Corporate Governance and Bank Performance: The Case of

Bangladesh
Mohammad Ziaul Hoque
Department of Accounting and Finance, Monash University, Australia
Md. Rabiul Islam
Department of Economics, Monash University, Australia
Hasnan Ahmed
School of Business, United International University, Bangladesh

ABSTRACT
This paper empirically investigates the influence of corporate governance mechanisms on
financial performance of 25 listed banking companies in Bangladesh over the period 20032011. Estimated results demonstrate that the general public ownership and the frequencies of
audit committee meetings are positively and significantly associated with return on assets
(ROA), return on equity (ROE) and Tobins Q. Directors ownership and independent
directors have significant positive effects on bank performance measured by Tobins Q.
Keywords: Corporate governance, audit committee meetings, financial performance
JEL Classification: G32, G34, G38
I. INTRODUCTION
Bank governance has become a prominent issue ever since the collapse of many banks during
and after global financial crisis. For instance, 80 American banks died between 2007 and
2009 due to onslaught of global financial crisis and a number of banks have become
moribund throughout the globe. Recent bank failures, high incidents of loan defaults, bank
insolvency have lighted the importance of good governance.

Therefore, regulators in

developing countries like Bangladesh have become more concerned about the financial heath
and governance of banking industry.

Electronic copy available at: http://ssrn.com/abstract=2208903

A large body of empirical studies on corporate governance have emerged during the
last decade which focused mainly on the relation between corporate governance and firm
performance. The issue of bank governance and bank performance has received inadequate
attention, particularly in developing countries like Bangladesh. The nature of bank business is
different than that of non-bank business: bank receives deposits and provides loans; bank
uses money of depositors to create riskier assets. Depositors bear the risk of losing money as
they do not know how banks used their money. For example, demand deposits which are
short-term liabilities are invested in long term assets such as home loans for 20 years. Good
governance in the banking industry is required to maintain public trust and confidence in the
banking industry; to run an efficient financial system without excessive risk exposures; to
establish an efficient and reliable depository and financing system to fuel the wheels of the
economy. The diverse stakeholders such as directors, investors and depositors have direct
interest in bank performance ( Adams and Mehra, 2003) unlike the non-banking firms.
Bank intermediates between savers (depositors) and borrowers and influence money
demand and supply in the economy. Regulators make sure that deposits do not lose money
and borrowers return money and that economy does not suffer in any way and as such they
interact with the banks for day to day operations through banking laws and regulations.
Unlike non-financial institutions, banks are subject to dual monitoring: one by the regulatory
bodies and the other by the bank board. The monitoring and oversight of the regulators and
the compliance of banks with regulatory requirements (John, Mehran and Qian, 2003)
provides an alternative governance mechanism which is absent in non-financial industry. It
follows that effective supervision of banking industry by the regulators can work as
complementary force for good governance. Apart from monitoring, regulators such as central
bank of a country intervene in the management of banks in terms of makeup of board of
directors and their responsibilities relating to supervision of banking activities. For instance,
2

Electronic copy available at: http://ssrn.com/abstract=2208903

Bangladesh Bank- central bank of Bangladesh- capped the number of directors of bank board
to thirteen directors and provides approval to the appointment of bank CEOs.
There is very little literature which focused mainly on bank governance issue (Adams
and Mehran, 2003; Spong and Sullivan, 2007) and most of the existing literature focused
mainly on non-bank firm governance and have narrowly focused on the bank governance
issues. As such the objective of this paper is to narrow down this gap and to contribute to the
body of knowledge relating to bank governance. Particularly, this paper investigates the
impact of governance on bank performance in Bangladesh which is an emerging economy in
South Asia, where institutional, regulatory and legal environment are different than those in
force in developed economies. In order to promote good governance in the banking sector,
regulatory response was provided by the Bangladesh bank and other regulatory organisations.
The Companies Act 1994 is the law which mainly governs incorporated entities in
Bangladesh. The act provides for certain supervisory functions and rights to the shareholders
to attend meetings, appoint and remove directors, and to obtain financial information as well
as to approve the balance sheet annually. The other prominent legal and regulatory
frameworks were provided by the Banking Companies Act 1991, the Financial Institutions
Act 1993, the Securities and Exchange Commission Act 1993, and the Bankruptcy Act 1997
etc.
These legal and regulatory frameworks were found to be inadequate and inefficient
for promoting good governance in Bangladeshi banking sector. Bangladesh Bank - the central
bank of the country - promulgated codes of corporate governance for banks in 2003. It
distilled rules and regulations relating to responsibilities and authorities of the Chairman,
CEO and Board of Directors. Other prominent features of this bank governance were related
to instituting committees such as Audit Committee and guidelines for appointment of bank
directors. Therefore, this study contributes to the literature as the first paper that explicitly
3

Electronic copy available at: http://ssrn.com/abstract=2208903

investigates the impact of these latest governance directives unleashed by the Bangladesh
Bank on the performance of Bangladeshi banking sector in terms of good governance.
The remainder of the paper proceeds as follows. Section II provides an overview of
bank governance in Bangladesh; Section III briefly presents the theoretical perspective;
Section IV describes previous studies and hypothesis development; Section V reports data
and research methodology; Section VI presents the analysis of the empirical results, and;
Section VII provides conclusion.

II. BANK GOVERNANCE IN BANGLADESH: AN OVERVIEW

Banking sector in Bangladesh has been featured by myriad decreasing profitability,
increasing non-performing loans, increased loan loss provisions, eroded credit discipline, low
recovery rate, inferior asset quality, poor governance, excessive interference from the
government of the day and the bank-owners, weak regulatory and supervisory role etc.
(Hassan, 1994; USAID, 1995; Haque et al., 2007). Internal control system along with
accounting and audit qualities are believed to have been substandard (World Bank, 1998;
CPD, 2001). The reports by the Banking Reform Commission (BRC) (1999) and Bangladesh
Enterprise Institution (BEI) (2003) raised serious concerns on the banking sector and
criticized the quality of governance.
Banking sector in Bangladesh is constituted by 57 banks and almost all of them are
commercial banks. The four largest banks are owned by the state and rest are owned by the
private investors. Of them, 27 banks are listed with the Dhaka Stock Exchange (DSE) as of
December 2009. In addition to directives of the Bangladesh Bank, Bangladesh Enterprise
Institute (BEI) has published The Code of Corporate Governance for Bangladesh in 2004.
Securities and Exchange Commission (SEC) issued guidelines in the form notification in
4

2006 for the listed firms in order to enhance corporate governance in the interest of investors
and the capital market. These guidelines prescribed dealt with the matters relating to (i) board
size, number of independent directors, appointment of Chairman and CEO and Directors'
Report to shareholders; (ii) Appointment of CEO, Head of Internal Audit, and Company
Secretary, attendance of Board Meeting by CEO and Company Secretary; (iii) Audit
Committee and its reporting to Board of Directors/ Commission and to the shareholders; and
(iv) engagement of external auditors etc. All listed companies (including listed banking
companies) in Bangladesh are required to follow these prescribed guidelines. They have to
provide reporting the status of compliance on corporate governance in Director's Report.
Other regulatory measures include:

proper test

for appointment of directors,

disqualification of directors on the ground of conviction, appointment of qualified and

experience directors, capping of the number of directors to 13, non-eligibility of close
relatives of the directors for the position in bank board, limitation of the directors loans to
50% of paid up value of the shares held by the directors, criminalising insider trading and
constitution of audit committee of board of directors .These regulatory response may lead, it
is expected, to better disclosure of financial information, uplifting standard of banking
activities. Recently, the financial markets of developing economies like Bangladesh have
experienced rapid changes due to the growth of wider range of financial products. As a result
of this, banks have been involved with high risk activities such as trading in financial markets
and different off-balance sheet activities more than ever before (Greuning and Bratanovic,
2003), which necessitates an added emphasis on good governance of banks in Bangladesh
(Haque et al., 2007). Given that Bangladeshi banking sector is relatively less efficient and
less experienced for asset and liability management, good governance is even more required
to establish a sound banking system.

The Bangladeshi banking sector is dominated and controlled by founder family

members who are also dominant player in corporate sector, foreign owners and the
government. Farooque et al (2007) reports that five largest shareholders hold more than 50%
of ordinary shares, most of the CEOs and the directors are from controlling families. Asian
Development Bank (2003) finds that important decisions taken at a family meeting are
stamped at board meeting. Company board has less independence due to dominance of
family-appointed directors who set the addendum of the board meeting to implement their
own agenda. The management and the board are intertwined which reduces the opportunity to
prevent insider trading ; the independent or non-executive directors who have social or family
connection with controlling shareholder group fails to provide independent judgment and
minority shareholders rights are largely ignored or supressed (Farooque et al 2007). The
existence of conflict between family member dominated board members and minority
shareholders has been a regular feature in Bangladesh like other developing countries (Oman
et al , 2003).
Given the existence of family members dominated board and the dominance of
majority shareholders over minority shareholders, the implementation good governance
practices in Bangladeshi banking sector may experience serious setbacks which may not yield
expected results. Our study would like to examine the justification of such apprehension.

III. THEORETICAL PERSPECTIVE

Prior research in the area of corporate governance depicts the intricacies of multi-faceted
nature and behaviour of the companies. One argues that no one theoretical perspective can
fully encapsulate the complicacies of an organization (Cullen et al, 2006), that necessitates
various theories to provide better explanation for corporate governance characteristics and
6

mechanisms from different point of view and different dimensions. Daily et al. (2003) opined
that a multi-theoretic approach to corporate governance is essential recognising the many
mechanisms and structures that might reasonably enhance organisational functioning. As
governance literature suggests, the study will explain the complicacies of relevant governance
mechanisms in the light of the two corporate governance theories agency theory, and
stewardship theory of which agency theory will dominate and the rest one is situational
explanatory.
Cullen et al. (2006) suggest that the agency and stewardship theories centre upon the
firm and the attainment of corporate goals. At the level of the firm, agency theory focuses
upon the conflicting interests of principles and agents. Stewardship theory purports interest
alignment between the steward and organizational objectives. Agency theory explains the
agency problems arising from the separation of ownership and control. It provides a useful
way of explaining relationships where the parties interests are at odds and can be brought
more into alignment through proper monitoring and a well-planned compensation system
(Davis et al., 1997). The agency problem arises when the desires or goals of the principal
and agent conflict, and it is difficult or expensive for the principal to verify what the agent is
actually doing (Eisenhardt, 1989).

Principal can curb agency conflicts by establishing

appropriate incentives for the agent and by incurring monitoring costs. Jensen and Meckling
(1976) define agency costs as the sum of, (a) the monitoring expenditures by the principal,
(b) the bonding costs, and (c) the residual loss. Conflicts of interest, together with the
inability to costlessly write perfect contracts and/or monitor the controllers, ultimately reduce
the value of the firm. The agency problem not solved by contracting is addressed through the
use of various governance mechanisms. Agency theory provides a basis for firm governance
through the use of internal and external mechanisms (Roberts et al., 2005) that protect

shareholder interests, minimise agency costs and ensure agent-principal interest alignment
(Davis et al., 1997).
Another perspective that seeks to explain the behaviours is stewardship theory. The
stewardship perspective suggests that the attainment of organisational success also satisfies
the personal needs of the steward. The steward identifies greater utility accruing from
satisfying organisational goals than through self-serving behaviour. Stewardship theory
recognises the importance of structures that empower the steward, offering maximum
autonomy built upon trust. This minimises the cost of mechanisms aimed at monitoring and
controlling behaviours (Daviset al., 1997). For finding answers to the research questions,
empirical data have been examined from the perspective of agency theory, and stewardship
theory has been used as complementary to explain agency theory from broader perspective.

IV. LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT

Prior studies on the relationship of corporate governance mechanisms and corporate

performance are seen to include various internal and external mechanisms, among which
board size, board composition, board committees, CEOs position-duality, CEOs incentives
and ownership interest, ownership concentration of insiders and outsiders, multiple
directorships, debt financing, market for corporate control etc. are mentionable. Financial
performance measures being used are accounting based measures and market based
measures. To address problems mentioned above, the study discusses below relevant
governance mechanisms and performance measures in the perspective of existing literature.

A. BOARD SIZE

The board of directors is the top executive body of a company and assigned with the
responsibility of formulating policies and strategies and supervising operations of the
company. Fixing the optimal number of board of directors is a dilemma, although Bangladesh
Bank pronounced that the board of directors of the bank-companies shall be constituted of
maximum 13 (thirteen) directors. However, the directors of the banks, where the number of
directors is more than this number, shall be allowed to complete their present tenure of office
(BRDP circular no. 16 dated 24-07-2003). Companies Act 1994 (Bangladesh) limits the
minimum number of directors to be at least 3 for a public limited company. The proverb too
many cooks spoils the broth may be true for being so many number of directors and again
decision-making precision may be hampered because of being too small number of directors.
Empirical evidence indicate that the size of the board does matter as it affects the extent of
monitoring, controlling and decision making in a company (Monks and Minow, 1995;
Haniffa and Hudaib, 2006). Yermack (1996) find out an inverse relationship between board
size, and profitability and Tobins Q. Haniffa and Hudaib (2006) find board size negatively
significant-association with market performance and positive significant association with
accounting performance measure that indicate contradictory results of the board size, while
Holthausen and Larcker (1993) find no association between these two variables.

B. BOARD COMPOSITION

INDEPENDENT DIRECTORS: The board is the vital part of a company that acts on behalf of the

owners. The board is assigned with delegated authorities by the owners to formulate policies
and strategies, ensure internal control, monitor, evaluate and compensate the top management
to enhance the effectiveness of the organization. So, the successfulness of a company mostly
depends on the balanced composition of board consisting of inside and outside directors.
Most regulatory efforts have concentrated on the issue of independence of the board. In an
9

attempt to reduce the CEOs influence over the board, many countries have introduced
requirements that a minimum fraction of the board be composed of so-called independent
directors. The rationale behind these regulations is that if directors are not otherwise
dependent on the CEO they are more likely to defend shareholders interests (Becht et al,
2005). In Bangladesh, SEC in its notification (Feb. 20, 2006) made it compulsory to appoint
at least one-tenth of the total number of companys board of directors subject to a minimum
of one, independent director to enhance core competencies considered relevant in the context
of each company. Chiang (2005) argues that as the independent directors are more
specialized to monitor the board than the inside directors to run the business successfully by
reducing the concentrated power of the CEO, it helps the company to prevent misuse of
resources and enhance performance. Krivogorsky (2006) also observes significant positive
relationship between independent directors and performance of 81 European companies. In
contrast, directors who are unrelated to the firm may lack the knowledge or information to be
effective monitors. Yermack (1996), Agrawal and Knoeber (1996) and Bhagat and Black
(1998) find a negative relationship between the proportion of independent directors and
performance.

NON-INDEPENDENT AND NON-EXECUTIVE DIRECTORS: The composition of board structure

is an important mechanism because the presence of non-independent and non-executive

directors represents a means of monitoring the actions of the executive directors and of
ensuring that the executive directors are pursuing polices consistent with shareholders
interests (Fama, 1980). Some authors argue that boards dominated by non-executive directors
may help to alleviate the agency problem by monitoring and controlling the opportunistic
behaviour of management and also by ensuring that managers are not sole evaluators of their
own performance (Williamson, 1985; Jensen and Meckling, 1976; Baysinger and Hoskisson,
10

1990). Such boards may also help in reducing management consumption of perquisites
(Brickley and James, 1987), removing non- performing CEOs and other board personnel
(Weisbach, 1988; and Pettigrew and McNulty, 1995) and working as external forces to
seriously consider the responsibilities of managers and inside directors for the greater benefit
of the shareholders. In contrast, the view that the board of directors may resolve agency
problems through monitoring has been challenged by managerial hegemony theory, which
views boards as passive instruments that hold allegiance to the managers who selected them,
lack knowledge about the firm, and depend on top executives for information (Kosnik, 1987).
Both anecdotal and empirical evidence suggests that outside directors are not always effective
monitors of managers (Baysinger and Hoskisson, 1990; Hill and Snell, 1989). It is evident
from skimming through the relevant disclosure of information of this study that almost all
non-executive directors have multiple shareholdings and directorships. So, it is not
unjustified to raise the issue that they are to remain busy with so many works in different
places round the clock and have little time to look into one thing of a particular company
minutely other than to have birds eyes view.
Empirical evidence on the non-executive directors and performance is mixed. Some
authors found positive relationship between the outside directors and the firms performance
(Choi, Park, and Yoo, 2007; Pearce and Zahra, 1992; Stearns and Mizruchi, 1993; and Wang
et al, 2007). In contrast, in the UK, Weir and Laing (1999) found insignificant relationship
between non-executive director representation and performance. However, Baysinger and
Hoskisson (1990) and Harmalin and Weisbach (1991) find no relationship between board
composition and performance when both relate to the same year. Haniffa and Hudaib (2006)
also found no relationship and commented that boards dominated by non-executive directors
do not seem to affect performance regardless of the measures used.

11

C. CEO REMUNERATION

To curb agency conflicts and to reduce agency costs, a company may choose three
types of CEO incentive alignment mechanisms to implement to monitor the CEO -the CEO
duality mechanism, CEO ownership mechanism, and CEO compensation mechanism. CEO
duality determines the relationship of CEO to the chairperson of the board of directors and it
occurs when the same person holds the position of CEO and chairperson of the board. The
agency model argues that boards dominated by executive directors are more difficult to
control, a situation that would clearly apply to duality (Fama and Jensen, 1983). In case of
banking sector in Bangladesh, Bangladesh Bank rules and SEC guidelines regarded the
practice of duality undesirable. As a result, agency conflict in this sector is expected and
believed to have been seemingly minimized to some extent. The second one is CEO
ownership mechanism an incentive alignment device that a company may implement to
align management to the interest of the outside shareholders and thus reduces agency
problem. Due to convergence of interest, so much ownership of managers in a company
increases, so much goal congruence of the management and the outside shareholders is
believed to be achieved. However, Jensen and Rubacks (1983) entrenchment hypothesis
posit different point of view that the more shares management holds, the higher the
possibility that manager decision-making is overly conservative due to security of their
positions. It appears that the impact of the CEO share-ownership and the firms value is more
complex than is presumed in the literature. Interesting enough that the CEOs in banking
sector are hardly seen to have possessed shares of the same bank while dealing with primary
data for this study and as a result no hypothesis is required to be drawn in this respect. The
last usual one is CEO compensation mechanism that implies that a company may pay higher
remuneration to the managers, especially to the CEO to align interest with shareholders
12

interest as financial incentives. This alignment should induce CEO to take actions that create
firm value and thus curb agency conflict.
Using time series data from the UK and Germany, Conyon and Schwalbach (2000)
find a significant positive association between cash pay and company performance in both
countries. In contrast, Brick et al (2006) argues that an excessive level of compensation for a
CEO provides an indicator of poor corporate governance structure and that this is a precursor
to the underperformance of firms. Basu et al. (2007) also finds that relative to ownership and
monitoring variables, excessive pay levels have a negative association with subsequent
accounting performance. Similar negative relationship between excess director compensation
and firm performance is reported by Brick, Palmon and Wald (2006). Recently, Duffhues and
Kabir (2008) questions about the conventional wisdom of using executive pay to align
managers interest with those of shareholders after finding no systematic evidence that
executive pay of Dutch firms is positively related to corporate performance.

D. AUDIT COMMITTEE
Consistent with the agency theory, audit committee works as an additional control
mechanism that ensures that the shareholders interests are being safeguarded. In consistent
with the Cadbury proposal as to formation of audit committee, Bangladesh Bank and SEC
have made it compulsory for all banks to constitute a board audit committee consisting of a
minimum of three members and it will hold at least three meetings in a year. The committee
will review the financial reporting process, the internal control system and management of
financial risks, the audit process, conflicts of interest, infringement of laws etc. Thus, audit
committee works as another internal control mechanism in the board structure, the impact of
which should be to improve the quality of the financial management of the company and
hence its performance (Weir et al, 2002). As constitution of audit committee is mandatory
13

for banking companies in Bangladesh, every company has an audit committee in existence
but there is no way to understand the effectiveness with the merely existence of the
committee. In this case, the total numbers of meeting held in a year have been used as a proxy
to internal control mechanism to judge the effectiveness of the committee in this study.
Relatively little has been reported showing the impact of audit committee and
corporate performance. However, Klein (1998) finds that neither the presence of an audit
committee nor its structure has an effect on accounting and market performance. The author
(2002) also finds a negative relation between audit committee independence and abnormal
accruals. Again, Brown and Caylor (2004) shows the evident that solely independent audit
committees are positively related to dividend yield, but not to operating performance or firm
valuation. Similarly, Vafeas and Theodorou (1998) find no evidence to support the view that
the structure of subcommittees significantly affected performance. On the other hand, after
surveying the international companies, Ho (2005) reports that audit committee has strong and
positive relationships with the average return on equity.

E. OWNERSHIP CONCENTRATION
Ownership structure that shows the concentration of ownership by inside shareholders or
outside shareholders plays a vital role in effective corporate governance. It is argued that
when firms effectively become controlled by larger shareholders, deviations in the control of
cash flow rights induce such controlling shareholders to expropriate wealth by seeking
personal benefits at the expense of minority shareholders. The existence of controlling
shareholders thus implies agency costs arising from conflicts between controlling
shareholders and outside investors (Shleifer and Vishny, 1997; Claessens et al., 2000, 2002;
14

and La Porta et al., 2000; Lemmon and Lins, 2003; Chen and Lee, 2008). Chen and Lee
(2008), referring many other examinations of the relationship existing between ownership
structure and firm value, asserted that within family firms, the family members can accrue
additional benefits based upon their high level of insider ownership, as well as the low levels
of external stockholders and foreign ownership (Yeh et al., 2001; Randoy and Goel, 2003;
Brunello et al., 2003). Empirical results on the relationship between ownership concentration
and corporate performance are ambiguous. In the banking sector of Bangladesh, ownership
pattern includes sponsor/director ownership, institutional ownership, government ownership,
foreign ownership and public ownership. Of those, government ownership, and foreign
ownership are negligible and the study investigates the effectiveness of governance
mechanism on the performance with the rest three types of ownership concentration while
examining relationship.

SPONSORS OR DIRECTORS OWNERSHIP: With a fiduciary obligation to shareholders, and the

responsibility to provide strategic direction and monitoring, the boards role in governance is
very important (Gillan, 2003). In the banking sector of Bangladesh, on an average 85 percent
directors of a company are non-executive-non-independent directors holding much shares in
their companies, and almost all CEOs do not hold shares of their respective companies who
take only cash remuneration in the form of cash salary and cash bonuses. Similarly debtequity ratio on an average is 15 times than the equity. In this perspective, to seek to maximize
their best interest, it is usual to have agency problems between different groups between
managers and directors, between directors and outside shareholders, and between directors
and creditors/depositors. As a result, the agency costs are believed to be enhanced to curb
agency problems. According to the convergence-to-interest model, there is a relationship
between directors shareholdings and performance because the greater the financial stake, the
15

greater the costs for not maximizing shareholders wealth (Jensen and Meckling, 1976). As
the agency costs relating to managers are obviously increased to align the managers, the
board of directors is supposed to maximize their wealth at the expense of creditors/ depositors
interests. In that case, the board of directors maximize return on shareholders equity by
expropriating return on total assets and the difference between the two returns is worth
mentioning but nothing matters how big volume of shares the directors are holding rather
than to be working as non-executive-non-independent directors. In this situation, the
relationship between board shares and performance is ambiguous as the different researchers
found. Using 123 Japanese firms-level data from 1987 to 1995, Chen, Guo and Mande (2003)
report a monotonic relation between Tobins Q and managerial ownership. They find that Q
increases monotonically with managerial ownership, thus, suggesting greater alignment of
managerial interests with those of stockholder with the increase in ownership. Referring
empirical researches in respect of the relationship between performance and managerial share
ownership, Haniffa and Hudaib (2006) commented that the size of insider ownership does
matter and the effect can be both positive and negative. The positive relation at low levels of
managerial ownership suggests incentive alignment while the negative relation at high levels
of managerial ownership provides evidence that managers become entrenched and can
indulge in non-value-maximizing activities without being disciplined by shareholders
(Himmelberg et al., 1999).

INSTITUTIONAL OWNERSHIP: Compared to total ownership, share of institutional ownership

records 8 to 9 percent in the banking sector in Bangladesh, but considering the increased
investment in shares and role of institutional ownership in the mechanisms of corporate
governance, it has come in relevance. Institutional investors generally do have some
characteristics that make them unique and distinct shareholders. Firstly, institutional investors
16

typically hold shares as part of a portfolio investment strategy as can therefore be

distinguished, at least commercially, from other shareholders. A second and related point, is
that although ownership of shares in investment-companies, is legally attributable to the
institution, the shares are economically attributed to the ultimate investors and clients of the
institution (Jonathan, 2007). Institutions are financial intermediaries who do not hold the
shares for their own benefit as the financial returns are distributed to their investors and
clients (Tan and Keeper, 2008).
Shleifer and Vishny (1997) states that the institutional ownership can reduce the
agency cost and enhance firms performance through the reduction of managerial
opportunism and minority expropriation. But institutional investors as external investors
cannot influence the key decisions about companies operation. Lehmann and Weigand
(2000) find positive impact of ownership concentration on profitability for firms with
financial institutions as largest shareholders which is consistent with the view that banks are
better (more efficient) monitors to lower the agency costs. Ho (2005) reports that significant
institutional investors holdings raise board vigilance, which in turn has a positive effect on
firm performance. Short and Keasey (1997) show that in the absence of other large external
shareholders, institutional investors have a significant positive effect on the firm
performance. On the other hand, Agrawal and Knoeber (1996) find no significant relationship
between performance and institutional stockholding. Dhnadirek and Tang (2003) found no
significant association between institutional ownership and firm performance. They argued
that the external monitoring by terms of institutional ownership does not always result in
greater profitability or better corporate governance. Hence, the impact of institutional
ownership on companys performance has remained explored without any consensus. The
study seems that only institutional ownership cannot be effective to enhance the operating

17

performance by interfering the activities of management as the role is laid on the board of
directors.

GENERAL PUBLIC OWNERSHIP: Jensen and Meckling (1976) apply agency theory to the

modern corporation and model the agency costs attached to outside equity: when ownership
and control of corporations are not fully coincident, there is potential for conflicts of interest
between owners and controllers. These conflicts of interest, together with the inability to
costlessly write perfect contracts and/or monitor the controllers, ultimately reduce the value
of the firm (Cullen et al, 2006). Furthermore, incentives to perform direct monitoring are
weaker for dispersed ownership due to free-rider problems (Gugler, 2001; and Grossman and
Hart, 1982). Domination by large shareholders may also damage performance due to large
exposure to a firms risk (Demsetz and Lehn, 1985; Haniffa and Hudaib, 2006). Berle and
Means (1932) argue that when ownership becomes increasingly dispersed, shareholders
become powerless to control professional managers as they cannot effectively carry out
monitoring of management, the diffuseness of ownership and performance should have a
negative relationship.
According to convergence-of-interest model of Jensen and meckling (1976), the
increase of managerial ownership strengthens corporate performance as the interests of
management and stockholders are aligned. But Demsetz (1983) refuted this view, identifying
offsetting costs of insider ownership. He posits that no single ownership structure is suitable
for all situations if the value of the corporations assets is to be maximized (Welch, 2003).
Consiquently, this gave rise to the belief that the ownership structure of the firm was an
endogenous variable. That is, the ownership structure depends on the individual
characteristics of the organization (Fishman et al, 2005). Only for this reason, different
empirical studies on the association between ownership concentration and corporate
18

performance give ambiguous results. Holderness and Sheehan (1988) found a positive
correlation between shareholdings of large investors and firm performance. Similarly, in the
UK, Leech and Leahy (1991) found a positive relationship between external shareholdings
and performance. In contrast, Demsetz and Lehn (1985) and Demsetz and Villalonga (2001)
found no empirical relationship between ownership structure and profitability, and Murali
and Welch (1989) and Weir et al. (2002) also drew the same conclusion.

F. COMPANY SIZE
The size of company (proxied by total assets) is considered in this study as control variable to
have a relationship with other factors, for example, there is a strong relationship between
firm size and CEO compensation (e.g., Murphy, 1985). The literature is in harmony with
this tendency. On average, larger companies are better performers as they are able to
diversify their risk (Ghosh, 1998). Furthermore, larger company has larger market share and
market power in respect of customers and volume of investment. Larger firms have larger
investors bases than smaller ones. Again, company size may be measured in different ways
such as sales turnover, total assets, capital employed, etc. In this study, total assets have been
used as the measure of company size. Actually, to measure the magnitude of a company, total
assets is such a determinant that may preferably be used than other measures as the
accounting measure because sometimes a medium firm may have larger sales volume, for
example, due to increase in assets turnover.

G. DEBT FINANCING

Debt financing or leverage may play a significant role in governance mechanisms especially
in the banking sector for two unique characteristics of banks opacity and strong regulations.
19

Due to opacity, depositors do not know the true value of a banks loan portfolio as such
information is incommunicable and very costly to reveal, implying that a banks loan
portfolio is highly fungible (Bhattacharya et al., 1998). As a consequence of this asymmetric
information problem, bank managers have an incentive each period to invest in riskier assets
than they promised they would ex ante (Arun and Turner, 2003). The opaqueness of banks
also makes it very costly for depositors to constrain managerial discretion through debt
covenants (Capiro and Levine, 2002). Referring different studies Haniffa and Hudaib (2006)
assert that debt forces managers to consume fewer perks and become more efficient to avoid
bankruptcy, the loss of control as well as loss of reputation (Grossman and Hart, 1982). Debt
contracting may also result in improved managerial performance and reduced cost of external
capital (John and Senbet, 1998). In short, debt may help yield a positive disciplinary effect on
performance. On the other hand, debt can increase conflicts of interest over risk and return
between creditors and equity holders. Like other variables, relationship of gearing ratio with
performance shows conflicting results in different studies. Dowen (1995), McConnell and
Servaes (1995), Short and Keasey (1999) and Weir et al. (2002) found a significant negative
relationship between gearing and corporate performance. However, Hurdle (1974) found
gearing to affect profitability positively.

H. BANK PERFORMANCE MEASURES

A companys operations and successfulness are integrally connected. Studies show that the
concept of companys performance is multidimensional. But the fact is that the companys
investors, shareholders and other stakeholders find its successfulness in the financial
performance. The financial performance measures can be divided into two major types: (1)
accounting- based measures (e.g., Return on Assets, Return on Equity, or Return on Sales),
20

and (2) market- based measures (e.g. Tobins Q ratio). There has been extensive empirical
research using different performance measures for examining the relationship between
corporate governance and firms performance. There are some researches where either
accounting-based measure or market-based measure has been used but some researchers have
used both the measures. When both the measures have been used, almost all the researchers
have found significant relationship with one measure but no relationship with other measures.
This may be attributed for using different type of numerators and denominators used for
calculating financial performance.
Different researchers argue differently in favour of their using measurement base.
Some argue that if the capital market is unstructured and much volatile, Tobins Q ratios of
different companies give misleading results. Accounting measures have been criticised on
the grounds that they are subject to manipulation, that they may systematically undervalue
assets as a consequence of accounting conservatism and that they may create other distortions
as well (Sanchez-Ballesta and Garcia-Meca, 2007). Joh (2003) argues that accounting
profitability is a better performance measure than stock market measures for at least three
reasons. First, market anomalies may act as an impediment to all available information being
reflected in the stock price. Second, a firms accounting profitability is more directly related
to its financial survivability than is its stock market value. Finally, accounting measures allow
users to evaluate the performance of privately held firms as well as that of publicly traded
firms.
In the perspective of the literature review above, the study aims at investigating
empirically as to

whether the number of board members; proportion of independent

directors, and proportion of non-independent non-executive directors in the board; CEO

compensation; number of audit committee meetings; proportion of board ownership,

21

proportion of institutional ownership, and proportion of general public ownership; debtequity ratio; and company size have any significant influences on corporate performance.

V. METHODOLY AND DATA

A. EMPIRICAL METHODOLOGY
To investigate the effects of corporate governance variables on financial performance of
Bangladeshi listed banking companies, this study uses the following dynamic panel
regression model:

PERFOM it 0i 1 PERFOM i ,t 1 2 ln BM it 3 INDit 4 ln NINE it 5 SDOit 6 INOit

7 GNPit 8 ACM it 9 ln CEOit 10 ln TAit 11 ln DEQit u it

(1)

In this model, the dependent variable is banks financial performance (PERFOM) measured
by return on total assets (ROA), return on shareholders equity (ROE) and Tobins Q (Q). The
independent variables consist of eight corporate governance variables, namely number of
board members (in logarithm) (lnBM), proportion of independent director (IND), proportion
of non-independent and non-executive directors (NINE), sponsor/director ownership (SDO),
institutional ownership (INO), general public ownership (GNP), number of audit committee
meetings (in logarithm) (ACM), and Chief Executive Officers compensation (lnCEO); and
two control variables, such as company size proxied by total assets (in logarithm) (lnTA) and
debt-equity ratio (in logarithm) (lnDEQ). uit is the random error term and subscripts i and t
represent firm and time period, respectively.
The panel model in equation (1) includes the lagged dependent variable
( PERFOM i ,t 1 ) as one of the explanatory variables and thus the use of ordinary least squares
(OLS) estimator could lead to inconsistent estimates. Allowing fixed effects with time
dummies ( uit f i t it , where f i indicates time invariant bank level fixed effects, t
22

represents time dummies and it is the serially uncorrelated error term) we can remove time
invariant within group omitted variable bias. Still there is a clear simultaneity problem as the
lagged dependent variable ( ROAi ,t 1 or, ROE i ,t 1 or, Qi ,t 1 ) is correlated with the error term

it by virtue of its correlation with the time-invariant component of the error term, fi . In this
case, the usual approach to estimating a fixed-effects model - the least squares dummy
variable estimator (LSDV) - generates a biased estimate of the coefficients because the
lagged dependent variable is correlated with the error term, even if it is assumed that the error
term is not itself autocorrelated (Greene, 2003).
Therefore, in presence of lagged dependent variable as a regressor, the usual ordinary
least squares (OLS) estimator suffers from biases due to unobserved heterogeneity and
possible endogeneity of the regressors. Due to the possibility of unobserved firm-specific
effects, the OLS estimator may result in upwardbiased estimates of the autoregressive
coefficients if firm-specific effects are important (Bond, Elston, Mairesse and Mulkay, 1997).
A within group estimator (LSDV), after transforming the data to deviations from firm mean,
in order to eliminate firm-specific fixed effects, is not consistent either because the
transformed lagged dependent variable and the transformed error term are negatively
correlated (Nickell, 1981).
This issue may be addressed by applying the generalized method of moment (GMM)
dynamic panel estimator where the endogenous explanatory variables are instrumented with
their suitable lags so that the instruments are not correlated to the error term. Anderson and
Hsiao (1982) suggested a first-differenced transformation to eliminate time invariant fixed
effects and constant in GMM estimation. Arellano and Bond (1991) argue that the AndersonHsiao estimator fails to take all orthogonality conditions and thus the estimator becomes
inefficient. They propose a difference GMM estimator, allowing lagged values of the
23

endogenous regressors as instruments. However, Arellano and Bover (1995) and Blundell
and Bond (1998) argue that the lagged level of the endogenous variables may be poor
instruments for the first differenced variables and therefore they suggest lagged differences as
instruments, which is popularly known as system GMM.
Although GMM estimates do come with a price of possibly poor finite sample
performance, Blundell and Bond (1998) observe that system GMM estimator produces
efficiency gain when the number of time series observation is relatively small in Monte Carlo
simulations. Furthermore, Beck, Levine, and Loayza (2000) argue that system GMM estimator
is efficient in exploiting time series variations of data, accounting for unobserved country
specific effects, allowing for the inclusion of the lagged dependent variables as regressors and
thereby providing better control for endogeneity of the entire explanatory variables. Therefore,
we will emphasize more on two-step system GMM estimation in our empirical study although
OLS level and Within Group or, fixed effects estimates are also reported.
Arellano and Bover (1995) and Blundell and Bond (1998) prescribe several standard
tests that are needed to satisfy while using system GMM estimators. F-test examines the joint
significance of the estimated coefficients. The validity of the instruments used can be tested
by reporting both a Hansen test of the over-identifying restrictions, and direct tests of serial
correlation in the residuals or error terms. The key identifying assumption in Hansen test is
that the instruments used in the model are not correlated with the residuals. The AR(1) test
checks the first order serial correlation between error and level equation. The AR(2) test
examines the second order serial correlation between error and first differenced equation. The
null hypotheses in serial correlation tests are that the level regression shows no first order
serial correlation as well as the first differenced regression exhibit no second order serial
correlation.
24

B. DATA ANALYSIS
The sample companies used in this study are banking companies listed on the Dhaka Stock
Exchange (DSE) in Bangladesh. As at December 31, 2009, a total of 27 banking companies
were listed on the main board of the DSE. Excluding two banking companies- one for being
listed at the end of 2007 and another for data missing, a sample of 25 banking companies is
used in this study. The study is conducted on nine years data from 2003 to 2011 of the
companies under study. The study primarily collected data from the published annual reports
of the company. Besides, the companies websites and DSE websites were the supplementary
sources of data for the study. The reason for considering data from 2003 is that the
Bangladeshi listed banking companies, in compliance with Bangladesh Banks (Central
Bank) directives, instituted audit committees and additional regulatory reforms only from
2003 and we want to examine their impact on banks financial performance.
The dependent variable is corporate performance and three measurements, viz., return
on assets (ROA), return on equity (ROE), and Tobins Q are taken into account as proxies for
accounting-based measure of performance and market-based measure of performance. All
performance data refer to the end of the respective financial years as reported in the
companies financial statements. Market price of shares of a company at the close of the
financial year as published by SEC has been considered to calculate market capitalization. As
interest expenses of a bank are considered as operating expenses, profit before taxation has
been taken into account in calculating return on assets. In calculating total assets, fictitious
assets that have no real value have been excluded. Tobins Q has been calculated by market
capitalization plus total debt divided by total assets and considered as the higher the value of
Q, the more effective the governance mechanisms, and the better the markets perception of
the companys performance (Weir et al., 2002). Similarly, a higher ROE and a higher ROA
25

indicate effective use of companys assets in serving shareholders economic interests

(Haniffa and Hudaib, 2006). The nature of the panel data used in this study is unbalanced
since data is not available for all the sample companies over the entire sample periods.
Table-1: Descriptive Statistics: 2003-2011
Variables
ROA
ROE
Q
BM
IND
NINE
SDO
INO
GNP
ACM
CEO
TA
DEQ

Mean
2.722
19.083
1.133
13.243
4.010
85.836
39.435
12.090
42.250
8.085
5.145
55242
14.806

Std. Dev.
1.705
9.985
0.301
3.871
6.254
9.816
24.154
12.262
24.420
8.282
2.812
44250
4.909

Minimun
-0.133
-5.231
0.120
6.000
0.000
56.667
0.000
0.000
0.000
0.000
2.842
3970
5.703

Maximum
17.205
48.912
2.386
27.000
23.714
100.000
96.150
46.610
95.850
73.000
11.300
275429
33.671

Observation
223
222
222
223
221
220
220
220
220
222
221
222
222

Notes: The sample contains 25 Bangladeshi listed banking companies over the period 2003-2011. ROA= return on total
assets (in percentage), ROE= = return on shareholders equity (in percentage), Q = Tobin's Q, BM = number of board
members, IND = independent directors (in percentage), NINE = non independent and non executive directors (in
percentage), SDO = sponsors or directors ownership (in percentage), INO = institutional ownership (in percentage), GNP =
general public ownership (in percentage), ACM= number of audit committee meetings, CEO = CEO remuneration (in
million Taka), TA = total assets (in million Taka), DEQ = debt-equity ratio (in percentage).

Table-1 presents summary statistics for the key variables used in this study over the period
2003 to 2011. There is a wide variation in corporate governance and financial performance
measures across the banking companies. The average value of ROA, ROE and Tobins Q are
2.72%, 19.08% and 1.13, respectively, indicating consistent increase in accounting as well as
market return in Bangladeshi listed banking sector. The average board size is 13.24, which is
more or less within the size as recommended by Bangladesh Bank but still the number is high
in at least 25 percent companies. As per rule, the maximum number of board members will
be 13, however, where the number of directors is more than this number, shall be allowed to
complete their present tenure of office (circular no. 16 dated 24-07-2003). The proportion of
independent directors, on an average is 4.01% ranging from 0% to 23.71%, suggesting that
there are some companies where there is even no independent director at all in their board;
26

although, SEC rules (2006) recommend maintaining at least one-tenth of the total or
minimum one independent director in every company. The average proportion of nonindependent non-executive directors in the board is 85.84%, implying that that the board is
composed of mainly non-independent outside directors. It is said that the directors are
businessmen having directorships in at least 5 other multi-faceted companies. The same trend
is observed while surveying annual reports for this study.
In respect of ownership, the average proportion of shareholdings by the board of
directors is 39.43% indicating concentrated ownership and quite strong voting power of the
directors. The average value of institutional ownership is 12.09%, indicating poor holdings
suggesting negligible voting power in selecting directors in the board.

The average

proportion of general public ownership is 42.25 and standard deviation is 24.42, indicating
defuse ownership pattern among the general public who hold lesser proportion of ownership
in most of the companies.
On an average, the audit committee meets 8.08 times per year, however, there are
companies that do not hold any audit committee meeting, implying serious shortfall in the
effectiveness of audit committee and slackness in the internal control system. The average
amount of CEO compensation per year shows that the most of the companies pay Tk. 5.14
million while the maximum is 11.30 million indicating a very wide variation among the
companies in terms of CEO remuneration. Average book value of banks total assets is Taka
55242 million indicating smooth increase of assets over the sample period. Assets have
mainly been accumulated by the process of reinvestment of a part of earnings apart from the
amount of earnings taken as dividend from the business. It is for obvious

reason that the

depositors find it convenient to invest their savings elsewhere other than banks at a higher
rate of return as the bank rate of interest on different deposits are getting down over times.
The overall mean for debt-equity ratio is 14.81, indicating that the investment of depositors
27

and creditors in the banking business is on an average 14.81 times as much as the investment
of the shareholders. It also implies that in every Taka of assets in the business, the depositors
and creditors claim is fifteen times larger than the common shareholders.
It becomes salient form the above discussion and as received from banks statements
that the average rate of interest on deposits (7 percent or less) in the bank and yearly rate of
inflation (on average 8 percent, source: CIA World Fact book) are more or less equal in the
country. The directors are prominently non-independent outside businessmen having
concentrated ownership in the bank. CEOs are highly paid professionals without positionduality and ownership interests. The shareholders are getting average yearly return at the rate
of 19.08 percent on their investment having been the owners of only one-fifteenth in the total
assets invested in the banks. Average assets of banks are getting increased overtime and the
debt-equity ratio is gradually decreasing due to less rate of interest on deposits. The situation
leads one to comment that banking business is such an attractive less-risky business that pays
off the businessmen higher rate of return with minimum investment at the expense of
depositors money under the direct supervision of the government.

Table-2: Correlation Matrix: 2003-2011

ROA
ROE
Q
BM
IND
NINE
ROA 1.00
ROE
0.53**
1.00
Q
0.31**
0.16**
1.00
**
BM
0.13
0.08
0.12
1.00
**
IND
-0.07
-0.06
0.16
-0.15** 1.00
**
NINE 0.09
0.17
-0.12
0.22**
-0.69**
1.00
**
**
SDO
-0.11
0.06
0.16
0.20
-0.07
-0.03
INO
-0.10
-0.16** -0.01
-0.03
0.41**
-0.42**
**
**
GNP
0.22
-0.02
0.16
0.00
-0.07
0.02
**
ACM -0.08
0.03
0.11
0.10
-0.14
0.15**
**
**
CEO
0.05
-0.02
0.29
-0.02
0.29
-0.40**
**
**
TA
-0.02
0.03
0.42
0.04
0.19
-0.21**
**
**
DEQ
-0.36
-0.08
-0.07
-0.14
0.06
0.11
Notes: ** indicates 5% level of significance. See also notes to Table 1.

28

SDO

INO

GNP

ACM

CEO

TA

DEQ

1.00
0.18**
-0.49**
0.06
0.08
-0.01
0.06

1.00
-0.27**
-0.23**
0.17**
0.04
-0.06

1.00
0.03
0.27**
0.17**
-0.16**

1.00
0.03
0.45**
0.08

1.00
0.45**
-0.26**

1.00
0.04

1.00

Table-3: Variance Inflation Factor (VIF) & Tolerance (TOL): 2003-2011

BM
IND
NINE
1.23
2.3
2.42
VIF
0.81
0.43
0.41
TOL
Notes: See notes to Table 1.

SDO

2.13
0.46

INO

GNP

1.52
0.65

2.41
0.41

ACM

1.44
0.69

CEO

2.2
0.45

TA

DEQ

1.85
0.54

1.55
0.64

Table 2 shows the pair-wise correlation matrix for the variables reported in this study. This
correlation matrix examines the pattern of relationships between the variables under
consideration. Among the independent variables, the coefficients of correlation between
IND and NINE (-0.69), and between GNP and SDO (-0.49) are higher than the
coefficient of correlation between other corporate attributes but did not reach beyond 0.80 in
any way.One of the suggested rule of thumb for multicollinearity test is that if the pair-wise
or zero-order correlation coefficient between two regressors is high, say, in excess of 0.8,
then multicollinearity is a serious problem (Gujarati, 2004). The estimated pair-wise
correlation coefficient is less than 0.70 and thus the explanatory variables are unlikely to have
multicollinearity problems. Variance Inflation Factor (VIF) or Tolerance (TOL), a formal test
of multicollinearity, concludes with the same findings. According to Haan (2002), some
researchers use a VIF of 5 (TOL of 0.2) and others use a VIF of 10 (TOL of 0.1) as a critical
threshold and the results of this study show that the VIF and TOL of the explanatory
variables reported in Table 3 are far lower than the threshold level. Therefore, it is evident
that the estimated regression results are less likely to have multicollinearity problems.

VI. EMPIRICAL RESULTS

Table 4 summarizes dynamic panel regression results of 25 Bangladeshi listed
banking companies, based on the pooled OLS (columns 1, 4 & 7), fixed effects (columns 2,
5 & 8) and system GMM (columns 3, 6 & 9) estimators for the dependent variables, return
29

on total assets (ROAit), return on Shareholders equity (ROEit) and Tobins Q (Qit),
respectively. Since a lagged dependent variable is included in the regression models as an
explanatory variable, both OLS and fixed effects estimators are likely to suffer from
estimation biases due to possible endogeneity of the regressors. Therefore, this study
concentrates on a system GMM estimator that captures unobserved heterogeneity and reduces
endogeneity bias in the estimation. System GMM estimator satisfies a battery of the
specification tests, namely the F-test for joint significance, Hansens test for instrument
validity and the AR(1) and AR(2) tests for first-order and second-order serial correlation,
respectively. The coefficients of one period lagged ROA, ROE and Q are found to be positive
and statistically significant in all cases at the 1% level. Therefore, for Bangladeshi listed
banks, previous years financial performance has significant positive impact on current years
financial performance.
Table-4: Effects of Corporate Governance Mechanisms on Financial Performance of Bangladeshi
Listed Banking Companies: 2003-2011

ROAi,t-1

OLS
(1)

ROAit
FE
(2)

0.83***
(6.62)

0.80*** 0.45**
(6.32) (2.39)

GMM
(3)

OLS
(4)

ROEit
FE
GMM
(5)
(6)

Qi,t-1

INDit
lnNINEit
SDOit
INOit
GNPit
ACMit

lnCEOit

Qit
FE
(8)

GMM
(9)

0.74***
(4.52)
0.07
(0.77)
0.01**
(2.04)
0.18
(0.70)
0.01**
(2.15)
-0.01
(-1.29)
0.01
(1.50)
0.01
(0.68)
0.03
(0.74)

0.80***
(4.92)
0.06
(0.83)
0.01*
(1.68)
0.25
(0.95)
0.01**
(2.06)
-0.01
(-1.04)
0.01
(1.33)
0.01
(0.79)
0.03
(0.71)

0.49**
(2.31)
0.14
(0.35)
0.05*
(1.90)
0.39
(0.30)
0.01*
(1.81)
-0.01
(-1.00)
0.01**
(2.18)
0.03**
(2.32)
-0.14
(-0.60)

0.89*** 0.89*** 0.69***

(11.63) (11.69) (6.54)

ROEi,t-1

lnBMit

OLS
(7)

0.71*
(1.69)
-0.02
(-0.70)
-2.17
(-1.34)
-0.01
(-1.04)
-0.02
(-0.18)
0.02
(1.25)
0.01
(0.86)
-0.12
(-0.88)

0.68*
(1.67)
-0.02
(-0.81)
-1.72
(-1.25)
-0.01
(-0.72)
-0.04
(-0.05)
0.02
(1.30)
0.01
(0.86)
-0.16
(-1.22)

0.92
(0.98)
0.06
(0.95)
0.01
(0.02)
0.01
(0.60)
0.01
(1.09)
0.03**
(2.65)
0.03***
(3.30)
-0.24
(-0.47)

0.32
(0.17)
0.07
(0.49)
-6.28
(-0.85)
0.01
(0.43)
-0.06
(-1.04)
0.06**
(2.02)
0.01
(0.15)
-1.24
(-1.41)
30

0.30
(0.15)
0.07
(0.48)
-6.57
(-0.85)
0.01
(0.40)
-0.06
(-1.00)
0.06*
(1.88)
0.01
(0.14)
-1.25
(-1.40)

1.20
(0.23)
0.39
(1.22)
-0.10
(-0.50)
0.01
(0.15)
-0.02
(-0.25)
0.07**
(2.22)
0.03**
(2.39)
-3.82
(-1.55)

lnTAit
lnDEQit
Constant
Observation
R-Squared
F-Test (p-value)
AR(1) Test (p-val)
AR(2) Test (p-val)
Hansen Test (p-val)

-0.62
(-1.05)
0.22
(0.27)
15.86*
(1.72)
167
0.42

-0.77
(-1.13)
0.41
(0.45)
16.23*
(1.81)
167
0.44

-0.47
(-0.82)
0.23
(0.37)
16.70
(1.61)
167

0.01
(0.01)
0.30**
(2.55)
50.33
(1.47)
167
0.60

0.02
(0.02)
0.32**
(2.28)
52.36
(1.45)
167
0.61

0.00
0.02
0.20
0.34

-2.04
(-0.88)
0.78**
(2.38)
56.75
(0.98)
167
0.00
0.02
0.21
0.44

-0.03
(-0.37)
0.09
(1.06)
-1.33
(-0.94)
167
0.46

-0.06
(-0.79)
0.14*
(1.70)
-1.46
(-1.13)
167
0.59

-0.07
(-0.40)
0.66**
(2.30)
-1.30
(-0.05)
167
0.00
0.01
0.21
0.44

Notes: OLS = Ordinary Least Squares, FE = Fixed Effects, and GMM = System GMM estimator.
The numbers in parentheses are t-statistics and are based on robust standard errors. *, ** and ***
denote 10%, 5% and 1% significance levels, respectively. F-test is the joint significance tests of the
estimated coefficients. Hansen test measures the validity of the instruments where the null hypothesis
is that the instruments are not correlated with the residuals. The null hypotheses in AR(1) and AR(2)
tests are that the error terms in the first difference regression exhibit no 1st order and 2nd order serial
correlation respectively. 2nd and 3rd lags of the explanatory variables are taken as instruments for the
differenced equation, whereas 1st differences of the explanatory variables are taken as instruments for
the level equation in the System GMM. Time and company dummies are included but not reported for
brevity. See also notes to Table 1. In order to ensure that the empirical results are not driven by
outliers all of the variables are winsorized at the top and bottom 1 percent of their distributions, i.e.,
values at the 1% and 99% percentiles are reduced. ln indicates natural logarithm.

Board members are found to have positive and significant influence on bank
performance measured by ROA in both OLS and fixed effects estimations; however, the
relationship becomes insignificant though positive in system GMM. The effect remains
positive but insignificant while banks performance is measured by ROE as well as Tobins Q.
These results are consistent with the findings of Holthausen and Larcker (1993), Yermack
(1996), Eisenberg et al. (1998), Hermalin and Weisbach (2000), who suggest that the market
perceives larger boards as ineffective as they tend to be symbolic rather than being part of the
actual management process (Haniffa and Hudaib, 2006).
Neither of the board composition variables -proportion of independent director (IND)
and proportion of non-independent non-executive director (NINE) is turned up to be
31

significant in all the models while bank performance is measured by ROA and ROE.
However, the estimated coefficients of IND are found to be consistently positive and
significant at least at 1% level in all three estimators only when bank performance is
measured by Tobins Q, implying that independent directors help Bangladeshi listed banks to
improve their market based performance. This results is consistent Becht et al (2005) who
argue that independent directors protects interests of minority shareholders against both the
CEOs and the block holders actions.
Among the ownership structure variables, the extent of influence of directors
ownership (SDO), institutional ownership (INO) and general public ownership (GNP) on
bank performance provides mixed evidence. GNP has significant positive effects on banks
performance, whereas SDO exerts significant positive effects only in market based
performance (Tobins Q). INO does not show any significant effects on bank performance
either of the estimators.
The estimated coefficients of the number of audit committee meetings are consistently
positive and significant at 5% level in system GMM estimator, implying that increasing
frequencies of audit committee meetings could significantly raise Bangladeshi banks
performance. On average, each additional meeting of audit committee could raise annual
ROA, ROE and Tobins Q of listed banks by approximately 0.03%. This result is consistent
with the findings of Duncan (1991) and Vanasco (1994) who argue that audit committees
improve firms performance by providing better financial reporting to control firms financial
risk. Therefore, firms that do not comply with audit committee recommendations may face
serious financial irregularities and corporate failures (Mangena and Pike, 2005).
The coefficient of CEOs remuneration (CEO) is insignificant and somewhere
negative in all the measures of performance. The positively significant correlation between
CEO compensation variable and companys total assets indicates that larger banks pay much
32

compensation than the smaller ones to the CEOs. However, the result of negative effect of
CEO compensation on performance is in keeping with the findings of Basu et al. (2007) who
posit that relative to ownership and monitoring variables, excessive pay levels have a
negative association with subsequent accounting performance.
As a control variable, the size of banks (measured by total assets, TA) shows negative
but insignificant effects on financial performance in all three alternative methods. The
coefficient of another control variable financial leverage (measured by debt-equity ratio,
DEQ) is found to have significant positive effects on Bangladeshi banks when their
performances are measured by ROE and Tobins Q. Ultimately the average rate of return on
assets (2.72%) is very negligible due to this non-performing asset against higher rate of return
on equity (19.08%) that is the effect of high degree of trading on equity.

VII. CONCLUSION
The study investigates the extent of compliance with the statutory norms and guidelines
relating to corporate governance and the influence of corporate governance mechanisms on
financial performance of the 25 listed banking companies in Bangladesh. Accounting based
measures such as ROA and ROE and market based measure such as Tobins Q are used to
measure the financial performance of these banking companies over the period 2003-2011.
Estimated results in this study confirm a significant positive association between audit
committee meetings and Bangladeshi banks financial performance. Directors ownership and
independent directors are found to be significantly and positively related with bank
performance. Finally, levered banks are found to perform better than that of non-levered
banks in Bangladesh.

33

The results indicate that a good number of companies does not comply the mandatory
requirements for board size, appointment of independent directors in the board, and holding
audit committee meetings set forth by the central bank and the Security and Exchange
Commission (SEC) implying remarkable shortfall in corporate governance practice in
Bangladeshi banking sector. The board is seen to have been prevalently dominated by the
outside non-independent directors having multiple directorships and the companies are
actually run by the independent managers having no duality and no ownership interest. The
rate of return on shareholders equity is constantly much higher. The debt equity ratio is
gradually decreasing due to decreasing rate of interest on depositors investments in banks.
The CEO remuneration is increasing over the years in keeping with the increase in banks
total assets and the increased percentage of return on shareholders equity.

In this study, various aspects of rules and regulations of corporate governance, its
practices and the influences on the companies performance in the banking sector in
Bangladesh have been examined and analyzed. Based on the analysis, certain findings have
come out and some suggestions have been put forward to improve the situation prevailing in
the arena of corporate governance and practices. This study makes several contributes to the
growing literature on corporate governance. There are few studies regarding corporate
governance mechanisms and companies performance in developing countries. Very few
such studies can be found in the context of financial sector in Bangladesh. From this
perspective, the study has immense value to the planners and regulators. The study will
provide additional support for the view that while much emphasis on corporate governance
mechanisms is necessary to safeguard the interest of stakeholders, good corporate governance
on its own cannot make a company successful. Companies need to balance corporate
34

governance structure with key drivers of performance by taking and implementing strategic
decision and risk management with the efficient utilization of organizations resources.
Using different estimators and alternative performance measures this study
empirically finds that a very few governance variables have significant positive effects on
financial performances of Bangladeshi banking companies. The results in the context of
developing countries contend with the findings of Fahy et al. (2005) and PAIB Committee
(2004) that corporate governance of an organization ensure conformance but does not directly
ensure performance, rather helps to achieve performance. Good corporate governance with
the goal of providing strategic plan and effective risk management and efficient utilization of
organizations resources can achieve performance.

References
Agrawal, A. and Knoeber, C.R. (1996), Firm Performance and Mechanisms to Control Agency
Problems Between Manager and Shareholders, Journal of Financial and Quantitative
Analysis, Vol. 31, pp. 377-89.
Al Farooque, O., Van Zijl, T., Dunstan, K., and Karim, A. K. M. W. (2007), Corporate
Governance in Bangladesh: Link between Ownership and Financial Performance, Corporate
Governance: An International Review, 15(6), 1453-1468.
Anderson, T. and C. Hsiao (1982). "Formulation and Estimation of Panel Data." Journal of
Econometrics, 18: 47-82.
Arellano, M. and Bond, S. (1991), Some Test of Specifications for Panel Data: Monte Carlo Evidence
and an Application to Employment Equations, Review of Economic Studies, Vol. 58, 277297.
Arellano, M. and Bover, O. (1995), Another Look at the Instrumental Variable Estimation of Error
Component Models, Journal of Econometrics, Vol.68, 29-51.
Banking Reform Commission (BRC) (1999), The Report of the Banking Reform Commission, formed
by the Government of Bangladesh.
Bangladesh Enterprise Institute (BEI) (2003), A Comparative Analysis of Corporate Governance in
South Asia: Charting a Roadmap for Bangladesh, BEI, Dhaka, Bangladesh.
Baum, C. F. (2006). An Introduction to Modern Econometrics Using Stata, College Station, TX, Stata
Press.
Baum, C. F., M. E. Schaffer and S. Stillman (2003). "Instrumental variables and GMM:
Estimation and Testing." Stata Journal, 3(1): 1-31.
Beck, T., R. Levine, and N. Loayza (2000). "Finance and the Sources of Growth." Journal of
Financial Economics, 58: 261-310.
Bhagat, S. and Black B. (2002), The Non-correlation between Board Independence and Long-term
Firm Performance, The Journal of Corporation Law, Vol. 27, No. 2, pp. 231.
Bhagat, S. and Bolton, B. (2008), Corporate Governance and Firm Performance, Journal of Corporate
Finance, Vol. 14, No. 3, pp. 257-273.
35

Blundell, R. and Bond, S.R. (1998), Initial Conditions and Moment Restrictions in Dynamic Panel
Data Models, Journal of Econometrics, Vol.87, 115-143.
Boehren, O. and Oedegaard, B. (2003), Governance and Performance Revisited. Working
Paper No. 28/2003, European Corporate Governance Institute.
Bond, S., Elston, J., Mairesse, J. and Mulkay , B. (2003), Financial Factors and Investment in
Belgium, Germany, France and the UK: A Comparison Using Company Panel Data, Review
of Economics and Statistics, Vol. 85, 153-165.
Brick, I. E., Palmon, O., and Wald J. K. (2006), CEO Compensation, Director Compensation, and
Firm Performance: Evidence of Cronyism?, Journal of Corporate Finance, Vol. 12, No. 3,
pp. 403-423.
Cho, M-H. (1998), Ownership Structure, Investment, and the Corporate Value: An Empirical
Analysis, Journal of Financial Economics, Vol. 47, No. 1, pp. 103-121.
CPD (2001), Financial Sector Reforms, A Report Prepared by CPD Financial Sector Task Force,
Dhaka.
Demsetz, H. and Villalonga, B. (2001), Ownership Structure and Corporate Performance, Journal of
Corporate Finance, Vol. 7, pp. 209-33.
Du, H. (2006), Roundtable Discussion on Corporate Governance Guidelines of SEC and its
implementation practices in Bangladesh, The Dhaka Stock Exchange, available online at
http://www.dsebd.org/pdf/roundtable.pdf
Fahy, M., Roche, J. and Weiner, A. (2005), Beyond Governance -Creating Corporate Value through
Performance, Conformance and responsibility, John Wiley & Sons, Ltd.
Fama, E. F., (1980), Agency Problems and the Theory of the Firm. Journal of Political Economy
vol. 88, pp 134-145.
Greene William H (2003). Econometric Analysis, (5th Edition).Singapore: Pearson Education, Inc:
307-321.
Gregory, H.J. and Simms, M.E. (1999), Corporate Governance: What it is and Why it Matters, The
9th International Anti-Corruption Conference (Kuala Lumpur).
Haniffa, R. and Hudaib, M. (2006), Corporate Governance Structure and Performance of Malaysian
Listed Companies, Journal of Business Finance & Accounting, 33(7) & (8), 1034-1062.
Haque, A. K. E., Jalil, M. B. and Naz, F. (2008), State of Corporate Governance in Bangladesh:
Analysis of Public Limited Companies-Financial, non-Financial Institutions and State Owned
Enterprises, Working Paper No. 2, Center for Research and Training, East West University,
Bangladesh.
Hassan, K. (1994), The Financial Sector Reform in Bangladesh., Hassan, K., Banking and Finance in
Bangladesh, Dhaka Bangladesh.
Hayashi, F. (2000). Econometrics, Princeton University Press.
Hermalin, S. and Weisbach, M. (1991), The Effects of Board Composition and Direct Incentives on
Firm Performance, Financial Management, Vol. 20, pp. 101-112.
Himmelberg C. P., Hubbard, R. G. and Palia, D. (1999), Understanding the determinants of
managerial ownership and the link between ownership and performance, Journal of Financial
Economics, Vol. 53, No. 3, pp. 353-384.
Klein, A. (1998), Firm Performance and Board Committee Structure, Journal of Law and Economics,
Vol. 41, No. 1, pp. 275-303.
Lins, K. V. (2003), Equity Ownership and Firm Value in Emerging Markets, Journal of Financial &
Quantitative Analysis, Vol. 38, No. 1, pp. 159-184.
Loderer, C. and Martin, K. (1997), Executive Stock Ownership and Performance Tracking Faint
Traces, Journal of Financial Economics, Vol. 45, No. 2, pp. 223-255.
Nickell, S. (1981), Biases in Dynamic Models with Fixed Effects, Econometrica, Vol. 49, 1417-1426.
PAIB Committee (2004), Enterprise Governance -Getting the Balance Right, New York: IFAC,
Professional Accountants in Business.
Roodman, D. (2009), How to Do xtabond2: An Introduction to Difference and System GMM in
Stata, The Stata Journal, 9: 86-136.
Rose, C. (2005), Managerial Ownership and Firm Performance in Listed Danish Firms: In Search of
the Missing Link, European Management Journal, Vol. 23, No. 5, pp. 542-553.
36

USAID (1995) Impact Evaluation of Financial Sector Reform Program: Technical Assistance Project
Bangladesh, A Paper Prepared by Development Associated Inc. and Published by USAID.
Weir, C., Laing, D. and McKnight, P. J. (2002), Internal and External Governance Mechanisms: Their
Impact on the Performance of Large UK Public Companies, Journal of Business Finance &
Accounting , Vol. 29, pp. 579-611.
World Bank (1998), Bangladesh: Strategy for Establishing a Sound and Competitive Banking Sector,
Vol. 1 & 2, Finance and Private Sector Unit, South Asia Region, World Bank.

37