The Effects of Corporate Governance Practices on Financial

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


Signature: ………………………… Date……........…………

Dr. MirieMwangi

Chairman,

Department of Finance and Accounting


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

iv

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

1

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).

2

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).

3

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

4

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.

5

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.

6

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

7

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,

8

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

9

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


iv. To identify the relationship between board sizeson financial performance among


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.

10

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).

11

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

12

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%


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%


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


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


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%


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)


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


Documents

The Effects of Corporate Governance Practices on Financial