Does Human Capital Influence the Relationship Between Highest-Paid Director Compensation and Financial Performance in Nigerian Banks?

Does Human Capital Influence the Relationship Between Highest-Paid Director Compensation and Financial Performance in Nigerian Banks?

Ahmed Abubakar Zik-Rullahi¹ & Haleemah Yetunde Zik-Rullahi²

¹Department of Accounting, Faculty of Management Sciences, University of Abuja, P.M.B 117, Gwagwalada-Abuja

²Department of Accounting, Nile University of Nigeria, Jabi, Abuja, Nigeria

DOI: https://dx.doi.org/10.47772/IJRISS.2024.81100010

Received: 15 October 2024; Accepted: 24 October 2024; Published: 27 November 2024

ABSTRACT

This study examines the influence of human capital on the relationship between highest-paid director compensation and financial performance in listed deposit money banks in Nigeria, focusing on Net Interest Margin (NIM) and Tobin’s Q as performance indicators. The study adopted a Feasible Generalized Least Squares (FGLS) regression analysis to test the moderating effect of human capital, incorporating interaction terms between director compensation and human capital metrics. The analysis indicates that higher compensation for the highest-paid director is associated with lower Net Interest Margin, suggesting a negative impact on financial performance. In contrast, no significant relationship was found between director compensation and Tobin’s Q. Additionally, the interaction between director compensation and human capital did not demonstrate a significant effect on either performance indicator. These findings lead to the conclusion that while higher remuneration for directors may negatively affect NIM, there is no meaningful link with Tobin’s Q. The study underscores the importance of human capital as a potential moderator and highlights the need for banks to reassess their compensation strategies and enhance governance frameworks to ensure that executive pay structures effectively promote organizational performance.

Keywords: Highest Paid Director Compensation, Human Capital, Financial Performance, Net Interest Margin (NIM) and Tobin’s Q.

INTRODUCTION

The influence of human capital on financial performance has garnered increasing attention, particularly within the banking sector, where it is crucial for listed deposit money banks in Nigeria. Human capital, encompassing the collective skills, knowledge, and experience of employees, directly affects a bank’s operational efficiency, financial stability, and overall performance (Ali, Egbetokun, & Memon, 2018; Ofurum et al., 2023). In today’s rapidly evolving financial environment, characterized by swift technological advancements and stringent regulatory changes, banks must strategically leverage their human capital to sustain competitive advantages and achieve exceptional financial outcomes.

In the context of Nigeria, deposit money banks play a vital role in the financial system, contributing significantly to economic development and financial inclusion (Adegbola et al., 2018). The effectiveness and efficiency of these banks are profoundly influenced by the quality of their human capital and the compensation strategies of their leadership, particularly the highest-paid directors (Ahamed, 2022). The compensation packages for these directors can significantly impact employee motivation, talent acquisition, and the overall strategic direction of the bank (Barde & Ahmed, 2020).

Research indicates that well-compensated directors are better positioned to attract top talent and drive organizational performance (Nwachukwu et al., 2023). For instance, Oke and Aremu (2020) demonstrate that banks investing in comprehensive training and development programs for their employees exhibit significantly higher levels of operational efficiency and customer satisfaction compared to their less-invested counterparts. Additionally, Adeyemi and Idowu (2021) highlight that strategic investments in employee development, along with competitive director compensation, correlate positively with key financial metrics such as return on assets (ROA) and return on equity (ROE).

The Nigerian banking sector faces unique challenges, including rigorous regulatory requirements, rapid technological changes, and intense market competition (Hassan et al., 2019). According to Afolabi et al. (2022), the ability of banks to effectively navigate these challenges is significantly reliant on the competencies and adaptability of their workforce, which can be influenced by the compensation strategies of their highest-paid directors. The integration of advanced technologies into banking operations necessitates a skilled and agile workforce, making effective leadership and strategic compensation critical (Olaniyi & Oyewole, 2021).

Empirical studies reinforce the idea that banks with robust human capital management strategies and competitive compensation for top leadership tend to achieve better financial performance (Nguyen et al., 2020). Nwachukwu et al. (2023) find that Nigerian banks with well-established human capital development programs experience improved profitability and operational efficiency. This study aims to delve deeper into how human capital influences the relationship between highest-paid director compensation and financial performance, providing a comprehensive analysis and actionable recommendations for enhancing bank performance through strategic human capital management.

Statement of the Problem

Despite the critical role of human capital in driving financial performance, there is a limited understanding of how it interacts with executive compensation, specifically the compensation of the highest-paid directors, within the Nigerian banking sector. While previous studies have established a link between human capital development and bank performance, the specific influence of highest-paid director compensation on this relationship remains underexplored.

Many Nigerian banks struggle to effectively leverage their human capital due to challenges such as inadequate training programs, ineffective leadership strategies, and a lack of alignment between executive compensation and employee performance. As a result, banks may not fully capitalize on the potential benefits of investing in human capital, ultimately affecting their financial outcomes.

Furthermore, the dynamic nature of the banking industry marked by rapid technological changes and stringent regulatory requirements demands a reevaluation of how compensation strategies for top executives can enhance or hinder the motivation and effectiveness of employees. This research aims to address these gaps by investigating how human capital influences the relationship between highest-paid director compensation and financial performance in Nigerian banks, thereby providing insights that could lead to more effective management strategies and improved financial outcomes.

Objectives of the Study

The main objective of the study is ascertaining the influence of human capital on the relationship between highest-paid director compensation and financial performance in Nigerian banks. The specific objective is to:

i. Assess the effect of human capital on the relationship between highest-paid director compensation and financial performance in listed deposit money banks in Nigeria.

Research Questions

The study provided answer to this research question:

i. How does human capital affect the relationship between highest-paid director compensation and financial performance in listed deposit money banks in Nigeria?

Statement of Hypotheses

The hypothesis in null form (H0) guided this study:

H0: Human capital does not moderate the relationship between the highest-paid director compensation and financial performance in listed deposit money banks in Nigeria.

H1: Human capital moderates the relationship between the highest-paid director compensation and financial performance in listed deposit money banks in Nigeria.

Significance of the Study

This study holds significance for various individuals and institutions, including:

i. Bank Management and Executives: Insights from the research will help bank leaders understand the critical role of human capital in enhancing financial performance, guiding them in structuring compensation packages that align with employee development.
ii. Human Resource Professionals: HR practitioners can benefit from findings related to effective human capital management strategies, enabling them to design training and development programs that optimize workforce capabilities and drive organizational success.
iii. Policy Makers and Regulators: The study will provide valuable information for policymakers in the banking sector, helping them craft regulations that promote best practices in executive compensation and human capital investment.
iv. Investors and Stakeholders: Investors and stakeholders in listed deposit money banks can use the findings to make informed decisions, understanding how human capital and director compensation impact financial performance.
v. Academic Researchers: Scholars and researchers will find the study beneficial as it adds to the existing body of knowledge on human capital and executive compensation, offering a framework for future studies in related fields.
vi. Students and Practitioners: Students and professionals studying finance, management, and human resources can gain insights into the practical applications of human capital theories in the banking sector.

LITERATURE REVIEW

Conceptual Review

Concept of Human Capital Theory

Human Capital Theory (HCT) serves as a foundational concept in economic and management studies, positing that investments in education, training, and health significantly enhance individual productivity and economic value. This theory underscores that just as physical capital contributes to productivity improvements, human capital—which encompasses knowledge, skills, and health—plays a vital role in organizational success. Within the banking sector, HCT is particularly relevant as financial institutions increasingly recognize the necessity of investing in their workforce to drive operational efficiency and financial performance. Recent empirical research supports this assertion, demonstrating that effective human capital management can significantly influence banking performance. For instance, Davis and Martinez (2023) reveal that comprehensive human capital strategies, including targeted training and effective management practices, are linked to improved financial outcomes in banks. Their study indicates that banks investing in their employees’ skills and capabilities tend to outperform their peers in profitability and operational efficiency. Similarly, Patel and Zhao (2024) further validate HCT by showing that investments in human capital enhance innovation and operational efficiency, reinforcing the theory’s relevance in the modern banking landscape. This evolving perspective highlights the need for banks to prioritize human capital development; by aligning their strategies with HCT principles, they can leverage their workforce as a key driver of competitive advantage and sustained financial success (Ali et al., 2018; Mirza et al., 2020).

Highest-Paid Director Compensation

Highest-paid director compensation is a critical aspect of corporate governance and organizational performance, reflecting the financial incentives provided to top executives. This compensation often includes salaries, bonuses, stock options, and other benefits, designed to attract and retain talented leaders who can drive company success. Research indicates that competitive compensation packages for directors can enhance their motivation and performance, ultimately benefiting the organization (Jensen & Murphy, 1990). However, excessive compensation may lead to agency problems, where directors prioritize personal financial gain over the interests of shareholders (Fried & Ganun, 2006). In the context of Nigerian banks, where regulatory frameworks and market dynamics differ from those in Western economies, understanding the implications of director compensation becomes crucial. The relationship between compensation and performance is influenced by factors such as company size, industry standards, and the overall economic environment (Core, Holthausen & Larcker, 1999). Therefore, examining the compensation of the highest-paid directors within Nigerian banks offers valuable insights into how these financial incentives align with organizational performance and human capital development (Haque & Ntim, 2020; Ofurum et al., 2023).

Operational Efficiency and Financial Performance

Operational efficiency, which refers to the effective and efficient use of resources to deliver products and services, is crucial for improving financial performance in any industry, including banking. This concept is particularly salient in the banking sector, where efficient operations can lead to substantial cost savings and revenue growth. Enhanced operational efficiency is often reflected in key financial metrics such as Return on Assets (ROA) and Return on Equity (ROE), which measure a bank’s profitability relative to its assets and equity, respectively. Recent studies underscore the positive relationship between operational efficiency and financial performance in banks. Huang and Liu (2024) found that banks investing in employee training and streamlined management practices achieved better cost management and revenue generation. Their research indicates that a well-trained workforce and efficient management processes contribute significantly to improved financial metrics (Huang & Liu, 2024). Similarly, Gupta and Sharma (2023) highlighted operational efficiency as a critical determinant of financial performance in banks. Their study emphasizes that banks with high operational efficiency, driven by robust human capital strategies, tend to perform better financially (Gupta & Sharma, 2023). The linkage between operational efficiency and financial performance highlights the importance of integrating effective human capital management into operational strategies. Banks that focus on optimizing their processes and investing in their employees’ skills are better positioned to achieve superior financial outcomes. This alignment not only improves operational efficiency but also enhances overall financial performance, reinforcing the need for strategic investment in human capital.

Financial performance (NIM and Tobin’s Q)

Financial performance is a critical measure of organizational success, particularly in the competitive landscape of the Nigerian banking sector. This study highlights the role of human capital in influencing financial performance, specifically through the lenses of Net Interest Margin (NIM) and Tobin’s Q. NIM serves as a key indicator of a bank’s profitability and efficiency in managing its interest income relative to its interest expenses, while Tobin’s Q reflects market valuation and growth potential, providing insight into investor perceptions of a bank’s financial health (Promise et al., 2024).

Effective utilization of human capital—encompassing skills, experience, and competencies of the workforce—can significantly impact these performance metrics. Research has shown that organizations that prioritize human capital development are better positioned to optimize financial outcomes. For instance, high-performance work systems that include strategic planning and employee engagement can lead to enhanced operational efficiency and profitability. In their study on Nigerian banks, Promise et al. (2024) found that such systems contribute positively to NIM, indicating a direct correlation between human capital investments and profitability.

Furthermore, Tahir et al. (2023) emphasized the importance of aligning management practices with human capital development to enhance financial performance, particularly through indicators like Tobin’s Q. Their findings reinforce the notion that strategic management practices are essential in leveraging human capital to achieve superior financial results.

Theoretical Review

The study was theoretically underpinned on Human Capital Theory (HCT). It was developed by Gary Becker, posits that investments in education, training, and health significantly enhance an individual’s productivity and economic value. This theory is particularly relevant to the study as it provides a foundational framework for understanding how human capital influences organizational performance, specifically in the context of the banking sector.

In examining the relationship between highest-paid director compensation and financial performance, HCT emphasizes the importance of skilled and knowledgeable employees as key drivers of a bank’s success. By aligning executive compensation with human capital development initiatives, banks can motivate leaders to invest in their workforce, thereby fostering an environment that enhances employee capabilities and, consequently, overall financial performance.

Moreover, HCT supports the notion that strategic investments in human capital can lead to improved operational efficiency and innovation, both of which are crucial for banks operating in a competitive and rapidly changing environment. This theory not only underscores the significance of human capital in achieving financial goals but also highlights the role of leadership in facilitating these investments. Thus, utilizing HCT as the theoretical underpinning for the study allows for a comprehensive exploration of how human capital and executive compensation intersect to impact financial performance in Nigerian banks.

Empirical Review

Ojo and Sulaimon (2022) conducted a study titled “The Impact of Employee Training and Educational Qualifications on Financial Performance: Evidence from Nigerian Deposit Money Banks”. They evaluated secondary data from annual reports of listed banks using multiple regression analysis. Their study found a positive and significant relationship between employee training and educational qualifications and financial performance metrics such as Return on Assets (ROA) and Return on Equity (ROE). Enhanced training programs and higher employee qualifications were associated with better financial outcomes, highlighting the role of human capital in improving financial performance.

Ahmed and Fatima (2021) examined “Employee Experience, Management Quality, and Financial Performance: A Panel Data Analysis of Nigerian Banks”. They analyzed panel data from 15 banks over a decade, using fixed-effects and random-effects models. The study revealed that employee experience and management quality had a significant positive impact on net profit margin and earnings per share. This research underscored the importance of skilled and experienced personnel in achieving strong financial performance.

Johnson and Olabode (2023) investigated “The Effect of Human Capital Practices on Financial Performance in Nigerian Deposit Money Banks”. They collected primary data through structured questionnaires administered to HR managers and financial officers, applying correlation and regression analysis. The findings showed that effective human capital practices, such as recruitment, training, and employee motivation, positively influenced financial performance metrics like ROA and profitability ratios. This study emphasized the importance of well-managed human capital.

Bello and Adebayo (2024) conducted a study titled “Long-Term Investments in Professional Development and Financial Performance: Evidence from Nigerian Banks”. They analyzed data from 10 banks over a 12-year period using vector autoregression (VAR) and Granger causality tests. Their research found a strong positive causal relationship between investments in professional development and improved financial performance indicators. This study highlighted the strategic value of long-term human capital investments for sustained financial success.

Emeka and Chinyere (2020) explored “Human Capital Management and Financial Performance in Nigerian Deposit Money Banks: A Mixed-Method Approach”. They combined quantitative analysis of financial data with qualitative interviews of senior bank managers. Their findings demonstrated that investments in employee skills, leadership development, and job satisfaction positively impacted financial metrics such as profitability and operational efficiency. The study confirmed that effective human capital management practices are crucial for maintaining a competitive advantage and achieving financial success.

METHODOLOGY

Research Design

This study utilized an ex-post facto design to investigate the influence of human capital on the relationship between highest-paid director compensation and financial performance in listed deposit money banks in Nigeria. This approach allows for the analysis of existing financial performance data, examining how variations in human capital and executive compensation have impacted these outcomes over time. By analyzing historical data, the study aims to provide insights into the interactions between human capital, executive compensation, and financial performance in the banking sector.

Area of Study

The study was conducted in Nigeria concentrating mainly on deposit money banks in Nigeria

Sources of Data

This study utilized secondary source of data collection drawn from the audited financial statements of the various deposit money banks in Nigeria spanning the years 2008 to 2022.

Population and Sample Size of the Study

The study’s population consists of 22 banks listed on the Nigerian Exchange Group as of December 31, 2022, selected based on their classification as Deposit Money Banks by the Central Bank of Nigeria. All 22 banks constitute the sample size for this study.

Model Specification

In this study, a Feasible Generalized Least Squares (FGLS) regression analysis was employed to assess the impact of explanatory variables on financial performance and to explore the moderating effect of human capital. The model is specified as follows:

FPit = β0 + β1HPDIit + β2HCit + β3(HPDIit * HCit) + Ԑit …………………………………….(i)
NIMit = β0 + β1HPDIit + β2HCit + β3(HPDIit * HCit) + Ԑit …………………………………….(ii)
TQit = β0 + β1HPDIit + β2HCit + β3(HPDIit * HCit) + Ԑit …………………….…………….(iii)

Where:

FP = Financial Performance
NIM = Net Interest Margin (NIM)
TQ = Tobin’s Q Ratio
HPDI = Highest Paid Director Compensation
HC = Human Capital
e = Error term
i and t = bank i and year t

In the model specification, the interaction term HPDIit * HCit represents the relationship between highest-paid director compensation and human capital, allowing this study to test the moderating effect of human capital on the relationship between director compensation and financial performance.

RESULTS

Summary of Regression Result

Table 1: FGLS Regression Results for NIM and Tobin’s Q

Source: Stata 13 Output, 2024

The analysis examines the impact of the highest paid director on the financial performance of banks, specifically using Net Interest Margin (NIM) and Tobin’s Q as measures. For the NIM model, the coefficient for the highest paid director (HPDI) is -0.1807512, indicating a negative relationship with NIM. The p-value of 0.08 suggests that this relationship is statistically significant, providing strong evidence that higher remuneration for the highest paid director correlates with lower NIM. Consequently, the hypothesis positing a positive relationship between the highest paid director and financial performance is rejected, affirming that increased compensation may hinder financial outcomes.

In contrast, the Tobin’s Q model reveals a coefficient for the highest paid director of -0.120174, with a p-value of 0.56. This indicates that there is no significant relationship between the highest paid director and Tobin’s Q. Therefore, the null hypothesis cannot be rejected, suggesting that any observed impact of the highest paid director on Tobin’s Q is likely due to chance.
Hence, the findings indicate that while a negative relationship exists between the highest paid director and NIM, there is no significant impact on Tobin’s Q. This highlights the complexity of how executive compensation can influence different measures of financial performance in the banking sector.

SUMMARY OF FINDINGS

This study investigated the relationship between the highest paid director and financial performance in listed deposit money banks in Nigeria, focusing on Net Interest Margin (NIM) and Tobin’s Q. The key findings are as follows:

i. The regression analysis for NIM revealed a coefficient of -0.1807512 for the highest paid director, indicating a negative relationship. With a p-value of 0.08, this relationship is statistically significant, suggesting that higher compensation for the highest paid director is associated with lower NIM. As a result, the hypothesis asserting a positive relationship between the highest paid director and financial performance is rejected.
ii. In contrast, the analysis for Tobin’s Q showed a coefficient of -0.120174 with a p-value of 0.56, indicating no significant relationship. This lack of significance means that the null hypothesis cannot be rejected, suggesting that any observed relationship between the highest paid director and Tobin’s Q is likely coincidental.
Hence, the findings indicate a complex dynamic between executive compensation and financial performance, with a significant negative effect on NIM but no discernible impact on Tobin’s Q. These results highlight the importance of evaluating the implications of executive remuneration on various performance metrics within the banking sector.

CONCLUSION

This study explored the relationship between the highest paid director and financial performance in listed deposit money banks in Nigeria, focusing on two key metrics: Net Interest Margin (NIM) and Tobin’s Q. The findings indicate a significant negative relationship between the highest paid director and NIM, with a coefficient of -0.1807512 and a p-value of 0.08, suggesting that higher compensation for the highest paid director is associated with decreased financial performance in terms of NIM. Consequently, the hypothesis predicting a positive correlation between the highest paid director and financial performance is rejected.

In contrast, the analysis found no significant relationship between the highest-paid director’s compensation and Tobin’s Q. This indicates that the remuneration of the highest-paid director does not have a meaningful effect on the market valuation and growth potential of the banks studied. As a result, the changes in director compensation may not influence investor perceptions or the overall financial health of these institutions. This finding highlights the need for banks to consider other factors that might drive market value, rather than solely focusing on executive pay structures.

RECOMMENDATIONS

Based on the findings of this study, two key recommendations are proposed below:
i. Banks should evaluate their compensation packages for the highest-paid directors to ensure they align with long-term financial performance goals. Given the negative association with Net Interest Margin, it may be beneficial to tie compensation more closely to performance metrics that drive profitability and efficiency.
ii. Investing in human capital is essential for improving financial performance. Banks should prioritize training and development programs that enhance employee skills and engagement, as a more skilled workforce can lead to better decision-making and operational effectiveness.
iii. Establishing high-performance work systems that promote collaboration, innovation, and employee motivation can help leverage human capital more effectively. These systems should include clear strategic planning, performance monitoring, and recognition of employee contributions.
iv. Since Tobin’s Q did not show a significant relationship with director compensation, banks should adopt a broader range of performance metrics beyond executive pay. This may include customer satisfaction, market share, and operational efficiency, providing a more holistic view of organizational health.

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