1 Corporate Governance and Bank Performance

Corporate Governance and Bank Performance – An International comparison Vietnam and Malaysia Dao Thanh Binh and Dao Minh Tam1

29 December, 2014

Abstract Corporate governance has become one of the most popular phenomena that draw the worldwide attention recently as this issue has significant influences on the performance of almost every business. Regarding banking industry, the adoption of good corporate governance is much more vital, because a smooth and well-performed banking system lies at the heart of economic development in each country. This paper is to provide a deep look into the relationship between corporate governance and performance of banking sector, especially in two countries, namely Vietnam and Malaysia by presenting both theoretical framework and empirical study. The part of theoretical framework provides readers with profound knowledge about corporate governance in general as well as bank corporate governance in particular with two famous frameworks. In the empirical study section, a number of commercial banks in Vietnam and Malaysia have been randomly chosen as a sample to run econometric models which examine the effect of several variables of corporate governance on the bank performance. The overall result of study shows that board size, audit committee size, and capital adequacy ratio has a significant effect on both Vietnamese and Malaysian commercial banks and there exists the difference in the influence of some corporate governance proxies on the bank performance between Vietnam and Malaysia. Key words: Corporate governance, Malaysia, Vietnam, Capital Adequacy Ratio, Board Size, Audit committee 1. Introduction. 1.1 Research background and objective of study Recently, corporate governance has been progressively well-aware by world-wide researchers. The reason for the popularity of this issue is the occurrence of several scandals such as 1997 Asian financial crisis, Eron and Worldcom in the US, or Libor scandal in the UK. These scandals are considered an alarm of a poor corporate governance standard. If corporate governance serves a key function in assuring the health and development of the economic system, it is worth a great deal of concern. It is a common knowledge that the most important goal of almost every firm is to maximize the value of all shareholders and it is undeniable that high-quality corporate governance mechanisms play a crucial role in increasing the capability of the firm to achieve their defined objectives. Hence, corporate                                                              1

FMT, Hanoi University, Km9 Nguyen Trai Street, Thanh Xuan, Hanoi. Corresponding author: [email protected]

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governance issue should be considered primary objectives in all economic sectors, particularly banking industry, because based on their function of allocating funds from savers to borrowers in an efficient manner, banks are known as a principal component of financial system and economy. As a result, a number of studies have been conducted to discuss the topic of general corporate governance as well as corporate governance in detail. Among ASEAN countries, there are many features in common between Vietnamese banking system and Malaysian banking system. Both Vietnamese banks and Malaysian banks are operating in an emerging financial market. In addition, due to the globalization and integration, either Vietnamese banks or Malaysian banks are faced up to increasingly fierce international competition as well as the requirement for changes in structure. Last but not least, it cannot be denied that the issue of corporate governance has not been paid a significant amount of attention in both countries for a long time. In Vietnam, a survey carried out by International Finance Corporation (IFC) with the assistance of Vietnam’s State Securities Commission (SSC) in 2001 shows that most Vietnamese firms at that time just had a very fundamental understanding of corporate governance. Malaysia also coped with corporate governance problems. Financial crisis in the Asia in 1997 raised the public awareness of the weakness of Malaysian corporate governance system (Abidin, et al., 2007). Hence, according to Lai (2004), after 1997 Asian crisis, Malaysia found it necessary to improve the corporate governance practices in firms to recover the confidence of investors. However, it was not until 2011 that Malaysian Code on Corporate Governance was introduced. Therefore, this paper aims at analyzing the relationship between corporate governance and bank performance in both Vietnam and Malaysia as well as increasing the public attention to the importance of this issue and recommending some necessary solutions to enhance the efficiency and profitability of banking system. First of all, this paper analyses whether or not a significant relationship between the corporate governance mechanisms and performance of banking firms exists in both Vietnam and Malaysia, whether corporate governance and bank performance in Vietnam differ from that in Malaysia. This research paper is organized as follow: Section 1 is the introduction of the topic. Section 2 firstly discusses the background of the study and its contribution to all parties. Then, it presents and explains all theoretical frameworks of general corporate governance and bank corporate governance in detail. Particularly, fundamental concepts of bank corporate governance are illustrated by the two most wellknow frameworks (External- Internal corporate governance mechanism and Triangle Model). These two models are also the bases to build up the empirical study on the situations in Vietnam and Malaysia. The next section reviews Vietnamese banking sector and Malaysian banking system. Section 4 proposes econometric models on the basis of two theoretical frameworks to assess the effect of corporate governance on bank performance. A regression model is run to evaluate the influence of four corporate governance variables: board size, audit committee size, the occurrence of foreign ownership and capital adequacy ratio on Return on equity represented for the performance of banks. Another regression model is also formed to test how board composition influences the bank performance. In the last part, a conclusion is made based on the research findings and some recommendation for future studies as well as policy adoptions will be given.

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2. Literature Review 2.1. Theories on Corporate Governance Corporate governance has drawn the attention of many researchers from all over the world. Therefore, a number of preceding studies carried out on similar topics will be shortly discussed in this part. One of the most renowned documents providing a deep insight into corporate governance is Principles of Corporate Governance released by Organization for Economic Co-operation and Development (OECD) in 1999 and reviewed in 2004. This document has been considered a worldwide benchmark for qualified corporate governance. The important role of corporate governance was stated in the principles that “one key element in improving economic efficiency is corporate governance”. It is defined by OECD principles that “Corporate Governance involves a set of relationship between company’s management, board, shareholders and other stakeholders. It also provides the system through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined” (OECD Principles of Corporate Governance 2004). Another well-known definition of Corporate Governance which was given by Singaporean Committee on Corporate Governance can be found in the research by Fan (2004). Corporate Governance definition is “the processes and structure by which the business and affairs of the company are directed and managed, in order to enhance long-term shareholder value through enhancing corporate performance and accountability, whilst taking into account the interest of other stakeholders. Good corporate governance therefore embodies both enterprise (performance) and accountability (conformance)”. Finance Committee on Corporate Governance in Malaysia (2001) also gives an explanation to the “Corporate Governance” term: “Corporate governance is the process and structure used to direct and manage the business and affairs of the company towards enhancing business prosperity and corporate accountability with the ultimate objective of realizing long term shareholder value, whilst taking account the interests of other stakeholders”. This implies that corporate governance is not only aware of the shareholders but also the other stakeholders. Regarding all these definitions and the analyses of other studies on the same topic, the description of corporate governance can be summarized as the following points. Corporate governance involves the structure through which the goal of a corporation is set up and the methods of achieving this goal are controlled. In addition, corporate governance identifies the way to manage the relationship among all stakeholders of the corporation so that the conflict of interest between owners and managers can be resolved. Agency theory is the most popular theory used to discover the topic of corporate governance. Therefore, this theory is also mainly discussed among corporate governance theories in this research. A popular principal-agent game states that principals hire agents to do things for them and expect that agents will act in their best interests. However, both principals and agents have their own objective functions that they want to maximize. Principals aim at maximizing profits from the business, while the objective of agents is to maximize the utility by selecting the best contract available from principals for appropriate income level which is correspondent to their efforts. Although there are several types of nexus contracts between principals and agents in practice, in this part of the research, the relationship between shareholders and managers is mainly discussed due to our focus on corporate governance in firms. According to the agency theory, as shareholders (called principal) who are owner of the corporation are willing to bear risk but are not likely to possess interest or time to keenly

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manage the corporation (Brealey, et al., 2008), a contractual relationship is made, which enables managers (called agents) to make day- to- day decisions and control the company on behalf of the principal. The problem arises from the separation between ownership and management, which leads to the fact that agents often act on their own interest rather than making efforts to satisfy the interest of principals. Instead of managing the corporation in the way to maximize the long-term wealth of shareholders, agents apply management methods that enable them to satisfy their desire for status, power, job security or income (James and Houston, 1995)

Figure 1: Agency Model

Hire and Delegate

Self‐ interest

 

Principals 

Agents

Perform

Self‐ interest 

Source: Abdallah and Valentine (2009) The conflict of interest between agents and principals can be explained by three noticeable problems stated by Jensen and Smith (1985), namely “choice of effort”, “differential risk exposure”, and “differential time horizon”. Demsetz and Lehn (1985) indicate that the diverging objectives of “cooperating parties”- the principal and agent resulted from the separation between ownership and control inevitably creates the incentives for moral hazard2 and adverse selection3. As a consequence, the resolution of moral hazard and adverse selection leads to unavoidable cost for firm so called agency cost. Obtaining zero agency cost is certainly impossible in practice because the managing cost to achieve zero agency cost level will be even much higher than the agency cost. However, it is indicated by Shankman (1999) that the main focus underlying agency theory is to create an efficient alliance of goal between two “co-operating parties” involved in order to decrease the agency cost. Agency cost defined by Jensen and Meckling (1976) is the sum of managing expense used by the principal to restrict the deviant activities of the agent; “bonding expenditure” by the agent will ascertain that the agent will act to satisfy the interest of the principal or to ensure the principal will be compensated if the activities of agents have negative impacts on the principal; and the residual loss which is the decrease of welfare due to the divergence between the agents decisions and those decisions that would lead to the maximization of the welfare of the principal.                                                              2

Moral hazard refers to the danger of agents not putting forth their best efforts or shirking from their tasks.

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Adverse selection refers to the possibility of agents misinterpreting their ability to do the work agreed, in other words, agents may adopt decisions inconsistent with contractual goals that embody their principals’ preferences (John Fontrodona, 2006)

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A brief summary of agency theory can be found in the table below provided by Eisenhard (2012) Table 1: Fundamental Aspect of Agency Theory Key idea

Principal- agent relationships should reflect efficient organization of information and risk- bearing costs

Unit of analysis

Contract between principal and agent

Human assumption

Self interest, Bounded rationality, Risk aversion

Organizational assumptions

Partial goal conflict among participant Efficiency as the effectiveness criterion Information asymmetry between principal and agent

Information assumption

Information as a purchasable commodity

Contracting problem

Agency (moral hazard and adverse selection). Risk sharing

Main problem

Relationships in which the principal and agent have partly differing goals and risk preferences (e.g. compensation regulation leadership impression management, whistle blowing, vertical integration, transfer pricing)

Source: Agency theory (Eisenhard) Apart from all the criteria presented in above table, three more assumptions which play an important role in differentiating bank corporate governance and general corporate governance can be found out in the research conducted by Dao and Hoang (2012). These criteria include: -

“Normal / Competitive markets”

-

“The relationship of information asymmetry is the principal- agent relationship between managers and owners”

-

“Optimal capital structure requires limited gearing/financial leverage” (Modigliani and Miller theorem), (cited in Dao and Hoang, 2012)

Although agency theory is known as the central foundation of corporate governance, this theory has its own drawback. The theory just concerns the demands of two parties involved: top executives and board of directors rather than other stakeholders such as employees, customers or other environments. The shortcoming of this theory can be reduced in the stakeholder theory. Stakeholder theory discusses the interest of all stakeholders who may gain benefits from or be harmed by the actions of corporation. According to Dao and Hoang (2012), the affected parties in a company can be divided into two main categories: “internal and external”. “Internal” group of stakeholders comprises of executives, board of directors and employees. On the other hand, the “external” one includes customers, suppliers, debt creditors, trade creditors and shareholders. All these stakeholders are involved in managing process of the firm’s performance in different way with different purposes. Among all of them, three parties that affect the performance of the corporation directly and substantially are shareholders, board of directors and executive board. These three parties are mainly in charge of controlling the firm to assure that all the set-up goals of the business will be achieved.

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Nonetheless, the objective of a corporation is not solely making profit to satisfy its investors and executive boards. It is stated by Abrams (1951) that a corporation invariably finds out the way to create a balance among the interests of its various stakeholders in order to ensure that every constituency will achieve some certain degree of satisfaction for their interest. In general, stakeholder theory implies that it is necessary to define how a corporation should be and what it should do to manage the interest of all stakeholders. From the point of view of Friedman (2006) the corporation should also consider itself as one of stakeholder group and it needs to determine as well as manage its own interests, demands and perspectives in accordance with several ethical principles. Managers of the firm play a vital role in this stakeholder management. Managers of the firm should ensure to satisfy the needs of all stakeholders so that each constituency can earn benefit from the corporation and their rights in decision making are respected. At the same time, executive board needs to make sure of the long-term survival of the firm to prolong the profit for each group of stakeholders. All the principles mentioned above are the main content of normative stakeholder theory. Two other approaches of stakeholder theory are descriptive/empirical and instrumental. Although these approaches are quite different, they all have a “normative core” and indicate the way that the firm should be governed and the way that managers should act. Therefore, in the later part of stakeholder theory, we just give the definition and brief discussion on these other two approaches. The descriptive approach concentrates on the way managers and stakeholders behave in practice and how they consider their roles and actions. Meanwhile, the instrumental one defines the action that managers should take if they want to work in the favor of their own interests. In case the personal interest is reckoned as the interest of corporation, which is usually known as maximizing the wealth of shareholders, the fact that the managers treat stakeholders in the way that the stakeholders conceive will lead to a longrun success of the firm. Stewardship theory: In contrast to agency theory, in steward theory, managers are regarded as good stewards, who are willing to sacrifice their self- interests and act in the best interests of the shareholders (Donaldson and Davis, 1991), so the bases of stewardship theory are the behavior of executives. From the point of views of Davis, Schoorman and Donaldson (1997), the behavior of stewards is pro-organizational and it produces higher utility than self-regarding behavior. Also, steward seeks to achieve the goals of the corporations, so steward’s behavior is not conflict with the interests of organization. In stewardship theory, managers behave in a way to seek other values in their jobs such as a good reputation, a job well done, a sense of worth, a sense of purpose or feelings of satisfaction rather than attempting to enhance their individual wealth. Stewards find their strong duties and commitment to the firm. Hence, when the organizational goal is achieved or the long-term wealth of shareholders is maximized, utilities of stewards are at the maximum point too. If the firm want to implement stewardship theory, it will be necessary to define the detailed roles and expectations of managers. The expectations should be result-oriented or goal-oriented, and they should be defined to provide managers with the sense of appropriate challenges, capability and worth. In summary, instead of using self-serving interests as the starting point like agency theory, stewardship theory discusses the sense of obligation and duty of managers to the firm. Managers set up their own goal which is not to satisfy their personal interests, yet to fulfill the interests of the firm. Therefore, instead of controlling and monitoring managers as stated in agency theory, shareholders will empower and trust the managers. The brief description of stewardship theory can be found in figure 2 below

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Figure 2: The steward theory

Empower and Trust Profit 

 

Shareholders 

Stewards 

Protect and maximize  shareholders’ wealth 

Intrinsic &  extrinsic  motivation

Source: Abdallah and Valentine (2009) Resource Dependency Theory The origin of resource dependency theory is the existence of environmental linkage between the corporation and the outside resources. According to Pfeffer and Salancik (1978), directors act as a connection between outside factors and the firm by selecting resources required for the survival of the firm. Therefore, board of director plays an important role in taking vital components of external environment into the firm. Williamson (1985) indicated that transaction costs related to environmental interdependency could be cut down by “environmental linkages” or “network governance”. The organization is in need of indispensible resources, which leads to the development of exchange relationships or “network governance” among organizations. In addition, interdependence in organizational relationships also exists due to the unequal allocation of needed resources. There are a number of factors that exacerbate the character of this dependence. Some of these factors were pointed out by Donaldson and Davis (1991): the important roles of the resources, the relative lack of the resources and the extent to which the resources are concentrated in the environment. Furthermore, directors may act to connect the external resources with the firm to overcome uncertainty caused by the outside environment (Hillman, Cannella Jr & Paetzols, 2000), since effective management to deal with the uncertainty is significantly vital for the existence of the company. According to Gales and Kesner (1994) the resource dependency rule stated that the directors seek to resources such as information, skills and key constituents (suppliers, buyers, public policy decision makers, social groups) and “legitimacy” that will reduce uncertainty. Therefore, Hillman et al. (2000) implies that the possible outcomes of linking the firm with external environmental factors and decreasing uncertainty is reduction in the transaction cost associated with external dependency. This theory is in favor of the appointment of directors to multiple boards on the account of their chances to collect information and develop network in various ways. 2.2. Theories on Bank Corporate Governance One of the most famous standards used to ensure the quality of corporate governance system in the world is Basel II issued by Basel Committee in Banking Supervision. The detailed framework including rules and principles that can be practically adopted in management for banking sector is clearly reflected in Basel II. Pillar I of Basel II indicates the standard to maintain the capital at a safe level, which enables

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banks to cover credit, market and operational risks. These are subject to the monitoring and assessment of their supervisors. Pillar II provides a framework of external and internal bank corporate governance and risk management methods. Meanwhile, Pillar III focuses on corporate governance in terms of transparency and market- discipline mechanism. In addition to Basel II, there are some other studies that also address the theoretical model on corporate governance. The very well-known study which was conducted by Macey and O’Hara (2001) stated four factors that differentiate corporate governance in banks and that in non-banking corporations. Another framework named as “triangle model” was developed by Tandellin et al. (2007) investigated the influence of corporate governance on bank performance and risk management. Apart from these theoretical models, a variety of empirical studies were conducted with the efforts of finding out the effects of corporate governance on bank performance. Among these studies, the very first research to mention is “Corporate Governance and Performance in Banking Firms: Evidence from Indonesia, Thailand, Philippines and Malaysia” by Praptiningsih (2009). This study creates a regression model on a sample of 52 banks and data collected from 2003 to 2007 to test the relationship between corporate governance and bank performance. Another research for similar topic “relationship between corporate governance and bank performance in Hong Kong” carried out by Yung (2009) ran a regression model on 24 licensed banks in Hong Kong from 2005 to 2007. Also, the relationship between corporate governance and bank performance was explored in the research “Impact of Corporate Governance on Performance of Banking Sector on Malaysia” by Bahreini (2013) which used a regression model constructed from the data of 20 licensed banks in Malaysia during the period of five year from 20052006). In Vietnam, the relationship between corporate governance and bank performance was analyzed by Dao and Hoang (2012) in the research “Corporate Governance and Performance in Vietnamese Commercial Banks” which formed a regression model on the data collected from 11 licensed commercial banks in Vietnam from 2008 to 2010. Another research raised concern of this topic is “Political connection in Corporate Governance and performance” conducted by Nguyen (2012) who ran a regression model on data of 32 Vietnamese commercial banks during the period of 2008 and 2011. All of these studies show that the corporate governance have significant effects on the performance of banks. 2.2.1.

External- Internal Bank Corporate Governance Mechanism

Internal Bank Corporate Governance It is stated by Dao and Hoang (2012) that in common practice, depositors often seek to the bank that presents high level of commitment to them. Hence, depositors depend on the information about the aim of managers and owners to adopt good corporate governance. This aim mainly refers to the internal aspect of bank, which is called internal corporate governance. Internal corporate governance was defined by Llewellyn and Sinha (2000) as a system for planning, organizing, leading, monitoring and controlling of the firm’s management regarding to the utilization of resources and the level of risk taking. To be more specific, in banking sector, two major components that establish the quality of corporate governance are management structure and ownership structure. Basel Committee on Banking and Supervision (1999) attributes the responsibility of board of director and bank management to the implementation of good corporate governance. According to Adams and Ferreira (2007), the boards of Directors accomplish their duties of advising and monitoring by choosing appropriate board size and composition. As for banking sector, there have been a number of literatures

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which mention the relationship between Board Characteristics of a bank (including board size and board composition) and its performance Nonetheless, there has been no ultimate result from empirical studies about the effect of Board Characteristics of a bank on its performance due to the mixed evidence from different research. A study in the US conducted by Belkhir (2008) finds no significant relationship between the board size and composition of banks and their performance. In contrast, another study in Hong Kong shows that there is a positive relationship between the board size and the performance of banks (measured by ROA) (Yung, 2009). The same result is obtained for Vietnamese commercial banks in the studies of Dao and Hoang (2012). The research conducted by Adam and Mehran (2008) concludes that the appearance of independent members makes no significant effects on performance of banks, but banking firms with boards dominated by outsiders perform better. In the empirical section of this paper the relationship between Board Characteristics and performance of banks will be analyzed on both Vietnamese and Malaysian banks. External Corporate Governance Due to the reduction in liquidity of banks, managers will not always take extreme risk-taking action to satisfy the interest of depositors. Hence, depositors still need to depend on outside mechanisms which can ascertain that the managers will not act in their interest. This outside mechanism is known as external bank corporate governance. According to Macey and O’Hara (2001), the external corporate governance mechanism involves market control and regulatory system. The market control including competitive forces related to financial products and take-over activities is less discussed in banking sector. On the other hand, regulatory system plays a central role in external bank corporate governance. It is considered a key factor to make sure that bank managers will act in alignment with the interests of shareholders. In banking sector, the regulation and regulators are the representatives of external corporate governance (Cillanelli and Gonzalez, 2000) In each country, Central Bank plays an important role in regulating banking system. By acting as the lender of last resort and controlling money supply, central banks try to maintain the stability and health of the whole financial system. Apart from central banks, some international organizations which are also responsible for ensuring good regulation in banking sector are World Bank, International Monetary Fund (IMF), European Central Bank (ECB), etc. In practice, there are several regulatory barriers to banking activity which are pointed out by Dao and Hoang (2012): “Entry of new domestic and foreign banks”, “Capital requirement”, “Restriction to bank activities”, “Safety net support”, “Disclosure of accurate comparable information” and “Ownership structure”. To sum up, the regulatory system of banks indicate the individual interests which are different from the private interests of banks. The main purpose of bank regulation is to satisfy the public interest, peculiarly the interest of customers.

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Figure 3: Internal and External Framework of Bank Corporate Governance BANK CORPORATE GOVERNANCE FRAMEWORK 

INTERNAL BANK  CORPORATE 

Management  Structure 

EXTERNAL BANK CORPORATE

Ownership  Structure 

Market Control 

Regulatory  System 

Source: Macey and O’Hara (2001) 2.2.2.

Triangle Model

This model aims at discussing bank corporate governance in terms of risk management and bank performance. According to Tandelillin (2007), corporate governance can influence the performance of banks either in a direct or indirect ways by regulating risk management. The relationship between corporate governance and bank performance By implementing good corporate governance, owners and managers of banks are able to enhance the market creditability. As a result, funds can be collected at a lower cost and lower risk level. Therefore, it is believed that banks that apply good corporate governance show better performance. There are many empirical studies that support for this belief. Jiang, et al., (2009) show a positive relationship between corporate governance and Chinese bank performance in their empirical study. Another research conducted by Black, Jang and Kim (2003) also finds out a positive influence of corporate governance on bank performance. In addition, Durnev et al., (2003) use data of largest firms from stock markets in multicountries to run a regression model on the relationship between corporate governance and market valuation. They conclude that higher- quality corporate governance leads to better operating performance and higher market valuation.

Relationship between corporate governance and risk management In banking sector there is a clear relationship between corporate governance and risk management. Interested parties in banks are not only aware of how to enhance earning on their investment but also concerned about the level of bank risk that they are liable for. Therefore, good corporate governance involves both increasing expected return and managing risk exposures. There are various types of risks that banks have to face up to such as interest risk, market risk, credit risk, liquidity risk, operational risk, and solvency risk. In banking system, corporate governance mechanism defines the way to manage these types of risks from various points of views. However, most of these points of views concentrate on the role of regulations and regulators. One of the most famous risk management methods in banking industry is the Capital Adequacy Ratio (CAR), which is measured by bank capital over the risk-weighted assets.

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Relationship between bank performance and risk management: Both bank performance and risk management depends on the implementation of good corporate governance. Also, there is a relationship between these two factors. The interrelation between bank performance and risk management is represented by the trade-off between risk-bearing and returnearning. When bank managers manage the risk of banks well, they will be able to improve the performance of banks. Better bank performance will lead to an increase in bank reputation and public recognition, which allows banks to enjoy lower cost of risky capital and other sources of fund. The interaction between all factors involved in triangle framework is presented briefly in figure 4 below: Figure 4: Triangle Framework on Bank Corporate Governance

Ownership

Corporate Governance

Risk Management 

Bank Performance

Source: Tandelilin (2007) 3. An overview of Vietnamese and Malaysia Commercial Banking system and Corporate Governance status 3.1. Vietnamese commercial banking sector and corporate governance status Vietnamese Commercial banking sector includes three major groups namely State Own Commercial Banks (SOCBs), Joint Stock Commercial Bank (JSCBs), Joint Venture Banks & Foreign Banks (JVBs & FBs). Vietnamese commercial banking system acts as a intermediate attracting the deposits from savers, providing financing for borrowers and banking services for customers. Vietnamese Commercial banking sector has been proving its crucial role in accelerating economic development by allocating financial resource to all economic sectors and stabilizing the purchasing power of the domestic currency. Vietnamese commercial banking sector increases in all aspects such as total asset, capital size, deposit market share, credit market share, diverse products and services. According to the data collected from State bank of Vietnam, in late 2012 the total assets of the whole commercial banking sectors reaching 4,916,437 billion VND (equivalent - 234.12 billion USD)4 increased by 8.82% in comparison with 2011. More specifically, the total asset of SOCBS was higher than the other two groups (2,201,660 billion VND compared with 2,159,363 billion of JSCB and 555,414 billion of JVBS and FBs). In terms of capital size, the whole commercial banking sector acquired the chartered capital of 365,312 billion VND, which was 39.02% higher than the chartered capital of the whole sector in 2011. Although the chartered capital in                                                              4

1 USD = 21,000 VND

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SOCBs presented the highest increasing speed (28.08%), JSCBs obtained the largest capital size with 177,624 billion VND (regarding to 111,550 billion VND of SOCBs and 76,138 billion VND of JVBs and FBs). Vietnamese commercial banking sector also can be reviewed through the market share of each group in Deposit and Credit market. Figure 5: Deposit Market Share

Figure 6: Credit Market Share

Source of figure 5 and 6: SBV and bank annual reports It is clear from two bar charts above that the market share of JSCB in both deposit and credit market increased gradually from 2007 to the early 2012. Although, in 2007, the market share of SOCBs dominated the market structure in both deposit and credit markets with the percentage of 59.50% and 59.30% respectively, during the period, SOCBs market share experienced a downward trend. On the contrary, with the active operation, JSCBs stably accelerate their market share in both markets and even achieve higher percentage of market share in deposit market than SOCBs from 2010 to 2012. The excess of JSCBs deposit market share over SOCBs market share rose from just 1.6% to 3.7%. One of the main reasons for the growth of JSCBs market share in both markets is the outburst of security market in 20062007 and the diversification of shareholder composition as well as the concentration on retail banking among JSCBs.

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Apart from these achievements above, in recent years Vietnamese Commercial banking sector also face with a number of challenges. One of the most remarkable problems is the high level of bad debts. In 2012, there was an alarming rise in the amount of bad debts. In September 2012, in the whole banking system, the amount of bad debts increased by 66% in comparison with the figure of bad debts in 2011 up to 10% of bad debt for the whole system. The highest quantity of bad debts came from Commercial banking sector. The commercial banking sector accounted for 95.5% of bad debts among all financial sectors. Particularly, State Owned Commercial Banks held 50.5% of total bad debts of the commercial banking system. Until now, high level of bad debts is still a great concerning issue in Vietnamese commercial banking system. Also, in September 2012, the net profit of the whole banking sectors decreased by 40%. Many commercial banks suffered from big loss such as Navibank, Habubank, TienPhong Bank, GP Bank, Western Bank, Trust Bank, ACB, SHB and Agri Bank These recent financial problems are a compelling reminder of the critical importance of corporate governance in Vietnamese banking system, which has not been addressed adequate attention for a long period of time. In the meeting sponsored by State Bank of Vietnam and US Department of Treasury, David Hawkins, US Treasury Banking advisor, stated that “No country's financial sector is perfect, but every country can seek to improve governance to make banking a stable pillar of the economy. Good corporate governance would create public trust and confidence in banks and the banking system”. Hence to overcome all challenges and enhance the long-term development of Vietnamese commercial banking, it’s necessary to improve the effectiveness of bank corporate governance and the role of State Bank of Vietnam is to give guidance to banks for effective corporate governance. 3.2. Malaysian commercial banking sector and corporate governance status The Malaysian banking system can be divided into three major groups: Commercial banks, finance company and merchant banks. Of them all, commercial banking sector is considered the backbone of the Malaysian banking sector, since it plays a noticeable role in providing funds for the economy. According to Sufian and Parman (2009), the Malaysian banking system accounted for approximately 70 percent of the total assets of the financial system. The table below illustrates the total assets contribution of three groups making up Malaysian banking system. Table 2: Asset of Malaysian Banking System (RM Million) Period

Commercial bank

Finance company

Merchant bank

2004

761,254.8 (87.26%)

68,421.1

42,691.0

2005

884,599.5 (92.30%)

26,874.9

46,921.7

2006

1,027,812.7 (94.04%)

-

65,101.8

2007

1,145,816.0 (93.81%)

-

75,613.1

2008

1,279,314.3 (95.62%)

-

58,663.9

2009

1,364,664.1 (95.68%)

-

61,542.2

2010

1,486,332.9 (95.91%)

-

63,446.3

2011

1,713,821.3 (96.17%)

-

68,267.6

Source: Jamal et al. (2012)

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As can be seen from the table, the quantity of assets contributed by commercial banking system dominated the total assets of the whole Malaysian Banking System. It was followed by the contribution of the two other groups finance companies and merchant banks. Since financial crisis in 1986, 1996 and 2008, the Malaysian banking system has undergone lots of structural reform. After many merger and acquisition, at the end of 2012 there are 24 commercial banks with 9 domestic banks and 15 foreign banks. Table 3: Assets of Local and Foreign Commercial Banks Period

Domestic Bank

Percentage

Foreign Bank

Percentage

2003

449,338.9

74%

159,719.1

26%

2004

576,985.9

76%

184,256.7

24%

2005

684,576.6

77%

200,154.6

23%

2006

802,391.3

78%

225,421.4

22%

2007

871,468.1

76%

274,347.9

24%

2008

979,658.4

77%

299,655.9

23%

2009

1,056,488.4

77%

308,175.8

23%

2010

1,153,304.4

78%

333,028.5

22%

2011

1,361,679.1

79%

352,142.2

21%

Source: Hamidi (2012) and authors The table revels that the total assets contribute by commercial banking sector increased every year. More specifically, domestic commercial banks made larger contribution to the total assets of the commercial banking system than the foreign commercial banks. From 2003 to 2011, there was a significant and continual growth in the total assets of domestic commercial banks and the figure reached RM 1,361,679.1 million (equivalent – 389.05 billion USD)5 . The amount of total assets held by foreign commercial banks also experienced an upward trend; however, at a lower speed. In 2011, foreign banks owned around RM 352,142.2 million worth of financial assets. The rapid growth of Malaysian commercial banking system can be explained by reform and consolidation of Malaysian banking system, which aligns with the financial liberalization that taking place around the world. The financial liberalization makes room for more competition among both domestic and foreign commercial banks in local banking system. To achieve these significant developments, Malaysian commercial banking system has undergone lots of structural change and reform, especially in corporate governance since financial crises. After the failure of numerous firms in financial crises 1987, 1996 and 2008, corporate governance in Malaysia has received much more attention than before. These crises highlighted weaknesses in corporate governance in Malaysia, which led to attempts to amend and improve the entire corporate sector in Malaysia (Singam, 2003). According to a study about corporate governance in some developing countries in Asia carried out by the Asian Development Bank (ADB), there are several factors that cause the exposure of Malaysia and other Southeast Asian countries to severe problems with their economies and financial system during the financial crisis. These factors consist of the ineffective board of directors, loose internal controls, poor audits, inadequate disclosure and shortage of legal enforcement. Recently, Malaysia has taken this issue into account and several efforts have been made to improve the corporate governance for a sustainable development of the whole financial system in general and the commercial banking system in particular.                                                              5

1 USD = 3.50 RM

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The very first step to enhance the quality of Malaysian corporate governance was the establishment of Finance Committee on Corporate governance in 1998 that consists members in both government and industry. In March 2000, Malaysian Code on Corporate Governance which generated fundamental principles for the corporate governance system in Malaysia was released by this committee. The principles mainly focus on board of directors, director’s remuneration, shareholders and accountability and audit. Also, in March 2001, Financial Sector Master Plan was initiated by Bank Negara Malaysia to shape the future direction for the development of financial sector over the last ten years. Factors of corporate governance that are proposed by this master plan include boosting shareholders’ and consumers’ activisms, establishing and enhancing regulatory control and priority sector financing. Some of the specific measures to the banking sector are the requirement of having board committees to ensure further improvement corporate governance, the adoption of a transparent, clearly structured and early warning system for weak banking institutions, promote mergers and acquisitions between banking firms to increase the number of large capitalized banks and set up deposit insurance institution. 3.3. Common features of Vietnamese and Malaysian banking systems and corporate governance issues: As both Vietnamese and Malaysian banking systems develop emerging economies, they have some common features and the same problems to cope with. The very first problem of banks in developing economies like Vietnam and Malaysia is banking crises. Both Vietnamese and Malaysian banking industries were badly influenced by many crises in 1990s. Particularly, Asian crisis started in Thailand in 1997 and Global crisis from the USA in 2008 created a negative impact on the performance of banking industries in Vietnam and Malaysia. The main causes of being badly affected by these crises are attributed to poor lending and weak corporate governance system. During the crises, the impaired loans in the emerging economies have been generally much greater than that in developed countries (Hawkins and Mihaljek, 2001). One of the most prominent consequences of banking crises is the change in the bank ownership structure. Fears of bank failures led to the interference of governments by nationalizing banks which were in trouble, and then returning them to private ownership, or by promoting merger and acquisition among banks, as well as take-over activities. The second problem is the high level of foreign competition due to the globalization and deregulation. Traditionally, banking industries in emerging markets were highly protected. According to Hawkins and Mihaljek (2001), for many years, banks in these economies constantly achieved good spread on regulated deposit and lending rate. Also, domestic banks benefit from the high barrier for foreign entry. However, global market, technology advancement, macroeconomic pressures and worldwide banking crises in 1990s have proved a demand for the banking industry and regulators to change the way of doing business, deregulate the banking system and open up financial market for foreign entry. As a result, the border between financial products, bank and non-bank financial institutions and the geographical locations has started to be eliminated. Also, the number of foreign banks increased rapidly in banking industries of the emerging economies. These changes have put higher level of competitive pressures on domestic banks in Vietnam, Malaysia and other emerging economic markets. In addition, an increasing presence of foreign participants posed a number of analytical and policy issues in the emerging economies. Some analytical issues are business focus of foreign and domestic banks and the impact of foreign presence on domestic banks. The political issues include how much and what sort of foreign entry should be permitted as well as what key supervisory issues appear as a consequence of a larger number of foreign participants.

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The next issue that banking industries in both Vietnam and Malaysia have been experiencing is merger and acquisition. As mentioned above, after banking crises, many banks in emerging markets are encouraged to merge, so that the number of large capital-sized banks will increase. Historically, Malaysian banking system included a large number of small institutions. However, since Asian financial crisis 1997 and several domestic financial crises, lots of merger and acquisition activities have been taken place in Malaysian banking system because the crises exposed the vulnerabilities of small banks and the needs of these institutions to maintain a high level of capital. In order to minimize the potential impact of systematic risks on the banking sector as the whole, the Malaysian government strongly encourage the merger and acquisition among commercial banks such as the mergers between the Pacific Bank and Phileo Allied Bank, between Hock Hua Bank and Public Bank, between Hong Leong Bank and Wah Tat Bank, between International Bank and Malaysia Sabah Bank, BSN Commercial Bank and Affin Bank, etc...As a result, ten banking groups were formed. These ten banking groups were called anchor banks. Each bank obtained minimum shareholders’ funds of RM 2 billion and asset base of at least RM 25 billion (Fadzland, 2004). Recently, merger and acquisition has also become a popular trend in Vietnamese banking system after the Global crisis in 2008. The number of merger and acquisition transactions among Vietnamese banks increased significantly in 2008 with the record of 10 transactions during the year (Nguyen, 2013). Although M&A activities decreased slightly between 2009 and 2010, Vietnamese banking system witnessed a larger number of merger and acquisition transactions with higher value between 2011 and 2012. Some highlighted M&A transactions should be mentioned are the merger between HabuBank and SHB, the merger among three banks including FicomBank, TinNghiaBank, SCB to establish Saigon Commercial Bank (SCB), and Eximbank merge with Sacombank. According to Nguyen (2013), the M&A activities clearly make Vietnamese commercial banking system stronger. An illustration for this is the merger between HabuBank and SHB. HabuBank used to be a small and weak bank which was required to restructure. However, after merging with SHB, HabuBank was able to make allowances for most of it loans and started to earn profit from the fourth quarter of 2012. Another evidence for advantage of merger and acquisition is the success of merger among three banks mentioned above to establish SCB. After 1 year of merger, new SCB made profit of nearly 82 billion VND. The last common feature of Vietnamese and Malaysian banking system is reflected in the status of corporate governance mechanism in these banking industries. Like other banking systems in developing economies, before financial crises, corporate governance had been a new concept to most of banks in Vietnam and Malaysia. Therefore, it is undeniable that bank corporate governance had not been paid sufficient attention for such a long time. There are several issues that Vietnamese and Malaysian banking sectors all face with. According to Cheung and Chan (2003), the first issue of bank corporate governance in Vietnam, Malaysia and other emerging economies is the ownership structure including family-owned institutions and state-controlled banking firms. Banks which are part of larger family owned businesses are often abused to maximize the interest of family rather than aiming at maximizing the interests of all shareholders or other stakeholders. On the other hand, the problem of corporate governance caused by state control over the banking firms is that government may attempt to achieve policy goals which may not necessarily align with the interests of shareholders. Therefore, it is understandable that in either case, corporate governance is very poor. Another corporate governance phenomenon of Vietnamese and Malaysian banking industries is the lack of transparency of information disclosure. This is mainly caused by the shortage of uniformity in the accounting and audit standards among countries in Asia. As a consequence, some banking firms may only disclose aggregate profits figures rather than net profit or net loss figures, and the implementation of

16

different accounting treatments on discretionary items may have significant impact on net profit figure. The lack of information transparency will cause investors to be confused when they have to make investment decisions. The last issue of corporate governance of both Vietnamese and Malaysian banking sectors mentioned by Cheung and Chan (2003) is caused by legal system and enforcement. The legal system in Vietnam and Malaysia may present an obstacle to implement proper corporate governance principles. For example, it may be practically difficult and pricey for shareholders to have lawsuits against corporate insiders who take illegal action such as undisclosed related-party transactions, self-dealing (of shares), insider trading, and bribery. Such lawsuits are still extremely rare in Asian countries like Vietnam and Malaysia. Due to the common features and issues of Vietnamese and Malaysian banking industries mentioned above, it is reasonable to test the relationship between corporate governance factors and bank performance and make a comparison between the commercial banking sectors of the two countries in this research. 4. An Econometric model for Corporate Governance Analysis in Vietnamese and Malaysian banks 4.1. Research Methodology In this section, we will focus on analyzing the relationship between corporate governance and bank performance in both Vietnam and Malaysia. Then, the comparison of results between two countries will be made. There are various theories included in corporate governance for instance: agency theory, stakeholder theory, resource dependency theory and so on. However, due to the limited scope of this research, agency theory will be mainly explored in terms of Board of Director (principal) and working performance of executive board (agent). Also, our econometric model is based on the structures of two main corporate governance frameworks offered by Macey and O’Hara (2001) and Tandelilin et al (2007). As for the first framework “Internal and External Corporate Governance” of Macey and O’Hara (2001), we will essentially concentrate on the internal side. It means that the relationship between Board characteristics of a bank (including board size, board composition), Audit committee size of a bank and its performance will be concerned. Another framework involved is “Triangle framework” constructed by Tandelilin et al (2007). The model will cover all three triangles mentioned in the framework: Board of Director, Risk Management and Bank Performance. Selection and description of variables used in the model Regarding the theoretical bases used to form our econometric model, relevant variables are selected and briefly described as follows: Bank performance: performance of the bank can be measured by several proxies such as return on equity (ROE), return on asset (ROA), and Tobin’s Q. Among them all, ROE of Vietnamese and Malaysian banks will be chosen in our model to present the performance of the bank, as ROE indicates the return that shareholders will receive for their investment in a corporation. In addition, ROE reflects the level of leverage used by the firm, which is considered the risk craving of shareholders. This ratio is simply calculated by taking net income available to common shareholders divided by the average of common equity.

17

Risk management: the risk management of bank will be measured by the proxy capital adequacy ratio (CAR). CAR is calculated by the total equity over estimated risk weighted assets both on and off- balance sheet. There are several sources enables us to get this ratio such as annual report of the bank released by banks or bank analysis report conducted by a security company. Shareholder characteristics: Almost one third of Vietnamese commercial banks and more than a half of Malaysian commercial banks comprise foreign investment in their ownership structure. Therefore, foreign ownership variable should be taken into account. This proxy will act as a dummy variable denoted DF. This dummy variable will equal to 1 if foreign ownership exists (around 5% ownership) in banks and 0 if there is no foreign investment. Board of Directors: Measured by the following variables: -

Board size (BS) indicates the number of people elected to be in the Board of Director by all common shareholders in annual shareholder meeting. This information can be easily obtained from annual report of the bank

-

Board characteristic and composition: the characteristics of Board of Director is reflected by a number of proxies such as percentage of female members; percentage of non- executive member; and percentage of foreign members in the Board of Directors

Audit committee size (ACS): Audit committee is a committee of the board of directors. One of the key roles of this committee is to work on all aspects of financial reporting. A survey carried out by Raghunandan & Mullen (1996) (cited in Bahreini, 2013) on effectiveness of audit committee between firms with and without financial reporting problems implies that firms which cope with financial reporting problems have no audit committee. The smaller the committee size is, the more effectively the audit committee can solve and discuss issues (Berlin and Bromlow, 2005). Hence, this model tends to include this proxy to test the relationship between audit committee size and performance of banks. The information of audit committee size can be extracted from annual report of the banks. Population and sample At the end of 2012, there are 39 licensed commercial banks in Vietnam and 24 commercial banks in Malaysia. As a result, 39 Vietnamese commercial banks and 24 Malaysian banks are considered as two populations. The list of 39 banks and 24 banks were recorded on the basis of their different asset values. Then, a sample of 31 Vietnamese banks and 21 Malaysian banks were selected from these lists. The data for each variable of 31 Vietnamese banks and 21 Malaysian banks were collected within the period of 5 years from 2008 to 2012. These data are represented as panel data. This period is considered relevant time frame because this period witnessed the advancement of banking system as well as difficulties that Vietnamese banks as well as international banking system underwent. Most of the data for all variables of these samples above are collected from annual report as well as financial statement of each bank and some bank analysis reports conducted by security companies6. Regression methodology is adopted in the research to assess the relationship between corporate governance structure and bank performance. In details, OLS method is used with the assumption that all assumptions of the classical multiple linear regression hold.                                                              6

The authors would like to thank Bahreini, M. for providing us some Malaysia data & guiding us to look for further data

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4.2. Analysis on quantitative model of Corporate Governance and Bank Performance Descriptive Statistic Descriptive analysis has been used to represent the characteristics of all variables involved in the economic model. In this study, descriptive analysis was used to describe the features of variables of interest namely Return on equity (ROE), Board size (BS), Capital adequacy ratio (CAR), Audit Committee size- (ACS) by calculating indicators of central tendency such as mean and median. Also, the maximum and minimum as well as the dispersion from the average (Standard deviation) are also represented. Table 4: Summary of Statistic Description of Variables ROE

BS

CAR

ACS

Mean

11.587

7.544

16.317

3.623

Median

11.170

7.000

14.215

3.000

Maximum

34.060

13.000

55.900

7.000

Minimum

-4.050

4000

6.140

3.000

Std.Dev.

6.502

1.810

8.878

0.822

N

260

260

260

260

Source: Data collected by authors Firstly, as to regard to characteristics of dependent variables, it is clear from the table that ROE of all commercial banks in Malaysia and Vietnam varied from 34.060% to -4.050% with the mean of 11.587%. It means that both Vietnamese and Malaysian commercial banks generated relative high return of equity of 11.59% on average. Nonetheless, there is a significant spread among all observations and their mean. The Royal Bank of Scotland Berhad incorporated in Malaysia gained the lowest return of equity of 4.05% in 2012, while in 2008 the Standard Charter Malaysia Berhad obtained the highest percentage of ROE (34.06%). As for the features of independent variables including Board size, audit committee size and capital adequacy, the table indicates that the average of board size among all commercial banks in Vietnam and Malaysia is 7.54 with a wide range from 4 to 13 members. Most of commercial banks in both Vietnam and Malaysia have medium board size. In Vietnam, most of state owned commercial banks (SOCBs) such as Agribank, Vietinbank still kept their board size of 7 members over the period of 2008 and 2012; however, most of big joint stock commercial banks (JSCBs) have larger size of board directors. Meanwhile, in Malaysia, most of foreign commercial banks have smaller size of board directors ranging from 3 to 5 members than that of domestic commercial banks varying from 7 to 13 members. On the contrary to the board size, almost all Vietnamese and Malaysian commercial banks have small size of Audit committee with the mean of 3.623. The standard deviation is quite low (0.822) because most of commercial banks in both countries have 3 to 4 members in their audit committee. Public bank in Malaysia has the largest audit committee size, rising from 6 to 7 members from 2008 to 2012.

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The last independent variable is capital adequacy ratio (CAR) which is used to measure the risk management of the bank. The table shows that the average of CAR is 16.317% which meets the requirement of State Bank of Vietnam and Bank Negara Malaysia. However, the CAR among commercial banks ranged from 6.14% to 55.9%, which indicates that there is a gap in CAR among commercial banks. In Vietnam, larger commercial banks, especially those belong to SOCBs group tend to have lower CAR than smaller-size commercial banks. The prominent example for that fact is Agribank, one of the largest state owned commercial banks, yet CAR of Agribank was lower than the minimum requirement of SBV in four consecutive years. Curiously, the highest CAR belonged to a small joint stock commercial bank MDB. In Malaysia, foreign commercial banks seem to have higher CAR than local banks. Most of foreign commercial banks incorporated in Malaysia had CAR greater than the average value of 16.3% during the period of 5 years, particularly in 2008 Bank of China Malaysia Berhad obtained the highest CAR of 38%. Correlation Analysis Before the regression model is run, the matrix correlation between our variables (dependent and independent) is performed in the table below. The matrix shows that variables in the model are not highly correlated. Table 5: Correlation Matrix Result ROE

BS

CAR

ACS

ROE

1.000000

0.248837

-0.366550

0.219487

BS

0.248837

1.000000

-0.100096

0.083760

CAR

-0.366550

-0.100096

1.000000

-0.052827

ACS

0.219487

0.083760

-0.052827

1.000000

4.3. Regression Analysis General Model Firstly, our general model consists of one dependent variable ROE- return on equity and three independent variable including board size (BS), Capital adequacy ratio (CAR), Audit committee size (ACS) and the occurrence of foreign ownership to test the effect of corporate governance on the performance of commercial banks in both Vietnam and Malaysia. In this model, we just want to test the importance of foreign ownership presence in the shareholding, so this variable is treated as dummy variable. We denote DF as a dummy variable which is equal to 1 if there is the presence of foreign ownership in the bank and equal to zero if there is no foreign ownership in this bank. Also we include AR (1) in our model as Auto regressive degree 1. Equation 1: Estimated ROE= 6.924 + 0.4748*BS – 0.217*CAR + 1.229*ACS + 0.170*DF + 0.388*AR(1) t-stat (res): 2.648, 2.079, -4.864, 2.506, 0.1825, 6.758 R2 = 32.56%, Adjusted R2 = 31.23%, n=260

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Equation 2: Estimated ROE= 7.045 + 0.47*BS - 0.216*CAR + 1.219*ACS + 0.389*AR(1) t-stat (res): 2.788, 2.077, -4.883, 2.504, 6.797 R2 = 32.55%, Adjusted R2 =31.49%, n= 260 As can be seen from equation (1) and equation (2) board size and audit committee size show a positive relationship with the return on equity, meanwhile the CAR represents negative relationship. Since tstatistic of DF is smaller than critical value (1.960), the dummy variable is insignificant. The more detailed explanation will be provided for further understanding of the model: Board Size: The positive beta coefficient shows a positive relationship of board size on bank performance in both Malaysia and Vietnam. It can be interpreted that ROE is expected to increase 0.47% if the board size increases by one person. This result is quite aligned with the result generated by Dao and Hoang (2012) in their research about “Corporate governance and Performance in Vietnamese Commercial Banks”. In their discussion and finding, Dao and Hoang (2012) also found the positive relationship between board size and Vietnamese commercial bank performance with the increase of 1.95% in ROE when the board size increase by one person. CAR: Both equation 1 and 2 indicate a negative between CAR and bank performance in both countries. When CAR increases by 1%, then ROE will decrease by 0.216% on average, holding other variables constant. The same result was revealed in the research and Dao and Hoang (2012) with 1% increase in CAR leading to the decline of 0.37 in ROE. Audit Committee size: It is indicated in both equation that there is a positive relationship between number of members of audit committees and the performance of commercial banks. ROE is expected to increase to 0.487% on average when audit committee size rises by one person. Bahreini (2013) also made the same conclusion in her study about the impact of corporate governance on performance of banking sector in Malaysia. She found that when audit committee size increases by 1 person, the ROE will increase to 0.33% on average, holding other variable constant. Dummy Variable: from equation 1, it can be interpreted that dummy variables has insignificant impact on the performance of commercial banks in both Vietnam and Malaysia. It means that the presence of foreign ownership in shareholding structure creates no significant impact on the effectiveness of commercial banks in Malaysia and Vietnam. Differences between Malaysia and Vietnam After testing the impacts of some corporate governance proxies on the performance of commercial banks, other models have been run to test whether there is a difference in the effect of corporate governance variables on bank performance between Vietnam and Malaysia. We will use a dummy variable to test the presence of the differences between two countries. The Dummy variable is denoted as Vietnam which is equal to 1 if the data belong to Vietnamese commercial banks and equal to 0 if these belong to Malaysian commercial banks. Equation 3: Estimated ROE= 8.371 + 0.425*BS + 2.000*ACS + 1.770*DF + 0.051*VN*BS 1.352*VN*ACS + 0.304*VN*CAR – 1.725*VN*DF + 0.360* AR (1) t-stat (respectively): 2.943, 1.294, -3.908, 3.033, 1.0968, 0.137, 2.299, -1.655, -0.854, 6.076. R2 = 34.24%, Adjusted R2 = 31.86%, n= 260

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Equation 4: Estimated ROE = 9.294 + 0.394*BS + 1.836*ACS – 0.435*CAR – 1.2618* VN*ACS + 0.243*VN*CAR + 0.361*AR (1) t-stat (res): 3.423, 1.715, 3.371, -4.0246, -2.282, 2.172, 6.208 R2 = 33.91%, Adjusted R2 = 32.33%, n= 260 As can be seen from equation (3) that both t-statistics of VN*BS and VN*DF are insignificant. Therefore, it can be indicated that there is no significant difference in the impacts of board size and presence of foreign ownership on commercial bank performance between two countries. Meanwhile, it is clear from both equations (3) and (4) that “there exist a significant difference in the way that CAR and Audit committee size influence the performance of commercial banks in Vietnam and Malaysia”. The adjusted R2 in equation 4 with fewer variables is higher than the one in equation 3 with three additional variables and the F-test for dropping variable also confirm that model 4 is better than model 3. The R- square of equation 4 is 33.91%, it means that the 33.91% of dependent variables can be explained by independent variables. Also, various tests presented in the appendix shows that there is no possible error namely multicollinearity, heteroscedasticity and autocorrelation that can make result violate assumptions made before testing. Result discussion: now we will focus on discussing the contribution of each explanatory variable to the model 4. Firstly, it is really understandable why Board size has a positive relationship with the performance of banks. There are a number reasons explaining why large board size will lead to better performance of banks. Large board of directors will broaden provision of valuable advice and networks. A larger boar could generate better decisions since these decisions are made based on a variety of competencies and experiences. Last but not least, larger board size can be a good factor in lowering the probability of power concentration into the hand of small group of directors. The result here combine with the statistic descriptive on Board Size showing that for some banks they can still increase the number of Broad Size to increase the performance. However, possible foreign ownership can lead to internal operational costs significantly high in term of technological enhancements which as a result reduce the ROE. Secondly, negative but quite small coefficient of CAR indicates a negative relationship between CAR and bank performance in short term. As discussed in previous sector, CAR is a mean of reducing the credit risk to protect banks as well as their creditor. A higher CAR tends to decrease the amount of risk on equity. Hence, it also lowers the expected return of equity required by Investors. In addition, most of businesses will have to take risk for rapid growth as higher risk, higher return. Therefore, banks must face with the trade-off between safety and return. To maintain a moderate level of CAR, banks need to evaluate thoroughly all requested loan as well as strengthen capital utilization efficiency which influences bank profit. However, this negative relationship may not be true in the long run when a an appropriate capital structure and sufficient CAR can enhance the public trust in the banks, banks will benefit from obtaining financial resources at lower cost, which will increase profitability of banks. Thirdly, regarding the insignificant impact of foreign ownership presence on bank performance, the possible reason is that not only the occurrence of foreign ownership in capital structure has influence on ROE but the involvement of foreign ownership levels such as composition and area of contribution also need to be taken into account as well. It means that if foreign owners merely contribute capital without

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providing technology, experience, knowledge and expertise management for invested banks, ROE may not increase. Finally, in terms of audit committee size, there are some advantages of larger audit committee size leading to higher ROE. With a larger size, audit committee may have more expertise from each individual in several necessary aspects such as accounting, finance and supervisory then the probability of accuracy of financial statements are high and quality of result are more accurate. Also, with the diversity of knowledge and experience of a large audit committee, the committee will be able analyze problems of financial statements better and give more effective and quicker responses to all issues, so that they can ensure the financial statements of company have been properly done and protect the interest of shareholders. Board Composition Model The last question is to test the board composition to see whether it has effect on performance of commercial banks in Vietnam and Malaysia. Firstly, we will examine the effect of board size on performance of commercial banks. Then, we will analyze how board composition contributes to ROE by adding other variables of boar composition such as Percentage of female members (PFE), percentage of foreign members (PFOM) and percentage of non-executive members (PNEX). The resulting regression models are presented from equation 6 to 9 Equation 5:

Estimated ROE = 4.833 + 0.894*BS R2 = 6.19%, Adjusted R2 = 5.82%, n= 260

t-stat (res): 2.872, 4.126 Equation 6:

Estimated ROE = 10.983 + 0.840*BS + 1.588*PFE – 1.088*PFOM -6.703*PNEX () R2 = 7.34%, Adjusted R2 = 5.89%, n=260

t-stat (res): 2.573, 3.882, 0.498, -0.461, -1.636 Equation 7:

Estimated ROE = 10.856 + 0.833*BS -6.4900*PNEX R2 = 7.13%, Adjusted R2 = 6.40%, n=260

t-stat (res) 2.651, 3.805, -1.612 Equation 8:

Estimated ROE = 4.928 + 0.896*BS – 0.764*PFOM R2 =6.23%, Adjusted R2 = 5.50%, n=260

t-stat (res): 2.883, 4.12, -0.335 Equation 9:

Estimated ROE = 4.557 + 0.900*BS +2.121*PFE R2 = 6.36%, Adjusted R2 = 5.63%, n= 260

t-stat (res): 2.631, 4.147, 0.685

It is clearly seen that none of variables of board composition in these equation are significant as the tstatistics of these variable are all lower than the critical value (1.960). Both R-squared and Adjusted Rsquared in equation from 6 to 9 are extremely low and lower than 10. It indicates that board composition has very small effect on the performance of commercial banks in both Malaysia and Vietnam. This result was also stated in the study of Dao and Hoang (2012). Also in the study of Bahreini (2013), she also concluded that there was no significant effect of percentage of female in board composition on the performance of Malaysian commercial banking sector.

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5. Conclusion and Recommendation 5.1. Summary The model suggested that board size, capital adequacy and audit committee size have significant effect on performance of commercial banks represented by ROE in Vietnam and Malaysia. However, there is a difference in the impact of CAR and Audit committee size on bank performance between Vietnam and Malaysia. On the contrary, the foreign ownership presence and the board composition such as percentage of female, foreign ownership, and non-executive members have an insignificant impact on performance of banks. 5.2. Recommendation For further research, the quality of board of directors should be taken into account, since it also contributes to the strength of corporate governance in banks. Boards of directors are responsible for the operations and financial safety of banks. Hence, it is necessary to make sure that members of board directors are well qualified for their position to accomplish their missions. They also should have a clear understanding of their important role in corporate governance and are not influenced by outside factors such as management and other concerns. The board structure should also be designed in the way that can satisfy and protect the interests of other stakeholders such as managers, depositors and lenders. Until now, both in Vietnam and Malaysia, boards of directors are mainly formed with the aim of protecting interests of shareholders. In terms of foreign ownership, our model finds out that there is insignificant relationship between foreign ownership and bank performance in short run. However, in long run, it is possible that banks may benefit from foreign ownership in their structure. Also, apart from capital contribution, the contribution of foreign owners in other areas should be examined such as the involvement and provision of their expertise management. Regarding to risk management, there are a lot of safety requirement apart from CAR that banks need to concern. Banks should develop a high quality internal control mechanism with clear policies and procedures which allow necessary and prompt measures to be taken to address risk. Vietnamese and Malaysian commercial banks should learn from foreign banks in developed markets which have lots of experience in dealing with risk management and applying Basel II Last but not least, each bank should have an audit committee with the size corresponding to that of banks. Apart from audit committee size, future studies can focus on analyzing the effect of audit committee composition, quality of committee members and the number of audit committee meetings on the performance of banks./.

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APPENDIX MAIN EQUATION OF MODEL

TEST MULTICOLINEARITY- AUXILIARY REGRESSION- NO ERROR OF MULTICOLINEARITY

Dependent Variable: ROE Method: Least Squares Date: 04/24/14 Time: 09:59 Sample (adjusted): 2 260 Included observations: 259 after adjustments Convergence achieved after 8 iterations

Dependent Variable: BS Method: Least Squares Date: 12/15/14 Time: 12:00 Sample (adjusted): 2 260 Included observations: 259 after adjustments Convergence achieved after 6 iterations

Variable

Coefficient

Std. Error

t-Statistic

Prob.

Variable

Coefficient

Std. Error

t-Statistic

Prob.

C BS ACS CAR VN*ACS VN*CAR AR(1)

9.294432 0.394321 1.836465 -0.435084 -1.261834 0.243495 0.361367

2.714711 0.229893 0.544738 0.108105 0.552861 0.112081 0.058205

3.423728 1.715235 3.371284 -4.024664 -2.282371 2.172482 6.208539

0.0007 0.0875 0.0009 0.0001 0.0233 0.0308 0.0000

C ACS CAR VN*ACS VN*CAR AR(1)

6.817530 0.448569 -0.028690 -0.380367 0.034617 0.607287

0.597345 0.150754 0.030464 0.158254 0.031514 0.050017

11.41306 2.975507 -0.941749 -2.403516 1.098460 12.14172

0.0000 0.0032 0.3472 0.0170 0.2730 0.0000

Mean dependent var

7.540541

0.339105 0.323370 5.288230 7047.276 -795.3172 21.55023 0.000000

R-squared Adjusted Rsquared S.E. of regression Sum squared resid Log likelihood F-statistic Prob(F-statistic)

0.419895

R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood F-statistic Prob(F-statistic)

0.408430 1.384779

S.D. dependent var Akaike info criterion

1.800435 3.511852

485.1562 -448.7848 36.62554 0.000000

Schwarz criterion Hannan-Quinn criter. Durbin-Watson stat

3.594250 3.544981 2.185170

Inverted AR Roots

Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion Hannan-Quinn criter. Durbin-Watson stat

11.52193 6.428871 6.195499 6.291630 6.234150 2.066134

.36 Inverted AR

27

Roots

.61

TEST OF AUTOCORRELATION- NO AUTOCORREALTION

TEST OF Heteroskedasticity – NO ERROR of Heteroskadasticity

Breusch-Godfrey Serial Correlation LM Test:

Heteroskedasticity Test: Breusch-Pagan-Godfrey

F-statistic Obs*R-squared

1.118949 2.297893

Prob. F(2,250) Prob. Chi-Square(2)

0.3283 0.3170

F-statistic Obs*R-squared Scaled explained SS

Test Equation: Dependent Variable: RESID Sample: 2 260 Included observations: 259 Presample missing value lagged residuals set to zero. Variable

Coefficient

Std. Error

t-Statistic

Prob.

C BS ACS CAR VN*ACS VN*CAR AR(1) RESID(-1) RESID(-2)

0.133444 -0.008098 -0.038972 0.004625 -0.005889 -0.003581 0.317989 -0.354506 -0.068230

2.717434 0.230294 0.546420 0.108430 0.555897 0.112500 0.268907 0.279600 0.116300

0.049107 -0.035165 -0.071322 0.042653 -0.010593 -0.031835 1.182525 -1.267906 -0.586671

0.9609 0.9720 0.9432 0.9660 0.9916 0.9746 0.2381 0.2060 0.5580

R-squared Adjusted Rsquared S.E. of regression Sum squared resid Log likelihood F-statistic Prob(F-statistic)

0.008872

Mean dependent var

-1.11E-14

-0.022844 5.285736 6984.751 -794.1631 0.279737 0.972196

S.D. dependent var Akaike info criterion Schwarz criterion Hannan-Quinn criter. Durbin-Watson stat

5.226378 6.202032 6.325628 6.251725 2.005491

0.874541 4.400352 7.693129

Prob. F(5,253) Prob. Chi-Square(5) Prob. Chi-Square(5)

0.4987 0.4933 0.1740

Test Equation: Dependent Variable: RESID^2 Method: Least Squares Date: 12/15/14 Time: 12:04 Sample: 2 260 Included observations: 259

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Variable

Coefficient

Std. Error

t-Statistic

Prob.

C BS ACS CAR VN*ACS VN*CAR

16.35876 1.489757 0.240491 -0.059178 2.794788 -0.642910

23.65535 1.914511 4.460522 0.883973 4.483761 0.914841

0.691546 0.778140 0.053915 -0.066946 0.623313 -0.702756

0.4899 0.4372 0.9570 0.9467 0.5336 0.4829

R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood F-statistic Prob(F-statistic)

0.016990 -0.002437 52.45805 696217.3 -1390.113 0.874541 0.498700

Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion Hannan-Quinn criter. Durbin-Watson stat

27.20956 52.39424 10.78080 10.86320 10.81393 1.909160