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Electronic copy available at: http://ssrn.com/abstract=2284814 0 Faculty of Postgraduate Studies and Scientific Research German University in Cairo The Effects of Corporate Governance on Bank Performance A thesis submitted in partial fulfillment of the requirements for the degree of Masters of Business Administration By Ahmed Mohsen Salem Al-Baidhani Supervised by Prof. Dr. Ehab K. A. Mohamed Dr. Mohamed Basuony May 22, 2013

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  • 1. Faculty of Postgraduate Studies and Scientific Research German University in Cairo The Effects of Corporate Governance on Bank Performance A thesis submitted in partial fulfillment of the requirements for the degree of Masters of Business Administration By Ahmed Mohsen Salem Al-Baidhani Supervised by Prof. Dr. Ehab K. A. Mohamed Dr. Mohamed Basuony May 22, 2013 0 Electronic copy available at: http://ssrn.com/abstract=2284814
  • 2. Abstract Whereas banks operate under different management, board of directors, ownership structures, and government regulations, there is no specific optimal corporate governance model that may be applied to all banks. This study focuses on corporate governance and its effects on bank performance, regarding both conventional and Islamic banks, verifying the relationships between corporate governance and bank performance and consequent effects related thereto. The study focuses on internal corporate governance factors only. It concentrates on investigating the effects of corporate governance on bank performance in regard to the respective variables, which included investigating the effects of ownership structure, board structure, audit function, and other related variables, such as bank size, age and type, on banks profitability, measured by each banks ROE, ROA, and Profit Margin; analyzing it through using the Statistical Package for the Social Sciences (SPSS) software, in terms of descriptive statistics, Pearson correlation matrix, and regression analysis. The study focuses on conventional and Islamic banks operating in the Republic of Yemen and the six Gulf Cooperation Council (GCC) countries, namely Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates. The study indicates that there is a significant relationship between corporate governance and bank performance through profitability, measured by ROE, ROA, and Profit Margin. It is found that the two predictors, Age and Number of Board Meetings, have a positive and significant effect on banks profitability measured by the outcome ROE; that the two predictors, Board Independence and Bank Size, have a negative and significant effect on banks profitability, measured by ROA; and that there are three corporate governance independent variables, Ownership Concentration, Age, and Board Committees, of which Age and Board Committees have positive and significant effects while Ownership Concentration has a negative and significant effect on banks profitability, measured by the dependent variable Profit Margin. These results are consistent with the results of similar studies referred to hereunder. Keywords: corporate governance, bank performance, profitability, ROE, ROA, profit margin, banks, Yemen, GCC countries 1 Electronic copy available at: http://ssrn.com/abstract=2284814
  • 3. Table of Contents Abstract...1 Table of Contents2 1 Introduction. 4 2 Literature Review.......9 2.1 Corporate Governance and Bank Performance9 2.2 Corporate Governance Parties....10 2.2.1 Internal Governance......11 2.2.1.1 Ownership and Control.....11 2.2.1.2 Role of Management and Board of Directors.......12 2.2.1.3 Role of the Audit Committee and Internal Auditor..................13 2.2.2 External Governance.....14 2.2.2.1 Role of External Auditors... 15 2.2.2.2 Accepted Accounting Practices....16 2.2.2.3 Government Regulations...16 2.2.3 Basel Accords (Basel Agreements)...17 2.2.4 Role of Other Interested Stakeholders.......17 3 Research Methodology.................18 3.1 Research Question and Objectives.........18 3.2 Hypotheses.........19 3.3 Method and Procedure...........20 3.4 Sampling and Data Collection...........21 3.5 Variables............22 4 Analysis and Discussion...25 4.1 Descriptive Analysis..........25 4.2 Correlation between variables.......26 4.3 Regression Analysis..........28 4.3.1 The Effects on Profitability, measured by ROE..............30 4.3.1.1 Model Summary ROE.........31 4.3.1.2 ANOVA ROE.....31 2 Electronic copy available at: http://ssrn.com/abstract=2284814
  • 4. 4.3.1.3 Coefficients ROE.........32 4.3.2 The Effects on Profitability, measured by ROA.......32 4.3.2.1 Model Summary ROA......34 4.3.2.2 ANOVA ROA......34 4.3.2.3 Coefficients ROA.........35 4.3.3 The Effects on Profitability, measured by Profit Margin.35 4.3.3.1 Model Summary Profit Margin....37 4.3.3.2 ANOVA Profit Margin....38 4.3.3.3 Coefficients Profit Margin...38 5 Summary and Conclusion........40 6 Research Limitations...42 References............43 Appendix......51 3
  • 5. 1 Introduction Corporate governance is a system used to direct and control an organization. It includes relationships between, and accountability of, the organizations stakeholders, as well as the laws, policies, procedures, practices, standards, and principles which may affect the organizations direction and control (Cadbury Report 1992). It also includes reviewing the organizations practices and policies in regard to the ethical standards and principles, as well as the organizations compliance with its own code of conduct. In order to safeguard their long-term successes, organizations implement corporate governance to ensure that they are directed and controlled in a professional, responsible, and transparent manner (SarbanesOxley Act 2002). There are two types of corporate governance: first, internal governance, such as shareholders, board of directors, managers, and internal auditors; and second, external governance, such as market incentives, accepted accounting practices, and government regulations. The main reasons behind the importance of the current corporate governance are the separation of organizations ownership and management control, the corporate scandals since the 1990s and until now, and managements accountability to a continuously increasing number of stakeholders. The increasing demand on the corporate governance and accountability related to the board of directors, particularly the recent lawsuits and investigations made the creation of audit committees an extremely necessary step. The Committee of Sponsoring Organizations of the Treadway Commission (COSO), established in the United States and supported initially by the Institute of Management Accountants (IMA), the American Accounting Association (AAA), the American Institute of Certified Public Accountants (AICPA), the Institute of Internal Auditors (IIA) and Financial Executives International (FEI) recommended certain oversight practices for audit committees to follow, providing guidelines about the audit responsibility in evaluating and strengthening corporate controls. COSO also provides thought leadership to executive management and governance entities on critical aspects of organizational governance, business ethics, internal control, enterprise risk management, fraud, and financial reporting. 4
  • 6. It has established a common internal control model against which companies and organizations may assess their control systems. To emphasize on the need for corporate governance, the U.S. Securities and Exchange Commission (SEC) confirmed its interest in such committees by: (a) urging registrants to form audit committees comprised of outside directors, (b) requiring all publicly held companies proxies to disclose information about the existence and composition of their committees, and (c) requiring publicly held companies to state the number of the committee meetings held annually and to describe their committees functions. As part of the corporate governance mechanism, the committee oversees the organizations management, internal and external auditors to protect and preserve the shareholders equity and interests; however, the committees nature and scope of work should be reviewed to make sure that it is capable of playing its role in this regard appropriately, especially after being recently criticized for its shortcomings in achieving the corporate governance objectives. In 1987, the National Committee on Fraudulent Financial Reporting (the Treadway Commission) was created to identify factors that can lead to fraudulent financial reporting and recommend procedures to reduce fraud incidences. The 1987 Treadway report identified the committees as effective means for corporate governance and suggested a list of objectives for these committees to consider. Among the numerous recommendations detailed in the report, the Commission stated that such committees should be informed, vigilant, and effective overseers of the financial reporting process and the companys internal controls. In order to improve the oversight responsibility related to the committee, board of directors, management, internal auditors, and external auditors, in 1999 the Blue Ribbon Committee (BRC) referred to the role of the corporate governance, suggesting that the committee report should be included annually in the organizations proxy statement, stating whether the committee has reviewed and discussed the financial statements with the management and 5
  • 7. the internal auditors. As a corporate governance monitor, the committee should provide the public with correct, accurate, complete, and reliable information, and it should not leave a gap for predictions or uninformed expectations. It is very important to determine and understand the corporate governance oversight and monitoring functions in order to establish and improve the credibility and trustworthiness of the relevant committees as a corporate governance mechanism. The Sarbanes-Oxley Act of 2002, which was passed mainly to protect investors, has a big impact on the corporate governance and accountability, as well as on corporate disclosure. In order to be accepted in most of the Stock Exchange Markets, an organization should have good corporate governance. As part of the corporate governance, the above committees should also examine the non-audit services, referred to above; Arthur Andersen, for instance, as Enrons external auditors, was paid US$27 million for non-audit services, in addition to the US$25 million for auditing services, which created conflict of interest and affected the auditors independence negatively. It is expected that the committees will play a broader corporate governance role in the future, and that the main parties in the governance field support them strongly; however, observers see that there should be a clear and written statements showing the corporate governance mechanism, such as the activities, responsibilities, and objectives. Recent discussions of corporate governance are about the principles raised mainly in three documents: The Cadbury Report (UK 1992), the Principles of Corporate Governance by Organization for Economic Co-Operation and Development (OECD Paris 1998 and 2004), and the Sarbanes-Oxley Act (US Congress 2002). The Cadbury and OECD reports reveal the general principles around which organizations should operate in order to assure proper corporate governance. The Sarbanes-Oxley Act, informally referred to as SOX, is considered a U.S. law issued by the federal government to legislate several of the principles recommended in the Cadbury and OECD reports, such as the following: Shareholders rights and their exercise of these rights should be respected by their organizations (e.g., organizations should communicate necessary information to these shareholders and help them to participate in relevant organizational meetings). 6
  • 8. Other stakeholders, such as customers, suppliers, employees and local communities, also have legal and social rights and interests in these organizations which should show respect and due diligence. The organizations board of directors should have the necessary competence and skills to enable it to review and monitor the management activities. It should also be committed and independent, and should have the proper size and composition. The organizations should have a written code of conduct focusing on integrity and business ethics that should be respected and acted upon by the board of directors, managers, and other officers in the organization. Such code should also be used in selecting new officers, managers, or directors for the organization. In order to meet the disclosure and transparency requirements, the roles, authorities, and responsibilities of the board of directors and management should be clear and made public to the relevant stakeholders to know who is accountable and what his/her accountability is. Meanwhile, the organizations financial reports should be clear, true, transparent, and all necessary and material information should be disclosed. Bank governance was altered tremendously during the 1990s and early 2000s, principally due to bank ownership changes, such as mergers and acquisitions (Berger et al. 2005; and Arouri et al. 2011). The worldwide financial crisis of 2008, which started in the United States, was attributable to U.S. banks excessive risk-taking. Consequently, in order to control such risk and draw peoples attention to the agency problem within banks, there are statements made by bankers, central bank officials, and other related authorities, emphasizing the importance of effective corporate governance in the banking industry since 2008 and until now (Beltratti and Stulz 2009; and Peni and Vahamaa 2011). Therefore, any similar crisis occurred or may occur in the future might be explained as a result of bank governance failure. 7
  • 9. This study focuses on banks operating in Yemen and the GCC countries in order to provide empirical evidence on the effects of corporate governance on bank performance. I used data provided by reliable and credible resources, such as Bankscope database, audited financial statements, and respective banks published reports to examine whether there is a relationship between strong governance and higher profitability. My relevant hypotheses are listed hereunder. The study concentrates on investigating the effects of corporate governance on bank performance in regard to the respective variables, which included investigating the effects of ownership structure, board structure, audit function, and other related variables, such as bank size, age and type, on banks profitability measuring that by each banks ROE, ROA, and Profit Margin, analyzing it through using the aforementioned SPSS, in terms of descriptive statistics, Pearson correlation matrix, and regression analysis. In addition to this first section, this paper is organized as follows: the second section describes the roles of key players in corporate governance, both internal and external; the third section states the research question, objectives of the study, relevant hypotheses, method used in collecting and processing the research data, and definitions of the used variables; the fourth section shows the study analysis and discussion including descriptive statistics, correlation between variables, and regression analysis; the fifth section reveals the summary and conclusion of the study; and the last section points out the research limitations. 8
  • 10. 2 Literature Review There have been substantial literature on corporate governance and its effects on bank performance. The relevant issues that would be addressed in this regard include ownership concentration and control, roles and responsibilities of board of directors and management, roles and responsibilities of audit committees and auditors (internal and external), accepted accounting practices, and government regulations. 2.1 Corporate Governance and Bank Performance Corporate governance standards and principles are extracted from local and international laws, regulations, and rules, as well as from the organizations bylaws, codes of conduct, and resolutions. Corporate governance focuses on the control systems and structures by which managers are held accountable to the banks legitimate stakeholders. The benefits that will be gained by hired managers differ significantly from the benefits that will be received by managers who are also major shareholders; the latter will benefit from their salaries as well as from the bank earnings and stock returns. There are ways that the shareholders may align their interests with the interests of hired managers (Van der Elst 2010). Wealth, or ownership concentration, is another factor which may affect the active players in a bank and the banks governance (Arouri et al. 2011). Deposit insurance incentives and regulatory discipline are also other factors that may influence the governance process at banks (Beltratti and Stulz 2009). The relevant factors of this literature include managers and their incentives, directors and their oversight tasks, shareholders and their ownership concentration in a bank, deposit insurance incentives, and regulatory discipline, as well as these factors effects on the governance framework at banks. Each of these factors may reinforce or replace other factors, or interact differently in the governance process. 9
  • 11. Much of the empirical findings on corporate governance and performance in non-financial institutions are also applicable to financial institutions. However, the optimal designing of bank governance structure is very complex and important relative to unregulated, nonfinancial firms for several reasons. They are prudentially regulated and highly levered compared to other companies and hence bank governance deserves special attention (Adams and Mehran 2003). Moreover, the stakeholders interests at banks extend beyond the shareholders interests since the bank depositors, creditors, and regulators have stakes in the banks as well. Governments are also worried about banks reputations, and consequently regulate their governance, because a banks failure negatively affects the respective countrys economy, and may even spread globally, similar to what happened during the 1997 Asian financial crisis (Pathan et al. 2005) and the 2008 U.S. financial crisis (Peni and Vahamaa 2011). 2.2 Corporate Governance Parties Corporate governance parties include internal parties, such as the organizations shareholders, internal auditors, audit committee, board of directors, CEOs, CFOs, and other executives and managers; and include external parties, such as customers, suppliers, external auditors, stock exchanges, and government authorities. Other parties who have a stake in the organization may include the organizations employees, creditors, and the community at large. The governance chain depends on the size of the organization. In a small family business, it is very simple, consisting of shareholders, board of directors, and managers; some of whom may be family members. In large publicly-held organizations, the chain may include managers, senior executives, executive directors, board, investment managers, trustee of funds, and beneficiaries. The relationship in this governance chain is called Principal-Agent relationship where the principal pays the agent to act on his/her behalf (Johnson et al. 2008). 10
  • 12. 2.2.1 Internal Governance The organizations internal governance has been divided into three main groups, as follows: 2.2.1.1 Ownership and Control As they grow, many organizations move from private ownership (family business) to a publicly-held corporation. This decision may be made due to the need for more equity to finance such growth. Thus, the role of the owners will change as these family members will become part of a wide group of shareholders who transfer their control (i.e., decision rights) to the board of directors, and subsequently to the relevant managers who should act in the shareholders best interests (Johnson et al. 2008). Consequently, a corporate governance framework should be established, comprising a control system that helps aligning the said shareholders interests with the managers and directors incentives. Even though ownership and control structure indicates the types and composition of shareholders in the organization, it should be noted that control is not necessarily an exchangeable term with ownership because there are other items, such as ownership pyramids, voting rights, and various kinds of shares that should be considered in this regard (Johnson et al. 2008). A bank ownership structure may vary from having just a few owners to having a wide and diversified group of stockholders. Some banks may be managed by controlling individuals, while other banks may hire independent managers to operate such banks. Each of these ownership and control relationships may have a strong effect on a banks performance (Johnson et al. 2008). Additionally, ownership concentration and control are different from one country to another. For example, in the Anglo-Saxon countries, the institutional investors own, and consequently control, most of the large banks shares, while in Japan most of these shares are owned by financial companies and industrial corporations. These large investments in the banks give the shareholders the right to control and monitor the banks management (Lehman and Weigand 2001). 11
  • 13. Although concentrated ownership may result in superior performance, it may also result, negatively, in extracting the banks benefits by the controlling stockholders on the account of the minority stockholders (Spong and Sullivan 2007). Therefore, the stockholders goal and motivation may affect the bank performance. According to the financial theory, managers who are also major stockholders benefit through stock returns if they control costs and improve bank performance; but hired managers whose ownership interest is minimal, if any, may not be rewarded in the same manner for the same improved performance (Johnson et al. 2008). In order to deal with the aforementioned principal-agent issue related to hired managers, stockholders and the board should be very careful in conveying their objectives to these managers. Meanwhile, these managers performance should be put under scrutiny, and superior performance should be rewarded (i.e., awarding bonuses, stock options, etc., to these managers). 2.2.1.2 Role of Management and Board of Directors The board of directors is typically the governing body of the organization. Its primary responsibility is to make sure that the organization achieves the shareholders goal. Therefore, the board is accountable to these shareholders. The board of directors has the power to hire, terminate, and compensate top management (Johnson et al. 2008). Therefore, it safeguards the organizations assets and invested capital. In addition to setting the banks objectives (including generating returns to shareholders), the board of directors and senior management affect how banks run their daily operations, meet the obligation of accountability to banks shareholders, and consider the interests of other recognized stakeholders (Basel Committee 2005). During its regular meetings, the board identifies, discusses, avoids, and solves potential problems. Board size and/or composition may affect the bank performance, as stated hereinafter. Board structures and boards capabilities to monitor the banks executives and managers vary from one bank to another (Van der Elst 2010). In order to provide reasonable 12
  • 14. assurance that the bank is accomplishing its objectives as regards reliable financial reporting, operating efficiency, and compliance with laws and regulations, the bank should implement a reliable internal control system monitored by the board of directors, audit committee, and the banks top management. The members of some boards of directors may be selected by the banks president or CEO, who is also the Chair of the Board, and consequently cannot be terminated by the shareholders; such practice is known as duality (Arouri et al. 2011). 2.2.1.3 Role of the Audit Committee and Internal Auditors The main task of the banks audit committee and internal auditors is testing the design and implementation of the banks internal control system and the fairness and reliability of its financial statements. Listing all the tasks of the audit committee and internal auditors is beyond the scope of this paper. However, I would refer to the tasks that are directly related to the activities of both of them, as follows: after the U.S. corporate scandals and the collapse of Enron and WorldCom, as well as Arthur Andersen and others, the internal audit tasks have been changed, especially pursuant to the issuance of the aforementioned Sarbanes-Oxley Act of 2002. One of the main responsibilities of the audit committee is to enhance and maintain the internal auditors independence in order to enable them to achieve their duties. The relationship between the audit committee and internal auditors is important for both parties to fulfill their job commitments. The internal auditors provide the committee with the necessary information to which they have direct access, same as the organizations management, in order to enable the committee to accomplish its oversight and monitoring mission. On the other hand, the committee supports the position of the internal audit function and submits managements irregularities and other relevant managerial and financial issues to the board of directors, after discussing such issues with the internal auditors and relevant other parties (Pathan et al. 2005). 13
  • 15. The committee is concerned with recruiting and terminating the head of the internal audit, and the frequency and duration of the meetings with the internal auditors, as well as ensuring that the internal auditors, especially their head, can communicate directly with the committee anytime. This committees meetings with the head of the internal audit enhance the independence of the internal audit function, supporting the parties discussion about managements errors, irregularities, violations, and fraud. Whereas the oversight of financial reporting and the monitoring of the internal audit performance are two of the main activities of the audit committee, it is mandatory that the committee members, or at least one of them, should have the financial or accounting expertise in order to understand the technical and control issues related to the internal audit to enable the committee to review the internal auditors activities and the results they reach to (Sarbanes-Oxley Act 2002). Consequently, independence and financial expertise are very critical for this committee to play its important role and take advantage of the internal auditors performance. Whenever there are problems or obstacles, the committee performs the necessary investigations using internal feedback, its expertise, and external consultations if needed. Evaluation of the organizations internal control structure and process should also be one of the basic functions of the audit committee and internal auditors. The committee also evaluates the internal auditors effectiveness, their plans and work arrangements, as well as the resources allocated to them. Additionally, the internal auditors should be involved in issues related to the organizations joint ventures, environmental matters, and international operations. As a corporate governance reform, the above-mentioned Act increased the audit committees and internal auditors independence from management. 2.2.2 External Governance External corporate governance consists of the control that external stakeholders exercise over the bank, which include the following: 14
  • 16. 2.2.2.1 Role of External Auditors As part of the Audit Function, the external auditors tasks could be considered as internal and/or external corporate governance. Listing all the tasks of the external auditors is beyond the scope of this paper; however, I would refer to the tasks that are directly related to the audit committee activities as follows: the committee nominates and assists in selecting the external auditor (also called certified public accountants CPA, Chartered Accountants CA, et al.) to audit and/or review the organizations accounts and issuing his/her opinion about the correctness and accuracy of the organizations financial statements, and that these statements present fairly the financial position of the organization. Changing the external auditors also requires direct interference by this committee. In order to protect and preserve the shareholders interests, the committee oversees the nature and scope of work of the external auditors, evaluates their effectiveness, and recommends the proper audit fees that should be paid to them. The committee also assists in ensuring that the external auditors are independent, and that there is no conflict of interest which may weaken the external auditors ability of issuing their opinion about the organizations financial statements and financial position. The external auditors submit their reports to the audit committee where both parties discuss important issues, such as managements errors, irregularities, and fraud; problems or obstacles in the internal control process; and problems related to the preparation of financial statement or financial reporting. The U.S. AICPA requires that external auditors communicate with the audit committee formally as a main part of the audit performance. It also requires that the audit committee receives additional information from the external auditors that may help it in the oversight of the financial reporting and disclosure process. Moreover, the AICPA requires that the external auditors communicate with the committee regarding errors, irregularities, illegal acts, and internal control structure. The committee reviews the external auditors management letter and submits its relevant notes to the board of directors. This committee also reviews the external auditors plans and 15
  • 17. arrangements of works, and may ask the external auditors to report to it about any differences or disputes between them and the organizations management. Additionally, the committee facilitates the communications between the external auditors and the organizations board of directors and attends their relevant meetings. For independence purposes, the committee may review any non-audit service agreements with the external auditors to understand the nature and magnitude of relevant fees paid. Regulations worldwide require that each banks financial reports should be audited by independent external auditors who issue a report that accompanies the banks financial statements. In order to remove the conflict of interest which jeopardizes the integrity of the banks financial statements and maintain, as well as increase, the external auditors independence, the United States Congress issued the above Sarbanes-Oxley Act to prohibit auditing firms from providing both auditing and management consulting services to the same client. Similar laws have been issued in other countries. 2.2.2.2 Accepted Accounting Practices The U.S. GAAP and European IFRS allow managers various methods to choose from regarding their recognition of financial reporting elements. In order to make their bank performance look better than what it really is, the managers may abuse such choice advantage and thereby increase the information risk for users through falsification of values, concealing fraud, or hiding important information that should be disclosed. 2.2.2.3 Government Regulations Corporate governance has been reformed by many governments; one of these reforms is the above Sarbanes-Oxley Act which was issued in 2002 after the U.S. corporate scandals. Some governments hired consulting firms and sponsored committees to consult with 16
  • 18. regarding corporate governance issues, which included, among other things, internal control requirement, external disclosure of information, audit function and responsibilities, and the role and effectiveness of directors (Johnson et al. 2008). 2.2.3 Basel Accords (Agreements) Basel Accords issued by the Basel Committee on Banking Supervision (BCBS) which is located at the building of the Bank for International Settlements in Basel, Switzerland. The BCBS, which was formed on June 26, 1974 in response to the liquidation of Herstatt Bank of Cologne, Germany, does not enforce its recommendations although most countries implement them. Three Accords have been published by the BCBS so far, as follows: Basel I of 1988 regarding the minimum capital requirements for banks; Basel II of 2004 and its updates during 2005-2009 with respect to capital requirements, supervisory review, and market discipline; and Basel III which is agreed upon by the BCBS in 2010-2011 as regards capital adequacy, stress testing, and market liquidity risk. 2.2.4 Role of Other Interested Stakeholders There are other stakeholders, such as customers, suppliers, employees, and local communities to whose rights the organizations pay very little attention. Organizations should understand that these stakeholders have contractual and social rights, and that there is a corporate social responsibility (CSR) imposed on these organizations towards these stakeholders (Johnson et al. 2008). 17
  • 19. 3 Research Methodology 3.1 Research Question and Objectives There are lots of writings discussing the effects of corporate governance on corporate performance in financial and non-financial institutions. Although many of these writings talk about the corporate governance effects on bank performance, only a few of them talk about such effects in the Arab World. In order to answer the research question What are the effects of corporate governance on bank performance? there are other questions that need to be answered; this study focuses on the following questions: A- What are the effects of ownership structure, board structure, and audit function on banks profitability? B- What kind of profitability, higher or lower, will a bank with stronger corporate governance have? C- Which of the above corporate governance variables is/are significantly related to banks profitability? The study answers the research question through investigating the effects of corporate governance on bank performance in regard to the respective variables, which included investigating the effects of ownership structure, board structure, audit function, and other related variables, such as bank size, age and type, on banks profitability measuring that by each banks ROE, ROA, and Profit Margin, analyzing it through using the above-mentioned SPSS, in terms of descriptive statistics, Pearson correlation matrix, and regression analysis. In the United States, Europe, and many other countries around the world, there are bank examination reports that provide much of the bank governance information, such as the responsibilities of the bank managers and policymakers, the amount of stock each shareholder have, the family relationship among the banks shareholders, directors, 18
  • 20. policymakers and senior managers, as well as the personal wealth and other relevant matters enjoyed by these bank members. Such bank reports are not available in the Arab World. However, Bankscope reports show some financial and non-financial information about banks, including banks operating in the Arab World. I used such information and information from other relevant reports and websites detailed hereunder. 3.2 Hypotheses The following hypotheses have been tested in previous banking researches. For instance, (Glassman and Rhoades 1980) compared financial institutions controlled by their owners with those controlled by managers and found that the owner-controlled institutions had higher earnings. (Allen and Cebenoyan 1991) found that bank holding companies were more likely to make acquisitions that added to firm value when they had high inside stock ownership and more concentrated ownership. (Cole and Mehran 1996) discovered higher stock returns at thrifts that either had a large inside shareholder or a large outside shareholder. These studies thus offer some support for the hypothesis that stockholdings provide an incentive to run a bank better and achieve higher earnings for its stockholders. In light of the aforementioned and in order to answer the research questions listed above, the study hypotheses would be as follows: H1: There is a significant and positive relationship between corporate governance (ownership structure, board structure, and audit function) and bank performance H2: Banks profitability is positively and significantly affected by ownership structure (such as ownership concentration and foreign ownership), board structure (such as board independence, board committees, duality, and board meetings), and audit function (such as 19
  • 21. external audit type), as well as by bank size and age. 3.3 Method and Procedure In order to test the aforementioned hypotheses, I used quantitative method to investigate the effects of corporate governance on bank performance in regard to the respective variables, which included investigating the effects of ownership structure, board structure, audit function, and other related variables, such as bank size, age and type, on banks profitability measuring that by each banks ROE, ROA, and Profit Margin, analyzing it through using the above-stated SPSS, in terms of descriptive statistics, Pearson correlation matrix, and regression analysis. I used Bankscope database to select the country, Yemen or a GCC country, and selected the top fifty banks from the above seven countries, as detailed hereunder. I also used the respective banks websites and other websites to extract the relevant financial and nonfinancial information about each bank from its published audited financial statements, annual reports, and other relevant information. Afterwards, I analyzed the data, using the aforementioned SPSS. After collecting and measuring the data, the analysis of data includes, but not limited to, the following: First, data reduction which involves selecting, coding, and categorizing the data. Second, data analysis using the above SPSS, displayed in the form of table or matrix so that the data could be understood. Third, drawing conclusion based on the aforementioned analysis. The study focuses on banks, both conventional and Islamic, operating in Yemen and the GCC countries. 3.4 Sampling and Data Collection As explained above, my targeted population is the conventional and Islamic banks operating in Yemen and the GCC countries. I used the aforementioned Bankscope database, the respective banks audited financial statements, annual reports, and other related information published on these banks websites as well as other relevant reliable websites, to collect the 20
  • 22. data needed about the selected banks as regards the subject dependent and independent variables. Table 1 below shows the population and samples selected per country: Table 1 Population and samples per country Country Bahrain Population (All Bankscope List) 58 Kuwait 33 10 7 Oman 14 7 7 Qatar 14 7 7 Saudi Arabia 22 12 9 United Arab Emirates 39 19 7 Yemen 13 11 8 193 95 59 Total Population (Banks only) 29 Sample Size 14 My sample includes conventional and Islamic banks operating in Yemen and the aforementioned six GCC countries. I used 2011 since it is the latest year for which the respective banks should have their audited financial statements published by now. Consequently, I excluded from the sample all banks that do not have these audited financial statements or their annual reports available. I also excluded banks about which no sufficient data is available. I did not consider financing, insurance, or non-bank institutions since they are different from banks with respect to their specific characteristics, management structures, accounting procedures, and audit functions. My final sample consists of the largest 50 conventional and Islamic banks operating in Yemen and the six GCC countries. The process of selecting this sample is based on the values of these banks total assets and the consequent ranking stated by Bankscope database. 21
  • 23. Any bank excluded due to any of the above reasons has been replaced with the next immediate bank in ranking. Table 2 hereunder summarizes the sample selection: Table 2 - Sample selection Number of banks selected from Bankscope Database based on its ranking for 2011 and the number of banks in each country 59 No annual reports available for 2011 (3) No sufficient data about bank (6) Final sample 50 3.5 Variables For bank performance measurement, the dependent variables used are the profitability measures ROE, ROA, and Profit Margin. Meanwhile, the independent variables used in regard to corporate governance are categorized into four sections, as follows: 1) Ownership structure which include ownership concentration, institutional ownership, foreign ownership, and alignment of interests; 2) Board structure which include board size, board independence, duality, board committees, number of board members, number of nonexecutives on board, number of board meetings per year, existence of remuneration/compensation committee, and existence of nomination committee; 3) Audit function including external audit type, existence of audit committee, number of audit committee members, number of audit committee non-executive members, and number of audit committee meetings per year; and 4) Other related variables that include bank type, bank age, bank size, and existence of corporate governance reports. Table 3 hereunder shows the definition and measurement of these twenty-five variables: 22
  • 24. Table 3 - Definition and measurement of variables Variable Symbol Definition Measurement Dependent Variables ROE The amount of return on banks equity Net Income divided by Average Total Equity ROA The amount of return on banks assets Net Income divided by Average Total Assets PROFIT.M Profit Margin Net Income divided by Revenue TYPE Bank Type Conventional bank = 1; Islamic = 0 AGE Age of Bank 10 years old or more = 1; less than 10 years old = 0 BNK.SIZE Bank Size Bank assets amounting to US$ 1 Billion or more = 1; less than US$ 1 Billion = 0 OWN.CONC Ownership Concentration Adding up all share ratios of shareholders of the bank who have 5% or more (excluding others) INSTITUT Institutional Ownership If there is/are institutions holding bank shares (i.e., Institutional) = 1; Non-institutional = 0 FOREIGN Foreign Ownership ALIGN.IN Alignment of Interests If there is/are Foreign ownerships = 1; Non-foreign = 0 Owner Manager = 1; Hired Manager = 0 BRD.SIZE Board Size 5 members or more = 1; less than 5 members = 0 BRD.INDP Board Independence Number of non-executive members on the board divided by Total number of board members DUALITY CEO Duality Duality: If the CEO and Chairman are Not the same person = 1; If otherwise = 0 BRD.COMT Board Committees If there is a Board Committee (Audit, Compensation, etc.) = 1; If not = 0 Independent Variables 23
  • 25. EXT.AUDT External Audit Type If the external auditor is one of the Big 4 CPA Firms = 1; Any other = 0 BRD.MBRS Number of Board Members Total number of board members during 2011 BRD.NONX Number of NonExecutives on Board Number of non-executive members on the board during 2011 BRD.MTNG Number of Board Meetings per Year Number of board meetings held during 2011 CG.RPRT Corporate Governance Report If Corporate Governance Report exists = 1; If it does not = 0 REM.COMT Remuneration /Compensation Committee If Remuneration / Compensation Committee exists = 1; If it does not = 0 NOM.COMT Nomination Committee If Nomination Committee exists = 1; If it does not = 0 AUD.COMT Audit Committee If Audit Committee exists = 1; If it does not = 0 AUD.MBRS Number of Audit Committee Members Number of Audit Committee members during 2011 AUD.NONX Number of Audit Committee NonExecutive Members Number of the non-executive members in the Audit Committee during 2011 AUD.MTNG Number of Audit Committee Meetings per Year Number of audit committee meetings during 2011 24
  • 26. 4 Analysis and Discussion For statistical analysis, I used the aforementioned SPSS, as follows: 4.1 Descriptive Analysis Table 4 hereunder provides descriptive statistics of the respective variables. Bank Age is shown with a mean of 29.74 years and a median of 30.5 years which indicates that the banks in the region have an average of 30 years of experience, which ranges from 4 to 75 years. Bank Size with an average of 92% (close to 1 unit) indicates that most of the respective banks have large amount of total assets (exceeding US$1 billion). Ownership Concentrations average exceeds 62% which means that most of the bank shares are owned by block holders, which also has a significant impact on bank performance. Board Committees also with on average of 92% indicates that most of the relevant banks have committees facilitating and assisting the banks boards of directors in performing their tasks. Meanwhile, Board Independences average which exceeds 62% indicates that most of the respective banks boards are independent (consist mostly of non-executive members). Board Meetings indicates that the banks boards met approximately 5 times during 2011, with an average of 4.94, which is a good indication about the monitoring and supervising the banks operations by the board of directors. The Profit Margin is shown as a high average of 37.62%, but with a negative profit margin of -37% as a minimum. The table also shows a higher Return on Assets with an average of 1.65 times, but with a negative return of -90% as a minimum. Likewise, Return on Equity is shown as the highest return with an average of 10.29 times, but also with a negative return of -7.65 times. 25
  • 27. Table 4 Descriptive statistics Variable ROE ROA PROFIT.M TYPE AGE BNK.SIZE OWN.CONC FOREIGN ALIGN.IN DUALITY BRD.COMT EXT.AUDT BRD.MBRS BRD. NONX BRD.INDP BRD.MTNG CG.RPRT REM.COMT NOM.COMT AUD.COMT AUD. MBRS AUD.NONX Mean Std. Deviation 10.286 6.065221365 1.6474 1.06112149 0.3762 0.219562552 0.78 0.46467017 29.74 15.44814895 0.92 0.274047516 0.6233906 0.28482618 0.6 0.494871659 0.16 0.37032804 0.08 0.274047516 0.92 0.274047516 0.9 0.303045763 9.48 2.224538475 8.46 2.042507463 0.6233906 0.28482618 4.94 1.633951015 0.86 0.350509833 0.74 0.443087498 0.59183673 0.496586991 0.86 0.350509833 3.02 1.477587664 2.78 1.374550019 Minimum -7.65 -0.9 -0.37 0 4 0 0.05 0 0 0 0 0 6 4 0.05 0 0 0 0 0 0 0 Maximum 22.48 4.91 0.75 2 75 1 1 1 1 1 1 1 19 13 1 9 1 1 1 1 6 5 4.2 Correlation between variables For correlation between independent corporate governance variables among themselves, and between these independent variables and dependent bank profitability variables, I used Pearson Correlation Matrix shown below as Table 5, briefed as follows: The Profitability measures ROE and Profit Margin are positively and significantly correlated with Bank Age at the 5% level (2-tailed). ROA shows a significant negative correlation with Board Independence at the 1% level and with Bank Size at the 5% level (both 2-tailed). Profit 26
  • 28. Margin also shows a significant negative correlation with Ownership Concentration at the 1% level, and positive significant correlation with Board Committees at the 5% level (both 2-tailed). ROE and Profit Margin also show a significant negative correlation with Board Independence at the 5% and 1% levels respectively (both 2-tailed). Profit Margin is also positively and significantly correlated with Audit Committee at the 5% level (2-tailed). Moreover, there are significant correlations among the dependent variables and also among the independent variables at the 1% and 5% levels, such as between ROE, ROA, and Profit Margin; as well as between Bank Size and Board Committees, between Foreign shareholders and External Auditors, and between Ownership Concentration and Board Independence (all at the 1% level). Regression results and respective explanations regarding the relationships, and consequent effects, between banks profitability and relevant corporate governance variables are discussed hereunder. 27
  • 29. Table 5 Pearson correlation matrix ROE ROE ROA PROFT. M PROFT.M .804** .611** 0.196 -0.024 BNK.SIZE OWN.CONC FOREIGN ALIGN.IN DUALITY BRD.COMT EXT.AUDT BRD.MBRS BRD. NONX BRD.INDP BRD.MTNG CG.REPRT REM.COMT NOM.COMT AUD.COMT BNK.SIZE OWN. CONC FOREIG N ALIGN. IN DUALITY BRD. COMT EXT. AUDT BRD. MBRS BRD. NONX BRD. INDP BRD. MTNG CG. REPRT REM.C OMT NOMC OMT AUD. COM T 1 .674** AGE AGE 1 ROA TYPE TYPE 0.123 * .361 -0.205 -.286* 1 0.198 1 0.168 * .324 0.066 1 0.019 0.024 1 -.286 -.453 -.369 0.185 -0.070 0.059 1 -0.102 0.015 -0.005 -0.035 -0.131 0.060 0.022 1 -0.150 -0.007 -0.090 -0.147 -0.032 -0.072 0.097 0.245 -0.087 0.184 0.026 -0.019 0.034 -0.185 0.057 0.241 0.082 0.165 0.179 -0.106 0.107 0.131 -0.029 0.141 * 0.178 ** .313* ** .358* .457** -0.242 ** .676 1 0.129 0.087 0.145 0.098 -0.014 -0.010 -0.053 -0.271 0.024 -0.070 -0.013 0.252 0.096 -0.235 0.139 -0.188 -0.273 0.105 0.251 0.185 -0.070 0.059 0.022 0.097 0.057 0.080 0.020 -0.085 0.011 0.019 -0.093 0.010 0.007 -0.083 -0.207 0.176 0.119 .332* -.286* -.453** -.369** 0.158 0.045 0.191 0.117 -0.244 0.022 0.070 0.160 -0.068 -0.116 0.068 0.065 0.080 0.113 -0.225 0.016 -0.167 0.014 0.014 0.193 * .298 .314* 0.058 -0.096 -0.203 .393** .306* 0.161 .359* * .306 -0.230 .361** 1 0.779** -0.020 -0.037 0.100 0.254 -0.196 .408** .376** ** .540 .409** ** .376 .376** .538** .370** 1 .639** 1 -0.003 0.103 -0.042 0.010 -0.242 -0.230 -0.013 -0.273 1 0.070 0.081 0.119 -0.020 1 0.166 0.092 -0.037 0.270 0.191 0.090 0.100 -0.049 -0.073 0.254 -0.069 -0.108 -0.196 * .354 .518** ** .634** ** .497 .562 .359* .406** ** .731 ** .634 1 .692** 1 ** 1 ** .457 .681 .311* .492** ** .413 ** .502 1 .724** ** .549 **. Correlation is significant at the 0.01 level (2-tailed). *. Correlation is significant at the 0.05 level (2-tailed). 4.3 Regression Analysis Since there is more than one independent variable to explain the variance in each of the three dependent variables, I used the multiple regression analysis and relevant stepwise method in order to assess the degree and character of the relationship between the banks profitability three outcome measures (ROE, ROA, and Profit Margin) and corporate governance predictors described above. Each predictor variable has its own coefficient, and 28 1 ** .373 1
  • 30. the outcome variable is predicted from a combination of all the variables multiplied by their relevant coefficients plus a residual term, as follows: Regression Equation: y = a + b1x1 + b2x2bnxn + i where y is the outcome variable; b1 refers to the coefficient of the first predictor (x1); b2 represents the coefficient of the second predictor (x2); bn refers to the coefficient of the nth predictor (xn); and i is the difference between the predicted and the observed value of y for the ith participant. The stepwise method relies on the computer selecting the variables based upon mathematical criteria, under which the regression equation is constantly being reassessed, removing from the model any predictor that meets the removal criterion and reassessing for the remaining predictors. Consequently, we get the linear combination of predictors that correlate maximally with each of the aforementioned three outcome variables. The Model Summaries hereunder show the collapse of the individual correlations between the independent variables and each dependent variable into a Multiple R (also called Multiple Correlation Coefficient). R Square (or R) is the amount of variance explained in the dependent variable by the predictors. calculates Adjusted R. In addition to calculating R and R, SPSS also This adjusted value indicates the loss of predictive power or shrinkage. It tells how much variance in the dependent variable would be accounted for if the model had been derived from the population from which the sample was taken. The Analysis of Variances (ANOVA) examines the significant Mean differences among more than two groups on an interval or ratio-scaled dependent variable. Its results show whether or not the Means of the various groups are significantly different from one another, as indicated by the F statistic. Regarding the Coefficients tables, the t-test is used to measure whether or not the predictors make a significant contribution to the model; and the b-values refer to the positive or negative relationship between the predictors and the respective outcome. The smaller the value of Sig.(and the larger the value of t), the greater the 29
  • 31. contribution to the Model (Field 2009). The 1% error refers to a 99% level of confidence and the 5% error refers to a 95% level of confidence. 4.3.1 The Effects on Profitability, measured by ROE As stated hereunder, the two predictors (Age and Number of Board Meetings) have positive and significant relationships with, and consequently positive and significant effects on, the outcome ROE. Bank Age has a positive and significant impact on ROE due to the learning curve principle which makes a bank learn from its previous good and bad experience for correction, improvement and more development, as long as other corporate governance predictors remain constant. Older banks have higher ROE than younger banks due to the interaction between the bank age and the market share, as well as the longer tradition and good reputation that could have been built by the passage of time. Therefore, bank age contributed significantly to the performance measures of ROE. Since they focus on increasing their market share rather than on improving profitability, newly established banks are not profitable in their first years of operations. This result is consistent with the results of the studies of (Stathopoulos et al. 2004; and Athanasoglou et al. 2005). The Number of Board Meetings per year also has a positive and significant effect on ROE. The increase in the Number of Board Meetings means an increase in monitoring, follow-up, supervision, direction, and attentiveness by the board of directors which leads to facilitating the banks operations and assisting management in achieving the banks objectives through making the right decision on the right time, taking advantage of the available opportunities and avoiding the potential threats. The frequency of board meetings helps the board members to know the senior management team and to understand the banks operations in order to perform the board tasks appropriately. This result is consistent with the results of the studies conducted by (Davidson et al. 1998; Godard and Shatt 2004; and Bouaziz and Triki 2012). 30
  • 32. 4.3.1.1 Model Summary - ROE The individual correlations between the independent variables and dependent variables ended up into the multiple R (or the multiple correlation coefficients). Therefore, column R in the following ROE, ROA, and Profit Margin summary models indicates the values of the multiple correlation coefficients between the predictors and the outcomes (Field 2009), as follows: Table 6 refers to the correlation between the two predictors (Age and Number of Board Meetings) and the dependent variable ROE. In this model, the R square of 21.4% is the amount of variance explained in the ROE by the above two predictors. The difference between R square and the Adjusted R square is 3.4% (i.e., 21.4% - 18%). This small shrinkage means that if the model were derived from the population rather than from the sample, it would account for 3.4% less variance in ROE. Table 6 ROE Model summary Model R R Square Adjusted R Square Std. Error of the Estimate ROE .463 .214 .180 5.57592 4.3.1.2 ANOVA ROE ANOVA tests if the Model is significantly better at predicting the outcome ROE than using the mean as a best guess. The F-ratio represents the improvement in prediction that results from fitting the model, relative to the inaccuracy that still exists in the model. The Mean Square is then calculated for each term by dividing the SS by the df. For the ROE ANOVA shown hereunder under Table 7, the F value is highly significant (at the 1% level) which means that the Model is a significant fit of the data. 31
  • 33. Table 7 ROE ANOVA Model Sum of Squares df Mean Square F Sig. Regression 389.509 2 194.755 6.264 .004 Residual 1430.183 46 31.091 Total 1819.692 48 4.3.1.3 Coefficients - ROE The t-test here is used to measure whether the predictors make a significant contribution to the model. As regards the ROE measure, Table 8 shows that both predictors (Age and Number of Board Meetings) have positive b-values which means that there is a positive relationship between them and the outcome ROE. Consequently, as Age increases, ROE also increases; and as the Number of Board Meetings increases, so does the ROE. Age makes a significant and positive contribution at the 1% level, and Number of Board Meetings also makes a significant and positive contribution at the 5% level. Table 8 ROE Coefficients Model (Constant) AGE Unstandardized Coefficients B Unstandardized Coefficients Std. Error Standardized Coefficients Beta t Sig . -.652 .177 1.093 3.425 .054 .507 .443 .292 -.190 3.272 2.156 .850 .002 .036 BRD.MTNG 4.3.2 The Effects on Profitability, measured by ROA Board Independence means that the majority of the board members are non-executive members indicating that the board is exercising its powers of directing, controlling, and 32
  • 34. monitoring independent from the executive management. The study shows that Board Independence has a significant and negative correlation with, and consequently a significant and negative effect on, the banks ROA. Although board independence is traditionally supported for its unbiased monitoring which may lead to improved performance, the study reveals that the boards of the banks need to have reasonable number of executive managers (insiders) who bring different knowledge and skills to the boards. These insiders may improve the boards decisions with respect to investment, strategic planning, and other relevant decisions. Insiders have both knowledge and incentives to do a better job; they are well-informed about their banks, and they have their human capital as well as their financial capital (especially if they are owner managers) committed to their banks. This result is consistent with the results of other studies of (Baysinger and Butler 1985, Vancil 1987; Weisbach 1988; Klein 1998, Hall and Liebman 1998; Bhagat et al. 1999; and Bhagat and Black 2000). In a well-organized bank, the Bank Size (i.e., with larger amount of total assets) offers great help to the banks mobility taking advantage of its financial strength pursuing available business opportunities effectively, avoiding potential threats, and overcoming its weaknesses. Through their created economies of scale, larger banks lower their average costs which affects their banks profitability positively and enables them to exercise market power through stronger brand image or implicit regulatory (too big to fail) protection. However, the positive effect of a growing banks size on its profitability turns to be negative after a certain limit due to bureaucratic problems and poor expenses management. In addition to this cost issue, Bank Size also controls for product and risk diversification which leads to a negative relationship and effect between Bank Size and ROA since increased diversification leads to higher credit risk and consequently to lower returns. Therefore, the study reveals this negative correlation and effect by Bank Size on profitability, measured by ROA. Meanwhile, the above-mentioned larger amount of total assets reduces the ROA ratio to a great extent which leads to the aforementioned negative correlation and effect between Bank Size and the outcome ROA. This result is consistent with the results of studies conducted by (Berger et al. 1987; Boyd and Runkle 1998; Miller and Noulas 1997; 33
  • 35. Eichengreen and Gibson 2001; Pasiouras and Kosmidou 2007; Kosmidou 2008; and Athanasoglou et al. 2008). 4.3.2.1 Model Summary - ROA Table 9 reveals the correlation between the independent variables (Board Independence and Bank Size) and the dependent variable ROA. In this model, the R square of 27.7% is the amount of variance explained in the ROA by these two predictors. The difference between R square and the Adjusted R square is 3.2% (i.e., 27.7% - 24.5%). This small shrinkage means that if the model were derived from the population rather than from the sample, it would account for 3.2% less variance in ROA. Table 9 ROA Model summary Model R R Square ROA .526 Adjusted R .277 .245 Square Std. Error of the Estimate .92978 4.3.2.2 ANOVA - ROA Similar to the ROE ANOVA, the ROA ANOVA shown below under Table 10, indicates that the value of F is also highly significant (at the 1% level) meaning that the Model is a significant fit of the data. 34
  • 36. Table 10 ROA ANOVA Model Sum of Squares df Mean Square F Sig. 8.801 .001 Regression 15.218 2 7.609 Residual 39.767 46 .864 Total 54.984 48 4.3.2.3 Coefficients - ROA Table 11 ROA Coefficients shows that the two predictors (Board Independence and Bank Size) make significant contributions to the model. Board Independence makes a significant and negative contribution at the 1% level, and Bank Size makes a significant and negative contribution at the 5% level. Table 11 ROA Coefficients Model Unstandardized Coefficients B Unstandardized Coefficients Std. Error Standardized Coefficients Beta t Sig . (Constant) BRD.INDP BNK.SIZE 3.604 - 1.653 - .993 .535 .468 .486 -.443 -.257 6.733 - 3.529 - 2.044 .000 .001 .047 4.3.3 The Effects on Profitability, measured by Profit Margin Profit Margin is an indication of a companys pricing strategies and how well it controls costs. It is found that Ownership Concentration, Age, and Board Committees are the three corporate governance independent variables which have significant relationships with the dependent variable, Profit Margin. 35
  • 37. Ownership Concentration has a significant impact on Profit Margin. This impact could be positive, helping the banks decision-making, reducing agency costs, and leading to higher profit rates, better performance, and better profit margin (Claessens et al. 1997; and Fuentes and Vergara 2003). However, the study indicates that Ownership Concentration has a significant and negative effect on Profit Margin allowing the banks controlling shareholders to expropriate the banks resources for their own private benefits by different ways, such as through related-party transactions (which leads to a negative effect on the growth rate of the banks net assets), or through transferring the resources from one entity in which the controlling shareholders own less to other entities in which they own more. These negative effects lead to lower profit rates and lower profit margin. This result is consistent with the results of the studies conducted by (Jensen and Meckling 1976; Leech and Leahy 1991; Slovin and Sushka 1993; Shleifer and Vishny 1997; Thomsen and Pedersen 2000; Joh 2003; Cronquist and Nilsson 2003; and Karaca and Eksi 2012). Similar to the aforementioned impact on ROE, Bank Age also has a significant and positive correlation with, and consequently a significant and positive impact on, Profit Margin due to the learning curve principle referred to under No. 4.3.1. Longer good reputation and interaction between the bank age and the market share lead to higher profit margin. This result conforms to the results of the studies of (Stathopoulos et al. 2004; and Athanasoglou et al. 2005). Board Committees, which include Audit, Remuneration/Compensation, and Nomination Committees, also have significant and positive relationships with, and consequently significant and positive impacts on, Profit Margin. They control the bank managements opportunistic behavior, monitor closely the bank activities, and reduce the banks risk-taking appetite. They facilitate the board functions and responsibilities, and hence board effectiveness. The Committees oversee the banks operations, focusing on the banks compliance to rules and regulations, and addressing any financial errors, misstatements, or irregularities. The Audit Committee helps the board of directors in auditing, monitoring, supervising, and controlling the financial and managerial issues of the bank, as well as 36
  • 38. facilitating the boards relationship with internal and external auditors. It also monitors, verifies, and safeguards the integrity and credibility of the process of accounting, auditing, and financial reporting; enhances transparency for banks stockholders and creditors; and resolves disagreements between management and external and internal auditors. The Audit Committee also ensures that the bank has an effective internal control and reliable financial reporting system, and that it complies with the regulatory requirements and the banks code of conduct. The Remuneration/Compensation Committee recommends and monitors the level and structure of remuneration for banks management and compensation to the board members properly for their ordinary and extra-ordinary efforts. The Nomination Committee recommends the right people to the board and to the banks shareholders. This result corroborates the results of the studies of (Pincus et al. 1989; Anderson et al. 2004; and Barth et al. 2004). 4.3.3.1 Model Summary Profit Margin Table 12 indicates the correlation between the three predictors (Ownership Concentration, Age, and Board Committees) and the outcome Profit Margin. In this model, the R square of 32.6% is the amount of variance explained in the Profit Margin by the above three predictors. The difference between R square and the Adjusted R square is 4.4% (i.e., 32.6% - 28.2%). This small shrinkage means that if the model were derived from the population rather than from the sample, it would account for 4.4% less variance in Profit Margin. Table 12 Profit Margin Model summary Model R R Square Adjusted R Square Std. Error of the Estimate Profit Margin .571 .326 .282 .1860 37
  • 39. 4.3.3.2 ANOVA Profit Margin Similar to the above ROE and ROA ANOVA, Table 13 regarding the Profit Margin also indicates that the F value is extremely significant (at 0% level) which means that this Model is also a significant fit of the data. Table 13 Profit Margin ANOVA Model Sum of Squares df Mean Square F Sig. .771 3 .257 7.425 .000 Residual 1.591 46 3.460E-02 Total 2.362 49 Regression 4.3.3.3 Coefficients Profit Margin For the Profit Margin Coefficients , Table 14 shown hereunder indicates that there are three predictors (Ownership Concentration, Age, and Board Committees) that make significant contributions to the model. Age makes a significant and positive contribution at the 1% level; Board Committees also makes a significant and positive contribution at the 5% level; and Ownership Concentration makes a significant and negative contribution at the 5% level. Table 14 Profit Margin Coefficients Model Unstandardized Coefficients B Unstandardized Coefficients Std. Error Standardized Coefficients Beta t Sig . (Constant) OWN.CONC AGE BRD.COMT .117 -.205 4.839E-03 .264 .142 .097 .002 .101 -.265 .304 .330 .822 - 2.117 2.783 2.621 .416 .040 .008 .012 38
  • 40. Table 15 below shows a summary of the aforementioned regression results in regard to the subject three models. Table 15 - OLS Regression Results Model 1 (Dependent Variable ROE) Coefficients Constant t- statistics -.652 Coefficients Model 3 (Dependent Variable Profit Margin) 3.604 3.272 -.993 t- statistics Coefficients 6.733 .117 0.822 0.685 -0.190 .177 AGE Model 2 (Dependent Variable ROA) t- statistics 4.839E-03 2.783 BNK.SIZE -2.003 OWN.CONC -1.854 . -.205 -2.117 BRD.COMT 0.096 1.712 .264 2.621 BRD.INDP -1.854 2 Adjusted R . 2.156 0.396 1.395 0.277 0.326 0.180 0.245 0.282 6.264 2 R 1.093 -3.529 0.214 BRD.MTNG -1.653 -0.727 -2.044 8.801 7.425 0.004 0.001 0.000 F-statistics p-value for F- test 39
  • 41. 5 Summary and Conclusion The study was made on a sample of top fifty conventional and Islamic banks from Yemen and the GCC countries. I used the aforementioned SPSS which included using descriptive statistics summarized as mean, standard deviation, minimum, and maximum in order to have information about the respective banks practices and characteristics related to the subject corporate governance and bank performance. Pearson correlation matrix shows that there is a correlation between many of the variables. The study investigates the relationship between, and consequently the effect of, internal corporate governance (categorized as ownership structure, board structure, audit function, and other respective variables such as bank size, age, and type) on banks profitability, measured by ROE, ROA, and Profit Margin. These bank performance profitability measures were regressed on twenty two corporate governance predicting variables, classified into the aforementioned categories. It is found that the two predictors, Age and Number of Board Meetings, have a positive and significant effect on banks profitability measured by the outcome ROE, the result which corroborates the results of the studies referred to hereinabove. Meanwhile, I found that the two predictors, Board Independence and Bank Size, have a negative and significant effect on banks profitability, measured by ROA, the result which conforms to the results of the studies conducted by the aforementioned researchers. Finally, it is found that there are three corporate governance independent variables, Ownership Concentration, Age, and Board Committees, of which Age and Board Committees have a positive and significant effect while Ownership Concentration has a negative and significant effect on banks profitability, measured by the dependent variable Profit Margin. This result is also consistent with the results of the studies indicated above. These result-references are stated under No. 4 Analysis and Discussion. It is also found that the above three empirical results support the theoretical framework of the study, and that the study hypotheses are empirically validated about the banks operating in Yemen and the six GCC countries in accordance with the above-stated analytical 40
  • 42. methods. Consequently, it is concluded that there is a significant relationship between corporate governance and banks profitability; and that banks profitability, measured by ROE, ROA, and Profit Margin, is significantly affected by ownership concentration, board meetings, board independence, and board committees, as well as by bank age and bank size. It is worth-mentioning that the external auditors reports of Al-Ahli Bank of Kuwait and all the Saudi banks taken in the sample have been signed by two of the big four CPA firms simultaneously, which could mean additional bank governance that has not been taken into consideration. Results may be of interest to banks stakeholders, regulators, and policy makers. Future researches could provide additional views about this relationship between bank performance and internal corporate governance; as well as relationship between bank performance and external corporate governance, such as government regulations. 41
  • 43. 6 Research Limitations It is known that such a case study cannot be generalized as it is designed to investigate into, and understand, specific elements. Consequently, the findings of this study cannot be generalized to all banks since the sample was limited to banks operating in Yemen and the GCC countries, and excluded all other banks operating elsewhere. The study will also be limited to the aforementioned specific elements and variables; therefore, it cannot be generalized to all other elements and variables of the banking industry. Additionally, information confidentiality and unavailability of information are two major limitations that prevented me from collecting complete, correct, and accurate data. Moreover, the study concerns the above specific countries; thus, the findings cannot be generalized to other countries since each country and/or region has its own characteristics. Moreover, as stated above, I could not find much literature talking about the effects of corporate governance on bank performance in the Arab World, except what is referred to above. 42
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  • 52. Appendix Table A OLS Regression OLS Regression Results Dependent Variables (1) ROE Constant TYPE AGE BNK.SIZE OWN.CONC FOREIGN ALIGN.IN DUALITY BRD.COMT EXT.AUDT BRD.MBRS BRD. NONX BRD.INDP BRD.MTNG CG.RPRT REM.COMT NOM.COMT AUD.COMT R2 Adjusted R2 F-statistics p-value for F- test MAX VIF Observations (2) ROA (3) Profit Margin -0.190 6.733 0.822 0.493 3.272 -2.003 -1.854 -0.665 -1.285 -1.501 0.096 0.575 -0.963 0.171 -1.854 2.156 -0.183 0.067 -0.440 -0.290 0.214 0.549 0.685 -2.044 . 0.394 0.097 1.301 1.712 1.209 0.957 1.200 -3.529 0.396 1.159 1.300 0.329 1.663 0.277 1.161 2.783 -0.727 -2.117 -0.654 -0.805 0.003 2.621 0.680 -0.522 -0.082 . 1.395 . . . . 0.326 0.180 6.264