The Impact of Board Structure, Ownership Concentration, and ... - BZU

The Impact of Board Structure, Ownership Concentration, and CEO Remuneration on Performance of Islamic Commercial Banks in Pakistan

The Impact of Board Structure, Ownership Concentration, and CEO Remuneration on Performance of Islamic Commercial Banks in Pakistan *Nadeem Ahmed Sheikh **Sitara Kareem Abstract This paper examines the affect of board structure (i.e. board size and board composition), ownership concentration, and CEO remuneration on financial performance of Islamic commercial banks in Pakistan over a period of 11 years from 2004 to 2014. Our results show that board size is the only board attributes which is significant and positively related to return on assets and return on equity. Board composition is positively related to return on assets while negatively related to return on equity however the relationship is insignificant. Ownership concentration and CEO remuneration are positively related to both measures of performance but the relationship is insignificant. Finally, bank size is significant and positively related to both measures of performance. In synopsis, board size is the only internal governance attribute that has material effects on financial performance of Islamic commercial banks in Pakistan. Keywords:

Islamic Commercial Banks, Performance, Pakistan

Introduction The importance of Islamic banking in Pakistan is increasing gradually and can be assessed with the fact that a number of conventional commercial banks either opened branches of Islamic banking or created a window of Islamic banking along with conventional banking. Since Islamic banks are the part of the financial system of the country and are bound to act in accordance with the regulations framed the State Bank of Pakistan and Securities and Exchange Commission of Pakistan (SECP). Whether corporate governance indicators affect the financial performance of Islamic commercial banks in Pakistan is a question that needs to be tested empirically. Numerous studies have explored the affect of corporate governance on firm performance however their findings are unclear. More importantly, findings of these studies are mainly based on data of non-financial firms. A few attempts have been made to examine the affect of corporate governance on performance of financial sector firms. In particular, a little is known about the Islamic commercial banks. Thus a diminutive research on Islamic commercial banks and conflicting results of earlier empirical studies are few reasons that have necessitated the need to investigate the impact of board structure, ownership concentration, and CEO remuneration on financial performance of Islamic commercial banks in Pakistan. ____________________________________________________________________________ *Assistant Professor, Institute of Management Sciences B. Z University, Multan. **Institute of Management Sciences B. Z University, Multan.

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Pakistan Journal of Islamic Research Vol 15, 2015

To the authors’ knowledge no study has yet explored these dimensions with respect to Islamic commercial banks in Pakistan. We are sure that findings of this study fill a gap in literature with respect to Pakistan. In addition, findings of this study provide support to bank managers and regulatory authorities in their decision making process. The remainder of this paper is arranged as follows. The next section presents the review of literature. It is then followed by methodology and data description. Results and debate on findings are presented in the next section. Conclusion is provided at the end. Literature Review: A number of studies have examined the affect of board structure, ownership structure, and CEO compensation on firm performance. Unfortunately, findings of earlier empirical studies are not only inconsistent but also unclear. For example, Lee and Isa (2015) have examined the affect of directors’ remuneration on performance of banks in Malaysia during 2003-2011. They observed that directors’ remuneration has a direct relationship with performance measured as return on asset and return on equity. Al-Saidi and Al-Shammari (2015) analyzed the data of 103 listed firms in KSE (i.e. Kuwait Stock Exchange) during 2005-2010 to estimate the relationship between ownership structure and performance. They found that ownership concentration has no linkage to performance. Thus their results negate the implications of agency theory on KSE listed firms which suggest that ownership concentration affect the firm performance by improving monitoring and reducing the conflict of interest. Grassa and Matoussi (2014) conducted a study to examine the current governance practices and governance structure of Islamic banks in GCC countries (i.e. Saudi Arabia, Qatar, Kuwait, Bahrain and UAE) and Southeast Asia countries (i.e. Indonesia and Malaysia). While analyzing the data of 83 Islamic banks during 2002-2011 they observed that Islamic banks boards are stable however boards of directors of Islamic banks in GCC countries are somewhat larger than boards of directors in Southeast Asia countries. Zouari and Taktak (2014) examined the data of 53 Islamic banks in fifteen countries during 2005-2009 to understand the relationship between performance and ownership structure. They found that ownership is concentrated at 49%, and institutional investors come first than the state investors, and family stockholders come in the last. Notably, they found that blockholders ownership have no significant linkage with performance. Nguyen, et al. (2014) observed that independent directors on the boards have no significant relationship with firm performance. Basuroy, et al. (2014) conducted a study to investigate whether CEO compensation generates incentives to engage in managerial behavior that increases the customer satisfaction and in turn increases the firm value. They observed that CEO compensation is an important factor that explains variation in customer satisfaction and value of the firm.

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Sheikh, et al. (2013) conducted a study to examine the affect of some corporate governance variables on performance of non-financial firms in Pakistan. They found that managerial ownership and non-executive directors are inversely while board size, CEO duality, and concentrated ownership are directly related to performance. In addition, CEO duality is directly related to book-based measure of performance. Xiao, et al. (2013) examined the data of Chinese listed firms during 2006-2010 to investigate the determinants of CEO cash compensation in the context of corporate governance and performance. They found a positive association between CEO compensation and performance. Dogan and Yildiz (2013) analyzed the data of banks listed on ISE (i.e. Istanbul Stock Exchange) during 2005-2010 to understand how board size affects the performance. They found that board size is inversely related to bank performance. Liang, et al. (2013) used the data of 50 largest Chinese banks during 2003-2010 to investigate the influence of board characteristics on banks’ assets quality and performance. They found that independent directors on the boards and the number of board meetings have a positive affect on both banks’ assets quality and performance. In addition, they observed that board size has an inverse relationship with bank performance. Al-Saidi and Al-Shammari (2013) examined the data 9 listed banks in Kuwait during 2006-2010 to estimate the effect of board composition on performance. They used two methods namely pooled OLS and 2SLS to estimate the relationship. The results of pooled OLS method indicate that board size and non-executive directors have an inverse relationship with performance. Alternatively, results of 2SLS method indicate that CEO duality has a direct while board size has an inverse relationship with bank performance. Ranti and Samuel (2012) analyzed the data of Nigerian banks to examine the affect of board size on performance. They found that board size is inversely related to bank performance. In addition, their results indicate that a bank with board size below 13 is more feasible than a bank with board size more than 13. Furthermore, they found that banks with larger boards seem to be less profitable than banks with smaller boards. Foroughi and Fooladi (2012) analyzed the data of listed firms in Tehran Stock Exchange to explore the affect of ownership concentration on performance. They found that ownership concentration has an inverse relationship with performance. Moreover their results indicate that the relationship between ownership concentration and performance depends on the industry type. Tomar and Bino (2012) examined the data of 14 listed banks in Jordan during 1997-2006 to investigate the affect of some corporate governance variables such as ownership structure, board size, and board composition on bank performance. They observed that board composition and ownership structure have substantial influence on bank performance. In addition, they have shown that board size has no significant relationship with bank performance. Sami, et al. (2011) observed that independent directors are positively related to both book-based and market-based measures of performance. Jaafar and El-Shawa (2009) used the data of 103 firms in Jordan to understand how ownership 51


concentration and board characteristics affect the firm performance. Their results indicate that multiple directorship, board size, and ownership concentration have a direct relationship with performance. Omran (2009) observed that higher proportion of outside directors and changes in board composition positively affect the performance of newly privatized firms in Egypt. Haniffa and Hudaib (2006) observed that board size and shareholdings of five largest stockholders are positively related to both market-based and book-based measures of performance. Krivogorsky (2006) used the data of 87 European firms during 2000-2001 to investigate the affect of ownership structures and boards of directors on profitability. He observed that independent directors and the level of relational ownership have a direct relationship with the profitability. Moreover, he observed that managerial ownership has no significant relationship with profitability in continental European companies. Admas and Mehran (2003) conducted a study to explore effects of corporate governance on bank holding companies. They found that bank holding companies have bigger boards. Moreover, outside directors on these boards are significantly higher, and have more committees and meet somewhat more regularly. Alternatively, CEOs in bank holding companies hold smaller equity and receives less compensation than manufacturing firms. Furthermore, a smaller number of institutions hold shares of bank holding companies compared to manufacturing firms. Gedajlovic and Shapiro (2002) analyzed the data of 334 Japanese corporations during 1986-91 to understand that how ownership structure affects the firm performance. They found that ownership structure has a direct relationship to corporate performance. In sum, review of most recent studies indicates that fewer attempts have been made to understand the influence of corporate governance variables on performance of Islamic commercial banks. Moreover, results of prior empirical studies yield equivocal findings. Thus a little research on Islamic commercial banks and equivocal findings are few reasons that have necessitated the need to understand the affect of board structure, ownership concentration, and CEO remuneration on financial performance of Islamic commercial banks in Pakistan. Methodology and Data Description Data Description: Our aim is to examine the affect of board attributes, ownership concentration, and CEO remuneration on financial performance of Islamic commercial banks in Pakistan. The data published by the State Bank of Pakistan presents financial information of 5 Islamic commercial banks operating in Pakistan namely Albaraka Bank (Pakistan) Limited, BankIslami Pakistan Limited, Burj Bank Limited, Dubai Islamic Bank Pakistan Limited and Meezan Bank Limited. Owing to special nature of the study we took data from annual reports published by the Islamic commercial banks during the study period i.e. 2004-2014. It is important to note that Meezan Bank Limited is the only Islamic commercial bank which data found completed over a period of 11 years whereas the data of other banks included in the study found incomplete due the reason that these banks have started their operations at different point in time during the study period. Resultantly, final sample based on 52


43 firm-year observations regarding 5 Islamic commercial banks over a period of 11 years from 2004 to 2014. Variables: Definitions of variables are reported in Table 1. Notably, definitions are extracted from literature relevant to corporate governance so that results of this study can be compared with prior empirical studies. Table 1: Definition of Variables Variable Proxy Definition Dependent variables Return on assets ROA Profit before taxes / Total assets. it

Return on ROEit equity Independent variables Board size BSIZ

Profit before taxes / Shareholders equity.

Board composition

BCOM it

Non-executive directors in a bank’s board / Total number of directors.

Ownership concentration CEO remuneration Control variable Bank size

OWNCit

Shares held by 5 to 10 largest shareholders / Total common shares. CEO remuneration / Total return earned by the bank

it

CEORit

SIZEit

Log of board size.

Natural log of total assets.

Methodology A panel data technique namely ordinary least squares method used to determine the effects of board structure, ownership concentration, and CEO remuneration on financial performance of Islamic commercial banks in Pakistan. The basic regression equations express as follows:

ROAit   0  1 BSIZ it   2 BCOM it   3 OC it   4 CEOR it   5 SIZE it   it (Eq.1)

ROEit   0  1BSIZ it   2 BCOM it   3OCit   4CEORit   5 SIZEit   it (Eq. 2) Empirical Results: Descriptive statistics is presented in Table 2. The mean return on assets is 0.11% and return on equity is 3.37%. The return on equity is higher than return on assets due to lower proportion of equity employed by Islamic commercial banks in the country. We have taken log of board of directors to measure the board size. The mean board size is 0.94. It is important to note that minimum number of directors in 53


sample banks boards is 7 and maximum number of directors is 11. Why Islamic commercial banks have more board members? Findings of earlier empirical studies indicate that board size has a direct relationship with firm size (Adams and Mehran, 2003). Notably, Islamic commercial banks have large assets base compared to manufacturing firms in the country as reported by Sheikh and Wang (2011). More importantly, results of pair-wise correlation of variables given in Table 3 show that board size is significantly positively related to bank size. The mean of board composition (i.e. proportion of non-executive directors) is 81.87% which is quite significant and this may be due to sensitive nature of banking business which necessitates the need for effective monitoring of management. The mean ownership concentration indicates that 5 to 10 large shareholders on average owned 58.60% of outstanding shares. Moreover, it is worth mentioning that in an Islamic bank namely Dubai Islamic Bank (Pakistan) Limited 100% shares are held by the Dubai Islamic Bank PJSC UAE (i.e. the holding company and its nominee directors). CEO remuneration represents 1.23% of total return earned by the sample banks during the study period. Finally, the mean natural log of total assets held by sample banks is 17.644. Table 2: Descriptive Statistics Variable N Mean SD MIN MAX 43 ROAit -0.0011 0.0172 -0.0466 0.0217 43 ROE 0.0337 0.1511 -0.3243 0.3160 it

BSIZ it

43

0.9413

0.0743

0.8450

1.0413

BCOM it

43

0.8187

0.1207

0.3333

0.9090

OCit

43

0.5860

0.2152

0.3690

1.000

CEORit

43

0.0123

0.0143

0.0021

0.0812

SIZE it

43

17.644

1.0266

15.208

19.896

Pair-wise Correlation of Variables Pair-wise correlations of variables are presented in Table 3 which indicates that board size is significant and positively correlated with both measures of performance. Board composition is positively associated with both performance measures and negatively associated with board size however the relationship is insignificant. Ownership concentration is significant and positively associated with board composition. Ownership concentration is negatively correlated with return on equity. Board size is directly associated with return on assets however the relationship is insignificant. CEO remuneration is significant and negatively associated with both performance measures and board size. In addition, CEO remuneration is negatively correlated with board composition and ownership concentration but the relationship is insignificant. Finally, bank size is significant 54


and positively correlated with both performance measures and board size. In synopsis, coefficients of independent variables are reasonably small and hence giving no reason for problem of multicollinearity. Table 3: Correlation Matrix Variable

ROAit

ROAit

1

ROE it BSIZ it

ROE it

BSIZ it BCOM it OCit

CEORit SIZE it

1 0.91** * 1 0.45** *

0.48** *

BCOM it

0.16

0.03

-0.13

OCit

0.08

-0.03

-0.23

0.29*

1

CEORit

0.32**

0.33**

0.34**

-0.08

-0.14

1

1

1 0.51** 0.57** 0.45** 0.20 0.07 -0.66 * * * Note: *,**,*** indicates the level of significance at 10%, 5% and 1%

SIZE it

Regression Results and Discussion Table 4 reports the regression results of Eq.1 which shows that board size is significant and positively related to return on assets. Moreover, board composition, ownership concentration, and CEO remuneration are positively related to return on assets however the relationship is insignificant. Bank size is significant and positively correlated with return on assets. Table 5 presents the regression results of Eq.2 which indicates that board size is significant and positively related to return on equity. Board composition is negatively while ownership concentration and CEO remuneration are positively related to return on equity however the relationship is insignificant. Bank size is significant and positively related to return on equity. Our results show that board size is the only board attributes which has a significant positive affect on financial performance of Islamic commercial banks in Pakistan. The positive relationship is in line with implications of resource dependence theory which suggest that a big board with astronomical links to the environment increases the banks’ ability to get the resources at lower costs and thereby increase the performance. In general, no one can deny the importance of 55


relationships, in particular in banking business, because of the fact that core of banking business is to accept deposits. Although bigger boards may consume more resources than smaller boards however their ability to get the resources from external environment at lower costs positively affect the performance. Alternatively, our results indicate that board composition, ownership concentration, and CEO remuneration have no significant relationship with the financial performance of Islamic commercial banks in Pakistan. Finally, bank size has a significant positive impact on financial performance of Islamic commercial banks in Pakistan. Notably, Islamic commercial banks are bigger in size in terms of their assets base than manufacturing firms in Pakistan as reported by Sheikh and Wang (2011). Notably, bigger size of banks provides the justification of bigger banks boards. Table 4: Effects of Explanatory Variables on ROAit Variable C

Coefficient -0.2099

t-Statistic -3.62 2.26

Prob. 0.001

0.0831

SD 0.0579 0.0367

BSIZ it BCOM it

0.0159

0.2041

0.78

0.439

OCit

0.0093

0.0115

0.81

0.422

CEORit

0.0960

0.2147

0.45

0.657

SIZE it

0.0062

0.0032

1.95

0.059

0.3595

N

43

0.2730

F-Statistic

4.15

0.0146

Prob. (F- Statistic)

0.0043

R

2

Adjusted R Root MSE

2

0.030

Table 5: Effects of Explanatory Variables on ROE it Variable C

Coefficient -1.8711

t-Statistic -3.79

Prob. 0.001

0.6057

SD 0.0579 0.3129

BSIZ it

1.94

0.061

BCOM it

-0.0224

0.1738

-0.13

0.898

OCit

0.0142

0.0982

0.14

0.886

CEORit

1.1789

1.8288

0.64

0.523

SIZE it

0.0753 0.3983

0.0274

2.74

N

0.009 43

0.3170

F-Statistic

4.90

0.1249

Prob. (F- Statistic)

0.0015

R

2

Adjusted R Root MSE

2

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Conclusion: This study has explored the affect of board structure, ownership concentration, and CEO remuneration on financial performance of Islamic commercial banks in Pakistan over a period of 11 years from 2004 to 2014. Regression results show that board size has a significant positive affect on performance. The positive relationship confirms the prophecy of resource dependence theory which shows that a big board with astronomical links to the environment plays its role to get the resources from external environment at lower costs and in turn has a positive affect on performance. Notably, regression results show that other variables such as board composition, ownership concentration and CEO remuneration have no significant relationship with financial performance of Islamic commercial banks in the country. Finally, bank size has a significant positive affect on financial performance of Islamic commercial banks in Pakistan. It is important to note that Islamic banks are bigger in size in terms of their assets base than manufacturing firms in the country. Thus bigger size of the banks provides the justification of bigger banks boards as shown by prior empirical studies. In sum, our results provide a base upon which a more detail analysis of Islamic commercial banks could be based. In addition, findings of this provide support to manager in their decision making process. Moreover, our results illuminate the insights of regulatory authorities (e.g., SECP) in formulating the regulations to improve the quality of governance in Pakistan. Owing to data limitations we have explored the effects of internal governance variables on performance however to investigate the effects of external governance variables on financial performance of Islamic commercial banks is the task for future research. References: Adams, Renée, and Hamid Mehran. “Is corporate governance different for bank holding companies?” Economic Policy Review, (2003): 123-142. Al-Saidi, Mejbel, and Bader Al-Shammari. “Ownership concentration, ownership composition and the performance of the Kuwaiti listed non-financial firms.” International Journal of Commerce and Management, 25, no. 1 (2015): 108-132. Al-Saidi, Mejbel, and Bader Al-Shammari. “Board composition and bank performance in Kuwait: an empirical study.” Managerial Auditing Journal, 28, no. 6 (2013): 472-494. Basuroy, Suman, Kimberly C. Gleason, and Yezen H. Kannan. “CEO compensation, customer satisfaction, and firm value.” Review of Accounting and Finance, 13, no. 4 (2014): 326-352.

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