the effects of corporate governance practices on financial
TRANSCRIPT
i
THE EFFECTS OF CORPORATE GOVERNANCE PRACTICES ON FINANCIAL
PERFORMANCE OF LISTED PETROLEUM FIRMS AT THE NAIROBI
SECURITIES EXCHANGE
BY
PHARIES EMITUNDO
D63/66137/2013
A RESEARCH PROJECT SUBMITTED IN PARTIAL FULFILMENT FOR THE
AWARD OF THE DEGREE OF MASTER OF SCIENCE IN FINANCE,
SCHOOL OF BUSINESS, UNIVERSITY OF NAIROBI
NOVEMBER, 2017
ii
DECLARATION
This research project is my original work and has not been submitted for examination in
any other university.
Signature: ………………………… Date……........…………
PhariesEmitundo
D63/66137/2013
This research project has been submitted for examination with my approval of the
University supervisor.
Signature: ………………………… Date……........…………
Mr. Jay Gichana
Lecturer, Department of Finance and Accounting
University of Nairobi
Signature: ………………………… Date……........…………
Moderator,
Lecturer, Department of Finance and Accounting
University of Nairobi
Signature: ………………………… Date……........…………
Dr. MirieMwangi
Chairman,
Department of Finance and Accounting
University of Nairobi
iii
CHAPTER ONE: INTRODUCTION…………………………………………..1
1.1.Background of the Study……………………………………………………… 1
1.1.1. Corporate Governance……………………………………………... 2
1.1.2 Financial Performance……………………………………………………... 5
1.1.1. Petroleum Sector in Kenya……………………………………….... 6
1.2. Research Problem…………………………….…………………………………8
1.3.Objective of the Study……………………………………………………..….. 10
1.3.1. Main Objective……………………………………………………………. 10
1.3.2. Specific Objectives……………………………………………………….... 10
1.4.Value of the Study……………………………………………………………... 11
CHAPTER TWO: LITERATURE REVIEW…………………………………..12
2.1.Introduction…………………………………………………………………….. 12
2.2.Theoretical Framework……………………………………………………........ 12
2.3 Empirical Literature Review…………………………………………................ 14
2.4 Summary of Literature………………………………………………….……... 16
2.5 Conceptual Framework……………………………………………………….... 17
CHAPTER THREE: RESEARCH METHODOLOGY……………………….18
3.1.Introduction……………………………………………………………………. 18
3.2.Research Design……………………………………………………………….. 18
3.3 Unit of Analysis…………………………………………………………………18
3.4 Population…………………………………………………………………….... 18
3.5 Operationalization of Variables…………………………………………………18
3.6 Data Collection…………………………………………………………............ 19
3.7 Data Analysis………………………………………………………………….. 20
3.8 Test of Significance……………………………………………………………..20
3.9 Validity and Reliability………………………………………………………... 20
REFERENCES…………………………………………………………………… 21
APPENDIX I WORK PLAN……………………………………………………. 27
APPENDIX II BUDGET…………………………………………………………28
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LIST OF ABBREVIATIONS
CARG Compounded Annual Rate of Growth
CMA Capital Markets Authority
COE Cash Operating Expense
CoS Cost of Sales
DCF Discounted Cash Flow
EPS Earnings Per Share
ERC Energy Regulatory Commission
EV/EBIT Enterprise Value / Earnings Before Interest Taxes
EV/EBITDA Enterprise Value / Earnings Before Interest Taxes,
Depreciation and Amortisation
FCFs Free Cash Flows
FSB Financial Stability Board
FY2015F Financial Year 2015
ISS Institutional Shareholder Services
KES Kenya Shillings
LPS
NSE Nairobi Securities Exchange
OECD Organization for Economic Cooperation and Development
OLS Ordinary Least Squares
OMC Oil Marketing Companies.
PSGT Principle for corporate governance trust
ROA Return on Assets
ROE Return on Equity
SACCOs Savings and Credit Cooperative Societies
v
USD United States Dollar
UAE United Arabs Emirates
WACC Weighted Average Cost of Capital
y/y Year over year
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CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Corporate governance as a subject matter has dominated the policy agenda in developed
market economies especially among very large firms for some time and recently in the
developing world it is gaining momentum (Haselip, et al., 2015).Academicians, regulators,
governments tend to focus on the corporate governance more agressively at the
culmination of every financial crisis in order to improve investors confidence that would
therefore attract more investments (Nyiraneza, Mbabazize, &Shukla, 2015). In his
studyTodorovic(2013)notes thatcorporate governance is an important element for
enhancement of investors’ confidence, and improvement of economic growth and increase
of competitiveness.Timeand again an argument has advancedin relation to the governance
structure of corporate organization, and how it affects the firm's ability to respond to
external factors that have some significance on its performance (Dolgopyatova, Iwasaki,
Yakovlev, &Avdasheva, 2016; Page &Spira, 2016) it has been noted in this regard that
firms that are well governed perform extremely better and that good corporate governance
is essential to firms (Nyarige, 2012).
Corporate governance as defined by the Cadbury Report is the system by which businesses
are controlled and directed (Cadbury, 1992).Its role is to resolve the conflict of interest
between shareholders and mangers which is mainly a principal-agent problem arising out
of separation of ownership and control (Bhaduri&Selarka, 2016; Bushman & Smith, 2003,
Fama& Jensen, 1983,Jensen &Meckling, 1976). According to (Mohan and Marimuthu,
2015). Corporate governance generally refers to accepted, customs, laws, norms, and
regulations and habits ascertaining the manner the company running.
The role of effective corporate governance therefore is of a big importance for the society
as whole. Firstly, it encourages the efficient and effective use of scarce resources within
the firm and the economy. Secondly, it makes flow of resourcesto the most efficient places
i.esectors or entities. Thirdly, it enables the managers to focusmore on improving
performance (Brogi, 2008; Fox, Gilson, &Palia, 2016; Madanoglu, &Karadag, 2016).
Fourth, it provides a method or tool of choosing the best executive to run the scarce
resources. Finally, it provide the environment for the organization to comply with the
regulations, rules and ways of society (Bowen & William, 2008; Griffith, 2016).
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1.1.1 Corporate Governance
The term corporate governance refers to the processes and rules which seeks to control
and direct the management actions being performed within a firm. Ever since the
globalization captured the business world, corporate governance has become a major
concern. Corporate governance according to Tandelilin et al.(2015) is believed to be
among the decisive issues taken into consideration by foreign and local investors before
joining any developing economies across the borders. Previously, several researchers have
emphasized corporate governance rationale and governance related issues to that surfaced
during the financial crisis of 2008 (Newell et al., 2014). The practicality of corporate
governance as an instrument to boost productivity and performance of corporate firms was
echoed by the collapse of financial markets and its repercussions. A number of empirical
research on corporate governance significance on a firm performance have been carried
out by researchers like (Maingi, 2016)
Previous studies have a common notion that well-organized corporate governance can
enable proper utilization of resources within not only the company but also economy in
general. It can also increase the international and domestic confidence, hence leading to
low cost of capital investment. Moreover, it ensures the responsibilities of the Board as
well as the management. The Board members will also comply with the law and make fair
judgments for the benefit of the business. Effective corporate governance might not
eliminate corruption instantly or completely, however, makes it harder for corrupt
practices to take place. Good corporate governance can help in creating a strong corporate
management as well as enhancing the results for shareholders and society in general.
Researchers like Phan(2013), Ben Amar and Andre (2006), Mahar and Andersson (2008),
Burki and Ahmed (2010) and several other have agreed on the most significant aspects of
corporate governance which include structure and mandate of board of directors, their
remuneration, service roles of institutional directors, director ownership, freedom
availability to an enterprise, BoD member accountability, audit functions
institutionalization, financial reporting and shareholder linkage. Countries such as
Germany, US and UK have come up with diverse corporate governance models which are
implemented there. The development of World Governance Index (WGI) showed the
World Bank interest in matters related to corporate governance. WGI assessed the
corporate performance of different countries on three main criteria’s that are Regulations,
Corruption and Rule of Law (OECD, 2009).
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1.1.2 Measures of Corporate Governance in Kenya
This section interrogates, in respect of the above discussion the prevailing corporate
governance system in Kenya. The nature of corporations as a developing economy is
characterized by small and medium-sized enterprises most of which are not listed on the
Nairobi Stock Exchange (NSE).(Gatamah 2005).It was estimated in 2001 that only 30% of
businesses operated in the formal sector with less than 1% listed on the NSE. More
recently, as of the beginning of 2010, almost 99% of formally registered enterprises
operated outside the capital market authority regulation (NSE 2010) and only 47
corporations were publicly held. This peculiar structure of factors of production gives
space for undemanding governance structures and an almost nonexistent market for
corporate control.
A large number of companies in Kenya have majority shareholding as observed by The
standard Report(2009). These concentration of ownership structures in Kenya support
Reed (2002:233) as cited in Gustavson et al (2005) and Shleifer and Vishny (1996:38)
suggest that for developing states a conflict of interest is more distinct between majority
and minority shareholders and not between the managers and shareholders. La Porta et al
(1998) on the other hand argues that the common law system presence should result in
stronger shareholder protection regulation. Nevertheless the presence of common law in
Kenya, Nganga et al (2003) comparative study of shareholder rights report the lack of
minority shareholder rights where unsatisfied shareholders have two options: sue the
company or sell their shares.
However, many of the Kenya’s Corporation is limited liability companies regulated by the
available corporate common law and market oriented commonly referred to as Anglo-
American model system of governance. Just as amny former colonies of Britain, the
country’s corporate common law is envisaged within the 1962 Companies Act of Chapter
486, Laws of Kenya which is the same as that of the Companies Act of 1948 in England
(Musikali 2008). Various independent regulating bodies such as the Central Bank of
Kenya, and the Capital Markets Authority (CMA), Institute of Certified Public
Accountants Kenya (ICPAK) are availed in minimum financial reporting and accounting
requirements
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1.1.2 Financial Performance
According to Grant (2016) the term performance refers to the company’s reflection on
how resources are utilized in a manner which assists it to obtain its objectives. Herman’s
(2007) noted that financial performance refers to the incorporation of financial indicators
to ascertain the objective extent of achievement, company investment support
opportunities and financial resource contributions. According to Rutagi (1997) the term
financial performance means as how well an organization may be performing while other
scholars defines organizational performance as the achievement extend and outcomes
within a particular organization (Harper, 2015; Namisi, 2002).
In most circumstances four firm measures on performance can be utilized, grouped into
accounting based measures and measures based on the market to affirm the nexus between
corporate governance and the firm performance. The four include Return on Equity,
Return on Assets, Net profit margin on sales and the Tobin’s Q. the proponent of Tobin's
Q ratio was opined by Prof James Tobin of University of Yale, who deduced that the
market value combined of all the companies within the stock market should be
commensurate to the their replacement costs (Ali, Mahmud & Lima, 2016). In short this is
the market ratio value of equity and the debt divided by the cost of replacement of the total
assets. Firms incorporating the Tobins Q tenets are more successful and are believed to be
utilizing resources amicably while those with lesser Tobin’s Q than the unity are
misappropriating resources (Chen, 2001).
1.1.4 Relationship between Corporate Governance and Financial Performance
The governance structure of any corporate entity affects the firm’s ability to respond to
external factors that have some bearing on its performance. The concept is gradually
warming itself to the top of policy agenda in the African continent like in Ghana and
South Africa. Indeed, it is believed that the Asian crisis and the seemingly poor
performance of the corporate sector in Africa have made the concept of corporate
governance a catch phrase in the development debate (Berglof and Thadden, 1999).
Empirical studies have provided the nexus between corporate governance and firm
performance. Bebchuk, Cohen and Ferrell (2004) indicate that well governed firms have
higher firm performance.
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Maher & Anderson (1999) indicate among the most striking distinctions between nations
corporate governance practices is the distinction in the control and firm ownership that are
existing across the countries. Corporate governance systems can be differentiated based on
the degree of control, ownership and identity of shareholders controlling. While other
systems are marked by versed ownership while others tend to be marked by ownership
concentration or control. Within the outsider systems of corporate governance the
fundamental conflict of interest between influential managers and widely-dispersed
weaker shareholders. Within the other side of insider, the key conflict is between weak
minority shareholders and their control. These conflicts could probably dictate the number
of directors, background, education and the frequency of holding meetings. The final
result from all these key developments will have a repercussion on the organizational
financial performance
It is assumed that a larger board will make it difficult for organizations to arrive at
decisions faster while a leaner board of directors will be faster in making decisions that are
likely to improve on the financial performance of the organization. If the board of any
company has subcommittees that can address various specific issues, there is potential for
such an organization to perform better financially. The CEO duality in an organization has
also been linked to poor financial performance. If a CEO assumes two roles there may be
lack of focus and commitment and this is likely to hurt the financial performance of the
organization (Guze, 2012).
1.1.5 Petroleum Sector in Kenya
Wanjiku (2011) noted that petroleum sector is normally grouped into three key
components which include downstream, midstream and upstream. Operations of the
midstream are normally enjoined within the downstream cadre. The preliminary phase
include the production, exploration and crude oil transportation and the petroleum gas
products to the transformation point into final products which are basically refineries. The
processing of the crude petroleum is handled by the downstream activities, the marketing
and distribution affairs of all the petroleum derived products according to Raed et al.
(2006). Petroleum is non-renewable natural resource. The petroleum has the problem of
inevitable eventual depletion within the world’s supply of oil. A typical chain supply of oil
normally begins with the crude oil producer, next the oil is moved to the refiner,
transporter, the wholesaler and finally to the gas pump where consumers receives the
products.
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There is no known oil or petroleum reserve in Kenya. The government of Kenya is
attracting foreign interest in oil exploration and there is a recommendable modest
upstream oil activity. Other energy sources are endowed in the country which includes
wind power, solar, wood fuel and coal which are untapped. According to nation’s
encyclopaedia (2010), the Kenyan government has immensely spent close to $ 1.7 million
on oil exploration activities by the year 2008. One of the Kenya’s major sources of
commercial energy is petroleum, and has previously accounted close to 82% of the
nation’s requirement on commercial energy. An yearly average of 2.5 million tons is the
domestic demand of petroleum products in Kenya, originating from the Gulf region,
basically as crude oil for processing at Kenya Petroleum Refineries Limited or petroleum
end products (Nairobi Business Daily, 2010).
Table 1.1 Crude Oil Imports into Kenya between January and March 2013
Importer Metric tones %
KenolKobil 163630 40.4
Gulf energy 159856 39.4
Addax Kenya 81905 20.2
Total 405391 100.0
Source: KPRL
During the 1994 October liberalization, a distinctive feature of Kenya oil sector was
relatively at higher levels under the direct participation by the government and
significantly very low levels engagement with the private sector. There were seven oil
companies tasked with the mandate of distributing, marketing, procuring and importation
of oil. The supply mandate was played by the National Oil Corporation at about 30% of
the crude oil requirement into the country. Many upcoming oil marketing firms have been
offered necessary permits by the government since the dawn of liberalization to indulge in
petroleum products trading, to be precise export and import, retail and wholesale of the
gas and petroleum products. The incorporation of National Oil Corporation of Kenya
Limited was in 1981 under the companies Act of Cap 486. The main role of the
company’s was to basically direct activities related to exploration of petroleum oil
products upstream This study seeks to explore the nexus between corporate governance
and financial performance among petroleum firms listed within the NSE as at August 2017
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Table 1.2 Market share of Petroleum Oil Companies in Kenya
Company %
Total 31.1
Kenolkobil 18.7
Shell 17.8
Libya oil 11.7
Gapco 6.1
National oil 4.0
HashiEnergy 2.0
Oilcom 1.4
Gulf energy 1.2
Engen 1.2
Fossil 0.9
Rivapet 0.8
1.2 Research Problem
It is a fact that the objectives pursued by shareholders and corporate managers tend to be
differing and contradictory with regards to their own interests. Consequently, this has
nurtured the conception of a wide spectrum of approaches and processes ensuring that
conflicting interest’ spill-over are minimized. One of the compromises that have been
given birth to address this divergence is corporate governance (Lamport et al. 2011).
Wangechi(2015) said ―corporate governance first came into vogue in the 1970s in the
United States (U.S). With the collapse of Enron and Arthur Andersen in the U.S and
similar disasters in the U.K such as Marconi, corporate governance has become
increasingly important. In the light of corporate financial crises in the latter part of the
1990s and 2000, the issue of corporate governance has risen to the head of the
international agenda as an important component of the global financial architecture.
In Kenya, cases where managers and directors have been accused of poor corporate
governance resulting to corporate scandals include the collapse of Euro Bank in 2004, the
placement of Uchumi Supermarkets under receivership in 2004 due to mismanagement,
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the near collapse of Unga Group, National Bank of Kenya and more recently Board room
wrangles and the discovery of secret overseas bank accounts for siphoning company
money by some directors at CMC Motors (Madiavale, 2011). The recently publicized
huge losses and numerous unresolved disputes resulting to court cases by Kenya Airways
and KenolKobil have also thrust corporate governance practices into the spotlight.
Leora, et al (2004) find that differences in firm-level contracting environment would affect
a firm’s choice of governance mechanisms, in line with arguments put forth in (Wanyama,
2009). However with only one year data, they are not able to control the fixed effects and
to test the causality. In a study by Luo Lei, potential contribution can be obtained in this
area by analyzing a number of corporate governance mechanisms based on time-varying
firm-specific data. Using the methodology in Agrawal and Knoeber, (1996), he examined
four mechanisms used in controlling agency problems — insider shareholdings, block
holdings, institutional shareholdings and leverage status of the firm. Findings reveal an
interesting relationship between governance and performance. It is the change of
governance that determines performance rather than the governance level. Further he
found that an investment strategy that buys firms with greatest improvement in
governance and sells firms with largest deterioration in governance yields 36.7 percent
excess returns over the sample period.
Wanjiku et al (2011) carried out a study to establish the Corporate Governance practices
of firms and its relationship with the growth of Companies listed at the Nairobi Securities
Exchange using a causal comparative research design. The study found a positive linear
dependence of growth and Corporate Governance. Mang’unyi (2011) carried out a study
to explore the ownership structure and Corporate Governance and its effects on
performance of firms focusing on selected banksin Kenya. His study revealed significant
difference between Corporate Governance and financial performance of banks. Wanjiru
(2013) did a study on effects of corporate governance on financial performance of
companies quoted at the NSE. She relied on 40 companies. The study foundthat a strong
relationship exist between Corporate Governance practices under study and the firms’
financial performance. There was a positive relationship between board composition and
firm financial performance.
Most of the research identified was either focused on a specific sector of the economy,
used a different methodology in carrying out the study and in measuring financial
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performance, obtained mixed and conflicting results or considered aspects of the board of
directors as a key factor in corporate governance of companies in general and did not give
it much thought given that it is the top most organ in governance that sets the tone.
According to ChogeKipleting, further research should be carried out, more research on
individual board structures are needed to assess the effects on its performance. Hence, the
researcher intents to fill the gaps identified by giving much emphasis on the block
ownership, institutional ownership, board independence and board sizes as variables of
corporate governance that affects corporate financial performance of the petroleum quoted
at the NSE guided by the following question: What is the effect of corporate governance
on financial performance of petroleum firms listed at the Nairobi Securities Exchange?
1.3 Objectives of the Study
The main objective of the study was to establish the effect of corporate governance on
financial performance of petroleum firms listed at the Nairobi Securities Exchange.
1.3.1 Specific Objectives
i. To evaluate the influence of block ownership on financial performance of the
petroleum firms listed in Nairobi Securities Exchange.
ii. To determine the relationship between institutional ownership and financial
performance of the petroleum firms listed in Nairobi Securities Exchange.
iii. To ascertain the effect of board independence on financial performance among
petroleum firms listed in Nairobi Securities Exchange.
iv. To identify the relationship between board sizeson financial performance among
petroleum firms listed in Nairobi Securities Exchange.
1.4 Value of the Study
The study will benefit shareholders and other stakeholders of listed companies by giving
an insight into the corporate governance practices of firms and their effects on financial
performance of petroleum firms. Potential investors will also find the study useful.
Individual investors (both small scaleand large scale) who have different investment needs
will be able to make more informed investment decisions. Institutional investors whose
needs are different from individual investors will also find the study useful.The study will
contribute to the existing body of knowledge and form the basis for further studies.
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1.5 Definition of key terms
Board independence
The number of non-executive directors to total number of directors in a company
(Uwuigbe, 2012).
Board size
The total number of directors in a firm (Ibrahim et al. 2010).
Block ownership
Computed as the total firm’s outstanding shares owned by block holders
(Stepanova&Ivantsova, 2012).
Corporate Governance
Ways in which suppliers of finance to a firm assure themselves of a fair return on their
investment (Shleifer&Vishny, 1997).
Institutional ownership
The fraction of a firm's shares that are held by institutional investors.That one minus the
fraction of the company’s shares held by non- institutions that is individual investors
(Kee&Hao, 2011).
Return on Asset
A measurement used to show the ability of the company to utilize assets in an efficient
way to generate profits (Mohamad, et al. 2011).
Return on Equity
The rate of return on ownership interest (shareholders of equity) of the common stock
owners(Vintila&Gherghina, 2012).
Tobin’s q The ratio between the market value and replacement value of the same physical
assets(Vintila&Gherghina, 2012).
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CHAPTER TWO
LITERATURE REVIEW
2.1 Introduction
This section provided an overview of the main theories of corporate governance and how
they influence financial performance of petroleum firms.
2.2 Theoretical Framework
This study will utilize a combination of four theories, namely: agency theory, stewardship
theory, resource dependence theory and transaction cost economics theory as theoretical
framework analytical framework.
2.2.1 Agency Theory
It has been noted that separation of control from ownership implies that professional
managers manage a firm on behalf of the firm’s owners (Kiel & Nicholson, 2003).
Conflicts normally arise when a firm’s owners perceive the professional managers not to
be managing the firm within the best interests of the owners. Eisenhardt (1989), the
agency theory is concerned with analyzing and resolving challenges that occur in the
nexus between principal and their agents or the top management. The theory rests on the
premise that the mandate of organizations is to maximize the wealth of their owners or the
shareholders (Blair, 1995).The agency theory agrees that majority of the businesses
operate under conditions of incomplete information and uncertainty.
Such conditions normally expose firms to two agency challenges namely adverse selection
and moral hazard. Adverse selection occurs when a principal cannot affirm whether an
agent accurately champions his or her capability to do the work for which he or she is paid
to do. On the other hand, moral hazard is a situation under which a principal cannot be
certain if an agent has put forth maximal effort (Eisenhardt, 1989). According to the
agency theory, superior information available to professional managers assists them to
gain advantage over owners of the various firms. The logic is that a firm’s top managers
might be more fascinated in their personal welfare than in the welfare of the firm’s
shareholders.
In summary, the idea of agency theory can be tied to Coase, (1937) but the idoelogies of
the theory have only been applied to directors and boards since the 1980’s. According to
this theory, people are normally self-interested rather than altruistic and normally cannot
be trusted to act in the best interests of others. On the contrary, people normally seek to
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maximize their own utility. The agency theory brings out a clear picture on the
relationship between directors and shareholders as a contract (Adams, 2002). This brings
out the notion that the actions of directors, acting as agents of shareholders, should be
checked to affirm that they are in the best interests of the shareholders.
2.2.2 Stewardship Theory
According to Donaldson & Preston, (1995) and Freeman, (1984), stewardship theory, also
referred as the stakeholders’ theory, adopts a diverse approach from the agency theory. It
begins from the premise that organizations serve a broader social purpose than just
maximizing the wealth of shareholders. The stakeholders’ theory postulates that
corporations are social entities that impact the welfare of many stakeholders where
stakeholders are individuals or groups that interact with organization and that affect or are
affected by the achievement of the firm’s main objectives. Stakeholders can be very
instrumental to corporate achievement and have moral and legal rights (Ulrich, 2008).
When stakeholders get what they want from a firm, they return to the firm for more.
In summary, the stewardship theory suggests that a firm’s board of directors and its CEO,
acting as stewards, are more motivated to act in the best interests of the firm rather than
for their own selfish interests. This is because, over time, senior executives tend to view a
firm as an extension of themselves (Clarke, 2004). Therefore, the stewardship theory
argues that, compared to shareholders, a firm’s top management cares more about the
firm’s long term success (Mallin, 2004).
2.2.3 Resource Dependency Theory
This theory traces its origin to the open system theory. It urges that organizations
exhibitvarying level of dependence on externalenvironment, especially in regard to
resources they need for their operation. As a consequence, organizations are faced with
uncertainty in their acquisition of resources (GrewalandDharwadkar, 2002). This theory
continues to posit that such an organization that relies on externalresources will experience
reduced levels of managerial discretion and interference with organisation’sachievement
ofits main goals. As such this reluctance in the execution of managerial duties has the
potential to threaten the very existence of the organization.
When exposed to such costly circumstances, the management takes a proactive measure to
utilize external dependence to the organization’s advantage. The success of an
organization can be defined to be the extent to which an organizations maximize their
13
power (Allaire and Firsirotu, 1989; Ulrich and Barney, 1984). Within the foremention
premise, an organization may strive to manage increasing levelsof external dependency by
either avoiding or adopting to external demands or implementing appropriate strategies.
The main essence of this premise is grounded on the assumption that superior financial
performance is generally a product of cautious management of uncertainties and
dependencies. Therefore selection of appropriate strategies to implement a positive
influence and consequentlycontrol the environment to ones advantage becomes a
significant consideration factor indeciding appropriate strategies.This plays a key role in
deciding whether the firmcontributes or withholds its vital resources to a mutual benefit of
both the client and the organisation (Allaire and Firsirotu, 1989).
2.2.4 Transaction Cost Economics Theory
The firm can be viewed as a governance structure whose governance problems may be
considered stem from various contractual hazards. These may include: asymmetries of
information, self-interested opportunism, specificity of asset, small number bargaining and
problems related to bounded rationality (Learmount, 2002). Transaction cost economic
theory has overwhelmingly borrowed from the work of Coase (1937) whose main
proposition is that; corporations can save costs if they can concentrate on their core
business instead of focusing entirely on non core business activities. Based on the above,
corporate governance in an organization should help the firm identify internal mechanisms
and measures which can economize transaction costs that are associated with these
contractual hazards.
The underlying assumption regarding transaction cost economic theory states that firms
have become so large such that they have become a substitute for the market in
determining resource allocation; where the unit of analysis is the number of transactions
processed. Transaction cost economic theory proposes that the high costs that firms incur
in successfully executing transactions at times makes them support in-house production
and markets as economic governance structures between two extreme governance
structures (Williamson, 1975).
2.3Empirical Literature Review
Most of the studies on the link between corporate governance and firm performance
confirm causality (Abor&Adjasi, 2007). However, some evidence indicates strong
relationship (Miseda, 2012) while others indicate very weak relationship
14
(Aljifri&Moustafa, 2007; Basu, Hwang, Mitsudome, &Weintrop, 2007).Black (2001), for
instance found a strong correlation between corporate governance and firm performance,
as represented by stock valuation. Choi and Hasan (2005) examined the effect of
ownership and corporate governance on Korean bank’s performance during 1998 – 2002
by using a simple ordinary least squared model reporting that the existence of one foreign
director on the board improves firm performance significantly, but multiple foreign
directors on the board do not improve firm’s performance.
In the same way, the empirical evidence is supportive of the hypothesis that large
shareholders are active monitors in companies, and that direct shareholder monitoring
helps boost the overall profitability of firms. This result is also borne out by studies of
managerial turnover (Amoako&Goh, 2015; Jung, 2014); Ogega, 2014; Otieno, 2012;
Wangechi, 2015). For example, Franks and Mayer (1994) find a larger turnover of
directors when large shareholders are present, again indicating that large shareholders are
active monitors. It seems, therefore, that the beneficial effects of direct monitoring, and a
better match between cash flow and control rights, more than outweigh the costs of low
diversification opportunities or rent extraction by majority owners.
Uwuigbe (2011), researches on corporate governance and financial performance of banks
inNigeria. This study made use of secondary data in establishing the relationship between
corporate governance and financial performance of the 21 firms listed in the Nigerian
Stock Exchange. A panel data regression analysis method was adopted in analyzing the
relationship that exists between corporate governance and the financial performance of the
studied firms. The Pearson correlation was used to measure the degree of association
between variables under consolidation. From the analysis: an inverse correlation between
board size and ROE was seen - indicates a significant negative effect of board size on the
financial performance of the listed firms; outside directors do have significant but negative
impact upon firm performance as measured in terms of ROE (Regression result showed a
negative association between the variables); the more firms’ equity owned by the
directors, the better the firms’ financial performance (a strong significant positive
correlation); and firms which disclose more on corporate governance issues are more
likely to do better than those that disclose less (a positive correlation).
Ahmad and Mensur (2012) examined corporate governance and financial performance of
firms in the post-consolidation era in Nigeria and found out that dispersed equity holding
does have an impact on the earnings and dividend of firms. They also found out that board
15
size does not have an impact on profitability of firms. In another study, Ashenafi, Kalifa
and Yodit (2013) examined corporate governance and impact on firm performance in
Ethiopia. A quantitative method of data analysis was employed which involved descriptive
and inferential statistical analysis and multivariate regression analysis. The descriptive
statistics were used to analyze the means and standard deviations of regression variables.
They conducted classical linear regression analysis and found out that explanatory
variables such as capital adequacy ratio, board size, and existence of audit committee have
significant relationship with firm performance; while square of capital adequacy ratio and
firm size have significant negative relationship with performance measured using
ROE.This means that as the variables increase, performance goes down and vice versa.
The study therefore recommended that as a means to strengthen the commercial firms in
Ethiopia, the government of National bank of Ethiopia should be concerned about the
level of both the internal and external corporate governance mechanisms of firms.
Oyoga, (2010), examined whether the performance of financial institutions listed on the
NSE is affected by the corporate governance practices they have put in place. Board
independence, shareholding compensation, board governance disclosure and shareholders
rights were adopted as independent variables. Whereas the corporate governance index
constructed as per Globe and Mail rankings using data from financial institutions and
performance measures drawn from annual financial reports was adopted as a dependent
variable. The findings of the study revealed that there is a positive relationship between
boards composition with performance of financial institutions listed on NSE. On overall
the study found that financial institutions listed on NSE should endeavor to attain the
highest possible level of corporate governance.
Oyoga, (2010) in a study of corporate governance and firm performance of financial
institutions listed at the NSE adopted a corporate governance index constructed from
Global and Mail ranking as a dependent variable. However the presence of fewer listed
firms at the NSE compared to those in established stock markets and the fact that NSE
manifests weak form efficiency, made the use of this corporate governance index place
very high thresholds on these financial institutions (Wepukhulu, 2016). It could have been
on this basis that it became precisely hard for Oyoga (2010) to explain whether the
performance of these financial institutions was affected by the corporate governance
practices in place.
16
Majority of the studies dealing with corporate governance have concentrated on financial
institutions especially commercial banks, savings and credit co-ops (SACCOS) and Micro-
finance institutions insurance companies. Very few studies have dwelt on corporate
governance of other sectors. From the studies done, it’s evident that there is ground for
further probing of the aspect of corporate governance practices of other sectors locally.
This study will therefore look at corporate governance practices of petroleum firms listed
on the Nairobi Securities Exchange (NSE), and how those practices influence their
financial performance.
2.4 Summary of Literature
Literature has established relationship between corporate governance and firm’s
performance. Literature has identified factors such as board size (Ranti& Samuel, 2012),
diversity of the board (Wachudi&Mboya, 2009), education (Adams & Ferreira, 2007;
Fairchild & Li, 2005; Nicholson & Kiel, 2004), board ownership (Hasan and Al-Mutairi,
2011; Wellalage& Locke, 2012), leverage (Weil, 2003; Khiari, et al., 2005) and firm size
(Chen, 2001; Mohanty, 2002; Mollah&Talukdar, 2007; Weir et al., 2003). These research
efforts majorly focused in the banking sector with a few focusing in other sectors. The
major gap identified in the previous literature is lack of focus in other areas like the energy
sector which are the main drivers of the economy.
The failure is that much effort was dedicated to financial institutions and banks. Another
gap is that studies in the region such as Wepukhulu (2016), Oyoga (2010) and Nyarige
(2012) focused their studies in the stock exchange but left out other listed companies
which are in the energy sector and other areas of the economy. It seems most studies are
biased to the financial institutions without regard to the drivers of the financial industry
such as petroleum industry, manufacturing and other sectors.Corporate governance and
financial performance in the petroleum industry has not been given in-depth attention in
previous literature. Many studies have linked them to general reforms in government and
to environmental concerns (Carlile& Tilton, 1998; Pollio& Uchida, 1999).It is therefore
evident from previous literature that the financial performance of the petroleum firms in
relation to corporate governance has not been adequately addressed in literature. More so
the relationship between board characteristics with performance needs to be examined in
detail in this important sector. This is what this research seeks to address.
2.5 Conceptual Framework
17
The researcher seeks to establish if block ownership, institutional ownership, board
independence and board size affect financial performance of listed petroleum firms as
measured by the surplus or deficit they report in their financial statements.
Figure 2.1 Conceptual framework.
Monitoring
Figure 1: conceptual framework
Block ownership
Shareholders decisions
Monitoring and control
of owners
Board Size
Number of board members
Number of outside directors
Institutional ownership
Board decisions
Monitoring costs
Shareholder value
Board independence
Board deliberations
Controlling top management
Integrity
Financial Performance
Tobin’s Q
Dependent Variable
Independent Variables
18
CHAPTER THREE
RESEARCH METHODOLOGY
3.1 Introduction
This chapter designed the arrangement of conditions for collection and analysis in a
manner aimed at combining relevance to the research purpose with economy in procedure.
This is the blueprint for the collection, measurement and analysis of data. It designed
decisions to happen in respect of: Where the study wasto be carried out,what type of data
is required, where the data was found, periods of time the study covered, techniques of
data collection was used,how the data was analyzed?
3.2 Research Design
Gay (1981) notes that a research design is the structure of the research. It is the glue that
holds all the elements in a research project together. For the purposes of this study, the
researcher applied a descriptive research design. A descriptive study is concerned with
determining the frequency with which something occurs or the relationship between
variables. According to Cooper and Schindler (2003), a descriptive study is concerned
with finding out the what, where and how of a phenomenon. Thus, this approach was
appropriate for this study, since the researcher intended to collect detailed information
through descriptions which are useful for identifying variables and hypothetical constructs.
3.3 Unit of Analysis
The unit of analysis in this study wastwo listed petroleum firms namely; KenolKobil
Limited and Total Kenya Limited
3.4 Population
A population is an entire group of individuals, events or objects having
commoncharacteristics that conform to a given specification (Mugenda&Mugenda, 2003).
Thepopulation of this study consistedthe two listed petroleum firms listed (KenolKobil
Limited and Total Kenya Limited) within the NSE as at August 2017
3.5 Operationalization of Variables
3.5.1 Independent Variables
Independent variables were those related to agency theory and corporate governance
practices among the two listed petroleum firms in Kenya namely: block ownership:
computed as the total firm’s outstanding shares owned by block holders - sum of the
twolargest stakes in the listed petroleum firms equity (Stepanova&Ivantsova, 2012),
institutional ownership wasmeasured as % of shares held by institutions as disclosed in the
19
annual financial reports, board independence measured as the number of non executive
directors divided by the total number of directors, board size: measured as the logarithm of
the number of board members and firm size a control variable measured as logarithm of
total petroleum firm assets.
3.5.2 Dependent Variables
Dependent variables constituted of one financial performance measures that was applied in
controlling for robustness namely: Tobin’s q ratio (TBQ) named after the Nobel Laureate
James Tobin. It is defined as the ratio of market value of equity to the net worth of the
firm. Tobin‟s q (TBQ) = Market value of Equity
Net worth of the firm
Market value of equity is the difference between the market value of the firm and value of
debt. Net worth is the amount by which the firm’s assets exceed liabilities. If the
calculated q ratio is greater than 1, there is a strong incentive for investment in the firm, to
say, there are valuable growth opportunities for the firm. Since TBQ ratio is expressed as
the firm market value to its replacement value, it decreases over time an indication of
reduction in firm value. For unquoted firms the research wascalculatedand estimated
market value of equity based on the formula below (Durant &Massaro, 2004).
Estimated market value of equity of unquoted firm=Current price of quoted firm X(own funds (of unquoted firm)
Own funds (of quoted firms)
3.6 Data Collection
The study collected data from secondary sources that were published financial statements,
Energy Regulatory Commission (ERC) reports, Ministry of Energy and Petroleum
statistics, industry reports, newspapers websites and other related studies.
3.7 Data Analysis
The data was then analyzedstatistically to evaluate and identify the relationship
betweencorporate governance and financial performance in Kenya. A simple regression
model analysis was used.Lionel and Khalid (1995) indicate that regression analysis is used
where a particularinternal attribute measure may have a significant impact in a variant
context.The model employed was based on the simple regression model:
20
Y= β0+β1X1+ β 2X2+ β 3X3+ β4X4 + ε
Translating the variables then indicates that the formula was applied as follows: Where:-
β1, β2, β3 and β4 is the regression coefficient of the independent variables
Y = Dependent variable (financial performance) measured by Tobins Q
β0 = Constant term explained by other factors other than corporate governance.
X1 = Block Ownership - measured by percentage of shares held by institutions as
disclosed in the financial statements.
X2 = Institutional Ownership- Measured by the number of non executive directors divided
by the total number of directors.
X3 = Board Independence - Measured by percentage of the total number of directors
X4 = Board sizes- Measured by the number of board members.
ε is the error term normally distributed about a mean of zero. For computation purposes it
is assumed to be 0.
3.8 Test of Significance
According to Cooper and Schindler (2003), data resulting from observational study or
experiment renders itself to statistical inference. This inferences provideanalysts with tools
to carry outtests of significance which provide insightsin assessing evidence to reach a
decision on a claim about the population from which the sample has been drawn. The
decision would be either to support or reject hypothetical claims based on sample data. A
test of significance starts by formulating a null hypothesis H0.A null hypothesis is a
premise that has been formulated and proposed as being believed to be true or used as a
basis for argument, but has not been proved.
21
CHAPTER FOUR
RESEARCH RESULTS AND DISCUSSION OF FINDINGS
4.1 Introduction
This chapter presented empirical findings of the study and inference of the obtained results
of the nexus between corporate governance practices and financial performance among
listed petroleum firms at NSE by employing the variables, tools and techniques described
in chapter three.Data analysis has been carried out in line with specific objectives. The
results have been interpreted, discussed and conceivable implications pointed out. This is
presented in the chapter.
4.2 Demographical Data on Kenolkobil and Total Kenya Limited
4.2.1 KenolKobilLimited
Kenolkobil is one amongst many publicly listed companies on the NSE. It has immense
investment portfolio within Eastern, southern and central regions of Africa. It comprises of
nine African countries. Kenyan office is the headquarters. Other countries are Congo DR,
Burundi, Mozambique, Zimbambwe, Uganda, Rwanda, Tanzania and Ethiopia.
When it comes to sourcing and marketing of crude petroleum products and refined oil
kenolkobil group is a great force to reckon within Africa’s corporate sphere. This is a
cording to a report by Old Mutual Security Research Equities (2013). In Kenya,
KenolKobil commands21.8%market share. It is the second biggest oil marketing company
in Kenya. It is second to Total Kenya which has 22.4% in market share. However,
KenolKobilis the largest corporation in terms of overall market including exports. It
commands 18.8% of this market, ahead of Total Kenya Limited which has 17.9%.
4.2.2 Total Kenya Limited
Total Kenya Limited is like an appendage of Total OutreMer Group which is the largest
oil and Gas Company, ranked fourth in the world and currently operating in close to 100
countries. The company boasts of the largest market share in Kenya which stands at
21.4%. It is the second largest (22.5%) trader within Kenya in LPG products (Old Mutual
Security Research Equities, 2013).It also has close to 175 retail-outlets across Kenya.
Upon acquisition of Caltex in 2008, Total Marketing Kenya bought eight nine branded
Caltex station service, seven fuel depots, one terminal, one lubricant blending plant and
six aviation facilities. The group participates in all the issues related to oil industry
22
exploration and production to marketing and refining and it spectacularly standout in the
market of chemicals (Old Mutual Security Research Equities, 2013).
4.3 Descriptive Statistics Results
Results from descriptive statistics were utilized outlining the basic characteristics of data
by availing simple summaries about measures used and the sample. Tronchim, (2006)
agrees that descriptive analysis is a great way of analyzing each aspect of quantitative
data analysis using quantitative techniques. Discriptive stsitics was utilized within this
study for computation purposes on maxima, means, standard deviation and minima of the
data which was collected for analysis
The Table 4.1 shows descriptive statistics results on the nexus between the corporate
governance techniques (block ownership, institutional ownership, board independence
and board size as they connected to issues relating to financial performance of the listed
petroleum companies within the Nairobi Stock Exchange in Kenya (TBQ ratio) taking
into account the effect of firm size as a control variable.
Table 4.1: Descriptive Statistics
Variables Observations Minimum Maximum Mean Standard
deviation
TBQ ratio 33 .00 9.13 .9367 1.4224
Block 33 .59 1.00 .6814 .21685
ownership
Institutional 33 .00 .59 .1998 .16402
ownership
Board 33 .17 .92 .6747 .13890
independence
Board size 33 .60 1.18 .8633 .12959
Bank size 33 2.88 5.51 4.1179 .60476
From the data received from the two listed petroleum firms at the NSE in Kenya (Table
4.4), the findings indicate that management boards of petroleum firms in Kenya comprised
an average of eight directors (antilog. Of .8633), maximum of sixteen (1.18 antilog) with
four as the minimum(.60 antilog). This formed a deviated of 1 (.12865 antilog) mean of
the director. The findings further indicated that independent directors constituted of
67.47% of the board size, with a maximum of 92% and a minimum of 17% that were
spread on either side of the mean by 13.89%. On average institutional investors held
19.98% of equity stakes in these firms, with a maximum of 59% and a minimum of 0 that
23
were spread on either side of the mean by 16.402%. Block holders on average owned
68.14% of equity stakes with a maximum of 100% and a minimum of 59% that were
spread on both sides of the mean by 21.685%.
The average size of assets in these petroleum firms (firm size) during (2010-2016) was
Kshs.13, 119 million (antilog. of 4.1179), with a maximum of Kshs.323, 594 million
(antilog. Of 5.51) and a minimum of Kshs.759 million (antilog of 2.88) that deviated on
both sides of the mean by 60.476%. Using Tobin‟s q ratio as a measure of financial
performance, the findings indicated that petroleum firms reported .9379 an average
Tobin’s q ratio with the highest/ maximum being 9.13 and a minimum of zero. This gave
a deviation of 1.42 about the mean.
4.4 Inferential Statistics Results
4.4.1 Correlation Analysis
Correlation coefficient values is shown below in table 4.2 between the independent and
dependent variables and among the dependent variables themselves.
The examination of the correlation coefficients helps in accepting or rejecting the null
hypothesis by computing a significance correlation between the explanatory variables. The
linear relationship degree between two variables in correlation oscillates between +-1 and
1. The +1 correlation suggests a very strong linear relationship which is positive among
variables hence bring about the concern of multicolinearity challenge (Sekran, 2003). On
overall the correlations were very low. Only block ownership and institutional ownership
had a correlation coefficient of -.781. However the rest of the variables had correlation
coefficients that were generally moderate (less than .445). On overall the correlation
coefficients were far much less than 0.8 threshold indicating that there was no concern for
multicolinearity (Kennedy, 1985).Therefore, we fail to dismiss the null hypothesis that a
correlation does not exist among the explanatory or descriptive variables.
24
Table 4.2: Partial Correlation Analysis
Control TBQ Block Institutional Board Board size
variables ratio ownership ownership
independe
nce
TBQ ratio 1.000
correlation
Significance .
(1-tailed)
Block -.047 1.000
ownership
correlation
Significance .171 .
(1-tailed)
Institutional -.016 -.781 1.000
ownership
Significance .376 .000* .
(1-tailed)
Board -.008 -.116 .096 1.000
independence
Significance .432 .009* .026* .
(1-tailed)
Board size .158 -.127 .012 .437 1.000
Significance .001 .005* .408 .000* .
(1-tailed)
* Significant at 5%
one tailed level.
**significant at
10% one tailed
level.
According to the table above 5% level of significance was observed which is a positive
and significant correlation between TBQ ratio among the listed petroleum firms with
board size (r=.158, p-value=.002). Implying that, the correlation between board size with
TBQ ratio existence slightly above and past the implications of petroleum firm size.This
invariably implies that as the petroleum firm board size increases so does TBQ ratio
heightens after regulating for the impact of petroleum firm size.
Negative though not statistically significant correlations at 5% level of significant were
observed between block ownership (r=-.047, p-value= .171), institutional ownership (r=-
.016, p-value=.376), board independence (r=-.008, p-value=.432) each with TBQ ratio.
Implying that, the correlations between institutional ownership and block ownership with
TBQ ratio does not exist above and beyond the effects of firm size. Hence: high levels of
block ownership, high levels of institutional ownership and board independence has no
25
implications on the financial performance among the listed petroleum companies within
the Nairobi Stock Exchange in Kenya when TBQ ratio is adopted as a financial
performance measure after controlling for the effect of listed petroleum firms at the NSE
in Kenya
4.5 Regression Analysis
Model 1
TBQit=f (β1X1it,β2X2it,β3X3it,β4X4it ................................................................ (1)
Meaning Tobin‟s q of a listed petroleum firms at the NSE in Kenya at any given
time is a function of: β1X1it, β2X2it,
β3X3it, and β4X4it.
TBQit =βo+β1X1it+β2X2it+β3X3it+β4X4it+β5X5it+εit....................................................... (2)
Where:
TBQit -Is financial performance measured by Tobin’s q ratio.
Subscripts i and t represent firm and time period, respectively.
Y-TBQi
βo- Intercept term
X1-Proportion of block ownership
X2-Proportion of institutional ownership
X3-Board independence.
X4- Board size
X5-Control variable firm size
εit - error term.
The study computed a hierarchical multiple regression in order to test the null hypothesis
that there was no relationship between the TBQ ratio and the independent variables
(predictors) which were block ownership, board size, board independence and institutional
ownership after controlling for the effect firm size. The results were as per table 4.3
below:
26
Table 4.3: Regression Model Summaryc (TBQ ratio)
Model R R-Square Adjusted R Square F change df1 df2 Sig. F Durbin
R-Square change change Watson
1. .498a
.248 .240 .248 33.714 4 410 .000
2.
.584b .341 .333 .094 58.063 1 409 .000 1.664
.Predictors: (Constant) Block ownership, Board size, Board independence, Institutional
ownership.
b.Predictors: (Constant) Block ownership, Board size, Board
independence, Institutional ownership, Bank size.
c. Dependent variable: TBQ ratio.
Based on model 2 (step 2) in the Model Summary table 4.10 above, when the control
variable firm size was added in the analysis, (F (1,409) = 58.063; P< .05), the regression
results indicate that the predictors variable, block ownership, institutional ownership,
board size and board independence contributed to the overall relationship with
performance as measured by Tobin’s q. 58.063 of the F-statistics accompanied with the
ratio probability of .000 showed that the general model was significant going by its level
of significance at 5% and that board independence, board size, block ownership and
institutional ownership were of great significance in showing the financial performance
variation among the listed petroleum companies in regard to TBQ ratio. This brought
about the null hypothesis that any change in R² was relatively commensurate to 0 was
rejected. The study hypothesis that petroleum companies’ size decreases the error in
prediction of the financial performance among the listed petroleum firms within the
Nairobi Stock Exchange with regard to TBQ ratio was affirmed. After introducing the
control variables petroleum companies the increase in R2 in the analytical framework was
.094. The table below (Table 4.11) emulsifies results from regression analysis where
coefficient estimated for every variable are indicated when Tobin’s q was utilized as a
measure for financial performance.
.
27
Table 4.4: Regression Results of TBQratioa
Unstandardised
Coefficien
ts
Standardiz
ed
Model B Std Error Beta T Sig.
Toleran
ce V.I.F.
1 (Constant)
-
2.010 .667 -3.012 .003
Block
ownership -.687 .475 -.109 -1.565 .118 .376 2.659
Institutional -.804 .471 .120 -1.709 .088 .375 2.668
ownership
Board -1.754 .473 -.171 -3.708 .000 .865 1.156
independence
Board size 5.516 .529 .449 10.432 .000 .802 1.247
2 (Constant) -4.045 .680 -5.951 .000
Block
ownership -.553 .418 -.087 -1.323 .187 .375 2.664
Institutional -.509 .443 -.076 -1.150 .251 .372 2.689
ownership
Board -.794 .461 -.077 -1.723 .086 .801 1.249
independence
Board size 2.234 .656 -.202 3.430 .001 .457 2.190
Bank size .987 .130 .420 7.690 .000 .531 1.884
a. Dependent variable TBQ ratio.
The overall regression equation for this model is
Y =-.4.045-.553X1-.509X2-.794X3+2.234X4 +.987X5
Based on the beta coefficient statistic of (t = 7.690, p<0.001) of the control variable firm
size, the null hypothesis slope ( to mean the beta coefficient) which is equated to 0 was
actually dismissed. The study hypothesis on the notion that the nexus on corporate
governance indicators utilized(institutional ownership, block ownership, board
independence and board size and the financial performance in relation to TBQ ratio
among the petroleum companies listed at the Nairobi Stock Exchange in Kenya is affected
significantly by the size of the petroleum firm was supported.
The beta coefficient for the relationship between the TBQ ratio and petroleum firm size
was .987 (the control variable). The implication is that there is a direct relationship as
signified by the positive coefficient. Implying that bigger petroleum firm size is associated
with higher financial performance whenTBQ ratio is adopted as a measure of petroleum
firm financial performance. The hypothesis that high petroleum firm sizes are associated
with high financial performance in terms of TBQ ratio was supported.
28
Firm size and board size were established to bear positivity in statistical significance at a
level of 5%. Implying that; as board size and bank size of petroleum firms in Kenya
increases so does the TBQ ratio increases too. Institutional ownership, block ownership,
and board independence were found not to be significant in this relationship. Meaning that
the pressure exerted by: block owners, institutional owners and independent board of
directors have no influence on TBQ ratio of listed petroleum firms in Kenya. Although
Institutional ownership, block ownership, and board independence were found not to be
statistically significant, the fact that they had a negative beta coefficient was assessed as an
important outcome. Board size had the highest beta coefficient (β =2.234, P< .05), firm
size (β =.987, P<.05), institutional ownership (β=-.509, P>.05), block ownership (β= -
.553, P>.05) and board independence (β= -.794, P >.05).
4.6 Kenolkobil Limited Company Financial Performances
4.6.1 Subsidiaries to Drive Topline Growth
The study projects a Compounded Annual Rate of Growth (CARG) of 12.1% inrevenues
in three-years to FY2017F. This growth is driven by contributions notably from
subsidiaries amounting to over 40%. Another factor of growth is improved operating
environment. The study expects that KenolKobil’s turnaround strategy will fuel growth in
key markets while observing that KenolKobil’s competitiveness is considerably low in
some markets. In 2015, its subsidiaries were profitable with exception of Tanzania’s.
The subsidiary of Tanzania is believed to hold an excess inventory and faced the
challenges of proliferation inefficiencies at Dar es Salaam port.
4.6.2 Growth Prospects in Alternate Revenue
A potential growth opportunity was noted by the study within the trading desks of African
Countries. It alleged that the growth could contribute to proximately ten percent to twenty
percent with the bottom line according Old Mutual Security Research Equities, (2013).
Even though the sales are discounted, these alternative businesses have a low operating
risk exposure because of the purchases in bulk. The operations of Kenolkobil were
discontinued within Dar es Salaam. It blamed the moved on regulatory constraints. It then
shifted its focus to try and strengthen its Tanzanian subsidiaries. There is a need to
actually realize that the firm owns trading desks within Zimbabwe the Ex Beira port and
Kenya which will significantly play a pivotal role in bottom-line growth stimulation of the
company according to Old Mutual Security Research Equities of 2013
29
4.6.3 Conservative Approach to Forex Exposure
Noting that Kenyan local currency is relatively stable and its hedging policy is under
termination, this study shares the opinion that KenolKobil stands at a better position of
forex losses minimization. The disparity in USDollar is blamed for the forex risk being
experienced at KenolKobil Company; domestic currencies receivables denominated versus
contract liabilities denominated according to a report by Old Mutual Security Research
Equities in 2013. Foreign borrowing stands at about 60% of overall borrowings. It is
envisaged that a strong Kenyan shilling will results to slightly lower interests that are
payable to borrowings that are denominated in dollars.
Potential Buyout Target
Kenolkobil still possesses as a potential takeover target in the near future, despite the
unsuccessful attempt to acquire Puma, given the market reports indicating FY2015F
EV/EBIT and EV/EBITDA trade of multiples of about 10.15 x & 8.9 x respectively (Old
Mutual Security Research Equities, 2013). Further, analysis indicates that it has a financial
score of7.32 FY2015F which is believed to be healthy on the empirical model of the
Altman z-score’s. Corporate bankruptcy probability prediction is highly utilized under the
tenets of this model. However, with a financial score that is healthy, it is highly
anticipated that the corporation would have a high ROE of about 31.6% in 2015F (Old
Mutual Security Research Equities, 2013).
4.6.4 Financial Condition
Financial reports of KenolKobil indicated that the corporation incurred a net loss Ksh 6.32
billion the year ending 31st December, 2016. This loss resulted from a Ksh 4.63Bforeign
exchange net losses (Old Mutual Security Research Equities, 2013). The table below
shows the key indicators from the results:
KES m 2015 2016 % growth
Net sales 192,527 222,441 -13.4%
Cost of sales (188,239) (210,107) -10.4%
Gross profit 4,288 12,333 -65.2%
Other income 483 281 72.0%
Distribution costs (996) (1,203) -17.2%
Administrative expenses (5,860) (4,175) 40.3%
Forex losses (4,606) (1,155) 298.6%
Finance income 78 263 -70.2%
30
Finance costs (2,351) (1,413) 66.4%
Share of profit in Associate (2) 3 -175.3%
(L)/ PBT (8,965) 4,934 -281.7%
(L)/ PAT (6,285) 3,274 -292.0%
LPS (4.27) 2.22 -292.3%
Source: Filings of the Company
4.6.5 Inventory Excess Holding and the Fallin International Oil Prices Hurt Sales
KenolKobil recorded a decline in turnover of KES 192.5B (13.4%) year over year in
comparison to KES 222.42B within 2015(Old Mutual Security Research Equities, 2013).
This was attributed to excess inventory holding levels accompanied by international prices
surge of oil products with the particular duration or period. In view of this, the corporation
adopted a strategy that promotes moderate inventory holding so as to cushion itself from
negative effects results from fluctuation in international price. When sales were compared
to Cost of Sales (CoS),it was noted that CoS dropped though gradually by 10.4% y/yof the
sales. Consequently, gross profit declined by a significant amount (KES. 4.3 billion)
comprising 65.2%y/y. the greatest big blow on gross profit margin was in 2016( 2.3%
from 5.6%) according to Old Mutual Security Research Equities in 2013
4.6.6 KenolKobil in a Forex loss and Hedging Policy Lands
On the other hand, incurred administrative costs went up by 41.3% to close to 5.86B from
about Ksh. 4.18 B within the same period. KenolKobil initially entered into a contract in
order to hedge its rates of exchange at Ksh. 100 for US dollar, a decision that led to the
loss of Ksh. 4.6B since the shillings appreciated to a value of about Ksh. 85 per US dollar.
KenolKobil’s costs on borrowing increased by 66.6 % to hit Ksh.2.4B mark.In general,
the firm suffered KES 6.3 billion in net losses.
4.6.7 Valuation
In order to perform a fair value estimate on KenolKobil, this study utilized 3 years
Discounted Cash Flow (DCF) model of valuation. The equity cost otherwise known as
discount rate that was assumed at 17.7% was computed using the following parameters:
Free Rate Risk anchored at 13.23%, Premium market risk factored at 6.0%, Beta value of
0.76x, and considering a long term sustainable growth rate of 6.12percent (Old Mutual
Security Research Equities, 2013). ThisDCF model effectively discounts Free Cash Flows
(FCFs) in the selected three-year period. This estimated FCFs by discounting them
utilizing a Weighted Average Cost of Capital (WACC) approach. A debt cost of thirteen
31
percent was employed in computation, as well as a tax rate of 30.0% (Old Mutual Security
Research Equities, 2013). The target resulting price is Ksh. 14.80 per share
The corporation stands to gain from close to USD 70 million (although not incorporated in
within the valuation) that is still in contention with Kenya Pipeline Company (KPC) as a
result of unfair and improper allocation of storage capacity.
KES(m)
(12m to
Dec) 2013A 2014E 2015E 2016E
Terminal
Value
EBIT (6,260) 3,312 4,920 6,505
Add:
Depreciation &
Amortization 603 619 609 635
EBITDA (5,658) 3,931 5,528 7,140
Less: Net
Working Cap
change 11,744 446 (1,714) (2,326)
Less: Net
Interest (2,273) (1,745) (1,729) (1,718)
Less: Tax (858) (573) (957) (1,436)
Less:
Capex (854) (819) (809) (835)
Free
cashflow 2,102 1,241 320 824
FCFF 3,695 2,462 1,530 2,027 39,012
Discount
Period 0.53 1.53 2.53 2.53
Discount
factor @
WACC 0.94 0.85 0.76 0.76
Present value of
free cash flow 2,325 1,295 1,539 29,629
Value of operations 34, 788
Add Cash(less net debt) (13,183)
Market capitalization 21,606
No of shares (m) 1,472
Per share value 14.70
Current price 10.35
Upside/(downside) 41.8%
32
4.6.8 Forecasted Financial Statements
The table below shows KenolKobil’s consolidated statement (Old Mutual Security
Research Equities, 2013).
Consolidated Statement of Comprehensive Income for KenolKobil Ltd
KES m (12m to Dec) 2013A 2014F 2015F 2016F 3yr CAGR%
Turnover 192,527 209,4 255,553 271,142 12.1%
% change (13.4%) 8.8% 22.0% 6.1%
Cost of sales (188,239)
(200,88
2)
(244,564
) (258,127) 11.1%
Gross profit 4,288 8,588 10,989 13,015 44.8%
Gross profit Margin (%) 2.2% 4.1% 4.3% 4.8%
EBITDA (5,658) 3,931 5,528 7,140
EBITDA Margin (%) - 1.9% 2.2% 2.6%
Depreciation (603) (619) (609) (635)
EBIT (6,260) 3,312 4,920 65
EBIT margin (%) - 1.6% 1.9% 2.4%
Profit Before Tax (8,965) 1,909 3,191 4,787
Tax credit/(expense) 2,680 (573) (957) (1,436)
Net Profit (6,285) 1,336 2,234 3,351
Net profit Margin (%) - 0.6% 0.9% 1.2%
EPS (KES)-Diluted (4.3) 0.9 1.5 2.3
% change (292.0%) 116.6% 67.1% 50.0%
DPS (KES) 0.50 0.50 0.50
Dividend cover 1.8 3.0 4.6
Payout ratio (%) 55% 33% 22%
Source: Company Filings
The growth in EBITDA margin is linked to the cost management renewal focus. This entails
disposal and job cuts of KenolKobil’s under- and non-performing assets
Without factoring KES 4.6b in net foreign exchange losses in FY2016, EBITDA is at KES -
1.1b due to excess holding of inventory and increased price volatility within the duration
under review.
33
KenolKobil Ltd. Consolidated Statement of Financial Position
KES(in m) (12m to Dec) 2013A 2014F 2015F 2016F 3yr CAGR%
Fixed assets 8,144 8,344 8,544 8,744 2.4%
Current assets 24,540 27,779 31,590 34,785 12.3%
Total assets 32,684 36,123 40,134 43,529 10.0%
Shareholders’ equity 6,446 7,782 9,280 11,895 22.7%
Non-current liabilities 898 668 668 668
Current liabilities 25,341 27,673 30,186 30,967 6.9%
Total equity & liabilities 32,684 36,123 40,134 43,529 10.0%
NAVPS 4.38 5.29 6.31 8.08 22.7%
Source: Company Filings
Shareholding Structure
Wells Petroleum Holdings has 24.9% shares in KenolKobil, which makes it the largest
shareholder in the company. Petro Holding Ltd and High field Company Ltd control
17.3% 12.5% of KenolKobil’s share capital respectively. Kenol-Kobil free-float currently
stands as 31.4%.
Shareholder No. Of shares % shareholding
Wells Petroleum Holdings Ltd. 366,614,280 24.91%
Petroholdings Ltd. 255,211,080 17.34%
Highfield Ltd. 183,350,000 12.46%
Chery Holding Ltd. 116,080,400 7.89%
Energy Resources Capital Ltd. 88,185,720 5.99%
Others 462,319,720 31.41%
Total 1,471,761,200 100.00%
Source: Company Filings
4.7 Total Kenya Limited
4.7.1 Margin Stagnation under Local Conditions
Market trends strongly suggest that high concentration in regulated prices in the local
market will continuously constrain in the foreseeable future(Old Mutual Security Research
Equities, 2013). The study predicts a three-year CAGR of about 6.3percent to FY 2016 F
with regard to revenue resulting from realization of sales under various influences, which
34
include new OTS contracts, enhanced services and competitive products outsourcing and
services.
4.7.2 Efficient Operations
One main concern in KenolKobil quarters is high operating expenses. The study
extrapolates agross margin of 5.1% in the FY2017F, which should be above that of
Kenol(-4.9%) within FY2015 F. The margin of EBITDA is expected to drop to 1.2% in
FY2017F, a value that is below that of Kenol(– 2.4%) in the FY2015F. This stems from
high operating costs and is expected to drain company’s core performance.
4.7.3 Outlined Capital Expenditure a concern over debt
Following the restructuring of its totalcapital, which entailed changing of the Ksh 5.3B
(thus USD 62.55 m) loan that was owed by the parent company into 332 million shares of
preference, KenolKobil made better its debt to ratio of equity from 168.4% in 2011 to
36.6%. All in all, the company is expected to delve deeper in its borrowing which stands at
DER of - 44.6% in FY2015F due to the company’s negative cash position. It is expected
that its capital expenditure will grow to KES 1b an equivalent of USD 12m in the next
three years(Old Mutual Security Research Equities, 2013)..
4.7.4 Financial Condition
On the other hand, Total Kenya reported a net loss of KES 202 million in the year
endeding December 31, 2015. The loss was attributed to meeting the legal costs related to
the activities of the Triton Firm. The below shows the indications of the above results:
KES m 2015 2016 % growth
Gross sales 119,789.0 105,590.4 13.4% Indirect taxes and duties (12,338.5) (13,055.3) -5.5%
Net sales 107,450.5 92,535.0 16.1%
Cost of sales (101,577.1) (87,860.7) 15.6%
Gross profit 5,873.5 4,674.4 25.7%
Other income 302.2 680.0 (55.6%)
Operating expenses (4,652.7) (3,962.4) 17.4%
Finance income 48.5 0.5 8817.1%
Finance costs (1,554.7) (1,592.3) 2.4%
Foreign exchange (loss)/
Gain (81.0) 257.6 -131.4%
(L)/ PBT (64.3) 57.9 -211.2%
(L)/ PAT (202.1) (71,436.0) -99.7%
LPS 0.32 0.24 -99.7%
Source: Company filings
35
Total Kenya posted a turnover growth in net sales of KES 107.5 billion (16.1%). This was
realized from improved sales that were occasion from acquisition of several contracts.
These contracts involved supplying the industry with products which are refined under the
pretext agreement of OTS (Old Mutual Security Research Equities, 2013). Its gross profit
increased by KES 5.9billion (25.7%). Consequently, its gross profit margin slightly rose
from 5.1% in 2011 to 5.5%. Operating expenses roseby KES 4.7 billion(17.4%). This was
attributed to debt settlement amounting to KES 673.6million. The debt resulted from
supply dispute currently in London court, and was owed to Glencore– which is a Swiss
trading conglomerate. Glencore supplied Triton with diesel fuel to enable Triton supply
KenGen, a power generating company in Kenya, in its partnership agreement.Total had
guaranteed Triton in this contract. Glencore claimed money for the diesel supply from
Total Kenya since Triton had run out of business (Old Mutual Security Research Equities,
2013).
Triton run out of business in 2008 with an overwhelming debt ranging to overKES
7.6billion owed to Kenya Pipeline Company. It was claimed that Triton had siphoned and
sold to the market oil without the consent of financiers. This move prompted the Kenyan
government to institute a probe (PwC audit) into the allegations. A drastic increase in
interest ratesand a rising bank borrowing inflated interest costs to KES 1.6b and higher
working capital requirements respectively. Other forms of income plummeted to KES
302.2million (55.6%) due to fewer assets disposal in comparison to the previous year. In
general, Total Kenya recorded a LPS worth KES 0.32.
4.7.5 Valuation
In order to perform a fair value estimate of Total Kenya, this study used a three year
DCFvaluation model. The CoE otherwise known as discount rate that was assumed at
18.0% was computed using the following parameters: Risk Free Rate (RFR) pegged at
13.1%, Market Risk Premium factored at 6.0%, a Beta value of 0.805x, and considering a
long term sustainable growth rate of 6.0%(Old Mutual Security Research Equities, 2013).
ThisDCF model effectively discounts Free Cash Flows (FCFs) in the selected three-year
period. This estimated FCFsby discounting them using a Weighted Average Cost of
Capital (WACC) approach. A cost of debt of 14.0% was used in computation, as well as a
tax rate of 30.0% (Old Mutual Security Research Equities, 2013). The resulting target
price is KES 13.25 per share.
36
KESin m (12m to Dec) FY13 FY14 FY15 FY16
Terminal
value
EBIT 1,523 1,367 1,718 1,524
Add: Depreciation &
Amortization 167 342 350 358
EBITDA 1,690 1,710 2,068 1,882
Less: Net Interest (1,506) (717) (717) (720)
Less: Tax (36) (200) (299) (266)
Less: CapEx (682) (542) (550) (558)
Less: Net Working Cap change 5,047 (445) (268) (559)
Free cash flow 4,513 (194) 233 (221)
FCFF 5,507 308 735 283 3,054
Discount Period 0.53 1.53 2.53 2.53
Discount factor @ WACC 0.93 0.80 0.69 0.69
Present value of free cash flow 285 587 196 2,107
Source: Company filings
4.9 Total Kenya’s Board and Management Structure
The Board of Management of Total Kenya’s is led by the chair. The current chair is Jean
Papee. The Managing Director is Alexis Vovk, a Master’s Degree graduate in Business
Administration from ESSEC Business School Paris, France. The company directors are
listed in the table below:
Company Directors
Chairman of the Board Jean Papee
Managing Director Alexis Vovk
Finance Director Patrick Waechter
Company Secretary J.L.GMaonga
Source: Company filings
4.9.1 Shareholding Structure of the Company
Total OutreMerholds the largest (72.2%) share in Total Kenya, Total Africa Limited holds
6.13%,KibungaJ.K. holds 2.24% and at the same time approximately 18.02% shares are
free float state.
Shareholder No. of shares
%
shareholding
Total OutreMer 126,300,714 72.16%
Total Africa Ltd. 10,729,260 6.13%
Kimani John Kibunga 3,920,643 2.24%
37
Shah Rajesh Dharamshi 1,732,784 0.99%
Kibirichia Stores Ltd. 805,132 0.46%
Others 31,540,173 18.02%
Total 175,028,706 100.00%
Source: Company filings
4.9.2 Risks in Investment
Despite the appealing and optimism witnessed in the oil and gas industry in the region, the
producers face a number of significant challenges that include;
4.9.3 Price controls
According to this studyprice control will significantly impact Total Kenya as opposed to
KenolKobil. KenolKobil enjoys more diversifyin the region. This price control policy
negatively affects other players especially small players who find it difficult to generate
profits due to the thin margin set at the retail end.Producers and Marketers face revenue
margin constraints resulting from the price formular that has been adapted by ERC. The
formular does not fully factor all elements that affect the costs in the supply chain and
inflationary adjustments(Old Mutual Security Research Equities, 2013). The study noted
that listed downstream oil marketers enjoy relatively well diversification in oil and gas
products. Their investment inLPG aviation,fuel oil and commercial generates comparably
higher profits. The studywasnoted with concern the volatility in shifting levels of profits
generated in these segments as witnessed in the past years.
4.9.4 Inadequate levels of infrastructure
The study noted that inadequate infrastructure is still a huge obstacle in the East African
region in supporting refinery,storage and transportation (pipelining) of products. Logistical
constraints and the practicality of transporting products within oil industry in Kenya has
imparted negatively on business operations. Most successful downstream oil marketers in
the region have in one way or another utilized state controlled infrastructure or have had to
find third party alternative solutions to this obstacle(Old Mutual Security Research
Equities, 2013). KenolKobil has either purchased or leased additional storage capacities to
enhance its distribution and storage flexibility. With only one oil refinery at Mombasa the
East African region has a refining capacity of just 70,000bpd which does not sufficiently
meet the huge consumption in the region.
38
4.9.5 Foreign Exchange Risks
The study noted with concern the volatility of currency in the region. A significant
depreciation in the regional currencies to other world major currencies could pose risks of
encountering higher costs in crude oil importation.
4.9.6 Corporate Governance
Corporate Governance (CG) may be defined as the process or system that govern the way
companies are directed, controlled and held accountable. CG standards are aimed to
improve value that translates to the stakeholder. It ensures corporates are responsibly
structured, operated, transparent and accountable in their business operations and that they
provide accurate financial statements.Total Kenya Limited adheres to strict codes of
conduct that enables it comply with highest CG standardsat both regional and international
levels and fromCompanyto Group levels. This is support by continuous review of its CG
performance and standards. Constant reviews of CG has enable Total Kenya to
continuously stay up-to-date with changing developments in CG and remain in strictly
compliant.
In addition, Total Kenya upholds a vibrate anti-corruption policy and guidelines that
discern various corruption practices. It has its own Ethics Officer and Compliance Officer
to enforce, protect and champion policies that have been developed in this realm against
internal and external violations. These policies and guidelinesrange from mechanisms
relating to whistle blowing, creating awareness and enforce compliance,
conductingtraining in anti-corruption for all of its employees using e-learning.
4.9.7 Board of Directors
The Directors of Total Kenya Limited are appointed to the board by the shareholders for a
term of three-year. A director may be re-elected to the board after serving his term.The
board of directors is mandated to debate and formulate directives which are then passed to
the Management Committee which is empowered to implement the directives. The
management board consists of all heads of departments and an Audit Committee. The
organizational management is structured in a framework that is run in a procedural manner
and exhibits internal checks and balances. The staff are also trained to ensure they
understand their duties and job descriptions
39
4.9.8 Audit Committee
The Audit Committee is chosen by the Board of directors. It seats in the management
committee. It has a minimum composition of three directors. The chair of this committee
is an independent, non-executive director. Members appointed to this committee have
reputable background in finance and accounts management.External auditor(s) also form
part of this committee. The main duties of audit committee is to review financial reports,
internal audit reports, management letters, briefing managing director, conducting
interviews for the managers, inspecting performance and among other important duties.
The Committee is mandated to conducta minimum of four formal meetings in a year.
4.9.9 Management Committee
This Committee, consists of the Managing Director and all the Heads of Departments and
their responsibilities entail meeting on fortnight basis in order to review companies
performance, evaluate issues, discuss and review operational strategies, and facilitate
intra-company’s business activities, communication and processes.
SHAREHOLDERS ANALYSIS
TOP 10 SHAREHOLDERS
Rank Name Shares Held Percentage
1 Total Outre-Mer 580,804,822 92.26
2
Total Africa
Limited 10,732,950 1.70
3
Kimani, John
Kibunga 4,136,508 0.66
4
Shah, Rajesh
Dharamshi 1,728,386 0.27
5
Benjamin, Emmett
Joseph 570,900 0.09
6
The Jubilee Insurance Company Of Kenya
Limited 566,736 0.09
7
APA Insurance
Limited 565,700 0.09
8 Cannon Assurance (Kenya) Limited 544,000 0.09
9
Standard Chartered Nominees non Resd A/C
9306 499,600 0.08
10 Rahim, Ahmed MianAbdur 459,960 0.07
600,609,862 95.40
40
Share Distribution Schedule
By Number Of Share Range
Range No. of
Members Total No. Percentage
of Shares
1 - 500 2,230 514,332 0.08
501 - 1,000 1,006 865,530 0.14
1,001 - 5,000 1,675 4,326,955 0.69
5,001 - 10,000 449 3,382,727 0.54
10,001 - 50,000 368 7,689,325 1.22
50,001 - 100,000 64 4,527,003 0.72
100,001 - 500,000 39 8,586,284 1.36
500,001 - 1,000,000 4 2,247,636 0.36
1,000,001 -
999,999,999,999 4 597,402,666 94.89
5,908 629,542,458 100.00
By category of
shareholder
No. of Members Group Total Percentage
Quantity
84 FOREIGN INVESTORS 592,927,171 94.18
5,304 **E.A.P.S. INDIVIDUALS 30,259,126 4.81
451 **E.A.P.S INSTITUTIONS 6,356,161 1.01
5,839 TOTALS 629,542,458 100.000
**East Africa Partner States
4.10 Responsibilities of Directors in financial statements
The directors of Total Kenya are mandated to ensure that financial statements are well,
fairly and accurately prepared in strict compliance with International Financial Reporting
Standards and inline with the Kenyan Companies Act.They are also responsible to
41
facilitate preparation of reports to support internal control in an accurate error-free
manner.
2015 2016
Notes KShs’000 KShs’000
ASSETS
NON-CURRENT ASSETS
12 8,358,986 8,168,038
Property, plant and
equipment
Prepaid operating leases 13 713,782 680,726
Goodwill 14 416,679 416,679
Intangible assets 15 88,002 61,858
Deferred tax asset 17 369,452 304,844
9,946,901 9,632,145
CURRENT ASSETS
18 14,953,214 13,794,942
Inventories
Trade and other receivables 19 8,128,992 6,861,165
Due from related
companies 20 (i) 1,942,885 2,151,599
Cash and cash equivalents 27 (ii) 4,979,505 499,174
30,004,596 23,306,880
Non-current assets
classified as held for sale 21 32,668 41,579
30,037,264 23,348,459
TOTAL ASSETS 39,984,165 32,980,604
EQUITY AND
LIABILITIES
EQUITY
22 9,974,771 9,974,771
Share capital
42
Share premium 23 1,967,520 1,967,520
Retained earnings 3,436,769 2,250,385
15,379,060 14,192,676
NON-CURRENT
LIABILITIES
25 1,117,028 854,765
Trade and other payables
CURRENTLIABILITIES
11 4,955 5,723
Unclaimed dividends
Tax payable 9 (iii) 510,394 132,829
Trade and other payables 25 7,833,432 6,312,448
Due to holding company 20 (iii) 12,612,844 7,023,485
Due to related companies 20 (ii) 31,822 298,024
Short term borrowings 26 2,494,630 4,160,654
23,488,077 17,933,163
TOTAL EQUITY AND
LIABILITIES 39,984,165 32,980,604
The financial statements were approved and authorized for issue by the Board of Directors on 2 April 2016
and were signed on its behalf by:
4.11 Discussion of Research Findings
The study further revealed that TBQ ratio as a financial performance measure suffers from
heteroskedasticity problem. The heteroskedasticity problem in this case did not arise as a
result of: wrong specification of the model, any intervention or an omission of a very
important variable but due to sub-population differences. For example, between 2008 and
2015 between 4 - 7petroleum firms in Kenya were listed translating to 20% to 25% of all
the petroleum firms that were in operation.TBQ ratio for unlisted firms were computed
from data drawn from annual financial reports; whereas TBQ ratio for listed petroleum
firms were computed from stock returns data available at the NSE. Based on the findings
of Bhagat and Black (2002) that there is no relationship between TBQ ratio and corporate
governance variables when data drawn from annual financial reports is used its
computation, whereas there is some relationship when stock return data from the stock
43
exchange is used. Heteroskedasticity became a problem when TBQ ratio was adopted as a
performance.
TBQ ratio was seen to have the highest standard deviation of 142.224% when adopted as a
financial performance indicator. The high standard deviation in TBQ ratio could be
attributed to the high levels of volatility experienced in the Kenyan petroleum firm sector
that ensued from both internal and external economic shocks that were evident during the
period of study. In the first instance, there were enormous bank failures in the 90‟s, that
were subsequently followed by the Asian financial crisis of late 90s, the post election
violence of 2007 and the world financial crisis 2007- 2008 that took a negative toll on the
financial performance of listed petroleum firms at the NSE.
Objective 1: block ownership and Financial Performance Listed Petroleum Firms at
NSE
The descriptive statistics results (Table 4.1) indicate that block holders in Kenyan
petroleum sector are diversified as indicated by the standard deviation of .21685. Implying
that, they may be holding diversified portfolios hence further reduction of risk may not be
in their interest. This leaves the management with the option of investing in very safe
instruments such as government securities that do not fetch very high returns and
extending loans to highly secure clients. This might have led to low levels of financial
performance in some of these listed petroleum firms at the NSE. These findings are in line
with those of Denis et al. (1997) that block holders widely hold diversified portfolios
hence further reduction of risk through diversification are not in their interest. This is
further supported by the findings of Bolton and Von Tadden, (1998) that high block
ownership limits diversification leading to reduction of tolerance towards risk by owners
of a firm that may negatively affect firm performance. In the Kenyan context, block
holders within the petroleum firms in most cases demand that they should be consulted
over a wide range of issues leading to delays in decision making processes that negatively
impact on financial performance. On examination of the trade-off between ownership
concentration and liquidity which may affect the informational role of the stock market
Holmstrom and Tirole (1990) andAdmatiet al. (1994) find that high ownership
concentration reduces the owners tolerance towards risk that negates on firms
performance.
44
Objective 2: institutional ownership and Financial Performance Listed Petroleum
Firms at NSE
Given that institutional investors have a duty to monitor the management and the position
they hold on various issues need to be taken seriously, the management of petroleum firms
are at times forced to cede to their demands regardless of whether they improve the
financial performance of these institutions. This is because the ability of institutional
shareholders to move in and out of the firm will not go without affecting the share price.
These findings are in line with those of Han and Suk, (1998) and Hirschman, (1970) that
due to the high ownership stakes and the amount of shares institutional investors can buy,
their movement into the firm increases the share price and their exit drastically reduces the
share price.
Institutional shareholders in firms can choose to adopt a passive behavior that makes them
only interested in short-term returns of their investments by taking advantages from stock
prices variations even if such fluctuations are temporary and have negative effect on the
long-term financial performance. These findings are supported by the descriptive statistics
results (Tables 4.1) which indicate that institutional ownership in Kenyan listed petroleum
firms is fairly spread (standard deviation of 16.402%). In view of this, they are able to
choose the kind of investments different firms in which they own shares should venture
into, hence restraining the ability of the firm’s management to participate in the same even
if they affect on firms financial performance negatively. In view of the above top
management turnover in Kenyan petroleum sector has been a matter of concern since the
financial performance of these listed petroleum have hampered by absence of memory on
some of the major decisions that were made. These findings are in line with those of Denis
and Denis (1995) that top management turnover is likely to be high in the presence of high
ownership by financial institutions.
Objective 3: Board Independence and Financial Performance of Listed Petroleum
Firms at NSE
Descriptive statistics results (Table: 4.1) indicate that the boards of directors of listed
petroleum firms at the NSE in Kenya are independent; where 67% of the board of
directors in these petroleum firms constitute of individuals who do not work for them.
These results demonstrated that listed petroleum firms in Kenya have adhered to the
corporate governance prudential guidelines of 2001 which stipulate that: independent
directors should constitute of 2/3 of the board size. The correlation analysis results (Table
45
4.3) indicate a negative correlation coefficient (r) -.075 between board independence and
Tobin’s q that is not significant at 5% level (.063). The regression coefficient is -.023 that
is also not significant at 5% level (.668).
These results indicate that although independent directors play a critical role in decision
making processes in petroleum firms in Kenya, there is no direct link between board
independence and performance of these listed petroleum firms when Tobin’s q is adopted
as a financial performance measure. This could be attributed to the fact that: board
independence in itself is affected by financial performance. Listed petroleum firms in
Kenya have been known to react to bad financial performance by adding outside directors
to the board an action that entails costs to the petroleum firms by way of fees, travel
expenses, stocks and stock options that tend to offset their effect on financial performance
in line with the findings of (Adams &Mehran, 2002). At the same time the degree of
independence in the board of these listed petroleum firms is unobservable since the choice
of individuals to join the firm’s board from outside is endogenous. This creates a missing
link between board independence and financial performance of these listed petroleum
firms in line with the findings of (Cole et al. 2008).
Objective 4: Board Size and Financial Performance of Listed Petroleum Firms at
NSE
Owing to the low financial performance levels posted by small petroleum firms in Kenya,
it can be argued that the larger boards in these petroleum firms play more of a symbolic
role rather than fulfilling their intended functions. Most of the boards are known to be
characterized by a diminished sense of individual responsibility and increased bureaucracy
that extends to the management team that may prevent meaningful dialogue needed to
foster financial performance. This scenario creates a conducive environment for the CEO
to control and manipulate the board making it provide the worst financial reporting
oversight that lowers financial performance. These is in line with the findings of Lipton
and Lorsch, (1992) that large boards prevent meaningful dialogue and that it is easier for
the CEO to control and manipulate large boards, Yoshikawa and Phan, (2003), find that
large boards are a creation of the CEO so as to entrench himself in the company and
Jensen (1993) finds that as board size increases, they become less effective at monitoring
the management because of free-riding problems amongst directors and increased
decision-making time hence leading to negative performance.
46
There are two main issues that complicate empirical work on boards of directors in
Kenyan listed petroleum firms as they relate to financial performance. In the first place,
both board size and listed petroleum firms at NSE financial performance are endogenous.
The financial performance is as a result of the actions of previous managers and itself; a
factor that influences the choice of subsequent directors. According to Hermalin and
Weisbach (2001) negative relationship between board size and financial performance
implies that petroleum firms should be encouraged to limit their board size so as to realize
positive results. We therefore fail to reject the null hypothesis that there is no significant
relationship between petroluem board size and financial performance of petroleum firms
in Kenya and reject the alternative hypothesis that there is a significant relationship
between board size and Tobin’s q and conclude that there is a relationship between board
size and financial performance of listed petroleum firms at the NSE in Kenya by the end
of August 2017.
47
CHAPTER FIVE
SUMMARY OF FINDINGS, CONCLUSIONS AND RECOMMENDATIONS
5.1 Introduction
The aim of this chapter was to avail a summary, make conclusions and recommend on
necessary measures to improve the identified qualitative and quantitative analysis
analyzed in chapter four. Results summary are critically correlated in regard to theoretical
and available empirical literature. The conclusion is premised on the specific objectives.
On the other hand study recommendations are deduced from the discussion and conclusion
of the findings. The chapter is arranged in three categories, namely; findings summary,
conclusion and study recommendations.
5.2 Summary of Findings
The study sought to find out the nexus between corporate governance and financial
performance of the listed petroleum firms at the NSE. A factor analysis was utilized in the
study to decrease the amount of constructs with regard to board independence to the few
that can significantly explain board independence issues in governance of listed petroleum
firms at the NSE. Corporate governance proxies include; board independence and board
size (internal corporate monitoring mechanisms) and block ownership and institutional
ownership (ownership governance mechanisms).
5.3 Conclusion
A number of critical issues have been revealed by empirical findings from the study in
relation to corporate governance practices among the listed petroleum firms at the NSE.
The study draws conclusion that Tobin’s q serves as the best measure of financial
performancein the study of corporate governance as it relates to financial performance
among the listed petroleum firms at the NSE. The findings are supported by Shleifer wand
Vishny, (1997) who explained shareholder wealth maximization objective of the various
firms listed and the meaning of corporate governance, that is the methods in which
suppliers of relevant corporations guarantee themselves of acquiring a fair return on their
investments.
The findings further reveal that TBQ ratio yields better results in the study of corporate
governance and financial performance when the focus is on listed petroleum firms at the
NSE. Otherwise it is bound to suffer from heteroskedasticity problem.The study concludes
that there is a negative and significant relationship between board size, institutional
ownership and block ownership with financial performance in terms of TBQand that there
48
is no relationship between board independence and financial performance oflisted
petroleum firms at the NSE. Therefore if petroleum firms are to improve their financial
performance they should direct their efforts towards other variables other than board
independence. At the same time, listed petroleum firms at the NSE in Kenya should
explore ways in which they should improve on board's effectiveness.
The results further point to the fact that petroleum firm size has a positive effect in the
relationship between corporate governance and financial performance of listed petroleum
firms at the NSE. Any time firm size has been introduced as a control variable the
explanatory power of the model has been seen to improve.The results further indicate that
listed petroleum firmsat the NSE have embraced corporate governance as per 2001, 2006
and 2013 prudential guidelines. This is confirmed by drastic decline in petroleum firm’s
failures and the fact that these firms have an average board size of 8 members which is
more than a minimum of 5 as prescribed by the prudential guidelines where ⅔ of these
board members are independent directors, though on overall the study finds that small
petroleum firms in Kenya have bigger boards.
5.4 Recommendations
Based on the findings of this study, the researcher presents two types of recommendations
namely: recommendations for areas of further research and recommendations for action.
5.4.1 Areas for further research
The study focused only on how certain sets of board characteristics impact on financial
performance among listed petroleum firms at the NSE. While the characteristics covered
were important, there are other diverse variables such managerial ownership, family
ownership, remuneration committee; board meeting, capital structure and disclosure that
could not be included hence should be considered in future studies.
Further studies should be undertaken with a view of understanding the history of
ownership patterns of petroleum firms in Kenya and the implication of these ownership
patterns for the design of corporate governance regulations so as to foster financial
performance of these petroleum firms.
5.4.2 Policy Recommendation
Based on the findings of this study, in order to improve the effectiveness of the board this
study recommends that the regulator should have a seat in the boards of listed petroleum
49
firms at NSE in Kenya. In view of the findings that listed petroleum firms in Kenya have
got relatively the same board size that impact on their financial performance negatively,
the study recommends that the board size of individual firms should be pegged on the
firm’s capital tier group whereby firms in the same capital tier have similar board size.
Institutional shareholders should engage in business with petroleumfirms in which they
own shares at an arm’s length and their activities monitored closely by the regulator.
50
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56
APPENDIX I WORK PLAN
Activity / Time Jun
2017
Jul
2017
Jul
2017
Aug
2017
Sept
2017
Nov
2017
Dec
2017
Developing draft proposal
Writing final Proposal
Preparation of instruments
Proposal defense
Pre-testing instruments and data
collection (fieldwork)
Editing and processing of data
Analysis of data
Report writing
Project Defense
Final report writing and submission
Graduation
57
APPENDIX II BUDGET
S/N ITEMS QUANTITY UNIT COST
(KSHS)
TOTAL COST
(KSHS)
1. Reams of Printing Papers 5 400 2,000
2. Proposal Typing and
Printing
50 50 2500
3. Note book 13 100 1300
4. Folder 10 100 1000
5. Flash disk 14 1500 6000
6. Pilot Survey 180,000 180,000
7. Principal Researcher 5 researchers 30000 each 150,000
8. Supervisors fee 3 supervisors 15000 each 45000
9. Developing and
photocopying of
questionnaires
400 copies 65 26000
10. Travelling, Accommodation
and literature search
1 person 80,000 80,000
11. Internet services 10,000 10,000
12. Project typesetting and
Printing
1000 pages 30 per page 30000
13. Photocopying 10 copies 300 per copy 3000
14. Binding 5 copies 100 per copy 1000
15. Research Consultancy 45000
58
16. Sub-total 583800
17. Contingencies 10% of total 58380
Grand total 525420
Source: Self Sponsored
APPENDIX III
APPENDIX I: PETROLEUM FIRMS LISTED AT NSE AS AT 18TH
AUGUST2017
BY SEGMENTATION
LISTED PETROLEUM FIRMS AT NSE
KenolKobil Ltd
Total Kenya Ltd
59
APPENDIX IV: DIRECTORS & PROFESSIONAL ADVISORS AT TOTAL
KENYA LIMITED
Jonathan
Molapo
(Non-executive) Chairman Appointed September
24, 2015
Jean Papee (Non-executive) Resigned September
24, 2015
Ada Eze (Executive)
(Alternate to
Jonathan Molapo
as
Managing Director Appointed August 27,
2015
Alexis Vovk (Executive) Resigned August 27,
2013
Patrick
Waechter
(Executive)
Alternate to Ada
Eze
Finance Director
Maurice
K’Anjejo
(Executive) (Alternate to
MomarNguer)
Daniel Mayieka (Non-executive) (Alternate to
AuroreDelarue)
Alice Mayaka (Non-executive)
Vincent
Guerard*
(Non-executive) Resigned August 27,
2016
AuroreDelarue (Non-executive) Appointed August 27,
2016
MomarNguer* (Non-executive)
Source: Company filings
60
APPENDIX V: KENOLKOBIL BOARD AND MANAGEMENT STRUCTURE
KenolKobil board is led by the Chairman and Group Managing Director Jacob I Segman.
Under the new statutory requirements by the Capital Markets Authority (CMA), Jacob
Segman will be stripped of chairmanship but will remain CEO of KenolKobil and a
director at the company. Under Mr. Segman’s watch are various country management
teams. Kenya, which is the group’s largest operation, is run by a management team led by
Mr. David S Ohana.
Directors
Chairman/Group managing director Jacob I Segman
Non-Executive P.N. Jakobsson
Non-Executive T.M. Davidson
Non-Executive D. Ndonye
Non-Executive J. Mathenge
Non-Executive D. Oyatsi
Finance Director Pat Lai
Company Secretary W Juma
Source: Company filings