EFFECT OF INTERNAL CONTROLS ON FINANCIAL PERFORMANCE OF COMMERCIAL BANKS IN KENYA BY WANYIRI WINFRED WANJIRU D61/7257/2017 A RESEARCH PROJECT SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE AWARD OF THE DEGREE OF MASTER OF BUSINESS ADMINISTRATION, SCHOOL OF BUSINESS, UNIVERSITY OF NAIROBI NOVEMBER 2019 DECLARATION I pronounce to have personally developed this Research Project Report and is not a copy of any other work submitted to any institution for assessment. All references are dully acknowledged. Signature …………………………………….. Date …………………………… Wanyiri Winfred Wanjiru D61/7257/2017 As the University Supervisor, I approve the submission of this Research Project Report for examination. Signature………………………………………… Date..................…………… Joseph Barasa Department of Finance and Accounting School of Business-University of Nairobi ii DEDICATION To: My dear mum, Lucy Wanyiri and loving dad, Simon Wanyiri (you are the reason I have come this far); and My beloved siblings, Cate Wanjira And Veroh Wangui (for your prayers and constant re-assurance of success) And finally, My best friend, Elly Kimani (Your unrelenting motivation and support throughout the Research Project) iii ACKNOWLEDGEMENT I thank the Almighty God for endowment of life and opportunity to come this far. Secondly, I sincerely appreciate the commitment and support made by the following companions and work partners; Mr. Joseph Barasa, my supervisor, owing to his direction all through the entire research composing process and Mr. Oduor from Bank Supervision Department for his assistance in obtaining bank’s financial statements reports for the years under study. Mr. Elly Kimani for his technical assistance required during data analysis. Thank you so much for your noteworthy assistance in making this research process a success. All others who supported me, space doesn’t allow me to mention your names. Please receive my most earnest and heartfelt appreciation. iv TABLE OF CONTENTS DECLARATION........................................................................................................................... ii DEDICATION.............................................................................................................................. iii ACKNOWLEDGEMENT ........................................................................................................... iv LIST OF TABLES ..................................................................................................................... viii LIST OF FIGURES ..................................................................................................................... ix LIST OF ABBREVIATIONS ...................................................................................................... x ABSTRACT .................................................................................................................................. xi CHAPTER ONE ........................................................................................................................... 1 INTRODUCTION......................................................................................................................... 1 1.1 Background of the Study .............................................................................................. 1 1.1.1 Internal Controls ................................................................................................. 2 1.1.2 Financial Performance ........................................................................................ 4 1.1.3Internal Controls and Financial Performance ...................................................... 4 1.1.4 Commercial Banks in Kenya .............................................................................. 6 1.2 Research Problem ......................................................................................................... 7 1.3Research Objectives ....................................................................................................... 9 1.4 Value of the Study ...................................................................................................... 10 CHAPTER TWO ........................................................................................................................ 11 LITERATURE REVIEW .......................................................................................................... 11 2.1 Introduction ................................................................................................................. 11 2.2 Theoretical Review ..................................................................................................... 11 2.2.1 Agency Theory ................................................................................................. 11 2.2.2 Stakeholder Theory ........................................................................................... 12 2.2.3 Stewardship Theory .......................................................................................... 13 v 2.3 Determinants of Financial Performance ..................................................................... 14 2.3.1 Liquidity ........................................................................................................... 14 2.3.2 Operational Efficiency ...................................................................................... 15 2.3.3 Bank Age .......................................................................................................... 15 2.3.4 Bank Size .......................................................................................................... 16 2.3.5 Capital Adequacy ............................................................................................. 16 2.3.6 Asset quality ..................................................................................................... 17 3.3.7 Earnings ............................................................................................................ 17 2.3.8 Management Quality ........................................................................................ 17 2.4 Empirical Review........................................................................................................ 18 2.5 Conceptual Framework ............................................................................................... 22 2.6 Summary of Literature Review ................................................................................... 22 CHAPTER THREE .................................................................................................................... 24 RESEARCH METHODOLOGY .............................................................................................. 24 3.1 Introduction ................................................................................................................. 24 3.2 Research Design.......................................................................................................... 24 3.3 Study Population ......................................................................................................... 24 3.4 Data Collection ........................................................................................................... 25 3.5 Reliability and Validity ............................................................................................... 25 3.6 Data Analysis .............................................................................................................. 25 3.6.1 Diagnostic test .................................................................................................. 26 3.6.2 Conceptual model ............................................................................................. 26 3.6.3 Analytical Model .............................................................................................. 26 3.6.4 Operationalization of Variables ........................................................................ 27 3.6.5 Test of Significance .......................................................................................... 28 vi CHAPTER FOUR ....................................................................................................................... 29 DATA ANALYSIS, FINDINGS AND INTERPRETATIONS ............................................... 29 4.1 Introduction ................................................................................................................. 29 4.2 Descriptive Statistics ................................................................................................... 29 4.3 Correlation Analysis ................................................................................................... 31 4.4 Regression Analysis .................................................................................................... 32 4.5 Interpretation of the Findings...................................................................................... 34 CHAPTER FIVE ........................................................................................................................ 36 SUMMARY, CONCLUSIONs AND RECOMMENDATIONS ............................................. 36 5.1 Introduction ................................................................................................................. 36 5.2 Summary of the Findings ............................................................................................ 36 5.3 Conclusions ................................................................................................................