EFFECT OF AGENCY COSTS ON FINANCIAL PERFORMANCE OF LISTED

COMPANIES IN NIGERIA
BY
Awuhe1, P. O., Prof. Tsegba2, I. N. & Dr. Duenya3, M. I.
1&2
Department of Accounting and Finance, College of Management Sciences,
Joseph Sarwuan Tarka University (Formerly University of Agriculture) Makurdi,
Benue State- Nigeria.
3
Department of Accounting, Federal Polytechnic, Wannune,
Benue State- Nigeria.

ABSTRACT
This study investigated the effect of agency costs on financial performance of listed
companies on the Nigerian Exchange Group. Specifically, the study examined the effect of
monitoring cost, bonding cost, and residual loss on financial performance of listed financial
and non-financial companies in Nigeria. The study adopted the ex-post facto research
design. The study used a sample of 20 companies (ten each from the financial and non-
financial sectors) from a population of 111 companies consistently listed on the Nigerian
Exchange Group for ten years (2011-2020) using the filtering and random method. Data
were sourced from annual reports of the sampled companies and Machameratios. Panel
regression estimate was used for data analysis. Based on the recommendation of the
Hausman Specification test and Breusch-Pagan Lagrangian multiplier test for random
effects, the random effect model was adopted for the financial sector. Similarly, the fixed
effect model was adopted for the non-financial sector based on the recommendation of the
Hausman Specification test and Wald test. The results of the study suggested that significant
difference exist in the effect of agency costs on financial performance of listed financial and
non-financial companies in Nigeria. The result of the study also established that while
monitoring cost and residual loss exert a significant positive effect on financial performance
of companies in the financial sector, bonding cost on the other hand exert a significant
positive effect on financial performance of companies in the non-financial sector. The study,
therefore, recommended that since the findings of this study have provided evidence that
monitoring cost and residual loss exert significant effect on financial performance in the
financial sector, companies in this sector should prioritize agency cost in the form of
monitoring cost and residual loss as they exert an influence on financial performance in the
sector. The study also recommended that companies in the non-financial sector should
prioritize agency cost in the form of bonding cost as it exerts an influence on financial
performance in the sector.

Key Words: Agency Costs, Monitoring Costs, Bonding Costs, Residual Loss, Financial
Performance, Listed Companies, Nigeria.

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1.0INTRODUCTION

After the start of the industrial revolution in the nineteenth century and the development of
joint stock corporations, there were many investors that had no direct role or involvement in
the management of their organizations. However, their only involvement was through the
selection of the board of directors (BoD) that was saddled with an oversight function of the
business units. The day-to-day management of the joint stock companies was entrusted into
the hands of the management team that was separated from the owners. This gave birth to the
principal (owner)-agent (management) relationship.

Jensen and Meckling (1976) have conjectured that the agency relationship is a contract under
which one or more persons (the principal(s)) engage another person (the agent) to perform
some service on their behalf which involves delegating some decision-making authority to
the agent. As asserted by Jensen and Meckling (1976), if both parties to the relationship are
utility maximizers, there is a good reason to believe that the agent will not always act in the
best interests of the principal. The principal can limit divergences from his interest by
establishing appropriate incentives for the agent and by incurring monitoring costs designed
to limit the aberrant activities of the agent. In addition, it will pay the agent to expend
resources (bonding costs) to guarantee that he will not take certain actions which would harm
the principal or to ensure that the principal will be compensated if he does take such actions.
However, it is generally impossible for the principal or the agent at zero cost to ensure that
the agent will make optimal decisions from the principal’s viewpoint.

Since the relationship between the stockholders and managers of a corporation fit the
definition of a pure agency relationship, it is obvious that the issues associated with the
separation of ownership and control in the modern diffuse ownership corporation are
intimately associated with the general problem of agency. In a nut shell, agency costs result
when the principal uses a combination of incentives, punishment, bonding and managerial
processes to monitor the actions of their agents; so as to minimize the chances that the agents
will pursue their own interest rather than those of the principal (Chrisman, Chua & Litz,
2004).

Extant literature has provided evidence that agency costs have a potential to influence firm
performance; thus, can be regarded to be a determinant of firms’ financial performance other
than the generally referred to firm-specific attributes in the literature. Therefore, the
divergence of interests between managers and shareholders and associated agency costs are
assumed to be detrimental to the firm leading to lower financial performance (Gürbüz, Aybar
& Yeşilyurt, 2016).

The theoretical perspective has also provided relationship between agency costs and financial
performance. According to agency theory, without the incurrence of agency costs, agents
who are not owners and, therefore, neither bear the full costs nor reap the full benefits of their
actions would not act in the best interest of the principals. They would be less committed,
repetitively shirk and engage in the consumption of perks (Ross, 1973; Jensen & Meckling,

2
1976). The resultant effect would be poor long term financial performance. Similarly, the
processes, systems, structures and resources expended by the principals in order to monitor
and align their interest with those of the agent result in expenses which lower the net income
of the firm. The view of the agency theory is however, criticized by the stewardship theory by
providing an argument that managers as agents are good stewards and will always act in the
best interest of the organization even without been monitored. Therefore, monitoring costs
are irrelevant and will only lower the financial performance of the organization. The
transaction cost theory further, concords with the agency theory but from a different view
where the theory postulates that managers, as agents, if not well supervised and monitored
will pursue their individual interest which may be at the expense of the financial performance
of the firm.

This study, therefore, seeks to examine the effect of agency costs on financial performance of
listed firms on both financial and non-financial sectors of the Nigerian Exchange Group. This
study is motivated by the dearth of assessment and comparative studies on the effect of
agency costs on financial performance of listed firms in the financial and non-financial
sectors of the Nigerian Exchange Group. The study is also motivated by the paucity of studies
on the choice of the three categories of agency costs measurement posited by Jensen and
Meckling (1976) in the agency theory, namely, monitoring costs, bonding costs and residual
loss.

The specific objectives of the study are categorized into three group. The first group
(Objectives 1-3) seeks to examine the effect of monitoring cost, bonding, costs, and residual
loss on the financial performance of listed financial companies in Nigeria. The second group
(Objectives 4-6) seeks to ascertain the effect of monitoring cost, bonding, costs, and residual
loss on the financial performance of listed non-financial companies in Nigeria. The third
group (Objectives 7-9) seeks to find out whether significant differences exist on the effect of
monitoring cost, bonding, costs, and residual loss on the financial performance of listed
financial and non-financial companies in Nigeria. These objectives are presented below.

i. Examine the effect of monitoring costs on financial performance of listed financial

companies in Nigeria.

ii. Examine the effect of bonding costs on financial performance of listed financial
companies in Nigeria.

iii. Examine the effect of residual loss on financial performance of listed financial
companies in Nigeria.

iv. Examine the effect of monitoring costs on financial performance of listed non-financial
companies in Nigeria.

v. Examine the effect of bonding costs on financial performance of listed non-financial

companies in Nigeria.

vi. Examine the effect of residual loss on financial performance of listed non-financial
companies in Nigeria.

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vii. To ascertain whether significant difference exists in the effect of monitoring costs on
financial performance of listed companies on the financial and non-financial sectors of
the Nigerian Exchange Group.

viii. To ascertain whether significant difference exists in the effect of bonding costs on
financial performance of listed companies on the financial and non-financial sectors of
the Nigerian Exchange Group.

ix. To ascertain whether significant difference exists in the effect of residual loss on
financial performance of listed companies on the financial and non-financial sectors of
the Nigerian Exchange Group.

The paper is organized into five sections including this introduction as section one. A review
of the conceptual, theoretical and empirical literature is carried out in section two. The
hypotheses tested in this study are also presented in this section. The methodology used in the
paper is presented in section three, while section four presents the results and discussions.
Section five concludes the paper with a summary, conclusions, and recommendations.

2.0 LITERATURE REVIEW

2.2 Conceptual Framework

This section presents the relevant concepts to the phenomenon of interest in order to give an
insight into the study. These concepts include; agency costs and financial performance.

2.1.1 Agency costs

Jensen and Meckling (1976) defined agency costs as the sum of: (i) the monitoring
expenditures by the principal; (ii) the bonding expenditures by the agent; and (iii) the residual
loss.

Jensen and Meckling (1976) and Bortych (2017) argued that it is expected in the agency
relationship that the agent will not always act in the best interest of the principal. In order to
limit the agent’s divergences from the principal’s interest, the principal puts checks and
balances which are referred to as monitoring costs (Bortych, 2017). Some of the monitoring
costs include, staffing costs, budget control costs, auditing costs, compensation costs (cash &
equity), additional layers of management costs, directorship costs, indenture costs and
contract enforcement costs among others.

The bonding costs are costs incurred that are beyond the perking remuneration of the agents
with the aim of discouraging the agents from acting in his own best interest rather than that of
the principal or organization. Such costs include, advertising expenditures, license fees, asset
utilization costs, managerial ownership, travel and vehicle expenses, maintenance and repair
costs, attorney fees and legal fees, utilities, such as telephone.

As articulated by Abdulrahman (2014), residual loss as a category of agency costs are the
losses incurred by the organization after incurring both monitoring and bonding costs to align

4
the interest of the agent with that of the principal. Costs such as expanded workforce, high
debt ratio, wasteful expenses, higher interest expense, higher equity costs, represent cases of
residual costs. Agency costs’ main function is the mitigation on the impacts of agency
problems.

2.1.2 Financial performance

Financial performance is a subjective measure of how well an organization uses its assets
from its primary mode of business to generate revenues. The term is also used as a general
measure of a firm's overall financial health over a given period. Analysts and investors use
financial performance to compare similar firms across the same industry or to compare
industries or sectors in aggregate. Similarly, Kyazze, Nsereko and Nkote (2020) opined that
financial performance is a practice of measuring effectiveness and efficiency of an action.
The commonly used measures of financial performance in extant literature include, but not
limited to, Return on Assets (ROA), Return on Equity (ROE), Net Profit Margin (NPM),
Earnings before Interest and Taxes (EBIT), Return on Investment (ROI), and Return on
Capital Employed (ROCE).

2.2 Theoretical Framework

This sub-section outlines the agency theory, free cash flow theory, and transaction costs
theory.

2.2.1 Agency theory

Agency theory was advanced by Jensen and Mecklings (1976). The theory explains the
contractual relationship between the principal and agent where the principal contracts the
agent to act on his behalf (Eisenhardt, 1989). Jensen and Meckling (1976) asserted that where
the principal and the agent are both utility maximizers, the most probable occurrence is that
the agent will not always act in the best interests of the principal. If both parties had the same
interests, there would be no conflict of interests and no agency problem (Jensen & Meckling,
1976).

Nur (2014) posited that there is a high probability of conflict of interest between the principal
and agent because the agent may not always seek to maximize shareholders wealth because
of separation of ownership and control in a modern corporation. Smith (1976) explained the
agency conflict as when professionals are employed to manage the businesses of other people
and would not put as much effort in the management of such companies as the actual owners
would; but would instead, be less keen, negligent and profuse.

Two broad ways in which agency conflicts can be mitigated have been identified in the
literature. First, the principal monitoring agent’s behaviour to ensure that the agent actually
behaves as stipulated in the contract and comparing actual performance of the agent as
measured by the outcome relative to expectations (metering). The principal cannot monitor
the agent’s behaviour or meter his performance without the incurrence of costs which gives
rise to agency costs (Sharma et al, 2001). As articulated by Wanyonyi (2018), Khalid and

5
Rehman (2014), posits that monitoring or metering the actions of agents include but not
limited to the appointment of independent directors, engagement of auditors.

The second way is by allowing managers have a stake in the firm they manage. The agency
theory argued that agency costs may be reduced if insiders (managers, directors, and other
executive officers) increase their ownership in the firm, because this can help to align the
interests of both managers and shareholders (Jensen & Meckling, 1976). According to the
agency theory, managerial ownership is a bonding mechanism which aligns the interest of
managers with those of the principal thereby, maximizing performance.

2.1.2 Free cash flow theory

Jensen (1986) developed the free cash flow hypothesis. Free cash flow is defined by Jensen
(1986) as the cash flow in excess of the cash that is needed to invest in all positive NPV
projects. The free cash flow hypothesis assumes that managers with access to free cash will
invest it in negative NPV projects instead of paying it out to shareholders as dividends. The
free cash flow theory posits that high free cash flow increases assets dis-utilization and may
demonstrate below optimal level performance.

Free cash flow may result in an increase or a decrease in firm performance/value depending
on its utilization (McCabe & Yook, 1997). Effective assets utilization would increase the firm
performance/value, whereas ineffective assets utilization would decrease the firm value.

The free cash flow theory is related to this study in the sense that the theory regards the free
cash flow as a category of agency costs (residual loss) which if not properly managed, will
result to assets dis-utilization which will affect financial performance.

2.1.3 Transaction cost theory

The transaction cost concept was formally proposed by Ronald Coase in 1937 to explain the
existence of firms. He theorized that transactions via market mechanisms incur cost,
particularly the costs of searching for exchange partners and making and enforcing contracts.
According to the theory, managers are seen as opportunists who arrange firms’ transactions in
their own interests (Williamson, 1979).

The theory suggests that each type of transaction produces coordination costs of monitoring,
controlling, and managing transactions.

The implication of this theory is that if transactions of managers as agents are not supervised
or monitored, the managers may prefer to pursue their own interest or venture into projects
which may not necessarily result to improved financial performance of the organization.
Thus, according to this theory, agency costs are necessary to align manager’s interests with
that of the principal which is aimed at improving firm’s financial performance.

2.3 Empirical Review

Alkurdi, Hamad, Tneibat and Almarzouky (2021) examined the impact of ownership
structure and agency cost on firm performance in Jordan. The study population comprised of

6
all 180 Jordanian companies and the study sample was 61 Jordanian first market firms listed
on the Amman Stock Exchange for 7 years from 2012 to 2018. The study measured agency
costs using bonding cost (managerial ownership). The study employed the fixed effect
regression model for analysis. The result of the study found that bonding costs have
significant negative effect on financial Performance. Okewale et al. (2020) examined the
relationship between agency cost and firm performance on 18 food and beverage quoted
firms on the Nigerian Exchange Group for a period of 9 years (2010-2018). The study
measured agency costs using bonding costs (managerial ownership). Data collected were
analyzed using fixed effect regression model with the aid of STATA 10. The result of the
study showed that bonding costs have insignificant positive effect on financial performance.

Hermuningsih, Kusuma, Fasa and Panjaitan (2020) examined the relationship between
agency cost and performance of firms registered on the Indonesia Ordinary Interchange. The
study sample comprised of 14 listed companies from the food and beverages buyer sub-sector
for a period of 5 years from 2014-2018. The study measured agency costs using bonding cost
(managerial ownership). The study employed the multiple linear regression and moderated
regression analysis. The result of the study found that bonding costs have significant positive
effect on financial Performance. Ahmed et al. (2020) examined the relationship between
agency cost and firm performance. Data for the study were generated from annual reports and
accounts of 19 insurance companies out of a population of 28 listed Insurance companies on
the Nigerian Exchange Group from year 2012 to 2017. Data were analyzed using panel
regression model. The results of the study showed that monitoring costs are positively and
significantly related to financial performance.

Serem et al. (2020) conducted a study on the effect of agency costs on financial performance
of Deposit Taking SACCOS in North RIFT, Kenya. The study measured agency costs using
monitoring costs (audit fees). The study used primary data from a population of 266 staff of
all the 16 registered Deposit-Taking SACCOs in North Rift Region, Kenya. The study
sample was 48 respondents comprising of chief executive officers, finance officers and
internal auditors of the Deposit-Taking SACCOs selected using purposive sampling method.
The study employed the simple linear regression as analytical technique and the results
revealed that monitoring costs (audit fees) have significant positive influence on financial
performance of Deposit-Taking SACCOs in North Rift Region in Kenya. Nuhu et al. (2020)
examined the impact of agency costs on financial performance of listed consumer goods
companies in Nigeria. The study employed the ex-post facto and descriptive research design
and the study period covered ten years from year 2007-2016. The study proxied agency costs
using residual loss. The study employed the Pearwise correlation and Panel regression
technique of data analysis. Findings of the study revealed that residual loss have significant
negative effect on firm’s financial performance.

Abughniem et al. (2020) conducted a study to examine the effect of agency costs on financial
performance of listed firms on the Amman Stock Exchange (ASE). The sample of the study
included 100 listed firms from all sectors in the Jordanian stock market over six (6) years
period from 2010-2015. The study measured agency costs using residual loss (free cash
flow). The study employed the pooled OLS technique for statistical analysis and the results

7
indicated that residual loss (free cash flow) has significant negative effect on financial
performance. Agbogun and Taiwo (2020) examined the relationship between agency cost and
performance. The study population was 65 companies while the sample size comprised of 20
quoted companies from the manufacturing sector of the Nigerian Stock Exchange for a period
of 15 years from 2004-2018. The study employed panel least square multiple regression for
analysis. The study measured agency costs using residual loss, while performance was
measured profitability. Findings of the study showed that residual have positive but
statistically insignificant relationship with the financial performance of manufacturing firms
in Nigeria.

Kithandi (2020) analyzed the effect of agency costs on financial performance of petroleum
and energy sector firms listed on the Nairobi Stock Exchange. The study used data for five
(5) petroleum and energy sector firms listed on the Nairobi Stock Exchange as at 2015. In
order to draw conclusion, the study employed the multiple regression analysis and the
findings indicated that there is a negative relationship between residual loss and financial
performance of petroleum and energy sector firms listed in the Nairobi Stock Exchange.
Kenn-Ndubuisi and Nweke (2019) examined the relationship between agency cost and firm
financial performance in Nigeria using 80 non-financial firms quoted on the Nigerian Stock
Exchange from 2000 to 2015. The study proxied agency costs using residual loss (financial
leverage). Panel data technique in the form of the pooled regression model, fixed effect
model, random effect model, and the marginal model were employed to test hypotheses. The
result of the study revealed that financial performance (earnings per share) is significant and
negatively related to residual loss while financial performance (return on equity) showed an
insignificant negative relationship with the residual loss.

Herdinata (2019) examined the relationship between agency cost and performance. The study
was conducted on a sample of 130 companies in Indonesia for a period of 16 years from year
2001 to 2016. Data for the study was sourced from Indonesian Capital Market Directory and
Indonesian Securities Market Database. The study measured agency costs using residual loss.
The study employed simultaneous equation model with Three-Stage Least Square technique.
The results showed that residual loss have positive and significant effect on company
financial performance. Akinleye and Dadepo (2019) examined the relationship between
agency cost and performance. The study used secondary data where the data were collected
from annual reports and accounts of 10 selected companies out of a population of 44 quoted
companies from the manufacturing sector of the Nigerian Exchange Group for a period of
five years spanning from 2012 to 2016. The study measured agency costs using residual loss.
The random effect technique was adopted for the study. Findings of the study showed that
residual loss have positive and significant effect on financial performance.

Ndeto (2019) investigated the effect of monitoring costs, bonding costs and residual loss on
financial performance of microfinance institutions in Machakos County in, Kenya. The study
employed the linear regression model for analysis and found a significant negative effect of
monitoring costs on financial performance. Also established was that bonding costs have
significant negative effect on financial performance. The study equally established a
significant positive effect of residual loss on financial performance. Hoang, Tuan, Nha, Long

8
and Phuong (2019) conducted a study to examine the effect of agency costs on financial
performance of Vietnamese listed companies. The study sample included 736 companies in
Vietnam during the period of 5 years from 2010 to 2015. Agency costs was measured in the
study using bonding costs and residual loss. The study employed the fixed effect regression
model for statistical analysis and the result indicated that bonding costs and residual loss have
negative and insignificant effect on financial performance.

Wanyonyi (2018) examined the impact of agency costs on financial performance of

commercial banks in Kenya. An agency cost was measured with monitoring costs (directors
remuneration and audit cost) while financial performance was measured with profitability.
The study population was 42 licensed Deposit Money Banks (DMBs) as at 2017 operating in
Kenya, while 26 DMBs constituted the sample size of the study. Data were sourced for 5
years between 2013 to 2017. The study adopted the exploratory research design and
employed Durbin Watson test, multicollinearity test, and multiple regression technique as
statistical tools. The study found that monitoring costs have significant positive effect on
financial performance. The implication of this is that high agency cost leads to higher
financial performance. John-Akamelu, Iyidiobi and Ezejiofor (2017) studied the effect of
agency costs on the financial performance of food production firms in Nigeria for a period of
6 years from 2009 to 2014.Agency costs was measured using residual loss (financial
leverage). The study adopted the ex post facto research design and used data for six (6) food
manufacturing companies listed in Nigeria. The paired sample t-test analysis was employed
as analytical technique and the results showed that residual loss have significant positive
effect on the financial performance of food production firms in Nigeria.

Akani and Kenn-Ndubuisi (2017) examined the effect of agency costs and board structure on
firm performance in Nigeria. The study employed secondary data from forty (40) listed
companies on the Nigerian Stock Exchange (NSE) for a period of 9 years from 2008 to 2016.
The study employed the pooled OLS, unit root test, granger causality, and cointegration test
as analytical tools. The results of the study established that there exists a significant negative
relationship between residual loss and financial performance. Warrad and Omari (2015)
examined the impact of agency costs on Jordanian services sector’s performance during the
period from 2009 to 2012. The study measured agency costs using residual loss. Data for the
study was sourced from the financial reports of eight Jordanian services companies listed on
the ASE for the period of four years from year 2009 to 2012. The study employed the
analysis of variance (ANOVA) for analysis and the result showed that there is a positive but
insignificant impact of residual loss on the financial performance of Jordanian services
companies.

Yetty and Se (2015) examined the relationship between agency cost and performance of
manufacturing companies listed on the Indonesia Stock Exchange. The study sample
comprised of 123 listed companies from three sub-sectors of manufacturing for a period of 4
years from 2010-2013. The study measured agency costs using bonding cost (managerial
ownership). The study employed the statistical t-test, statistical f-test and path analysis. The
result of the study found that bonding costs have significant positive effect on financial
Performance. Enekwe, Agu and Eziedo (2014) explored the effect of agency costs on

9
financial performance of Nigerian pharmaceutical companies. The study used secondary data
for 11 years from 2001 to 2012 and a sample of three companies. The study employed
Pearson correlation and multiple regression models to analyze the data collected. It was
established that residual loss have insignificant positive impact on profitability of the
pharmaceutical industry in Nigeria.

Raza (2013) examined the effect of agency costs on performance of firms listed on the non-
financial sector of the Karachi Stock Exchange. The study period covered six years from year
2004 to 2009. The study population was 482 non-financial firms listed on KSE and the study
sample comprised of all 482 firms. The study measured profitability using ROA and ROE
while, agency cost was measured using residual loss. The study employed the pooled OLS
model for analysis and findings of the study established a negative relationship between
residual loss and financial performance. Jabbary, Hajiha and Labeshka (2013) examined the
impact of agency costs on firm performance of listed firms on Tehran Stock Exchange. The
study proxy agency costs residual loss, while, financial performance was proxy by return on
asset and return on capital employed. Seventy-three (73) firms listed in Tehran Stock
Exchange for a period of 5-years from 2006 to 2010 constituted the sample size using the
systematic sampling method. The study employed the Pearson correlation analysis,
multicollinearity test and multiple regression techniques for statistical analysis and the result
showed that there is a positive and significant relationship between residual loss and financial
performance. Rashidah and Siti (2005) examined the relationship between agency cost and
firm performance. The study distributed questionnaires to 246 companies listed on the Main
Board of the Kuala Lumpur Stock Exchange (currently known as ‘Bursa Malaysia’).
Additional data was sourced from the sampled companies annual reports and accounts for
seven years between 1996 and 2002. The study measured agency costs using monitoring cost
(directors remuneration), while performance was measured using financial performance. The
study employed the stepwise regression and multiple regression model for analysis and the
result showed that monitoring cost have no significant association with financial
performance.

2.4 Hypotheses Formulation

Nine hypotheses are tested in this study, related to each of the nine objectives set out in
section one of this study.

Ho1 Monitoring costs have no significant effect on financial performance of listed financial
companies on the Nigerian Exchange Group.

Ho2 Bonding costs have no significant effect on financial performance of listed financial
companies on the Nigerian Exchange Group.

Ho3 Residual loss have no significant effect on financial performance of listed financial
companies on the Nigerian Exchange Group.

Ho4 Monitoring costs have no significant effect on financial performance of listed non-
financial companies on the Nigerian Exchange Group.

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Ho5 Bonding costs have no significant effect on financial performance of listed non-financial
companies on the Nigerian Exchange Group.

Ho6 Residual loss have no significant effect on financial performance of listed non-financial
companies on the Nigerian Exchange Group.

Ho7 There is no significant difference in the effect of monitoring costs on financial

performance of listed financial and non-financial companies the Nigerian Exchange
Group.

Ho8 There is no significant difference in the effect of bonding costs on financial performance
of listed financial and non-financial companies on the Nigerian Exchange Group.

Ho9 There is no significant difference in the effect of residual loss on financial performance
of listed financial and non-financial companies on the Nigerian Exchange Group.

3.0 METHODOLOGY

The research design adopted for this study is the ex post facto research design. The
population of the study comprises of 111 financial and non-financial companies that have
been consistently listed on the floor of the Nigerian Exchange Group for ten years up to year
2021. The financial sector consists of 39 firms while the non-financial sector consists of 72
firms.The study adopted 10% minimum sample size as posited by Balsley and Clover (1988)
quoted in Tapang, Bessong and Ujah (2015) and Bassey and Tapang (2012) as the ideal
sample size in research. Consequently, 10 companies were randomly selected from each
sector of the financial and non-financial sectors. Data for the study were sourced from
Machameratios and annual report and accounts of the sampled companies

The study consists of both dependent and independent variables. The dependent variable is
financial performance which is proxied by earnings per share (EPS), while the independent
variable is agency costs which are split into monitoring costs (audit fee), bonding costs
(managerial ownership), and residual loss (free cash flow). Data are analysis is carried out
through panel regression technique and paired sample t-test. The panel regression model for
the study is given below.

EPSit= β0 + β1AUDFit +β2MOWNit +β3FCFit +eit.

where;
EPS = Earnings per share
Ƒ = the Function of the vector of the independent variables
AUDF = Audit Fee
MANOWN = Managerial Ownership
FCF = Free Cash Flow

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4.0 RESULTS AND DISCUSSION

This section presents and discusses the results obtained from data analysis.

4.1 Descriptive statistics

Descriptive statistics in this study is made up of the mean, standard deviation, maximum, and
minimum for both the dependent and the independent variables. The value shows the average
value of the data set, the standard deviation shows the spread of the data, while the maximum
and the minimum tells us the highest and lowest values in the data set respectively. The
descriptive statistics of the study is presented in Table 1 below.

Table 1: Results of Descriptive Statistics (N=200)

Standard
Variables Mean Minimum Deviation Maximum Observations
EPS 1.76 -7.43 3.48 22.83 200
AUDF 79,005.43 3,500.00 125,719.58 607,500.00 200
MOWN 15.20 0 21.65 85.29 200
FCF 23,554,857.94 646,000.00 92,320,518.44 1,062,313,891.00 200

Table 1 showed that EPS has a mean value of N1.76 indicating the average value of EPS of
the sampled companies during the period of study. The minimum EPS value was -N7.43.
The standard deviation value of EPS was N3.48, Furthermore, the maximum EPS of the
sampled companies was N22.83. AUDF has a mean value of N79,005,000.43, indicating the
average value of audit fee paid by the sampled companies during the study period. AUDF
also has a minimum value of N3,500,000.00, standard deviation value of
N125,719,000.58,and maximum value of N607,500,000.00during the study period.

MOWN has a mean value of 15.20%, indicating the average percentage of managerial
ownership possessed in the sampled companies during the study period. MOWN also has a
minimum percent of 0%, standard deviation value of 21.65%, and maximum value of
85.29% during the study period. Finally, FCF has a mean value of N23,554,857,000.94,
minimum value of N646,000.00, standard deviation value of N92,320,518,000.44, and
maximum value of N1,062,313,891.00, during the study period.

4.2 Diagnostic Tests

Three tests are conducted in this study to ensure that data meet the requirements for analysis
through the regression technique. They include data normality tests, multicollinearity and
heteroskedasticity tests.

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4.2.1 Normality test

Skewness and kurtosis was employed to test for data normality in this study as presented in
Table 2. As can be observed from the result of Table 6, the skewness and kurtosis values of
all the study variables are between -1 and +1, indicating that the study variables are normally
distributed.

Table 2: Result of Skewness and Kurtosis for Normality Test

Obs Skewness Kurtosis
EPS 200 0.0000 0.0000
AUDF 200 0.0010 0.1425
FCF 200 0.0000 0.0000
MOWN 200 0.0000 0.0000

4.2.2 MulticollinearityTest
Multicollinearity arises where a single explanatory (independent) variable is highly correlated
with a given set of other explanatory variables (Hair, Hult, Ringle, and Sarstedt, 2017).The
most common ways of testing multicollinearity are correlation analysis and variance inflation
factor/tolerance levels, which are presented in Tables 3 and 4.
Correlation Matrix
Table 3: Results of Pearson Correlation (N=200)

| AUDF MOWN FCF

AUDF | 1.0000
MOWN | -0.1975 1.0000
FCF | 0.1036 0.0381 1.0000

The result of the Pearson correlation analysis indicates that the highest correlation coefficient
between the independent variables is -0.1975 for AUDF and MOWN. Judging from the
result of the correlation matrix, there is no indication of multicollinearity between the
independent variables of the study.

Variance Inflation Factor (VIF) and Tolerance level

Table 4: Result of Variance Inflation Factor and Tolerance

Variable VIF 1/VIF

AUDF 1.05 0.948636

MOWN 1.04 0.957532

FCF 1.01 0.985702

13
 Mean VIF 1.04

As can be observed from Table 4, the VIF ranges between values of 1.01 to 1.05 with a mean
of 1.04 which is below the threshold of 10 indicating the absence of multicolinearity among
the variables of the study. On the other hand, the tolerance level ranges from values of
0.948636 to 0.985702 which is above the threshold of 0.1 also indicating the absence of
multicolinearity among the variables of this study.

4.2.3 Heteroskedasticity test

Table 5: Result forHeteroskedasticity Test

Variable Chi-Sq. Value Probability Value

Model 63.30 0.0000

Note: Ho (null): Homoskedastic

To test for heteroskedasticity in this study, the Breusch-Pegan test was performed which
showed a P-value of 0.0000, implying that there is presence of heteroskedasticity. As a result,
the robust regression test was further performed to correct the heteroskedasticity presence.

4.3 Regression Results

4.3.1 Results for Financial Sector Results

The panel regression technique for the financial sector showed that the Hausman
specification has a p-value of 0.8258 as presented in Table 6, implying that the random effect
model is preferable to the fixed effect model. The choice of the random effect model by the
Hausman specification test further necessitates the Breusch and Pagan Lagrangian multiplier
test for random effects to be conducted in order to choose between the result of the pooled
OLS and the random effect model as presented in Table 7 Which showed an F-statistic p-
values of 0.0000, implying that the random effect model is more preferable than the pooled
OLS model in inferencing the study’s result for the financial sector.

Table 6: Result of Hausman Specification Test for Financial Sector

Test Summary Chi-Sq. Value Probability Value

Cross-section random 0.90 0.8258

Note: Ho: Random effect model is preferable to fixed effect model

Table 7: Result of Breusch and Pagan Lagrangian multiplier test for random effect
Financial Sector

14
 Test Statistic F-statistic Value Probability Value

LM test 186.43 0.0000

Note: Ho: Pooled OLS regression model is more appropriate than random effect model

Table 8: Random Effect Regression Result for Financial Sector

EPS Coefficient Z statistics Probability

AUDF 1.857151 5.15 0.000*

MOWN -.000816 -0.13 0.896

FCF .0501901 2.58 0.010*

C -7.644734 -4.48 0.000

R-squared 0.3554

F-statistic 37.37

Prob(F-statistic) 0.0000
Observations 100

The regression result of Table 8 showed an R-square value of 0.3554, indicating that 36% of
the changes in the dependent variable (EPS) of the sampled companies over the period of
interest is explained by the independent variables. Table 8 also shows an F-statistic value of
37.37 with its associated P-value of 0.0000, indicating that the regression model is
statistically significant at 5% level, this means that the specified regression model provides a
better fit than the intercept only model and can be used for statistical inferencing.

Furthermore, Table 8 shows that AUDF has a coefficient of 1.857151 and associated P-value
of 0.000, indicating that audit fee as a proxy of monitoring cost has a significant positive
effect on financial performance proxied by EPS at 5% level of significance. MOWN also, has
a coefficient of -.000816 and associated P-value of 0.896, indicating that managerial
ownership as a proxy of bonding cost has an insignificant negative effect on financial
performance proxied by EPS at 5% level of significance. The regression result further
showed that FCF has a coefficient of .0501901 and associated P-value of 0.010, indicating
that free cash flow as a proxy of residual loss has a significant positive effect on financial
performance proxied by EPS at 5% level of significance.

4.3.2 Results for Non-Financial Sector

The panel regression technique for the non-financial sector showed that the Hausman
specification has a p-value of 0.0468 implying that the fixed effect model is preferable to the
random effect model. The choice of the fixed effect model by the Hausman specification test

15
further necessitates the Wald test to be conducted in order to choose between the result of the
pooled OLS and the fixed effect model as presented in Table 10. Which has an F-statistic p-
values of 0.0000, implying that fixed effect model is more preferable than the pooled OLS
model in inferencing the study’s result for the non-financial sector.

Table 9: Result of Hausman Specification Test for Non-Financial Sector

Test Summary Chi-Sq. Value Probability Value

Cross-section random 7.96 0.0468

Note: Ho: Random effect model is preferable to fixed effect model

Table 10: Result of Wald test for Non-Financial Sector

Test Statistic F-statistic Value Probability Value

Wald test 24.04 0.0000

Note: Ho: Pooled OLS regression model is more appropriate than fixed effect model

Table 11: Fixed Effect Regression Result for Non-Financial Sector

EPS Coefficient T Probability

AUDF .6757802 0.32 0.751

MOWN .0557308 3.36 0.001*

FCF .0001806 0.00 0.998

C -1.593009 -0.17 0.864

R-squared 0.1231

F-statistic 4.07

Prob(F-statistic) 0.0093
Observations 100

Note: *= 1% level of significance

The regression result of Table 11 showed an R-square value of 0.1231, indicating that 12% of
the changes in the dependent variable (EPS) of the sampled companies over the period of
interest is explained by the independent variables. Table 11 also shows an F-statistic value of
4.07 with its associated P-value of 0.0093, indicating that the regression model is statistically

16
significant at 5% level, this means that the specified regression model provides a better fit
than the intercept only model and can be used for statistical inferencing.

Furthermore, Table 11 shows that AUDF has a coefficient of .6757802 and associated P-
value of 0.751, indicating that audit fee as a proxy of monitoring cost has an insignificant
positive effect on financial performance proxied by EPS at 5% level of significance. MOWN
also, has a coefficient of .0557308and associated P-value of 0.001, indicating that managerial
ownership as a proxy of bonding cost has a significant positive effect on financial
performance proxied by EPS at 5% level of significance. The regression results further
showed that FCF has a coefficient of .0001806 and associated P-value of 0.998, indicating
that free cash flow as a proxy of residual loss has an insignificant positive effect on financial
performance proxied by EPS at 5% level of significance.

4.4 Test for Equality of Means (T Test)

The test for equality of means was adopted in testing hypotheses seven to nine of this study.
The test for equality of means (t test) was used to compare the means of agency cost among
non-financial and financial listed companies on the Nigerian Exchange Group and the result
is presented in Table 12.

Table 12: T Test Result for Comparison of Differences in Agency Cost among Listed
Financial and Non-Financial Companies in Nigeria

Variable Non-Fin Fin Mean P- % of Ranking

Companies Companies Difference value Change
Mean Mean

Monitoring Cost 44,239.58 113,771.28 69,531.70 0.000* 61.1% 2

Bonding Cost 17.4 13.0 4.4 0.135 25.3% 3

Residual Loss 8,297,078.83 38,812,637.04 30,515,558.21 0.021* 78.6% 1

Note: *=5% Significance level

Table 12 depicts the test for equality of means of agency cost among listed financial and non-
financial companies in Nigeria. The means are presented for non- financial companies;
financial companies; and the mean difference, which is the difference between the financial
and non-financial companies. The mean difference is used as the basis of assessment of the
difference in agency cost among the financial and non-financial companies in Nigeria. The
test is performed based on the assumption of the general null hypothesis of t test that there is
no difference between the means of agency cost in the financial and non-financial sectors in
Nigeria. The result from Table 12shows a monitoring cost mean of N44,239.58 and
N113,771.28 for the non-financial and financial sectors respectively, while the mean
difference between the two sectors is N69,531.70 representing 61.1% increase in monitoring
cost of the financial sector from the non-financial sector. Monitoring cost equally has a p-

17
value of 0.000, indicating that the difference in monitoring cost among listed financial and
non-financial companies in Nigeria is statistically significant at 5% level.

The result from Table 12 shows a bonding cost mean of 17.4% and 13% for the non-financial
and financial sectors respectively, while the mean difference between the two sectors is 4.4%
representing 25.3%increase in bonding cost of the non-financial sector from the financial
sector. Bonding cost equally has a p-value of 0.135, indicating that the difference in bonding
cost among listed financial and non-financial companies in Nigeria is not statistically
significant at 5% level.

The result from Table 12 shows a residual loss mean of N8,297,078.83 and N38,812,637.04
for the non-financial and financial sectors respectively, while the mean difference between
the two sectors is N30,515,558.21 representing 78.6% increase in residual loss of the
financial sector from the non-financial sector. Residual loss equally has a p-value of 0.021,
indicating that the difference in residual loss among listed financial and non-financial
companies in Nigeria is statistically significant at 5% level.

As can be observed from Table 12, the components of agency costs adopted by the financial
and non-financial sectors to enhance their performance varies. This is because, the financial
sector which is the highly regulated and specialized sector incur more agency costs in the
form of monitoring cost and residual loss than the non-financial sector, while the non-
financial sector incur more bonding cost than the financial sector. This analysis explains why
there is significant positive between the two sectors in monitoring and bonding cost.

4.5 Discussion of Findings

The findings of the study are discussed according to the study objectives as follows:

Objective 1: To examine the effect of monitoring costs on financial performance of

listed financial companies on the Nigerian Exchange Group.

The result of data analysis for hypothesis one revealed that monitoring cost has a significant
positive effect on financial performance (EPS). This result tallies with the findings of Ahmed
et al. (2020) and Wanyoyni (2018) which found that monitoring costs are positively and
significantly related to financial performance. The result of hypothesis one of this study is
consistent with that of Serem et al. (2020) which found that monitoring costs (audit fees)
have significant positive influence on financial performance of Deposit-Taking SACCOs in
North Rift Region in Kenya. The result of hypothesis one on this study is however,
inconsistent with the findings of Ndeto (2019) which revealed that monitoring cost has a
significant negative effect on financial performance.

This result support the agency theory which postulates that managers as agents, when
supervised and monitored will venture into only profitable projects which will enhance the
performance of the organization.

Objective 2: To examine the effect of bonding costs on financial performance of listed

financial companies on the Nigerian Exchange Group.

18
The result of data analysis for hypothesis two revealed that bonding cost has an insignificant
negative effect on financial performance (EPS). The finding of this study also fails to support
the result of Hoang et al. (2019) which found that bonding cost has an insignificant negative
effect on financial performance (ROE).

The result is however inconsistent with the study of Alkurdiet al. (2021) and Ndeto
(2019)which revealed that bonding cost has a significant negative effect on financial
performance.
Objective 3: To examine the effect of residual loss on financial performance of listed
financial companies on the Nigerian Exchange Group.

The result of data analysis for hypothesis three revealed that residual loss has a significant
positive effect on financial performance (EPS). This result tallies with the findings Herdinata
(2019), Akinleye and Dadepo (2019), and Jabbary et al. (2013) which found that residual loss
has a significant positive effect on financial performance. The result of this study further fails
to support the findings of Abughniem et al. (2020) and Akani and Kenn-Ndubuisi
(2017)which disclosed that residual loss (free cash flow) has significant negative effect on
financial performance. The result of this study also fails to support the findings of Raza
(2013)which found that residual loss has a negative effect on financial performance.

The result of hypothesis three supports the free cash flow theory which posits that free cash
flow as a category of agency costs (residual loss) if not properly managed, will result to
assets dis-utilization which will affect financial performance.

Objective 4: To examine the effect of monitoring costs on financial performance of

listed non-financial companies on the Nigerian Exchange Group.

The result of data analysis for hypothesis four revealed that monitoring cost has an
insignificant positive effect on financial performance (EPS). The result of hypothesis one of
this study support the study of Rashidah and Siti (2005) which revealed that monitoring cost
has a positive but insignificant effect on financial performance.

Objective 5: To examine the effect of bonding costs on financial performance of listed

non-financial companies on the Nigerian Exchange Group.

The result of data analysis for hypothesis five revealed that bonding cost has a significant
positive effect on financial performance (EPS). This result tallies with the findings of
Hermuningsih et al. (2020) which found that bonding cost has a significant positive effect on
financial performance. The result of this study is also consistent with the study of Yetty and
Se (2015) which disclosed that bonding cost has a significant positive effect on financial
performance. The findings of this study also conform with the studies of Berķe-Berga et al.
(2017) which found that bonding cost has a significant positive effect on financial
performance. The result of this study also supports the study of Okewale et al. (2020)which
disclosed that bonding cost has a positive effect on financial performance.

19
This result also supports the agency theory which postulates that the alignment of ownership
and management (bonding) will minimize the agency costs in reaching, monitoring, and
enforcing agreements. Therefore, increasing the managers’ ownership of the firm will reduce
managerial opportunism which will enhance financial performance.

Objective 6: To examine the effect of residual loss on financial performance of listed

non-financial companies on the Nigerian Exchange Group.

The result of data analysis for hypothesis six revealed that residual loss has an insignificant
positive effect on financial performance (EPS). This result tallies with the findings of
Agbogun and Taiwo (2020) which found that residual loss has positive but statistically
insignificant relationship with the financial performance of manufacturing firms in Nigeria.
The result of hypothesis three of this study further confirms the findings of Warrad and
Omari (2015) which disclosed that residual loss have positive but statistically insignificant
effect on financial performance of Jordanian services companies. The result of this study also
supports the findings of Enekwe et al. (2014) which found that residual loss has an
insignificant positive effect on financial performance. This result is inconsistent with the
study of John-Akamelu et al. (2017) which disclosed that residual loss has a significant
positive effect on financial performance.

The result of hypothesis six of this study is inconsistent with the study of Kithandi (2020)
which revealed that there is a negative relationship between residual loss and financial
performance of petroleum and energy sector firms listed in the Nairobi Stock Exchange. The
result is inconsistent with the result of Nuhu et al. (2020) and Kenn-Ndubuisi and Nweke
(2019), which revealed that residual loss has a significant negative effect on financial
performance.

Objective 7: To ascertain whether significant difference exists in the effect of

monitoring costs on financial performance of listed financial and non-financial sectors
of the Nigerian Exchange Group.

The result of data analysis for hypothesis seven revealed that there is significant difference in
the effect of monitoring cost on financial performance of listed financial and non-financial
sectors of the Nigerian Exchange Group. There is however, dearth of prior research studies to
support this hypothesis. The paucity of supporting or contrarian studies to the result of
objective seven of this study indicates the dearth of prior empirical studies on the level of
difference of the effect of monitoring cost on financial performance of financial and non-
financial sectors of Nigeria, hence, a contribution of this study to knowledge.

Objective 8: To ascertain whether significant difference exists in the effect of bonding

costs on financial performance of listed financial and non-financial sectors of the
Nigerian Exchange Group.

The result of data analysis for hypothesis eight revealed that there is no significant difference
in the effect of bonding costs on financial performance of listed financial and non-financial

20
sectors of the Nigerian Exchange Group.There is however, dearth of prior research studies to
support this hypothesis. The paucity of supporting or contrarian studies to the result of
objective eight of this study indicates the dearth of prior empirical studies on the level of
difference of the effect of bonding cost on financial performance of financial and non-
financial sectors of Nigeria, hence, a contribution of this study to knowledge.

Objective 9: To ascertain whether significant difference exists in the effect of residual

loss on financial performance of listed financial and non-financial sectors of the
Nigerian Exchange Group.

The result of data analysis for hypothesis nine revealed that there is significant difference in
the effect of residual loss on financial performance of listed financial and non-financial
sectors of the Nigerian Exchange Group. There is however, dearth of prior research studies to
support this hypothesis. The paucity of supporting or contrarian studies to the result of
objective nine of this study indicates the dearth of prior empirical studies on the level of
difference of the effect of residual loss on financial performance of the financial and non-
financial sectors of Nigeria, hence, a contribution of this study to knowledge.

5.0 CONCLUSION AND RECOMMENDATIONS

Based on the findings of this study, the study concluded that; monitoring costs and residual
loss positively and significantly affect financial performance (EPS) of listed financial
companies on the Nigerian Exchange Group, while bonding cost negatively and
insignificantly affect financial performance of listed financial companies on the Nigerian
Exchange Group. The study equally concluded that monitoring costs and residual loss
positively but insignificantly affect financial performance of listed non-financial companies
on the Nigerian Exchange Group, while bonding costs positively and significantly affect
financial performance of listed non-financial companies on the Nigerian Exchange Group.
Furthermore, significant differences exists in the effect of monitoring cost and residual loss
on financial performance of listed financial and non-financial sectors of the Nigerian
Exchange Group, while insignificant differences exist in the effect of bonding cost on
financial performance of listed financial and non-financial sectors of the Nigerian Exchange
Group.

The study therefore recommended that companies in the financial sector should prioritize
agency cost in the form of monitoring cost and residual loss as there exert an influence on
financial performance in the sector. Also, companies in the non-financial sector should
prioritize agency cost in the form of bonding cost as it exert an influence on financial
performance in the sector.

The study has contributed to knowledge by ascertaining that there is significant difference
between the various components of agency costs on financial performance in the financial
and non-financial sector. This study provided evidence that companies in the highly regulated

21
financial sector incur higher agency costs in form of monitoring and bonding cost, while,
companies in the non-financial sector incur higher agency costs in form of bonding cost. The
implication of this result is that in midst of limited resources available to companies and the
inability of companies to incur all three components of agency costs, this study’s result will
provide a hierarchy of the most relevant agency cost to incur based on the sector.

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