Research Seminar in Corporate Governance, MBA 3rd Trimester, UGC, January 15, 2014 Presented By: Group 5 Samiksha Neupane,Sagun Prajapati, Samipa Dahal, Shreesh Parajuli,Sudeep Nepal A Synopsis on:Corporate Governance in Banking System:An Empirical Investigation Authors: Abhiman Das and Saibal Ghosh About the authors:Mr Abhiman Das has worked as a assistant adviser in department of statistics and information management of Reserve bank of India. He has released several research paper in the field of economics also.Mr Saibal Ghosh has also worked as a higher level official in Reserve Bank of India and has released several research papers.

Abhiman Das

Research Context Virtually every major industrialized economy and major international organization has made efforts in recent years to refine their views on how large industrial corporations should be organized and governed. Academics in both law and economics have also intensely focused on corporate governance [La Porta et al1998]. Despite the growing literature in the field very little attention has been focused on the issue of the corporate governance, especially in banking organizations [Shleifer and Vishny 1997]. This is particularly strange in light of the fact that a significant amount of attention has been paid to the role that banks themselves play in the governance of other sorts of firms [Macey and O’Hara 2003]. The corporate governance of banks in developing economies is important for several reasons. First, banks have an over-whelming dominant position in developing economy financial systems, and are extremely important engines of economic growth [King and Levine 1993; Levine 1997]. Second, as financial markets are usually underdeveloped, banks in developing economies are typically the most important source of finance for the majority of firms. Third, as well as providing a generally accepted means of payment, banks in developing countries are usually the main depository for the economy’s savings. Fourth, many developing economies have recently liberalized their banking systems through privatization/disinvestments and reducing them role of economic regulation. Consequently, managers of banks in these economies have obtained greater freedom in how they run their banks. No satisfactory explanation has yet been provided however a significant attention has been paid to the role that banks themselves play in the governance of other sorts of firm. Purpose of study The fundamental objective of the research is to examine the issue of corporate governance in banking organizations in the Indian context. The paper seeks to explore the link between CEO turnover and bank performance. The focus of the paper is on evaluating corporate governance in an emerging country banking market, the focus is on corporate governance outcomes rather than on corporate governance mechanisms. Significance of study The potential advantage of the corporate governance is organizational effectiveness and improvement in CEO’s performance. Corporate governance of banks of developing countries has a great importance as banks have dominant position in the developing economy financial systems and are extremely important engines of economic growth. Econometric Methodology Looking at the relationship between CEO turnover and performance tests whether corporate governance is effective or not on its own, it fails to prove how to make it effective. We estimate a relationship between CEO turnover and corporate performance of the following form: CEO turnover = f ( firm performance, control variables ) (1) In particular, we test whether there exists a negative relationship between CEO turnover and firm performance. Since CEO turn-over is a binary variable, we choose to estimate the following logit regression: Pr ob {CEO turnover} =f ( β firm performance, +γ ' Z) (2) where β captures the relationship of interest, γ is a k x 1 vector of coefficients, Z is a k x 1 vector of control variables and f (.) is the logistic function f(a)=[exp(a)/1+exp(a)]. The model is estimated using bank-specific fixed effects. Measurement and Data The estimation procedure comprises of two sets of results. First, we estimate the relationship between CEO turnover and performance in public sector banking system and in a subsequent stage, we estimate the relationship for all bank groups (public/old and new private/foreign). There are several data constraints we need to reckon with in this case. First, not much is known about the CEO apart from his/her name. There is also paucity of consistent data on characteristics that will affect then probability of CEO turnover such as the age and tenure at the firm. It is plausible to argue that these CEO characteristics are uncorrelated with firm performance. In that case, their absence will worsen the fit of the regression models, making it harder to find any effect of firm performance on CEO turnover, but will not bias the coefficient on firm performance. Second, we do not also know whether in case of departure of the CEO, it was voluntary or otherwise. Obviously, the link between forced CEO turnover and firm performance is what is relevant to the effectiveness of a corporate governance system, the topic addressed 4by the paper. To control for this possibility, we introduce year dummies: the identifying assumption being firm performance affected the probability of forced turnover, while year

dummies affected the probability of unforced turnover. Third, in several cases, the CEO of one bank might have gone on to later become the CEO of another bank. Our conjecture is that the measures of firm performance included would, along with the year dummies, pick up some of these effects. We use return on assets (RoA), calculated as net profit to total asset, as the measure of firm performance as it is the most encompassing measure. To account for the fact whether previous year’s performance affects CEO turnover, we also use the change in RoA calculated as RoA minus the previous year’s RoA [Anderson and Campbell, 2003]. As per our hypothesis, the coefficient on RoA should be negatively related with CEO turnover. We also alternately employ operating profits (EARN) as a measure of performance. We employ several controls to account for bank-specific features. First, we employ natural logarithm of total assets (SIZE) to ascertain the fact whether turnover is higher in bigger banks or otherwise. Second, we employ the capital adequacy ratio (CRAR) to examine whether better capitalized banks exhibit lower CEO turnover. The ‘gamble for resurrection’ strategy would suggest that inadequately capitalized banks would tend to have a riskier loan portfolio in order to shore up their capital levels, which is likely to lead to lower profitability and consequently, higher turnover. The non-performing loan ratio (NPL), defined as the ratio of gross non-performing loans to gross advances is also included as an explanatory variable to capture the efficacy of credit risk management at the bank. To the extent that the bank had poor credit risk management techniques, this would reflect adversely on CEO performance and possibly result in higher turnover. Finally, to control for the economic environment, we employ the real GDP growth rate (GDPGR), but do not conjecture any sign on this variable and instead, leave the same to be econometrically determined. Finally, as mentioned earlier, year dummies have been included to capture any time-specific effects. Results From the result of the empirical exercise two sets of results are presented: the first with RoA as a measureof bank performance and the other, with operating profits as ameasure of bank performance.Three salient features of the results deserve a mention. Ir-respective of whether which measure of bank performance isconsidered, lagged value of the performance measure has asignificant influence on CEO turnover. In other words, bankperformance does impinge upon CEO turnover. Second, SIZE is observed to negatively and significantly impact CEO turnover, suggesting that bigger banks tend to have lower probability of rotation of CEOs. It might well be possible that, only with them passage of time, CEOs tend to become fully conversant with the functioning of bigger banks, this would suggest that CEOs in bigger banks tend to get a longer tenure to cover for the lock-in period to become fully conversant with the bank’s operations. Third, capital is observed to have a significant influence on CEO turnover: inadequate capital position being associated with higher CEO turnover. Better-capitalised banks are perceived as safer; lower capital, as a consequence, reflects inadequately on CEO performance, thereby possibly engendering higher turnover. An interesting question of importance is whether performance of CEO is, in any way, impacted by the fact whether a bank is listed or otherwise. Towards this end, we construct a variable (LISTING), which assumes value 1 for the year (and all sub-sequent years) in which a bank has made an equity offering, and zero, otherwise. Several features of the results deserve a mention. First, most variables which were significant in the earlier case retain their significance in this case as well. Thus, lagged performance measures are significant in almost all cases, except foreign banks for whom contemporaneous performance measure is found to have a significant impact on CEO turnover. Conclusion It is observed that, among bank-specific variables, there exists a negative correlation between the dependent variable and performance (as measured by RoA), suggesting CEO turnover is lower in banks with better performance. It is also observed that bigger banks as well as those with higher non-performing loans have lower CEO turnover. The paper has studied corporate governance in emerging markets by examining Indian banking systems in India. In a sample of 27 public sector banks in India, CEOs of poorly performing banks are likely to face higher turnover than CEOs of well-performing ones. Along this dimension, corporate governance is effective. Measures of performance based on return on assets have the strongest association with CEO turnover, while listed firms have a weaker association. Similar results are obtained when the sample is extended to encompass the entire banking system, include a sample of foreign/new private and old private banks. These findings do not imply that corporate governance in Indian banks is perfect. Indeed, the results presented may contain seeds of concern for the future of emerging market corporate governance. Limitations 1) Sample size is limited to 27 public sector banks. 2) Conclusion is not unanimous i.e limited within developing country only. Critical Appreciation/Future Scope 1) The work of Abhiman Das and Saibal Ghosh was a pioneer in the area of corporate governance. 2) This study work has cleared the factors that affect a CEO’s performance in an organization. 3) As emerging markets like India continue to grow and become more integrated with the global economy, more research can be conducted to examine the corporate governance systems.