case study of the uk banking sector

8/9/2019 Case Study of the Uk Banking Sector

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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 articiants to bank oacity. !ome oliticians, financial

leaders, and certainly many in the general ublic 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 suosed to serve "#iang, $u % &iraorn, 201'(. The ercetion has grown that the

cororate governance of banks was so rela)ed in the years leading u to the beginning of the

crisis that rotecting stakeholders became secondary to attemting to generate as much

revenue and rofits as ossible "*dams, 2012(.

In the +nited ingdom, Prime -inister ordon /rown reuested a review to be

conducted for the cororate governance of banks in the +nited ingdom to determine the

roblems related to bank cororate governance, as well as recommend suggestions for how to

imrove bank cororate governance in the country "-ullineu), 2011(. The maor roblem

that led to the review to be conducted was the financial crisis that was considered to be as a

result of bank oacity. The review was thus e)ected to determine the effectiveness in risk

management in the banks and to determine the effects of cororate governance to

erformance and risks. The review was thus e)ected to address the roblem of the changing

atterns on banks boards and come u with recommendations on how imrovements could be

effected on the banks cororate governance

The recommendations that were ut forth from the alker 3eort included changes to

the comosition and role of the /oard of 4irectors of banks in the +nited ingdom such that

they are comrised of a broader range of eole from within and outside of the banks they

reresent, as well as take on a greater risk5management role as oosed to a sole focus on

revenue and rofit generation "#e/lanc, 2010(. 6rom the alker 3eort, uestions arise


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about the aroriate role of cororate /oards of 4irectors in reducing risk while also

enhancing erformance.

The chater takes to review the secific studies that have been carried out reviously

concerning cororate governance and the effects that it has on banks. /asel 7ommittee on

/anking !uervision, "201( argues that banks lay a vital role in the running of the

economy. 6or this reason, effective cororate governance becomes a critical factor in the

running and roer functioning of the banking sector and the economy as a whole. They are

determinants of the erformance of the economy as they determine the money suly and the

lending of money to the ublic. ithout roer regulation, the banks could adversely affect

the erformance of the economy as some eole may want to enrich themselves at the

e)ense of the economy. The banks thus serve a maor role in the economy as they serve the

role of intermediating funds from the savers to the deositors and incororate them in

activities that suort the enterrise and assist in economic growth. The bank governance

thus lay a maor role in the financial system of any given banks and the economy as a whole

"/asel 7ommittee on /anking !uervision, 201(. It is for this reason that the banks need to

adot cororate social resonsibility through the adotion of otimal cororate governance

structure. The study focuses on four main variables namely9 board si:e, board meeting

freuency, role duality and the number of number of non5e)ecutive directors in the business.

The chater will review the oinions of revious studies concerning the four variable and the

strengths and gas that e)ist in their studies. The review is thus done to investigate the

otimal structure for cororate governance that should be used and the effect that each of the

chosen structures has on the erformance and risk in the organi:ation. 4ifferent banks have

different cororate structures in terms of board si:e, number of non5e)ecutive 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 erformance and reducing risk. The


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cororate governance thus determines the allocation of authority and resonsibility within the

banks and in turn hels the board to set the banks strategyies and obectives, oerate banks

day to day business, establish control functions and rotect the interests of the deositors,

take into account the interest of the stakeholders and recogni:e the shareholders obectives

Bank opacity

*ccording to 6lannery, wan, % ;imalendran, "200( the urose of banks in the

economy differs from the urose of the other industrial firms. The difference of the

functions brings in the reason as to why the banks are usually subected to more strict

regulations than the other firms in the economy. !tringent regulations have been ut u to

control the banks< caital and risks "6lannery, wan, % ;imalendran, 200(. The urose of

the regulation of the banks is to hel revent systemic bank runs which are usually caused by

the inherent instability of banks. 6lannery, wan, % ;imalendran, "200( continue to argue

that the rationale behing banks regulation is mainly a cororate governance roblem.

=owever, given thast the investors lack information on how to monitors their investments, the

would be an increase in the adverse selection roblems and moral ha:ards. *s a result, banks

need to have a regulator to who should act as a monitor to the banks "6lannery, wan, %

;imalendran, 200(

>l5/annany, "2008( argues In the +nited ingdom


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negotiate bills of e)change and other credit instruments. 6inally, they rovide mechanisms

through which firms and governments can make ayments to each other "The 6inancial

3eort 7ouncil, 200@(.

To the economy, the banks are key role layers esecially in the suly of money. The

banks are institutions that are set u to hel imrove the allocation of funds. They allow for

funds transfers from one area to another thus heling to imrove the state of the economy in a

country. The banks can however, bring negative effects to the economy which would force

the economy to undererform. In an instance where banks choose to withhold funds and not

offer loans to both the ublic and other bank would mean that the free flow of money would

not be available thus the economy will be affected negatively ">l5/annany, 2008(.

iuliano, "200@( argues that to the economy, the banks also act as roviders of

liuidity through the issuance of demand deosits. *s a result, there is a great liability on the

banks side to that is usually evident in the balance sheet. /orrowers in such an instance are

e)ected to be more informed than the lenders in the issues concerning their investments.

iuliano, "200@( also argues that the banks are the lenders of last result to the economy. 6or

banks to effectively rotect their deositors and also hel to revent bank runs that usually

lead to moral ha:ards within the banks, then the deosit insurance becomes imortant

"iuliano, 200@(.

How the u!ine!!e! o" ank! a""ect! ri!k and per"or#ance can e percei$ed or de"ined

y di""erent !takeho%der!

/anks serves the welfare of all the stakeholders, it is imossible for a single bank to

obectively meet their demands "7larkson, 1AA(. The different stakeholders erceive

erformance and risks of banks different and thus each of the stakeholders takes to be art of

the bank


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identifies ways to hedge out risks while imroving erformance to hel attract more

customers and investors into the comany "*ndreas % Ballelado, 7ororate governance in

bankingC The role of board ofdirectors., 2008(.

&takeho%der'! per!pecti$e on per"or#ance and ri!k

*ccording to 4onaldson % Preston, "1AA?( reutation is an imortant factor as it

heavily influences the erformance of a bank through the si:e of its customers. The

erformance of the bank is reliant on the management of risks in organi:ation. It is for this

reason that erformance and risk are interrelated. -anaging the reutation of banks through

risk management and imrovement of the erformance reuires the banks to adot soft skills

like the anticiation of future trends and needs, understanding the reuirements of all the

stakeholders, listening to them and lanning to enable ositive action of the bank.

The shareholders of the banks are known to be risk averse yet they e)ect to have otimal

erformance. There is thus a collision between the shareholders and the directors as the

directors like taking risks to imrove on the erformance of the comany. The value of the

erformance that is affected by the si:e of risks that a bank takes is the difference between the

book value of the comany


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*ccording to #evine % #aeven, "200A( financial risks are other maor 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 organi:ation "#evine % #aeven, 200A(.

*nna, Takeshi, % *igbe, "200A( argue that oor management in the banks would lead to

misaroriation of funds thus increasing the financial risks. !imilarly, the board of directors

is also determinants of the financial risks that an organi:ation faces. here the board of

directors do not work to ensure that the management they emloy are cometent 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 "*nna, Takeshi, % *igbe,

200A(.

*ccording to Plath % -ongiardino, "2010( asymmetry information risks could be

viewed as a situation whereby one of the arties involved in a given transaction osses more

information comared to the other thus making them suerior. *symmetry information in

banks can lead to either adverse selection or moral ha:ards which have negative imlications

in a bank. The banks may take advantage of the current economic conditions to increase the

interest rates for customers so as to rovide 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 enoy the benefits through imroved erformance "Plath % -ongiardino,

2010(.

>llul % Eerramilli, "2010( argues that the oerational risks in banks is the risk which

is associated with the administrative and oerational rocedures in banks. eaknesses in the

administration rocedures main through the adotion of weak controls and weak management

structures would mean that the oerational risks associated with businesses are high. Fther


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minor risks that should also be considered in banks include the market risks, insolvency risks,

strategic risks and liuidity risks ">llul % Eerramilli, 2010(.

The Hou!e o" Co##on! trea!ury co##ittee

The =ouse of 7ommons treasury committee was a committee that was tasked with

investigating into the root causes of the banking crisis and roosals to the government on

how to enhance the strategic obectives of the banking sector "The =ouse of 7ommons

Treasury 7ommittee, 200A(. *ccording to =ouse of 7ommons Treasury 7ommittee, "200A(

the the crisis was invoked by a number of factors among them low interest rates, e)cess

liuidity and lack of faith in innovation in the banking sector. There was also failure by the

regulatory authority to introduce suervisory systems that would have been designed to

rotect the ublic from systemic risks. The committee also argues out that the crisis led to the

collase 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 deosits after

nothern rock was declared solvent. 6inally, the crisis also saw the merger between the #loyds

and =/F


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consideration, the shareholder engagement olicies, international cometitiveness and the

degree of rescritiveness "#eblanc, 2010(. 3eflecting the concerns that were raised through

the consultative rocesses made by alker, the following recommendations were raised.

7ororate governance should focus on the board si:e, its ualifications and the comosition.

GIn ractice, decisions on board si:e will deend on articular circumstances, including the

nature and scoe of the business of an entity, its organisational structure and leadershi style

"alker, 200A(.H 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 rovide freuent training to the business to enhance develoment in the business. The

board should also rovide dedicated suort to both the e)ecutive and non e)ecutive directors

of the board esecially on the matters that are relevant to the activities of the business. The

suervisory rocess should give close attention to the balance of the board to enhance the risk

strategies that are rovided for by the board. alker in the alker review also recommends

that the board should be functions roerly and its erformance should be evaluated. The

none)ecutive directors should challenge and test any roosals ut forward on the strategies

suggested by the e)ecutive. ith the suort of the chairman and other seniors, the board

should ensure roer leadershi of the business and effectiveness in the various asects and

deartments of the bank. The board should also facilitate and encourage the directors

esecially in matters concerning the discussion and decision making "The alker 3eview,

200A(.

alker, "200A( 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 reare a code of resonsibilities to hel govern the institutional

investors. alker also made recommendations on the governance of risk in that he roosed a


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board risk committee to be formed to hel advice the boar on all the current risks that the

business is e)osed to and the future risk strategies which they lan to undertake "alker,

200A(.

alker, "200A( also makes key contributions to the role of duality in the organi:ation.

=e argues that the 7>F also being the chairman of the board brings in both negative and

ositive imlications to the organi:ation. The division of the two roles to have different

eole in the two ositions would mean an increase in the views as they would be diverse

from the two eole while at the same time increasing the administrative costs. The alker

3eview, "200A( argues that the freuency of board meetings being held as has its own

imlications to the banks. Provided the board meetings conveyed rovide ositive resolutions

to hel imrove on the bank


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The first declaration of the credit crunch in the +nited ingdom was first made on

*ugust A, 200D "/eltratti % !tui:, 2012(. /eltratti % !tui:, "2012( argues that at this time, the

financial markets stalled since they lacked liuidity since the banks stoed 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 ower. 6inally, there were weaknesses in reorting for

both the financial transactions and for risks "/eltratti % !tui:, 2012(.

7ororate governance is all about the control and directing the different deartments of an

organi:ation to best achieve the interest of long5term erformance. The directors are

continuously suosed to work towards imroving the erformance of the banks and reduce

risks.

*ccording to the Turner 3eview, "200A( the credit crunch started as a result of the

collase of the #ehman /rothers global bank in 2008 and it almost brought down the

country


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funding as it made the bank suscetible to liuidity risks. *ccording to 6ranco % 4avid,

"200A( the +


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the lending activities of the banks, the caital for infrastrucuture develoment reduced. The

money sul in the economy of the +nited ingdom was also negatively affected since the

banks were not available to effectively rovide the economy with easy money suly otions.

*ll activities in the economy were thus adversely affected by the credit crunch "=su, 201'(.

E""ect! o" corporate )o$ernance on per"or#ance and ri!k

-ahfoudh % u, "2012( argues that cororate governance entails the means through

which banks sets targets to be imlemented by other stakeholders like the shareholders and

the emloyees to imrove on the erformance of the organi:ation "-ahfoudh % u, 2012(.

7ororate governance comrises of the board of directors of banks who are an imortant tool

in the develoment of the organi:ation, oortunity creation, leverage and management of the

banks. The board of directors, not necessarily the owners of the banks are the ones tasked

with roviding the organi:ation with a strong management to hel hedge out risks in the

banks as well as make imrovements on the erformance of the organi:ation. /y focussing

on cororate governance, the study targets to e)amine board meeting freuency, board si:e,

non e)ecutive directors on the board and role duality "-inton, Taillard, % illiamson, 2010(.

Board !i*e

In"%uence on per"or#ance

*ccording to -inton, Taillard, % illiamson, "2010( the si:e of the board is a maor

issue on the erformance and risk issues for the banks in the +nited ingdom. #arger boards

are more likely to ools resources together and thus encourage the information flow and

rocessing abilities. The bigger the si:e of the board, the more skilful they are and as a result,

there is an imroved decision making rocess. #arger boards allow for collective decision

making leading to the adotion of strategic decisions and actions into the banks to hel

imrove on their erformance "-inton, Taillard, % illiamson, 2010(. -ahfoudh % u,

"2012( argues that the larger boards are more likely to access and secure imortant resources


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from the environment around the banks and the different stakeholders. The larger boards

assist in develoing better board interlocking relationshis and create indeendence in the

decisions that are made for the organi:ation. The bigger boards are in most cases diverse in

their ideas and they tend to romote diversification of ideas for better services in the

organi:ation and as a result lead to better erformance in the banks. Therefore, there is a

ositive relationshi that e)ists between the si:e of the board and the erformance of the

banks.

4avid E. , "1AA( argues that different structures in the cororate governance systems

rovide differences in the board effectiveness to rovide roer governance. =e argues out

that there is an inverse relationshi that e)ists between the erformance of the board in terms

of board value and the board si:e "4avid E. , 1AA(. #iton % &ay, "1AA2( recommends that

for a board to achieve otimal erfornance for the business it sould comrise a ma)imum of

ten eole. =e argues that even if the board si:e was to increase, the e)ected benefits would

still be overweighed by the costs of remuneration and the seed at which the decisions are

made within the organi:ation "#iton % &ay, 1AA2(.

Eermack "1AA@( argues that the board si:e has its effects on the real value of the

comanies. The comanies with smaller si:es of the board of directors have great advantages

in rovide better value for the comanies as it ensures otimal resource utili:ation and easy

and fast flow of information in the organi:ation. The small board of directors ensures that the

gas within the organi:ation are easily identified and worked on to reduce the risks that the

businesses face "Eermack, 1AA@(. *dams % -ehran, "2008( argues that there is a negative

relationshi that e)ists betwen the erformance of the organi:ation and board si:e. The

cohesion that e)ists for small board allows the communication and cordination of costs to

reduce the director roblems. 6or large boards, the incentives for directors to manage


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information is lower as comared to the small boards. =owever, the si:e of the board is also

determined by the economic environment around the business "*dams % -ehran, 2008(.

In"%uence on ri!k

The bigger board are more likely to have control over the risks that face the

organi:ation thus imroving the erformance of the banks "-ahfoudh % u, 2012(. ith

otimal board si:e, the risks facing the organi:ation are reduced as the board effectively

manages both the reutation risks and the financial risks that face the organi:ation. The si:e

of the board brings in other costs related risks as such as the monitoring costs. The larger

board si:es will have to be monitored often as there may be other in the board that do not

rovide value for money yet they enoy the benefits ust like others in the board. Thus

according to Pathan % !kully, "2010( the board si:e is neatively related to the directors

monitoring costs thus may have an increase in risks faced by the organi:ation "Pathan %

!kully, 2010(.

#adio % ;estor, "200A( suorts this argument when he argues out that the norms of

most boardrooms never change. The norms create a dysfunctional board such that the to

managers are never criticised in their actions "#adio % ;estor, 200A(. !hort coming are thus

e)ected to be evident in such banks as only the ideas and oinions of the to managers are

taken into ractice thus increasing the risks that the organi:ation faces.

Board #eetin) "re+uency


4uring and after the credit crunch crisis, the freuency of the board meetings was an

imortant characteristic of the banks in the +nited ingdom. *ccording to =udain % =aniffa,

"200@( the firms stock erformance ositively relates to the number of board meeting and the

freuency that the directors of the firms attended the meetings. The imortance of board

meetings is that it is a channel through which the directors can e)change knowledge and


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information concerning the activities of the firm and how best to tackle the weaknesses to

imrove on the erformance of the firms "=udain % =aniffa, 200@(.

+adiale, "2010( argues that the freuency of the board meetings strategically allows

for better erformance of the organi:ation as it encourages innovation and strategic

orientation through the flow of information when then board meets. The freuency of board

meetings encourage efficiency and effectiveness in the decision making rocess of the banks.

*s a result, high uality innovative decisions are made that imrove on the erformance of

the organi:ation and reduce the risks that the banks faces to enhance the imrovement of the

services offered. The advantage of the freuency of board meetings for banks is that it could

hel bring imrovements in the resource utili:ation. Ftimal resource utili:ation could mean

that there is increased erformance in the organi:ation while the costs incurred are greatly

reduced "+adiale, 2010(.

;ikos, "1AAA( 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 freuency of board meetings in

organi:ation would mean that the organi:ation has been undererforming during the revious

years and the board seeks to address imortant issues that will imrove on the erformance.

The board meetings thus hel the directors to monitor the erformance of the organi:ation

and imrove on it where gas are identified ";ikos, 1AAA(.

In"%uence on ri!k!

=owever, there are also risks involved in the board meeting freuency. The more the

board meetings being held in the bank


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*dams, *lmeida, % 6erreira, "200?( argues that different individuals usually think

differently. ith different eole taking the ositions of chairman and 7>F, then more

diverse oinions are likely to be made to suort the erformance of the organi:ation

"*dams, *lmeida, % 6erreira, Powerful 7>Fs and their imact on cororate erformance,

200?(. 3enee % =amid, "2011( argues that different eole have different characteristic and

ualifications. =aving different eole in the two seats would arguably mean that better

decisions will be made and as a result, an increase in erformance for the organi:ation "3enee

% =amid, 2011(.

#inck, ;etter, % Eang, "2008( argues that revious studies conducted have not

e)licitly addressed the determinants of 7>F duality. The little that is already known ca

however be used to determine the role duality of 7>F and its effects on erformance. The

7>F osses secific knowledge that can be used esecially for the large and comle) banks.

In this case #inck, ;etter, % Eang, "2008( argues that the role duality hels the banks rea

maor benefits "#inck, ;etter, % Eang, 2008(.

In"%uence on ri!k

=udain % =aniffa, "200@( sees the duality as a concet that is not consistent with the

checks and balances of an organi:ation. =e continues to argue that duality is a concentration

of ower to one osition which in turn reduces the boards effectiveness to make decisions.

The managerial and monitoring decisions are fully made by the 7>F meaning that there are

weaknesses in the management team which may lead to reduced erformance for the

organi:ation and an increase in business risks. 4uality thus limits the indeendence of the

board as they are in most cases working under duress from the 7>F. eisbach, "1A88(

suorts the oinion that the other directors in the organi:ation are likely to be deendent as

their decisions are made from the decisions of the 7>F "eisbach, 1A88(.


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=afi:a % !usela, "2008( argue that the role duality should have a searation of owers that

allows for monitoring of the management. In such a case, the 7>F may not introduce over

ambitious lans as they will need to be aroved by the chairman of the board who must

consult with the rest of theboard members before comming into any conclusion "=afi:a %

!usela, 2008(.

3enee % =amid, "2011( however, argues that the si:e of the institution will determine

whether the institution should have different eole in the osition of chairman of the board

and that of the 7>F or the same erson. * small institution with different eole in the two

ositions would mean an increase in risks as oosed to the erformance benefits that would

be recorded "3enee % =amid, 2011(.

The nu#er o" non,e-ecuti$e director! on a oard


*ccording to =iggs, "200'( the non e)ecutive directors of the board are imortant to

the banks as they rovide technological, technical and strategic assistance to the internal

e)ecutive directors. The non e)ecutive directors are vital as they offer effective monitoring to

the organi:ation. The non e)ecutive board usually act as mentors to the board as a whole and

are active articiants who hel in the develoment of strategies to be used in the business.

The effect that the number of non5e)ecutive directors has on the business could be viewed in

two dimensions "=iggs, 200'(. *ccording to here the erformance of the organi:ation is at

stake, the non5e)ecutive directors bring in new ideas and information into the board that is

used to enhance the erformance of the organi:ation. The more the number of non e)ecutive

members, the more the information gathered geared towards imroving the erformance of

the banks. =aving a big si:e of non e)ecutive directors would mean that the business would

benefit from the e)erience of the board thus would lead to an increase in the seed at which

the strategies of the comany are imlemented.


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Pablo % >leuterio, "2008( argue that the role of the directors is to ensure effective

management of finances and enhance erformance. The non5e)ecutive directors allow for

better management of resources and finances as they introduce their e)erience into the

board. The higher the number of non5e)ecutive directors, the higher the returns that are

e)ected as it hels the board to effectively manage its resources. "Pablo % >leuterio, 2008(.

In"%uence on ri!k!

*ccording to Iyala, "2011( the risks that are accomanied by the number of non5

e)ecutive directors on the board in the banking sectors are evident since they are not fully

involved in the affairs of the business. The non5e)ecutive directors do not invest enough time

into the business thus the business may have an increase in risks for more cost "*lmeida,

6erreira, % *dams, 200?(. The remunerations of the non5e)ecutive directors may not rovide

value for money as they may be aid for time that they did not serve the interest of the banks.

The more the number of non e)ecutive directors, the more the risks as some may not work as

they await the others to work thus the business incurs e)tra costs without any value for

money "!tewart, 2011(.

A)ency theory

alker, "200A( defines the agency relationshi as a relationshi in which a erson

who is the rincial engages or emloys another who is the agent to act on his behalf and it

includes being granted the authority to delegate and make decisions for the organi:ation

"alker, 200A(. *dams % 6erreira, "200D( argue that the agency theory is art of a bigger

toic of the cororate governance. It is a roblem that arises among the shareholders of the

business as they decide who is best suited to run the business. It is therefore, the roblem that

arises when the directors dictate how the comany is to be run whilst the shareholders own

the organi:ation "*dams % 6erreira, 200D(. 4emset:, !aidenberg, % !trahan, "1AAD( argue

that the directors may in most cases not act in the best interest of the shareholders and thus


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the agency theory was coined to consider the roblem and identify what best could be done to

revent the roblem "4emset:, !aidenberg, % !trahan, 1AAD(.

*ccording to -ay, "1AA?( mistrusts may occur between the agent and the rincial

and thus the rincial establishes roer incentives for the agent. !imilarly, the rincial may

limit the divergence of the agent by incurring monitoring costs that are made to hel limit the

oortunistic actions of the agent "-ay, 1AA?(. 4esite roviding these actions to reduce

divergence between the agent and the rincial, some divergence may still remain but could

be viewed as residual loss for the rincial "alker, 200A(. 4avidson % !ingh, "200'( argues

that the residual loss is the indirect additional agency costs that relates to directors urchasing

e)ensive materials for themselves at the e)ense of the shareholders. The costs that are

incurred by the shareholders in the agency relationshi include the remuneration ackages for

the managers, management costs that are incurred for the rovision of annual reorts,

committee activities and management analysis to risk. Fther costs likely to be incurred

include the monitoring costs and the bonding costs "4avidson % !ingh, 200'(

&takeho%der theory

*ccording to 6reeman, icks, % Parmer, "200( he term stakeholder is a term used

for organi:ations to refer to the grous that have legitimate claim on the organi:ation. The

stakeholder theory governs the organi:ational management and establishes business ethics

that address the morals necessary for roer running of the organi:ation. The stakeholders of

the organi:ation include shareholders, regulators, bondholders, and customers, savers,

borrowers and managers. >ach of the grous that comlete the stakeholders of the firm is

maor contributors in the interest of the firm. >ach of them rovides the firm with critical

resources necessary for the running of the firm "4emset:, !aidenberg, % !trahan, 1AAD(. The

stakeholders of a firm could be divided into both internal and e)ternal stakeholders. The

internal stakeholders include emloyees, shareholders and the managers while the e)ternal


22/39

Partial Title 22

stakeholders include the suliers, regulators, customers, society among others "6reeman,

icks, % Parmer, 200(.

"4onaldson % Preston, 1AA?( argues that the stockholders or the shareholders rovide

the comany with the caital necessary to run the business. In return, the shareholders e)ect

the caital to be ma)imi:ed through rofit ma)imi:ation while reducing costs and risks. The

managers together with emloyees rovide the organi:ation with human caital

commitments, skills and time for the investments of the shareholder to bear fruits and reali:e

rofits. 7ustomers are among the most imortant art of the business as they suly revenue

to the organi:ation. In e)change to the revenue that is sulied to the organi:ation, the

customers e)ect value for money through goods and services rovided to them. The

creditors are a source of finance for the organi:ation. In e)change, the creditors e)ect the

loans that they rovide to be reaid to them as and when they fall due together with the

interest that has accrued to the loans. The suliers are the roviders of the inuts of the

organi:ation that are acuired at the lowest ossible rices and are acuired deending on the

buyers< demands "4onaldson % Preston, 1AA?(.

Who are the principa%! o" ank!

*ccording to the agency theory, the shareholders are the main rincials of banks. In

this case, the shareholders are considered to be the rincials as they delegate the business

duties to the directors who are considered to be the agents in the business. The arguments by

&ensen "2001( roose that shareholders ought to be the rincials of the banks due to a

number of factors. 6irst, the shareholders are the owners of the business in most cases, and

thus their interest should be considered first. !econdly, the shareholders are the reasons why

businesses come into e)istence and thus the reason why their interest should be served first.

ithout the business, other stakeholders would not have any control of the business thus

another vital reason behind &ensen


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Partial Title 2'

*ccording to !aidenberg, !tahan, % 4amsets, "1AAD( the stakeholder


24/39

Partial Title 2

incometent management. *ccording to Pathan % !kully, "2010( the board of directors is

resonsible for utting u mechanisms for internal controls. The internal controls are

imortant to the organi:ation as they are maor determinants of erformance and risk control

for the banks. eak controls would mean that the banks do not achieve their full otential

thus the board of directors become imortant role layers in the banks "Pathan % !kully,

>ndogenously !tructured /oards of 4irectors in /anks., 2010(.

*ccording to #iang, Pisun, % Pornsit, "201'( the structure of the board of governance

should be of otimal si:e and should meet regularly to ass on information and discuss on

issues concerning the banks. The structure of the board of directors is a determinant of

erformance and risks to the organi:ation. The structure of the board of directors is related to

cororate governance as the board needs to ensure that they act in accordance to the cororate

social resonsibilities. The welfare of all the stakeholders should be incororated in the

affairs of the comany and thus the structure of the board of directors should be made to

ensure its suorts their welfare "#iang, Pisun, % Pornsit, 201'(.

6inancials risks are likely to increase for oorly structured board of directors. The

management of the finances of the banks would be oor since the board of directors would

not be structured well to suort the monitoring of the management.

Corporate )o$ernance

7ororate governance is the system through which the organi:ations and controlled

and directed and it secifies the secific rights and resonsibilities of the organi:ation. The

cororate governance involves the establishment of a strong relationshi between both the

internal and e)ternal stakeholders of the organi:ation. It is therefore a design that forces the

management of the organi:ation centrali:e their activities on the welfare of all stakeholders.

7ororate governance with regards to banks entails the boards that are set u together with

the systems that are set to control the board. 7ororate governance with regards to banks


25/39

Partial Title 2?

entails the systems ut in lace to ensure otimal erformance is achieved and that they

reduce all the tyes of risks that the banks face. In order to achieve resonsible cororate

governance for banks the cororate social resonsibility of the banks towards its stakeholders

should be considered. The cororate governance has often been shaing the olicies of their

comanies to achieve a wide range of environmental and social toics and resonsibilities.

Proer cororate governance means that there are strong structures and a comosition of well

behaved boards under scrutiny for their activities "*ndreas % Ballelado, 7ororate

governance in bankingC The role of board ofdirectors., 2008(.

&ay, &ohn, % ;ickolaos, "2002( in their article argue that according to the cadbury

reort, the strucuture of the cororate governance should consist of both thehe)ecutive and

non e)ecutive directors. The cudbury reort recommended that deending of the si:e of the

institution, there should be atleast three non e)ecutive directors and the osition of the

chairman of the board should be held by a different individual from that of the 7>F. The

division of both ositions in the board hels to imrove the the board


26/39

Partial Title 2@

organi:ation to hel deliver long5term success to the organi:ation. The concet of cororate

governance goes beyond the activities of the board of directors. The regulatory art of the

banks is an imortant obective of the cororate governance. 3egulation in the banks

enhances safety, stability and soundness in the activities of the organi:ation "637, 2010(.

>F74, "200( argues that cororate governance is a system that allows organi:ations

to remain cometitive in the changing world. they argue that cororate governance should be

adoted together with other innovative ractices to enable businesses meet the changing

demands and gras any new oortunities within the organi:ation. 7ororate governance is

also a concet that kees the management on their feet as it tasks the senior management with

the resonsibility of oerational management. The cororate governance thus deals with both

the internal and e)ternal structures of the firm and ensures that they rovide the firm with the

best risk management otions ">F74, 200(.

echani!#! o" corporate )o$ernance

eir, -cnight, % #iang, "2002( argues that effective cororate governance is an essential

art of a business. The cororate governance ensures that the business sets and achieves

strategically its goals. >fficient cororate governance effectively combines olicies, controls

and guidelines that that are aimed at achieving the needs of the stakeholders. 6or cororate

governance to be effective in the banks, it should be accomanied by a combination of

various mechanisms namely internal, e)ternal and indeendent audit. The internal

mechanisms are those that are aimed at achieving the obectives of the internal stakeholders

such as the emloyees, directors and the shareholders. The internal mechanisms ensure

smooth oerations through segregation of the different resonsibilities by the board of

directors "eir, -cnight, % #iang, 2002(. The internal mechanisms are the easiest for

banks to control and thus should be otimi:ed by the organi:ation. The stakeholders should

therefore bear their resonsibilities and ensure that they achieve the obectives of the banks.


27/39

Partial Title 2D

4avidson % !ingh, "200'( argues that the e)ternal mechanisms are the controls that are

controlled from outside the organi:ation. The e)ternal mechanisms include the legal

comliance by the business and effective debt management from the creditors and suliers.

The banks have little control over the e)ternal mechanisms and thus in most cases leave it to

the control of the e)ternal mechanism. The indeendent audit on the other hand rovides for

cororation to ensure that the financial statements rovided reresent a fair value of the

bank


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Partial Title 28

shareholders aroach thus views the business as a legal instrument that comes into being

only for the ma)imi:ation of the interests of the shareholders. In most cases, the shareholders

aroach does not adhere to the rincial of the cororate social resonsibility and in most

cases other stakeholders of the business and the environment at large is neglected "-acey %

FJhara, 200'(. hen the shareholders aroach is ut into ractice, the management would

only focus on making rofits without considering the other stakeholders in the firm. If rofit

making is the comany


29/39

Partial Title 2A

/er"or#ance

*dams, *lmeida, % 6erreira, "200?( erformance could be described as both ositive

and negative outcomes of a business. The erformance of businesses needs to be tracked to

ensure that they stay within that financial year lan. 6or the management of erformance to

be made effective, it reuires the consulted efforts of all the stakeholders of the business. The

management of erformance in the case of banks reuires a selection of goals, a union of the

methods of measurements relevant to the organi:ation to be measured against its goals and

regular intervention by the managers to imrove on the erformance to best achieve the goals

set. The main erformance management rocesses include financial lanning, modeling of

the business, oerational lanning and reorting analysis to strategically kee track of the

erformance indicators in banks "*dams, *lmeida, % 6erreira, Powerful 7>Fs and their

imact on cororate erformance, 200?(.

Ri!k!

illiamson, "1A88( argues that risks in general business refers to the ossibility of

businesses recording lowers rofits and at times even losses which could be due to

unforeseen business issues. *mong the uncertainties that are likely to bring about business

risks include changes in tastes and references of the consumers, cometition, obsolesce of

the roducts and services and changes in government olicies "illiamson, 1A88(. /lasko %

!inkey, "200@( 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 e)ternal risks. The internal risks of

banks are those arising from events that take lace within the organi:ation such as

management skills and technology and thus are controllable. Fn the other hand, the e)ternal

risks are the risks that are taking lace outside the business remises and are in most cases

uncontrollable. !uch factors include the economic factors such as ricing ressure and market

risks and the olitical factors such as government olicies "/lasko % !inkey, 200@(.


30/39

Partial Title '0

!inan % Phili, "200( 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 multile needs that are seemingly oosing each other. The

management of such duties leads the organi:ation to the management of two maor risks

namely the solvency risks and the liuidity risks. Poor management in the banking industry

would mean that there are more risks in the sector that may force the collase of different

bank "!inan % Phili, 200(.

Thierno, #aetitia, % *mine, "200A( focus their argument in the view of risk taking and

control of the banking sector. They argue that the searation of ownershi of the business

from control is an imortant means to reduce risks. The owners are in most cases lacking the

skill reuirements to control the business and thus should hire a board that has the skill

reuired. ith the searation 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, #aetitia, % *mine, 200A(

Conc%u!ion

The literature was undertaken to identify other eoles oinion on cororate governance and

the effects that it has on the banks. The study was aimed at roviding an otimal structure on

banks that are aimed at achieving the best erformance 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 e)istence, the welfare of the other stakeholders should also be

considered. The study however also resents gas as the four variables investigated on may

not offer a comlete investigation on cororate governance. Fther variables like the number

of women in the board, board indeendence and distinction between ownershi and control

are factors that influence the erformance and risks in banks.


31/39

Partial Title '1

#ittle studies concerning the board structure and its effects to erformance and risks have

been conducted. It is therefore, hard to determine the best structure that should be adoted by

the banks to ensure best erformance and risks reduction. >ach tye of structure that has been

adoted for the board brings out its own advantages and disadvantages. /lasko % !inkey,

"200@( argue that ast erformance of the banks affects the structure of the board. The

findings in our study suort the idea that board structure is an imortant determinant of bank

erformance. iven that the board structure is relevant to the banks erformance, the

formulation of olicies regarding banks governance should be structured in such a way that

they benefit the organi:ation by increasing its erformance "/lasko % !inkey, 200@(.

The regulators should carefully reconsider some of the reuirements of being a bank

director to make the bank director market more cometitive and actively encourage ualified

directors to comete in the market. !imilarly, small boards tend to imrove bank

erformance. The study thus rovides evidence that the structure of the board for the banks

and consistent with its efficiency and erformance. 6urther study on board structure

determinants is necessary to enhance academic understanding of this subect.

Ta%e 1 &u##ary o" Literature Re$iewed

!tudy Bariables 6indings

-inton, Taillard, %

illiamson, "2010(

!i:e of the board and

erformance of the firm

#arger si:es of the board are

likely to ool resources

together and encourage the


32/39

Partial Title '2

flow of information.

Pathan % !kully, "2010(. !i:e of the board and risks

faced by the firm

larger board si:es will have

to be monitored thus

increasing the monitoring

costs and in return increasing

the financial risks

=udain % =aniffa, "200@( 6reuency of board meeting

and erformance of the firm

board meetings rovide a

channel through which the

directors can e)change

knowledge and information

concerning the activities of

the firm and how best to

tackle the weaknesses to

imrove on the erformance

of the firms+adiale, "2010( 6reuency of board meeting

and erformance of the firm

6reuency of board meetings

allow firms to be governed

making them relatively

rofitable and valuable to the

shareholders

*dams, *lmeida, % 6erreira,

"200?(

3ole duality and erformance

of the firm

3ole duality allows for more

diverse information thus

leading to innovation within

the business.

=iggs, "200'( ;umber of non5e)ecutive

directors and erformance of

the firm

*llows the outsourcing of

ideas and information to be

used by the firm to hel

imrove on erformance


33/39

Partial Title ''

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case study of the uk banking sector

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