosure through the annual report (or concise annual report), half year financial report and quarterly reporting of exploration, production and corporate activities, Notices of meetings and explanatory material, The annual general meeting, and Periodic newsletters or letters from the Chairman or Chief Executive Officer (Welsh, 2007). The Company was committed to the promotion of investor confidence by ensuring that trading in the Company‟s securities took place in an efficient, competitive and informed market. The Board was committed to timely disclosure of information and effective communication with its shareholders. This commitment was effected through the application of the External Disclosure and Market Communications Policy and a Communications strategy which included processes which ensured that directors and management were aware of and fulfilled their obligations (Welsh, 2007). 2.4 Organizational Performance According to Toudas et al., (2007), corporate governance was extensively important to the value of the firm as the policies were important for the firm to grow. In the same article it was found out that firms that were shareholder and manager friendly attained negative abnormal returns. So the writers recommended that the firms were to practice corporate governance in order to get the better returns in future. Organizational performance is a complex and multidimensional phenomenon (Ress & Robinson, 2004). Previous research suggested that organizational performance measurement provided managers with not only a means of control, which specified the gap between what was expected and what was actually achieved, but also support for developing strategy and questioning their perceptions and assumptions about their organizations, which was consistent with the concept of double-loop learning (Neely & Najjar, 2006). A wide variety of definitions of firm performance were proposed in the literature (Barney, 2002). The existing literature on corporate governance practices had used accounting-based performance measures, such as return on equity (ROE) return on assets (ROA), and market-based measures, such as Tobin‟s Q, as proxies for firm performance (Abdullah, 2004; Epps & Cereola, 2008). 2.5 Corporate Governance and organizational Performance It was widely acclaimed that good corporate governance enhanced a firm‟s performance (Eichholtz & Kok, 2011; Braga-Alves & Shastri, 2011; Gakam et al., 2009). In spite of the generally accepted notion that effective corporate governance enhanced firm performance, other studies reported negative relationship between corporate governance and firm performance (Hutchinson, 2002) or never found any relationship (Park & Shin, 2003; Prevost et al., 2002; Singh & Davidson, 2003; Young, 2003). There are many studies on the relationship between corporate governance and firm performance. One study showed that corporate governance enhanced operating performance and prevented fraud (Omeiza Micheal, 2009). In general terms, although several attempts at establishing a link between corporate governance and firm performance confirmed causality, the literature indicated relationships that ranged between a strong and very weak association (Abor & Adjasi, 2007).For instance, while Black (2001) found a strong correlation between corporate governance and firm performance,however studies of Gompers, Ishii and Metrick (2003), Klapper and Love (2004), Nevona (2005), Bebchuk, Cohen and Ferrell (2006), Black and Khana (2007), Bruno and Claessens (2007), Chhaochharia,Vidhi and Laeven (2007), El Mehdi (2007), Kyereboah-Coleman (2007), Larcker, Richardson and Tuna (2007), Brown and Caylor (2009) revealed varying degrees of positive association (Love, 2011). On the other hand, Ferreira and Laux (2007), Gillan, Hartzell and Starks (2006) and www.iosrjournals.org 96 | Page Effect Of Corporate Governance On Performance Of Sugar Manufacturing Firms In Kenya: A Case Pham, Suchard and Zein (2007) all found a negative relationship between corporate governance and firm performance. Companies with better corporate governance had better operating performance than those companies with poor corporate governance (Black, Jang, & Kan, 2002). Jensen and Meckling (1976) were concurrent with the view that better governed firms had more efficient operations, resulting in higher expected returns. It was also believed that good corporate governance helped to generate investor goodwill and confidence. Another study demonstrated that the likelihood of bankruptcy was related to poor corporate governance characteristics (Daily & Dalton, 1994). It was pointed out that the nature of performance measures ( restrictive use of accounting based measures) such as return on assets (ROA), return on equity (ROE), return on capital employed (ROCE) or restrictive use of market based measures (such as market value of equities) could also contribute to this inconsistency (Gani & Jermias, 2006). Furthermore, it was argued that the “theoretical and empirical literature in corporate governance considered the relationship between corporate performance and ownership or structure of boards of directors that used only two of these variables at a time” (Krivogorsky, 2006). Hermalin and Weisbach (2007) and McAvoy et al., (1983) studied the correlation between board composition and performance whiles Hermalin and Weisbach (2007), and Demsetz and Villalonga (2001) studied the relationship between managerial ownership and firm performance. The rewards of good corporate governance included reduction of waste on non- productive activities such as shirking, excessive executive remuneration, perquisites, asset-stripping, tunneling, related-party transactions and other means of diverting the firm‟s assets and cash flows. It also resulted in lower agency costs that rose from better shareholder protection, which in turn led to greater willingness to accept lower returns on their investment. The firm ultimately ended up enjoying higher profits as it incurred lower cost of capital. Importantly, firms became more attractive to external financiers in direct proportion to a rise in their corporate governance profile. Finally, managers became less susceptible to making risky investment decisions, and focused more on value-maximizing projects that generally facilitated organizational efficiency. The ultimate outcomes of these corporate governance benefits were generally higher cash flows and superior performance for the firm (Love, 2011). Most of the studies on the link between corporate governance and firm performance confirmed causality (Abor & Adjasi, 2007). However, the evidence indicated between a strong and very weak relationship. Black (2001), for instance found strong correlation between corporate governance and firm performance, as represented by stock valuation. Some other studies however argued against a positive relationship between corporate governance and firm performance (Ferreira & Laux, 2007; Gillan, Hartzell & Starks, 2006; Pham, Suchard & Zein, 2007). 2.6 Conceptual Framework The framework for this study considered corporate governance as a dependent variable a key component influencing the firm performance of sugar manufacturing industry. The conceptual framework for this study is illustrated in Figure 2.1. According to this framework, the corporate governance of sugar manufacturing industries is the independent variable whereas organizational performance is the
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