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This study examines the effect of board composition on critical decisions of Nigerian quoted firms. The six critical decisions studied were Chief Executive Officer’s (CEO) total compensation, CEO’s incentive pay out of total compensation, the level of firm unrelated diversification, intensity of firm research and development expenditures, firm’s debt intensity and CEO turnover. The six hypotheses formulated for the study were estimated using the Z-test, analysis of variance (ANOVA) and generalized least square (GLS) multiple regression. The findings of the study showed that board composition had negative effect on CEO’S total compensation; while board composition had positive effect on critical decisions such as; CEO
incentive pay out of total compensation, firm unrelated diversification, firm’s research and development expenditure, firm debt intensity and CEO turnover. The findings of the study provide partial evidence on the effective of the agency theory. One of the greatest contributions of the studies is the discovery of entirely agency conflict which is between the non-executive board members and shareholders. The theoretical framework and findings of this study are expected to stimulate scholars for further research on mechanism for resolving this entirely new version of agency conflict in the Nigerian corporate environment.


1.1 Background of the Study

Corporate governance systems have evolved over centuries, often in response to corporate failures or systemic crises. For example, much of the securities law in United States were put in place in response to the stock market crash of 1929 (Iskander and Chamlou, 2000: 16). The Enron collapse also led to the enactment of ‘The Sarbanes-Oxley Act 2002’.It is pertinent to note that the principles of company laws in Nigeria were derived from English law, which can be traced to the influence of colonization.

The early companies that operated in Nigeria were British based companies. By virtue of Colonial statutes enacted between 1876 and 1922, the laws applicable to companies in Nigeria at this time were the common law, the doctrines of equity, and the statutes of general application in England on the first day of January, 1900 subject to any later relevant statute (Nigerian Law Reform Commission, 1991: 92).

The implication of this approach is that the common law concepts such as the concept of the separate and independent legal personality of companies as enunciated in Salomon v. Salomon was received into the Nigeria Company law and has since remained part of the law (Amao and Amaeshi, 2008: 1-16). With the continuous growth of trade, the colonialist felt it was necessary to promulgate laws to facilitate business activities locally. Hence, the first company law in Nigeria was the Companies Ordinance of 1912, which was a local enactment of the Companies (Consolidation) Act 1908 of England.

The Ordinance was amended severally and consolidated into the Companies Ordinance of 1922 (Nigerian Law Reform Commission, 1991: 109). The 1922 Ordinance was subsequently amended in 1929, 1941 and 1954 respectively. The attainment of independence in 1960, coupled with the vitriolic criticisms that trailed the existing company law in Nigeria at that time, led to the enactment of Company Act of 1968.
One of the important provisions of the 1968 Act was the legislation that all companies operating in Nigeria must be incorporated in the country. However, the legal framework of the Act has its root in the British legislation. The Company Act of 1968 was, of course, a replica of the United
Kingdom Companies Act of 1948.

The 1968 Company Act was also criticized for not taking into cognizance the peculiar nature of the Nigerian corporate environment, but protected only British business interest in Nigeria. Amao and Amaeshi (2008: 1-16) argue that British nationals controlled the major enterprises in Nigeria, and to protect their economic interests, they had to bring their company legislation. They further argued that the mimicking of the United Kingdom’s Companies Act in Nigeria failed to accommodate the economic interests and development aspirations of the country. In responding to the agitation that the Nigerian economy was dominated by direct foreign investment capital, the government made the promotion of indigenous participation in industrial activities one of its core policies in the Second National Development Plan.

According to CBN (2000), “before 1972, the Nigerian economy was dominated by foreign investment capital. In the Second Development Plan period, therefore, the promotion of indigenous participation in industrial activities became one of the prominent policy instruments designed to encourage industrial development”, led to the promulgation and implementation of Nigerian Enterprise Promotion Decree of 1972 (also known as the Indigenization Decree of 1972 amended in 1977). 

The 1972 Act categorized all businesses into two schedules (Schedule1 and Schedule 11).
Schedule 1 contained the list of all enterprises exclusively reserved for Nigerians, while Schedule 11 listed enterprises in which Nigerians must have at least 40 per cent equity holding. The difficulties encountered in the implementation of the Decree led to its amendment in 1977.
The 1977 amendment categorized all businesses into three schedules and became more liberal to foreign investors.
This legislation changed the landscape of Nigerian corporate environment. The policy was alleged to have been adopted by the Nigerian government to limit the level of foreign control in the Nigerian economy (Ejiofor, 1981:20-23). To drive home this point, the Sixth Progress Report on the implementation of the 1977 Act showed that the Nigerian Enterprise Promotion Board  (the implementer of the Decree) did not stop at regulating equity ownership, but asked companies to have certain minimum number of Nigerian executive directors on their boards.

indigenization policy not only localized corporate activities among Nigerians, but also created an avenue for the government to launch itself into the ownership and control of banks in Nigeria. According to Ezeoha (2007:18-21), “it was for instance during the implementation [of the
indigenization policy] that government utilized the opportunity to take over the controlling shares in the three largest foreign-owned banks in the country – namely First Bank, Union Bank and United Bank for Africa”. This policy reform led to the takeover of most foreign-owned companies by Nigerians and State participation in many areas of the economy.

The consequence was that many state-owned enterprises were set up in virtually all areas of the economy. Most of these companies were monopolies and remained so for a long time. This also promoted poor corporate governance practice in Nigeria. By the middle of the 1980s, concerted efforts to appraise the performance of these public corporations showed that the corporations were economic waste pipes. The need for a rethink coupled with the pressure from International Monetary Fund led to the adoption of the Structural Adjustment Programme (SAP).

 Uche (2002: 59-67) notes that, “the Structural Adjustment Programme was designed to achieve balance of payments viability by altering and restructuring the production and consumption patterns of the economy, eliminating price distortions, reducing the heavy dependence on consumer goods imports and crude oil exports, enhancing the non-oil export base, rationalizing the role of public sector and achieving sustainable economic growth”. In order to downsize the public sector and allow the government concentrate on regulation of corporate environment in Nigeria, the Privatization and Commercialization Act was promulgated in 1988.

This Act established the privatization and commercialization programme of public corporations, which is still ongoing to this day. The privatization programme is under the purview of the Bureau of Public Enterprises. The shady manner the political class in Nigeria handled the privatization exercise helped in promoting corporate scandal instead of good corporate governance practice. 

The need to reform the Nigerian Companies Law in the post Structural Adjustment Era gained importance because of the following; at the time of promulgating the Company Act of 1968, the United Kingdom Companies Act of 1948 on which the 1968 Act was based, was already being subjected to very critical examination and actions for improvement (in fact the Jenkins Report was already published and, indeed, the companies Act of 1967 had already been enacted); the changes in the Companies Law of Ghana, a sister country with similar experience; and the inability of the statute to cope with the challenges of the Enterprise Promotion exercise and Structural Adjustment Programme (Nigerian Law Reform Commission, 1991).

The Companies Act of 1968 was repealed by the Companies and Allied Matters Act of 1990 as amended in 2007. The new law contained some radical features. It codified a good number of rules of common law and equity applicable to companies. It also codified some important provisions normally contained in articles of association (Okonkwo, 2009: 79-92). The introduction of the Corporate Affairs Commission to replace the companies’ registry was a major innovation. Some other major landmarks of the Act relates to the doctrine of constructive notice, pre-incorporation contracts, share capital, payment of shares in kind, debentures, directors and secretaries, minority protection, financial statements, audit committee and insider trading.

The Act which regulates all quoted companies in Nigeria all recommended for more outside or independent directors. In the wake of the global financial crisis in 2008, there were corporate governance reforms. Nigeria followed the trend in the globe by establishing voluntary governance code in 2003 which was reviewed in 2011. One of the major recommendations of the code was also the issue of board composition. Specifically, the code recommended for more outside director in company boards. Corporate boards are by definition the internal governing mechanism that shapes firm governance, given their direct access to the two other axes in the corporate governance triangle: managers and shareholders (owners). In today’s volatile corporate environment, corporate boards are very important for smooth functioning and strategic policy making of the organizations.
Boards are expected to perform different functions, for example, monitoring of management to mitigate agency costs (Eisenhardt, 1989:57-74; Shleifer and Vishny, 1997:737-783; Roberts, McNulty and Stiles, 2005:5-26), hiring and firing of management (Hermalin and Weisbach, 1998:96-118), provide and give access to resources (Hillman, Canella and Paetzold, 2000: 235- 255; Hendry and Kiel, 2004: 500-520), grooming CEO (Vancil, 1987:43-71) and providing strategic direction for the firm (Tricker, 1984:201-219; Van der Walt and Ingley, 2001: 174-185, Kemp, 2006: 56-73). Boards also have a responsibility to initiate organizational change and facilitate processes that support the organizational mission (Hill, Green and Eckel, 2001: 28-32; Bart and Bontis, 2003: 361-381).
In addition, the boards seek to protect the shareholder’s interest in an increasingly competitive environment while maintaining managerial professionalism and accountability in pursuit of good firm performance (Ingley and Van der Walt, 2001: 174-185; Hillman and Dalziel, 2003: 383-
396; Hendry and Kiel, 2004: 500-520; McIntyre, Murphy and Mitchell, 2007:547-561).

The role of board is, therefore, quite daunting as it seeks to discharge diverse and challenging responsibilities. The board should not only prevent negative management practices that may lead to corporate failures or scandals but also ensure that firms act on opportunities that enhance the value to all stakeholders. To understand the role of board, it should be recognized that boards consists of a team of individuals, who combine their competencies and capabilities that collectively represent the pool of social capital for their firm that is contributed towards executing the governance function (Carpenter and Westphal, 2001: 639-600; Lynall, Golden, and Hillman, 2003: 416-431;Vera-Munoz, 2005: 115-127).

As a strategic resource, the board is responsible to develop and select creative options in advancement of the firm. Research on corporate board is influenced mainly by Agency Theory. Agency Theory argues that where there is separation of management and ownership, the manager (i.e. agent) seeks to act in self-interest which is not always in the best interests of the owner (i.e. principal) and departs from those required to maximize the shareholder returns.

This agency problem can be set out in two different forms known as adverse selection and moral hazard (Eisenhardt, 1989:57-74; Barkema, and Gomez-Mejia, 1998:135-147). Adverse selection can occur if the agent misrepresents his ability to perform the functions assigned and gets chosen as an agent. Moral hazard occurs if the chosen agent shirks the responsibilities or underperforms due to lack of sufficient dedication to the assigned duties. Such underperformance by an agent, even if acting in the best interest of the principal, will lead to a residual cost to the principal (Jensen and Meckling, 1976:305-360).

These costs resulting from sub-optimal performance by agents are termed as agency costs.
In order to mitigate the agency cost, a principal will establish controls and reporting processes to regularly monitor agent’s behaviour and performance outcomes (Fama, 1980:288-307; Jensen and Meckling, 1976: 305-360; Shleifer and Vishny, 1997: 737-783). A major prescription of
agency theory is that effective boards will be mainly composed of outside directors (Johnson, Daily and Ellstrand, 1996:409-438). According to this perspective, inside directors are unlikely to monitor a CEO’s actions effectively because their employment with the firm makes them beholden to the CEO (Patton and Baker, 1987:10-18).

In contrast, Baysinger and Hoskisson (1990:72-87) highlight the benefits associated with having a high representation of inside directors. Their argument is based on the notion that inside directors’ superior information enables them to better evaluate complex decisions the firm has to make. To test empirically whether board composition matters, one stream of research has examined the effect of board composition on firm performance, but the results of this research stream have been mixed and inconsistent (Dalton, Daily, Ellstrand and Johnson, 1998:269-290; Finkelstein and Hambrick, 1996:151-183; Zahra and Pearce, 1989:291-334).

In response to these inconsistent findings, several researchers have conducted meta-analytic reviews on the relationship between board composition and a firm’s financial performance. These reviews provide little evidence of a systematic relationship (Dalton et al., 1998; Rhoades, Rechner and Sundaramurthy, 2000:76-91).
Another stream of research suggests that, rather than examining a board’s monitoring effectiveness by using the firm’s financial performance as a proxy, a more accurate evaluation can be gained by examining discrete decisions that involve a potential conflict of interest between management and shareholders (e.g., Mallette and Fowler,1992:1010-1035; Sundaramurthy, 1996:377-394). Such decisions will be referred to in this thesis as “critical decisions.”

The rationale behind this line of inquiry is that whereas board monitoring has a direct effect on firms’ critical decisions, it has only an indirect effect on firm performance. Moreover, a company’s financial performance is influenced by a multitude of endogenous and exogenous factors beyond the composition of its board (Kosnik, 1987:163-185;Felo, 2001:208-218). A recent review of studies conducted on the effect of board composition on discrete critical decisions made by firms has found that the evidence on this relationship is equivocal (Bhagat
and Black, 1999:921-963; Kang, and Sorensen 1999:121-144).
Given the inconclusive findings in the extant research, the purpose of the present study is twofold. First, to examine whether a systematic relationship exist between the board composition and critical decisions of Nigerian quoted firms. Second, to contribute to literature since most
literature reviewed in this work were from developed economies, and based on the researcher’s knowledge, there is no study in our jurisdiction along this line.


1.2 Statement of Problem

While it is clear that boards have a crucial responsibility towards strategy, every board does not participate equally in strategic decision making. Some boards are considered ‘passive’ while others are considered ‘active’, based on their involvement in strategic decision making process.
Corporate governance literature demonstrates a swing from passive school of the 1970s and 1980s to the active school prevalent over the last ten years”. Proponents of the active school suggest several roles for the boards.
It is generally believed that the effectiveness of a board depends on its active participation in the strategic decisions of the firm. Agency theory opened a new strand of argument, which posits that it is not enough for a board to actively participate in strategic decision making, but, that the
quality of that decision depends on how effective the firm has resolved its agency problem. Based on this, most scholars have advocated for a corporate board that constitute majorly of outside directors.

This has generated raging debate among scholars and practitioners on the effect of outside directors or board composition on critical decisions of firms. Most studies used data from developed economies like United States of America, United Kingdom among others. Considering the volatile nature of emerging economies and the rate of corporate failure, it has become imperative to investigate the effect of board composition on critical decisions of the firm. This study is poised to fill this important research lacuna.

1.3 Objectives of the Study

The thrust of this study is to investigate the effect of corporate board composition on the critical decisions of Nigerian firms. In order to give this proper attention, the study will pursue the following specific objectives.
1. To examine the effect of board composition on Chief Executive Officer’s (CEO’s) total compensation.
2. To investigate the effect of board composition on CEO’s incentive pay out of total compensation.
3. To ascertain the effect of board composition on firm’s unrelated diversification.
4. To examine the effect of board composition on firm’s research and development expenditures.
5. To determine the effect of board composition on the firm’s debt intensity.
6. To examine the effect of board composition on the firm’s CEO turnover.

1.4 Research Questions


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