Effects of Financial Innovations and Firm Size on Agency Costs Amongst Commercial Banks in Kenya

Abstract

This study examines the effect of financial innovations and firm size on agency costs amongst Kenya’s Commercial Banks. The study was motivated by the significant growth in branchless banking innovations in Kenya over the study period coupled with major geographical expansion by commercial banks leading to steep rise in banks’ total assets. The focus of the study is on the 11 commercial banks listed at the Nairobi Securities Exchange except for one of the banks which according to the Central Bank of Kenya is also mortgage service provider. The study uses secondary data largely collected from the Central Bank of Kenya Bank Supervision Annual reports and the financial reports of the individual banks. The financial innovations covered include the mobile banking and Automated Teller Machines. The study uses Koyck distributed lag model estimated using system generalized method of moments. The results provide strong empirical evidence linking firm size to agency costs whereby bigger commercial banks account for higher agency costs. The empirical results show that the effect of mobile banking on agency costs is lagged, in that current mobile banking does not show an inverse relationship with agency costs. On the other hand, the lagged (future) mobile banking significantly affects agency costs in an inverse manner. Lastly, no evidence is found linking ATMs with agency costs in Kenya’s listed banks over the study period. The study suggests that the management of commercial banks in Kenya should have a long term view of financial innovations such as mobile banking. This is because the evidence provided by this study suggest that the effect of mobile banking on agency costs is felt long after the innovation has been adopted. Lastly, the study recommends future studies covering mobile banking and ATM transactions at firm level and their resultant effect on agency costs in the banking sector.