Strategic Finance

Assignment 1

Student Name:

UOB ID:

Unit Code :

Word Count: 2400 Max: 2640

Submission Deadline : 27th August 2021

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Table of Contents
Table of Figures ......................................................................................................................... 3

List of Tables ............................................................................................................................. 3

List of Abbreviations ................................................................................................................. 4

1.0 Introduction .......................................................................................................................... 5

2.0 Challenges of Creating an effective board of directors ....................................................... 5

2.1 Board Independence and board size ............................................................................... 6

2.2 CEO duality and CEO power........................................................................................... 6

2.3 Foreign Directors and female Directors ........................................................................... 7

2.4 Effectiveness of committees ............................................................................................ 7

3.0 Corporate Governance Practices regarding the selection and performance of board of
directors...................................................................................................................................... 8

3.1 Background to the organisation ....................................................................................... 8

3.2 Profitability ...................................................................................................................... 9

3.3 Liquidity........................................................................................................................... 9

3.4 Efficiency ....................................................................................................................... 10

3.5 Financial ratings ............................................................................................................. 11

4.0 Conclusion ......................................................................................................................... 12

References ................................................................................................................................ 13

Appendices............................................................................................................................... 16

Appendix 1: Board Diversity at Lloyds Banking Group ..................................................... 16

Appendix 2: Profit After Tax Performance (2016-2020) .................................................... 17

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Table of Figures
Figure 1: Corporate Governance Structure ................................................................................ 8

List of Tables
Table 1: Profitability ratios ........................................................................................................ 9
Table 2: Liquidity ratios........................................................................................................... 10
Table 3: Efficiency Ratios ....................................................................................................... 11
Table 4: Credit Ratings of the Lloyds Banking Group ............................................................ 11

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List of Abbreviations

BOD- Board of Directors

CG- Corporate Governance

NED - Non Executive Director

UK- United Kingdom

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1.0 Introduction
Corporate governance has been widely defined as the mechanism which directs and controls
organisations (Cadbury report, 1992). Weak corporate governance practices could lead to
corporate failures such as the financial crisis of 2007/8, thus the importance of corporate
governance has grown over the years (Clichici, 2016). On the other hand, Uadiale (2010)
argues that CG has continued to receive considerable emphasis by academics, regulatory
bodies and market participants in recent years since the theory and empirical research still
provides contradictory views, mainly on the impact of the good GC practices on company
management and performance.

This paper aims to assess the challenges faced by organisations when creating effective
boards using empirical research. Moreover, the corporate governance practices of the
company selected (Lloyds Banking Group PLC) has been conducted by analysing the
financial ratios for the year 2020.

This analysis comprises of 4 sections; introduction where the importance and objectives of
the paper have been outlined, next, the challenges of creating effective BODs have been
assessed using literature. In the third section, this paper assesses the corporate governance of
a UK listed company. Finally a logical conclusion has been provided with a summary of the
analysis.

2.0 Challenges of Creating an effective board of directors

Despite the positive attributes of CG, several authors have highlighted that organisations face
certain challenges when developing effective BODs. These include highly ineffective
independent and large sized boards (Ghosh, 2006; Garg. 2007; Rashid, 2018), CEO duality
leading to excessive CEO power, highly diverse but ineffective boards and ineffective CG
committees being appointed. Corporate BODs are the principal internal corporate
governance structure, overseeing management and matching shareholder interests with
management (Brennan, 2006). Therefore, the challenges faced by the organisation when
creating effective BODs have been analysed below.

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2.1 Board Independence and board size
Corporate collapses such as Enron, HIH insurance and WorldCom lead to much attention
being paid to the concept of BOD's independence. However, studies by Rashid (2018) and
Fauzi & Locke (2012) suggested that the board independence has a negative impact on the
firm economic performance, possibly due to a one size fits all concept of CG is not effective
in all cases. In addition, non-executive directors may have irrelevant experience or restricted
time to carry out their duties efficiently (Alshetwi, 2017).

On the other hand, the ideal board size has been argued by several theories. The Agency and
resource dependency theories support the board with a high number of directors while
stewardship theory suggests that a smaller board allows for effective management (Kalsie and
Shrivastav, 2016). Ghosh (2006) and Garg (2007) in their studies also emphasises that a large
board size would have a negative influence on the firm performance, where several
researchers suggested that a BOD of less than 6 members was ideal (Ghosh, 2006; Garg.
2007; Rashid, 2010).

2.2 CEO duality and CEO power

Even though CEO duality has been encoraged by corporate several researchers argue that it
would lead to excessive power being provided to the CEO. Considering the theoretical
perspective, agency theory emphasizes that a company should not be led by a single
individual who plays a dual role as the chairman of the BOD and CEO. Moscu (2013) notes
that the duality of functions may be an issue, since the performers of the firm are the same
who should assess its effectiveness. Several empirical research also support this claim, where
Chen, Lin, and Yi (2008) and Iyengar and Zampeli (2009) found no substantial evidence that
CEO duality influences listed firms' performance. Palanissamy (2015) also highlights that
CEO duality allows strong power being possessed by the CEO which provides an
opportunity to conceal whatever is in a business, leading to a lack of company transparency.
Therefore, CEO duality may cause more issues than benefits when considering the CG
matters of the organisation.

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2.3 Foreign Directors and female Directors
Diversity within boards may foster independence of opinions and improve discussion and
constructive debate. However, The UK accounting norms, laws and regulations, governance
standards, and management practices are likely to be less familiar to foreign directors,
making it more difficult for them to evaluate management performance and dispute the
choices of the management (Xie, 2012). These factors imply that FIDs are probably
weakening the efficacy of the monitoring board, leading to more agency difficulties between
management and shareholders, and eventually to weaker corporate performance.

On the other hand, increased female representation in BODs have been proposed across the
CG practices worldwide (Medland, 2004). However, findings of Adams and Ferrerira (2009)
stated that female board members had a negative influence on the firm performance possibly
due to male directors having fewer meeting attendance problems. On the other hand, Srinidhi
et al., (2020) identified that female directors are of the minority and that they do not possess
symbolic power such as hierarichal authority on past male dominant BODs. No suggestions
have been provided as to how female directors should act in the face of such setbacks have
been made (Srinidhi et al., 2020).

2.4 Effectiveness of committees

Committees are formed as audit committee, remuneration committee and nomination
committee to take up significant responsibilities of the BOD. Despite the expected benefits of
such committees such as increased efficiency due to specialised decision making by the
members (De Kluyver, 2009), they could lead to isolation of duties due to the siloed structure
of committees as it leads to directors to specialise in specific tasks. This may lead to entire
board of directors not having equal access to information generated through these committees
(Reeb and Upadhyay. 2010). Such structures may lead to hindering of inter-committee
interactions which could lead to negative implications.

On the other hand, academics argue that such committees may take decisions which are
merely symbolic than being substantive in making changes within the organisation (Gai,
Cheng and Wu, 2021). For instance, appointing a new female board member with no
experience and no mentoring being provided, could be a symbolic way for the board to
develop external impressions in the form of greater diversity as the nomination committee is

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allowed to choose whom to nominate (Mc Donald and Westphal, 2013). Therefore, such
symbolic decisions could lead to negative long term implications.

3.0 Corporate Governance Practices regarding the selection and

performance of board of directors

3.1 Background to the organisation

Lloyds Banking Group plc which was established in 1865, is a UK-based listed financial
services firm that has a range of banking and financial services in the UK and a number of
sites abroad. The firm is operating in three sectors with its Headquarters in London: UK
Retail Banking, Insurance and Investment and Wholesale and International Banking. The
group operates as the largest retail and commercial financial services provider in the UK with
a customer base of over 25 million and 61,576 employees (Lloyds Banking Group, 2021b).
The group currently follows the "UK Corporate Governance Code of 2018". The board
members comprise of 12 members where 8 are Non Executive Directors. The Corporate
Governance structure of the group is demonstrated in figure 1 below.

Figure 1: Corporate Governance Structure

Source: (Lloyds Banking Group, 2021a)

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3.2 Profitability
These ratios assess sales and investment returns and hence the company's capacity to create
profits.. In the case of Lloyds Group the Net profit margin has declined significantly over the
past year.

The board of Directors comprise of 12 members thus it would be difficult to come to a

decision due to the even number of directors. Moreover, several studies indicated that the
ideal board should comprise of 6 or less members suggesting that the BOD of Lloyds bank is
double the expected size. This could also cause a financial burden to the organisation.

For instance, the group claimed that within this financial year the company will be spending
an additional 100 million pounds on bonuses (White and Withers, 2021), despite the
declining growth of profits over the past 5 years as indicated in Appendix 2.

On the other hand, findings by Petchsakulwong and Jansakul (2018) indicated that more non-
executive directors on the board indicated increased profitability. However, in the case of
Lloyds bank, the financial performance seems to be declining despite 66.6% of the board
comprising of NEDs. This could be due to oversized boards being a high cost to the group
due to free-rider conflicts as well as from issues related to coordination, flexibility and
control in decision making process as highlighted by García-Ramos, Díaz-Díaz and García-
Olalla (2017).

Table 1: Profitability ratios

Ratio/Indicator 2019 2020 Change

Net Profit Margin 5.81 2.96 49.0534% decrease

3.3 Liquidity
Pandey (2009) states that a weak liquidity position threatens the firm's solvency and makes it
hazardous and unhealthy, while negative current assets ratios indicate negative liquidity and
might prove damaging to the reputation of the organization. In the case of Lloyds Group, the
current ratio has declined significantly during the year indicating a reduction of liquidity.
However, the operating cash flow of the group has increased by nearly 1.5 times possibly due
to reduction in investing activities during the global pandemic.

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Liquidity needs to be an important consideration when conducting CG reforms in the group
as the group faced several difficulties during the financial crisis of 2007/08. During this
period the Bank of England accused the Lloyds group of illegal behavior after its traders
manipulated interest rates in order to reduce the emergency lifeline charges at the height of
the financial crisis.

Table 2: Liquidity ratios

Ratio/ Indicator 2019 2020 Change

Current Ratio 2.81 1.52 45.9075% decrease

Operating Cash flow 11,281 27,171 140.856% increase

(GBP m)

3.4 Efficiency
These ratios assess how efficiently the firm manages the inventory, sells and manufactures
items or uses assets for revenue generation. Therefore, the board structure is a vital
component when assessing the efficiency of the organisation. This is due to the board having
crucial duties to supervise, monitor and control the management team to implement the
organisation's established policies. The efficiency ratios over the past year has declined
significantly.

CEO duality is an important board characteristic when improving the efficiency of an

organisation. Since the Chairman and CEO are seperate roles in the case of Lloyds Group, it
is expected that fair decisions are being taken and the management is assessed in a fair
manner. This is because CEO duality could negatively compromise the monitoring and
desciplining functions of the BOD by the Chairman-CEO, who may control the BOD agenda
and influence the flow of information in manner which considers questioning the
management effectiveness as inappropriate (Pettigrew, 1973). Therefore, by appointing an
independent chair at Lloyds Group, the position would serve as focal point which allows
directors to raise and communicate any concerns they may have regarding the CEO (Robert,
McNulty and Stiles, 2005).

Bennedsen et al. (2008) used Return on Assets as a an indicator to measure firm performance
of listed companies with 6 or more members and found out that no relationship exists

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between board size and firm performance. This may be the case of Lloyds Group, as the large
size of the board has not lead to an increase in financial performance over the years.

Table 3: Efficiency Ratios

Ratio/ Indicator 2019 2020 Change

Return on Investment 1.848 0.918 50.3247% decrease

Return on Assets 0.3605 0.159 55.8946% decrease

3.5 Financial ratings

The assessment of companies by governance rating agencies usually relies on how effectively
companies satisfy one or more codes' processes and practices (Turnbull, 2011). Weak
corporate governance may create bank failures that can result in large government expenses,
potential impact on deposit and insurance systems as well as possibly macroeconomic
consequences such as contagion risks and payment systems impacts (Clichici, 2016). As a
result, studies by McKinsey (2002) suggests that a vast majority of investors are willing to
pay premiums for enterprises with strong levels of governance, due to greater trust in the
BOD of such firms.

Studies by Bhojraj and Sengupta (2003) suggests that having a greater number of
independent directors have a positive impact on credit ratings as the level of supervision
provided is more effective, thus the possibility of default decreases and credit rating
increases. Similarly, Anderson, Mansi and Reeb (2004) revealed that a large board size,
existence of an audit committee, and independence of the audit committee have a negative
influence on debt costs. A lower loan cost suggests a decreased default risk, which increases
credit ratings which could be the case of Lloyds bank as indicated in Table 4 below.

Table 4: Credit Ratings of the Lloyds Banking Group

Rating Agency Long term rating Short term rating

Standard & Poor's BBB+ A-2

Fitch A F1

Moody's A2 P-1

Source: Lloyds Bank PLC (2021)

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4.0 Conclusion
Lloyds Group is committed to strong governance, policies and procedures, and its
management team is working to achieve the highest corporate management and transparency
standards. A quantitative ratio study (liquidity measurement, profitability indicators, financial
ratings and efficiency indicators) reveals satisfactory ratings for Lloyds among the
four parameters which positively increase corporate governance. However, the performance
has been declining over the past years, most significantly in the year 2020. The negative
performance is most likely due to the global pandemic.

Nevertherless, the CG practices of the bank does have a few challenges. For instance, the
board composition comprises mainly of non-executive directors who may not be actively
involved in the firms decisions. Moreover, the number of board members are above the
recommended number of 6 members by researchers which may be a great financial burden to
the bank during a global pandemic. It is important the company addresses these issues if not,
it would face negative implications such as those during the financial crisis of 2007/08.

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Appendices

Appendix 1: Board Diversity at Lloyds Banking Group

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Appendix 2: Profit After Tax Performance (2016-2020)

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 Profit After Tax (2016-2020)
5000
4500 4506
4000
3500 3649
3000 3006
2500 2605
Year
2000
1500 1387
1000
500
0
2015 2016 2017 2018 2019 2020 2021

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