Corporate governance among banks listed in the Philippine Stock Exchange.
Kabigting, Leila C.
INTRODUCTION
Asian central banks initiated corporate governance reforms among
banks as an aftermath of the 1997 Asian Financial crisis. By 2008, when
the global financial crisis set in, corporate governance reforms already
in place among Philippine banks provided safety nets which minimized
falling asset prices and losses.
Since 2002, listed companies in the Philippines have been required
to discuss their adoption of best practices in Corporate Governance in
their annual reports on SEC Form 17-A submitted to the Securities and
Exchange Commission (SEC).
This paper evaluates corporate governance among banks listed in the
Philippine Stock Exchange (PSE) from the period 2005-2009. Our main goal
is to investigate the determinants of corporate governance and the
dynamics of their relationship to corporate governance. Thus, we will
test the following hypotheses:
HYPOTHESES
HI: Corporate governance (as proxied by insider ownership) has a
significant relationship with an independent board of directors, bank
size, return on assets (ROA), return on equity(ROE), earnings per share
(EPS), age, and non performing loans ratio (NPL).
H2: Corporate governance (as proxied by board size) has a
significant relationship with an independent board of directors, bank
size, return on assets (ROA), return on equity(ROE), earnings per share
(EPS), age, and non performing loans ratio (NPL).
LITERATURE REVIEW
Jensen and Meckling (1976) agency theory discussed that agents or
managers perform functions on behalf of shareholders. However, these
agents or managers will prioritize maximizing his wealth ahead of the
shareholders' value since his compensation is tied to managerial
performance. Thus, Jensen and Meckling (1976) discussed that internal
and external monitoring costs are incurred to minimize conflict of
interest. As Elsayed (2007) cited Johnson et al. (1996), the board of
directors' main functions are: "monitoring management actions,
advising the CEO and getting external resources that are vital to build
corporate capabilities (p. 1204)."
Elsayed (2007) defined the total number of directors on the board
as the measure of board size. El Mehdi (2007) showed that board size is
positively related to corporate governance which means a larger board
would have more directors to monitor agency problems, review management
actions, bring greater opportunities. The presence of independent
directors in the board enhance board governance, reduce financial
statement fraud, increase transparency and disclosure, and protect
minority shareholders. (Leung and Horwitz, 2004). However, El Mehdi
cited Jensen (1993) that there is an upper limit to boards, which is
eight directors, as more than this will affect group dynamics and board
performance. On the other hand, El Mehdi (2007) and Barucci and Felini
(2005) cited that there is a large literature establishing a negative
relationship between board size and firm performance; see Hermalin and
Weisbach (2001), Yermack (1996) and Barucci and Ceccacci (2005).
Corporate governance literature uses two alternative approaches to
measuring corporate performance. The first uses accounting measures of
corporate performance. These include return on assets, return on equity
and earnings per share. Elsayed (2007) presented that return on assets
is net profit divided by total assets, which reflects operating results
rather than capital structure decisions. The relationship between
earnings and managerial shareholdings can be positive (Korczak and
Korczak, 2009) or negative (Korczak and Korczak, 2009; Kuznetsov,
Kapelyushnikov, Dyomina (2008) at higher levels of managerial
shareholdings.
Barucci and Felini (2005) studied the determinants for corporate
governance in listed firms in the Italian stock exchange. These included
balance sheet data, ownership structure, company performance and
qualitative features. They concluded that companies with a large
shareholder and/or large minority blockholders have poor governance and
protection of shareholders. However, Korczak and Korczak (2009)
presented that concentrated holdings of several investors rather than a
single large shareholder will result into the blockholders protecting
themselves thus making sure that managers and investors' interests
are aligned.
Barniv and Bao (2009), Elsayed (2007) discussed the other approach
to measuring corporate performance applies market valuation measures,
especially the Tobin's q ratio which takes into account risk,
return and present value of future profits. Elsayed (2007) presented
Tobin's q ratio as:
Tobin's q ratio = [Market Value + Book value of Preference
Capital + Book value of Long term Debt + Book value of Inventory + Book
value of Current Liabilities - Book value of Current Assets] / [Total
Assets] (see Lee and Tompkins, 1999).
Barniv and Bao (2009) defined EPS as earnings per share in their
earnings-return regression. Their findings showed that valuation models
perform better for companies with a greater analyst following, smaller
forecast errors, relatively high public ownership and a strong board
structure.
Korczak and Korczak (2009), Kuznetsov, Kapelyushnikov, Dyomina
(2008) and Elsayed (2007) introduced control variables such as board
size, institutional ownership and management shareholding, firm size,
age in the estimated models affecting performance and ownership, so that
there will be no specification errors. Size is the logarithm of the
firm's total assets. (El Medhi, 2007). Kuznetsov, Kapelyushnikov,
Dyomina (2008) defined age as the number of years since the firm was
founded. Their results showed that in terms of the control variables,
the regression coefficients for the size are positive and significant
while the firm's age has proven to be insignificant.
EMPIRICAL ANALYSIS
The study included the following listed banks in the Philippine
Stock Exchange: Banco de Oro (BDO), Bank of the Philippine Islands
(BPI), China Banking Corporation (CHIB), Metropolitan Bank and Trust
Corporation (MBT), Philippine National Bank (PNB), Philippine Bank of
Communication (PBC), Rizal Commercial Banking Corporation (RCB),
Security Bank (SECB), Union Bank of the Philippines (UBP) from
2005-2009. Most of the banks are traded daily. Also, the following
banks: BDO, MBT, BPI, PNB, RCB, UBP, CHIB, belong to the top 10 banks
that already comprise 70%-75% of the total assets of the commercial
banking industry. Data was taken from the annual reports and 17-A from
years 2005-2009 and from the data set from years 2005-2008 provided by
Lagmay, Chong and Lee (2010).
The study used panel data estimations with fixed effects to help
control for unobserved heterogeneity. We used the fixed effects since we
are not using variances per se but the actual values themselves. Also,
stationarity is assumed here. (Lagmay, Chong, Lee, 2010).
The dependent variable in the first model is corporate governance
(proxied by insider ownership (io) and the independent variables:
independent directors, bank size, age, roe, roa, npl, eps.
The second model has corporate governance (proxied by board size)
as the dependent variable and the independent variables are: independent
directors, bank size, age, roe, roa, npl, eps.
The first model (Table 2) resulted to the non-significant
variables: bank age, independent directors, non performing loans (npl)
and return on equity (roe). Bank age is defined as when the bank was
founded. The result shows that insider ownership has nothing to do with
bank age. This is consistent with Kuznetsov, Kapelyushnikov, Dyomina
(2008) study that found bank age to be an insignificant variable in
corporate governance. Although, Leung and Horwitz (2004) showed that
independent directors have a positive relationship to corporate
governance, our results show that it is insignificant and negative
relationship. This could be that there are at least two independent
board of directors in the bank who may only give advice/suggestions but
banks usually have concentrated family ownership. The non performing
loan (NPL) is insignificant because this is a result of credit policy
administration of the bank while insider ownership set the directions of
the bank. NPL is more of the result of the day to day operations of a
bank. However, NPL and insider ownership are positively related. This
may be explained by some banks having DOSRI (Directors, Owners,
Stockholders and Related Interests) loans incurred in earlier years that
are non-performing. Over the five-year period, banks were able to reduce
their non performing loan ratios.
Return on equity and insider ownership have a negative relationship
which is consistent with the findings of Yeo et al (2002) and Gul and
Wah (2002) as cited by Korczak and Korczak(2009) and Kuznetsov,
Kapelyushnikov, Dyomina (2008). These studies showed that the
association between earnings and managerial ownership is negative at
higher levels of managerial shareholdings and at blockholder controlled
ownership.
The significant variables include bank size, eps, and return on
asset (ROA). Bank size and ROA are positively related to insider
ownership while EPS is negatively related. Kuznetsov, Kapelyushnikov,
Dyomina (2008) used size as a control variable and their regression
coefficients for the SIZE are positive and significant. In this study,
the positive relationship between bank size and insider ownership can be
a sign that large firms in the sample have larger insider ownership
concentration and have better investment capabilities.
The positive relationship between insider ownership and ROA are
consistent with Korczak and Korczak (2009),Kuznetsov, Kapelyushnikov,
Dyomina (2008). Family controlled firms have higher profitability (as
proxied by Return on assets).
Earnings per share and insider ownership are negatively related.
This result is similar to ROE and insider ownership, where there is a
negative relationship. As stated earlier, in cases of higher levels of
managerial shareholdings in the US, Singapore and Russia, the
relationship of earnings and managerial ownership is negative (Korczak
and Korczak(2009) and Kuznetsov, Kapelyushnikov, Dyomina (2008).
The results of Model 2 where board size proxies for corporate
governance resulted to the following significant variables: Independent
directors, EPS, ROA, and ROE. The insignificant variables are bank age,
bank size, npl.
Bank age has nothing to do with the board size. The increase in the
number of directors is usually for board control although other factors
are also taken into consideration. Also, bank size is insignificant
because it is the Asset Liability Committee (ALCO) that sets interest
rates of the bank, investment policy, pricing issues, liquidity
management. ALCO is composed mostly of senior managers of the bank and
it is only the bank President/Chief Executive Officer (CEO) that is part
of the Board. ALCO reports to the board their policies, if there are
changes, they will be prospective rather than retrospective. ALCO meets
regularly (once a week) as compared to the board that meets only twice a
month
NPL, similar to bank size is insignificant. NPL is a result of day
to day operation of any bank although the board sets the strategic
directions.
Independent directors, as a variable, is significant, implying that
the more independent directors in the board, the greater the ability to
monitor activities of management and protect shareholders' interest
and enhance corporate governance.(Leung and Horwitz 2004). They can
offer other viewpoints or /strategies than what the bank may be used to.
Independent directors also serve as a deterrent to immediate and costly
reactions during the crisis.
Earnings, returns ratio (EPS, ROA, ROE) are significant. However,
ROE and EPS are negatively related to board size. Listed Philippine
banks are often characterized as having concentrated ownership by
insider ownership, a majority is part of the board of directors. As
individual insider ownership, there is a clear representation of
ownership. However, as individuals who are part of institutions that are
also insider ownership, the representation of ownership may not be
clear. As earlier stated, only the President/CEO is part of the ALCO,
thus, there is board representation in the decisions that affect ROE and
EPS. The findings on ROE and EPS are consistent with Leung and Horwitz
(2004)findings where East Asian firms have high concentrated ownership
resulting to lower informativeness of earnings as reflected in the
earnings-return relation.
In 2008, the global financial crisis sent banks and investment
banks either declaring bankruptcy or being bailed out. For the
Philippine banking system, the Bangko Sentral ng Pilipinas (BSP)
reported that only the banks with collaterized debt obligations were
affected by the crisis and not one collapsed as a result of the crisis.
After the 1997 Asian Financial Crisis, Asian banks adopted reforms
particularly on corporate governance. Initially, there was resistance to
corporate governance since banks in Asia are owned by taipans or
families. Eventually, banks adopted leading practices and principles of
corporate governance. These included transparency, accountability,
fairness/equity, risk management, independent board of directors. These
corporate governance practices cushioned the impact of the global
financial crisis for Philippine banks.
SUMMARY AND CONCLUSION
The paper analyzed the relationship of corporate governance with
bank size, age, non performing loan ratio, earnings per share, return on
average assets, return on average equity and independent directors. Our
findings showed that corporate governance as proxied by insider
ownership has significant relationship with ROA, bank size and EPS. Both
bank size and ROA are positively related while EPS is negatively related
to corporate governance. And we summarized that corporate governance as
proxied by board size has significant relationship with independent
board, EPS, ROA and ROE. Both independent board and ROA are positively
related while EPS and ROE are negatively related to corporate
governance.
Philippine banks were minimally affected by the Global Financial
Crisis in 2008 since they have corporate governance structures in place.
The findings showed that the presence of independent directors in the
board suggests effectiveness in increasing disclosure, transparency,
enhancing corporate governance. Also, the reduction of non-performing
loans ratios over the years since the 1997 Asian Financial Crisis showed
that banks monitor the quality of their loans, disposing of the non
performing assets through special asset vehicles. Philippine banks are
cautious about lending and exposures to risky assets which is why they
were minimally affected by the Global financial crisis.
Although ownership of Philippine banks is still largely
concentrated, it is not a deterrent against improving corporate
governance which resulted to higher profitability. With greater
transparency demanded of them, Philippine banks focus more on coming up
with client friendly products and services instead of simply increasing
their asset size just to be the biggest but without concern for good
corporate governance.
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Leila C. Kabigting, University of Guam
Table 1: Definition of Variables
Variables Definition
Insider ownership Insider ownership can be represented by the
(proxy for corporate tables in 17/A that show the number of shares
governance) of people/parties who can be considered as
inside shareholders
Board size (proxy Total number of directors on the board. At
for corporate least 5 but no more than 15 according to the
governance) Revised Code of Corporate Governance of 2009
Independent Minimum of 2 or 20% whichever is lower but at
directors all instances at least 2
Return on average net income/average total assets or net
assets (or resources income/average total resources
as the case maybe
Return on average Net income/average total equity
equity
Non performing Non/performing Loans (net of NPLs Classified
loan ratio (%) as Loss)/Gross Loans (net of NPLs Classified
as Loss)
Earnings per share Net income/number of shares outstanding.
(basic)
Size Log of total assets. Asset sizes are too big
to consider for regression. This incorporates
possible time lags
AGE Year when bank was incorporated
Variables A priori Literature
expectation
Insider ownership
(proxy for corporate
governance)
Board size (proxy Positive El Mehdi (2009)
for corporate
governance)
Independent Positive Leung and Horwitz (2004)
directors
Return on average Positive Korczak and Korczak (2009)
assets (or resources Kuznetsov, Kapelyushnikov,
as the case maybe Dyomina (2008)
Return on average Positive Leung and Horwitz (2004)
equity Negative Yeo et al (2002) and Gul and
Wah (2002) as cited by
Korczak and Korczak(2009) and
Kuznetsov, Kapelyushnikov,
Dyomina (2008).
Non performing Negative Lagmay, Lee, Chong (2010)
loan ratio (%)
Earnings per share Positive Barniv and Bao (2009)
(basic)
Size Positive El Medhi, (2007) Kuznetsov,
Kapelyushnikov, Dyomina
(2008)
AGE Insignificant Kuznetsov, Kapelyushnikov,
Dyomina (2008)
Table 2: Modell: Fixed-effects, using 45 observations
Included 9 cross-sectional units
Time-series length = 5 Dependent variable: io
Coefficient Std. Error t-ratio
const 35.8449 16.1998 2.2127
bankage 0.0343062 0.0432757 0.7927
independent -1.2865 1.84776 -0.6963
bank_size 3.12722 1.61087 1.9413
eps -0.586091 0.162011 -3.6176
roa 11.7678 6.21973 1.8920
roe -0.408465 0.751113 -0.5438
npl 0.397937 0.376232 1.0577
Mean dependent var 76.31991 S.D. dependent var
Sum squared resid 2898.722 S.E. of regression
R-squared 0.537495 Adjusted R-squared
F(15, 29) 2.246800 P-value(F)
Log-likelihood -157.5729 Akaike criterion
Schwarz criterion 376.0524 Hannan-Quinn
rho -0.019295 Durbin-Watson
p-value
const 0.03495 **
bankage 0.43437
independent 0.49182
banksize 0.06199 *
eps 0.00112 ***
roa 0.06851 *
roe 0.59073
npl 0.29893
Mean dependent var 11.93490
Sum squared resid 9.997796
R-squared 0.298268
F(15, 29) 0.029964
Log-likelihood 347.1458
Schwarz criterion 357.9219
rho 1.638807
Test for differing group intercepts -
Null hypothesis: The groups have a common intercept
Test statistic: F(8, 29) = 1.50706
with p-value = P(F(8, 29) > 1.50706) = 0.197902
Table 3 : Model 2: Fixed-effects, using 45 observations
Included 9 cross-sectional units
Time-series length = 5
Dependent variable: boardsize
Coefficient Std. Error t-ratio
Const 8.56509 1.97105 4.3454
Bankage 0.00324843 0.00526541 0.6169
Independent 0.595533 0.224819 2.6489
bank_size 0.178363 0.195996 0.9100
Eps -0.100831 0.0197121 -5.1152
Roa 3.6409 0.756762 4.8112
Roe -0.31962 0.0913888 -3.4974
Npl -0.019132 0.0457766 -0.4179
Mean dependent var 12.51111 S.D. dependent var
Sum squared resid 42.91232 S.E. of regression
R-squared 0.677943 Adjusted R-squared
F(15, 29) 4.069742 P-value(F)
Log-likelihood -62.78341 Akaike criterion
Schwarz criterion 186.4734 Hannan-Quinn
Rho -0.259238 Durbin-Watson
p-value
Const 0.00016 ***
Bankage 0.54209
Independent 0.01293 **
bank_size 0.37031
Eps 0.00002 ***
Roa 0.00004 ***
Roe 0.00154 ***
Npl 0.67907
Mean dependent var 1.740196
Sum squared resid 1.216444
R-squared 0.511362
F(15, 29) 0.000590
Log-likelihood 157.5668
Schwarz criterion 168.3429
Rho 2.010814
Test for differing group intercepts -
Null hypothesis: The groups have a common intercept
Test statistic: F(8, 29) = 0.948643
with p-value = P(F(8, 29) > 0.948643) = 0.493436
