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Chapter Two
LITERATURE REVIEW

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1.0.

Introduction
In the aftermath of the global financial crisis that began in 2008, banks around the

world have received the brunt of the blame for the crisis. The 2008 financial crisis was
highly linked by most economic participants to bank opacity. Some politicians, financial
leaders, and certainly many in the general public have blamed banks for the crisis because of
the concern that they took on too much risk to the detriment of customers and countries they
were supposed to serve (Liang, Xu & Jiraporn, 2013). The perception has grown that the
corporate governance of banks was so relaxed in the years leading up to the beginning of the
crisis that protecting stakeholders became secondary to attempting to generate as much
revenue and profits as possible (Adams, 2012).
In the United Kingdom, Prime Minister Gordon Brown requested a review to be
conducted for the corporate governance of banks in the United Kingdom to determine the
problems related to bank corporate governance, as well as recommend suggestions for how to
improve bank corporate governance in the country (Mullineux, 2011). The major problem
that led to the review to be conducted was the financial crisis that was considered to be as a
result of bank opacity. The review was thus expected to determine the effectiveness in risk
management in the banks and to determine the effects of corporate governance to
performance and risks. The review was thus expected to address the problem of the changing
patterns on banks boards and come up with recommendations on how improvements could be
effected on the banks corporate governance
The recommendations that were put forth from the Walker Report included changes to
the composition and role of the Board of Directors of banks in the United Kingdom such that
they are comprised of a broader range of people from within and outside of the banks they
represent, as well as take on a greater risk-management role as opposed to a sole focus on
revenue and profit generation (LeBlanc, 2010). From the Walker Report, questions arise

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about the appropriate role of corporate Boards of Directors in reducing risk while also
enhancing performance.
The chapter takes to review the specific studies that have been carried out previously
concerning corporate governance and the effects that it has on banks. Basel Committee on
Banking Supervision, (2014) argues that banks play a vital role in the running of the
economy. For this reason, effective corporate governance becomes a critical factor in the
running and proper functioning of the banking sector and the economy as a whole. They are
determinants of the performance of the economy as they determine the money supply and the
lending of money to the public. Without proper regulation, the banks could adversely affect
the performance of the economy as some people may want to enrich themselves at the
expense of the economy. The banks thus serve a major role in the economy as they serve the
role of intermediating funds from the savers to the depositors and incorporate them in
activities that support the enterprise and assist in economic growth. The bank governance
thus play a major role in the financial system of any given banks and the economy as a whole
(Basel Committee on Banking Supervision, 2014). It is for this reason that the banks need to
adopt corporate social responsibility through the adoption of optimal corporate governance
structure. The study focuses on four main variables namely; board size, board meeting
frequency, role duality and the number of number of non-executive directors in the business.
The chapter will review the opinions of previous studies concerning the four variable and the
strengths and gaps that exist in their studies. The review is thus done to investigate the
optimal structure for corporate governance that should be used and the effect that each of the
chosen structures has on the performance and risk in the organization. Different banks have
different corporate structures in terms of board size, number of non-executive directors and
roles duality and each structure has different risks that it faces. The review thus tries to
understand the role of board structure enhancing performance and reducing risk. The

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corporate governance thus determines the allocation of authority and responsibility within the
banks and in turn helps the board to set the banks strategyies and objectives, operate banks
day to day business, establish control functions and protect the interests of the depositors,
take into account the interest of the stakeholders and recognize the shareholders objectives
Bank opacity
According to Flannery, Kwan, & Nimalendran, (2004) the purpose of banks in the
economy differs from the purpose of the other industrial firms. The difference of the
functions brings in the reason as to why the banks are usually subjected to more strict
regulations than the other firms in the economy. Stringent regulations have been put up to
control the banks capital and risks (Flannery, Kwan, & Nimalendran, 2004). The purpose of
the regulation of the banks is to help prevent systemic bank runs which are usually caused by
the inherent instability of banks. Flannery, Kwan, & Nimalendran, (2004) continue to argue
that the rationale behing banks regulation is mainly a corporate governance problem.
However, given thast the investors lack information on how to monitors their investments, the
would be an increase in the adverse selection problems and moral hazards. As a result, banks
need to have a regulator to who should act as a monitor to the banks (Flannery, Kwan, &
Nimalendran, 2004)
El-Bannany, (2008) argues In the United Kingdoms economy, just like any other
economy around the world, the banks play a major role in defining the status and stability of
the economy. There are levels of banking in the United Kingdom just as there are in other
countries (El-Bannany, 2008). The banks are the major determinants of the money supply in
the economy. The banks are also tasked with issuing currency notes and coins that helps in
the management of national debt thus making it a lender of last result. Furthermore, the banks
also accept deposits from the public, advancing loans to their clients and credit creation. They
however extend their services to serve foreigners through foreign exchange deals and

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negotiate bills of exchange and other credit instruments. Finally, they provide mechanisms
through which firms and governments can make payments to each other (The Financial
Report Council, 2006).
To the economy, the banks are key role players especially in the supply of money. The
banks are institutions that are set up to help improve the allocation of funds. They allow for
funds transfers from one area to another thus helping to improve the state of the economy in a
country. The banks can however, bring negative effects to the economy which would force
the economy to underperform. In an instance where banks choose to withhold funds and not
offer loans to both the public and other bank would mean that the free flow of money would
not be available thus the economy will be affected negatively (El-Bannany, 2008).
Giuliano, (2006) argues that to the economy, the banks also act as providers of
liquidity through the issuance of demand deposits. As a result, there is a great liability on the
banks side to that is usually evident in the balance sheet. Borrowers in such an instance are
expected to be more informed than the lenders in the issues concerning their investments.
Giuliano, (2006) also argues that the banks are the lenders of last result to the economy. For
banks to effectively protect their depositors and also help to prevent bank runs that usually
lead to moral hazards within the banks, then the deposit insurance becomes important
(Giuliano, 2006).
How the businesses of banks affects risk and performance can be perceived or defined
by different stakeholders
Banks serves the welfare of all the stakeholders, it is impossible for a single bank to
objectively meet their demands (Clarkson, 1994). The different stakeholders perceive
performance and risks of banks different and thus each of the stakeholders takes to be part of
the banks stakeholders due to different reasons. The banks have to serve each of the
stakeholders differently according to their welfare. They should ensure that the manager

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identifies ways to hedge out risks while improving performance to help attract more
customers and investors into the company (Andreas & Vallelado, Corporate governance in
banking: The role of board ofdirectors., 2008).
Stakeholders perspective on performance and risk
According to Donaldson & Preston, (1995) reputation is an important factor as it
heavily influences the performance of a bank through the size of its customers. The
performance of the bank is reliant on the management of risks in organization. It is for this
reason that performance and risk are interrelated. Managing the reputation of banks through
risk management and improvement of the performance requires the banks to adopt soft skills
like the anticipation of future trends and needs, understanding the requirements of all the
stakeholders, listening to them and planning to enable positive action of the bank.
The shareholders of the banks are known to be risk averse yet they expect to have optimal
performance. There is thus a collision between the shareholders and the directors as the
directors like taking risks to improve on the performance of the company. The value of the
performance that is affected by the size of risks that a bank takes is the difference between the
book value of the companys net assets and the market capitalization (Donaldson & Preston,
1995).
According to Clarkson, (1994) the customers are also an influence on the performance
of the bank. The risk that a bank faces from the actions of the customers is the reputation risk.
The reputation risks are those that arise from the negative perceptions that the consumers,
debt and bondholders and the market analysts. Such risks rise from the banks ability to
maintain the already existing and establish new relationships to enhance continuous access to
sources of finance. A bad reputation would, therefore, increase the risks and undermine
performance for the business (Clarkson, 1994).

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According to Levine & Laeven, (2009) financial risks are other major risks that banks
face. The financial risks involved in banks are in most cases related to the management of the
banks. Their weaknesses and the means through which they undertake their activities would
either increase or decrease the financial risks of the organization (Levine & Laeven, 2009).
Anna, Takeshi, & Aigbe, (2009) argue that poor management in the banks would lead to
misappropriation of funds thus increasing the financial risks. Similarly, the board of directors
is also determinants of the financial risks that an organization faces. Where the board of
directors do not work to ensure that the management they employ are competent then
financial risks are likely to accrue. The monitoring of the management by the board of
directors is vital as it also reduces the financial risks of the banks (Anna, Takeshi, & Aigbe,
2009).
According to Plath & Mongiardino, (2010) asymmetry information risks could be
viewed as a situation whereby one of the parties involved in a given transaction posses more
information compared to the other thus making them superior. Asymmetry information in
banks can lead to either adverse selection or moral hazards which have negative implications
in a bank. The banks may take advantage of the current economic conditions to increase the
interest rates for customers so as to provide for the welfare of the shareholders through more
returns. The customers in such a case suffer due to lack of knowledge while the shareholders
and the banks enjoy the benefits through improved performance (Plath & Mongiardino,
2010).
Ellul & Yerramilli, (2010) argues that the operational risks in banks is the risk which
is associated with the administrative and operational procedures in banks. Weaknesses in the
administration procedures main through the adoption of weak controls and weak management
structures would mean that the operational risks associated with businesses are high. Other

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minor risks that should also be considered in banks include the market risks, insolvency risks,
strategic risks and liquidity risks (Ellul & Yerramilli, 2010).
The House of Commons treasury committee
The House of Commons treasury committee was a committee that was tasked with
investigating into the root causes of the banking crisis and proposals to the government on
how to enhance the strategic objectives of the banking sector (The House of Commons
Treasury Committee, 2009). According to House of Commons Treasury Committee, (2009)
the the crisis was invoked by a number of factors among them low interest rates, excess
liquidity and lack of faith in innovation in the banking sector. There was also failure by the
regulatory authority to introduce supervisory systems that would have been designed to
protect the public from systemic risks. The committee also argues out that the crisis led to the
collapse of some banks like the nothern rock as they were forced into becoming lenders of
last resort in the system. Individuals flocked the banks to withdraw their deposits after
nothern rock was declared solvent. Finally, the crisis also saw the merger between the Lloyds
and HBOs that was iamed at preventing the colapse of the HBOs due to the crisis (House of
Commons Treasury Committee, 2009).
David Walker recommendations
David, (2009) in february of the same year was requested by the then prime minister
of the United Kingdom to make a review of the corporare governance on the UK. The review
was expected to pass on recommendations to the banking system on the reasons for critical
loss and failure in banks. The review would be expected to provide ways to reduce damages
and cab risks that were incresingly being experienced in the industry (David W. , 2009).
Leblanc, (2010) in the Walker recommendation argues that the corporate governance
of banks should consider a number of factors before they undertake any actions concerning
the welfare of the organization. The overall scope of the financial institutions should be a key

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consideration, the shareholder engagement policies, international competitiveness and the
degree of prescriptiveness (Leblanc, 2010). Reflecting the concerns that were raised through
the consultative processes made by Walker, the following recommendations were raised.
Corporate governance should focus on the board size, its qualifications and the composition.
In practice, decisions on board size will depend on particular circumstances, including the
nature and scope of the business of an entity, its organisational structure and leadership style
(Walker, 2009). They should ensure that the board has enough knowledge and understanding
on the affairs of the business to enable them to contribute effectively to the business. They
should provide frequent training to the business to enhance development in the business. The
board should also provide dedicated support to both the executive and non executive directors
of the board especially on the matters that are relevant to the activities of the business. The
supervisory process should give close attention to the balance of the board to enhance the risk
strategies that are provided for by the board. Walker in the Walker review also recommends
that the board should be functions properly and its performance should be evaluated. The
nonexecutive directors should challenge and test any proposals put forward on the strategies
suggested by the executive. With the support of the chairman and other seniors, the board
should ensure proper leadership of the business and effectiveness in the various aspects and
departments of the bank. The board should also facilitate and encourage the directors
especially in matters concerning the discussion and decision making (The Walker Review,
2009).
Walker, (2009) also recommended that the shareholders should also understand their
institutional roles with include engagement and communication. The board should be made
aware of the material changes that the shareholders have made in due time. The institutional
shareholders should also prepare a code of responsibilities to help govern the institutional
investors. Walker also made recommendations on the governance of risk in that he proposed a

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board risk committee to be formed to help advice the boar on all the current risks that the
business is exposed to and the future risk strategies which they plan to undertake (Walker,
2009).
Walker, (2009) also makes key contributions to the role of duality in the organization.
He argues that the CEO also being the chairman of the board brings in both negative and
positive implications to the organization. The division of the two roles to have different
people in the two positions would mean an increase in the views as they would be diverse
from the two people while at the same time increasing the administrative costs. The Walker
Review, (2009) argues that the frequency of board meetings being held as has its own
implications to the banks. Provided the board meetings conveyed provide positive resolutions
to help improve on the banks performance, then the meetings should be held more often. If
the board meetings held have no positive resolutions made and are therefore only for their
personal benefits then the frequency of the meetings should be reduced (The Walker Review,
2009).
Walker (2009) also argues that the non-executive directors in most cases do not spend
sufficient time and effort in the jobs. In most cases the roles and the incentives that the nonexecutive directors have are not clearly spelt out and thus the reason they underperform in the
organization. The more the non-executive directors are in a business the less the performance
as they tend to have allowances paid to them yet they dont provide positive results to the
banks (Walker, 2009). The Walker Review, (2009) however argues that in some instances the
non-executive directors bring positive results to the business. In the management of risks
faced by the banks, the non-executive directors should be increased so as to provide more
information on how to cab the risks that the organization faces (The Walker Review, 2009).
Credit crunch

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The first declaration of the credit crunch in the United Kingdom was first made on
August 9, 2007 (Beltratti & Stuiz, 2012). Beltratti & Stuiz, (2012) argues that at this time, the
financial markets stalled since they lacked liquidity since the banks stopped lending to each
other. The crunch was caused by the failure of the institutions to manage the inherent
business risks together with the remuneration incentives of the directors. The management of
risks in the banks lacked influence and power. Finally, there were weaknesses in reporting for
both the financial transactions and for risks (Beltratti & Stuiz, 2012).
Corporate governance is all about the control and directing the different departments of an
organization to best achieve the interest of long-term performance. The directors are
continuously supposed to work towards improving the performance of the banks and reduce
risks.
According to the Turner Review, (2009) the credit crunch started as a result of the
collapse of the Lehman Brothers global bank in 2008 and it almost brought down the
countrys financial system. The Lehman Brothers banks collapsed since the management and
other financial operators in the bank failed to foresee the and accurately assess the riskiness
that faced the banks. The credit crunch led to the liquidity crisis in the UK banking sector.
With banks not providing loans to others due to the crisis, there was liquidity crisis both in
the case of banks and in the public as a whole. The interbank activities were interrupted when
the banks stopped lending to each other (The Turner Review, 2009).
The northern rock bank also faced major credit crisis during this period. The crisis
started when the regulatory authorities announced that the bank had been declared solvent
and that it had sought liquidity assistance from the bank of England. The financial service
authority had warned of the changing trends in the market citing that there were sharp asset
growth rates, systemic under-pricing of risks and shifts in risks for financial instruments. The
FSA had also warned the nothern bank against wholly relying on the on wholesale market

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funding as it made the bank susceptible to liquidity risks. According to Franco & David,
(2009) the UKs regulatory regime was a role player in during the crisis as it had failed to
establish a bankruptcy regime for banks, and lacked a deposit protection scheme for the
banks. Similarly, the bank had also failed to establish a resolution regime that could be used
to handle troubled banks (Franco & David, 2009).
The Turner Review; (2009) argues that the corporate governance is expected to
determine a number of variables in the company among them including whether to lend or
not to lend to other financial institutions, how to manage the business risks, the power
granted to the different departments to manage the risks facing the organization and
management of weaknesses in the management of risks and reporting. The credit crunch was
influenced by the actions of the corporate governance of the different banks in the different
activities that they undertook that were against the welfare of the other stakeholders (The
Turner Review, 2009). In the case of the central depository system, the turner report argues
that the market discipline plans an important role in governing bank risks. To some extent the
market succeeds in determining the performance and riskiness is faces in facilitating an
effective and efficient capital allocation. Turner review continues to argue that the crisis
exposed that the market had its limitations as there are doubts on the possibility of perfect and
effective markets. It is not possible for the corporate governance mechanisms to be fully
functional alone without regular intervention by both the board of directors and the
government. According to Zandi, (2009) the action of denying lending activities to the other
banks meant that there was little money circulation in the economy thus the economy became
unstable. It was, therefore the failure of the corporate governance of the banks to undertake
their activities well that led to the credit crisis (Zandi, 2009).
The economy of the United Kingdom suffered during the credit crunch as there was
little infrastructure development witnessed. Hsu, (2013) argues that due to the reduction in

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the lending activities of the banks, the capital for infrastrucuture development reduced. The
money suppl in the economy of the United Kingdom was also negatively affected since the
banks were not available to effectively provide the economy with easy money supply options.
All activities in the economy were thus adversely affected by the credit crunch (Hsu, 2013).
Effects of corporate governance on performance and risk
Mahfoudh & Ku, (2012) argues that corporate governance entails the means through
which banks sets targets to be implemented by other stakeholders like the shareholders and
the employees to improve on the performance of the organization (Mahfoudh & Ku, 2012).
Corporate governance comprises of the board of directors of banks who are an important tool
in the development of the organization, opportunity creation, leverage and management of the
banks. The board of directors, not necessarily the owners of the banks are the ones tasked
with providing the organization with a strong management to help hedge out risks in the
banks as well as make improvements on the performance of the organization. By focussing
on corporate governance, the study targets to examine board meeting frequency, board size,
non executive directors on the board and role duality (Minton, Taillard, & Williamson, 2010).
Board size
Influence on performance
According to Minton, Taillard, & Williamson, (2010) the size of the board is a major
issue on the performance and risk issues for the banks in the United Kingdom. Larger boards
are more likely to pools resources together and thus encourage the information flow and
processing abilities. The bigger the size of the board, the more skilful they are and as a result,
there is an improved decision making process. Larger boards allow for collective decision
making leading to the adoption of strategic decisions and actions into the banks to help
improve on their performance (Minton, Taillard, & Williamson, 2010). Mahfoudh & Ku,
(2012) argues that the larger boards are more likely to access and secure important resources

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from the environment around the banks and the different stakeholders. The larger boards
assist in developing better board interlocking relationships and create independence in the
decisions that are made for the organization. The bigger boards are in most cases diverse in
their ideas and they tend to promote diversification of ideas for better services in the
organization and as a result lead to better performance in the banks. Therefore, there is a
positive relationship that exists between the size of the board and the performance of the
banks.
David Y. , (1994) argues that different structures in the corporate governance systems
provide differences in the board effectiveness to provide proper governance. He argues out
that there is an inverse relationship that exists between the performance of the board in terms
of board value and the board size (David Y. , 1994). Lipton & Jay, (1992) recommends that
for a board to achieve optimal perfornance for the business it sjould comprise a maximum of
ten people. He argues that even if the board size was to increase, the expected benefits would
still be overweighed by the costs of remuneration and the speed at which the decisions are
made within the organization (Lipton & Jay, 1992).
Yermack (1996) argues that the board size has its effects on the real value of the
companies. The companies with smaller sizes of the board of directors have great advantages
in provide better value for the companies as it ensures optimal resource utilization and easy
and fast flow of information in the organization. The small board of directors ensures that the
gaps within the organization are easily identified and worked on to reduce the risks that the
businesses face (Yermack, 1996). Adams & Mehran, (2008) argues that there is a negative
relationship that exists betwen the performance of the organization and board size. The
cohesion that exists for small board allows the communication and cordination of costs to
reduce the director problems. For large boards, the incentives for directors to manage

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information is lower as compared to the small boards. However, the size of the board is also
determined by the economic environment around the business (Adams & Mehran, 2008).
Influence on risk
The bigger board are more likely to have control over the risks that face the
organization thus improving the performance of the banks (Mahfoudh & Ku, 2012). With
optimal board size, the risks facing the organization are reduced as the board effectively
manages both the reputation risks and the financial risks that face the organization. The size
of the board brings in other costs related risks as such as the monitoring costs. The larger
board sizes will have to be monitored often as there may be other in the board that do not
provide value for money yet they enjoy the benefits just like others in the board. Thus
according to Pathan & Skully, (2010) the board size is neatively related to the directors
monitoring costs thus may have an increase in risks faced by the organization (Pathan &
Skully, 2010).
Ladipo & Nestor, (2009) supports this argument when he argues out that the norms of
most boardrooms never change. The norms create a dysfunctional board such that the top
managers are never criticised in their actions (Ladipo & Nestor, 2009). Short coming are thus
expected to be evident in such banks as only the ideas and opinions of the top managers are
taken into practice thus increasing the risks that the organization faces.
Board meeting frequency
Influence on performance
During and after the credit crunch crisis, the frequency of the board meetings was an
important characteristic of the banks in the United Kingdom. According to Hudain & Haniffa,
(2006) the firms stock performance positively relates to the number of board meeting and the
frequency that the directors of the firms attended the meetings. The importance of board
meetings is that it is a channel through which the directors can exchange knowledge and

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information concerning the activities of the firm and how best to tackle the weaknesses to
improve on the performance of the firms (Hudain & Haniffa, 2006).
Uadiale, (2010) argues that the frequency of the board meetings strategically allows
for better performance of the organization as it encourages innovation and strategic
orientation through the flow of information when then board meets. The frequency of board
meetings encourage efficiency and effectiveness in the decision making process of the banks.
As a result, high quality innovative decisions are made that improve on the performance of
the organization and reduce the risks that the banks faces to enhance the improvement of the
services offered. The advantage of the frequency of board meetings for banks is that it could
help bring improvements in the resource utilization. Optimal resource utilization could mean
that there is increased performance in the organization while the costs incurred are greatly
reduced (Uadiale, 2010).
Nikos, (1999) argues that the number of board meetings held annually by the board is
inversely related to the value of the firm an increase in the frequency of board meetings in
organization would mean that the organization has been underperforming during the previous
years and the board seeks to address important issues that will improve on the performance.
The board meetings thus help the directors to monitor the performance of the organization
and improve on it where gaps are identified (Nikos, 1999).
Influence on risks
However, there are also risks involved in the board meeting frequency. The more the
board meetings being held in the banks the more the financial risks as the board may meet
regularly without any value addition on the performance of the bank. The banks would incur
more costs to pay for the allowances and other expenses that are incurred for the meetings to
be undertaken yet no value is added (Collins & Kofi, 2011). Where the boards in question are
large, there would be an increase in risks as there would be difficulties in expressing their

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opinions due to the limited time that there is for the board meetings. The information
acquired during the meetings may thus not be sufficient enough to provide solutions to the
risks available (Pathan, 2009).
Maryan & Seyedah, (2013) argues out that the return on equity is highly influenced
by the board meetings frequency. His research provided the findings that higher the frequency
of board meetings and lower the return on equity that is recorded in the business (Maryan &
Seyedah, 2013). Nikos, (1999) argues that the board meetings are not necessarily useful to the
organization since the limited time the directors spend on the meetings is not necessarily used
for the meaningful exchange of ideas. The idea behind this argument is the fact that at all
times during the board meetings, the chairman of the board sets the agenda to be used during
the meetings. The routine that is used for the board meeting also pose negativities to the
organization as the opinions of some of the members of the board are not passed across to the
board (Nikos, 1999).
Role duality
Influence on performance
Duality greatly determines the leadership structures of the banks and other financial
institutions. Duality occurs when the same person occupies the same leadership positions
such as the chief executive officer together with the chairmanship for the banks. According to
Elsayed, (2007) the duality concept in banks means that the same individual is tasked with
the management roles, implementations and control in the organization (Elsayed, 2007).
According to Pathan, (2009), the CEO posses the specific knowledge of the firm that is vitals
for the understanding and running of the banks. Similarly, Pathan, (2009) continues to argue
that the banks that have hign information asymmetry are likely to benefit more from the CEO
role duality. Thus the role duality in banks has positive effect on performance.

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Adams, Almeida, & Ferreira, (2005) argues that different individuals usually think
differently. With different people taking the positions of chairman and CEO, then more
diverse opinions are likely to be made to support the performance of the organization
(Adams, Almeida, & Ferreira, Powerful CEOs and their impact on corporate performance,
2005). Renee & Hamid, (2011) argues that different people have different characteristic and
qualifications. Having different people in the two seats would arguably mean that better
decisions will be made and as a result, an increase in performance for the organization (Renee
& Hamid, 2011).
Linck, Netter, & Yang, (2008) argues that previous studies conducted have not
explicitly addressed the determinants of CEO duality. The little that is already known ca
however be used to determine the role duality of CEO and its effects on performance. The
CEO posses specific knowledge that can be used especially for the large and complex banks.
In this case Linck, Netter, & Yang, (2008) argues that the role duality helps the banks reap
major benefits (Linck, Netter, & Yang, 2008).
Influence on risk
Hudain & Haniffa, (2006) sees the duality as a concept that is not consistent with the
checks and balances of an organization. He continues to argue that duality is a concentration
of power to one position which in turn reduces the boards effectiveness to make decisions.
The managerial and monitoring decisions are fully made by the CEO meaning that there are
weaknesses in the management team which may lead to reduced performance for the
organization and an increase in business risks. Duality thus limits the independence of the
board as they are in most cases working under duress from the CEO. Weisbach, (1988)
supports the opinion that the other directors in the organization are likely to be dependent as
their decisions are made from the decisions of the CEO (Weisbach, 1988).

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Hafiza & Susela, (2008) argue that the role duality should have a separation of powers that
allows for monitoring of the management. In such a case, the CEO may not introduce over
ambitious plans as they will need to be approved by the chairman of the board who must
consult with the rest of theboard members before comming into any conclusion (Hafiza &
Susela, 2008).
Renee & Hamid, (2011) however, argues that the size of the institution will determine
whether the institution should have different people in the position of chairman of the board
and that of the CEO or the same person. A small institution with different people in the two
positions would mean an increase in risks as opposed to the performance benefits that would
be recorded (Renee & Hamid, 2011).
The number of non-executive directors on a board
Influence on performance
According to Higgs, (2003) the non executive directors of the board are important to
the banks as they provide technological, technical and strategic assistance to the internal
executive directors. The non executive directors are vital as they offer effective monitoring to
the organization. The non executive board usually act as mentors to the board as a whole and
are active participants who help in the development of strategies to be used in the business.
The effect that the number of non-executive directors has on the business could be viewed in
two dimensions (Higgs, 2003). According to here the performance of the organization is at
stake, the non-executive directors bring in new ideas and information into the board that is
used to enhance the performance of the organization. The more the number of non executive
members, the more the information gathered geared towards improving the performance of
the banks. Having a big size of non executive directors would mean that the business would
benefit from the experience of the board thus would lead to an increase in the speed at which
the strategies of the company are implemented.

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Pablo & Eleuterio, (2008) argue that the role of the directors is to ensure effective
management of finances and enhance performance. The non-executive directors allow for
better management of resources and finances as they introduce their experience into the
board. The higher the number of non-executive directors, the higher the returns that are
expected as it helps the board to effectively manage its resources. (Pablo & Eleuterio, 2008).
Influence on risks
According to Iyala, (2011) the risks that are accompanied by the number of nonexecutive directors on the board in the banking sectors are evident since they are not fully
involved in the affairs of the business. The non-executive directors do not invest enough time
into the business thus the business may have an increase in risks for more cost (Almeida,
Ferreira, & Adams, 2005). The remunerations of the non-executive directors may not provide
value for money as they may be paid for time that they did not serve the interest of the banks.
The more the number of non executive directors, the more the risks as some may not work as
they await the others to work thus the business incurs extra costs without any value for
money (Stewart, 2011).
Agency theory
Walker, (2009) defines the agency relationship as a relationship in which a person
who is the principal engages or employs another who is the agent to act on his behalf and it
includes being granted the authority to delegate and make decisions for the organization
(Walker, 2009). Adams & Ferreira, (2007) argue that the agency theory is part of a bigger
topic of the corporate governance. It is a problem that arises among the shareholders of the
business as they decide who is best suited to run the business. It is therefore, the problem that
arises when the directors dictate how the company is to be run whilst the shareholders own
the organization (Adams & Ferreira, 2007). Demsetz, Saidenberg, & Strahan, (1997) argue
that the directors may in most cases not act in the best interest of the shareholders and thus

Partial Title 21
the agency theory was coined to consider the problem and identify what best could be done to
prevent the problem (Demsetz, Saidenberg, & Strahan, 1997).
According to May, (1995) mistrusts may occur between the agent and the principal
and thus the principal establishes proper incentives for the agent. Similarly, the principal may
limit the divergence of the agent by incurring monitoring costs that are made to help limit the
opportunistic actions of the agent (May, 1995). Despite providing these actions to reduce
divergence between the agent and the principal, some divergence may still remain but could
be viewed as residual loss for the principal (Walker, 2009). Davidson & Singh, (2003) argues
that the residual loss is the indirect additional agency costs that relates to directors purchasing
expensive materials for themselves at the expense of the shareholders. The costs that are
incurred by the shareholders in the agency relationship include the remuneration packages for
the managers, management costs that are incurred for the provision of annual reports,
committee activities and management analysis to risk. Other costs likely to be incurred
include the monitoring costs and the bonding costs (Davidson & Singh, 2003)
Stakeholder theory
According to Freeman, Wicks, & Parmer, (2004) he term stakeholder is a term used
for organizations to refer to the groups that have legitimate claim on the organization. The
stakeholder theory governs the organizational management and establishes business ethics
that address the morals necessary for proper running of the organization. The stakeholders of
the organization include shareholders, regulators, bondholders, and customers, savers,
borrowers and managers. Each of the groups that complete the stakeholders of the firm is
major contributors in the interest of the firm. Each of them provides the firm with critical
resources necessary for the running of the firm (Demsetz, Saidenberg, & Strahan, 1997). The
stakeholders of a firm could be divided into both internal and external stakeholders. The
internal stakeholders include employees, shareholders and the managers while the external

Partial Title 22
stakeholders include the suppliers, regulators, customers, society among others (Freeman,
Wicks, & Parmer, 2004).
(Donaldson & Preston, 1995) argues that the stockholders or the shareholders provide
the company with the capital necessary to run the business. In return, the shareholders expect
the capital to be maximized through profit maximization while reducing costs and risks. The
managers together with employees provide the organization with human capital
commitments, skills and time for the investments of the shareholder to bear fruits and realize
profits. Customers are among the most important part of the business as they supply revenue
to the organization. In exchange to the revenue that is supplied to the organization, the
customers expect value for money through goods and services provided to them. The
creditors are a source of finance for the organization. In exchange, the creditors expect the
loans that they provide to be repaid to them as and when they fall due together with the
interest that has accrued to the loans. The suppliers are the providers of the inputs of the
organization that are acquired at the lowest possible prices and are acquired depending on the
buyers demands (Donaldson & Preston, 1995).
Who are the principals of banks
According to the agency theory, the shareholders are the main principals of banks. In
this case, the shareholders are considered to be the principals as they delegate the business
duties to the directors who are considered to be the agents in the business. The arguments by
Jensen (2001) propose that shareholders ought to be the principals of the banks due to a
number of factors. First, the shareholders are the owners of the business in most cases, and
thus their interest should be considered first. Secondly, the shareholders are the reasons why
businesses come into existence and thus the reason why their interest should be served first.
Without the business, other stakeholders would not have any control of the business thus
another vital reason behind Jensens arguments (Jensen, 2001).

Partial Title 23
According to Saidenberg, Stahan, & Damsets, (1997) the stakeholders theory, there
are other principals of banks among them including the government and the employers. A
principal- agent relationship exists between the government and the business and also
between the employers and employees. The government business relation exists as the
business owes a corporate responsibility to pay taxes to the government. The business is thus
obligated to report to the government its reports that represent free and fair performance of
the business (Saidenberg, Stahan, & Damsets, 1997).
A principal- agency relationship also exists between the employees and the
employers. According to Fiordelisi & Molyneux, (2010) the employers are in most cases the
board of directors who determine the number of employees to employ. The board of directors
enter into a contract with the employees which in return the board expects them to work
towards achieving the welfare of all the stakeholders of the business (Fiordelisi & Molyneux,
2010).
The role of the board of directors and how its structure is related to banks corporate
governance and performance and risks
The board of directors plays a major role in the running of the banks. The board of
directors is a central part of the corporate governance as they ensure that the welfare of all the
stakeholders of the business is taken care of. The board of governance is vital as they are
major determinants of the performance of the banks.
According to Jensen, (2001) the board of directors plays an important role of
monitoring especially towards the top management of the banks. Without being properly
monitors, the management may end up acting in ways that do not serve the interests of the
stakeholders. They may end up placing bonuses upon themselves which may not serve the
long term interests of all the stakeholders (Jensen, 2001). Similarly, Pathan, (2009) argues
that the board acts as a defense mechanism for the banks as they monitor to eliminate any

Partial Title 24
incompetent management. According to Pathan & Skully, (2010) the board of directors is
responsible for putting up mechanisms for internal controls. The internal controls are
important to the organization as they are major determinants of performance and risk control
for the banks. Weak controls would mean that the banks do not achieve their full potential
thus the board of directors become important role players in the banks (Pathan & Skully,
Endogenously Structured Boards of Directors in Banks., 2010).
According to Liang, Pisun, & Pornsit, (2013) the structure of the board of governance
should be of optimal size and should meet regularly to pass on information and discuss on
issues concerning the banks. The structure of the board of directors is a determinant of
performance and risks to the organization. The structure of the board of directors is related to
corporate governance as the board needs to ensure that they act in accordance to the corporate
social responsibilities. The welfare of all the stakeholders should be incorporated in the
affairs of the company and thus the structure of the board of directors should be made to
ensure its supports their welfare (Liang, Pisun, & Pornsit, 2013).
Financials risks are likely to increase for poorly structured board of directors. The
management of the finances of the banks would be poor since the board of directors would
not be structured well to support the monitoring of the management.
Corporate governance
Corporate governance is the system through which the organizations and controlled
and directed and it specifies the specific rights and responsibilities of the organization. The
corporate governance involves the establishment of a strong relationship between both the
internal and external stakeholders of the organization. It is therefore a design that forces the
management of the organization centralize their activities on the welfare of all stakeholders.
Corporate governance with regards to banks entails the boards that are set up together with
the systems that are set to control the board. Corporate governance with regards to banks

Partial Title 25
entails the systems put in place to ensure optimal performance is achieved and that they
reduce all the types of risks that the banks face. In order to achieve responsible corporate
governance for banks the corporate social responsibility of the banks towards its stakeholders
should be considered. The corporate governance has often been shaping the policies of their
companies to achieve a wide range of environmental and social topics and responsibilities.
Proper corporate governance means that there are strong structures and a composition of well
behaved boards under scrutiny for their activities (Andreas & Vallelado, Corporate
governance in banking: The role of board ofdirectors., 2008).
Jay, John, & Nickolaos, (2002) in their article argue that according to the cadbury
report, the strucuture of the corporate governance should consist of both thehexecutive and
non executive directors. The cudbury report recommended that depending of the size of the
institution, there should be atleast three non executive directors and the position of the
chairman of the board should be held by a different individual from that of the CEO. The
division of both positions in the board helps to improve the the boards independence and
thus improving the quality of the decisions made (Jay, John, & Nickolaos, 2002).
Corporate governance is the structure composed of a board of directors and senior
management that is necessary in an institution to guarantee a sound financial system and
consequently a countrys economic development. It is the definition of corporate governance
as argued out by the Basel Committee and it shows that the financial institutions are key role
players in any given economy. The corporate governance in this case should differentiate
ownership from control and ensure efficient allocation of resources within the various bank
departments (Basel Committee on Banking Supervision, 2010).
According to FRC, (2010) corporate governance is a system that is set up to help
control and direct companies. They argue that the purpose of the corporate governance in the
organization is to help facilitate effective management and entrepreneurial skills to the

Partial Title 26
organization to help deliver long-term success to the organization. The concept of corporate
governance goes beyond the activities of the board of directors. The regulatory part of the
banks is an important objective of the corporate governance. Regulation in the banks
enhances safety, stability and soundness in the activities of the organization (FRC, 2010).
EOCD, (2004) argues that corporate governance is a system that allows organizations
to remain competitive in the changing world. they argue that corporate governance should be
adopted together with other innovative practices to enable businesses meet the changing
demands and grasp any new opportunities within the organization. Corporate governance is
also a concept that keeps the management on their feet as it tasks the senior management with
the responsibility of operational management. The corporate governance thus deals with both
the internal and external structures of the firm and ensures that they provide the firm with the
best risk management options (EOCD, 2004).
Mechanisms of corporate governance
Weir, McKnight, & Liang, (2002) argues that effective corporate governance is an essential
part of a business. The corporate governance ensures that the business sets and achieves
strategically its goals. Efficient corporate governance effectively combines policies, controls
and guidelines that that are aimed at achieving the needs of the stakeholders. For corporate
governance to be effective in the banks, it should be accompanied by a combination of
various mechanisms namely internal, external and independent audit. The internal
mechanisms are those that are aimed at achieving the objectives of the internal stakeholders
such as the employees, directors and the shareholders. The internal mechanisms ensure
smooth operations through segregation of the different responsibilities by the board of
directors (Weir, McKnight, & Liang, 2002). The internal mechanisms are the easiest for
banks to control and thus should be optimized by the organization. The stakeholders should
therefore bear their responsibilities and ensure that they achieve the objectives of the banks.

Partial Title 27
Davidson & Singh, (2003) argues that the external mechanisms are the controls that are
controlled from outside the organization. The external mechanisms include the legal
compliance by the business and effective debt management from the creditors and suppliers.
The banks have little control over the external mechanisms and thus in most cases leave it to
the control of the external mechanism. The independent audit on the other hand provides for
corporation to ensure that the financial statements provided represent a fair value of the
banks performance. The internal audit provides the company with a fair view of the internal
future outlook of the bank (Davidson & Singh, 2003).
Corporate governance and the shareholder and stakeholder approach
The problem of corporate governance usually arises when there is need to separate between
the ownership of the entity and the control from public corporation. The corporate
governance aims at solving the agency opportunistic behavior towards the shareholders. Thus
between the shareholders and the stakeholders, corporate governance tends to have the
problem of who among the two should have their interest considered first and who are to be
the beneficiaries of the value created by the firm (Davidson & Singh, 2003).
The shareholder approach to corporate governance
There is a great difference between the shareholders approach and the stakeholders approach
to corporate governance (Heremans, 2007). The stakeholders approach is a broad theory as
compared to the shareholders approach. The shareholders are active members in the
stakeholders approach, thus the stakeholders approach encompasses all the stakeholders
including the shareholders. The shareholders approach on the other hand only includes the
affairs of the shareholders only being put into consideration. According to Donaldson &
Preston, (1995) whereas the stakeholder approach encompasses the interests of all parties
involved voluntarily or involuntarily in the business, the shareholders approach only entails
focusing on the interests of the shareholders only (Donaldson & Preston, 1995). The

Partial Title 28
shareholders approach thus views the business as a legal instrument that comes into being
only for the maximization of the interests of the shareholders. In most cases, the shareholders
approach does not adhere to the principal of the corporate social responsibility and in most
cases other stakeholders of the business and the environment at large is neglected (Macey &
O'hara, 2003). When the shareholders approach is put into practice, the management would
only focus on making profits without considering the other stakeholders in the firm. If profit
making is the companys only focus, the environment and the welfare of other stakeholders is
likely to be neglected and the end result could be that the performance of the company might
not achieve full potential.
The stakeholder approach to corporate governance
According to Freeman, Wicks, & Parmer, (2004) the stakeholder theory, the corporate
strategies of the companies should be designed in consideration to the interests and welfare of
the stakeholders. According to this approach, the stakeholders are identified as the individuals
or groups that contribute to the welfare of the organization, either voluntarily or involuntarily.
The stakeholders are thus potential beneficiaries or risk bearers. Addressing their welfare is
important as their demands have intrinsic value and thus the business has a responsibility to
meet their claims. Similarly, addressing the welfare of the shareholders would mean that the
company would record profits as they have great influence on the performance of the
business. With regards to the responsible corporate governance, the stakeholder theory serve
the purpose of understanding the different parties involved and thus pursuing for multiple
objectives for the business. The performance metrics that can be used to measure the
stakeholders perspective to corporate governance is the fair distribution of wealth and value
that is created and ensure that they maintain good relationships with the multiple stakeholders
(Freeman, Wicks, & Parmer, 2004).
Definition of performance and risks banking sector

Partial Title 29
Performance
Adams, Almeida, & Ferreira, (2005) performance could be described as both positive
and negative outcomes of a business. The performance of businesses needs to be tracked to
ensure that they stay within that financial year plan. For the management of performance to
be made effective, it requires the consulted efforts of all the stakeholders of the business. The
management of performance in the case of banks requires a selection of goals, a union of the
methods of measurements relevant to the organization to be measured against its goals and
regular intervention by the managers to improve on the performance to best achieve the goals
set. The main performance management processes include financial planning, modeling of
the business, operational planning and reporting analysis to strategically keep track of the
performance indicators in banks (Adams, Almeida, & Ferreira, Powerful CEOs and their
impact on corporate performance, 2005).
Risks
Williamson, (1988) argues that risks in general business refers to the possibility of
businesses recording lowers profits and at times even losses which could be due to
unforeseen business issues. Among the uncertainties that are likely to bring about business
risks include changes in tastes and preferences of the consumers, competition, obsolesce of
the products and services and changes in government policies (Williamson, 1988). Blasko &
Sinkey, (2006) argue that banks are in most cases in the business of service delivery and their
risks are likely to emerge either as internal risks or as external risks. The internal risks of
banks are those arising from events that take place within the organization such as
management skills and technology and thus are controllable. On the other hand, the external
risks are the risks that are taking place outside the business premises and are in most cases
uncontrollable. Such factors include the economic factors such as pricing pressure and market
risks and the political factors such as government policies (Blasko & Sinkey, 2006).

Partial Title 30
Sinan & Philip, (2004) argue that there is no other sector in the economy of any
country that faces more risks than the banking sector. It is so because the banks are tasked
with the duties of managing multiple needs that are seemingly opposing each other. The
management of such duties leads the organization to the management of two major risks
namely the solvency risks and the liquidity risks. Poor management in the banking industry
would mean that there are more risks in the sector that may force the collapse of different
bank (Sinan & Philip, 2004).
Thierno, Laetitia, & Amine, (2009) focus their argument in the view of risk taking and
control of the banking sector. They argue that the separation of ownership of the business
from control is an important means to reduce risks. The owners are in most cases lacking the
skill requirements to control the business and thus should hire a board that has the skill
required. With the separation of the two, the business decisions would be highly influenced
by the owners which would mean that irrational decisions are made and as a result, the risks
facing the business would increase immensely (Thierno, Laetitia, & Amine, 2009)
Conclusion
The literature was undertaken to identify other peoples opinion on corporate governance and
the effects that it has on the banks. The study was aimed at providing an optimal structure on
banks that are aimed at achieving the best performance while reducing risks. The study also
weighs out between the stakeholders theory and the shareholders theory and concludes that in
as much as the welfare of the shareholders is the main reason why banks together with other
businesses come into existence, the welfare of the other stakeholders should also be
considered. The study however also presents gaps as the four variables investigated on may
not offer a complete investigation on corporate governance. Other variables like the number
of women in the board, board independence and distinction between ownership and control
are factors that influence the performance and risks in banks.

Partial Title 31
Little studies concerning the board structure and its effects to performance and risks have
been conducted. It is therefore, hard to determine the best structure that should be adopted by
the banks to ensure best performance and risks reduction. Each type of structure that has been
adopted for the board brings out its own advantages and disadvantages. Blasko & Sinkey,
(2006) argue that past performance of the banks affects the structure of the board. The
findings in our study support the idea that board structure is an important determinant of bank
performance. Given that the board structure is relevant to the banks performance, the
formulation of policies regarding banks governance should be structured in such a way that
they benefit the organization by increasing its performance (Blasko & Sinkey, 2006).
The regulators should carefully reconsider some of the requirements of being a bank
director to make the bank director market more competitive and actively encourage qualified
directors to compete in the market. Similarly, small boards tend to improve bank
performance. The study thus provides evidence that the structure of the board for the banks
and consistent with its efficiency and performance. Further study on board structure
determinants is necessary to enhance academic understanding of this subject.

Table 1: Summary of Literature Reviewed

Study
Minton, Taillard, &

Variables
Size of the board and

Findings
Larger sizes of the board are

Williamson, (2010)

performance of the firm

likely to pool resources

together and encourage the

Partial Title 32

Pathan & Skully, (2010).

Size of the board and risks

flow of information.
larger board sizes will have

faced by the firm

to be monitored thus
increasing the monitoring
costs and in return increasing

Hudain & Haniffa, (2006)

Frequency of board meeting

the financial risks

board meetings provide a

and performance of the firm

channel through which the

directors can exchange
knowledge and information
concerning the activities of
the firm and how best to
tackle the weaknesses to
improve on the performance

Uadiale, (2010)

Frequency of board meeting

of the firms
Frequency of board meetings

and performance of the firm

allow firms to be governed

making them relatively
profitable and valuable to the

Adams, Almeida, & Ferreira,

shareholders
Role duality and performance Role duality allows for more

(2005)

of the firm

diverse information thus

leading to innovation within

Higgs, (2003)

Number of non-executive

the business.
Allows the outsourcing of

directors and performance of

ideas and information to be

the firm

used by the firm to help

improve on performance

Partial Title 33
Iyala, (2011)

Number of non-executive

A larger size of the NEDs

directors and risks faced by

will only increase the risks as

the firm

some will be dormant in the

board thus not providing
value for money.

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