Corporate governance, chief executive officer power and risk taking among commercial banks in Kenya

Abstract

Though the Modern Portfolio Theory suggest a positive relationship between risk and return, empirical studies in the banking sector show mixed findings. Excessive risk taking in the financial sector has been attributed to lapses in corporate governance issues. Study findings are inconclusive thus, there is need for further research. Research studies also show that CEO power influences the effectiveness of the board and the quality of its decisions thus could be a suitable moderator. Hence, this study sought to investigate the moderating effect of CEO power on the relationship between corporate governance and risk taking among commercial banks in Kenya. The study specific objectives were to determine the effect of board independence; board ownership; board members financial expertise and board meeting frequency on bank risk taking and to determine the moderating effect of CEO power on the relationship between board independence; board ownership; board members financial expertise and board meeting frequency on bank risk taking. The control variables for the study were bank age and bank size. Grounded on positivism research paradigm, the study was informed by Agency Theory, Prospect Theory and Resource Dependence theory. The study adopted both explanatory and longitudinal research design. The target population consisted of 43 commercial banks that were registered with Central Bank of Kenya during the period 2008 -2018. After applying the inclusion/exclusion criteria 36 banks formed the study population. The study used secondary data that was extracted from audited financial statements of individual banks and Central Bank of Kenya supervisory financial annual reports. Data was analyzed using descriptive and inferential statistics with the significance of each independent variable being tested at 95% confidence level. The Hausman test informed the choice between fixed effect and random effect with the test preference being fixed effect model (ρ< 0.05). The findings show that board ownership (β 3 = -0.38, p=0.000<.05) and board financial expertise (β 4 -0.42, p=0.000<0.05) had negative and significant effect on risk-taking in commercial banks in Kenya. However, board independence (β 1 =0.57, p=0.000<0.05) and board meeting frequency (β 2 = 0.90, p=0.000<.05) had positive and significant effect on risk-taking. CEO power had a buffering interaction effect on the relationship between board ownership (β= 0.041; ρ<0.05 ∆R 2 =0.04), board independence (β=0.260; ρ<0.0, ∆R 2 =0.01) board financial expertise (β=0.031; ρ<0.0, ∆R 2 =0.05) and risk-taking on commercial banks, while CEO power had enhancing interaction effect on the relationship between board meeting frequency (β= -0.027; ρ<0.05, ∆R 2 =0.01) and risk taking. Nevertheless, CEO power had significant moderating effect on the relationship between: board independence, board ownership,board financial expertise, board meeting frequency and risk taking. Thus, the study concluded that firms with high board ownership and board financial expertise have low probability of risk taking, while banks with high board independence and frequent board meetings have high probability of risk taking. Moreover, in banks with powerful CEOs, board financial expertise, board independence and board ownership increase bank risk taking. On the other hand, in banks with powerful CEO’s, board meeting frequency reduced risk taking. Based on the findings, the study recommends that banks should have a balanced number of executive to non-executive board members, board meetings with risk taking as an item in the agenda, a high number of board financial expertise and a considerable percentage of board share ownership. Ultimately, board members will be able to focus on banks’ agenda and ensure their role in monitoring and evaluating the consequences of their decisions especially when there is a powerful CEO.