Does Size Moderate the Linkage between Corporate Governance and Financial Performance? Evidence from Deposit Taking Sacco’s in Kenya

Deposit-taking Savings and Credit Cooperative Societies (SACCOs) are pivotal institutions in Kenya, facilitating financial inclusion and economic development by providing accessible savings and credit services. Despite their critical role, SACCOs face challenges such as governance deficiencies and regulatory compliance issues, which impact their financial performance (FP). This study employed a descriptive correlational design to investigate the interrelationships among corporate governance (CG), regulatory frameworks, and. Utilizing data from 815 SACCOs spanning the period from 2018 to 2022, collected through annual financial reports and supervisory data from the Sacco Societies Regulatory Authority (SASRA), the research reveals significant findings. The fixed effect panel regression model applied shows that CG positively influences FP, indicating that stronger governance practices enhance financial outcomes. Moreover, regulatory frameworks exert a substantial impact on FP, underscoring their role in ensuring financial stability. Importantly, the interaction between CG and regulatory frameworks further enhances FP, highlighting the synergistic effect when robust governance practices align with effective regulatory oversight. These findings underscore the critical role of regulatory frameworks in strengthening the CG-FP nexus within SACCOs, offering implications for enhancing management practices and regulatory strategies to sustain financial stability and bolster member confidence. Future research endeavors should expand to include a broader spectrum of SACCO types and consider longer study durations to deepen insights into governance dynamics and financial outcomes across the sector. 

Introduction

Deposit-taking Savings and Credit Cooperative Societies (SACCO’s) in Kenya are critical for catalyzing desired financial inclusion, presenting members affordable savings and credit alternatives (Ngeno, 2019). These institutions drive economic prosperity by offering loans for personal growth, corporate related projects, and agricultural endevours. Moreover, SACCOs enhance financial literacy and stability among their members, helping in poverty alleviation and improved living standards. By facilitating investments in income-generating activities, these cooperatives equally buttress local economies, significantly supporting community development and national economic development across the globe.

The corporate governance (CG) failures observed in numerous Kenyan financial institutions underscore the urgent quest for strong CG actions and a stringent regulatory environment. Incidences involving Imperial Bank, which fell into receivership in 2015 owing to fraud, Chase Bank, which faced analogous fate in 2016 following financial irregularities, and the governance challenges at the National Bank of Kenya, have all illustrated the critical role that effectual governance and regulations play in sustaining financial soundness, transparency in business operations, and stakeholder confidence (Odhiambo, 2019). Strong CG mechanisms and a wide-ranging regulatory architecture are essential to ease risks, enhance Financial Performance (FP), and avert future financial crises.

The nexus between CG and FP varies with prevailing the regulatory framework, which establishes guidelines as well as standards for corporate code of conduct and financial decision-making (Tanjung, 2020). Adherence to robust CG regulations augments a firm’s image capital and confidence among a plethora of stakeholders, thereby ameliorating FP. Regulatory requirements, such as core capital standards and liquidity maintenance, help in effectual management related risks and financial solidity (Nag & Chatterjee, 2020), potentially amplifying the CG-FP linkage. Conversely, a weaker regulatory regime diminishes this connection (Shahzad & Zulfiqar, 2022). Regulations align supervisory incentives and compensation with corporate welfare, motivating better FP. Transparent disclosure of financial information, as mandated by regulatory frameworks, increases stakeholder confidence and enhance FP.

There is sufficient evidence in empirical literature that CG and a solid regulatory regime are vital for upholding the integrity and stability of financial institutions (Queiri, 2024). Implementing effective CG practices promotes transparency, accountability, and ethical conduct within organizations, thereby building trust among stakeholders and investors. A robust regulatory framework sets out essential guidelines and standards for corporate conduct, financial decision-making, and risk management, which help to avert fraud, mismanagement, and financial crises (Narella, 2022). Combined, CG and regulatory measures improve organizational performance, safeguard shareholders’ interests, and enhance the overall health and stability of the financial system, fostering sustainable economic growth.

Furthermore, CG, founded on principles such as accountability, transparency, and security, is essential for the FP and overall success of a business. Accountability ensures that the board of directors acts in the best interests of the company and its stakeholders, fostering trust and stability (Mwangi & Nyaribo, 2022). Transparency involves regularly sharing detailed financial and operational information with shareholders, enhancing confidence and informed decision-making. Security addresses the protection of sensitive data, mitigating risks like data breaches. Good CG minimizes capital costs, boosts operational efficiency, and attracts investors by improving the company’s reputation and product quality (Mansour, 2022). These factors collectively enhance FP by increasing profitability, reducing risks, and promoting sustainable growth. Conversely, poor CG can lead to issues such as nepotism, corruption, and poor leadership, which undermine trust, increase liabilities, and negatively impact FP. Thus, effective CG is crucial for optimizing decision-making, safeguarding stakeholder interests, and ensuring long-term financial stability and success.

A robust regulatory framework provides necessary standards and guidelines for corporate conduct, financial decision-making, and risk management (Khatib & Nour, 2021). It ensures adherence to best practices, boosts public trust, and promotes financial stability by protecting against fraud, mismanagement, and financial crises. Together, CG and regulatory frameworks enhance organizational performance, protect shareholder interests, and contribute to the overall health and stability of the financial system, ultimately supporting sustainable economic growth. In the realm of deposit-taking SACCOs, CG and regulatory frameworks are crucial for maintaining financial stability and member trust. SACCOs encounter unique governance challenges that necessitate specific oversight measures, such as regular and engaged board activities, optimal board size, financial expertise among board members, and diversity to promote inclusive decision-making (Ngeno, 2019). Regulatory frameworks for SACCOs include capital requirements, liquidity buffers, supervisory practices, consumer protection, and risk management to ensure financial stability and resilience. By adhering to these specialized CG and regulatory measures, SACCOs can demonstrate their commitment to prudent operations, effective risk management, and regulatory compliance, thus enhancing trust among members, regulators, and stakeholders.

Research Problem

The deposit-taking SACCOs in Kenya continue to encounter several challenges that adversely affect their FP. A primary issue is poor revenue generation, for instance exemplified by Moi University SACCO, which struggled with a small membership base and low loan interest rates (SACCO Societies Regulatory Authority, 2020). This limited their income generation, hindering their ability to cover operational costs and expand their capital base, ultimately restricting their capacity to offer competitive financial products and services. Governance failures and poor stewardship have been significant issues as well. Moi University experienced CG lapses that led to financial instability and reduced member confidence (Mwangi & Nyaribo, 2022). Problems such as nepotism, lack of board diversity, and inadequate oversight mechanisms contributed to these failures.

Another notable example is Good Life SACCO which faced significant governance failures due to a lack of transparency and accountability among board members. This led to poor decision-making and financial mismanagement, eroding member trust and financial stability hence having negative implication on their FP. Insufficient capital also poses a pervasive problem (Ngeno, 2019). Nitunze SACCO also struggled with inadequate capital, which limited their ability to expand their loan portfolio and offer competitive financial products. This issue was exacerbated by difficulties in attracting and retaining sufficient member savings and external funding.

Stringent regulatory requirements from the Sacco Societies Regulatory Authority (SASRA) present another significant challenge. In 2018, SASRA revoked the licenses of two deposit-taking SACCOs, placing them under liquidation due to non-compliance with regulatory standards, such as inadequate capital adequacy and liquidity levels. While necessary for ensuring stability and integrity in the financial sector, these regulations can be burdensome and costly for SACCOs to comply with. Financial mismanagement is a further issue affecting many SACCOs. Several organizations have faced problems due to inappropriate business and investment decisions. Odhiambo (2019) highlighted that many SACCOs in Kenya make poor financial decisions due to a lack of financial expertise among their board members and management teams. This mismanagement leads to financial losses and undermines member trust.

Empirical studies investigating the relationship between CG, regulatory frameworks, and FP encounter significant inconsistencies due to diverse conceptual interpretations and contextual factors such as varying regulatory environments and economic conditions. Methodological challenges, including the use of different econometric models, sampling variations, and the choice of financial metrics, further complicate efforts to establish clear causal links between CG practices, regulatory effectiveness, and FP outcomes. Industry-specific characteristics also play a crucial role, necessitating tailored approaches to account for unique market dynamics. Addressing these gaps requires standardized methodologies and robust model specifications to enhance comparability and reliability across studies, as exemplified by research on deposit-taking SACCOs in Kenya.

Research Objective

The objective of this study is to determine the moderating influence of regulatory framework of the relationship between corporate governance and financial performance of deposit taking SACCOs in Kenya.

Theoretical Underpinning

The relationship among CG, regulatory framework and FP is grounded on two key theoretical frameworks: agency and stewardship theories. Agency theory, formulated by Jensen (1986), provides a foundational framework for understanding the dynamics of the principal-agent relationship within organizations. Central to this theory is the recognition that when ownership and control are separated, conflicts of interest can arise between shareholders, who seek to maximize their wealth, and managers, who act as agents making decisions on behalf of shareholders. These conflicts stem from managers potentially pursuing their own interests, which may diverge from those of shareholders, owing to asymmetries in information and incentives (Bawuah, 2023). Agency theory suggests that effective corporate governance mechanisms, such as independent boards of directors, rigorous monitoring, and performance-based compensation, can help mitigate these conflicts (Bui & Krajcsak, 2023). By aligning the interests of managers with those of shareholders via these mechanisms, agency theory postulates that entities can minimize agency costs linked with monitoring and controlling managerial conduct and thereby augmenting FP. This theoretical framework has significantly influenced CG practices across the globe, guiding efforts to structure firms in ways that scale down agency problems and optimize shareholder value.

Stewardship theory, introduced by Donaldson and Davis (1991), posits that executives act as stewards of shareholders’ wealth, aligning their interests with the long-term goals of the organization. Unlike agency theory, which focuses on potential conflicts of interest between managers and shareholders, stewardship theory emphasizes intrinsic motivations such as pride in work and commitment to organizational success (Erenaet al., 2022). This theory underscores the significance of empowerment, trust, and shared values in fostering a collaborative environment where managers are motivated to pursue collective objectives without extensive monitoring. Stewardship theory is particularly relevant in understanding the linkage among CG, regulatory frameworks, and FP. It suggests that effective CG practices, which encourage empowerment and trust among managers, not only align managerial actions with shareholder interests but also promote adherence to regulatory standards and ethical guidelines (Mandiriet al., 2023). This alignment enhances FP by fostering organizational efficiency, accountability, and sustainable decision-making practices that contribute to long-term value creation for stakeholders.

Empirical Literature

Several empirical studies have probed the complex nexus CG, regulatory frameworks, and FP across different contexts. For instance, Tembaet al. (2023) conducted research on Tanzanian commercial banks and reported that effective CG framework had a positive impact on FP, particularly when reinforced by adherence to prudential regulations such as capital adequacy and liquidity standards. Their study highlighted how CG structures and regulatory compliance play crucial roles in enhancing asset quality and earning ability within financial institutions.

In the United Kingdom, Kyere and Ausloos (2021) investigated CG practices in non-financial listed firms, revealing mixed effects on FP metrics. They identified liquidity as a significant moderator influencing the relationship between CG mechanisms, such as audit committees as well as board independence and financial outcomes. This empirical inquiry underscored the variability in CG across different organizational contexts and emphasized the significance of liquidity management in optimizing the impact of CG on corporate performance.

In Asian context, Tahir’s (2020) examination of Pakistan’s non-financial sector further elucidated the role of liquidity in conjunction with CG practices in driving FP. Using norm-Stata tests and seemingly unrelated regression models, the research demonstrated that robust CG frameworks positively influenced FP, with liquidity acting as a key moderator. This research underscored the necessity of integrating liquidity considerations into CG strategies to enhance financial outcomes and scale down risks, offering practical insights applicable to governance practitioners and policymakers.

Elsewhere, Nguyen and Dao’s (2022) comprehensive meta-analysis across global studies reaffirmed the positive impact of CG on firm value, with liquidity factors playing a significant moderating role. Their findings highlighted the diverse regulatory environments and economic conditions influencing CG-FP dynamics worldwide. Furthermore, Vincentet al. (2023) examined Indonesian insurance firms, noting how regulatory reforms affected CG practices and subsequent FP outcomes. Their study underscored the regulatory landscape’s impact on CG effectiveness and FP.

Conceptual Framework

The conceptual model illustrates the relationship among CG, the regulatory framework, and the FP of deposit-taking SACCOs. It highlights the metrics used to quantify these variables and their conceptual linkages. This model, as depicted in Fig. 1, provides a comprehensive view of how these elements interact and influence each other.

Fig. 1. Conceptual model.

Research Hypothesis

H₀₃: There is no significant moderating effect of regulatory framework on the relationship between corporate governance and financial performance of deposit taking SACCO’s in Kenya.

Methodology

The study adopted cross-sectional descriptive correlational design. The correlational approach quantitatively explored relationships among CG, regulatory framework, and FP of deposit-taking SACCOs in Kenya. The study’s population comprised 172 licensed SACCOs, and a census was conducted due to the manageable population size and accessible datasets. Secondary data covering 2018-2022 was collected from annual financial reports and SASRA’s supervision reports, focusing on CG attributes, regulatory frameworks, and FP.

Measurements

In this study, various indicators were used to measure the key variables: CG, regulatory framework, and FP. CG was assessed through multiple indicators, including board activity, board size, board financial expertise, board independence, and board gender diversity. These specific indicators provided a comprehensive view of the governance practices within the SACCOs. Additionally, a composite Corporate Governance Index (CGI) was created to encapsulate the overall governance score. The regulatory framework was measured using a composite score of capital standards and liquidity buffers, which essential prudential regulations are ensuring the financial stability and compliance of SACCOs. FP was measured by Return on Assets (ROA), a widely recognized indicator of financial performance that reflects the efficiency of asset utilization in generating profits.

Data Analysis

The study employed panel regression analysis to estimate the parameters. Based on the results of the Hausman specification test, a fixed effect model was utilized. Panel regression analysis offers several advantages, including the ability to control for individual heterogeneity, improve efficiency by using more data points, and capture the dynamics of changes over time. The fixed effect model, in particular, is advantageous as it accounts for unobserved variables that could vary across entities but remain constant over time, thereby controlling for time-invariant characteristics. This approach ensures that the estimates are not biased by omitted variable bias, leading to more accurate and reliable results when examining the relationship between CG, regulatory framework, and FP.

Econometric Model

(1) $$\begin{array}{r}{\text{FP}}_{\text{it}}={\mathrm{\beta }}_0+{\mathrm{\beta }}_1{\text{CG}}_{\text{it}}+{\mathrm{\beta }}_2{\text{RF}}_{\text{it}}+{\mathrm{\beta }}_3{\text{CG*RF}}_{\text{it}}+{\mathrm{\epsilon }}_{\text{it}}\end{array}$$

where FP is financial performance, CG denotes corporate governance, RF represents regulatory framework, CG*RF is the interaction between corporate governance and regulatory framework, β₀ is regression constant, β_1, β_2, and β₃ are regression coefficients.

Findings and Discussions

The descriptive statistics for the study variables are presented in Table I.

Table I. Descriptive Statistics

Variable	N	M	SD	CV	SK	KU
Corporate governance	815	1.42	0.07	0.24	0.27	1.50
Regulatory framework	815	0.34	0.26	0.72	0.12	17.64
Financial performance	815	0.02	0.05	2.28	−9.70	137.58

The descriptive statistics for the study variables are shown in Table I. CG had a mean (M) of 1.42 and a standard deviation (SD) of 0.07, resulting in a low coefficient of variation (CV) of 0.24, indicating minimal variability across the sample (N = 815). The skewness (SK) of 0.27 and kurtosis (KU) of 1.50 suggest that CG is slightly positively skewed and leptokurtic. The regulatory framework variable had a mean of 0.34 and a higher SD of 0.26, with a CV of 0.72, showing more variability in regulatory compliance. The SK of 0.12 and extremely high KU of 17.64 indicate a near-normal distribution with heavy tails. FP had a mean of 0.02 and a SD of 0.05, yielding a high CV of 2.28, indicating significant variability. The negative SK of −9.70 and high KU of 137.58 suggest a highly left-skewed distribution with extreme outliers. These results highlight differences in variability and distribution characteristics among the CG, regulatory framework, and FP variables.

Table II illustrates the findings on the relationship between CG, regulatory framework, and FP. The model accounts for 47% of the variance in FP (R² = 0.47), indicating a significant influence from both CG and regulatory factors. The model’s statistical significance is supported by an F-statistic of 2,405.56 (p < 0.05). CG positively impacts FP (β = 0.14, t = 4.00, p < 0.05), while regulatory framework also shows a significant effect on FP (β = 1.43, t = 13.94, p < 0.05). Importantly, their interaction term is significant (β = 0.76, t = 8.48, p < 0.05), suggesting a synergistic effect. This suggests that a stronger regulatory framework strengthens CG-FP relationship and vice versa.

Table II. Regression Results for Corporate Governance, Regulatory Framework and Financial Performance

Model: Fixed effect model
Panel variable: ID (strongly balanced)
Time variable: TIME, 2018 to 2022
Number of observations		= 815
Number of groups		163
R2	within	= 0.92
	between	= 0.15
	overall	= 0.47
F (3, 649)		==2,405.56
Prob> F		= 0.00
FP	β	SE	t	p	(95% Confid. Interval)
Constant	−0.08	0.03	−2.60	0.01	−0.14	−0.02
Corporate governance	0.14	0.04	4.00	0.00	0.07	0.21
Regulatory framework	1.43	0.104	13.94	0.00	1.23	1.636
Corporate governance * Regulatory framework	0.76	0.09	8.48	0.00	0.58	0.93

The study examined how regulatory frameworks influence the relationship between CG and FP through empirical testing of a null hypothesis, which was rejected, confirming the synergistic moderating role of regulatory frameworks in the CG-FP relationship. These findings are consistent with prior research, indicating that the effectiveness of CG in enhancing FP depends significantly on the regulatory environment in place. For instance, Tembaet al. (2023) in Tanzania found that prudential regulations strengthened the positive impact of CG on FP in commercial banks, echoing the moderating effect observed here. Similarly, studies by Kyere and Ausloos (2021) in the UK and Tahir (2020) in Pakistan highlighted how liquidity moderated the CG-FP relationship, similar to the regulatory framework’s role identified in this study. Further support comes from meta-analyses by Nguyen and Dao (2022) on CG, liquidity, and firm value, and Vincentet al. (2023) on CG and regulatory reforms in Indonesian insurance, all underscoring the regulatory framework’s crucial moderating influence on CG’s impact on FP.

Recommendation

Based on the findings, several actionable recommendations made for management practices and policy formulation. To begin with, it is advisable for organizations to prioritize enhancing their CG practices, given their demonstrated positive impact on FP. This involves promoting transparency in decision-making processes, strengthening the independence of boards, and implementing effective risk management frameworks. Secondly, policymakers should focus on establishing robust regulatory environments that exert significant influence on the nexus between CG and FP outcomes. This entails the adoption of clear and enforceable regulatory standards that foster accountability, ethical conduct, and sustainable practices within organizations. Thirdly, recognizing the synergistic effect observed between CG and regulatory frameworks, management should adopt integrated approaches where adherence to regulatory requirements enhances the efficacy of CG practices. This dual strategy can lead to superior FP outcomes and eradicate risks associated with governance deficiencies or regulatory non-compliance. Lastly, continuous monitoring and adaptation of governance structures and regulatory frameworks are crucial. Regular reviews should ensure alignment with evolving industry norms, technological advancements, and global best practices, thereby sustaining competitiveness and long-term viability

Suggestions for Future Research

Future research should expand beyond focusing solely on deposit-taking SACCOs to encompass a broader spectrum of financial institutions, including non-deposit-taking SACCOs, agricultural SACCOs, microfinance institutions, and other types of financial entities. This inclusive approach would provide a comprehensive understanding of how different governance practices and regulatory frameworks influence FP across various segments within the SACCO sector and broader financial landscape. By conducting comparative analyses across diverse SACCO types, researchers can identify common trends, unique challenges, and best practices, thereby enriching the literature and informing more targeted policy interventions and managerial strategies. Furthermore, future studies should consider employing longer time periods beyond the typical five years used in current research. Extended time frames in panel data studies offer greater depth and accuracy in observing changes and trends, allowing for a more nuanced understanding of causality and the evolution of relationships between variables over time. This extended perspective enhances the robustness and generalizability of findings, providing insights into both long-term patterns and the impact of infrequent events or policy shifts on financial outcomes across different sectors and contexts.

Conflict of Interest

The authors declare that they do not have any conflict of interest.