Differential market valuations of board busyness across alternative banking models

Transcription

1. Review of Quantitative Finance and Accounting (2020) 55:201–238 https://doi.org/10.1007/s11156-019-00841-4 ORIGINAL RESEARCH Differential market valuations of board busyness across alternative banking models Marwa Elnahass1   · Kamil Omoteso2 · Aly Salama1 · Vu Quang Trinh3 Published online: 3 September 2019 © The Author(s) 2019 Abstract This study comparatively assesses the influence of board busyness (i.e., multiple directorships of outside directors) on stock market valuations of both Islamic and conventional banks. For a sample of listed banks from 11 countries for the period 2010–2015, results show that board busyness is differentially priced by investors depending on the bank type. In conventional banks, board busyness is significantly and positively valued by the stock market. This result suggests that investors perceive some reputational benefits arising from a busy board (e.g., extended industry knowledge, established external networks or facilitation of external market sources). In contrast, we find no supporting evidence on the market valuations of board busyness in Islamic banks. This result might be attributed to, both, the complex governance structure and the uniqueness of the business model which require additional effective monitoring, relative to that employed in conventional banking. Our results also show that investors provide significantly low market valuations for busy Shari’ah advisory board which acts as an additional layer of governance in Islamic banks. Findings in this study offer important policy implications to international banking studies and regulations governing countries with dual-banking systems. Keywords  Firm valuations · Board busyness · Banking systems · Stock market JEL Classification  C23 · G01 · G21 · G28 · L50 · M41 1 Introduction Regulators and market participants in capital markets have long emphasised on the critical role of the board of directors, as a core corporate governance mechanism, in promoting a country’s economic growth and financial stability. A weak system of governance tends to offer substantial managerial opportunities to engage in risk-taking activities and fraudulent acts. Extant literature (e.g., Mallette and Fowler 1992; Faleye et  al. 2018; Lu and Boateng 2017; Jouida 2019) documents that an effective board of directors can monitor top * Marwa Elnahass marwa.elnahas@newcastle.ac.uk 1 Newcastle University Business School, Newcastle University, Newcastle upon Tyne, UK 2 University of Derby, Derby, UK 3 Huddersfield Business School, University of Huddersfield, Huddersfield, UK 13 Vol.:(0123456789)
2. 202 M . Elnahass et al. management on behalf of shareholders to reduce information asymmetry between managers and shareholders and thereby lessen agency costs. Resource dependence theorists assert that a board of directors is “a provider of resources, such as legitimacy, advice and council links to other organizations” (Hillman and Dalziel 2003, p. 383). Therefore, the quality of board monitoring and their engagements in managerial decision-making can have direct implications on firm value (Yermack 1996; Lin and Liu 2009; Liu 2015; Meng et al. 2018). Moreover, the uniqueness of governance in banking alongside the opacity related to several banking transactions imply a dominant impact of effective monitoring by the board of directors on investors’ trust and optimism (Adams and Mehran 2003; Faleye and Krishnan 2017). Appointing an outside busy board member (i.e., holding multiple directorships) can, hence, affect investors’ perceptions of their firm value. Furthermore, in line with the agency theory, investors are likely to pay more for bank equity when their interests are aligned with those of directors and managers. In other words, a bank market value is likely to increase as the agency conflicts diminish because such lower agency costs can effectively protect investors’ wealth. From this perspective, board busyness can influence bank market value by either restricting or encouraging managers from expropriating bank resources. This depends on the levels of agency costs and the complexity of a bank business model. Arguably, busy boards can offer reputational benefits to their firms such as extended business networking/connections and quick access to market resources (Brennan et  al. 2016). Holding multiple board seats can also promote effective monitoring due to rich experience and valuable skills from serving many firms (Jiraporn et al. 2008). This might enhance the quality of long-term decision making, and hence, such reputational benefits might lead to favourable implications on firm value (Field et  al. 2013; Muravyev et  al. 2016; Chou and Feng 2018). In contrast, other prior studies still suggest that board busyness can result in over-commitment and limited availability by boards who might be unable to fulfil their fiduciary duties and scrutinise risk-taking activities (Fich and Shivdasani 2006; Falato et al. 2014; Chou and Feng 2018), leading to adverse impact(s) on firm valuation. Evidence on the market valuations of busy boards of directors is limited (e.g., Ferris et al. 2003; Cashman et al. 2012), focused on non-financial firms (i.e., the industrial sector) and provided mixed findings. Within the banking setting, examining stock market valuations (see Caprio et  al. 2007; Belkhir 2009; Zulkafli et  al. 2010) is restricted to focus only on other corporate governance mechanism and characteristics (e.g., ownership structure, shareholder protection laws, board size, and CEO duality). Therefore, relatively little is known about whether board busyness can either improve or detriment the bank market value. Moreover, none of the prior studies in banking has given attention to the possible systematic differences of stock market valuations for busy boards across alternative bank types. An ideal setting for such an investigation is the unique systems of governance and business models employed by the Islamic versus conventional banks.1 Investigating the effects of busy boards across the two systems is important to the on-going debate associated with 1   The operations of Islamic banks are principally driven by a constrained banking model, which inherits both moral accountability values and legal responsibilities (Abdelsalam et al. 2016). Islamic banks operate on a business model that prohibits interests, complex derivatives, short-selling, aggressive risk-taking and speculation while they encourage risk-profit sharing between the firms and their depositors. Meanwhile, conventional banks provide their services on interest-basis. 13
3. Differential market valuations of  board busyness across… 203 factors contributing to the resilience and stability of both banking sectors (see Čihák and Hesse 2010; Abedifar et  al. 2013; Beck et  al. 2013). The rapid growth of Islamic banks implies that the impact of this bank type on the global economy might be substantial.2 The financial crisis in 2007 has also extended the attraction of exploring the market valuation of the Islamic banking model in comparison to conventional banking by practitioners and monetary authorities, to explore a viable and resilient alternative financial system to the conventional banking system (Wilson 2009). Islamic banks conduct operations based primarily on profit-loss sharing (PLS) arrangements, in which contracts between the banks and their depositors are equity-based (Olson and Zoubi 2008; Mollah et al. 2017). The governance structure employed by Islamic banks is likely to be more complicated than that of conventional (Safieddine 2009; Mollah and Zaman 2015). In both bank types, the board of directors is responsible for the implementation of strategic decisions, protection of the shareholders’ interest and maximisation of the bank value. However, for Islamic banks, under the constrained banking model and the nature of the products/services offered, board of directors has additional responsibilities related to the establishment of the appropriate Shari’ah governance framework besides the development of relevant policies to ensure that all activities are conducted in compliance with the Shari’ah law (Quttainah et al. 2013). Furthermore, for Islamic banks, additional agency costs are likely to be associated with the Islamic banking model. This is due to a peculiar institutional environment in Islamic banks including the special bank-depositors’ relationship.3 Moreover, unlike the single governance-layer in conventional banks (i.e., board of directors), Islamic banks are subject to a double-governance mechanism by a Shari’ah Supervisory Board (i.e., SSB) in addition to their regular board of directors.4 Decisions by the board of directors depend much on the supervision effectiveness of SSB for Shari’ah compliance (Mollah and Zaman 2015). SSB is hence referred as “supra authority” which monitors the board of directors’ decisions to ensure that they execute the ex-ante approved products/services (Beekun and Badawi 2005; Godlewski et al. 2016; Alsaadi et al. 2017). Finally, the structure and features of Islamic banking governance indicate that the popularity and the scarcity of experts in Shari’ah legitimacy on a global basis for both boards of directors and SSB have contributed to the busyness of the two boards in Islamic banks.5 Accordingly, the natures, qualities, and commitments of the board of directors in the two bank types are dissimilar (Mollah et al. 2017) and can have implications on investors’ valuation of board busyness. Under the presence of structural differences between conventional and Islamic banking business models, our premise is that differential stock market valuations of board busyness across the two bank types is plausible. Investors within the 2   The annual growth of Islamic banking is around 20% in 2012 (Malkawi 2013). Until 2015, their total assets reach $1.38 trillion, which is projected to further increase to $6.5 trillion by 2020 (IFSB 2017). From 1998 to 2005, Islamic banks showed tremendous growth in their assets by 111% while conventional banks only grew by 6% (Khan 2010). 3   With the absence of representation on the board of directors for depositors, Islamic bank managers have full control of the investment process of depositors’ funds which suggest high agency problems. 4   AAOIFI standard defines Shari’ah supervisory boards as “specialised jurists, particularly in Islamic law and finance, entrusted with the duty of directing, reviewing and supervising the activities related to Islamic finance to ensure they comply with Shari’ah rules and principles” (Lahsasna 2010; p. 217). The SSB has both consultative and supervisory functions to support the board of directors. 5   Few Shari’ah scholars who are highly experienced in the inter-disciplines of Shari’ah law and finance (Alnasser and Muhammed 2012) do exist worldwide. Therefore, there is a limited number of the most prominent scholars dominate the Islamic banking industry nowadays (Mollah and Zaman 2015). 13
4. 204 M . Elnahass et al. two banking sectors may hold different perceptions of the oversight and resource-creation roles of outside boards depending on the banking business model employed and the structure of governance including the need for additional monitoring like Shari’ah governance. A lower firm valuation of board busyness in Islamic banks is predicted when compared to their conventional counterparts. This is justified by the extended agency conflicts and the unique business model of Islamic banking, which requires effective scrutiny from two different boards (i.e., the board of directors and the SSB). We empirically examine whether board busyness is differently valued by investors engaging with the Islamic versus conventional banking sectors. We use an international sample of 386 bank-year observations for listed Islamic and conventional banks operating in 11 countries between 2010 and 2015. For the full sample (i.e., Islamic and conventional banks), results show that busy board of directors is significantly associated with the high bank value. Conditional on the bank type, we find strong evidence of differential market valuations of busy boards between Islamic and conventional banks. For conventional banks, investors tend to perceive board busyness as significantly increasing bank value. In contrast, investors in Islamic banks seem not to perceive board busyness, which reports insignificant results. We take a step ahead to study the channels underlying the board busyness and bank value among the two bank types. Our empirical analyses involve studying agency conflicts and board compensation channels. We find that board busyness is likely to exacerbate agency conflicts within Islamic banks leading to lower market valuation. However, this is less pronounced in conventional banks. Furthermore, a busy board of directors is associated with low compensation pay-outs. This is more evidential in conventional than Islamic banks. It is also more expensive to appoint a busy SSB than non-busy SSB. In additional analyses, board busyness becomes significantly perceived as reducing the Islamic bank value as the degree of board directorships increases. Moreover, Islamic banks with busy SSB exhibit significantly low market value. We also find an inverted U-shaped non-linear relationship between busy SSB and stock market valuation: at lower degrees of board busyness, investors tend to highly price busy SSB, yet at higher degrees of board busyness, the market value of Islamic banks decreases. Our results are robust in several model specifications (i.e., propensity score matching, first-differenced regressions and GMM) as well as alternative measures for board busyness and bank performance. To our knowledge, this study is the first to offer comparative assessments between Islamic and conventional banking market valuations by utilising an important board attribute such as busyness. The study’s findings are timely to the current debate of the complexity of corporate governance of Islamic versus conventional banking (e.g., Mollah and Zaman 2015; Mollah et al. 2017; Lassoued et al. 2017; Alandejani et al. 2017; Alqahtani et al. 2017; Elnahass et al. 2018). We extend prior literature studies through highlighting to the influence of institutional characteristics and governance structures on having distinct firm valuations for busy boards within the two banking sectors. This study also contributes to the stream of banking valuation studies in conventional banking (e.g., Caprio et al. 2007; Elyasiani and Zhang 2015) and identifies the possible preferential impacts of having a busy board. Moreover, results highlighting the adverse effects of SSB busyness on an Islamic bank value also add to a sizeable body of literature on corporate governance in Islamic banking discussing the importance of this board (e.g., Quttainah et al. 2013; Abdelsalam et al. 2016). The findings in this study provide valuable policy implications to regulators and market participants involved in the two banking sectors. For conventional banks, board busyness offers reputational benefits to banks which tend to contribute to shareholder wealth maximisation. However, such reputational benefits of busy boards tend not to hold in complex 13
5. Differential market valuations of  board busyness across… 205 agency environments and constrained business models like Islamic banking. Furthermore, findings suggest that effective Shari’ah monitoring seems to be an essential determinant for enhancing the market valuations of this banking sector. Our results suggest that market participants engaging with the Islamic banking sector tend to be more sensitive to the SSB busyness than the board of directors’ busyness. Having busy SSB seems to be negatively perceived by investors probably due to concerns related to the effectiveness of Shari’ah governance and moral accountability of the bank. Overall findings in this study raise a call to regulators and policymakers for the need to develop stricter criteria and guidelines to govern outside board directorships. The study also provides valuable insights to inform the debates raised by several external organisations regarding restrictions on the board multiple-directorship (e.g., National Association of Corporate Directors 1996 and the Council of Institutional Investors-CII 2003). The rest of this paper is structured as follows: the next section presents the background and theoretical framework. Section  3 discusses hypothesis development. Section  4 and 5 present data and sample, and methodology, respectively. Section 6 reports empirical results while Sect. 7 provides additional testing. Section 8 presents the sensitivities and robustness checks. Finally, Sect. 9 concludes. 2 Background and theoretical framework A board of directors (BOD) is responsible for approving a bank’s policies, procedures, and business strategies as well as resolving investor/manager agency conflicts by setting compensation, appointing, replacing and overseeing managers who cannot create value for investors. Strong governance implies an active role by boards in monitoring top managers, mitigating risks and enhancing long-term resilience all of which should be, in principle, positively priced by investors. This argument is in line with the Slack Resource theory which suggests that firms with higher market valuation tend to have more economic resources to invest in the long-term improvements of their governance mechanisms and board monitoring quality. This investment will lead to future higher firm valuation, creating a virtuous circle (Pae and Choi 2011). However, entrenched managers may have incentives to divert slack resources or free cash flows for their private interests (e.g., building an empire, increasing their compensation) (Jensen 1986). In such a case, those managers are less likely to use slack resources to invest in strengthening different governance mechanisms. Therefore, monitoring the effectiveness of outside directors for those managers becomes indispensable. Any reputational damage to the BODs, thus, could constitute a severe threat to the survival of the firm, and hence, have an adverse impact on the market valuations. From an agency theory perspective, ineffective boards can exacerbate agency conflicts between investors and managers by encouraging managerial perquisites and private control benefits (Jensen and Meckling 1976; Chen 2016; Boateng et al. 2017; Harkin et al. 2019). As being financially independent of insiders, a board should have the ability to withstand pressure from their bank to manipulate earnings and monitor the operating process. Hence, appointing outside directors should in principle strengthen corporate governance to alleviate the shareholder/manager and controlling-shareholders/minority-shareholders agency conflicts (Choi et al. 2007; Machuga and Teitel 2009). 13
6. 206 M . Elnahass et al. Previous studies on firm valuation and value relevance6 (e.g., Ball et  al. 2003; Zoubi et al. 2016; Goncalves et al. 2017) document that the value relevance of accounting information is important not only for investors but also for standard setters as it provides useful insights into several accounting issues. Moreover, information on non-financial indicators such as corporate governance mechanisms can still influence the ability of investors to price their firms and forecast future stock performance (Bose 2014; Yeh et al. 2015). The empirical research on the relationship between governance and firm value suggests that well-governed firms are associated with a higher stock market valuation (e.g., Yermack 1996; Gompers et  al. 2003; Sami et  al. 2011; de Haan and Vlahu 2013; Nguyen et al. 2015). Other sets of studies show that investors are likely to reward firms with effective governance by assigning a high firm value (see Epstein et al. 1994; Brown and Caylor 2006; Dittmar and Mahrt-Smith 2007; Choi and Jung 2008; Baek et  al. 2009). Pae and Choi (2011) also state that investors often require a lower cost of equity for well-governed firms as these factors can mitigate agency costs and enhance disclosure transparency within firms. Caprio et al. (2007) study the effects of governance (i.e., ownership structure, shareholder protection laws, cash flow rights, and empowering official supervisory and regulatory agencies) on the market valuations of banks. Similarly, Belkhir (2009) and Zulkafli et al. (2010) provide evidence on the relationship between bank value and governance (i.e., board characteristics, board size and CEO duality). With the growing opaqueness surrounding the banking industry, research studies investigating the association between firm valuation and board busyness are still scarce. Only within the non-financial sector, studies have provided mixed evidence on the relationship between board busyness and firm value. For example, Fich and Shivdasani (2006) show for a sample of large US industrial firms (i.e., Forbes 500) that busy outside directors might not be effective monitors on any board, and hence, negatively affect market-to-book ratios and governance. Cashman et al. (2012) also find that the presence of busy directors has a negative impact on market value, but only of large firms (i.e., S&P 500). Contrary, Perry and Peyer (2005) find that outside directorships for executives are likely to enhance firm value, possibly through either external networking opportunities or through signalling of high quality for the managerial decision-making process. They argue that outside directorships only negatively affect market valuations when the firm has high agency problems. Furthermore, Ferris et al. (2003) find no evidence that multiple directorships can shirk their responsibilities to serve on board committees and suggest an insignificant linkage between multiple directorships and the likelihood of securities fraud litigation. Investigating the board busyness attribute emerges from two opposing perspectives. The first one is the busyness view which contends that busy outside directors may fail in fulfilling their monitoring role as they are sitting on many boards and are likely to have relatively less time available to collect/process information that would support business strategies (Hart 1995; Jackling and Johl 2009). Busy outside directors tend to be less effective to monitor and control managerial opportunism, unlikely to provide thoughtful advice to executives, and, therefore, board busyness is expected to be detrimental to firms in the long-term (Falato et al. 2014; Zhang 2016). Therefore, board busyness is associated with weak governance structures (Core et al. 1999). As weak governance structure is perceived by market participants leading to low market valuations, market participants are more 6   Value relevance is defined as the ability of an accounting measure to capture and summarise information that affects the firm value. This measure is significantly associated with a set of information used by investors in a firm’s valuation such as share prices, stock returns, or market capitalisation (Barth et al. 2001). 13
7. Differential market valuations of  board busyness across… 207 likely to penalise their firms for poor monitoring (Core et  al. 1999; Fich and Shivdasani 2006). The second view is the reputational benefits emerging from appointing a busy board. Board busyness is associated with high popularity and reputational capital in the external labour market (Masulis and Mobbs 2014). Holding multiple board seats can also improve a board member experience, objectiveness, and proficiency in evaluating and overseeing the managers’ decisions (Harris and Shimizu 2004; Brennan et al. 2016). Arguably, their social ties make them excellent advisors and value-enhancing directors (Field et al. 2013). Busy directors thus can be assessed as valuable assets for their firms given their extensive and updated industry-specific knowledge. This board can, hence, offer a vital supportive role to inside directors (Clifford et al. 2017) as well as have established outside networks that could facilitate access to market sources and other strategic benefits. These reputational benefits can be positively priced by investors, and board busyness can be perceived as value-enhancing for a firm (Muravyev et al. 2016). Moreover, in line with the signalling theory, holding information content constant, firm valuations may depend on how information is categorised and presented (Peng and Xiong 2006). The extent of disclosure, reporting transparency, and news outcomes signal good news on favourable aspects related to financial and corporate information which in turn might lead to stock price over-valuing. Under a transactional setting, when an investor is considering purchasing stock from a listed firm, this firm might be interested in signalling the hidden value of the equity investment (Allen and Faulhaber 1989) or reporting extensive corporate information relating to strong governance mechanisms including effective BODs (Higgins and Gulati 2006). Conveying information on strong corporate governance to stakeholders eliminates the information asymmetry between firm managers and investors (e.g., Ballas et al. 2012; Bergh et al. 2014; Mitra et al. 2019). 3 Hypothesis development With the lack of evidence related to the possible effect of board busyness on stock market valuations of banks in general terms, additional research gaps emerge which particularly pertain to studying this effect within different bank types (i.e., Islamic and conventional banks). Based on the two distinct contradicting views of the busy board discussed above (i.e., the busyness versus reputational effects) and the limited evidence within the banking setting, we conjecture that board busyness can have either positive or negative implications on stock market valuations. However, the direction of the association will be ultimately conditional on the system of corporate governance employed, the levels of the agency costs and the banking business model, all of which could vary depending on the bank type. 3.1 Market valuations of busy board of directors in Islamic and conventional banks Islamic banks are distinguished from conventional banks by several aspects of their business models. Unlike conventional banks, depositors/investors in Islamic banks have no right to intervene in the financial and operating management of their funds (Abdel Karim 2001). Therefore, managers in Islamic banks have full control of the investment process of depositors’ funds which offer several opportunities to pursue their own benefits at the expense of their investors, which can result in investors carrying additional agency costs (Abdelsalam et al. 2016). Moreover, additional agency costs arise in Islamic banking given 13
8. 208 M . Elnahass et al. those outside directors who are expert in Shari’ah legitimacy are scarce worldwide, and there are few numbers of prominent and expert outside directors who dominate the Islamic banking industry. In Islamic banking, board busyness can reduce the monitoring ability of outside directors to effectively mitigate and prevent wealth expropriation from minority shareholders which could lead to substantial agency costs. Such expectation can be attributed to the limited time and attention given by busy outside directors to scrutinise the bank’s operations against risky and opportunistic activities/transactions, which is strictly impermissible according to the Shari’ah governance. Furthermore, operating on a constrained banking model might lead investors’ uncertainty regarding the streams of future cash flows which must be invested in compliance with the Shari’ah rules. Poor monitoring by busy boards can further destroy the trust of investors with regards to managers’ discretion and expropriation of rents (e.g., Caprio et al. 2007). Therefore, investors may anticipate that additional cash flow might be diverted, and a smaller portion of the firm’s profits will be paid off as dividends (La Porta et al. 2002). In contrast, conventional banks operate on a relatively less complex business model which facilitate alternative investment channels, quick access to market sources and risk diversifications through trading in financial instruments which are prohibited by Islamic banks (e.g., derivatives and options). Therefore, the various reputational benefits associated with board busyness are more likely to be available and pervasive for conventional banking to enhance the bank equity value, when compared to Islamic banking. Signalling such reputational effects to the stock market is expected to affect investors’ perceptions of board busyness positively. Moreover, in line with the representativeness heuristic theory, individuals are likely to overestimate “the probability of an event based on the similarity between its properties and the parent population’s properties”; for example, comparing the firm position with its competitors using several benchmark indicators (Chan et  al. 2004, p.5). For a conventional bank that appoints outside directors who serve in many banks, investors may overestimate the probability that these directors are more knowledgeable/ reputable and might also overestimate the fact that busy independent directors are certified as effective monitors of the banking operations and, hence, investors could anticipate subsequently high returns and high firm value. Accordingly, published information on board busyness in Islamic banking is expected to signal to the stock market weak systems of governance and/or increased cost of equity due to high information risk. Investors are expected to perceive board busyness as leading to ineffective monitoring quality and may request higher rewards for the possibly arising risks, suggesting lower stock price multiples in Islamic banks when compared to their conventional counterparts. This prediction is in line with the good management theory (Jamali et al. 2008; Pae and Choi 2011) which states that a positive relationship between low-quality monitoring by boards and the provision of low-quality corporate-level information. This relation is likely to be pervasive when operating under opaque/complex business models. This leads to the following hypothesis, stated in the alternative form: H1:  Board busyness is significantly and highly valued by conventional banks’ when compared to Islamic banks’ investors. 13
9. Differential market valuations of  board busyness across… 209 3.2 Market valuations of busy SSB in Islamic banks Islamic banks operate on a double governance mechanism (i.e., BODs and SSB). The presence of an extra layer of governance (i.e., SSB) could serve as an effective mechanism to monitor Islamic banks’ prioritisation of religious norms. The SSB’s primary role is to ensure Shari’ah compliance and minimise reputation risk, which may result in capital erosion among Islamic banks as well as in lawsuits by fund providers (Archer and Karim 2007). Members of this board also serve as the counterparts of conventional internal auditors who enhance the creditability and reliability of published financial and non-financial information in the stock market (Godlewski et al. 2016). Therefore, Shari’ah governance is expected to promote investors’ trust and confidence about the quality of published information by Islamic banks, who are presumably targeting investments and trades incorporate ethical and moral criteria (O’Sullivan 1996; Pomeranz 1997). Therefore, investment choices and stock price valuations are likely to be influenced by the outcomes of the screening process as well as decisions made by the SSB on the quality and sufficiency of the corporate information published by Islamic banks in compliance with the Shari’ah laws. To date, a limited number of Shari’ah advisors engage excessively in Islamic banks’ activities by sitting on many SSBs for banks operating globally (Wilson 2009; Godlewski et al. 2016). Reuters (2012) reports that the top 20 Shari’ah scholars hold about 55% of all board positions worldwide, and some scholars are much more in demand than others. As such, busy SSB can adversely affect Islamic bank investors’ valuation in two ways. First, given the high concentration of the workload undertaken by a small group of Shari’ah experts and the fact that SSBs’ performance is not regularly evaluated by the BODs (Mollah and Zaman 2015), SSB is expected to be less effective in their Shari’ah monitoring as a result of this such board busyness. This might signal a weak Shari’ah governance to the stock market and hence, reduce the bank value. Second, the scarcity and high reputation of Shari’ah scholars suggest that they might be expensive to appoint because their appointment reflects higher charges of salaries and remunerations which will have substantial implications on the bank financial performance leading to lower investor valuations. Prior studies suggest that expensive appoints of boards implies low-cost efficiency and poor firm performance (see Linn and Park 2005; Brick et al. 2006). This will in fact, directly affect the cost of equity and relative firm valuations in stock markets (Renneboog and Trojanowski 2011). In line with the Equity theory (Dah and Frye 2017), multiple directorships are associated with board entrenchment caused by the over-payment for those members.7 Accordingly, we conjecture that SSB busyness is likely to signal weak Shari’ah governance and low bank performance to the stock market leading to low market valuations for Islamic banks. This leads to the following hypothesis, stated in the alternative form: H2:  Islamic banks’ investors negatively value busy SSB. 7   The equity theory anticipates the reaction of individuals towards over- or under-reward situations. Specifically, directors make subjective assessments of the ratio of their efforts (input) and compensation (output) to those of other referents. They may experience dissonance if their perceived ratio is unequal to that of referents. Consequently, they often reduce their efforts or try to push their compensation to obtain a similar ratio to salient other referents. 13
10. 210 M . Elnahass et al. 4 Data and sample The consolidated financial data (in U.S. dollars) are collected from DataStream, Bankscope, Thomson One Reuters, and Bloomberg databases. We hand-collected the governance data for outside directors, Shari’ah advisors and board information from banks’ annual reports, corporate filings (e.g., security prospectuses or governance reports) and websites. We excluded grey directors who have personal and economic ties with the bank and management (Hsu and Wu, 2014). We followed Field et  al. (2013), Fich and Shivdasani (2006) and Chakravarty and Rutherford (2017) to count for the number of directorships held by directors in all for-profit private and public firms. In other words, we excluded directorships related to activities in sports clubs, non-for-profit, trusts and charitable institutions.8 Country macroeconomics/governance indicators are retrieved from the World Bank’s World Development Indicators database. We study listed Islamic and conventional banks in global stock markets for the period 2010–2015. The selected period allows us to avoid the potential impact of the global financial crisis shock of 2007–2009. The initial sample comprises a total of 3038 banks (196 Islamic banks and 2842 conventional banks) in 36 countries. In line with prior banking studies (e.g., Beck et al. 2013; Alqahtani et al. 2017; Mollah et al. 2017), we applied the following four criteria to filter the sample: (1) The countries with both types of banks have at least two listed banks; (2) the banks have annual reports (official websites), which are published as of 31 December; (3) The full-service investment banks and banks with Islamic windows were dropped from the sample9; and (4) The banks must have at least three consecutive years’ full data availability. Our final sample is an unbalanced panel data set covering 70 listed commercial banks (386 bank-year observations) operating in 11 countries. Countries such as Malaysia and Turkey, where Islamic banks have a significant share of the total banking industry, have been excluded from the sample as most Islamic banks are not listed as separated entities on the stock markets (Saeed and Izzeldin 2016). Table  1 presents the sample distribution by country and bank, with 27 listed Islamic banks (150 bank-year observations) and 43 listed conventional banks (236 bank-year observations). The percentage of bank representations is our sample for Islamic banks and conventional banks are reported as 38.9% and 61.1% respectively. The highest concentration of Islamic banks is found in Bahrain while Indonesia reports the highest level of conventional banks. 8   For example, the 2014’s annual report of Albarala Banking Group in Bahrain indicates the profile of Mr Abdulla Saleh Kamel (Vice Chairman of the board of directors) that is “…Mr. Abdulla Kamel has also been and remains very active in public and charitable activities through his membership of many international and local organizations and associations, such as Jeddah Chamber of Commerce (twice as Board Member), Young Presidents’ Organization, Friends of Saudi Arabia, The Centennial Fund and the Board of Trustees of the Prince of Wales Business Leaders Forum.” (Page 11). 9   We refer to conventional banks with Islamic windows as banks with an independent department which provides Islamic products with an SSB (Elnahass et al. 2014). Our sample, following the studies of Elnahass et  al. (2014, 2018) and Johnes et  al. (2014), excludes those banks because supervisory issues and accountancy requirements are expected to be different to those of full-ledged Islamic banks (Islamic Financial Services Board 2005). 13
11. 30 30 36 3 6 12 3 24 18 6 6 6 150 27 Bahrain Bangladesh Egypt Indonesia Jordan Kuwait Pakistan Qatar Saudi Arabia UAE Oman Bank-year observations Number of banks 80 12 72 41 15 30 42 12 12 10 386 70 60 Observations (full sample) 24.00 2.00 4.00 8.00 2.00 16.00 12.00 4.00 4.00 4.00 100 −  20.00 % (Islamic banks) 18.64 3.81 27.97 12.29 5.09 2.54 10.17 2.54 2.54 1.70 100 −  12.71 % (conventional banks) 20.73 3.11 18.65 10.62 3.89 7.77 10.88 3.11 3.11 2.59 100 −  15.54 % (full sample) The table reports the sample distribution of the study. The full sample comprises of 70 listed banks (386 observations) with 27 listed Islamic commercial banks (150 observations) and 43 listed conventional commercial banks (236 observations) in 11 countries for the period from 2010 to 2015 44 9 66 29 12 6 24 6 6 4 236 43 Observations (conventional banks) Observations (Islamic banks) Country Table 1  Sample distribution Differential market valuations of board busyness across… 211 13
12. 212 M . Elnahass et al. 5 Methodology 5.1 Measures of the bank market value Consistent with the prior literature, we measure the bank market value through a firmlevel market measure which is the Tobin’s q (hereafter, lnQ) (e.g., Cheng et  al. 2008; Ammann et  al. 2011; Cashman et  al. 2012; Black et  al. 2015; Gyapong et  al. 2016; Muravyev et al. 2016). lnQ is a forward-looking approximation of firm value that captures the value of intangible corporate resources (e.g., goodwill and trust from good board structure). It is estimated as the sum of a bank year-end book value of debt and market value of equity, divided by its year-end book value of total assets. The market value of equity is computed as the end-year number of outstanding shares multiplied by the stock prices (e.g., Busch and Hoffmann 2011; Cashman et al. 2012; Gyapong et al. 2016). Following previous studies (e.g., Black et  al. 2012), we take the natural logarithm of Tobin’s q to mitigate the impact of high-q outlier banks. The selection of this measure is justified for several reasons. First, we aim to investigate the long-term firm valuations of boards’ busyness. Therefore, unlike other shortterm accounting performance measures such as return on assets (ROA) or return on equity (ROE), lnQ offers long-term market valuations for a firm (e.g., Bhagat and Black 2001; Thomas and Eden 2004; Sami et  al. 2011). Second, relative to lnQ, ROA and ROE are likely to be subject to possible and direct earnings manipulation by management (Gyapong et  al. 2016). Moreover, this measure combines the market with book values of the bank equity, distortions from tax laws and accounting conventions are minimised (Wernerfelt and Montgomery 1988). Finally, lnQ is commonly known as one of the standard dependent variables in firm value research within the context of corporate governance (Fich and Shivdasani 2006; Black et al. 2012, 2014). 5.2 Measures of board busyness We define a busy board member (i.e., either BODs or SSB) as an individual who holds, at least, two outside directorships (e.g., Ferris et  al. 2003; Fich and Shivdasani 2006; Cashman et  al. 2012). Based on this and following Falato et  al. (2014), Elyasiani and Zhang (2015), and Chou and Feng (2018), we use a standard measure of board busyness which is the percentage of busy outside directors (%BBOD) and busy Shari’ah scholars (%BSSB). The %BBOD is calculated as the number of outside directors serving on two or more outside firms divided by the number of outside directors on the board. The %BSSB is defined as the number of Shari’ah advisors serving on at least two outside organisations divided by the number of Shari’ah advisors on the board. Using the percentage of board busyness provides a plausible assessment of the board advising and monitoring intensity under the assumption of high independence, substantial contributions in the firm strategic decisions and their sound reputation maintained in the industry (Fich and Shivdasani 2006). The higher percentage of busy outside directors/Shari’ah advisors, the higher the level of busyness of BOD/SSB which influences the monitoring quality of overall board (Ferris et al. 2003; Chakravarty and Rutherford 2017). Moreover, we focus on outside directors because they are primarily responsible for scrutinising managers while insiders are potentially on BOD for many other reasons (Cashman et al. 2012). 13
13. Differential market valuations of  board busyness across… 213 5.3 Empirical models Banks are likely to differ in the opportunities and challenges that they may encounter over the years due to the peculiar nature of their sector. This can lead to a situation where disclosure of board directorships, other board characteristics and bank market value are jointly and dynamically determined by unobserved bank-specific variables (e.g., quality and style of management, business strategy, market perception and bank complexity) (Henry 2008; Guest 2009), which pooled ordinary least square (OLS) estimation may detect and control (Kraatz and Zajac 2001; Wooldridge 2002). Therefore, we employ panel data estimations to mitigate endogeneity problems arising from potential unobserved bank-specific heterogeneity (e.g., Henry 2008; Guest 2009). Although better governance practices of a firm can enhance its profitability position, investors’ valuation may only be capturing the high profitability performance rather than perceiving the specific board busyness attribute. To overcome possible misinterpretations of the investors’ firm valuations, we include a comprehensive set of control variables to mitigate omitted-variable bias as well as utilised three-stage least-square (3SLS) estimations with instrumental variables (IVs) (e.g., Bhagat and Black 2001; Coles et al. 2008; Faleye et al. 2011) to mitigate the endogeneity between busy boards and bank valuation.10 The choice of valid IVs implies a correlation with the endogenous variable, and not with the error terms of the dependent variable11 (Elyasiani and Jia 2008). Consistent with Elyasiani and Zhang (2015), we use the number of public firms headquartered in the same country of the bank as our first IVs (source: World Bank). We contend that outside directors of the bank headquartered in countries with more public firms are more likely to find additional jobs in other companies. We, therefore, expect that the number of busy outside directors is positively related to the number of public firms headquartered in the same country. The other IVs employed for board busyness is the country-level income generating category (Source: World Bank). This variable takes a value of 1 if the “home” bank is in a middle and high-income generating nation, and 0 otherwise.12 We argue that directors of banks headquartered in the high-income countries with more skill-job opportunities are more likely to find director positions in other institutions (Goldberg and Pavcnik 2007; World Bank 2016). This might positively affect the number of the directorships by outside boards. Both IVs are correlated with possible endogenous variables (i.e., %BBOD; %BSSB) and should predict stock market valuations only indirectly, through their effects on endogenous variables (see Black et al. 2006). Indeed, in our study setting and sampled banks, those IVs can indirectly affect bank valuations because the country-level indicators are less likely to 10  The Wu-Hausman endogeneity test (e.g., Wu 1973; Hausman 1978) statistics reveal the presence of endogeneity biases. 11   Two diagnostic tests are performed to examine both IVs’ and the specification of our system equations’ validity. First, we present the Sargan test which shows the misspecification test with the null hypothesis of no misspecification. We then report the second test (Breusch and Pagan LM) to investigate whether crossequation disturbances are truly related and if the equations will need to be tested simultaneously. These statistics suggest that both IVs theoretically and statistically satisfy the necessary conditions for validity and relevance, and thus, findings obtained by 3SLS is more consistent and efficient than those of traditional pooled OLS. 12   World Bank (2015) classifies countries as middle and high income if their Gross National Income (GNI) per capita is more than $1045. By contrast, countries are categorised as low-income if their GNI per capita is $1045 or less in 2014. 13
14. 214 M. Elnahass et al. influence Tobin’s q endogenously. We, accordingly, specify the simultaneous models as follows: lnQit =