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The Impact of Corporate Governance on the

Profitability of Nepalese Enterprise


Aayush Nepal, Ambu Gyawali, Anita K. Luitel, Barsha Shrestha & Bidur Koirala
_____________________________________________________________________________________
Abstract
This study examines the impact of corporate governance on the profitability of Nepalese enterprises. The
data has been collected from annual reports of various companies for the period of three year ranging of
2012/13 to 2014/15. The profitability has been taken as dependent variable and board size, audit
committee members, board meetings, non executive directors & directors remunerations as independent
variables.
The result shows that audit committee and non executive directors has significant and positive impact on
profitability. Board meetings, board size, non executive directors & directors remuneration also have
positive impact on profitability but the results are not statistically significant.
Keywords: Corporate governance, profitability, board size, non executive directors, directors
remuneration, board meetings, audit committee members
_____________________________________________________________________________________
INTRODUCTION
Corporate governance is the set of processes, customs, policies, laws and institutions, affecting the way a
company is directed, administered or controlled. Corporate governance is a system of structuring,
operating, and controlling a company with a view to achieve long-term strategic goals to satisfy its
shareholders, creditors, employees, customers and suppliers (Das, 2009). Corporate governance plays an
important role for improvement of profitability. The improvement of firms profit is essential to attain
overall corporate objectives (Gill & Mathur, 2011).
Strong corporate governance is necessary for the all the business organizations because it plays an
important role in the management of organizations in both developed and developing countries.
Developed countries differ from developing countries in many ways (Achchuthan & Kajananthan, 2013).
For developing countries like Nepal, good corporate governance is an essential tool for globalization of
business organizations. Good corporate governance consists of transparency principle, accountability
principle, responsibility principle, independence principle and fairness principle which have direct effect
on corporate performance (Sri Kurniasih & B., 2013)
Properly applied corporate governance principles in the organization may increase the profitability and
returns improve its competitiveness, credibility and improve relations with key stakeholders such as
investors, business partners, employees, customers, etc. Todorovi (2013) investigated the effect of
corporate governance on the performance of Indian Banks and found that board of the directors has play

significant role in firm performance but the board meetings negatively impact on the financial
performance.
Good corporate governance does not only enhance the profitability but also increases firm performance.
By enhancing the overall performance of companies and increasing their access to outside capital, good
corporate governance contributes toward economic stability that reduces the vulnerability of the financial
crises. It reduces cost of capital and transaction cost. Corporate governance concerns with the relationship
among management, board of directors, controlling shareholders, monitoring shareholders and other
stakeholders (B.Latif, Shahid, Haq, Waqas, & Arahad, 2013).Poor corporate structure results indiscipline,
both on the part of management and workers. Poorly governed corporations not only pose a risk to
themselves, but they also cause barrier to others and could indeed pull down capital market. For instance,
the poor governance of a systematically important firm would pose a threat to the economy. Irrespective
of how sound macroeconomic policies are, if entities are not well governed, the macro-economic
objectives may not be attained (Ganiyu & Abiodun, 2012). Thus, corporate governance is important for
all types of business entities.
In context of Nepal, (Rawal, 2003) identified protection of shareholders rights, clarity in duties and
responsibilities of all stakeholders involved, disclosure and transparency, legal frameworks that
sufficiently address good governance mechanism are all important to ensure a healthy growth of financial
sector. Also, governance has been the topic of much recent academic work and policy discussion
(Khatiwada, 2002), (Rawal, 2003), (Kafle, 2004).
The purpose of this study is to investigate the impact of corporate governance in profitability of Nepalese
enterprise. The study includes both financial and non financial institutions of Nepal.
The remainder of this study is organized as follows: section two describes the samples, data and
methodology. Section three presents the empirical results and final section draws the conclusions and
discusses the implication of study findings.
Methodological aspects
The study is based on secondary sources of data which were gathered for 30 enterprises of Nepal. The
main sources of data were annual reports of the respective enterprises, NRB supervision report and
websites of the enterprises. The data were collected for profitability, board meeting, non executive
directors, board size, audit committee members and directors remuneration. Table 1 presents the list of
sample enterprise along with study period and number of observations.
Table1: List of enterprise along with study period and number of observations
S.No.
1
2
3
4
5
6

Name of the enterprise


Nepal Telecom Limited
Surya Tobacco Company Limited
Surya Life Insurance Company Limited
Himalayan Distillery Company Limited
American Life Insurance Company Nepal
Siddartha Life Insurance Company Limited

Study period

Observation

2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15

3
3
3
3
3
3

7
Security Board of Nepal
8
Neco Insurance Company Limited
9
Butwal Power Company Limited
10
Hydroelectricity Investment & Development Company
11
Chilime Hydropower Company Limited
12
Nepal Life Insurance Company Limited
13
Arun Valley Hdropower Development Company
14
Guras Life Insurance Company Limited
15
Sagarmatha Insurance Company Limited
16
Nepal Investment Bank
17
Bank of Kathmandu
18
Global IME Bank
19
Sunrise Bank
20
Nepal SBI Bank
21
Everest Bank
22
Machhapuchhera Bank
23
NMB Bank
24
NABIL Bank
25
Laxmi Bank
26
Agriculture Development Bank
27
Citizen Bank
28
Nepal standard and charter Bank
29
Nepal Bank Limited
30
Siddartha Bank
Total observations

2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15
2012/13 - 2014/15

3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
90

Thus, the study is based on 90 observations.


The Model
The model used in this study is, PATit = it+1BSit+2ACMit+ 3DRit+ 4NEDit+ 5BMit+it. Where,
PATit represents the profitability of firm i at time t. BSit, ACMit, DRit, NEDit and BMit represents
corporate governance variables of firm i at time t . it and it stand for the intercept and error term
respectively. 1 to 5 are the slope of the coefficients which influence the dependent and independent
variables.
Board of Directors
Board of directors may have a difficulty communicating with each other in a large size board, which
causes great detriment to firm performance. Yermack (1996), Eisenberg, Sundgren, & Wells (1998) prove
that the board size has a negative relation with firm performance. Based on it, the study develops
following hypotheses:

H1: There is significantly positive association between board size and profitability.
Number of Board Meetings
It is assumed that regular board meetings have a positive impact on bank performance. If board meetings
are held frequently, more discussions will be held on problems and prospects of business and business can
be expected to run more efficiently. Based on it, the study develops the following hypotheses:
H2: There is significantly positive association between board meetings and profitability.
Board Independence
Empirical evidence suggests more active and independent directors make better monitors. As for the
relation between board independence and form performance, if outside directors are independent and have
professional ability, they could be more objective to make decisions and monitor managers. Weisbach
(1988) and Huson, Parrino, & Starks (2001) corroborate that the higher ratio of independent directors
accounts for boards, the better the firm performance of the banks. It also means that if the board contains
more of executive directors, who lacks professional ability and could not make objective decisions and
monitor managers. Based on it, the study develops the following hypotheses:
H3: There is significantly positive association between non executive directors and profitability.
Audit Committee
In literature, some authors reported negative correlation between independence of audit committee and
earning management (Klein, 1998). Some researcher found that audit committee has positive and
significant impact on performance of the firm (Klein, 1998). According to some researchers it was found
that cost of debt financing can be lowered if there is entirely independent audit committee (Anderson,
Mansi, & Reeb, 2004). In some researches it was found that audit committee has positive and significant
impact on profit margin and return on equity of the firm (Yasser, Entebang, & Mansor, 2011). Based on
it, the study develops the following hypotheses:
H4: There is significantly positive association between audit committee members and profitability.
Directors Remuneration
Director remuneration has become one of the prominent topics in contemporary corporate governance due
to its controversial nature (Kabir, 2008). Based on it, the study develops the following hypotheses:

H5: There is significantly positive association between directors remuneration and profitability.
3. Presentation and analysis of data
Descriptive statistics
The number of board size ranges from 4 to 11, leading to the average of 7.6 persons. Likewise, the
number of audit committee member ranges from 3 to 5 persons, the number of non executive directors
ranges from 1 to 4. The average audit committee has been observed to 3.34 persons while the average non
executive director is 1.76 persons. The number of board meeting in a year ranges from 7 to 67 times,

leading to the average of 22.05 times in a year. Similarly, the amount of directors remuneration ranges
from Rs. 134000 to Rs. 448000. The average directors remuneration is Rs.964920. And the average
profitability is observed to be Rs. 1.1678 billion.
Table 1: Descriptive Statistics for the selected variables

BS
ACM
BM
NED
DR
PAT

N
90
90
90
90
90
90

Minimum
4
3
7
1
134000
4510000

Maximum
11
5
67
4
4480000
15200000000

Mean
7.6
3.3444
22.0556
1.7667
964920
1167800000

Std. Deviation
1.53462
0.65619
9.75009
0.76511
735139
2738720000

Correlation analysis
Having indicated the descriptive analysis Pearson correlations analysis is computed and results are
presented in table 2. Board size (BS), number of board meeting in a year (BM), non executive director
(NED) and directors remuneration (DR) are positively related with profitability. This indicates that
increase in board meeting, non executive directors and directors remuneration leads to decrease the
profitability of the Nepalese enterprise. Audit committee member (ACM) is positively related with
profitability of Nepalese enterprise indicating that increase in member of audit committee leads to
increase the profitability.
Table 2: Computation of Pearsons correlation coefficients among the selected variables
BS
1

ACM

ACM

0.138
0.193

BM

.213*
0.044

0.008
0.944

NED

-0.071
0.507

0.028
0.796

.347**
0.001

DR

0.088
0.407

.386**
0

0.068
0.524

0.046
0.665

PAT

0.145
0.171

.540**
0

0.051
0.633

0.19
0.072

0.047
0.661

BS

BM

NED

DR

PAT

*. Correlation is significant at the 0.01 level (2 tailed)


**. Correlation is significant at the 0.05 level (2 tailed)
Regression analysis
The regression of corporate governance variable on firm profitability has been analyzed by defining firm
profitability in term of net profit. The regression of corporate governance variable on profitability
produced the result as indicated in table 3. The table indicates that beta coefficient is positive for all
variables. The beta coefficient for board size is positive which shows that larger the board size of the
company, higher would be the profitability. Similarly, beta coefficient for audit committee member is
positive and statically significant. The result hence indicates that increase in member of audit committee,
leads to increase the profitability. Beta coefficient for non executive directors is positive and statically
significant at 5% level of significance. Hence, larger the number of non executive directors in the board
higher would be the profitability. The beta coefficient off board meeting and directors remuneration is
positive but not significant.
Table 3: Regression of corporate governance variables on profitability of Nepalese enterprises
The results are based on data of 30 Nepalese enterprises with 90 observations for the period of 2012/13 to
2014/15 by using linear regression model. The model is: PATit = it+1BSit+2ACMit+ 3DRit+ 4NEDit+
5BMit+it.

Model

Intercept

Regression Coefficient of Profitability

BS
ACM
BM
NED
DR
-8.05
2.596
-0.552
1.379
-6.374
2.255
2
-4.997***
6.024***
8.52
1.432
3
1.183
0.479
-3.568
6.812
4
-0.5
1.818*
9.993
174.581
5
2.081**
0.44
-7.213
1.286
2.213
6
-4.350***
0.794
5.843***
-7.332
1.159
2.217
9.321
7
-4.315***
0.695
5.820*** 0.359
-8.409
1.715
2.178
7.058
8
-4.810***
1.034
5.819***
2.057**
-8.916
1.806
2.497
7.195
9
-5.154
1.111***
6.298
2.139**
Note: * and ** shows that the levels of significance 1% and 5% respectively.
1

Adj. R2

SEE

0.01

2.724

1.902

0.284

2.318

36.283

0.009

2.7506

0.229

0.025

2.7039

3.307

0.009

2.7512

0.194

0.281

2.322

18.38

0.274

2.3341

12.174

0.300

2.2915

10.531

0.328

2.2458

9.67

VI. SUMMARY AND CONCLUSION


In recent years, several companies in the USA and elsewhere collapsed because of corporate governance
problem. The objective behind corporate governance is to safeguard the interest of shareholders. Many
companies have failed because of increasing corporate lootings. There is a doubt whether existing
regulatory framework is to educate to deal with corporate fraud. Thus, in recent years, corporate
governance assumed a great significance and Nepal is no exception Nepal is a developing country and
corporate governance concept is more important in developing country because they face more
competition in Globalization of business.
Corporate governance is nothing but a system by which companies are directed and controlled. Corporate
governance is the way in which suppliers of finance to corporation ensures themselves of getting a return
on their investment. Corporate governance is concerned with the way and means by which the
government of company (the directors) is made responsible to its elector (the shareholders).
The aim of this study is to evaluate that corporate governance impact on the profitability in Nepalese
enterprise. It determines the effect of board size, audit committee member, non executive directors,
directors remuneration and number of board meeting in a year on profitability of enterprise. This result is
based secondary data of 30 Nepalese companies for the period 2012/13 to 2014/15.
The study revealed that average profit of Nepalese enterprise is 1.1678 billion. Likewise, the average of
board meeting is 22 times during a year. The member of audit committee is observed as 3 people on an
average. The average number of non executive directors is 1. The average remuneration of board of
directors is Rs.964920.
The findings reveal that there is positive correlation of board size, non executive directors, directors
remuneration and board meeting with profitability. Likewise, audit committee member is positively
related with profitability. Hence, larger will be the member of audit committee, higher would be the
profit.
The regression result shows positive and significant relationship between audit committee member and
participation of non executive directors in the board. Hence, larger the number of non executive directors
in the board higher would be profitability of Nepalese enterprise.

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