bank's risk-taking and ownership structure – evidence for economics in transition stage
TRANSCRIPT
Applied Economics, 2011, 43, 1551–1564
Bank’s risk-taking and ownership
structure – evidence for economics
in transition stage
Shuching Choua,* and Fengyi Linb
aDepartment of Graduate Institute of Finance, National Yunlin University ofScience and Technology, 123, Section 3, University Road, Touliu, Yunlin,640 TaiwanbDepartment of Business Management, National Taipei University ofTechnology, 1, Section 3, Chung-Hsiao E. Rd., Taipei, 106 Taiwan
Conventional studies assume that inside management plays a major role
in corporate governance and argue that foreign institutional investors
may lack incentives to monitor invested firms due to their short-term profit
orientation. By utilizing 650 observations of Taiwan banks, this study
examines the effects of specific types of ownership on the risk-taking
behaviours of banks under differential ownership structures. In light of the
increasing foreign institution ownership during privatization, this article
further constructs relative governance strength variables to observe how
inside management and foreign institutions interact to affect these banks’
risk-taking. The results show that banks with higher inside management
ownership and higher government ownership have higher overdue loan
and lower capital adequacy ratios. Banks with higher foreign institution
ownership and stronger relative governance strength are associated with
lower overdue loans and higher regulatory capital. In general, the results
are consistent regardless of the choice of ownership structure or relative
governance strength of foreign institutions as independent variable. These
findings contribute to add evidence for risk-taking behaviour manifested
by banks in the emerging market, where feasible monitoring mechanisms
still need to be explored.
I. Introduction
In recent years, emerging markets in East Asia
have faced economic deregulation and the banking
sector is considered to have a critical role in facili-
tating the development of the capital market during
the transition stage (Lin, 2008). Thus, the corporate
governance of banking has been emphasized to
enhance these banks’ management (Ebrahim and
Herz, 2007). Previous researchers emphasized that
a bank’s ownership type will affect its governance
procedures (Graves and Waddock, 1994; Johnson
and Greening, 1999; Holland, 2001). Basel II
also points out that board members and senior
managers should oversee a bank’s internal control,
make strategic risk management plans, and assess
the adequacy of the bank’s capital position (Bank
International Settlement (BIS), 2004). However, since
the capital of most banks is provided by their
depositors, the motivation of inside management in
alleviating agency problems is questioned (Saunders
et al., 1990). Banks characterized by government
*Corresponding author. E-mail: [email protected]
Applied Economics ISSN 0003–6846 print/ISSN 1466–4283 online � 2011 Taylor & Francis 1551http://www.informaworld.com
DOI: 10.1080/00036840903018791
control are also claimed to be less efficient (Casu and
Molyneux, 2003) and may have higher overdue loans
due to implicit guarantee. Thus, alternative gover-
nance mechanisms such as institutional investors
(Bushee, 1998) and market discipline (Eiffinger and
Tesfaselassie, 2007) have been proposed to reinforce
bank governance.Since the late 1990s, Taiwan’s banks have experi-
enced a continuous privatization process including
two major steps: transformation from being gov-
ernment owned into privately owned, and infusion
of foreign institution ownership. As shown in Fig. 1,
from 2001 to 2006, the average government owner-
ship decreased from 11.21% to 6.73%, foreign insti-
tutions ownership jumped from 3.55% to 16.74%
and managerial ownership decreased from 22.48% to
20.10%.1 These phenomena indicate that deregu-
lation has caused a dramatic ownership change in
banks. Will this changing ownership structure
affect banks’ governance and risk-taking policies?
This is a vital question for local policy makers and
academic researchers (Douma et al., 2006).By utilizing 650 observations of Taiwan’s banking,
this study examines the effects of specific types of
ownership on a bank’s risk-taking behaviours and
compares these behaviours with those under differ-
ential ownership structures dictated by the type
of largest shareholders. In light of the increasingly
important role of inside management and foreign
institution in a bank’s privatization, we then con-
struct the comparative governance strength variables
of these two monitoring mechanisms (Cremers and
Nair, 2005) and observe how inside management and
foreign institutions interact to affect these banks’
risk-taking behaviours.
The major findings include the following: (1) bankswith higher inside management ownership andhigher government ownership have higher overdueloans and lower capital adequacy ratios, (2) bankswith higher foreign institution and with strongerrelative governance strength are associated withlower overdue loans and higher regulatory capitaland (3) the risk-taking behaviour by inside manage-ment is alleviated in banks whose largest shareholdersare foreign institutions. In general, the results areconsistent regardless of the choice of ownership orrelative governance strength of foreign institutionsas independent variable. These findings contribute toadd evidence regarding banks’ risk-taking behavioursin the emerging market, where feasible monitoringmechanisms still need to be explored.
The remainder of this article is organized asfollows. Section II develops the literature review.Section III describes the data and model. Section IVanalyses the regression results. Section V presentsthe results of the robustness tests. Section VIconcludes.
II. Managerial and Institutional Owners’Incentives in Monitoring
Managerial ownership incentives
The canonical incentive hypothesis suggests thata higher managerial ownership could mitigateagency problems (Jensen and Ruback, 1983; Stulz,1988; Shleifer and Vishny, 1997). Lee (2004), usingNonperforming Loan (NPL) ratio as proxy forbank risk taking, finds that Korean banks withhigher levels of inside ownership are gearedtowards modest, deliberate, and profitable risk-taking strategies during periods of regulatory strin-gency. He proposed that the controlling shareholdersare more prudent as far as risk taking is concerneddue to nondiversifiable human capital and stakes.
However, since depositors provide around 80– 90%of the capital, some researchers doubt whether thesmall pro rata of banks’ managerial ownership couldbecome effective incentives to alleviate agencyproblems. Cebenoyan et al. (1999) indicate that thriftswith higher managerial ownership exhibit unprof-itable risk-taking behaviour during years of regula-tory laxity. Gorton and Rosen (1995) demonstratethat a bank’s NPL increases along with an increasein managerial ownership. Girardone et al. (2004)
0369
121518212427
2000 2001 2002 2003 2004 2005 2006 2007
Year
Rat
io
Board Government Foreign
Fig. 1. Trend of ownership structure change
1 The numbers are listed in Table 3, and the detailed description is provided in Section ‘Ownership structure and bank’srisk-taking’.
1552 S. Chou and F. Lin
find that a bank’s inefficient management is posi-tively correlated with the level of NPLs in Italy.Meanwhile Saunders et al. (1990) find that bankswhose managers hold a relatively large proportionof these banks’ stocks exhibit significantly higherrisk-taking behaviours than those banks whosemanagers hold a relatively small proportion duringthe period of deregulation. Furthermore, Yeh andWoidtke (2005) present that companies dominatedby affiliated controlling families have poorer gover-nance than those companies not dominated byfamilies. In fact, the managerial indirect ownershipusually causes divergence of cash flow right andcontrol right in Asia and leads to a grave agencyconflict between the controlling shareholders and thesmall shareholders (La Porta et al., 1999; Claessenset al., 2000).
Based on the current empirical findings, it isstill debatable whether or not higher managerialownership could be an effective incentive to monitora bank’s risk-taking behaviour.
Institutional ownership incentives
Apart from inside management, institution owners’role in governance has been proposed from differentaspects. Black and Coffee (1994) and Stapledon(1996) argue that institutional investors usuallyfocus on the short-term investment horizon due tothe industry’s regular performance assessments andranking. The need to rebalance their portfolio forself-performance improvement also limits the institu-tion’s time and resources in actively involving itself inthe affairs of its portfolio companies. Thus, transientinstitutional investors are often referred to as inactive(Goergen and Renneboog, 2001; Goomper andMetrick, 2001) and myopic investors who focus onshort-term earnings (Hirschman, 1970; Bushee, 1998)and lack incentives to incur monitoring costs on theirinvested firms (Porter, 1992).
However, some researchers propose that institu-tional investors could be an alternative governancemechanism (Holland, 2001). The common feature ofall institutional investors is that they have higherabilities to absorb and process information ascompared to individual investors (Bjuggren et al.,2007). The information advantage gives institutionalowners better ability to monitor companies in whichthey invest and assert a noticeable managerial influ-ence over invested companies (Janicki and Wunnava,2004). By examining Fortune 500 firms, Neubaumand Zahra (2006) find that long-term institutionalownership is positively associated with corporatesocial performance. Douma et al. (2006) also findthat foreign-invested firms, which have larger
shareholding, higher commitment and longer-terminvolvement engage higher profitability. Bushee(1998) and Dechow et al. (1996) state that institu-tional ownership can reduce managerial incentives tomanage earnings upwards. Ginglinger and L’her(2006) also propose that stock repurchase will havegood market reaction, especially when the firm issupported by institutional investors. These empiricalfindings all suggest that institutional owners areinclined to be sophisticated investors who couldreduce moral hazard problems, leading to betterperformance.
In banking, Berger et al. (2005) find that foreign-owned banks tend to have lower NPL ratios anddemonstrate better long-term performance on theaverage than state-owned banks in Argentina. Boninet al. (2005) also present consistent findings, showingthat banks with strategic foreign owners are morecost-efficient, while government-owned ones are lessefficient. In transient economies such as that ofTaiwan, the government deregulates the restrictionof foreign institutions’ participation in local banking.Whether foreign institutions with minor ownershipcan play a prudent role in monitoring banks’ risk-taking behaviuor or simply take a role as inactiveshareholders comprise the major focus of this study.
III. Data and Methods
Data and variables
Sample. The sample consisted of public banks in theTaiwan Exchange for the period encompassing 2001to 2006. After excluding samples with missing data,an unbalanced panel of 37 banks with 650 quarterlyobservations was adopted for analysis. The datawere drawn from banks’ annual reports, the MarketObservation Post System and the Taiwan EconomicJournal data bank.
To observe bank ownership evolution, four typol-ogies of banks were used: private banks, banks heldby a financial holding corporation, banks held byfinancial holding corporations with the governmentas the largest owner and banks held by the govern-ment (Jones, 1998). As shown in Table 1, the numberof government-owned banks has decreased from 17to six since 2001 (first row), while the number ofprivate banks has decreased from 21 to six (secondrow). By the end of 2006, there were 15 banks held byfinancial holding corporations, of which eight werestill owned by the government, while seven bankswere held by private financial holding corporations(second column). Most government-owned and
Bank’s risk-taking and ownership structure 1553
private banks that disappeared were transformed intofinancial holding corporations or were merged withother banks.
Variables. Table 2 lists the variable definitions.Table 3 shows the summary statistics of variablesby year and by the type of largest shareholders. Asshown in Panel B of Table 3, the direct managerialownership decreased from 22.48% to 20.10%, whileultimate ownership was around 23.28% from year2001 to 2006. The stakes held by foreign institutionsincreased from 3.55% to 16.74% over a periodof 6 years, and the government’s stockholdingsdecreased by almost 48% from 11.21% to 6.73% asa result of privatization. Table 3 shows, in general,that the ownership structure changes with the decre-asing managerial and government ownerships andincreasing foreign institution ownership.
Following Basel II which focuses on banks’ creditrisks and capital sufficiency, this study uses 6-monthand 3-month overdue loans and regulatory capitalas indexes to measure banks’ risk-taking behaviours.In Taiwan, the 6-month overdue loan is officiallyrecognized by banks and showed a decrease from10.18% to 2.75% from 2001 to 2006 (sixth row inPanel B). On the other hand, the 3-month overdueloan decreased from 15.27% to 3.55% (seventh rowin Panel B). The decreasing trend of overdueloans reflects banks’ effort to writeoff bad debts incompliance with the policy of financial reform.Table 3 shows that the average capital adequacyincreased from 9.52% to 9.83% with an averageof 10.45% (the eighth row in Panel B), which isabove the Basel Accord’s suggested minimum of 8%.The increasing magnitude of assets and branches
in Table 3 shows the results of banks’ integration andacquisition in recent years.
Panel C of Table 3 presents the statistics according
to the type of largest shareholders. The banks whoselargest shareholders are their board members and
supervisors have the highest overdue loans (6.11%and 9.08%) and the lowest regulatory capital
(9.84%). In contrast, the banks whose largest share-holders are foreign institutions have the lowest
overdue loans (2.05% and 2.70%) and the highestregulatory capital (13.04%). The p-value of the
Kruskal–Wallis test statistics is almost significantat the 0.0001 level, indicating that the classification of
the three types of largest shareholders accounts forthe significant differences among the listed variables.
Ownership structure and risk-taking behaviour
As shown in Fig. 1 and Table 1, the banktransformations that occurred from 2001 to 2006
have caused ownership structure changes on threemajor shareholders: inside management, foreign
institutions and the government. According to theliterature, stockholders with higher ownership may
manifest a more aggressive attitude in controlling risk(incentive hypothesis) or are less prudent in risk
taking due to an agency conflict from the controlright. To observe how ownership structure affects
a bank’s risk-taking behaviuor, we first utilize thepro rata stock ownership of the three kinds of
shareholders as independent variables. Afterwards,we identify the large stockholders in order to exam-
ine how the concentrated ownership of insidemanagement, foreign institutions and government
Table 1. Bank ownership structure transition year 2001–2006
Time 01/01/2001 31/12/2006 Increase (decrease)
Bank held by governmenta 17 6 (11)Private bank 21 6 (15)Bank held by Financial HoldingCorporation
3 7 4
Bank held by Financial HoldingCorporation whose largest owneris governmentb
1 8 7
Total 42 37 (5)
Notes: This table reports the evolution of bank’s ownership structure in Taiwan over year 2001 to 2006.The four typologies of ownership structure stated in this table are classified by the identification of bank’slargest owner: private companies, financial holding corporations, government-owned financial holdingcorporations and government.a Including two nonpublic banks – Bank of Land and Taiwan bank. The first bank is owned by firstfinancial holding companies whose largest shareholder is government in year 2001.b Including two nonpublic banks – Bank of Land and Taiwan bank.
1554 S. Chou and F. Lin
shareholders will ultimately affect a bank’s risk-taking behaviour. The empirical models are
Overdueit ¼ �0 þ �1Boardsuprit þ �2Foreignit
þ �3Governmentit þ �4Optleverageit
þ �5Assetit þ �6Branchit þ "it ð1aÞ
Overdueit¼ �0þ�1Boardsupritþ�2Foreignit
þ�3Governmentitþ�4Boardsupr�Highit
þ�5Foreign�Highitþ�6Government�Highit
þ�7Optleverageitþ�8Assetit
þ�9Branchitþ�it ð1bÞ
Regulatory Capitalit
¼ �0 þ �1Boardsuprit þ �2Foreignit
þ �3Governmentit þ �4Optleverageit
þ �5Assetit þ �6Branchit þ �it ð2aÞ
Regulatory Capitalit
¼ �0 þ �1Boardsuprit þ �2Foreignit
þ �3Governmentit þ �4Boardsupr�Highit
þ �5Foreign�Highit þ �6Government�Highit
þ �7Optleverageit þ �8Assetit
þ �9Branchit þ �it ð2bÞ
where Overdue includes 6-month and 3-month over-due loan rate, Regulatory Capital is the capitaladequacy ratio set by the Basel Committee, andBoardsupr, Foreign and Government are the stockownership held by board members, supervisors,foreign institutions and the government. High isdummy equal to one if specific ownership ishigher than the mean value, and zero if otherwise.Optleverage is measured by the ratio of fixed assets tototal assets as the control variable for banks’ risks(Lee, 2004). Asset refers to the natural logarithmof the total assets. Branch represents the number ofbank branches in Taiwan. Asset and Branch wereused to control the effect of a bank’s size on its risk-taking behaviuor.
To account for the management’s ultimate controlright through cross shareholding or pyramid owner-ship structure as indicated by La Porta et al. (1999),the sum of direct and indirect managerial ownership(Ultimate) is also utilized as inside ownership. Themodels were similar to Equations 1a, 1b, 2a and 2b,but not listed for brevity. Second, considering howthe dominant owners may play a critical role inaffecting a bank’s risk-taking behaviour and influencethe other stockhloders, we further classify the samplesinto three subsets according to the type of largestshareholders and compare the risk-taking behaviourin the three subsets. The models used are the sameas (1a) and (2b).
Relative governance strength of inside blockholdersand foreign institutions
In light of the increasingly important role of insidemanagement and foreign institutions in a bank’sprivatization, we then focused on how inside man-agement and foreign institutions interact to affecta bank’s risk-taking behaviour. Following Cremersand Nair (2005), we constructed measurement rela-tive governance strength by classifying managerial
Table 2. Variable definition
Variable Definition
Boardsupr The direct ownership owned by boardand supervisors.
Ultimate The direct and indirect ownership ownedby board and supervisors indicated byLa Porta et al. (1999).
Foreign The shares owned by foreigninstitutions.
Government The shares owned by local government.6-month
overdueThe 6-month overdue loan rate.
3-monthoverdue
The 3-month overdue loan rate.
Regulary Capital The capital adequacy ratio set by BaselCommittee.
Optleverage Optleverage is measured by the ratioof fixed assets to total assets.
Asset Asset is the natural logarithm oftotal asset.
Branch Branch represents the number ofbranches of banks in Taiwan.
High High is a dummy variable equal to oneif specific type of ownership higherthan mean.
MIN MIN¼MIN (managerial, foreign) inwhich the managerial ownership andforeign institution ownership areclassified into low, middle andhigh levels (1, 2, 3) at a cutoff of33-percentile and 67-percentile.
MAX MAX¼MAX (managerial, foreign) inwhich the managerial ownership andforeign institution ownership areclassified into low, middle andhigh levels (1, 2, 3) at a cutoff of33-percentile and 67-percentile.
Govdummy Govdummy is a dummy variable equal toone if government is the largest ownerof bank, and zero if otherwise.
Foreignd Foreignd is a dummy variable to identifyforeign institutions as the weaker orstronger side of monitoring strength.
Bank’s risk-taking and ownership structure 1555
and foreign institution ownership into low, middle,and high levels (score¼ 1, 2, 3) at cutoff rates of33-percentile and 67-percentile. The one at thehigher class of the governance category is defined to
have relatively stronger governance. The empirical
models are
Overdueit ¼ 0 þ 1MINit þ 2MAXit þ 3Govdummyit
þ 4Optleverageit þ 5Assetit
þ 6Branchit þ it ð3Þ
Regulatory Capitalit
¼ �0 þ �1MINit þ �2MAXit þ �3Govdummyit
þ �4Optleverageit þ �5Assetit
þ �6Branchit þ !it ð4Þ
where MIN and MAX represent a bank’s weaker and
stronger monitoring mechanisms. If the coefficient on
MIN is significant, the weaker relative governance
strength will affect the bank’s risk taking even if the
other stronger monitoring mechanism exists (com-
plementary effect). Utilizing category variables rather
than original ownership proportions helps us avoid
Table 3. Characteristics of sample banks
Panel A: Samples descriptionSample period Year 2001–2006Number of Banks 37Bank-quarter observations 650
Panel B: Bank characteristics by year (mean value)
Sample 2001 2002 2003 2004 2005 2006 Average
Sample 650 66 113 131 127 98 115 111Boardsupr (%) 650 22.48 21.21 19.99 19.58 18.38 20.10 20.15Ultimate (%) 650 23.45 23.76 24.03 23.03 21.70 23.47 23.28Foreign (%) 650 3.55 3.83 5.66 9.33 10.39 16.74 8.52Government (%) 650 11.21 7.42 8.91 8.56 6.53 6.73 8.076-month overdue loan (%) 650 10.18 7.18 5.65 4.25 3.19 2.75 5.223-month overdue loan (%) 650 15.27 11.89 8.51 5.75 4.04 3.55 7.69Regulatory Capital (%) 400 9.52 10.73 10.56 10.87 11.14 9.83 10.45Optleverage 650 0.020 0.019 0.018 0.017 0.017 0.016 0.018Asset (in billion) 650 403 000 428 000 490 000 578 000 599 000 690 000 539 000Branch 650 60 65 68 75 78 84 73
Panel C: Bank characteristics by largest shareholder’s type
Boardsupr Foreign GovernmentSignificant test p-value(Kruskal–Wallis)
Sample 502 117 31Boardsupr (%) 21.01 11.87 37.41 50.0001Ultimate (%) 23.50 18.12 39.13 50.0001Foreign (%) 3.33 30.89 8.14 50.0001Government (%) 7.49 1.95 40.58 50.00016-month overdue loan (%) 6.11 2.05 2.78 50.00013-month overdue loan (%) 9.08 2.70 4.00 50.0001Regulatory Capital (%) 9.84 13.04 11.49 50.0001Optleverage 0.017 0.0020 0.016 0.0020Asset (in billion) 510 000 663 000 559 000 50.0001Branch 73 71 70 0.0103
0
3
6
9
12
15
18
Low
Foreign institution ownership
Ris
k-ta
king
(%
)
6-month overdue loan 3-month overdue loan
Regulatory Capital
Middle High
Fig. 2. Foreign institution ownership and bank’s risk-taking
1556 S. Chou and F. Lin
neglecting the governance function of foreign institu-tions due to their minor stockholdings in the earlystage of deregulation.
Given that the participation of foreign insti-tutions is expected to be a part of the steps leadingto deregulation and privatization, we further iden-tify the dummy variable Foreignd to observe thegovernance effect by foreign institutions. If thecoefficient of MAX*Foreignd/MIN*Foreignd is sig-nificantly negative or positive in Equations 5 and 6,the foreign institution is considered to have adominant/complementary governance effect inmonitoring a bank’s risk-taking behaviour.
Overdueit¼ ’0þ’1MINitþ’2MAXit
þ’3MIN�Foreignditþ’4MAX�Foreigndit
þ’5Governmentitþ’6Optleverageit
þ’7Assetitþ’8BRANCHitþ$it ð5Þ
Regulatory Capitalit
¼ �0 þ �1MINit þ �2MAXit þ �3MIN�Foreigndit
þ �4MAX � Foreigndit þ �5Govdummyit
þ �6Optleverageit þ #7Assetit
þ �8BRANCHit þ it ð6Þ
Methodology
The estimation is carried out with random effectsthrough the Feasible Generalized Least Squares(FGLS) method to correct cross-sectional hetero-scedasticity and panel-specific autocorrelation(Wooldridge, 2002). Wald tests are also conductedto test the joint significance of model parameters.The Breusch–Pagan Lagrangian Multiplier (LM)test (Breusch and Pagan, 1980) was applied inconsideration of the unobserved effects. All depen-dent variables have Variance-Inflating Factor (VIF)below 10, indicating no serious multicollinearity.
IV. Empirical Results
Ownership structure and bank’s risk-taking
Direct and ultimate ownership as monitoring
mechanisms. Table 4 presents the results of theFGLS regression estimates of Equations 1a–2bin which the pro rata ownerships of managementand foreign institutions are measured as abank’s monitoring incentives. The significant nega-tive coefficients of Boardsupr (coefficient¼ 0.012,
p¼ 0.071 in Panel A, first column) and Government(coefficient¼ 0.022, p¼ 0.029 in Panel A, firstcolumn) show that those banks with higher equityheld by inside management and government havehigher 6-month overdue loans. Both coefficientsof joint tests for Boardsupr (coefficient¼ 0.006,p¼ 0.000 in Panel A, second column) andGovernment (coefficient¼ 0.328, p¼ 0.020 in Panel A,second column) for model (1a) are also significant,verifying that higher inside management and gov-ernment ownership lead to higher overdue loans.Panel A in Table 4 also shows that a higherinside management ownership is related to a lowerregulatory capital (Boardsupr coefficient of jointtest¼�0.003, p¼ 0.020 in Panel A, last column;Government coefficient of joint test¼�0.023, p¼0.006 in Panel A, the last four column).
For Panel B in which ultimate ownership ispresented as inside blockholders, the results regardinginside management and the government are similar toPanel A. However, the coefficient of the joint test forForeign on overdue loan is significantly negative(coefficient¼�0.010, p¼ 0.070 in Panel B, secondcolumn; coefficient¼�0.022, p¼ 0.015 in Panel B,fourth column) and significantly positive on regula-tory capital (coefficient¼ 0.019, p¼ 0.017 in Panel B,last column). These results indicate that a higherforeign institution ownership is associated with alower overdue loan and higher regulatory capital.
In general, the results in Table 4 imply that themore stock ownership held by inside management(board members and supervisors) and the gover-nment, the higher are the risks posed to banks.In contrast, banks with higher foreign institutionownership have lower risks.
Monitoring effects within subgroups by the largest
shareholders. Table 5 examines the effect of owner-ship on a bank’s risk-taking behaviour in threesubsets classified by the largest shareholders. Forthe first subgroup in which board members andsupervisors are the largest shareholders, the coeffi-cients of Boardsupr and government are significantlypositive (Boardsupr coefficient¼ 0.039, p50.0001;Government coefficient¼ 0.058, p50.0001 inTable 5, first column). The Government coefficientis also negatively correlated with regulatory capital(coefficient¼�0.041, p¼ 0.004 in Table 5, thirdcolumn). This result indicates that higher insidemanagement ownership and government ownershipare associated with higher overdue loans and lowerregulatory capital when banks’ largest shareholdersare their board members and supervisors.
For the second subgroup in which the foreigninstitution is the largest shareholder, we find that
Bank’s risk-taking and ownership structure 1557
Table
4.Ownership
structure
andbank’srisk-taking
6-m
onth
overdueloan
3-m
onth
overdueloan
Regulatory
Capital
Model
specification
(1a)
(1b)
(1a)
(1b)
(2a)
(2b)
Panel
A:Ownership
isdirectownership
Intercept
30.727(5
0.0001)***
40.372(5
0.0001)***
78.519(5
0.0001)***
84.285(5
0.0001)***
�12.266(0.070)*
�8.512(0.187)
Boardsupr
0.012(0.071)*
�0.039(0.035)**
0.015(0.170)
�0.084(0.107)
�0.014(0.090)*
0.050(0.087)*
Foreign
�0.007(0.255)
�0.044(0.115)
�0.013(0.206)
�0.087(0.063)*
0.012(0.218)
0.002(0.961)
Government
0.022(0.029)**
�0.006(0.931)
0.017(0.271)
0.085(0.436)
0.016(0.110)
0.281(0.008)**
Boardsupr *High
–0.045(0.001)**
–0.086(5
0.0001)***
–�0.053(0.019)**
Foreign*High
–0.034(0.199)
–0.073(0.098)*
–0.018(0.669)
Government *High
–0.033(0.643)
–0.107(0.311)
–�0.258(0.014)**
Optleverage
46.577(0.004)**
54.300(0.001)**
68.713(0.007)**
73.694(0.007)**
�111.296(5
0.0001)***�150.223(5
0.0001)***
Asset
�1.466(5
0.0001)***�1.939(5
0.0001)***
�3.803(5
0.0001)***�4.024(5
0.0001)***
1.336(5
0.0001)***
1.129(0.001)**
Branch
0.014(5
0.0001)***
0.018(5
0.0001)***
0.026(5
0.0001)***
0.030(5
0.0001)***
�0.013(0.030)**
�0.007(0.260)
Jointtest
ofdifferentownership
BoardsuprandInteractionterm
–0.006(0.000)**
–0.002(0.000)**
–�0.003(0.020)**
ForeignandInteractionterm
–�0.010(0.165)
–�0.014(0.142)
–0.020(0.115)
GovernmentandInteractionterm
–0.328(0.020)**
–0.022(0.180)
–�0.023**(0.006)
Observations
650
650
650
650
400
400
Wald�2
93.38***
143.36***
177.03***
244.95***
53.33**
92.77***
LM
statistics
1104.17***
646.46***
1281.87**
830.66***
1012.61***
634.78***
Panel
B:Ownership
isultim
ate
ownership
Intercept
32.485(5
0.0001)***
37.178(5
0.0001)***
79.932(5
0.0001)***
75.264(5
0.0001)***
�12.724(0.070)*
�0.077(0.991)
Ultim
ate
�0.002(0.765)
0.029(0.015)**
�0.006(0.544)
�0.034(0.189)
0.002(0.846)
0.052(0.003)**
Foreign
�0.006(0.279)
�0.061(0.033)**
�0.012(0.033)**
�0.130(0.007)*
0.015(0.176)
0.051(0.176)
Government
0.026(0.010)**
0.034(0.648)
0.028(0.083)*
�0.052(0.626)
0.007(0.486)
0.332(0.002)**
Ultim
ate*High
–�0.022(0.005)**
–0.020(0.133)
–�0.032(0.014)**
Foreign*High
–0.051(0.060)*
–0.108(0.016)**
–�0.016(0.684)
Government *High
–�0.006(0.938)
–0.090(0.385)
–�0.329(0.002)**
Optleverage
41.536(0.009)**
48.594(0.009)**
62.143(0.013)**
67.843(0.001)**
�115.473(5
0.0001)***�177.189(5
0.0001)***
Asset
�1.543(5
0.0001)***�1.767(5
0.0001)***
�3.855(5
0.0001)***�3.560(5
0.0001)***
1.362(5
0.0001)***
0.694(0.052)**
Branch
0.015(5
0.0001)***
0.014(5
0.0001)***
0.026(5
0.0001)***
0.021(5
0.0001)***
�0.015(0.013)**
�0.002(0.780)
Jointtest
ofdifferentownership
Ultim
ate
andInteractionterm
–0.007(0.021)**
–�0.014(0.234)
–0.020(0.013)**
ForeignandInteractionterm
–�0.010(0.070)*
–�0.022(0.015)**
–0.019(0.017)**
GovernmentandInteractionterm
–0.339(0.015)**
–0.038(0.016)**
–0.003(0.008)**
Observations
650
650
650
650
400
400
Wald�2
94.00***
163.47***
178.47***
329.07***
63.45**
169.53***
LM
statistics
1093.72***
886.50***
1287.04**
971.06***
953.66***
971.06***
Notes:
This
table
examines
theeffect
ofownership
heldbyboard
andsupervisors,foreigninstitutionsandgovernmentonbanks’
risk-takingbehaviour.
Thevariable
definitionsare
listed
inTable
2.FGLSestimateswithfirm
-specific
random
effectsare
applied
forparameter
estimation.Wald
testsare
conducted
toexaminethejoint
restrictiononmodel
parameters.
TheLM
statisticsis
theresultofBreusch–PaganLM
test
forrandom
effects.
Heteroscedasticity-autocorrelationadjusted
p-values
are
reported
inparentheses.Allregressionscontain
yeardummiesandaconstantterm
.*,**and***indicate
statisticalsignificance
at10,5and1%
levels,respectively.
1558 S. Chou and F. Lin
Table
5.Ownership
structure
andbank’srisk-takingbylargestshareholder
Largestshareholder
Boardsupr
Foreign
Government
Dependent
variable
6-m
onth
overdue
3-m
onth
overdue
Regulatory
Capital
6-m
onth
overdue
3-m
onth
overdue
Regulatory
Capital
6-m
onth
overdue
3-m
onth
overdue
Regulatory
Capital
Model
specification
(1a)
(1a)
(2a)
(1a)
(1a)
(1b)
(1a)
(1a)
(2a)
Intercept
44.721(50.0001)***
107.919(50.0001)***
0.370(0.966)
11.267(0.001)**
15.944(0.002)**
–2.995(0.891)
–47.164(0.005)**
–91.765(50.0001)***
–20.003(0.483)
Boardsupr
0.039(50.0001)***
0.020(0.241)
0.017(0.243)
–0.007(0.127)
–0.008(0.257)
–0.019(0.423)
0.128(0.006)**
0.240(0.034)**
–0.001(0.994)
Foreign
–0.002(0.912)
0.013(0.669)
0.027(0.209)
–0.006(0.031)**
0.007(0.135)
–0.016(0.361)
–0.033(0.007)**
–0.070(0.006)**
–0.100(50.0001)***
Government
0.058(50.0001)***
0.078(0.001)**
–0.041(0.004)**
0.076(0.002)**
0.079(0.021)**
–0.021(0.448)
–0.106(0.037)**
–0.227(0.065)*
0.013(0.887)
Optleverage
153.368(50.0001)***
153.651(50.0001)***
–127.694(50.0001)***
51.609(50.0001)***
52.416(0.001)**
–202.902(50.0001)***
368.978(50.0001)***
1005.226(50.0001)***
529.508(0.011)
Asset
–2.286(50.0001)***
–5.389(50.0001)***
0.652(0.156)
–0.521(0.003)**
–0.711(0.008)**
1.157(0.301)
2.313(50.0001)***
4.300(50.0001)***
1.342(0.318)
Branch
0.018(0.001)**
0.040(50.0001)***
–0.011(0.049)**
–0.003(0.215)
–0.006(0.150)
–0.051(0.001)**
–0.028(50.0001)***
–0.058(50.0001)***
–0.044(0.175)
Observations502
502
314
117
117
67
31
31
20
Wald�2
166.34***
211.01***
40.57***
36.64***
27.62***
74.32***
173.32***
443.96***
21.15**
LM
statistics829.45***
1082.89**
362.95***
41.25***
51.63***
56.18***
28.26**
32.28***
0.28
Notes:Thistableclassifiesthesamplesinto
threesubsetsbythetypeoflargestshareholdersandexamines
theeffect
ofownership
onbanks’risk-takingbehaviourin
thethree
subsets.Thevariable
definitionsare
listed
inTable
2.FGLSestimateswithfirm
-specific
random
effectsare
applied
forparameter
estimation.Wald
testsare
conducted
toexaminethejointrestrictiononmodelparameters.TheLM
statisticsistheresultofBreusch–PaganLM
testforrandom
effects.Heteroscedasticity-autocorrelationadjusted
p-values
are
reported
inparentheses.Allregressionscontain
yeardummiesandaconstantterm
.*,**and***indicate
statisticalsignificance
at10,5and1%
levels,respectively.
Bank’s risk-taking and ownership structure 1559
the coefficient of Foreign is significantly negative(coefficient¼�0.006, p¼ 0.031 in Table 5, fourthcolumn). The coefficients of Government are signi-ficantly positive for the 6-month overdue loan(coefficient¼ 0.076, p¼ 0.002 in Table 5, fourthcolumn) and for the 3-month overdue loan(coefficient¼ 0.079, p¼ 0.021 in Table 5, fifthcolumn). However, the coefficients of Boardsuprin the second subgroup are all insignificant. For thethird subgroup in which the government is thelargest shareholder, we find that the coefficientsof Boardsupr on the overdue loan are signifi-cantly positive (coefficient¼ 0.128, p¼ 0.006 for the6-month overdue loan; coefficient¼ 0.240, p¼ 0.034for the 3-month overdue loan in Table 5). At the sametime, the coefficients of Foreign and Government areall significantly negative on the overdue loan.
Overall, the findings in Table 5 agree with thesummary statistics shown in Table 3 Panel C in whichthe subgroup with the largest ownership of boardmembers and supervisors has the highest overdueloan (6.11% for the 6-month overdue loan and 9.08%for the 3-month overdue loan) and lowest regulatorycapital (9.84%). In contrast, the subgroup with thelargest foreign institutions exhibited the lowest over-due loan (2.05% for the 6-month overdue loan and2.70% for the 3-month overdue loan) and highestregulatory capital (13.04%). The results imply thata higher inside management ownership and highergovernment ownership are related to a higher risk.In contrast, a higher foreign institution ownership isassociated with a lower risk.
In addition, there are some notable results. First, inthe subsets whose largest shareholders are foreigninstitutions, the inside management ownerships areall insignificant, indicating that foreign institutionsmay contest inside management and alleviate theirrisk-taking behaviour. Second, government owner-ship is negatively related to overdue loans in thesubset in which the largest shareholders come fromthe government. The explanation for this phenome-non is that the Taiwanese government has madeefforts to reduce bad debts during recent financialreforms. Therefore, the government became moreinfluential in reducing overdue loans when it is thelargest shareholder.
Relative governance strength and bankrisk-taking behaviour
In light of the increasing importance of foreigninstitution ownership and its debatable role inextant literature, this study further analyses howforeign institution ownership affects a bank’s risk-taking behaviour. Figure 2 illustrates the decreasing
trend of overdue loan and the increasing trendof regulatory capital as the governance strength offoreign institutions increases.
Table 6 takes the perspective of the relativegovernance strength of board members and foreigninstitutions. Recall that Foreignd is a dummy variableequal to one, indicating foreign institutions’ position.As shown in Table 6, the coefficients of the inter-action term of MAX and Foreignd are all significantlynegative (p¼ 0.022 in the second column, p¼ 0.008 inthe fourth column, P¼ 0.014 in the sixth column,and P¼ 0.020 in the last column). The joint test ofcoefficients of MAX and the interaction term arealso significantly negative (p¼ 0.073 in the secondcolumn, p¼ 0.018 in the fourth column, p¼ 0.036 inthe sixth column and p¼ 0.062 in the last column).These phenomena suggest that banks will have feweroverdue loans when their foreign institution ownershave higher relative governance strength than insidemanagement. This finding is consistent with theresults presented in Table 5 in which we find thatthe foreign institution owner may contest insidemanagement when the largest shareholders consistof foreign institutions.
Table 7 presents the details on the association ofregulatory capital and the relative governance powerof ownership. The significantly positive coefficientsof MAX (coefficient¼ 0.504, p¼ 0.011 in the firstcolumn and coefficient¼ 0.517, p¼ 0.028 in thesecond column) demonstrate that owners withhigher governance strength are inclined to maintainmore sufficient capital. However, significantly posi-tive coefficients of MIN show complementary mon-itoring effects by the weaker side of governancestrength as well (coefficient¼ 0.560, p¼ 0.001 in thethird column and coefficient¼ 0.541, p¼ 0.045 inthe last column). Furthermore, the coefficients ofthe interaction terms of MAX and Foreignd aresignificantly positive for both kinds of managerialownership measures (coefficient¼ 0.356, p¼ 0.001 inthe second column and coefficient¼ 0.168, p¼ 0.097in the last column). This result shows that foreigninstitution investors with higher relative governancestrength are associated with sufficient capital.
Control variables
For the control variables shown in Tables 4–7, thecoefficients of Asset are significantly negative foroverdue loans and significantly positive for regula-tory capital, implying that large banks pay muchattention to controlling risks. This may be becauselarger banks have gained more benefits from internaloperation improvements (Carbo et al., 2003) or havemore tangible and intangible resources for risk
1560 S. Chou and F. Lin
Table
6.Overdueloanandrelative
governance
strength
–managerialdirectstakeholder
asinsidemonitorincentive
Directownership
asinsidemonitor
Ultim
ate
ownership
asinsidemonitor
6-m
onth
overdueloan
3-m
onth
overdueloan
6-m
onth
overdueloan
3-m
onth
overdueloan
Model
specification
(3)
(5)
(3)
(5)
(3)
(5)
(3)
(5)
Intercept
35.903(5
0.0001)***
31.730(5
0.0001)***
77.962(5
0.0001)***
72.778(5
0.0001)***
36.139(5
0.0001)***
33.060(5
0.0001)***
75.847(5
0.0001)***
73.071(5
0.0001)***
MIN
0.032(0.771)
0.189(0.404)
�0.050(0.780)
0.171(0.646)
�0.150(0.165)
�0.059(0.741)
�0.345(0.056)*
�0.236(0.431)
MAX
�0.158(0.239)
�0.134(0.399)
�0.574(0.010)**
�0.490(0.058)*
�0.002(0.988)
�0.016(0.904)
�0.199(0.295)
�0.256(0.220)
MIN
*Foreignd
–0.005(0.962)
–0.096(0.607)
–0.046(0.608)
–0.073(0.614)
MAX*Foreignd
–�0.176(0.022)**
–�0.327(0.008)**
–�0.176(0.014)**
–�0.267(0.020)**
Govdummy
0.196(0.658)
0.171(0.714)
�0.081(0.904)
�0.122(�
0.859)
0.428(0.326)
0.115(0.799)
0.312(0.642)
0.040(0.952)
Optleverage
40.556(0.012)**
44.400(0.010)**
42.438(0.057)*
72.353(0.003)**
36.522(0.023)**
35.420(0.029)**
62.893(0.010)**
77.193(0.002)**
Asset
�1.699(5
0.0001)***�1.475(5
0.0001)***�3.645(5
0.0001)***�3.398(5
0.0001)***�1.712(5
0.0001)***�1.546(5
0.0001)***�3.586(5
0.0001)***�3.438(5
0.0001)***
Branch
0.018(5
0.0001)***
0.015(5
0.0001)***
0.028(5
0.0001)***
0.025(5
0.0001)***
0.017(5
0.0001)***
0.017(5
0.0001)***
0.028(5
0.0001)***
0.027(5
0.0001)***
Jointtest
offoreigninstitutionmonitoringeffect
MIN
andInteraction
term
(p-valueofF-test)
–0.194(0.287)
–0.267(0.213)
–�0.013(0.874)
–�0.163(0.724)
MAX
andInteractionterm
(p-valueofF-test)
–�0.310(0.073)*
–�0.817(0.018)**
–�0.192(0.036)**
–�0.523(0.062)*
Observations
650
650
650
650
650
650
650
650
Wald�2
95.98***
93.55***
234.99***
235.57***
93.38***
103.85***
122.06***
223.47***
LM
statistics
996.96***
852.71***
975.60***
817.79***
1058.12***
805.47***
1261.70***
913.71***
Notes:Thistableexamines
theeffect
ofbank’sinternalandexternalrelativegovernance
strength
onbank’sriskingtaking.Thedependentvariablesare
the6-m
onth
overdue
loanrate
andthe3-m
onth
overdueloanrate.Internalgovernance
power
isthelevelofdirectownership
ofboard
andsupervisors.Externalgovernance
power
isthelevelof
ownership
ofbyforeigninstitutions.Thevariable
MIN
denotestheweaker
sideofmonitoringstrength
andcapturesthecomplementary
effect
formonitoringbank’srisk-
taking.MAXdenotesthestronger
sideofmonitoringstrength
andcapturesthesubstitutioneffect
formonitoringbank’srisk-taking.Foreigndisadummyvariableequalto
oneiftheforeigninstitutionlocatesatMIN
orMAXmonitoringcategory.Thevariabledefinitionsare
listed
inTable2.FGLSestimateswithfirm
-specificrandom
effectsare
applied
forparameter
estimation.Wald
testsare
conducted
toexaminethejointsignificance
ofmodelparameters.TheLM
statisticsistheresultofBreusch–PaganLM
test
forrandom
effects(1980).Heteroscedasticity-autocorrelationadjusted
p-values
are
reported
inparentheses.Allregressionscontain
yeardummiesandaconstantterm
.*,**and***indicate
statisticalsignificance
at10,5and1%
levels,respectively.
Bank’s risk-taking and ownership structure 1561
management such that they usually bear heavierregulatory oversight than small banks (Lee, 2004).Meanwhile, the coefficients on Optleverage are signi-ficantly positive for overdue loans and significantlynegative for regulatory capital. The coefficients ofBranch are also significantly positive for overdueloans and significantly negative for regulatory capital.These results suggest that banks with higher operat-ing leverage and more branches are less prudent inrisk control. This finding may be attributed to thefact that most banks in Taiwan with more fixed assetsand branches were originally government owned.Thus, they may be less attentive to granting loans andmaintaining capital sufficiency due to the govern-ment’s implicit guarantee. Tables 4–7 also list thestatistics for model specification. The significantWald �2 and LM statistics demonstrate the appro-priateness of the models presented.
In general, the results are consistent regardlessof the choice of ownership or relative governancestrength of foreign institutions as independent vari-able. This finding is similar to that presented byMajumdar and Nagarajan (1997) and Koh (2003)
who found that institutional owners will be moreactively involved in their invested firms.
V. Robustness Test
To mitigate any bias attributable to cross-sectionaldependence, following the Bernard (1987) methodol-ogy, we estimate annual cross-sectional regressionsfrom 2001 to 2006 and use the estimated slopecoefficient for the six yearly regressions in order toobtain across-year mean coefficients for each vari-able. The results of the significance test for the time-series mean parameter are similar to the core resultslisted in the previous sections.
VI. Conclusion
In recent years, the banking sector in East Asia hasfaced deregulation and has undergone transformation
Table 7. Regulatory capital and relative governance strength
Direct stakeholder as inside monitor Dominant stakeholder as inside monitor
Model specification (4) (6) (4) (6)
Intercept �2.937 (0.701) �9.100 (0.224) �24.383 (50.0001)*** �16.627 (0.015)**MIN 0.162 (0.272) �0.485 (0.153) 0.560 (0.001)** 0.541 (0.045)**MAX 0.504 (0.011)** 0.517 (0.028)** 0.153 (0.342) 0.102 (0.582)MIN*Foreignd 0.175 (0.312) �0.111 (0.441)MAX*Foreignd 0.356 (0.001)** 0.168 (0.097)*Govdummy 0.105 (0.774) 0.343 (0.371) 0.086 (0.821) 0.022 (0.955)Optleverage �186.473
(50.0001)***�167.623
(50.0001)***�150.278
(50.0001)***�145.638
(50.0001)***Asset 0.838 (0.039)** 1.151 (0.004)** 1.972 (50.0001)*** 1.557 (50.0001)***Branch �0.014 (0.022)** �0.015 (0.010)** �0.029 (50.0001)*** �0.024 (50.0001)***
Joint test of foreign institution monitoring effectMIN and Interaction term
(p-value of F-test)�0.310 (0.326) 0.430 (0.075)*
MAX and Interaction term(p-value of F-test)
0.873 (0.002)** 0.270 (0.252)
Observations 400 400 400 400Wald �2 122.06*** 124.63*** 173.88*** 134.79***LM statistics 881.13*** 761.67*** 882.00*** 791.76***
Notes: This table examines the effect of bank’s internal and external relative governance power on bank’s regulatory capital asproxy for bank’s risking taking external governance power is the level of ownership owned by foreign institutions. Thevariable MIN denotes the minimum of the ownership level of foreign institution owner and inside management, and capturesthe complementary effect for monitoring bank’s risk-taking. The variable MAX denotes the maximum of the ownership levelof foreign institution owner and inside management, and captures the substitution effect for monitoring bank’s risk-taking.Govdummy is a dummy variable equal to one if government is the largest owner of bank. The variable definitions are listed inTable 2. FGLS estimates with firm-specific random effects are applied for parameter estimation. Wald tests are conducted toexamine the joint significance of model parameters. The LM statistics is the result of Breusch–Pagan LM test for randomeffects (1980). Heteroscedasticity-autocorrelation adjusted p-values are reported in parentheses. All regressions contain yeardummies and a constant term.*, ** and *** indicate statistical significance at 10, 5 and 1% levels, respectively.
1562 S. Chou and F. Lin
from being government-owned to private institutions.
How does this ownership change affect a bank’s risk-
taking behaviour? This issue has raised awarenessamong policy makers and academic researchers
(Douma et al., 2006). This article examines theassociation between a bank’s ownership structure
and risk-taking behaviour as presented through
overdue loans and regulatory capital. By analysinga sample of 37 banks with 650 quarterly observations,
the results show that banks with higher inside
management ownership and government ownershiphave higher overdue loans and lower regulatory
capital. Meanwhile, banks with higher foreign insti-tution ownership have lower overdue loans and
higher regulatory capital. Especially, the risk-taking
behaviour of inside management is alleviated inbanks whose largest shareholders are foreign institu-
tions, implying that foreign institutions are more
influential than inside management when they ownmore equity.
In general, the results are consistent regardless
of the choice of ownership or relative governancestrength of foreign institutions as independent vari-
able. These findings offer empirical implications
regarding bank governance from two perspectives.A bank’s inside owners with higher control power
seem to be less concerned with risk taking. Foreign
institutions become actively involved in the allevia-tion of overdue loan rates and maintain higher
capital adequacy ratios more apparently when theyhave higher ownership as compared to that of inside
management. The corporate governance of banks
has been emphasized recently to enhance bankingoperations and promote the development of capital
markets. The results imply that more foreign institu-
tion ownerships could be considered as a choice formonitoring mechanism. These results also contribute
to the growing body of evidence for governance inbanking where more governance mechanisms must
be explored in the current transition stage from the
viewpoint of risk control.
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