Electronic copy available at: http://ssrn.com/abstract=2284814

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Faculty of Postgraduate Studies and Scientific Research

German University in Cairo

The Effects of Corporate Governance on BankPerformance

A thesis submitted in partial fulfillment of the requirements for the degree of Masters ofBusiness Administration

By

Ahmed Mohsen Salem Al-Baidhani

Supervised by

Prof. Dr. Ehab K. A. Mohamed

Dr. Mohamed Basuony

May 22, 2013

Electronic copy available at: http://ssrn.com/abstract=2284814

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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 bank’s profitability, measured by each bank’s 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 bank’s profitability

measured by the outcome ROE; that the two predictors, Board Independence and Bank Size,

have a negative and significant effect on bank’s 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 bank’s

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

Electronic copy available at: http://ssrn.com/abstract=2284814

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Table of Contents

Abstract……………………………………………………………………………..….1

Table of Contents………………………………………………………………………2

1 Introduction……………………………………………………………….……… 4

2 Literature Review…...……………………………………………….……………...9

2.1 Corporate Governance and Bank Performance…………………………………9

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

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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

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1 Introduction

Corporate governance is a system used to direct and control an organization. It includes

relationships between, and accountability of, the organization’s stakeholders, as well as the

laws, policies, procedures, practices, standards, and principles which may affect the

organization’s direction and control (Cadbury Report 1992). It also includes reviewing the

organization’s practices and policies in regard to the ethical standards and principles, as well

as the organization’s 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 (Sarbanes-

Oxley 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 organization’s ownership and management control, the corporate scandals

since the 1990s and until now, and management’s 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.

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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 organization’s

management, internal and external auditors to protect and preserve the shareholders’ equity

and interests; however, the committee’s 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 company’s

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 organization’s proxy statement, stating whether the

committee has reviewed and discussed the financial statements with the management and

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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 Enron’s

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).

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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 organization’s 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 organization’s 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 people’s 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.

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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 bank’s profitability measuring that by

each bank’s 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.

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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 organization’s bylaws, codes of conduct,

and resolutions. Corporate governance focuses on the control systems and structures by

which managers are held accountable to the bank’s 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 bank’s 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.

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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, non-

financial 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 bank’s failure negatively affects the respective

country’s 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 organization’s

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 organization’s 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).

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2.2.1 Internal Governance

The organization’s 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 bank’s 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).

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Although concentrated ownership may result in superior performance, it may also result,

negatively, in extracting the bank’s 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 organization’s assets and invested capital. In addition to setting the bank’s

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 bank’s 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 board’s capabilities to monitor the bank’s executives and

managers vary from one bank to another (Van der Elst 2010). In order to provide reasonable

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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 bank’s top management. The members of some boards of directors may

be selected by the bank’s 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 bank’s audit committee and internal auditors is testing the design and

implementation of the bank’s 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 organization’s

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 management’s 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).

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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 committee’s meetings with the head of the internal audit enhance

the independence of the internal audit function, supporting the parties’ discussion about

management’s 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 organization’s 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 organization’s joint ventures, environmental matters, and

international operations. As a corporate governance reform, the above-mentioned Act

increased the audit committee’s and internal auditor’s 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:

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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 organization’s accounts and issuing his/her opinion

about the correctness and accuracy of the organization’s 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 organization’s financial statements and

financial position.

The external auditors submit their reports to the audit committee where both parties discuss

important issues, such as management’s 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

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arrangements of works, and may ask the external auditors to report to it about any

differences or disputes between them and the organization’s management. Additionally, the

committee facilitates the communications between the external auditors and the

organization’s 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 bank’s financial reports should be audited by

independent external auditors who issue a report that accompanies the bank’s financial

statements. In order to remove the conflict of interest which jeopardizes the integrity of the

bank’s 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

17

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).

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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 bank’s 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 bank’s 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 bank’s profitability measuring that by

each bank’s 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 bank’s shareholders, directors,

19

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: Bank’s 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

20

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 bank’s profitability

measuring that by each bank’s 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 non-

financial 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

21

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 Population(All Bankscope List)

Population(Banks only)

Sample Size

Bahrain 58 29 14

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

Total 193 95 59

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.

22

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 itsranking 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 non-

executives 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:

23

Table 3 - Definition and measurement of variables

Variable Symbol Definition Measurement

Dependent Variables

ROE The amount of returnon bank’s equity

Net Income divided by Average Total Equity

ROA The amount of returnon bank’s assets

Net Income divided by Average Total Assets

PROFIT.M Profit Margin Net Income divided by Revenue

Independent Variables

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 OwnershipConcentration

Adding up all share ratios of shareholders of the bankwho have 5% or more (excluding others)

INSTITUT InstitutionalOwnership

If there is/are institutions holding bank shares (i.e.,Institutional) = 1; Non-institutional = 0

FOREIGN Foreign Ownership If there is/are Foreign ownerships = 1; Non-foreign =0

ALIGN.IN Alignment of Interests 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 boarddivided by Total number of board members

DUALITY CEO Duality Duality: If the CEO and Chairman are Not the sameperson = 1; If otherwise = 0

BRD.COMT Board Committees If there is a Board Committee (Audit, Compensation,etc.) = 1; If not = 0

24

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 BoardMembers

Total number of board members during 2011

BRD.NONX Number of Non-Executives on Board

Number of non-executive members on the boardduring 2011

BRD.MTNG Number of BoardMeetings per Year

Number of board meetings held during 2011

CG.RPRT Corporate GovernanceReport

If Corporate Governance Report exists = 1; If it doesnot = 0

REM.COMT Remuneration/CompensationCommittee

If Remuneration / Compensation Committee exists =1; If it does not = 0

NOM.COMT NominationCommittee

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 AuditCommittee Members

Number of Audit Committee members during 2011

AUD.NONX Number of AuditCommittee Non-Executive Members

Number of the non-executive members in the AuditCommittee during 2011

AUD.MTNG Number of AuditCommittee Meetingsper Year

Number of audit committee meetings during 2011

25

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

Concentration’s 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 Independence’s 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 bank’s 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.

26

Table 4 – Descriptive statistics

Variable Mean Std. Deviation Minimum MaximumROE 10.286 6.065221365 -7.65 22.48ROA 1.6474 1.06112149 -0.9 4.91PROFIT.M 0.3762 0.219562552 -0.37 0.75TYPE 0.78 0.46467017 0 2AGE 29.74 15.44814895 4 75BNK.SIZE 0.92 0.274047516 0 1OWN.CONC 0.6233906 0.28482618 0.05 1FOREIGN 0.6 0.494871659 0 1ALIGN.IN 0.16 0.37032804 0 1DUALITY 0.08 0.274047516 0 1BRD.COMT 0.92 0.274047516 0 1EXT.AUDT 0.9 0.303045763 0 1BRD.MBRS 9.48 2.224538475 6 19BRD. NONX 8.46 2.042507463 4 13BRD.INDP 0.6233906 0.28482618 0.05 1BRD.MTNG 4.94 1.633951015 0 9CG.RPRT 0.86 0.350509833 0 1REM.COMT 0.74 0.443087498 0 1NOM.COMT 0.59183673 0.496586991 0 1AUD.COMT 0.86 0.350509833 0 1AUD. MBRS 3.02 1.477587664 0 6AUD.NONX 2.78 1.374550019 0 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

27

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 bank’s profitability and relevant corporate

governance variables are discussed hereunder.

28

Table 5 – Pearson correlation matrix

ROE ROA PROFT.M

TYPE AGE BNK.SIZE OWN.CONC

FOREIGN

ALIGN.IN

DUALITY BRD.COMT

EXT.AUDT

BRD.MBRS

BRD.NONX

BRD.INDP

BRD.MTNG

CG.REPRT

REM.COMT

NOMCOMT

AUD.COMT

ROE1

ROA .674**1

PROFT.M .804** .611** 1

TYPE0.196 -0.024 0.198 1

AGE .361*0.123

.324*0.168 1

BNK.SIZE-0.205

-.286* 0.066 0.019 0.024 1

OWN.CONC -.286* -.453** -.369**0.185 -0.070 0.059 1

FOREIGN-0.102 0.015 -0.005 -0.035 -0.131 0.060 0.022 1

ALIGN.IN-0.150 -0.007 -0.090 -0.147 -0.032 -0.072 0.097 0.245 1

DUALITY-0.087 0.184 0.026 -0.019 0.034 -0.185 0.057 0.241

.676**1

BRD.COMT0.082 0.165

.358*0.179 -0.106

.457**-0.242

.361**0.129 0.087 1

EXT.AUDT 0.107 0.131 .332* -0.014 -0.010 .393** -0.230 .408** 0.145 0.098 .639** 1

BRD.MBRS-0.029 0.141 -0.053 -0.271 0.024 -0.070 -0.013 0.252

.376** .538**-0.003 0.103 1

BRD. NONX0.178

.313*0.096 -0.235 0.139 -0.188 -0.273 0.105 0.251

.370**-0.042 0.010

.692**1

BRD.INDP -.286* -.453** -.369** 0.185 -0.070 0.0590.779** 0.022 0.097 0.057 -0.242 -0.230 -0.013 -0.273 1

BRD.MTNG0.158 0.045 0.191 0.117 -0.244 0.080 -0.020 0.020 -0.085 0.011

.354*0.070 0.081 0.119 -0.020 1

CG.REPRT0.022 0.070 0.160 -0.068 -0.116

.306*-0.037

.376**0.019 -0.093

.518** .634**0.166 0.092 -0.037 0.270 1

REM.COMT0.068 0.065 0.080 0.113 -0.225 0.161 0.100

.540** 0.010 0.007.497** .562** 0.191 0.090 0.100

.457** .681** 1

NOM.COMT0.016 -0.167 0.014

.314*-0.096

.359*0.254

.409**-0.083 -0.207

.359* .406**-0.049 -0.073 0.254

.311* .492** .724**1

AUD.COMT0.014 0.193

.298*0.058 -0.203

.306*-0.196

.376**0.176 0.119

.731** .634**-0.069 -0.108 -0.196

.413** .502** .549** .373**1

**. 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 bank’s

profitability three outcome measures (ROE, ROA, and Profit Margin) and corporate

governance predictors described above. Each predictor variable has its own coefficient, and

29

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 + b2x2………bnxn + εi

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 εi 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 R²) is the amount of variance explained in the

dependent variable by the predictors. In addition to calculating R and R², SPSS also

calculates Adjusted R². 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

30

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 bank’s operations and assisting management in achieving the bank’s 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 bank’s 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).

31

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.

32

Table 7 – ROE ANOVA

Model Sum of Squares df Mean Square F Sig.

Regression

Residual

Total

389.509

1430.183

1819.692

2

46

48

194.755

31.091

6.264 .004

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

UnstandardizedCoefficients

B

UnstandardizedCoefficientsStd. Error

StandardizedCoefficients

Beta t Sig .

(Constant)

AGE

BRD.MTNG

-.652.177

1.093

3.425.054.507

.443

.292

-.1903.2722.156

.850

.002

.036

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

33

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 bank’s 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 board’s 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 bank’s 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 bank’s 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;

34

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 Adjusted R Square Std. Error of the Estimate

ROA .526 .277 .245 .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.

35

Table 10 – ROA ANOVA

Model Sum of Squares df Mean Square F Sig.

Regression

Residual

Total

15.218

39.767

54.984

2

46

48

7.609

.864

8.801 .001

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

UnstandardizedCoefficients

B

UnstandardizedCoefficientsStd. Error

StandardizedCoefficients

Beta t Sig .

(Constant)BRD.INDPBNK.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 company’s 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.

36

Ownership Concentration has a significant impact on Profit Margin. This impact could be

positive, helping the bank’s 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 bank’s controlling shareholders

to expropriate the bank’s 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

bank’s 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 management’s

opportunistic behavior, monitor closely the bank activities, and reduce the bank’s risk-taking

appetite. They facilitate the board functions and responsibilities, and hence board

effectiveness. The Committees oversee the bank’s operations, focusing on the bank’s

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

37

facilitating the board’s 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 bank’s 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 bank’s code

of conduct. The Remuneration/Compensation Committee recommends and monitors the

level and structure of remuneration for bank’s 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 bank’s 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

38

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.

Regression

Residual

Total

.771

1.591

2.362

3

46

49

.257

3.460E-02

7.425 .000

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

UnstandardizedCoefficients

B

UnstandardizedCoefficientsStd. Error

StandardizedCoefficients

Beta t Sig .

(Constant)OWN.CONC

AGEBRD.COMT

.117-.205

4.839E-03.264

.142

.097

.002

.101

-.265.304.330

.822- 2.1172.7832.621

.416

.040

.008

.012

39

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)

Model 2(Dependent Variable ROA)

Model 3(Dependent Variable Profit

Margin)

Coefficients t- statistics Coefficients t- statistics Coefficients t- statistics

Constant -.652 -0.190 3.604 6.733 .117 0.822

AGE .177 3.272 0.685 4.839E-03 2.783

BNK.SIZE -2.003 -.993 -2.044 -0.727

OWN.CONC -1.854 . -.205 -2.117

BRD.COMT 0.096 1.712 .264 2.621

BRD.INDP -1.854 -1.653 -3.529 .

BRD.MTNG 1.093 2.156 0.396 1.395

R2 0.214 0.277 0.326

Adjusted R2 0.180 0.245 0.282

F-statistics6.264 8.801 7.425

p-value for F- test0.004 0.001 0.000

40

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 bank’s 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 bank’s 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

bank’s 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 bank’s 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

41

methods. Consequently, it is concluded that there is a significant relationship between

corporate governance and bank’s profitability; and that bank’s 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.

42

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.

43

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Appendix

Table A – OLS Regression

OLS Regression ResultsDependent Variables

(1)ROE

(2)ROA

(3)Profit Margin

Constant -0.190 6.733 0.822

TYPE 0.493 0.549 1.161

AGE 3.272 0.685 2.783BNK.SIZE -2.003 -2.044 -0.727

OWN.CONC -1.854 . -2.117FOREIGN -0.665 0.394 -0.654

ALIGN.IN -1.285 0.097 -0.805

DUALITY -1.501 1.301 0.003

BRD.COMT 0.096 1.712 2.621EXT.AUDT 0.575 1.209 0.680

BRD.MBRS -0.963 0.957 -0.522

BRD. NONX 0.171 1.200 -0.082

BRD.INDP -1.854 -3.529 .

BRD.MTNG 2.156 0.396 1.395

CG.RPRT -0.183 1.159 .

REM.COMT 0.067 1.300 .

NOM.COMT -0.440 0.329 .

AUD.COMT -0.290 1.663 .R2

0.214 0.277 0.326Adjusted R2

0.180 0.245 0.282

F-statistics 6.264 8.801 7.425p-value for F- test 0.004 0.001 0.000MAX VIFObservations 50 50 50

52

Table B – Regression Results

1) ROE:

Model Summary

Model R R Square

Adjusted R

Square

Std. Error of the

Estimate

1 .367a .135 .116 5.78838

2 .463b .214 .180 5.57592

a. Predictors: (Constant), age

b. Predictors: (Constant), age, brd.mtng

ANOVAc

Model Sum of Squares df Mean Square F Sig.

1 Regression 244.941 1 244.941 7.310 .010a

Residual 1574.752 47 33.505

Total 1819.692 48

2 Regression 389.509 2 194.755 6.264 .004b

Residual 1430.183 46 31.091

Total 1819.692 48

a. Predictors: (Constant), age

b. Predictors: (Constant), age, brd.mtng

c. Dependent Variable: roe

53

Coefficientsa

Model

Unstandardized Coefficients

Standardized

Coefficients

t Sig.B Std. Error Beta

1 (Constant) 5.683 1.828 3.109 .003

age .147 .054 .367 2.704 .010

2 (Constant) -.652 3.425 -.190 .850

age .177 .054 .443 3.272 .002

brd.mtng 1.093 .507 .292 2.156 .036

a. Dependent Variable: roe

2) ROA:

Model Summary

Model R R Square

Adjusted R

Square

Std. Error of the

Estimate

1 .459a .211 .194 .96069

2 .526b .277 .245 .92978

a. Predictors: (Constant), brd.indpndnc

b. Predictors: (Constant), brd.indpndnc, bnk.size

ANOVAc

Model Sum of Squares df Mean Square F Sig.

1 Regression 11.607 1 11.607 12.577 .001a

Residual 43.377 47 .923

Total 54.984 48

2 Regression 15.218 2 7.609 8.801 .001b

Residual 39.767 46 .864

Total 54.984 48

54

ANOVAc

Model Sum of Squares df Mean Square F Sig.

1 Regression 11.607 1 11.607 12.577 .001a

Residual 43.377 47 .923

Total 54.984 48

2 Regression 15.218 2 7.609 8.801 .001b

Residual 39.767 46 .864

Total 54.984 48

a. Predictors: (Constant), brd.indpndnc

b. Predictors: (Constant), brd.indpndnc, bnk.size

c. Dependent Variable: roa

Coefficientsa

Model

Unstandardized Coefficients

Standardized

Coefficients

t Sig.B Std. Error Beta

1 (Constant) 2.729 .332 8.217 .000

brd.indpndnc -1.713 .483 -.459 -3.546 .001

2 (Constant) 3.604 .535 6.733 .000

brd.indpndnc -1.653 .468 -.443 -3.529 .001

bnk.size -.993 .486 -.257 -2.044 .047

a. Dependent Variable: roa

55

3) Profit Margin:

Model Summary

.369a .136 .118 .2062

.475b .226 .193 .1973

.571c .326 .282 .1860

Model123

R R SquareAdjustedR Square

Std. Error ofthe Estimate

Predictors: (Constant), OWN.CONCa.

Predictors: (Constant), OWN.CONC, AGEb.

Predictors: (Constant), OWN.CONC, AGE, BRD.COMTc.

ANOVAd

.322 1 .322 7.576 .008a

2.040 48 4.250E-022.362 49.533 2 .266 6.847 .002b

1.829 47 3.892E-022.362 49.771 3 .257 7.425 .000c

1.591 46 3.460E-022.362 49

RegressionResidualTotalRegressionResidualTotalRegressionResidualTotal

Model1

2

3

Sum ofSquares df Mean Square F Sig.

Predictors: (Constant), OWN.CONCa.

Predictors: (Constant), OWN.CONC, AGEb.

Predictors: (Constant), OWN.CONC, AGE, BRD.COMTc.

Dependent Variable: PROFIT.Md.

56

Coefficientsa

.554 .071 7.825 .000-.285 .103 -.369 -2.752 .008.417 .090 4.651 .000

-.268 .099 -.348 -2.706 .0094.258E-03 .002 .300 2.328 .024

.117 .142 .822 .416-.205 .097 -.265 -2.117 .040

4.839E-03 .002 .340 2.783 .008.264 .101 .330 2.621 .012

(Constant)OWN.CONC(Constant)OWN.CONCAGE(Constant)OWN.CONCAGEBRD.COMT

Model1

2

3

B Std. Error

UnstandardizedCoefficients

Beta

Standardized

Coefficients

t Sig.

Dependent Variable: PROFIT.Ma.