Impact of Corporate Governance of Islamic Banks on Financial Performance: A Study of Pakistan, India and Bangladesh Islamic Banking System

Transcription

1. Iqra Journal of Business & Management (IJBM) Volume 2, Issue 1, 2018 IMPACT OF CORPORATE GOVERNANCE OF ISLAMIC BANKS ON FINANCIAL PERFORMANCE: A STUDY OF PAKISTAN, INDIA AND BANGLADESH ISLAMIC BANKING SYSTEM Mushtaq Younas MBA, Research Scholar. NUML University Peshawar. Email: mushtaqyounas9@gmail.com Umair Ahmed Assistant Professor. Qurtuba University of Science & IT, Peshawar. uahmed011@gmail.com Dr. Naveed Assistant Professor. Qurtuba University of Science & IT, Peshawar. Abstract The aim of this study was to evaluate impact of corporate governance on the financial performance of Islamic banks in Pakistan, India and Bangladesh. Data was collected from the Islamic banks of respective country’s stock exchange and annual reports of selected Islamic banks. Four (4) banks were selected from each country on purposive sampling technique so the total sample size was twelve (12) Islamic banks from three countries. Panel data was used for 5 years from 2014 to 2018. Regression analysis was used for every country’s econometric model. The result found that overall Corporate Governance affects the financial performance positively in Islamic banking sector of Pakistan, India and Bangladesh. Therefore it is suggested that Islamic banks should exercise such practice as a long term benefit. All the hypotheses developed for this study has been achieved through the analysis of this research study. Key words: Corporate Governance, Organization Performance, Islamic Banks INTRODUCTION Corporate governance is an emerging filed and playing a vital role in the overall performance of a corporation. It can be simply define as an association between shareholders, top management, board of directors which has the alignment towards the organizational success (Wheelen & Hunger, 2011). Corporate governance can also explain the relationship among the objective of board of directors and shareholders. Stakeholders has also an influence due to corporate governance because it is in their interest i.e. customers, employees, creditors, debtors, government agencies, banks, financial institutions and society at large. The major players are 11
2. Iqra Journal of Business & Management (IJBM) Volume 2, Issue 1, 2018 management, shareholders and board of directors. Mulili and Wong (2011) stated that corporate governance as a group of people getting together as one united body with task and responsibility to direct, control and rule with authority. Globalization encourages the emergence of competition to be getting tougher. Therefore, firms are continuously working to improve performance that reflected in their values. The values are significant for the firm, as the main goals of the firms are to increase their own value. High value is the desire of every firm’s owner to indicate the overall prosperity of the shareholders (Yilmaz & Buyuklu, 2016). According to Bhagat and Bolton (2008) in financial management, estimating capital requirement and its procurement is necessary. As to properly evaluate potential investment, firms must know how much their capital requirements. It is the role of every financial manager to form the Capital Structure (CS), Dividend Policy (DP) and Corporate Governance (CG). It is important for maximizing shareholders wealth for raising the value of the firm. It is also important for rising long term benefit to finance a company that can result in three types of securities i.e., equity shares, preference share and debenture. A CS is the combination of both shares and debenture. The shares are referred as owned funds whereas; the debenture can be defined as borrowed funds or debt funds. A CS can also be defined as the combination of equity, debt as well as short term financing. The CS is defined as how a firm can finances its overall actions and development by utilizing diverse source of funds. In the view of above background, money makes the business in the running position. However, money earn from diverse resources such as, equity and debt. For instance; equity can be classified as common stock, Preferred Stock (PS) or Retained Earnings (RE) (Sudana & Arlindania, 2011). On other hand, debt achieves in the form of issuing bonds or payable long term notes. In addition, dividend decision is also a major part of the financial management along with financing and investment decision (Sudana & Arlindania, 2011). Essentially, dividend is the profit from business getting after tax that is distributed among owners. On other side, Retained Earnings (RE’s) are the profit after tax that is retained in the business. The REs are not shared among owners but will remain in the business. In result, there are two choices of profit after tax, either distributed among the owners or retained in the business. Therefore, the question arises about the importance and understanding of dividend which is an important task for the corporation of financial policy. Another important aspect of dividend payout policy decision is, 12
3. Iqra Journal of Business & Management (IJBM) Volume 2, Issue 1, 2018 whether cash flow will be paid to investors or will be retained for reinvested by the firm. Therefore, the amount of the dividend depends on the dividend policy of each firm. The proportion of net profit after tax is distributed as dividends are usually presented in Dividend Payout Ratio (DPR). In case the dividend is paid well, the value of the firm become high with the corresponding increase in stock price. Conversely, if the dividend paid is small then the firm's share price is also low. Consequently, the ability of dividend payment is closely related to the profit achieved by the firms. For instance, if the firm makes a large profit, the ability to pay dividends is also high (Brav et al., 2008). Shareholders are the real owners of a limited liability firm (Aebi, Sabato & Schmid, 2012). They buy shares because they want to get a financial return. In most cases, shareholders will elect directors, and the directors are responsible for the appointment of managers in order to run the company on daily basis. The managers are considered to work on the behalf of shareholders but they are bounded with the policies of the respected company. These policies can improve the value of shareholders (Brown & Caylor, 2009). The aim of effectual corporate oversight mechanisms is to attain managers’ act in the best interests of the shareholders. It has been a leading pertain in the field of corporate governance and finance (Ghazali, 2010). The corporate governance is a control mechanism. It regulates and manages the company’s profile in order to increase the prosperity. Subsequently, it aims to create the value of shareholder (Macey & O’Hara, 2003). It is also concerned about the views of investors regarding the benefits provided by the company’s manager. The company’s manager should be confident, and will not darken or to invest in projects that do not benefit associated with the funds that have been invested by the investor. On other hand, corporate governance is associated to investors that control managers (Peni & Vahamaa, 2012). In order to find the effect of CS and CG on DP and firms value, Hartano et al. (2018), collected data for seven annual banking financial statements identified in Indonesia stock exchange (IDX) from 2008-2012 employing partial least square analysis. It was concluded that CS has positive significant effect on DP, while CG has negative non-significant effect on DP. Statement of Problem Now a day’s corporate governance is an emerging field in the global corporate market. The study aims to evaluate the influence of corporate governance on the firm financial performance in Islamic banks in three Asian countries i.e. Pakistan, India and Bangladesh. Islamic banking 13
4. Iqra Journal of Business & Management (IJBM) Volume 2, Issue 1, 2018 sector has a very vast scope in Muslim as well as non-Muslim nations it is very influential to evaluate the influence of corporate governance on the Islamic banks financial effectiveness. Objective of the Study The aim of this study is to investigate the influence of corporate governance of Islamic banks on their financial performance in Pakistan, India and Bangladesh. Significance of the Study This study will provide more awareness and detailed reflection on significance of various factors effecting corporate governance. Corporate governance is playing a vital role in the financial and overall performance of a company and firms are getting more yield with it. The study will be helpful for the policy makers and top management while making corporate policies so they must consider the elements which used in this study. LITERATURE REVIEW Carter and Simkins (2003) viewed as corporate governance as dealing with mechanisms by which stakeholders of a corporate exercise control over corporate insiders and management in such a way that their interests are protected. Islamic banks need to pursue different rules communicated in Quran Majeed and furthermore worthy by Muslim Societies, particularly the most reasonable finance methods in Islami banks (Suliman, 2000). Banking according to shariah resemble to the traditional banking system by offering diverse services and banking products to the customers and acknowledge its commitment in the monetary transactions among them. Some traditional banks are for all intents and purposes proportional for an Islamic banking system which need to do work in a similar way, so far those circumstance, conventional banking system is to seek out after the rules of Islam (Shariah) for financial activities with the goal that every one of the things promise to the customer must be in line as shown by Islamic Law. Shariah of Islamic banks shows that manipulative settlements and for that have a chance of Merger of interest for a concealed structure or out of line assertions ought to dependably be maintained a strategic distance from. Islamic Fiqah speaks to major and general Islamic decides and ensures that all activities are kept running inside the shadow of Laws of Shariah. (Siddique, 1985). According to Suleiman (2000) while investing the following are the motivational factors and consideration must be followed: 14
5. Iqra Journal of Business & Management (IJBM) Volume 2, Issue 1, 2018 a) Interest or Fixation of profit is not accepted in Islamic banks b) Always must be avoided the trades that incorporate speculative trades (Gharar) c) Poor and deprive people must be compensated by Zakat to strength them d) Eliminate all “Haraam” (Not allowed) sources of financing The Asian Development Bank says that corporate governance is the manner by which control is utilized in the administration of a nation's assets for improvement (Phan, 2001). Corporate governance establishes several principles, laws, control technics and laws which can help the management of a corporate for effective performance. Clarke (2004) described corporate governance as a way and sources of a company by which one can do administration of an organization (the executives) is suitable to its electorate the investors. Ruin (2001) expressed that corporate governance as a unit of individuals getting together as one joined body with undertaking and duty to direct, control and principle with power. Corporate governance can likewise be expressed as the arrangement of guidelines and systems that guarantee that supervisors do in fact utilize the standards of significant worth based administration (Alagathurai & Nimalathashan, 2013). Bauer et al. (2004) founded the joint effect of corporate governance and value of a firm on its profitability. Many researches are founded which shows that there is no positive association among corporate governance and profitability of an organization. Some studies are still going ahead to investigate the relationship between firm performance and factor of corporate governance while the outcomes were not fully supports it (Elmagrhi et al., 2017). Aboagye and Otieku (2010) investigated the critical impact of corporate governance on firm performance. Usually different researchers defined the board composition in different manner .Here in this research the board composition is measured as the number of shareholders as non-executive directors in the board and the senior management as executive directors in the board. As per Mahar and Anderson (2002) deficiencies, control and economic situation is concerned with the structure of corporate governance. It is generally accepted that a good governance is significant towards the firm financial as well as operational performance of a firm; it also leads to the market growth. Now a day’s Islamic banking system is rapidly growing throughout the world especially in Pakistan because it had been observed that almost all the conventional banks have separate branches as well as Islamic banking windows (Asif, Ahmed, Zahid & Khan, 2017). Due to economic recession many developed nations suffer a lot of financial crises due to which many 15
6. Iqra Journal of Business & Management (IJBM) Volume 2, Issue 1, 2018 firms suffer the bankruptcy. In those situations many states introduced the interest free projects and in other scenario the firms using free interest products were found stable in the recessions (Ahmed, 2009). Now a days many non-Muslim countries operating a separate windows and separate Islamic banking branches for their Muslim community. All the big financial institutions like world bank and IMF have a separate cell through which they investigate the progress and growth of Islami financial system in the world (Ahmad, 1995). Interest free banking offer advances on the basis of shariah and Modarabah, Musharika, Ijara etc. which highly influence the Islamic banks. From last two decks Islamic banking system has a continuous growth and its market share is now 7% in some years (Samad, 2004). This examination thusly holds the more broad sight and describes corporate governance in the association of planning as the way is which structures, methodologies, procedure and execution of a bank administered so as to allow positive associations and the concentrate utilization of intensity in the organization supervising favorable linkage of benefits with the purpose of pushing up offers cost and investors' fulfillment together with improved responsibility by a direct overseeing (Ibrahim & Rehman, 2010). An enhanced and composed administration of a company is a certification of best execution of firm and will dependably reach to the objectives which it sets to accomplish as it accept its capacities as per the progressed administrative systems. Then again, measurable support can confirm the nearness of an association of an idea for corporate governance is performance of a firm is commonly inadequate (Imam & Malik, 2007). Good Controlling implies the little appropriation of assets by investors controlling, this adds to best task of resources for increase a gainful outcome fit as a fiddle of return. As a financer and moneylenders will be moreover anxious to put resources into such firms in the business having incredible governance, in light of the fact that by this lower costs of capital will be confronted, which no uncertainty a confirmation of better governance of the firm. Distinctive accomplices, including specialists and sellers, will in like manner should be associated with and go into association in light of the fact that the associations are ideally thriving, progressively lovely, and strong contrasted with the firms less persuading governance. Recommendations for the economy as whole are in like manner undeniable. Budgetary advancement will be progressively down to earth, in light of the fact that the economy is less unprotected against a foundational chance. At the better security of speculators assets at firm dimension, the capital market will similarly be 16
7. Iqra Journal of Business & Management (IJBM) Volume 2, Issue 1, 2018 bolstered and end up being more made, which is principal for overseen budgetary improvement, meanwhile, incredible corporate governance is huge for building up an evenhanded and debasement free society. Powerless corporate governance in tremendous Businesses can be a productive zone for individuals searching for unlawful advantages in the associations. Giving certification of advantages to the minority investors and less corruptive associations between gigantic business and political power may realize an increasingly incredible condition for little associations and progressively fair sharing of benefits (Iskander and Chamlou, 2000). Measurement and operational definition of variables Dependent Variable - Financial Performance Return on Assets (ROA) The study used ROA as a proxy for financial performance. It can be measured as dividing net profit by total assets held (Hartano et al., 2018). Independent Variables –Corporate Governance Board Size (BS) Board size refers to the number of board members exist in a company’s board of directors. It can be measured by number of persons in board (Peni & Vahamaa, 2012). Board Independence (BI) Usually a board of directors of a company contain two different types of directors i.e. insider directors and outsider directors. According to Brennan (2006) the board of directors can perform the duty to control the operations of management and take part in the management on the behalf of the shareholders. Outsider directors has other responsibilities related to the company. Audit Committee It is an operating committee which is one of the major concern of a company’s board of directors which is corned with the investigation and controlling of financial reporting and true disclosure (Bauer et al., 2008). Firm Size It is used as a control variable and can be measured as the natural log of total assets (Bauer et al., 2008). 17
8. Iqra Journal of Business & Management (IJBM) Volume 2, Issue 1, 2018 RESEARCH METHODOLOGY Population and Sampling The study population includes all Islamic banks working in Pakistan, India and Bangladesh stock exchange. There are five (5) full-fledged Islamic banks in Pakistan, six (6) banks in Bangladesh and India have also five (5) banks. Purposive sampling technique was used to select the sample. From each country four (4) banks were selected. Total twelve 12 banks were the sample of the study. Sample detail is as follows: Table 1 Bank Details 1. 2. 3. 4. Pakistan Al-Baraka Bank Limited Bank Islamic Pakistan Limited Dubai Islamic Bank Limited Meezan Bank Limited Bangladesh Al Arfah Islamic Bank Limited First Security Islamic Bank Limited Islamic Bank Bangladesh Limited Shahjalal Islamic Bank Limited 1. 2. 3. 4. India Atharvved Finance Corporation Tameem Impex Associated Industrial Credit Society Al-Siraat Investment & Banking Baitun Nasr Urban Cooperative Society 1. 2. 3. 4. Data Collection Data was collected from the annual reports, stock exchanges and state bank web data banks. Data was collected from 2014 to 2018 (5 Years). Econometric Model The econometric model is as follows: ROA=β0 + β1BS + β2BC + β3BI + β4AC + β5SIZE +ei Where; ROA: Return on Assets BS: Board Size BC: Board Composition BI: Board Independence AC: Audit Committee SIZE: Bank Size 18
9. Iqra Journal of Business & Management (IJBM) Volume 2, Issue 1, 2018 et= Residual βo= Intercept (β1- β5) = Slope Research Hypotheses H0: Corporate Governance has no significant impact on financial performance H1: Corporate governance has a significant impact on financial performance H1.1: Board size has a significant impact on financial performance H1.2: Board Independence has a significant influence on financial performance H1.3: Board composition has a significant impact on financial performance H1.4: Audit Committee significantly effects financial performance H1.5: Firm size effecting financial performance significantly Theoretical Framework Independent Variables Board Size Board Independence Board Composition Audit Committee Bank Size Dependent Variables Return on Assets Analysis Table 2 Summary of Panel Diagnostic test Pakistan Tests Chow’s test Breuch Pagan Hausman test India Tests Chow’s test Breuch Pagan Hausman test Bangladesh Tests Chow’s test Breuch Pagan Hausman test Models P-Value Decision Pooled regression vs Fixed Effect model 0.000 Fixed effect model Pooled regression Vs Random Effect 0.184 Pooled regression model model Random Effect Vs Fixed Effect model 0.004 Fixed effect model The above table suggested that fixed effect model is appropriate Models P-Value Decision Pooled regression vs Fixed Effect model 0.826 Pooled effect model Pooled regression Vs Random Effect 0.000 Random regression model model Random Effect Vs Fixed Effect model 0.218 Random effect model The above table suggested that Random effect model is appropriate Models P-Value Decision Pooled regression vs Fixed Effect model 0.0264 Fixed effect model Pooled regression Vs Random Effect 0.044 Random regression model model Random Effect Vs Fixed Effect model 0.000 Fixed effect model The above table suggested that fixed effect model is appropriate 19
10. Iqra Journal of Business & Management (IJBM) Volume 2, Issue 1, 2018 Table 3 Regression Analysis PAKISTAN INDIA BANGLADESH (Fixed Effect Model) (Random Effect Model) (Fixed Effect Model) Coefficient P-Value Coefficient P-Value Coefficient P-Value C 0.3002 0.0000 -0.101 0.0000 0.4996 0.0000 BS 0.4213 0.0108 0.3327 0.0000 0.0541 0.6213 BC 0.3215 0.0000 -0.6491 0.0812 0.6269 0.0000 BI -0.2862 0.0817 0.0512 0.0411 -0.0475 0.0002 AC 0.2661 0.2146 -0.6296 0.0017 -0.0307 0.0000 SIZE 0.3601 0.0422 0.1031 0.0000 0.4229 0.0399 Variables R-Squared F-Stats 0.5453 0.4962 0.5576 ** ** 8.663** 8.352 6.195 The above table shows that the overall model is highly significant due to highly significant Pvalue. R-squared of Pakistan model represents 55% variations in dependent variable due to change in regressors of corporate governance. 50% variations were found in Indian context and 56% variations were found in the Bangladesh Islamic banks. If we discuss the individual variable only Size of a bank was found significant in all three countries. However, BS, BC were also significant while the random effect model of Indian Islamic banks showed that BS, BI and AC were found significant while only BC was found insignificant. In Bangladesh context only BS was found insignificant while BC, BI, AC were found significant. All the above results shows that all the individual variables has an impact on bank performance. In country context in India and Bangladesh corporate governance has more significant impact on bank performance as compare to Pakistan. The study accept the alternative hypothesis which suggests that corporate governance has a significant relationship with Islamic banks financial performance. CONCLUSION The study found overall significant impact of corporate structure on the firm performance in Islamic banks of Pakistan, India and Bangladesh. Board size has a positive impact on firm performance in Pakistan and India while no effects were shown in Bangladesh. Board composition were only insignificant in Indian context while Board independence and Audit committee was found insignificant in Pakistan. Size of bank was found significant in all context. An organism of corporate governance may dire for the maintance of association among the payment to economic advisor (individuals as well as institutions), corporate vision and 20
11. Iqra Journal of Business & Management (IJBM) Volume 2, Issue 1, 2018 administration, several associates as the do it for corporate sustainability. Recommendations Corporate governance is an important element for the emerging world and aid the corporate in great way through transferring top management training, skills, controlling and financial management can strengthen the regulations, monitoring and evaluation. It can boost the reputation of the corporate and also helpful for employees and management of the corporate because set rules and procedures can protect employee as well as employer. References Aebi, V., Sabato, G., & Schmid, M. (2012). Risk management, corporate governance, and bank performance in the financial crisis. Journal of Banking & Finance, 36(12), 3213-3226. Ahmad, A. (2004). Economic development in Islamic perspective revisited. Islamic Economics, 17(1). Ahmed, H. (2009). Financial crisis, risks and lessons for Islamic finance. ISRA International Journal of Islamic Finance, 1(1), 7-32. Alagathurai, A., & Nimalathashan, B. (2013). Corporate governance and banking performance: A comparative study between private and state banking sector in Sri Lanka. Allen, F., & Gale, D. (2001). Comparative financial systems: a survey: Citeseer. Anum Mohd Ghazali, N. (2010). Ownership structure, corporate governance and corporate performance in Malaysia. International Journal of Commerce and Management, 20(2), 109-119. Bauer, R., Frijns, B., Otten, R., & Tourani-Rad, A. (2008). The impact of corporate governance on corporate performance: Evidence from Japan. Pacific-Basin Finance Journal, 16(3), 236-251. Bauer, R., Guenster, N., & Otten, R. (2004). Empirical evidence on corporate governance in Europe: The effect on stock returns, firm value and performance. Journal of Asset management, 5(2), 91-104. Bhagat, S., & Bolton, B. (2008). Corporate governance and firm performance. Journal of Corporate Finance, 14(3), 257-273. Brav, A., Jiang, W., Partnoy, F., & Thomas, R. (2008). Hedge fund activism, corporate governance, and firm performance. The Journal of Finance, 63(4), 1729-1775. Brown, L. D., & Caylor, M. L. (2009). Corporate governance and firm operating performance. Review of quantitative finance and accounting, 32(2), 129-144. Carter, D. A., Simkins, B. J., & Simpson, W. G. (2003). Corporate governance, board diversity, and firm value. Financial review, 38(1), 33-53. Clarke, T. (2004). Theories of corporate governance. The Philosophical Foundations of Corporate Governance, Oxon. Elmagrhi, M. H., Ntim, C. G., Crossley, R. M., Malagila, J. K., Fosu, S., & Vu, T. V. (2017). Corporate governance and dividend pay-out policy in UK listed SMEs: The effects of 21
12. Iqra Journal of Business & Management (IJBM) Volume 2, Issue 1, 2018 corporate board characteristics. International Journal of Accounting & Information Management, 25(4), 459-483. Hartanto, H. K., Paramita, P. D., & Fathoni, A. (2018). The effect of profitability, leverage, and liquidity to dividend policy with good corporate governance as intervening variables (in textil and garment company listed in bei period of 2012-2016). Journal of management, 4(4). Imam, M. O., & Malik, M. (2007). Firm performance and corporate governance through ownership structure: Evidence from Bangladesh stock market. Iskander, M., & Chamlou, N. (2000). Corporate governance: A framework for implementation: The World Bank. Macey, J., & O'hara, M. (2003). The corporate governance of banks. Maher, M., & Andersson, T. (2002). Corporate governance: effects on firm performance and economic growth. Convergence and Diversity in Corporate Governance Regimes and Capital Markets, Oxford University Press, Oxford, 386-420. Muhammad Asif, Umair Ahmed., Muhammad Zahid, Aamir Khan,. (2017). Motives Behind the Transfer of a Bank From Conventional Banking to Islamic Banking in Pakistan. Journal of Business and Tourism, 3(02), 225 - 234. Oman, C., Buiter, W. H., & Fries, S. M. (2003). Corporate governance in developing, transition and emerging-market economies: Organisation for Economic Co-operation and Development, Development Centre. Peni, E., & Vähämaa, S. (2012). Did good corporate governance improve bank performance during the financial crisis? Journal of Financial Services Research, 41(1-2), 19-35. Phan, P. H. (2001). Corporate governance in the newly emerging economies: Springer. Ruin, J. E. (2001). Essential of Corporate Management: Malaysian Institut of Corporate Governance. Samad, A. (2004). Performance of Interest-free Islamic banks vis-à-vis Interest-based Conventional Banks of Bahrain. IIUM Journal of Economics and Management, 12(2), 115. Sudana, I. M., & Arlindania, P. A. (2011). Corporate governance dan pengungkapan corporate social responsibility pada perusahaan go-public di bursa efek Indonesia. Jurnal Manajemen Teori dan Terapan| Journal of Theory and Applied Management, 4(1). Suleiman, N. M. (2000). Corporate governance in Islamic banks. Társadalom és gazdaság Közép-és Kelet-Európában/Society and Economy in Central and Eastern Europe, 98-116. Wheelen, T. L., & Hunger, J. D. (2011). Concepts in strategic management and business policy: Pearson Education India. Yilmaz, C., & Buyuklu, A. H. (2016). Impacts of Corporate Governance on Firm Performance&58; Turkey Case with a Panel Data Analysis. Eurasian Journal of Economics and Finance, 4(1), 56-72. 22 View publication stats