COLLEGE OF PUBLIC FINANCE MANAGEMENT AND

DEVELOPMENT

DEPARTMENT OF ACCOUNTING AND FINANCE

Master’s Program (Regular)

RESERCH PROPOSAL

Effects of corporate governance on financial performance of

Private commercial banks in Ethiopia

By:- Kokeb Abera Duressa

ID Number: - ECSU2102381

ADVISOR:-Tigist B.(PHD)

December 2023
Addis Abeba
Corporate governance and its effect on performance: empirical
evidence from private commercial banks in Ethiopia, located in Addis
Ababa.

Addis Ababa, Ethiopia

March 11, 2020
 Table of Contents
CHAPTERONE........................................................................................................................................... 1
INTRODUCTION........................................................................................................................................... 1
1.1 Background ofthe Study.................................................................................................................... 1

1.2 statement oftheProblem................................................................................................................... 2

1.3 Objective ofthe Study……………………………………………………………………………………………………………..3

1.4 General objective .........................................................................................................................3

1.5 specific objective ..........................................................................................................................3

1.6 Significance oftheStudy..................................................................................................................... 4

1.7 Researchhypothesis........................................................................................................................... 4

1.8 Scope ofthe Study.............................................................................................................................. 5

1.9 Organization ofthestudy.................................................................................................................... 5

CHAPTERTWO.............................................................................................................................................. 6
REVIEWOF LITERATURE............................................................................................................................... 6
Introduction.............................................................................................................................................6

2.1 TheoreticalReview............................................................................................................................. 7

2.1.1 Corporate GovernanceTheories.................................................................................................. 7

2.1.2 Corporate Governance RelevanttoBanking............................................................................... 11
2.1.3 BoardResponsibility............................................................................................................... …11
2.1.4 Board QualificationandComposition......................................................................................... 12
2.1.5 BoardStructure......................................................................................................................... 13
2.1.6 SeniorManagement.................................................................................................................. 14
2.1.7 Governance ofGroupStructures................................................................................................ 15
2.1.8 Risk ManagementandCommunication...................................................................................... 15
2.1.9 Compliance............................................................................................................................... 16
2.1.10 Internal Audit................................................................................................................. 16
2.1.11 Compensation................................................................................................................ 16
2.1.12 Disclosure andTransparency........................................................................................... 17
2.1.13 The roleof Supervisor..................................................................................................... 18
2.1.14 FirmPerformanceDimensions........................................................................ …………….18
2.2 EmpiricalReview.............................................................................................................................. 19

2.3 ConceptualFramework.................................................................................................................... 23

CHAPTERTHREE......................................................................................................................................... 25
RESEARCH DESIGNANDMETHODOLOGY.................................................................................................... 25
3.1 ResearchDesign............................................................................................................................... 25

3.2 Population andSamplingTechnique................................................................................................. 26

3.3. SourceofData.................................................................................................................................. 26

3.4 Method ofdataanalysis.................................................................................................................... 27

3.5 Variable Measurements.................................................................................................................. 27

3.6 Model specification .........................................................................................................................28

 CHAPTER ONE
INTRODUCTION

1.1 Background of the Study

Corporate governance is overall approach as to how firms are managed and directed in the interest
of stakeholders. Enhanced notion to the shareholders bound business management; stakeholders
approach to managing is believed to lead to sustained optimum value adding. (Australian Stock
Exchange corporate governance council, 2003) states that; there are developed indices through
which compliances is insured as developed by various scholars. The concept of corporate
governance is developed along the growth of corporate firms where directors do represent
shareholders to oversee the management bureaucrats running the day to day operation of the firm.
By alternate other options Shareholders do invest with the expectation to achieve more than
comparable investment .To achieve enhanced value creation, a pool of shareholders do select board
of directors presumed to be technically and legally fit to insure whether the operation of the
company is done with this value enhancement frame work. Having robust corporate governance
system for a given firm would support the management effort in efficient resource utilization to
effectively achieve the value adding objective (Kirkpatrick, 2009).
Under such owner and management separated corporate setup, there appear an inevitable non-
convergence of shareholder and stakeholder objective and management objective. Corporate
governance is vital tool that, if properly applied, serves as bridging mechanism leading to
convergence of shareholders/ stakeholders and management interest. Good governance would
generally presumed to lead to better performance reflected by higher return on investment, dividend
pay, and share price and growth of operational capacity (Australian Stock Exchange corporate
governance council, 2003).

Basel committee on banking and supervision, 2006 writing stated corporate governance related with
banking industry involves the manner in which the business and affairs of banks are governed by
their boards of directors and senior management, which affects how they set corporate objectives,
operate the bank’s on a day-to-day basis, meet the obligation of accountability to shareholders and
interest of depositors, supervisors, align corporate activities and behavior with expectation that bank
operates in safe and sound manner, and in compliance with regulations.

Farther more; Obeten, Ocheni, and John (2014) stated corporate governance affects banks’
performance and value of the firm and that strong governance lead to higher levels of investment and
to growth opportunities. Corporate governance in banks contributes to collaborative working relation
between bank management and bank supervisors (Katrodia, 2011). The balance and effectiveness of
the corporate governance mechanism can create a better corporate financial performance
(Dharmastuti & Wahyudi, 2013). Generally; corporate governance is about building credibility,
ensuring transparency and accountability as well maintaining an effective channel of information
disclosure that would foster good corporate performance. It is therefore crucial that banking sector
observe a strong corporate governance ethos (Onakoya, Ofoegbu, & Fasanya, 2012). A bank’s
failure to follow good practices in corporate governance and the lack of effective governance are
among the most important internal factors which may endanger the solvency of a bank. Corporate
fairness, transparency and accountability are thus the main objectives of corporate governance,
taking into account the corporate "democracy", which is the broad participation of stakeholders
(Marcinkowska, 2012).
In Ethiopian context, the widely known corporate investment structure is in the financial sector,
mainly banking and insurance. Banking is one of the key financial medium and enabler to economic
performance of a given nation and business environment.
The National Bank is responsible to maintain stable rate of price and exchange, to foster a healthy
financial system and to undertake such other related activities as are conductive to rapid economic
development of Ethiopia (National Bank of Ethiopia establishment proclamation number 591/2008).
Hence, the National Bank of Ethiopia has issued Bank Corporate Governance Directives No
SBB/62/2015 to be effective from September 21, 2015 with the aim of giving way to balanced risk
taking and enhancing business prudence, prosperity and corporate accountability with the ultimate
objective of realizing long term shareholders’ value and customers’ and other stakeholders’ interest.
The directive states that corporate governance plays a vital role in maintaining the safety and
soundness of financial system in general and banking sector in particular.
As separation of owner and management is the pervasive attribute of our banking industry, having
robust corporate governance will insure stakeholder’s value enhancement and economic stability of
the nation at large. Given the above stated premise, having sound corporate governance system in
the banking industry would lead to better performing banks in the interest of all stakeholders. Thus;
the main aim of this study is to assess the effectives of corporate governance on commercial banks
performance in Ethiopia.

1.2 Statement of the Problem

In line with study conducted by OECD (2015) in the aftermath of the financial crises, the established
notion was the association of the crises with poor implementation of corporate governance codes and
principles while asserting importance of existing governance codes. The areas of weakness
contributing to the financial crises are identified as remuneration, risk management and
communication, board practice and shareholder’s rights. More on the financial reporting council of
UK has also concluded that it is not from lack of sound corporate governance framework but for lack
of proper implementation of existing codes and principles that brought the financial crises (Financial
reporting council, 2010)

Furthermore, the study conducted by World Bank in (2009) has established that corporate
governance implementation gaps and its detrimental effect was not limited to Developed nation but
also identified same weakness in developing countries too. Emerging country specific governance
draw backs emanating from concentrated ownership; existence of significant state owned financial
institution; and lack of proper guide on managing managers-shareholders conflict of interest were
also pointed out as a compounding factor that heighten the need for prudent and broader assessment
of governance in emerging country financial industry(United Nations, 2010). In light of findings of
international organizations study’s stated here in above as to corporate governance failures
contributing to financial crisis of US and Western economic power base, it would be prudent to
have wider corporate governance consideration relevant to banking for failure ramification would
not be limited to shareholders but depositors and wider economy. Implying the appropriateness of
broader view of corporate governance notion that covers the purpose; interest of stakeholder
considered in running; stakeholders in control of the firm; how it is controlled and management and
communication of risk (William et al, 2012).

By appointing the board of directors, shareholders have an instrument to control managers and
ensure that the firm is run in their interest. The two most important roles of a board of directors are
monitoring and advising. As a monitor the board supervises the managers so as to ensure that their
behavior is in line with the interests of the shareholders. As an advisor the board provides opinions
and directions to managers for key strategic business decisions (Hann & Vlahu, 2015).

Different scholars use different proxies of internal and external corporate governance mechanisms
to see their impact on bank performance Rao & Kidane, 2017; Olani & Berhanu, 2019; Ashenafi et
al. 2021; Assefa & Megbaru, 2014; Yenesew 2015; Kibrysfaw 2013; Firehiwot 2015; Abdurazak
2017. These various studies undertaken to assess effect of corporate governance on bank
performance have used a varied combination of governance mechanism as explanatory variables.
Moreover, results of the studies show varied effects of the corporate governance proxies in terms of
significance level and direction of relationship to bank performance. Hence the subject remains a
topic for further investigation to enable identify pertinent governance mechanisms that require due
attention. Healthy financial sector is fundamental for sustained growth and good corporate
governance ensures that banks are sound and stable. Therefore, this study contributes to existing
knowledge and bridge gap by identifying the effect of selected only internal corporate governance
mechanisms on performance of private banks in Ethiopia.

The main questions to be answered here is that:

1. What are the effects of internal corporate governance mechanisms on the performance of
private commercial banks?
2. Which elements of corporate governance proxies are more relevant to commercial bank of
Ethiopia?

1.3 Objective of the Study

1.3.1 General objectives
The general objective of the study is to examine the effect of corporate governance mechanism on
the performance of private commercial banks in Ethiopia.

1.3.2 Specific objectives;

 To examine the effect of internal corporate governance mechanisms on the performance of
private commercial banks
 To identify the elements of corporate governance principle are more relevant to private
commercial bank of Ethiopia?

1.4 Research hypothesis

The hypotheses of the study were established based on the conceptual framework for the research
study. In this particular study, Independent variables (board size, board gender diversity, Industry
related qualification of board members, Board ownership, Number of board meetings, Number of
board committees, Capital adequacy ratio, Legal reserve, Liquidity position and Management
efficiency) were measured to see if it has any relationship with dependent variable ( ROA as firm
performance). Accordingly, the research hypotheses were employed as follow.

Ho1: There is no relationship between board size and bank performance

Ho2: There is no relationship between board gender diversity and bank performance
Ho3: There is no relationship between industry related qualification of board members and bank
performance
Ho4: There is no relationship between board ownership and bank performance
Ho5: There is no relationship between number of board meetings and bank performance

Ho6: There is no relationship between number of board committees and bank performance

Ho7: There is no relationship between capital adequacy ratio and bank performance
Ho8: There is no relationship between legal reserve and bank performance
Ho9: There is no relationship between liquidity position and bank performance
Ho10: There is no relationship between management efficiency and bank performance

1.5 Significance of the Study

The result of this research is believed to contribute lot to private commercial banks in the country.
Among others, the research output help the banks to formulate and implement viable solution that
would enhance bank performance by improving the corporate governance. The research can also
assist top level managements and policy makers to better understand the issue. Furthermore the
results of this study also could be used as input to other researches who are interested to search
further on related problem in the future.

1.6 Scope of the Study

The main aim of this research is to examine the effect of corporate governance mechanism on the
performance of private commercial banks in the country. The study contributes to existing research
by increasing the time frame of study, increasing number of banks included in the sample, studying
banks under similar mode of operation and incorporating internal and external proxies of corporate
governance. Identifying variables through repeated studies using varied mix of corporate
governance proxies helps identify explanatory variables which significantly affect the bank
performance in Ethiopia located in Addis Ababa.
To come up with this problem and to know the position of all banks in the country six (6) year’s
data are collected from all 17 (Seventeen) commercial banks in the country a period from 2017 -
2022. Based on this except state owned banks all commercial banks whose has been operating since
2016 are included as case study.

1.7 Organization of the study

This study has five chapters. The first chapter is about introductory part of the study which includes
background of the study, statement of the problem, research questions, objectives of the study,
scope of the study, limitations of the study, and definitions of terms. The second chapter is about
literatures review which includes theoretical literature, empirical literatures and conceptual frame
work. The third chapter deals with methodology which includes description of the study area,
research approach, research design, population and sample, data sources and type, data collection
procedures, and ethical consideration. The fourth chapter is about data presentation and analysis.
The last chapter, fifth chapter is about summary of findings, conclusion and recommendations.
 CHAPTER TWO
LITATURE REVIEW
Introduction
Before digging into the concept of corporate governance and firm performance, it would
commonsensical to have a brief understanding of corporate governance as one notion and concept of
firm performance separately with theoretical facet and development as to relationship that exists
between the stated concepts in general and specific to the banking sector.

2.1 Theoretical Review

Corporate governance is defined as the system by which companies are directed and controlled,
(Cadbury Report (1992). The expansion to this definition as proposed by Kaplan (2010) has included
the direction and control of the firm, in the interest of shareholders highlighting agency issue involved
and in relation to those beyond the company boundaries suggesting a much broader definition that
brings in the notion of social responsibility. Under this broader scope, the interest of stakeholders is
included in addition to shareholder’s interest.

The purpose of corporate governance is described as system that monitors those parties within a
company who control the resources owned by investors (Kaplan, 2010). The supporting purposes are
stated as it ensures suitable balance of power on the board of directors; fair executive directors
remuneration; responsibility for monitoring and managing risk; independence of external auditor and
address other issues- business ethics, corporate social responsibility, and protection of
whistleblowers.
Firms are assumed to exist for the benefit of its owners who are assumed to be solely interested in the
maximization of their wealth. Managers, on the other hand, are the decision-makers in an
organization and they are implicitly assumed to automatically act in the best interests of the owners.
Generally there are a number of theories around like agency theory, Stakeholder Theory, Stewardship
Theory, Resource Dependency Theory, and Transaction Cost Theory are discussed here under.

Agency Theory
Firms are assumed to exist for the benefit of its owners who are assumed to be solely interested in the
maximization of their wealth. Managers, on the other hand, are the decision-makers in an
organization and they are implicitly assumed to automatically act in the best interests of the owners.
Agency theory recognizes that people are unlikely to ignore their own self-interest in making
decisions. The theory provides a means of establishing a contract between the principal and the agent
which will lead to optimal performance by the agent on behalf of the principal (Crowther & Seifi,
2011).
The advent of the modern corporation created a separation between ownership and control of wealth.
Even though owners would prefer to manage their own companies and reap the maximum utility for
themselves, this is impossible because of the capital requirements of the modern corporation.
Corporations grow beyond the means of a single owner, who is incapable of meeting the increased
economic obligations of the firm. Owners become principals when they contract with executives to
manage their firms for them. Executives accept agent status because they perceive the opportunity to
maximize their own utility. Principals invest their own wealth in companies and design governance
systems in ways that maximize their utility (Berle & Means, 1932).
The importance of Alchian and Demsetz’s model for corporate governance lies in the fact that it
justifies the role of shareholders as profit-earning entrepreneurs by using efficiency considerations.
The shareholders are the constituency that determines what objectives should be pursued by the firm
if it is to be efficient, but they also have the necessary incentives to ensure that these objectives are
actually pursued. The implication is that firms controlled by unconstrained managers are not efficient,
because of the divergence between the objectives of managers and those of profit-maximizing
shareholders. Hence, in order to promote efficiency and economic welfare, one would have to ensure
that within the firm structure there are sufficient constraints on managerial discretion aligning
management motivation to the profit- maximization objective which in turn leads to the maximization
of the firm’s market value (Dignam & Galanis, 2009).
In the theory of the firm, Jensen and Meckling state that the relationship between the stockholders
and the managers of a corporation fits the definition of a pure agency relationship. Corporations are
associated with the general problem of agency as there is separation of ownership and control. The
problem of inducing an “agent” to behave as if he were maximizing the “principal’s” welfare is quite
general.
Fama (1980) stated that the board is viewed as a market-induced institution, the ultimate internal
monitor of the set of contracts called a firm, whose most important role is to scrutinize the highest
decision makers within the firm.
A key issue in the agency view of corporate governance is how to align the interests of the agent with
those of the principal. Other important issues include the timely minimization of any divergences, and
how to balance the need for and the cost of monitoring with the benefits that arise from the separation
of control and ownership (Marnet, 2008).
Stakeholder Theory
According to Abrams’s article of 1951 (cited in Yusoff & Alhaji, 2012) this theory centers on the
issues concerning the stakeholders in an institution. It stipulates that a corporate entity invariably seeks
to provide a balance between the interests of its diverse stakeholders in order to ensure that each
interest constituency receives some degree of satisfaction.
According to Freeman (1984) managers bear a fiduciary relationship to stakeholders. Corporations have
stakeholders, that is groups and individuals who benefit from or are harmed by, and whose right are violated or
respected by, corporate actions. The stake holder theory states that corporations shall be managed in the interests
of its stakeholders and that directors shall have a duty of care to use reasonable judgment to define and direct the
affairs of the corporation. Freeman states that the stakeholders are those groups who have a stake in or claim on
the firm. He includes suppliers, customers, employees, stockholders, and the local community, as well as
management in its role as agent for these groups. The stakeholder theory does not give primacy to one
stakeholder group over another.

Wang and Dewhirst (1992) state that stakeholder theory can best explain how members of governing boards
think about the interests of corporate constituencies and thus how organizations are actually managed.

Stewardship Theory
Davis, Schoorman, and Donaldson (1997) define stewardship theory as situations in which managers are not
motivated by individual goals, but rather are stewards whose motives are aligned with the objectives of their
principals. In the theory, the model of man is based on a steward whose behavior is ordered such that pro-
organizational, collectivistic behaviors have higher utility than individualistic, self-serving behaviors. Where the
interests of the steward and the principal are not aligned, the steward places higher value on cooperation and
seeks to attain the objectives of the organization. This behavior in turn will benefit principals. Stewardship
theorists assume a strong relationship between the success of the organization and the principal’s satisfaction. A
steward who successfully improves the performance of the organization generally satisfies most groups, because
most stakeholder groups have interests that are well served by increasing organizational wealth. The steward
realizes the trade-off between personal needs and organizational objectives and believes that by working
towards organizational, collective ends, personal needs are met.
The essential assumption underlying the stewardship theory is that the behaviors of the executive are aligned
with the interest of the principals. Thus, stewardship theorists focus on structures that facilitate and empower
rather those that monitor and control. When both the principal and the manager choose a stewardship
relationship, the result is a true relationship that is designed to maximize the potential performance of the group.

Resource Dependency Theory

Resource dependency theory focuses on the role that directors play in providing or securing essential resources
to an organization through their linkages to the external environment. Directors bring resources to the firm, such
as information, skills, access to key constituents such as suppliers, buyers, public policy makers, social groups
as well as legitimacy (Abdullah & Valentine, 2009).
Pfeffer and Salancik (2003) state that organizations are constrained and affected by their environments and they
act to attempt to manage resource dependencies. Pfeffer (1972) asserts that boards enable firms to minimize
dependence or gain resources. Pfeffer (1972) finds that board size relates to the firm’s environmental needs and
those with greater interdependence require a higher ratio of outsider directors. He concludes “that board size and
composition are not random or independent factors, but are, rather, rational organizational responses to the
conditions of the external environment” Pfeffer and Salancik’s (1978) asserts that boards can manage
environmental dependencies and should reflect environmental needs. Pfeffer and Salancik (1978) suggest that
directors bring four benefits to organizations: (a) information in the form of advice and counsel, (b) access to
channels of information between the firm and environmental contingencies, (c) preferential access to resources,
and (d) legitimacy (cited in Hillman, Withers, & Collins, 2009)

Transaction Cost Theory

The main advantage that transaction cost economics brings to the study of corporate governance is that it
provides a robust framework to investigate contracting problems such as those occurring between the
management of the firm and its shareholders. The unit of analysis in transaction cost theory is the transaction.
Therefore, the combination of people with transaction suggests that in transaction cost theory managers are
opportunists and arrange firms’ transactions to their interests (Williamson 1996, cited in Abdullah & Valentine,
2009).

According to the theory, the equity governance structure has three important properties; first, shareholders bear
a residual claiming status. Second, the equity contract lasts for the duration of the life of the corporation. And
third, a safeguard in the form of a board of directors is created and awarded to equity-holders. According to this
view, the board bears a decision-review and monitoring relation to the firm’s management, including the review
and monitoring of management’s investment policy (Williamson, 1988 cited in Saravia & Chen, 2008)

Opportunism is defined by Williamson as “self-interest seeking with guile” and includes “calculated efforts to
mislead, deceive, obfuscate, and otherwise confuse.” According to this view, managers can be expected to
behave opportunistically whenever the relevant governance structure fails to contain them. Hence, opportunism
is the source of deviations from shareholder wealth maximization and constitutes a critical unit of the theory
(Williamson, 1996 cited in Saravia & Chen, 2008)
 2.2 Corporate Governance Relevant to Banking
Having sound corporate governance in banking is vital for proper functioning in the interest of savers and
depositors entrusting their resource tantamount to shareholders who have injected their investment,
notwithstanding the contribution to stability of the overall
economy.InlinewithBASELprincipleofcorporategovernance,corporategovernance is defined as a system that set
the allocation of authority and responsibility to carry out the affairs of the banks by its boards and senior
managers.

The principles of corporate governance outlined by BASEL are board’s overall responsibility; board
qualifications and composition; board own structure and practices; senior management; governance of group
structure; risk management, risk identification, monitoring and controlling; risk communication; compliance;
internal audit; and compensation.

2.2.1 Board Responsibility

In line with corporate governance principles of banks as outlined by BASEL committee, the board is
responsible for setting governance framework, corporate culture and value, and bank strategic objective, risk
appetite notwithstanding the oversight of senior management and overall operation of the bank. The board shall
exercise its responsibility with duty of care and loyalty as prescribed by relevant directive of National bank of
Ethiopia. The board is, therefore expected to set risk appetite and ensure adherence to risk policy; approve and
monitor capital adequacy, compliance policies, internal control, compensation system and assessment of related
party transaction as to risk and compliance with directive of the national bank of Ethiopia taking into account
the interest of depositor, shareholders, the supervisor, and other stakeholders.

Assignment and fixing fee of external auditor falls under the board responsibility horizon. As to senior
management, appointing chief executive officer and senior managements is part board responsibility.
Operational responsibility of the board includes among others – reviewing and approving strategies, policies,
business plan, and budgets; ensuring compliance of the bank with laws, regulation, policies and procedures;
monitoring performance; preventing conflict of interest; and ensuring capital adequacy; approving equity
investment decision.

Supervisor perspective board responsibility prescribe maintaining confidentiality of supervisor examination

report; timely addressing concern and instruction of the supervisor and implementation of findings of onsite
examination; and delivering minute of the general meeting within time frameset.

Staff perspective, the board needs to ensure existence of employee code of conduct. Furthermore, the board is
expected to put in place comprehensive risk management program.

2.2.2 Board Qualification and Composition

diverse skill and experience that is attuned to risk, size and complexity of the bank. To achieve balanced board
composition, the bank should have sound selection process based on skill diversity, relevant experience
availability, independence and integrity of the candidate. More on, the exposure of the candidate to local and
international competitive landscape and regulatory requirement is vital.

In line with National Bank of Ethiopia Bank Corporate Governance directive numbered SBB/62/2015, size of
board of directors is set to a minimum of nine with no upper limit. As to composition is prescribed to include
one third of minority (none influential) shareholders where those shareholders hold at least 30% that would be
one-fourth if they hold less than 30%.Qualification wise, the directive pinpointed that the pool shall consist
core competencies in area of banking, finance and accounting, legal, business administration, auditing,
information technology and investment management. More on the director goes further to recommending mix
of gender, though proportion is not vividly stated therein.

2.2.3 Board Structure

Setting appropriate governance structure in terms of leadership, size and use of committee to effectively
execute its responsibility lies within the horizon of the board of directors. The board shall have rules, by-laws
and relevant procedures to define its organization, responsibility, right and its activities. Such structure need be
reviewed and updated in line with internal and external operating dynamics of the firm, whilst maintaining
record of its activities carried to discharge its mandated responsibilities. The board chairperson shall assume the
vital role of ensuring proper functioning of the board by building trust, providing adequate information for
decision of the board, and promotion of critical discussion on mater of strategic importance. In pursuit of check
balance, having chairperson from non-executive board member is preferred. The structure shall also establish
specialized committee to enhance efficiency and focus.

Board committee should have a formal document setting their composition, scope, and mandate and working
procedures that need be disclosed to stakeholders.
 2.2.4 Senior Management

Senior managers are those delegated by board to carry out the day to day activity of the bank in line with
strategy, risk appetite and other policies approved by the board. Members of the senior management should be
recruited through formal process that ensures appropriateness of qualification, experience and personal
conduct. Senior management should establish management structure that promotes accountability and
transparency and delegation of staff to execute the duties. Under the auspices of direction given by the board,
the senior management shall establish and implement financial and non-financial risk the bank is exposed to
with appropriate procedure internal control and regulatory requirement in place as need be. To maintain the
reciprocity of the agency gap through supervision and to meet its responsibility entrusted to by shareholders,
the board should obtain information as to performance of the senior management and as to material matters-
change in business strategy, bank performance and position, cases of non- compliance, internal control failure
and regulatory concerns.

Directive SBB/62/2015 of National Bank of Ethiopia framed the responsibility of chief executive as to
governance under nine provisions. The scope starts with developing corporate strategy, policies, plans and
budget. Followed by preparation of organizational structure; allocation of authorities, duties and
responsibilities, and building sound management information system. Finally, it requires establishing effective
control system and risk management program with sound system to correct or address in case of deficiencies in
control or on managing risk. In addition, developing and implementing procedure manual and control system to
ensure compliance with laws and ensuring communication of such manual and control system to staff is what
the directive prescribes.

2.2.5 Governance of Group Structures

Albeit the pervasive financial industry in our country does not have group structure where parent-subsidiary
relationship exist, complex group structure by which branches are structured under territorial division appear in
Commercial bank of Ethiopia, the biggest state owned bank. Complexity of the structure can intricate the
identification and management of risk the bank is exposed, limiting the ability of the board and senior
management to oversight and supervise the operation of the bank effectively. The board should therefore
balance the profitability achieved through such structure and the risk the bank is exposed to through having
regular internal and external audit and review of the activities and the structure.
Given the pervasive financial industry structure in Ethiopia, there is no group structure of parent subsidiary
holding structure. Hence governance of group structure is not considered as corporate governance variable to
assess its effect on performance of the selected banks for the study.

2.2.6 Risk Management and Communication

Principle six of Basel code outline, the need for independent risk management function to be directed by chief
risk officer that develop, implement and monitor company wide risk governance framework, risk culture, risk
appetite, risk limit, and capital and liquidity needs as set by the board. Risk identification, monitoring and
control should be backed with internal control attuned to its risk profile and external risk landscape. To enable
informed decisions in discharging their respective responsibility of board and senior management, timely,
accurate and understandable communication as to bank wide, individual portfolio and other risk.

Walkers corporate governance review in UK banks recommend that board risk committee shall advice the
board as to as to pervasive risk exposure and risk strategy a head with special emphasis to capital and liquidity
management strategy. The recommendation further cedes the responsibility to ensure due diligence appraisal as
to strategic transactions risk aspects and implication to risk appetite and tolerance of the bank to the board.

2.2.7 Compliance

Under principles set by the board of directors, the board and senior management do assume the responsibility
to establish an independent compliance function that advice those in charge of corporate governance to ensure
operation that comply with applicable laws, regulation and internal control.

2.2.8 Internal Audit

Independent internal auditor whose function backed with clear mandate, sufficient and appropriate resource
access and reporting structure to board of directors shall provide assurance service as to internal control, risk
management and overall governance system. For the function to provide independent assurance in the best
interest of stakeholders, however, the attitude and overall policy of those in charge of the governance;
provision of adequate resource, recruiting qualified professionals and arranging resource for continues
development with changing professional standards and practice do play vital role. Thus to serve its purpose of
assuring the bank to focus on organizational objective developed by executives and approved by board that is
to optimized value whilst maintaining the associated risk within the set risk appetite limit, internal auditors
need be independent, objective, and with due skill and care (BPP,2011)
 2.2.9 Compensation

Board compensation committee overseas the remuneration system that would support sound corporate
governance, acceptable risk taking behavior, and implementation of the remuneration system by management
to enhance the value-adding objective to stakeholders.

Walkers review recommended that the board through its remuneration committee should include responsibility
to set overarching principle and parameters of remuneration policy organizational wise.

OECD corporate governance principle states the guideline as to remuneration by stratifying into guideline for
executives and Non-executive board members. It prescribes that the composition for remuneration of executive
to include appropriate blend of fixed remuneration and performance based remuneration.

Bases for setting fixed remuneration shall be in line with the bank scale of business, obligation at law and
labour market; and core performance requirement and expectation. As to performance-based remuneration, the
compensation need be set per agreed and clearly set performance target (OECD, 2014)

OECD guide line in respect of none executive directors or in our case board of directors is stated to be in form
of cash fees, superannuation contribution, and other benefits.

National bank directive numbered SBB/49/2011 however set annual board directors remuneration to a limit not
exceeding 50,000 with a monthly allowance not exceeding birr 2000, with no additional pay of financial or
none financial permissible rather than those set herein.

2.2.10 Disclosure and Transparency

Disclosure and transparency will enable stakeholder- shareholders, depositors, regulators and others- to
effectively assess the performance of board and senior management in governing the firm.

Section 12 of National Bank of Ethiopia directive SBB/62/2015 dictate the board and senior management to be
transparent to shareholders, depositor and other stakeholders focusing on related party transaction, board
composition and qualification, basic organizational structure, and disclosure as to financial performance. It
appears that respective disclosure provisions apply not to all but to relevant stakeholder. Disclosure as to
related party, foreign currency transaction, technology transfer is directed to the regulator. On the other hand,
Disclosure of board composition and qualification and audited financial reports are to the public with
requirement to be uploaded in company website.
 2.2.11 The role of Supervisor

Supervisors shall provide guidance and supervise the corporate governance of banks through established
directive, rules, policies and practices promoting sound corporate governance in the interest of stakeholders.
The supervision need be effected through regular interaction with board of directors and board committees the
as to effectiveness of the overall governance and to address governance improvement need and failures as need
be.

2.3 Firm Performance Dimensions

The business case stated by Kaplan (2010) outline enhancement of accountability as contribute to
maximization of sustainable wealth creation through better financial performance that is achieved through
better management. Further presumption is that better managers pay attention to governance.

Operation areas affected by issues in corporate governance are internal corporate governance stakeholders and
external corporate governance stakeholders. Internal stakeholders are those having an operational and corporate
governance role or other interest or claim in the company (Kaplan, 2010). Directors, company secretary, sub-
board management, and employee fall under internal corporate governance stakeholders.

Stakeholders having the role of influencing the operation of the company and having own interest and claim
over the firm such as auditors, regulators, government, stock exchange, small investors and institutional
investors (Kaplan, 2010).

2.4 Empirical Review

Sanjai Bhagat& Brian Bolton (2008) conducted a study entitled: “Corporate governance and firm
performance”. The study aimed at reviewing the inter-relationships among corporate governance, management
turnover, corporate performance, corporate capital structure, and corporate ownership from an econometric
viewpoint using Gompers, Ishii, and Metrick better governance model with sample period from 1990 to 2004
relying on financial data for evaluation its variables.

The result of the study is stated to show that better governance indices are significantly positively correlated
with better contemporaneous and subsequent operating performance. In addition, none of governance measures
is correlated with future stock market performance. Finally, disciplinary management turnover is positively
correlated with poorperformance.
John E. et al. (1998) conducted a study entitled “Corporate governance, chief executive officer compensation,
and firm performance”. The study examined the association between CEO compensation and quality of firm’s
corporate governance. It also examined whether week governance structures have poorer future performance.
The dependent variables were measure of CEO compensation- Total compensation, cash compensation, or
salary. On the other hand, the independent variables are defined as board structure and ownership structure.
Those variables are examined using cross sectional multiple regressions. Sample size of the study is 495
observations over three-year period taken from 205 public traded US firms. The data were collected from major
compensation consultants who have originally collected through mail survey method. The result of the study
suggested as weaker governance structure is associated with higher agency problems. In addition, increased
CEO compensation is associated with higher agency problem. Performance wise, firms with higher agency
problem are associated with poor performance.

Paul A. et al. (2019) conducted a study entitled: “Corporate Governance and Equity Prices”. The study is aimed
at examining corporate governance expressed in terms of shareholders rights whether or not it affects equity
prices. The model used is 24 governance rules to proxy for the level of shareholders rights. Sample of 1500
large firms in 1990s are used. The result of the study found that firms with stronger shareholder rights had
higher value and higher profit.

KateraJosph (2021) conducted a study entitled: “Corporate governance and business performance a case study
of selected companies in Uganda”. The study examined the relationship between corporate governance and
perceived performance of selected failed, poorly and well performing firms in Uganda. Developed conceptual
framework relates to transparency, fairness, and accountability to perceived performance. A sample of 200
boards of directors, CEO and top management were issued self- administered questioner with response rate of
54%. The results of the study indicate the existence of significant positive correlation coefficients between
transparency, fairness, accountability and perceived performance.

R Bauer et al. (2017) conducted a study entitled: “The impact of corporate governance on corporate
performance: Evidence from Japan”. The study has investigated the relationship between corporate governance
and corporate performance. The model used in the study is the six categories of GMI- board accountability,
financial disclosure and internal control, shareholder rights, remuneration, market for control, and corporate
behavior.

The result of the study indicated that well governed firms significantly outperformed poorly governed firms.
Further looking into detail variables to investigate the relationship of each sub-index with stock performance,
provision as to financial disclosureandinternal control, shareholder rights, and remuneration have a significant
impact on stock performance, albeit not all provisions of governance considered by GMI indices are relevant to
shareholders.

H. Kent Bakery and Gary E. Powell (2019) conducted a study entitled: “Management views on corporate
governance and firm performance”. The study has examined the view of top management of the fortune 1000
firms as to how corporate governance affects the performance of firm. Self-administered questioner is emailed
to CEO of fortune 1000 firms out of which only 6.5% is the response rate.

The result of the study shows as the responding managers agree with the notion that out of board characteristic-
composition and size- only composition as having effect on performance. As to shareholder right, the
respondents disagree that firm with weak shareholder’s right to show persistent stock market.

D.Vo and T. Phan (2018) conducted a study entitled: “Corporate governance and firm performance: Empirical
evidence from Vietnam”. The aim of the study is to quantify the relationship between corporate governance
and firm performance. Corporate governance is defined in terms of the size of board; the presence of female
board members; the duality of the CEO; the education level of board members; working experience of board
members; presence of independent directors; compensation of board; ownership of the board; and block
holders. Sample size of 77 firms over the longitude from 2006 to 2011 is analyzed using flexible generalized
least square method. The finding of the study state that all variables are having positive effect on performance
of the firm, excepted are board size variable that has negative relationship to performance and ownership of
board member variable that has non-linear relationship with firm performance as measured by return on asset.

R. Bauer et al. (2004) conducted a study entitled: “Empirical evidence on corporate governance in Europe: the
effect on stock return, firm value, and performance”, The study aimed at examining which of the eight
categories of Gov-Score governance index is most highly associated with firm performance.

Corporate governance variables are audit; board of directors; charter/by laws; director’s education; executive
and directors compensation; ownership; progressive practices; and state of incorporation. Governance variables
are measured using Gov-Score and data obtained from Institutional shareholders. Performance variables are
measured from three categories - operating performance, valuation and shareholder payout. A sample of 2,327
individual firms issued as of 1 February 2003.
The result of the study indicates that compensation, progressive practice, board of directors, director education,
state of incorporation and ownership are positively correlated whilst audit has positive sign twice, it has
significantly negative sign three times. As to charter/bylaws, has a positive sign only once.

Leora F. Klapper and Inessa Love (2002) conducted a study entitled: “Corporate governance, investor
protection, and performance in emerging markets”. The study explored the correlation between performance
measure and country wide legal and regulatory index and tested as how good corporate governance matters in
countries with weak shareholder’s protection and weak judiciary system.

A sample of 495 companies in 25 countries is selected based on firm size and investor interest. The instrument
is composite of 57 qualitative binary questionnaires. Governance index considered under the study includes
managerial compensation, board structure, disclosure and other minority shareholder protections.

The result of this study indicates that better governed firms are highly correlated with better performance.
Furthermore, the study indicates that having sound corporate governance is vital in countries with weak
regulatory environment.

Hamid Mehran (1995)conducted a study entitled: “Executive compensation structure, ownership, and firm
performance”. The objective of the study is examination of the effect of executive compensation structure on
selected manufacturing firms. The sample size of the study is 153 randomly selected manufacturing firms. The
sample is scoped period wise considering firms from 1979 to 1980.The result of the study portrays that firm’s
performance is positively related to compensation that is equity based.

2.5 Research Gap

Rao & Kidane, 2017; Olani & Berhanu, 2019; Ashenafi et al. 2021; Assefa & Megbaru, 2014; Yenesew 2015;
Kibrysfaw 2013; Firehiwot 2015; Abdurazak 2017, have conducted studies in Ethiopia. Except for Abdurazak
2017, the studies have included state owned banks in their sample; their results hence include effect of banks in
varying platforms of operation. Number of observation has also been limited. There is also tendency of the
studies to use internal corporate governance variables instead of including varied mix of governance proxies.
Study outcome will contribute in giving direction to make amendments and formulation of policies and
directives of corporate governance that best monitor, control and guide operation to benefit various
stakeholders.
 CHAPTER THREE

RESEARCH DESIGN AND METHODOLOGY

3.1Research Design

This study quantitative research approach was used to see the relationship between the financial performance
(ROA) of private commercial banks through specific and macroeconomic determinants.
The study also used explanatory research approach by using balanced panel research design to meet the research
objective. As explained by (Bhattacherjee, 2012), explanatory research attempts to identify causal factors and
outcomes of the target phenomenon.
A panel data stands for information across both time and space, and it measures some quantity about them over
time (Brooks, 2014). One of the merits of using panel data is addressing a broader range of the subject and
tackles more complex problems that would be possible with either of pure time-series or pure cross-sectional
data. Giving more informative data as it consists of both the cross-sectional information, which captures
individual variability, and the time series information, which captures dynamic adjustment is the other advantage
(Brooks, 2014).

3.2Target Population and Sampling

The target population of this study are; all private commercial banks that are operating in the country during the
study period i.e. 2017-2022. In Ethiopia, currently there are sixteen privately owned commercial banks.
As stated by (Kothari, 2004), purposive sampling is more desirable when the total population is small and a
known characteristic of them is to be studied. The numbers of banks in the country are few; however, adopted
balanced panel data needs a large number of observations; thus all private commercial banks were fulfilling
these criteria. The study tried to obtain data from all banks listed above but some of them are unable to provide
the required information, thus it is possible to draw conclusion using both secondary as well as primary date
collection since 102 observations (17 banks x 6 year’s data) are 53.5% of commercial banks are included.

3.3 Data Collection Instrument

Both primary and secondary data sources was used to collect the quantitative data of the study. The secondary
source of data for this research was from each banks annual report for micro (bank specific) factors whereas
macroeconomic factors are from NBE. The past (2017-2022 G.C) financial statement data i.e. balances sheet
and income statement are collected from NBE and each banks website. In order to increase the credibility and
reliability of the research findings, the study used audited financial statements.
Questionnaires distributed to board secretaries and finance managers are sources of primary data. Variables of
industry related qualification of board members, board ownership, and number of board meetings, number of
board committees and capital adequacy ratio have been collected from primary sources. In addition, the data for
board size, board gender diversity, and return on asset have been cross validated through primary sources.

3.4 Method of Data Analysis Techniques

Data analysis is a systematic process which applies statistical techniques to evaluate data through inspecting,
transforming and modeling data to draw useful information or decision making. This research adopted return on
asset as a proxy for financial performance of private commercial banks.
Thus ratios are calculated for financial performance (ROA) and explanatory variables of fourteen banks using
eight years period from 2017 to 2022 with the aid of Microsoft Excel. The descriptive statistics of both
dependent and independent variables were calculated over the sampled periods. This helps to convert the raw
data into a more meaning full form which enables the researcher to understand the ideas clearly. And then
interpret with a statistical description including standard deviation, mean, minimum & maximum. Then,
correlation analyses between dependent and independent variables will be done to see the degree of linear
association between them. Multiple linear regression analysis will be used at the end to determine the relative
importance of each independent variable in influencing the dependent variable (financial performance) of
Ethiopian private commercial banks. To conduct this, the researcher used statistical tools E-views 8 software.
The study has also performed diagnostic tests to ensure whether the OLS assumptions are violated or not.

3.5Variables and Measurement

Following review of theoretical and empirical literature, presented are the selected variables used as proxies to
study the effect of corporate governance on bank performance. Operational definitions of the constructs have
been included.

Agency theory, stakeholder theory, resource dependency theory, transaction cost theory are used as base to
select the variables. Moreover, empirical studies reviewed have used the variables as proxies for governance
mechanism.
3.6 Model Specification

To estimate the effect of corporate governance on banks’ financial performance, the following
regression model for the testing hypothesis is used. The panel data regression model was selected
based on review of literature.

ROAit= β0+β1x1it +β2x2it +β3x3it +β4x4it +β5x5it +β 6X6it +β7x7it+β8x8it +β9x9it +β10x10it
+β11x11it +β12x12it +ε it
Where: i, represent individual bank; t, represent time; β0, represent the constant; β1-12, represent coefficient for
the respective explanatory variables; ROA, represent return on asset of each bank and ε: represent the error term.
 CHAPTER FOUR
Cost and Time plan
I.1 Cost of budget Schedule

Measurement unit Quantity Price per unit Total price in birr

Descriptions
Paper sheet Pack 2 150 300
Pen '' 1 120 120
Printing Page 850 1 850
For internet (addition to Megabytes 3000 1 3000
AAU service)
Photocopy of materials '' 500 0.75 375
Mode of transport - 1000
Laminating the document Number 4 7 28
Binding the manuscript Number 4 150 600
Refreshment - 2000
Miscellanies expense - 1000
Contingency - 3000
Total cost 12, 273
 I.2 Budget Time Schedule (copy from the given time schedule)
NO Activity Time

1 Thesis titlesubmission and approval Oct 2- Oct 30/2023

2 Approval of title Nov 22-Nov 27/2023

3 Preparation of final proposal JAN 17-FEB 16/2023

4 Submission of final draft proposal in soft copy via FEB17-FEB 23/2023

CD to department approved by Adviser
5 Data collection FEB24-MAR23/2023

6 Data screening, encoding ,entry, generating MAR24-APRIL12/2023

preliminary analysis and interpretation
7 Writing of thesis up APRIL13-MAY11/2023

8 Submission of first thesis draft to Adviser MAY23-MAY30/2023

9 Incorporate Advisers comments and resubmission of JUNE1-JUNE13/2023

final thesis to the Adviser

10 Submission of final draft thesis in hard copy and JUNE15-JUNE20/2023

soft copy to department
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