Effective corporate governance mechanisms for the banking industry
Ellen Yu
LCCGE Monthly Seminar Series
Birkbeck College
24 February 2017
Research Question
Purpose of bank
Cultural differences
Shareholder model
- Maximise shareholder value
Executive
compensation
(pay dispersion)
2
Direct monitoring
Public
enforcement
Stakeholder model
&
- Balance interests of all
stakeholders
Legal environment
Executive
compensation
(pay equity)
Private
enforcement (Soft
law)
Design of executive pay remuneration
• Executive compensation literature – pay dispersion:
• Tournament theory (favoring greater pay dispersion) or
• Equity fairness theory (arguing for smaller pay dispersion)
• However, the emphasis on executive remuneration design varies from one
country to another - depends on whether other direct monitoring alternatives
are available.
• Lack of relevant empirical studies in the banking literature
• Comparative studies are relatively rarer.
• “A Golf tournament”? “Racing”? “A baseball game?”
Literature Review and Hypotheses
Tournament Theory vs the Equity Fairness Theory
• Tournament Theory
Lazear and Rosen (1981):
Good examples in professional sports
Empirical evidence on the tournament theory
obtained from business settings is rather limited
and somewhat mixed.
• the Equity Fairness Theory
Wade, O’Reilly and Pollock (2006), Lazear (1989)
large pay dispersion can increase envy and
dysfunctional behavior among team
members.
Evidence
Supporting - Studying university faculties,
Pfeffer and Leangton (1993)
• Hypothesis 1:
Executive pay dispersion brings a
positive impact on bank
performance and market
valuation.
Literature review
Cultural differences
o Cultural variables have only recently
gained acceptance in the finance
literature. (Zhu and Cai 2014, Zheng
et al. 2012, Aggarwal and Goodell
2014).
o To include Hofstede’s (1998, 2001)
cultural dimensions as control
variables
1. Individualism index
2. Power distance index
3. Masculinity index
4. Uncertainty Avoidance index
Hypothesis: Bank
performance is positively
associated with a national
cultural dimension
Theoretical Model
- Example
performanceit  a0  r  paydispit   s  paydispit   a ln  outputit    b j ln  input jit   c ln  fixedfactorit 
n
2
j 1
n
n

1
 g ln  outputit  ln  outputit    h jk ln  input jit  ln  inputkit   l ln  fixedfactorit  ln  fixedfactorit  
2
j 1 k 1

  q j ln  outputit  ln  input jit   r ln  outputit  ln  fixedfactorit    s j ln  input jit  ln  fixedfactorit 
n
n
j 1
j 1
  m j  control jit  ,
n
j 1
where the control variables control j
Such as the variable of capital adequacy, the variable of default risk, ownership (widely owned) respectively
Data Collection Key variable of executive pay dispersion
• Sample
• 63 banks chosen from OECD countries (18 developing
countries) and 29 banks from two developing countries,
China and India, and covers the period from 2004 to 2012.
• The greatest challenge - “executive pay dispersion”
based on total compensation
Table 6 Analyses on Tobin’s Q ratio – “a group of Civil Law countries banks (36 banks)”, 2004-2012
Performance indicators
Tobin’s Q ratio
Original equation 4 dimensions of
national culture
Eq(2)
Eq(3)
Individualism
index (IDV)
Power Distance
index (PDI)
Masculinity
index (MAS)
Eq(3)
Eq(3)
Eq(3)
Uncertainty
Avoidance
index (UAI)
Eq(3)
C
0.8903*
(0.5268)
Pay dispersion
(Pay dispersion)
2
Cultural Index - Individualism index
Cultural Index - Power Distance index
Cultural Index - Masculinity index
Cultural Index - Uncertainty Avoidance
index
-0.0851***
-0.0822***
-0.0886***
-0.0778***
-0.0791***
-0.0814***
(0.0194)
(0.0213)
(0.0206)
(0.0201)
(0.0198)
(0.0204)
0.0652***
0.0623***
0.0675***
0.0605***
0.0616***
0.0631***
(0.0143)
(0.0154)
(0.0151)
(0.0144)
(0.0144)
(0.0146)
0.0007
0.0002
(0.0011)
(0.0003)
-0.0008
-0.0002
(0.0011)
(0.0001)
-0.0004
0.0003
(0.0012)
(0.0002)
0.0005
-0.0002
(0.0006)
(0.0002)
Civil - Tobin Q
Developing - Profit
Table 13 Summary of our empirical results on our hypothesis 2
Hypothesis 2
• Hypothesis 2:
Effective corporate governance
structure brings a positive impact
on banking firm performance.
Better corporate governance
structure, greater bank
performance and market
valuation.
Banking firm
performance
(a) percentage of
independent board
members
(b) board size
(c) board meetings per
year.
Civil Law country
banks
× not significant
Negative;
× not significant
Common Law
country banks
× not significant
× not significant
× not significant
Developing country
banks
× not significant
Positive;
Positive;
A bigger board size
is better to bank
performance
More board meetings
per year is beneficial to
bank performance.
A smaller board size
is better to bank
performance
Table 14 Summary of our empirical results on our hypothesis 3
Hypothesis 3
• Hypothesis 3:
we predict that pay dispersion is
more strongly associated with
banking firm performance with
effective corporate governance
structure.
Banking firm
performance
(a) (pay dispersion)* (b) (pay dispersion)* (c) (pay dispersion)*
(percentage of
(board size)
(board meetings per
independent board
year)
members)
Civil Law country
banks
× not significant
Positive
× not significant
Common Law
country banks
× not significant
× not significant
× not significant
Developing country × not significant
banks
× not significant
× not significant
Hypothesis 4
• Hypothesis 4: The positive
association between firm
performance and executive pay
dispersion is stronger in firms
with strong public/private
enforcements
• Public enforcement: this index is
developed by Djankov et al.
(2008).
• private enforcement, named as
the anti-self-dealing index, for
72 countries.
Banking firm performance
(a) (pay dispersion)* (public
enforcements)
(b) (pay dispersion)* (private
enforcements)
Civil Law country banks
× not significant
Positive;
Pay dispersion is more strongly
associated with bank performance
with a stronger private
enforcement.
Common Law country banks
× not significant
Positive;
Pay dispersion is more strongly
associated with bank performance
with a stronger private
enforcement.
Developing country banks
Positive;
Negative
Pay dispersion is more strongly
associated with bank performance
with stronger public enforcement.
Pay dispersion is more weakly
associated with bank performance
with stronger private enforcement.
Hypothesis 5
Banking firm performance
Cultural dimensions (before adding
the governance structures and legal
enforcements)
Cultural dimensions (after adding
the governance structures and legal
enforcements)
Civil Law country banks
MAS +
MAS +
PDI -
IND –
PDI +
Common Law country banks
(Refer to Table 6)
(Refer to Table 10)
IND +
× not significant
PDI –
(Refer to Table 11)
(Refer to Table 8)
Developing country banks
IND +
IND +
PDI –
PDI –
MAS-
MAS-
UAI +
UAI +
(Refer to Table 9)
(Refer to Table 12)
Conclusion
In this study, we examine effective governance mechanisms for the banking
industry.
• Legal enforcements being the key factor to all our sample banks since these
enforcements can enhance banking performance.
• We also find that for Civil Law and Developing country banks, the national
cultural differences affect bank performance. This is in contrast to Common
Law country banks.
• Direct monitoring also works for Developing and Civil Law country banks.
• If the executive pay dispersion is used as the only one dimension of
incentive contract, it may not be an effective governance mechanism for
supervising banks’ managerial team.