how does corporate governance affect performance of banks...
TRANSCRIPT
Asma Ahmad
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How does corporate governance affect performance of banks in Palestine?
Submitted by Asma Ahmad
As part of the degree
Master of Business Administration
School of Management
University of Bath
Graduation Year 2010
This project may be made available for consultation within the University library and may be photocopied or lent to other
libraries for the purpose of consultation.
Word count: 19100 words
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Abstract:
One of the important elements of the corporate governance that has received
attention is the structure of the board of directors and ownership concentration.
Although many studies attempted to find any association between good governance
and firm’s performance, little convincing evidence has been provided about the
beneficial effect of good corporate governance on firms’ value and performance. To
address this issue, this study seeks to explore the factors that influence the relation
between corporate governance and performance of banks operating in Palestine
relying on financial ratios, namely ROA. The statistical analysis applied is the
Generalized Least Squares regression (GLS) through which a Cross sectional and Time
series data are investigated using Panel Regression. The primary findings indicate
that the board size, CEO duality, internal ownership, and the bank age have positive
impact with statistical significance on the performance of the sampled banks;
meanwhile, the board hierarchy, family ownership, bank size and debt ratio have a
significant negative relationship with performance. Moreover, it is found that both
the board size and the internal ownership have the most considerable influence on
the performance of banks in Palestine.
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Contents:
Abstract: ............................................................................................................................... 2
Chapter 1: INTRODUCTION ................................................................................................... 6
1.1 Background: .......................................................................................................... 6
1.2 Objective: .............................................................................................................. 8
1.3 Value of this study: ................................................................................................ 8
1.4 Scope: ................................................................................................................... 9
1.5 Structure: .............................................................................................................. 9
Chapter 2: LITERATURE REVIEW .......................................................................................... 11
2.1 Corporate governance concept and indicators: .................................................... 11
2.2 Corporate governance for banks: ......................................................................... 19
2.3 Theoretical framework: ....................................................................................... 26
CHAPTER 3: BANKING INDUSTRY IN PALESTINE ................................................................... 37
3.1Banks in Palestine: ..................................................................................................... 39
CHAPTER 4: FORMER STUDIES............................................................................................. 45
CHAPTER 5: METHODOLGY ................................................................................................. 54
5.1 Sample description: ................................................................................................... 54
5.2 Data collection: ......................................................................................................... 54
5.3 Model presentation: .................................................................................................. 56
CHAPTER 6: RESULTS AND DISCUSSION ............................................................................... 60
6.1 Descriptive analysis of the data: ................................................................................ 60
6.2 Statistical analysis of the data: ................................................................................... 68
Chapter 7: CONCLUSION ..................................................................................................... 82
7.1 Implications for practise: ........................................................................................... 87
7.2 Limitations: ............................................................................................................... 89
7.3 Directions for future research:................................................................................... 89
Appendix A: Results of Statistical Analysis ........................................................................... 91
References ........................................................................................................................ 104
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List of figures:
Figure 1: A corporate governance framework: the internal and external architecture
Figure 2: Agency theory
Figure 3: Stewardship theory
Figure 4: Stakeholder theory
Figure 5: Banking Industry in Palestine nowadays.
Figure 6: The boost up in the number of banks operating in Palestine.
Figure 7: The increase in the number of branches of banks operating in Palestine.
Figure 8: Variables considered for governance studies
List of tables:
Table 1: Branches of banks in Palestine
Table 2: Increase in the number of branches during 2001-2007
Table 3: Information related to banks operating in Palestine.
Table 4: Descriptive analysis of all variables (governance and controlling variables)
Table 5: Descriptive analysis of variables for national and foreign banks.
Table 6: Independent Samples t-test of the ROA
Table 7: Relationship between board size and ROA
Table 8: Relationship between board hierarchy and ROA
Table 9: Relationship between CEO duality and ROA
Table 10: Relationship between internal ownership and ROA
Table 11: Relationship between family ownership and ROA
Table 12: Relationship between bank size and ROA
Table 13: Relationship between bank age and ROA
Table 14: Relationship between age and ROA for national banks
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Table 15: Relationship between debt and ROA
Table 16: Results of regression model analysis
Table 17: Results of regression model analysis excluding the controlling variables
Table 18: Results of regression model analysis for foreign banks (regional banks
included)
Table 19: Results of regression model analysis for foreign banks excluding controlling
variables
Table 20: Results of regression model analysis for national banks
Table 21: Results of regression model analysis for national banks excluding
controlling variables
Table 22: Results of regression model analysis for the period of 2001-2003 (Israeli
invasion period)
Table 23: Results of regression model analysis for the period 2004- 2006
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Chapter 1: INTRODUCTION
For the last decades, there has been a growing awareness of the corporate
governance in both the advanced and developing economies. The high-profile
collapses of a number of large U.S. firms such as Enron Corporation and MCI Inc.
(formerly WorldCom) in 2001, stimulated governments and international
organizations to set regulatory principles for private and public companies (CFA
Institute 2005). These policies are intended to support corporate’ management- and
hence restore the public confidence in corporate governance -, and to ensure stock
markets’ efficiency which contributes to economic stability as confirmed by the
World Bank, International Monetary Fund, and Organization for Economic Co-
operation Development.
1.1 Background:
Companies have a major role in building and empowering the national economy, as
an economy’s progress is measured by the performance of companies in which
operates (Monks and Minow 2008). Particularly, banks are a model, of which private
companies consider, as banks are public limited companies that separate its
shareholders from its board of directors and management.
In view of the fact that banks are the main source for finance, that makes banks a
competent tool towards making a change of applying and adopting corporate
governance principles and basics through assuring transparency, information
disclosure and accountability (Cornwall 2007). On the other hand, as banks operate
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in a different sphere from private companies and trades its stocks in markets, which
assures the risk correlated with the type of business banks provide, and emphasizes
the importance of having an efficient regulatory system.
Palestine, as other developing countries, has started recently to give attention to
corporate governance, as there were conferences and workshops have been taken
place to promote for corporate governance practises. Unfortunately, many obstacles
appear to stop these initiatives, one of challenges is that there is no clear legal frame
in which Palestinian firms operate, and there is no homogenous among these
regulations, which substantially undermined the initiatives taken by the regulatory
organizations in the region (Awartani 2005).
After 2006, the stable political situation promoted for developing a number of local
organizations within the scope of monetary regulation. One of these organizations is
the Palestinian Capital Market authority which was established in 2005 as a body to
monitor operations pertaining to securities trading in the securities exchange
market, including the underwriting process of shares and bonds. Another
organization is the Palestinian Monetary Authority, as a body to assist in the
maintenance of the stability and effectiveness of the Palestinian financial system. In
2006, PMA has published a manual for principles of corporate governance for banks
in Palestine (Abdeen 2009).
Given that the corporate governance has been introduced for less than a decade in
Palestine, many questions arise about the relation between corporate governance
and banks’ performance in the financial industry in Palestine and particularly; are
banks in Palestine committed to any of the corporate governance policies? And if
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yes, is there any relation between these policies and banks’ performance? If a
relation exists, what factors influence this relation? Does this relation differ for local
banks from foreign ones? If it is different, then in which context?
1.2 Objective:
This study seeks to assess how the adoption of corporate governance structures
affects the performance of banks in Palestine. The study aims to investigate how
corporate governance’s customs and policies affect the growth and profitability of
the banks in Palestine. The study intends to reveal the effect of the nationality of a
bank on this relation, and to explore the relation from two perspectives, for banks in
Palestine in general and then differentiates between the national banks and the
banks with foreign and regional ownerships. Finally, the study attempts to shed the
light on which of the corporate governance practises have major influences on the
banks’ performance.
1.3 Value of this study:
This study is considered one of the few that explores the corporate governance
practises for banks in Palestine. Despite the increasing awareness of the corporate
governance in Palestine, studies have so far focused on the private sector, with no
statistically significant picture of corporate governance of the banking industry
institutions. This study is intended to contribute to the understanding and
knowledge related to the level of corporate governance adoption for banks in
Palestine as it takes into account the interaction between different governance
practises and performance.
If the results of this study are taken into consideration by banks executives to be
reflected in the future strategies and policies of banks, it is expected to shield
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shareholders’ and employees’ interests, to strictly decrease the opportunistic
behaviours of the executives, and to thrive the investments and hence maximize the
profits which in turns create more job opportunities (Abdeen 2009). As this enhance
the clients’ understanding of the banking industry where quality becomes the
ground of the relationship, and drives banks to apply corporate governance
standards and principles as a major criteria of the service quality.
1.4 Scope:
The study targets the sample of all banks operating in Palestine; compromising of 22
banks, 11 of which are national banks (established and registered in Palestine), and
the rest are 11 regional banks with branches operating in Palestine (externally
established and registered in Arab countries) and one foreign bank (externally
established and registered in a foreign country). The sampled banks are 18 banks of
which the data on financial performance and corporate governance indicators were
available either through the annual financial reports or through interviews with the
management of the banks.
The model considered for this study is basically based on Generalized Least Squares
regression (GLS) between corporate governance application and the performance
variable. The idea that we try to exploit, is that firms’ specific characteristics can
influence, with governance characteristics, firms’ performance.
1.5 Structure:
The work is divided in two parts. In the first part, we present, the theoretical
framework as an introduction to the concept and indicators of corporate governance
referring to the international organizations frameworks, and considering the
governance standards for banks (Chpater2), provide an overview on the current
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status of corporate governance adoption for banks in Palestine (Chapter3), and a
revision on former studies that test the relation between corporate governance and
performance and specifically discuss the impact of different corporate governance
indicators on enhancing firms’ performance (Chapter 4).
In the second part, we explain the methodology employed for the study and present
the statistic model adopted (Chapter 5), as well as different results obtained
(Chapter 6). The remaining of the paper concludes the discussion, the
recommendations for banks in Palestine, and the implications of the results for
further research (Chapter 7).
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Chapter 2: LITERATURE REVIEW
Corporate governance can be defined in different ways; depends on the way it is
handled or discussed, but broadly it is a term refers to the rules, processes, or laws
by which businesses are operated, regulated and controlled. Corporate governance
has been exposed to a great level of discussion and interest as part of economy
efficiency and responding to high profile of scandals involving abuse of corporate
power, at the management level as well as the board intervention, by which
restrains enterprises growth.
2.1 Corporate governance concept and indicators:
OCED, Organisation for Economic Co-operation and Development, defines corporate
governance as set of relationships between a firm’s management, its board, its
shareholders and other stakeholders (OECD 2004, p.13). Corporate governance, as
OECD believes, provides a structure through which the objectives of a firm are set
and the means of attaining those objectives are determined. To ensure an efficient
corporate governance system, according to OECD, a contribution from all market
participants is required; appropriate legal regulatory system besides self-regulation,
and voluntary standards by firms, which consequently improves the transparency
and reputation of a firm, moreover, enhances investor confidence and thus
contributes to a sustainable economy efficiency and growth.
According to OCED (2004, p.13), good corporate governance should provide proper
incentives for the board and management to pursue objectives that are in the
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interests of the firm and its shareholders and should facilitate effective monitoring,
thus, the presence of an effective corporate governance system, within an individual
firm and across an economy as a whole, helps to provide a degree of confidence that
is necessary for proper functioning of a market economy. As the result, the cost of
capital is lower and firms are encouraged to use resources more efficiently, thereby,
underpinning growth.
However, what constitutes corporate governance is still a topic of debate, from a
corporation’s perspective there is a need for boards of directors to balance the
interests of shareholders with those of other stakeholders—employees, customers,
suppliers, investors, communities—in order to achieve long-term sustained value.
From a public policy perspective, corporate governance is about nurturing enterprise
while ensuring accountability in the exercise of power by firms. The role of public
policy is to provide firms with the incentives and discipline to minimize the
divergence between private and social returns and to protect the interests of
stakeholders. Iskander and Chamlou (2002) articulate what forces good corporate
governance might entail; referring to the World Bank framework (figure 1) which
reflects interplay between internal incentives and external forces.
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Figure 1: A corporate governance framework: the internal and external architecture- Adopted from Iskandar
and Chamlou, 2002.
The internal architecture defines the relationship among the key players in the
corporation (figure 1). It is a set of internal arrangements that characterize the
relationship between the shareholders and managers. That includes the way tasks
and responsibilities are assigned to various players at the firm, and major decisions
are taken, besides the hierarchal relationship between general assembly, board of
directors and executive management with the regulatory approach that controls and
organizes this relationship in a way that mitigate the conflict of interests between
the three and to protect the interests of the firm. The center of this system is the
board of directors; as it is responsibility to assure the long term viability of the firm,
and provide oversight of management. As the role of the board varies between
countries; from approving the firm’s strategies and major decisions related to hiring,
monitoring and replacing management to ensuring consistency with regulations and
laws, and being answerable to different stakeholders, shareholders, employees and
Internal External
Financial Sector
Debt
Equity
Markets
Competitive factor
Foreign direct
investment
Corporate control
Laws and regulations
Standards
Accounting
Auditing
Other
Laws and regulations
Stakeholders
Reputational agents
Accountants
lawyers
credit rating
investment
bankers
financial media
investments
advisors
research
Shareholders
Board of Directors
Management
Core functions
Monitors Reports
Operates
Regulatory Private
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in some countries for creditors; yet its main duty is to protect the firm’s interest
rather than shareholders’ interests. The governance issues that might arise within
this scope vary depending on the ownership structure. At one end is the publicly
traded firm with widely dispersed shareholders with dominating management and
the challenge to select an independent board properly to monitor management’s
performance. At the other end is the closely held firm with a controlling shareholder
and the challenge facing the outside shareholders to prevent the controlling
shareholders from extracting excess benefits.
While internal mechanisms for corporate governance regulate the relationship
between players within a firm, external forces provide a level playing field and keep
players in line (figure 1). They are notably policy, legal, regulatory, and market that
together govern the behaviour and performance of the firm. External forces create
some sort of legal framework for competition policy, the legal machinery for
enforcing shareholders’ rights, systems for accounting and auditing, a well-regulated
financial system, the bankruptcy system, and the market for corporate control.
These external indicators enhance good corporate governance, and contribute to
competitiveness of firms. Yet, there is no single model of corporate governance. It is
an overview of market structure, legal systems, traditions and cultural and societal
values; the framework may vary by country and sector and even for the same
corporation over the time, but it shapes the agility, efficiency and profitability of all
corporations.
Meanwhile, and in 1999, OECD laid a foundation for good corporate governance
practises, as well as guidance on implementation, which can be adapted to the
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specific circumstances of individual countries and regions (OECD 2004, p.17). These
principles were a subject of a review process in 2004, in which it embraces eight
principles that ensure efficient corporate governance. Noting that the principles
were developed to address a wide spectrum of governance issues arise from the
separation of ownership and control, the power of certain controlling shareholders
over minority shareholders, and other issues relevant to a firm’s decision-making
processes, such as environmental, anti-corruption or ethical concerns. OECD
articulated that corporate governance is significantly influenced by the relationships
among participants in the governance system (OECD 2004, p.15); such as controlling
shareholders, which may be individuals, family holdings, or alliances, investors who
may ask for a voice in corporate governance, individual shareholders who are highly
concerned about protecting their interests against controlling shareholders self-
dealing, creditors can serve as external monitors over corporate performance, and
employees who contribute to the long-term success and performance of the
corporation, while governments establish the overall institutional framework for
corporate governance. The roles of those participants are subject to voluntary
adaptation and market forces that in turns reflect each market’s own economic,
social, legal and cultural circumstances, and hence develop their own practices.
As the purpose of the principles is to be a reference point rather than binding rules,
the principles are evolutionary and should be reviewed in case of any change in the
market circumstances. To sustain its competitiveness, a firm should adapt its
corporate governance practices so it can meet new demands and grasp new
opportunities; equally, governments have significant role in shaping an effective
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legal framework that provide a sufficient flexibility to allow firms to respond to
expectations (Monks and Minow 2008).
The level of which firms can achieve of sound corporate governance, substantially
influence investment decisions. As mentioned earlier that good corporate
governance enhances firms’ and markets’ reputations, which in turns contribute
partially to shape the international character of investment. Subsequently,
enhanced transparency of markets increases the flows of capital which enable
companies to access financing from a much larger pool of foreign investors as well as
domestic investors which reduces the cost of capital, underpins the good functioning
of financial markets, and ultimately induces more stable sources of financing.
Therefore if countries plan for long-term patient capital, corporate government
practises must be clear, well understood and communicated among its participants
and adhere to internationally accepted principles.
According to international organizations including OECD, the corporate framework
should promote transparent and efficient markets, be consistent with the rule of law
and clearly articulate the division of responsibilities among different supervisory,
regulatory and enforcement authorities (Monks and Minow 2008). For countries to
ensure an effective corporate governance framework, it should be developed
considering its effects on overall economic performance, and incentives it creates for
market participants to attain the practises. Legal requirements of the corporate
governance practises should adhere to the rule of law, and be transparent and
enforceable. The division among different authorities of the regulatory framework of
the governance system should be clearly explained, besides allocate the resources
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that support the supervisory authorities to fulfil their duties in a professional
manner.
Furthermore, the corporate governance framework should protect and facilitate the
exercise of shareholders’ rights. Basic shareholder rights should include the right to
secure methods of ownership registration; convey or transfer shares; obtain relevant
and material information on the corporation on a timely and regular basis;
participate and vote in general shareholder meetings; elect and remove members of
the board; and share in the profits of the corporation (OECD 2004, p.20). The
framework should facilitate the shareholders’ right to be sufficiently informed on
decisions related to major corporate changes such as releasing additional assets and
any extraordinary transactions that may affect the sales of a firm. Shareholders
should be informed about the voting procedures that govern general shareholder
meeting including date, location and agenda of general meetings, with the right to
propose resolutions and adjustments to the agendas.
The framework must facilitate the effective participation by shareholders in the
nomination and election of board members. The equity component of compensation
schemes for board members and employees should be subject to shareholder
approval. Information concerning mergers and sales of substantial portion of the
firm’s assets should be disclosed to shareholders in an efficient and transparent
manner, and transactions should take place at transparent prices that guarantee the
interest of shareholders. Furthermore, the framework should guarantee the
exercise of ownership rights of all shareholders including institutional investors, and
allow shareholders to consult with each other on issues regard their basic rights.
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Additionally, the framework should ensure an equitable treatment of all
shareholders including minority and foreign shareholders (OECD 2004, p.20). That
implies that all shares should carry the same rights, all investors should be updated
on the rights attached to all series and classes of shares before they purchase,
changes in voting rights should be approved by the classes of shares. All
shareholders should have the opportunity to obtain effective redress for violation of
their rights, as well as an opportunity to protect their legal rights and voting for
major decisions. Therefore, minority shareholders should be protected from abusive
actions by the controlling shareholders and chances of self-dealing should be strictly
eliminated. Key executives and board members should disclose whether they have
an interest in any transaction or any matter that influence the firm’s value.
The role of stakeholders should be recognized as well as part of the framework,
which is established by law or through mutual agreements and encourage active co-
operation between corporations and stakeholders in creating wealth, jobs, and the
sustainability of financially sound enterprises (OECD 2004, p.24). Stakeholders
should have the opportunity to obtain effective redress for any violation of their
rights; and to have access to relevant and reliable information on timely basis. The
framework should enhance employees’ participation, and promote employees and
their representative bodies to openly and freely communicate their concerns about
illegal practises to the board.
Ultimately, the corporate governance framework should ensure disclosure and
transparency are made on all material matters regarding the corporation, including
firm objectives, major share ownership, voting rights, the financial situation,
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operational results, foreseeable risk factors, issues regarding employees and other
stakeholders, and governance structure and policies of the firm (OECD 2004, p.24).
Information and reports should be delivered in accordance with high quality
standards, besides an annual audit should be carried out by an independent and
qualified auditor to provide an external assurance that the financial statements
precisely represent the financial position and performance for the firm. Channels for
disseminating information to relevant users should offer equal and cost efficient
access.
Finally, the framework should ensure as well, the effective monitoring of
management by the board, and the board’s accountability to the firm and the
shareholders; that implies that the board should treat different shareholder groups
fairly, applying high ethical standards (OECD 2004, p.24). The board is entitled to
monitor the effective of the corporate governance practises and carry adjustments
when they are required, to ensure transparent selection and nomination of its
member, and to review all major plans, risk policy, annual budgets, and setting
performance objectives of the firm.
2.2 Corporate governance for banks:
Banks have a vital and inevitable contribution to build a solid infrastructure for the
growth of any national economy; as banks acts as financial intermediary between
those who have capital (such as investors or depositors), and those who seek capital
(such as individuals wanting a loan, or businesses wanting to grow).Besides,
commercial banks, nowadays, are the backbone of national economies as they
provide guarantees and assurance to execute huge investment national enterprises,
in addition to other basic financial services of which banks offer to a broad segment
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of the population such as bank transfers, cheques and bills collection, salaries
payment, and access to payments systems (Cornwall 2007).
Banks are different from private companies since they provide credit and liquidity
which in turns affects the demand and supply on cash and capital in the market, and
hence influence the monetary policies. Moreover, the importance of banks to
national economies is underscored by the fact that banking is virtually universally a
regulated industry and that banks have access to government safety nets.
Consequently, any instability or underperformance of the banking sectors may cause
the private sector to wane, financial system to deteriorate, and other negative
consequences on the national economy level; therefore it is significantly vital to have
effective and corporate governance at every banking organization.
Following the financial crisis, of which the world witnessed end of the twentieth
century especially Asian countries, alongside with the substantial development in
financial markets and technology; there has been a great deal of attention given to
the issue of corporate governance for banking organizations in various national and
international fora. That awareness was translated into what Bank for International
Investment (BIS) has initiated in 1999; to help ensure the adoption and
implementation of sound corporate governance practices by banking organizations
worldwide. BIS, represented by Basel Committee, issued guidance on corporate
governance for banking and financial organisations, which is drawn from the OECD
principles of corporate governance issued in earlier in the same year.
In 2005 and 2006, Basel committee revised and updated these principles, confirming
that from a bank industry perspective, corporate governance involves the manner in
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which the business and affairs of individuals’ institution are governed by their boards
of directors and senior management , affecting how banks to set objectives
(including generating economic returns to owners), to run day-to-day operations of
the business, to consider the interest of stakeholders, to align activities and
behaviours of a corporate with expectations that banks operates in a safe and sound
manner, and in compliance with applicable laws and regulations; and to protect
interest of depositors. (BIS 2006, p.6). The papers, of which Basel committee issued,
highlighted seven general practises confirming the fact that these strategies and
techniques, which are basic to sound corporate governance, should be viewed as
critical elements of any corporate governance process, as they were suggested by
supervisors based on their experience with corporate governance problems at
banking organizations and propose type of practises that could help to avoid these
problems.
The committee highlighted the fact that there are no universally correct answers to
structural these governance issues, since different structural approaches to
corporate governance exist across countries, even laws need not be consistent from
country to country, so what the paper promotes for general principles that can be
practised regardless of the form used by a banking organisation (BIS 2006, p.7). Four
important levels of oversights should be included in the organizational structure of
any bank in order to ensure sound corporate governance, which are also beneficial
to government-owned banks; oversight by the board, oversight by individuals not
involved in day-to-day activities, direct line supervision of different business
activities, risk management and audit functions.
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One of the eight practises is to ensure that board members are qualified for their
roles and positions, aware of their contribution to achieve sound corporate
governance, and are not subject of undue influence from either management or
outside concerns. As the board of directors supervises the operational and financial
soundness of the bank to satisfy shareholders expectations, an effective qualified
number of board members are more capable to develop independency and
objectivity that avoid conflict of interest, and empower the board to question
management (BIS 2006, p.9).Qualified external directors can become a substantial
source of expertise that might help banks in crisis time and bring new perspectives
from other businesses that may improve the strategic direction of the bank. For the
board to accomplish this role, regular meetings with senior management and
internal audit are substantially mandate, firstly to establish policies and secondly to
asses and monitor progress toward corporate objectives, without being involved in
day-to-day management activities of the bank.
In a number of countries, bank boards have found it of assistance to form specialized
committees that help banks to provide a close oversight to attain their objectives.
These committees are risk management committee that receives periodic
information form senior management on risk exposures and risk management
activities in the bank such as activities in managing credit, market, liquidity,
operational, legal and other risks of the bank. Another committee which is an audit
committee that provides an oversight of the bank’s internal and external auditors by
reviewing audit scope, reports and making sure that senior management is taking
appropriate corrective actions to address control weaknesses and any other
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problems triggered by the auditors. It is preferred to have external board members o
this committee with banking or financial expertise. A compensation committee that
keeps an eye on the criteria and manners for payments of senior management and
other key personnel and make sure that they are a compliant with the bank’s culture
and objectives. Lastly, is a nomination committee that regulates and controls the
process of renewing and placing board members (Kim and Nofsinger 2007).
Another practise that contributes to sound corporate governance is establishing
strategic objectives and a set of corporate values that are communicated throughout
the banking organisation (BIS 2006, p.11). The board of directors are strictly
responsible for setting the strategic direction of the ongoing activities in the bank,
and approving corporate values for itself, management team and other employees.
These values are meant to ensure the timely and open discussion of problems and
diminish corruption and bribery in internal dealings and external transactions.
To avoid the senior management overly involved in business line decision making, an
appropriate oversight by senior management is required. The board of directors
should ensure that senior managers have the prerequisite skills and knowledge to
fulfil their duties and to exercise full control over employees. As the board provides
checks and balances to the senior management, senior management should consider
line managers in specific areas, that’s the reason a key management decision should
be made by more than one person (“four eyes principle”) (BIS 2006, p.11). Senior
management consists of a core group of officers responsible for the bank such as the
chief financial officer, division heads and the chief auditor. These individuals must
have the necessary skills and appropriate control over the key individuals in these
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areas. Despite the fact that senior management is responsible for creating a
hierarchy for accountability for the staff, they are ultimately responsible to the board
for the performance of the bank.
In addition to these practises, an effective utilising of the work conducted by internal
and external auditors, does contribute to lay a solid foundation of good corporate
governance in a bank. Board of directors utilize the auditors contributions as an
independent check on the information received from management on the
operations and performance of the bank (Kim and Nofsinger 2007). The board of
directors and senior management should recognize the vital role of auditors in the
corporate governance process and communicate this throughout the bank, taking
measure to enhance the stature of auditors, and acting in regard to auditors’
findings such as timely correction by management of problems identified by
auditors.
Furthermore, the board of director should ensure that compensation approaches are
consistent with the bank’s ethical values, objectives, strategy and control
environment. Compensation of senior management and key personnel should be
aligned with the strategic direction of the bank and be consistent with the bank’s
culture and values, and not to be overly associated with short-term performance and
trading gains; that way employees will be motivated to act in the best interests of
the bank and its long-term growth (BIS 2006, p.13).
Moreover, the board of directors is inevitably required to set and enforce clear lines
of responsibility and accountability for themselves, as well as senior management,
and finally, conducting corporate governance in a transparent manner where the
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board of directors and senior management provide sufficient information on the
structure and objectives of the bank with which stakeholders and general public can
judge the effectiveness of the board and senior management in governing the bank.
(BIS 2006, p.14). So, disclosure is required and desirable on various areas of the bank
operations; board structure (size, membership criteria, qualifications, skills), senior
management structure (roles, qualifications, reporting lines), basic organizational
structure and hierarchy including incentive structure and policies and information on
any other transaction that may affect the bank value.
However, applying these principles is not a guarantee for sound corporate
governance. The Basel Committee sheds the light on the significance of providing a
supportive environment of sound corporate governance which is not merely
associated with boards and senior management of banks, but also compromised of
other parties that have ultimate contribution to enhance corporate governance such
as governments through enforcing laws and regulatory frameworks, banking industry
associations through initiatives to impose industry principles and communicate them
to the public, stock exchanges though listing requirements and disclosure, and
auditors through setting standards on delivering reports to directors and
management (BIS 2006, p.15). Bear in mind, that corporate governance can be
constantly improved through periodic review and adjustments responding to
changes within the circumstances in the market, and addressing a number of legal
issues, such as the protection of shareholder rights; clarifying governance roles; and
aligning the interests of managers, employees and shareholders. All of these can
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help promote healthy business and legal environments that support sound corporate
governance in banks (BIS 2006, p.16).
2.3 Theoretical framework:
Theoretical underpinnings for the research in corporate governance came from the
classic thesis; “The Modern Corporation and Private Property” by Berle and Means
(1932) that discusses the separation of ownership and control for large corporate in
the United States (Abor and Biekpe, 2005), in which shareholders rely on the board
of directors to stimulate action that fulfils their expectations of value maximization,
senior managers run higher level of positions with a potential possibility of
significant discretion over the corporate resources overlooking the interests of the
shareholders. The study underlined the fact that when senior management on large
companies pursue high level of personal interest of which affects the economy
efficiency and wealth distribution among different segments in the United States
(Fama and Jensen 1983).
Moreover , Berle and Means studied the importance and consequences of the
separation of ownership and control (board of directors and executive
management); as businesses grow and shareholders increase in number, any
shareholdings that directors have will be proportionally smaller capital stake,
accordingly; directors' income will derive mostly from return on their labour as
directors, not from their capital investment; therefore, a guarantee to accomplish
shareholders’ interest, is to have on board number of board members who are not
profit-seeking controlling group. These efforts have drawn emphasis on the
shareholders rights to vote in general shareholder meetings, and on ensuring the
transparency in a firm by maintaining proper bookkeeping and accounting practices
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and information disclosure which come in a compliance with the practices that the
World Bank, OECD, and other international organizations have confirmed earlier.
Since Berle and Means thesis, different theories have been discussed in explaining
the corporate governance issue. These include the agency theory, the stewardship
theory, the resources dependence theory, and the stakeholder theory.
Although former theories have contributed to the conceptual theory of governance,
Jensen and Meckling (1976) efforts have influenced the current perspective of
governance. As they articulated the agency relationship by defining the agency costs
and showing its relationship to the ‘separation and control’ issue. They define an
agency relationship as contract under which “one or more persons (principal) engage
another person (agent) to perform some service on their behalf, which involves
delegating some decision-making authority to the agent” (Jensen and Meckling 1976,
p.4). As agent will not always act in the best interests of the principal, agency
problem takes place where the agent may extract perks out of a firm’s resources and
become less interested to pursue the principal’s interests. However, the principal
can diminish or strictly limit the divergence from his interest by incurring positive
monitoring and bonding costs (non-pecuniary as well as pecuniary) and establishing
appropriate incentives.
As agency costs include expenditure of auditing, budgeting, control and
compensation systems, bonding expenditures by the agent and residual loss are due
to divergence of interests between the principal and the agent (Tricker 2009).
However, it is generally impossible to avoid some diversion between the agent’s
decisions and those decisions which would maximize the welfare of the principal.
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This provides an introduction to view the linkage between good corporate
governance and corporate performance (efficiency), where the board of directors
controls the capital invested by the principals (shareholders) and oversights the
agent (senior management).
While Agency Theory assumes that agents might be opportunistic and self- serving
(individualistic), Stewardship Theory depicts them as pro-organizational and trust
worthy (Donaldson and Davis 1991); since the aim of management is to maximize
the firm’s performance. Stewardship Theory suggests that managers are not
motivated by individual goals, but rather are stewards whose motives are aligned
with the objectives of their principals; which clearly replaces the lack of trust to
which the agency theory refers with the respect for authority and inclination to
ethical behaviour. Thus the role of the board of directors is not only limited to
oversee the performance of management of seeking the objectives of the firm, but
Principals (Shareholders)
Board of Directors
Agents (top management)
Direct and steer
Oversights and
supervises
Figure 2: Agency theory
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also to act as a cooperative party that supports the Chief Executive Director to
handle his managerial responsibilities.
While the Agency Theory emphasizes on the necessity of the separation of control
and ownership, where the chair of the board is not held by the CEO, to safeguard
shareholder interests, the Stewardship Theory provides a different insight of which
stresses on setting a structure within the firm to empower the CEO with complete
authority over the firm; which ultimately assist him to attain a superior performance.
When CEO significantly contributes to achieve superior returns to shareholders, his
identification with the firm promotes a merging of individual ego and the
corporation, thus melding individual self-esteem with corporate prestige (Tricker
2009). Thus, stewardship theory focuses not on motivation of the CEO but rather
facilitative, empowering structures, and this situation is attained more readily where
the CEO is also chair of the board. Accordingly, variation of the firm performance is
explained by whether or not the firm structure helps the executive to formulate and
implement plans for high corporate performance; but the question arises of how far
executives can achieve the good corporate performance to which they aspire.
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On the other hand, the Resources Dependence Theory lays emphasis on the fact that
the ability of a firm to protect itself against the external environment and to reduce
uncertainty can be enhanced by the non-executive directors on board (Casciaro and
Piskorski 2005). The resource role is played by board of directors mainly through
leveraging their social and professional networks, advise, legitimacy, reputation, and
channels of communications to reduce the uncertainty of outside influences to
ensure the availability of resources necessary to their survival and development
(strategic resources). The board is hence seen as one of a number of instruments
that may facilitate access to resources critical to firm success. In order to secure
these strategic resources, the firm relies on individuals and organizations within its
external environment which are called “Stakeholders”. This theory suggests that a
firm excels to maximize shareholders’ value and to satisfy stakeholders’ interests.
Therefore, the firm picks for its boards selective members “Supporters” who are
capable of investing their counsel, knowledge, and channel of communication with
Principals
Board of Directors
Management
Supports Empowers
Figure 3: Stewardship theory
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external organizations, to gain preferential access to commitments or support from
important actors outside the firm.
Similarly, Stakeholder Theory considers the main role of the board members is the
provision of resources. Accordingly, the board should comprise representatives of all
parties that are critical to a firm's success. This will result in the firm's ability to build
consensus among all critical stakeholders. That creates some sort of necessary
cohesion and mediates the conflict of interest (Tricker 2009). A mandate to
guarantee effective corporate governance is to have representations of various
stakeholders groups; customers, suppliers, employees, the national community and
shareholders are deemed to also have a stake in the business of a firm.
Drawn from the earlier discussed theories and literature, principal practises of
corporate governance for firms have been derived related to either the board
indicators including board size, board skill level, or ownership, if it is internal, family,
or foreign ownership (Abor and Biekpe 2007, p.290). In some countries, bank boards
Stakeholders (employees, lenders,
investors, customers, suppliers,
the local community and
shareholders)
Representative Board of
Directors
Management
Provision of
resources Support
Figure 4: Stakeholder theory
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have found it useful to establish number of committees to oversee various
managerial soundness of the bank. Other researchers consider indicators related to
the committees and their compositions to assess the corporate governance practises
in a firm (BIS 2006, p.7); such as Audit Committee that provides oversight of the
bank’s internal and external auditors, Nomination Committee that assess the board
effectiveness for renewing and replacing board members, and Compensation
Committee that ensures that rewards and payments of senior management and
other key personnel are compliant with the bank’s culture, objectives and control
environment. The board related indicators will be considered for assessing the
adoption of corporate governance practises of Banks in Palestine, for data
availability purposes.
There is a view that larger boards enhance the corporate governance practises,
considering the diversity of the board’s expertise which in turns enriches the
managerial decision process and strictly limits the CEO’s domination (Abor and
Biekpe 2007, p.291). Jensen (1993) argues that the effectiveness of the boards and
CEO’s support improved by decreasing the number of members on board; since for
big boards, higher level of communications and efforts for facilitation are required to
coordinate among the members on one hand, and between the boards with the CEO
on the other. As it becomes difficult to coordinate when a board gets too big, as this
often creates problems, and makes it difficult to respond timely during the crisis and
emergency time; moreover it reduces the accountability of individual directors and
increases the possibility of free riding, as for the big boards, the main role for
managing and overseeing the bank is overtaken by a group of the members, while
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the rest will not have an efficient contribution, giving them the chance to take the
advantage of the first group. Even Jensen went to strict the number of directors for
the operating companies of no more than eight people as an element of six
principles to improve a governance structure within a firm(1993, p. 869).
Another indicator that could be of an interest for researchers is to assess the
governance structure within a firm is the board composition and control. Despite the
researches have investigated this issue so far such as the study delivered by Wyatt
and Rosenstein (1990), there is no clear conclusion of whether directors should be
employees (inside directors) or outsiders. The researchers support having inside
directors, argue the fact that the inside directors are more familiar with the firm’s
activities and have the chance to advance into positions to outperform incompetent
executives which in turns enhances the firm performance. Opponents to this view,
argue that non-executive directors may act as professional referees, and stimulate
actions aligned with the firm’s objective of maximizing shareholder value as the
independency of the board increases as the proportion of their non-executive
directors increases (Abor and Biekpe 2007, p.291). Bahgat and Bolton (2006, p.7)
shed the light on the positive correlation of stock ownership of board members with
the firms performance, they articulated this correlation as “It is plausible that an
independent board or board members with appropriate stock ownership will have
the incentive to provide effective monitoring and oversight of important corporate
decisions .....; hence board independence or ownership can be a good proxy for
overall good governance” this conclusion supports what Han and Suk (1998) find
that the
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level of insider ownership is positively related to stock returns but they warn of the
the problem associated with managers' entrenchment. However, Buckland (2001)
did not find any clear correlation between the independency of the board with
agency problem or cost.
Additionally, the level of training and educational qualifications among board
members and managers has a substantial influence on the firm’s performance (Abor
and Biekpe 2007, p.291). This positive correlation is due the ability of higher
educated directors to invest their knowledge and skills to gain access to external
information, develop networks and more detailed monitoring systems, and make
use of consultants. Although higher-level management qualifications may be useful
to firms, some researchers have still some doubts as to their relevance to good
corporate performance; moreover, others went to argue that there may even be a
negative effect on firm performance as a result of the occupational and professional
affiliations of highly qualified managers which may encourage increased agency cost
and opportunistic behaviour.
Abor and Biekpe (2007, p.292) argue that effectiveness of the board to oversight the
top management is diminished by the duality of the CEO. They define CEO duality as
“concentration of decision management and decision control in one individual”. For
the systems where the CEO also acts as chairman of the board that often increases
the possibility of conflict of interest and agency problems. Fama and Jensen (1998)
considers that CEO duality limit the efficiency of the board to provide monitoring
and control over the top management; thus giving preference for the system where
the CEO’s role is separated from that of the board chairman. While other researchers
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reported that companies with CEO duality have stronger financial performance
relative to other companies.
Finally, the ownership is one of the significant indicators of governance within a firm,
including inside ownership, family business and foreign ownership. This indicator
specifically has got the attention of international organizations and researchers to
lay the foundation for corporate governance practises; bear in mind its substantial
contribution to protect the interests and rights of minority shareholders, employees
and creditors of firms.
Some researchers found that high level of board and insider ownership has a positive
effect on the performance of the firm as they are more familiar and aware of the
internal policies, operations and systems which enable them to make right and
appropriate decisions. Consequently, it reduces outside owner’s intervention to
monitor and control the behaviour of the firm’s leadership, which reduces the value
of the firm. It is often argued that family led businesses create an atmosphere of love
and commitment toward the firm, and higher level of trust and altruism that
enhance communications between employees and managers and consequently
reduces the agency cost. However, other studies indicated that managers’ tendency
to be engaged in entrenchment increases in family firms resulting in weaker
performance. While foreign ownership ensures better access to the investment
opportunities (by having large foreign institutional investors who actively monitor
the actions of management), and facilitate stronger monitoring of managers. But
some researchers agree on limiting the managers and board ownership as a high
level of insider ownership is not efficient, given that managers will pursue policies to
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their own advantage instead of aiming at innovative entrepreneurial opportunities
and shareholder value maximization (Monks and Minow 2008).
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CHAPTER 3: BANKING INDUSTRY IN PALESTINE
Lately, corporate governance has been one of the topics that acquired major
consideration in Palestine, as noticed that workshops and conferences have been
taken place to advocate organizations applying corporate governance practises.
Unfortunately, these initiatives were restrained by obstacles that substantially
undermined the value of regulatory organizations’ contributions in the region; as
Sulivan (2005), believes that corporate governance of the private sector in Palestine
is fragile; highlighting various aspects of the vulnerability of the corporate
governance structure which are briefed as follows: maintaining board members of
chambers of commerce on charge for more than fifteen years, which implies no
elections have taken place for this period of time, weakness of the hierarchal
structure of the boards and its mechanism , chaos of the legal frame in which
Palestinian companies operate as some of its regulations lacks homogeneity, besides
monopolies spread by governmental organizations as well as private institutions.
Few attempts have been initiated to overcome these obstacles and empower the
governance structure of the Palestinian firms, represented by the International
Finance Corporation (IFC) project to lay the foundation for corporate governance
principles that comport with the Palestinian law and regulatory frames; considering
the instability of the situation in Palestine; however, and after the Palestinian
election in 2006, these efforts were impeded and hindered.
On the other hand; the stable political situation followed the 2006 elections, has
enhanced other attempts formed by local organizations. Such as the project
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commenced by Palestinian Capital Market Authority (PCM) to revive the efforts of
dedicating a national committee that works on developing corporate governance
principles that suit the criticality of the Palestinian situation. The national committee
of governance has been formed which reports to the PCM; and it has on board
organizations and individuals with interest to develop a Palestinian constitution of
governance that assesses the suitability of these principles with the international
criteria for governance. The committee is still working to publish the governance
principles once they are approved by related organizations in charge.
Furthermore, the Palestinian Monetary Authority (PMA) has drafted a Corporate
Governance Code for banks to ensure that banks in Palestine adopt sound corporate
governance practises which enhance public trust and confidence in the Palestinian
banking sector, and hence ensure the proper functioning of the bank sector (PMA,
2006). PMA articulates the aim of issuing the code as follows: enhance banks
awareness of good corporate governance practise and develop some sort of
approval on the importance of applying the principles properly to gain what they are
developed for, craft a regulatory structure for banks governance complying with
legal requirements of related laws, and provide instructions and guidance for banks
on how to achieve the best commitment with the practises.
The code has been set at high standards and derived from the international best
practises of the OECD principles of 2004, Basel Committee on Banking Supervision's
paper on enhancing corporate governance for banking organizations. The code
covers two sets of rules, instructions which represent complimentary good
governance practises which are drawn up from the Banking Law of which banks are
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required to comply with, and guidelines where banks are subject to the "comply or
explain" approach with regard to; however, it is possible that the guidelines will turn
into instructions in the future.
3.1Banks in Palestine:
In 1967, Israeli authority closed all Palestinian banks operating at that time; to be
replaced by six Israeli banks with 39 branches offering their banking services in both
West Bank and Gaza (PMA, 2006 and Bank of Palestine, 2008). In 1981, Palestine
Bank won a case against the Israeli court, which enabled the bank to commence its
operations in both West Bank and Gaza strip (PMA 2006 and Bank of Palestine
2008). Following the success of the Peace Process in 1994, Palestinian National
Authority (PNA) became in charge of the bank sector in terms of issuing regulations
and related appropriate legislations. In 1995, the Palestinian Monetary Authority
was initially established by a presidential decree to be an independent body to assist
in the maintenance of the stability and effectiveness of the Palestinian financial
system, and later by an act of the Palestine Legislative Council PMA Law Number (2)
of 1997 which outlined the full authority and autonomy of the PMA. PMA was
formed to deliver responsibilities listed within Paris Economic Protocol (PMA, 2006)
of licensing and regulating financial institutions and overseeing a payment system.
Since then, the number of operating banks in Palestine, especially national banks,
has increased gradually, from only two operating banks with nine branches, which
are Bank of Palestine P.L.C and Cairo Amman bank.
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Bank Industry in Palestine nowadays, compromises of Palestinian commercial banks
and foreign commercial banks that have branches in Palestine, and Palestinian
Monetary Authority that plays substantial supervisory role on banks (look appendix
A). There are 22 banks operating in Palestine till 2009, eleven are with foreign and
regional ownership (non Palestinian ownership) as follows:
Eight Jordanian banks including Arab Bank, Cairo Amman Bank, Jordan Bank,
Jordan Commercial Bank, Jordan Ahli Bank, Housing Bank, Jordan Kuwaiti
Bank, and Union bank for Saving.
Two Egyptian banks: Egyptian Arab Land Bank, and Principal Bank for
Development and Agricultural Credit
One foreign bank which HSBC Middle East
National banks are eleven: Bank of Palestine (PLC), Commercial Bank of
Palestine, Palestinian Investment Bank, Arab Islamic Bank, Al Quds Bank for
Development and Investment, Palestine Arab Investment Bank, Palestine
International Bank, Palestinian Islamic Bank, Al Aqsa Islamic bank, The
Palestinian Banking Corporation (PBC), and Raffah Bank.
Figure 5 shows the current banking industry in Palestine.
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The branches of the national banks represent 52.5% of the total branches in
Palestine, while the branches of the banks with regional (Arab) and foreign
ownership count for 47.5%, table 1 shows the branches for all banks
operating in Palestine:
National banks Number of
branches
Regional and foreign ownership Number of
branches
Bank of Palestine (PLC) 28 Arab Bank 23
Commercial Bank of Palestine 5 Cairo Amman Bank 16
Palestinian Investment Bank 9 Jordan Bank 8
Arab Islamic Bank 8 Jordan Commercial Bank 3
Al Quds Bank for
Development and Investment
11 Jordan Ahli Bank 5
Palestine Arab Investment
Bank
Housing Bank 7
Palestine International Bank 4 Jordan Kuwaiti Bank 2
Palestinian Islamic Bank 11 Union bank for Saving 1
Al Aqsa Islamic bank 2 Egyptian Arab Land Bank 7
The Palestinian Banking
Corporation (PBC)
2 Principal Bank for Development
and Agricultural Credit
1
Raffah Bank 2 HSBC Middle East 1
Table 1: branches of both national, regional (Arab) and foreign banks operating in Palestine- (PMA, 2006)
Banking Industry in Palestine
National Banks
Figure 5: Banking Industry in Palestine nowadays.
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Figure 6 shows the increase in the number of the banks operating in
Palestine between 2001 and 2007:
Figure 7 and table 2 demonstrate the increase in the number of the branches
of those banks, and it is clear that the number of branches of national banks
has increased and become more than the branches of the regional and
foreign banks after the year 2005.
2001 2002 2003 2004 2005 2006 2007
National Banks 58 59 60 62 71 79 85
Jordanian Banks 59 59 64 64 61 65 68
Egyptian Banks 8 8 8 8 8 8 8
Foreign Banks 1 1 1 1 1 1 1
All Banks 126 127 132 135 141 152 162
Table 2 Increase in the number of branches during 2001-2007- (PMA, 2006)
The boost up in the number of banks operating in
Palestine
National
Jordanian
Egyptian
Foreign
Figure 6: The boost up in the number of banks operating in Palestine- (PMA, 2006)
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Finally, table 3 illustrates some information related to some banks operating
in Palestine; noting that for regional and foreign banks, the year of
establishment point out the year of which the first branch was opened in
Palestine:
Year of establishment
Size of Asset
Debt ratio
Number of board members
CEO duality
Bank of Palestine (PLC)
1960 8.63 .91 11 yes
Commercial Bank of Palestine 1994 7.63 .82 13 No
Palestinian Investment Bank 1995 8.17 .73 11 Yes
Arab Islamic Bank 1995 8.34 .85 9 No
Al Quds Bank for Development and Investment
1995 8.02 .66 11 No
Palestine Arab Investment Bank 1996 7.15 .036 8 Yes
Al Aqsa Islamic bank 1997 8.17 .44 8 No
Arab Bank 1930/1994 10.3 .83 11 Yes
Cairo Amman Bank 1960/1994 9.08 .88 11 Yes
Jordan Bank 1960/1994 9.14 .89 11 No
Jordan Commercial Bank 1977/1994 8.71 .85 7 Yes
Jordan Ahli Bank 1955/1995 9.24 .88 13 Yes
National
Jordanian
Egyptian
Foreign
The boost up in the number of banks operating in
Palestine
Figure 7: The increase in the number of branches of banks operating in Palestine
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Housing Bank 1974/1995 9.61 .79 12 No
Jordan Kuwaiti Bank 1976/1995 9.07 .88 9 Yes
Union bank for Saving 1979/1995 8.95 .89 11 Yes
Egyptian Arab Land Bank 1947/1994 9.45 .98 6 No
Principal Bank for Development
and Agricultural Credit
1930/1996 9.41 .91 14 No
HSBC Middle East 1946/1998 7.25 .93 9 Yes
Table 3: Information related to banks operating in Palestine
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CHAPTER 4: FORMER STUDIES
The relationships between measures of corporate governance and organization
performance have been the interest of many researchers over the time, whether
organizations are firms or banks, paying more attention to study the internal
dimensions of corporate governance, and not considering the sectors in which firms
operate. In fact, corporate governance practises are always associated with big
businesses, because of the necessity to separate the ownership from control body;
bearing in mind that increasing firm size induces firms to set up more articulated
governance structures. While small firms were out of the scope for most of the
studies on corporate governance, assuming that corporate governance practises are
not applicable to the small firms; considering the number of employees and
shareholders – which influences their unity and commitment and then the level of
pressure that they can exert on the board to meet their interests- and most of these
firms are family-owned businesses or managed by one of the owners. Therefore;
small firms are often assumed not to be complex enough to raise corporate
governance issues. While some researchers believe that corporate governance
practises should be applied equally and in the same manners regardless of the firm
size.
Montemerlo (et al. 2008) in his study on corporate governance for SMEs (small to
medium-sized enterprises) in Italy, pointed out that small and medium sized
enterprises are traditionally assumed to eliminate agency costs because of the fact
that relations in family businesses are based on kinship, blood, sentiment, trust and
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altruism; since it counter-balances opportunistic behaviour; however, family nature
can bring about special agency costs due to the inconsistency between family and
executives’ goals, lacking market discipline, executives self-control for managerial
decisions, and adverse selection as a result of lacking the appropriate experience and
qualification which are mandatory to evaluate market options and opportunities.
These results explored by Montemerlo’s study leads to assume that firms of various
sizes incur different level of agency threats whether it is because of the agent or
because of the family ownership concentration in a firm; but as the more firms
become complex in size and ownership structure, the more it is necessary to
delegate tasks to agents (directors and managers) at various level, and the more
governance structure need to be articulated accordingly in order to keep agents
motivated.
The existing framework of governance in banks is defined by dimensions categorized
into two sets: variables related to the management including size of the board of
directors, hierarchy of the board, qualifications of the board members, qualifications
of the executive management and duality of the CEO, and the second set of variables
which are related to the ownership concentration compromised of internal
ownership, family ownership, and foreign ownership. Some researchers consider a
number of controlling variables for their studies of the relation between
performance and firm’s level of application of governance practises such as debt
ratio, size and age of the firm. Controlling variables are subject to be included as part
of the studies, to secure some sort of steadiness and reliability of the model and
eliminate the implication of debt ratio, size and age on the relation between
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governance and performance. Figure 8 shows the variables considered for corporate
governance studies.
Abor and Biekpe (2007) studied how the adoption of corporate governance structure
affects the performance of SMEs in Ghana. The study sampled 120 firms with less
than hundred employees in both the industrial and services sectors during a six-year
period, 1998-2003. The data used in the analysis was obtained from the financial
statements of SMEs and through interviews from the management of the firms. This
study seeks to examine the effects of corporate governance, and the ownership
structure on the performance of the firms. Return on assets (ROA) is used as a
measure of performance, and it is calculated by dividing profit before interest and
taxes by total assets. The independent variables tested to assess the corporate
governance practises compromise of variables related to ownership (inside
shareholding, family ownership, and foreign ownership), variables related to the
board and management structure (board Size, board composition, board skill,
management skill), and the existence of CEO duality in these firms. Other variables
were included as controlling variables to ensure the robustness of the model, and to
minimize specification bias and generalize results for banks and financial institutions
Governance
Ownership
Management
and board of
directors
Controlling
variables
board of
directors
Figure 8: Variables considered for governance studies
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internally and externally. These controlling variables include size, age, and debt ratio.
The methodology used is the regression analysis based on the results of Generalized
Least Squares (GLS) to analyze the cross sectional of the data gathered on banks over
the period between 1998 and 2003. The results show that board size has a significant
positive correlation with governance; as firms with larger boards perform relatively
better compared to very small boards; which is articulated by the variety of expertise
that the larger broads bring out to make better decisions. Results prove that the
level of training among board members and mangers could have a strong influence
on the performance of the firm. The results of this study indicate a statistically
positive relationship between CEO duality and firm performance; 86%of the firms
have been sampled for this study were with CEO duality which means that
combining the roles of both the CEO and board chairman demonstrate better
performance than those with two individuals performing such roles. Inside
shareholding, family business and foreign ownership had positive impact on
performance which they explained by CEO duality, and the fact that managers who
are shareholders seem to understand the business better, to have good knowledge
and appreciation of the operations of the firms, and are often in the position to take
decisions that are in the interest of maximizing shareholder value instead of
engaging in opportunistic behaviour. Moreover, family ownership creates an
atmosphere of love and commitment necessary for better performance. The model
shows a negative relationship between size, age, and performance. As firms get
larger, the agency cost increases and firms’ focus directed to manage day-to-day
issues; and that is why relatively smaller firms perform better than relatively bigger
firms. The study suggests that older firms are more likelihood to record higher
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profits as they get more experience to run operational and managerial issues with
efficiency, and invest in their long-term relations with customers and hence improve
quality of services offered. The results also indicate a negative association between
debt ratio and firm performance; as the debt ration increases, it reduces the returns
that can be invested in broadening the firms’ activities; and that’s why SMEs with
less debt in their capital structure appear to perform better than those that pursue
high debt policy.
Kahiri with others (Kahiri et al. 2007) studied the association between the efficiency
of governance practises and performance of 320 American over the period between
1994 and 2001. The sample is extracted from Fortune 500, which includes mainly
large firms. The firms operate in eleven different sectors; 17.5% in service sector,
17.8% in the production sector, 15.62% in roughly and detailed sales, 12.5% in
consumption services, 10.625% in technology sector, 6.25 in energy sector, and the
rest operate in financial sector, health, paper and publication, chemistry and
transport. The methodology used is the Stochastic Frontier Analysis that integrates
the variables to calculate a governance efficiency index of the sample- and on the
managerial efficiency-, based on different governance mechanisms. The idea that
the study seeks to exploit from the model adopted to compute the indexes, is that
firms’ specific characteristics can influence, with governance characteristics, firms’
performance. For this study, profitability is used as an indication on the
performance, which is measured by return on equity (ROE) and Tobin’sQ. The
governance elements considered for this study composed of independent variables
related to ownership structure (executive ownership, major shareholders ownership
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level, executive ownership level, and CEO ownership level), board of director
structure(board of directors size, number of independent and foreign members, and
CEO duality), and audit committee structure (internal auditing committee,
compensation committee and nomination committee). The controlling variables
examined by the study are firm size, debt ratio, and dividend yield. Results of the
study are in consistent with governance principles, as results show a positive impact
of board size, number of independent and foreign members on board, number of
periodic meetings have positive impact on performance, while CEO duality has a
negative relation with performance. All forms of ownership are negatively linked
with performance; meaning that ownership concentration implies control in hands
of few members. Meanwhile, internal auditing committee has a positive relation
with performance in terms of number of member, number of annual meetings,
number of members with finance degrees and qualifications, and number of
independent members. Other committees, compensation and nomination, have the
same positive relation with performance. However, the existence of the CEO on one
of the two committees has a negative impact on performance as it decreases the
profitability of the firm, which is consistent as well with the institutional governance
principles that mobilizes for the independency of the supervisory committees within
a firm to secure the minor shareholders’ interest against opportunistic behaviour of
the CEO and major shareholders.
While the study that Shaheen and Nishat (2004) delivered on Karachi Stock
Exchange, by creating a summary index “Gov-Score” as an indicator on governance
practices followed by the sampled firms. The data was collected for 226 individual
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firms in 2004, through a questionnaire containing 37 factors as either 1 or 0
indicating whether or not the firm’s governance standards are applied, then sum
each firm’s binary variables to derive the Gov-Score. The questionnaire covered
seven corporate governance categories; audit committee, board of directors, CEO
education, executive and director compensation, ownership, and progressive
practices during the year 2004 of membership duration of board members, oversight
on CEO performance, and internal system(charter) and rules that regulate voting
proportion, representation and firm’s capacity to issue preferred stock. The study
considers five performance measures spread across three categories: operating
performance, valuation and shareholder payout. The measures on performance are
return on equity (ROE), profit margin and sales growth, Tobin’s Q, and a single
measure on valuation and shareholder pay out which is dividend yield. The
methodology triggers the correlation between Gov-Score and firm performance’s
indicators using Pearson and Spearman Correlations. The study results prove that
compensation of executive and director is positively correlated with net profit
margin and sales growth, while progressive practices and ownership are positively
correlated with the five performance measures and statistically significant. The
results demonstrate that the internal ownership of the sampled firms is positively
correlated with the five performance measures, and the number of independent
directors has significant positive correlation with ROE. The study indicates that the
governance categories related to audit and board of directors are highly associated
with good performance with no clear evidence on the governance categories related
to director’s education and charter on good performance.
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In Palestine, very few studies were conducted concerning corporate governance; one
of them was delivered by Abdelkarim & Alawneh (2007). The study sampled the
most sixteen trading firms at PSE between 2005 and 2006. They relate corporate
governance and performance for the selected firms by considering ownership
concentration as one of governance dimensions, which is defined by the ownership
of top 5% shareholders, and Tobin’s Q as an indicator on performance. Control
variables are considered including annual sales revenue which is considered as an
indicator on the firm size, debt ratio, and the growth of net income. The study
triggers a negative impact of ownership concentration on the market value for the
firms mainly for the year 2006, which in turns weakens the corporate governance
and market efficiency all over. The results show a positive impact of firm size and
sales return on the firm performance, while growth of the net income has negative
relation with performance. Abdelkarim and Alawneh reported that Palestinian listed
companies have ownership concentration that affects information disclosure and
transparency that have an inverse impact on governance.
Finally, Brown and Caylor (2004), created an index of governance composed of 1868
firms for the year of 2003. The index is composite of 51 of governance practises that
are provided by Institutional Shareholder Services. As some previous studies, Tobin’s
Q is used as an indicator on performance for this study; while the 8 variables
encompassed on governance are : audit, board of directors, charter/bylaws, director
education, executive and director compensation, ownership, progressive practices,
membership duration of board members, oversight on CEO performance, rules that
regulate voting proportion and representation, shareholders’ right, firm’s capacity to
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issue preferred stocks, and state of incorporation. It is found that there is no
correlation between audit committees independence (CEO serves on none of the
committees) and performance. The results show that there is a positive impact of
board in terms of education, number of periodic meetings on commitment level of
directors with ownership criteria declared by the ISS. It is found that there is no
strong association between directors’ gaining an advanced managerial training (at
least one) and performance. Firm size and age were considered as controlling
variables.
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CHAPTER 5: METHODOLGY
This chapter includes the description of the sampled banks, the ways data was
collected, and the model used for the analysis.
5.1 Sample description:
The study considers all banks operating in Palestine whether they are national banks
(local ownership), Arab banks (Jordanian and Egyptian), or foreign bank. Currently,
22 banks operating in the Palestinian Occupied Territories (West Bank and Gaza
Strip). The study explores a sample of 18 banks out of the 22 banks (population
sample).
5.2 Data collection:
The variables examined by the analysis model (described later in this chapter)
compromised of financial variables and non financial variables. The data for financial
variables (related to performance) was drawn from financial annual reports which
are announced by some banks either through banks publications or through the
online databases at BankScope. While the data on non financial aspects of corporate
governance such as ownership concentration, board, and management related
variables, was collected directly from authorized representative parties of the
sampled banks, in case they are not available through earlier mentioned methods.
The period considered for the study is from 2001 till 2006, since during this period,
banks in Palestine started to give more attention to apply corporate governance
principles (Abdeen 2009). This consciousness was translated into different aspects; a
number of the banks included a separate section within their annual publications
and promotional materials on achievements and progress have been accomplished
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so far for that year. Besides, financial information for some banks for the years apart
from the considered period was not obtainable.
Four banks were exempted from the sample for various reasons; Raffah Bank as it is
established in 2006, and consequently the bank has no available data to be
considered for the study. The Palestinian Banking Corporation was excluded since
this financial institution is more a credit agency which is specialized in lending
Palestinian small and medium sized enterprises (SMEs) under funding agreements
(Palestinian Monetary authority, 2006).
Palestine International Bank (PIB) was not considered for the sample; since the bank
was seized by Palestinian Monetary Authority (PMA) in 2005 as a result of serious
legal loopholes in managing the PIB, which erupted following alleged administrative
irregularities by PIB top management (Center for Private Sector Development –
CPSD, 2006). PMA took the charge of running the PIB operations through a
committee that took over the role of the PIB board. PIB was prohibited from trading
its stocks at Palestinian Stock Exchange (PSE) in 2005. Besides, the bank
management and PMA were not cooperative to disclose the required data for the
study. Finally, Palestinian Islamic Bank was not included for the sampled banks,
because of the inability to gain the related data through both direct and indirect
sources.
Data for banks either with regional(Arab) or foreign ownership were drawn without
separating their branches operating in or out of Palestine; based on the assumption
that branches operating in Palestine follow the norms and rules set by the
headquarter of those banks, which is confirmed by the procedures and
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arrangements that the local branches follow; moreover, those banks announce their
financial reports and other related information for the bank in general and without
distinguishing local branches from branches abroad.
5.3 Model presentation:
This paper follows the tradition of empirical work in corporate governance by
examining the performance of the firm in the form of regression analysis. The
regression model used is the Generalized Least Squares regression (GLS) between
corporate governance variables and profit (performance) variable by applying Panel
Regression Model which merges cross sectional data over time series in one model;
which helps to get results that cannot be shown by using only part of the data.
The idea I try to exploit, from the model adopted, is that governance characteristics
can influence, with firms’ specific characteristics, firms’ performance. A firm
performance can be measured using different indicators such as profitability,
efficiency, effectiveness, employment capacity and others, while the profitability is
used as an indicator on performance which is measured by return on assets (ROA).
ROA is calculated by dividing the net income (before the deduction of interest and
tax) by total average assets. This indicator was selected as it shows how profitable a
company is relative to its total assets, and it gives an indication on how well a firm is
able to transfer the invested capitals into financial revenues. ROA is considered as
well as a pointer on the performance of the firm’s internal management as it
includes investors’ equity and drawings. Besides; the availability of the data for
calculating this indicator for the sampled banks.
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The definition of corporate governance depends on one’s purposes; it varies from a
broad definition backed with authority to a narrowed one concerning protecting
minor shareholders and stakeholders interest (Gill 2002). The definition explored by
this study encapsulated of how well a bank is managed and the level of compliance
with international standards discussed earlier; that is why the following aspects were
investigated; board related variables and ownership concentration variables. The
board related variables are size of the board, hierarchy of the board, qualifications of
the board members, and duality of CEO. Variables related to the ownership
concentration are internal ownership, family ownership and foreign ownership. The
way each variable is measured, described below:
Variable Measures
Board size Measured by the number of the members
Hierarchy of the board Measured by the percentage of the non executives on
the board
Qualifications of the board members Measured by the number of members with higher
education/qualifications
Duality of the CEO Takes two variables:
i. 1- if the CEO is the chairman ii. 0- if not.
Internal ownership Measured by the allowances owned or directed by CEO
and employees
Family ownership Takes two values:
i. 1- If more than 50% of the bank is owned or managed by a family or number of families
ii. 0- if not. Foreign ownership Takes two values:
i. 1- If the bank has an Arab or foreign ownership ii. 0- if it is a national bank(locally established
and registered)
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The variable of hierarchy of the board is measured by the percentage of the board
members that do not hold any executive managerial position, which in turns keep
the board members more disciplined and focused on their supervisory role on the
top management of the bank. Duality of the CEO is set to 1 in case that the CEO
takes the role of the chairman of the board during the period of time considered for
the study. The sample shows that the membership of the boards for the sampled
banks did not expire during the time frame considered for the study, highlighting
that the membership of the boards does expired by end of the year and not during
the year. For the family ownership variable, is considered 1 if the majority of the
bank (more than 50%) is owned or managed by a family or group of families.
To assure the reliability of the analysis model and to extend its explanatory aptitude,
three controlling variables to be considered; firm size, firm age and debt ratio. The
variables are measured as described below:
Variable Measures
Firm size Measured by assets in logarithms
Firm age Measured by number of years since the
bank is established to the year of
considering the sample
Debt ratio Measured by debt to capital ratio
Noting that those three controlling variables were chosen following the tradition of
the models examining the performance of the firm in general. As it is expected to
have results similar to the previous studies; firm size and debt ratio are negatively
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correlated with the performance, while firm age has a positive influence on the
performance.
The model used is:
Where:
: Variable of bank performance
: Constant and has specific value for each bank.
: Vector represents board related variables
: Vector represents ownership related variables
: controlling variables
: error term or disturbance
As other panel regression models, it is expected to be a subject to Hetroscedasticity,
which will be tested by calculating White Hetroscedasticity-Consistent Standard
Errors and Covariances.
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CHAPTER 6: RESULTS AND DISCUSSION
This chapter includes two sections, the first presents a discussion of the results of
descriptive analysis of the data collected (variables), and the second expounds the
statistical analysis result of the proposed model.
6.1 Descriptive analysis of the data:
Table (4) shows the descriptive analysis of all variables considered for the applied
model. It illustrates that the average of returns on assets (ROA) for the sampled
banks is 1.2%. While the average number of board members is 10, 92% of which do
not occupy executive managerial positions, and 78% of the members has higher
education degrees. 58% of the CEOs perform as board chairman. 12% of the total
shares are owned by CEOs and executives. 28% of the banks are family-owned banks
and 67% of the banks operating in Palestine are with foreign ownership. For the
sample, the average of the assets is 330 million Jordanian dinars, average age is 40
years and average debt ratio is 84%.
lowest value highest
value
Mean Standard
Deviation
Return on assets -4.42 17.58 1.2106 2.0983
Board size 6 13 10.241 2.0087
Board hierarchy .778 1 .9244 .06856
Qualifications of the board
members
6 13 10.167 1.931
CEO duality 0 1 .5833 .4953
Internal ownership 0 .52 .1203 .1561
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Family ownership 0 1 .2778 .4499
Foreign ownership 0 1 .6667 .4736
Firm size/ bank 6.65 10.266 8.5189 .8349
(4.5 Million
JD)
(18 Million
JD)
(230 Million
JD)
Firm Age/ bank 4 126 40.556 34.8665
Debt ratio .031 1.143 .8368 .20151
Table 4: Descriptive analysis of all variables (governance and controlling variables)
The average of the variables for banks operating in Palestine are shown in table 5;
separating banks with foreign ownership and others with national Palestinian
ownership; for national banks the average of return on assets (ROA) is 1.26%
whereas for foreign banks is 1.18%. 48% of the CEOs in national banks perform as
board chairman, 65% of the foreign banks is with CEO duality. The internal
ownership by management and board varies between .54% for foreign banks and
22% for national banks; whilst 29% of the national banks are family-owned, and 25%
of the foreign banks are with family-ownership. The average of the assets is 76
million Jordanian dinars for national banks and 844 million Jordanian dinars, and
debt ratio for national banks is lower compared to the foreign banks with 71%, and
91% respectively.
Mean for national banks Mean for foreign banks
Return on assets 1.2616 1.1781
Board size 10.19 10.27
Board hierarchy .9373 .9171
Qualifications of the board members 10.29 10.09
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CEO duality .48 .65
Internal ownership .22387 .05431
Family ownership .29 .27
Foreign ownership 0 1
Firm size/ bank 7.8786 8.9264
(76 Million JD) (844 Million JD)
Firm Age/ bank 13.45 57.8
Debt ratio .71441 .91473
Table 5: Descriptive analysis of variables for national and foreign banks.
Noticed from table 5 that the average of returns on assets for national and foreign
banks are significantly close, the variance between both averages was tested by
Independent Samples t-test, and table 6 reveals that the return on assets varies for
national banks, with no statistical significance, since the significance level (sig 2-
tailed) is larger than 5%.
Table 6: Independent Samples t-test of the ROA
Besides, table 5 shows that the average of board members is 10 for both national
and foreign banks, with roughly similar averages of ROA for both categories. The
belief that the performance improves as the board has more than 10 members can
be supported by the results shown in table 7; as the profitability (ROA) of banks with
boards composes of more than 10 members is 18% higher than the profitability of
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banks with boards of less than 10 members, and that applies for national banks,
foreign banks (including regional banks), and all banks operating in Palestine.
Banks with board of more than 10
members
Banks with board of less than 10
members
ROA for all sampled
banks
1.3 1.1
ROA for national banks 1.4 1.05
ROA for foreign banks 1.2 1.1
Table 7: Relationship between board size and ROA
The average of independent board members (hierarchy of the board) as results
illustrated in table 4 is 92%, with average of ten members per each board; which
implies that each board has 9 independent members. To investigate the relationship
between the hierarchy and the return on assets (ROA), table 8 illustrates that as the
percentage of the independent members increases (less executive members) the
return on assets decreases and that applies for national banks, foreign banks
(including regional banks), and all banks operating in Palestine.
Banks with board of 90%or more
of independent members
Banks with board of less than 90% of
independent members
ROA for all sampled
banks
1.15 1.35
ROA for national
banks
1.12 1.54
ROA for foreign banks 1.16 1.22
Table 8: Relationship between board hierarchy and ROA
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As mentioned earlier, 62%of banks in Palestine has CEO duality (table 4), as 7 banks
of the sample have CEOs who perform as the board chairman, 10 banks with two
individuals performing such roles during the time frame considered for the study,
and 1 bank had one person combining the roles of both the CEO and board chairman
for only 2 years of the years considered for the study. Table 9 demonstrates a
positive relationship between the duality of the CEO and the return on assets; as
ROA improves with duality of CEO, and decreases for banks that do have two
individuals for CEO and board chairman. That supports the belief that when a CEO
performs as a board chairman, he has a greater opportunity to positively intervene
with the board supervisory and directing role to which the board is entailed; by
applying his experience of managing the bank internal operations, and his skills to
draw the major plans of the bank.
Banks with CEO duality Banks where CEO does not perform as
Chairman
Total
number
Mean of the ROA Total Number Mean of the ROA
ROA for all sampled
banks
7 1.6 10 .64
ROA for national banks 3 2.2 4 .41
ROA for foreign banks 4 1.35 6 .86
Table 9: Relationship between CEO duality and ROA
To examine how does the internal ownership influence the performance of banks
operating in Palestine, table 10 shows the return on assets for banks with less or
more than 12% internal ownership (average of internal ownership of all banks
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operating in Palestine-table 1), revealing that return on asset increases as the
proportion of the shares owned by management and the firm employees increases.
Banks with internal ownership
of 12% or more
Banks with board of internal ownership
less than 12%
ROA for all sampled
banks
1.44 1.12
ROA for national
banks
1.4 1.05
ROA for foreign banks 1.5 1.14
Table 10: Relationship between internal ownership and ROA
Similarly; table 11 illustrates the return on assets for banks with less or more than
28% of family ownership (average of the family ownership for banks operating in
Palestine- table 4); showing a positive relationship between family ownership and
return on assets, ROA improves as more shares owned by a family or group of
families, and this applies for both national and foreign banks (regional included)
operating in Palestine.
Banks with family ownership of
28% or more
Banks with board of family ownership
less than 28%
ROA for all sampled
banks
1.46 1.12
ROA for national
banks
1.85 1.03
ROA for foreign
banks
1.2 1.17
Table 11: Relationship between family ownership and ROA
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However, size of the banks (measured by the assets) operating in Palestine is not of
similar influence on the performance for national, foreign, and all banks. The
average calculated for the size of the sampled banks is 330million Jordanian dinars
(table 4), table 12 reveals that return on asset for banks with less than or more that
the average is nearly the same which is 1.2, while the size of the banks has a
negative influence on return on assets for foreign banks (regional banks included),
and positive one on national banks. Similarity of the return on assets for all banks
can be explained by the rounding of the data entries and calculated averages. While
statistical and GLS analysis results contrast the expectations of the positive
correlation; which may result from the fact that the average size of the national
banks is significantly less than the average size of the foreign banks with 76 million
Jordanian dinars and 844 million Jordanian dinars respectively. Bearing in mind that
the average size of the national banks is radically less than the average size of all
banks, the relationship between ROA and the size for national bank stays positive as
the operating expenses are relatively little (the cost of generating the revenue is
comparatively little to the revenues generated), consequently when the operating
expenses increase, the net income decreases yield to lower ROA and then the
relationship turns to be negative.
Banks with assets of 330 M or
more
Banks with assets of less than
330 M
ROA for all sampled banks 1.2130 1.2079
ROA for national banks 2.85 1.18
ROA for foreign banks 1.15 1.3
Table 12: Relationship between bank size and ROA
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Results show that the average age of all sampled banks is 41 years, with 13.5 years
for national banks and 58 years for foreign banks (including regional banks), table 13
presents the returns on assets for banks with average age below and over 41 years
old.
All banks national banks Foreign banks
Total
number
Mean of the
ROA
Total
number
Mean of
the ROA
Total number Mean of
the ROA
Banks with age of
41 years or less
13 1.34 7 1.26 6 1.5
Banks with age of
more than 41
years
5 .88 0 0 5 .99
Table 13: Relationship between bank age and ROA
when the Egyptian Arab Land Bank is excluded from the sample; which is a
government bank that is established 121 years ago (category of over than 41 years),
because of its relatively less performance compared to the sampled banks during the
time considered for the study, the results of table 13 become consistent with the
GLS results with an average of 1.42 for the return on asset.
For national banks, comparing the return on assets for banks aged less than the
average to the ones aged more than the average, shows a positive influence for age
on performance, as the return on assets improves as the age increases, which is
explained by the accumulative experience and customer database a bank gains over
years. Look at table 14 below.
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National banks with age of 13.5
years or more
National banks with age of less
than 13.5 years
ROA for national banks 1.587 1.207
Table 14: Relationship between bank age and ROA for national banks
Finally, the debt ratio of all banks operating in Palestine is 84%, with 71% and 91%
for national banks and foreign banks correspondingly. As banks tend to gain
revenues and profits on granted loans higher than the interest paid to depositors;
therefore, when banks are not able to achieve higher returns on loans to the interest
paid to depositors, banks to raise fund by borrowing money from different financial
institutions and qualified banks which incurs higher debt ratios, less profits, and may
affect banks financial ability to pay the entailed interest payments in case of
customers not paying loan payments or paying late. Additionally, in such situation,
the central bank or the monetary authority asks for higher reserve rate from the
bank, which decreases the available financial resources that can be invested to
increase the bank profits and revenues. Table 15 shows the influence of debt ratio
on the performance of national, foreign, and all banks operating in Palestine.
Mean of ROA for all
sampled banks
Mean of ROA for
national banks
Mean of ROA for all
foreign banks
Banks with debt of
83% or more
1.01 .962 1.03
Banks with debt of
less than 83%
1.8 1.5 2.99
Table 15: Relationship between debt and ROA
6.2 Statistical analysis of the data:
The statistical analysis method adopted for this study is the GLS to examine how the
adoption of sound corporate governance principles affects the performance of banks
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in Palestine. Table 16 shows the general results for the egression model applied. The
results reveals that the coefficient of determination (R-squared) is .42, which is
interpreted as that 42% of the variations in the performance of a bank (dependent
variable), which is measured by ROA, can be explained by variation in the
independent variables considered for the model. This result can be considered
relatively good compared to former studies; as it was 39% for Abor and Biekpe
(2007). F-test indicates how much our model fits the population from which the data
were sampled (significance of the model), as the probability of the F-test in our
model is 0; less than 5% which is the significance level considered conventionally by
many mathematicians and researchers.
Table 16: Results of regression model analysis
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The print out shows the p values for the independents variables (last column);
indicating whether a relationship has a statistical significance. It is noticed that
Family Ownership and Firm Age have no statistical significance as p values of their t-
Statistics are .07 and .1 respectively, which are greater than 5%.
The table indicates positive sign for coefficients for the variables: Board Size, CEO
Duality, Inside Ownership, Foreign Ownership, and Firm Age, while it is negative for
the rest of the independent variables; Board composition, Board Skill, Family
Ownership, Firm Size, and Debt Ratio. Noting that the sign of the coefficient
interprets whether the relationship between the independent variables and the
dependent one is negative or positive, as the positive sign indicates positive
relationship and the negative sign indicates a negative relationship.
The results of the model illustrate that the board size has a positive and significant
influence on the performance; which confirms the belief that larger boards have a
greater possibility to attain a relatively better performance for the firm compared to
smaller boards. This result supports the assumption that larger boards have a wider
range of skills and expertise that can be invested to make better decisions.
Moreover, the firm benefits from the members’ networks to develop more solid
association with customers and to gain access to external information which
enhance the firm to expand its exposure, extend its customer base, and to gain
better access to investment opportunities. This finding is consistent with results of
previous empirical studies (Abor and Biekpe, 2007). The coefficient value for this
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variable is .96 which indicates that an increase in the board size by 1 lead to an
increase in ROA by 96%.
While the coefficient of the board composition is -2; an increase in the non executive
members by 1% decreases the ROA by 2%, therefore the portion of the board
members that does not occupy managerial positions within the firm has a negative
significant influence on the ROA. This result is consistent with the results of Buckland
(2001) and Khiari et al (2007), but it contradicts with what have been proved by
Shaheen and Nishat (2004) and Abor and Biekpe (2007). This result supports the
thought that executive board members contributes to enhance the firm
effectiveness as they do understand the business better, and have good knowledge
and appreciation of the operations of the firms which in turns enlighten the board to
make better decisions that are in the interest of the firm and hence uplift the firm
productivity.
The regression results point out a negative relationship with a statistical significance
of the educational level of the board members on the performance; as having one
more member with higher education causes a drop off in the ROA by 93%. This
result is shown for the analysis of all sampled banks and for foreign banks, but with
no statistical significance for local banks. Results of Abor and Biekpe (2007) and
Shaheen and Nishat (2004) support this finding. This result can be articulated by the
substantial role of the educational level and qualifications of the board members to
support the firm attaining an access to the relative required information within the
surrounding environment, and the advanced educational findings related to the
supervisory and accounting systems to enhance the firm efficiency, so what matters
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is the way the members leverage their knowledge and skills and not the educational
qualifications themselves.
Regard the CEO duality variable; the regression analysis results reveal a positive
significant influence of the CEO duality on the ROA. This indicates that for banks
operating in Palestine, the performance enhanced when the CEO perform as the
board chairman, as that increases the ROA by 58%. However, this contradicts with
the corporate governance principles that promote for separating the CEO’s role from
that of the board chairman, as the CEO duality often increases the possibility of
conflict of interest and agency problems, and limit the efficiency of the board to
provide monitoring and control over the top management. Meanwhile this finding is
similar with the results of Abor and Biekpe (2007) study. Considering the national
banks, the coefficient of the CEO duality is -2 (table 20); indicating a statistical
significant negative relationship which confirms the corporate governance principles.
Another governance aspect has a positive impact on the ROA is the inside
ownership; as the performance and the efficiency improve as the shares owned by
either executives or the board increase. As the inside shareholding implies having
shareholders who seem to understand the business better, to have good knowledge
and appreciation of the operations of the firms, the analysis spots that an increase in
inside ownership by 1% causes an increase in the ROA by %4.76, since such
employees are often in the position to take decisions that are in the interest of
maximizing shareholder value instead of engaging in opportunistic behaviour, as
they benefit from the success and financial outperformance of their firm, and this
considered one of the motivations for employees to enhance the firm efficiency by
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increasing their belonging to the firm. This finding applies to all banks operating in
Palestine, national banks, and foreign banks (look table 20).
Another finding that supports the results of both Bahgat and Bolton (2006) and Abor
and Biekpe (2007), is that the foreign ownership has a positive impact with high
statistical significance, as an increase in the foreign ownership by 1% increases the
ROA by 1.71%. This is an evidence that the banks with foreign ownership is more
efficient than the national banks as it is more opened to the external environment,
and to skills and expertise of others in managerial and supervisory aspects and this
diminish the agency costs and subsequently uplift the efficiency and performance of
the firm.
Finally, the results for controlling variables considered for our model support the
governance principles. The size of the bank has a negative relationship with the
performance; so smaller banks have better performance compared to larger ones;
since larger banks with more assets incurs relatively higher operating expenses
compared to the smaller ones, and higher managing and supervisory expenses
(agency costs), and it becomes more challenging for the banks to attain or exceed
the break-even point and start making profit, and therefore the limited assets of the
bank (size) drives the bank to make the best use of its resources and hence enhances
its efficiency.
The results show a positive impact of the bank age, calculated from the year
established to the date the sample considered, has a positive impact on the ROA. As
the bank gets older, it gains more experience that enhances its performance; mainly
if the bank follows special training programmes for the top management and
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employees. Moreover, the customers’ base gets expanded as customers prefer to
deal with the same bank as long as the relationship is based on a ground of mutual
trust and customers’ belonging to the bank gets stronger overtime. While debt ratio
has a negative relationship with statistical significance on ROA, as the debt increases
the performance declines, and this result is applicable on all banks, national banks,
or foreign banks(including regional banks) operating in Palestine.
To precisely examine the impact of the variables related to corporate governance
aspects on the performance, the analysis was carried out excluding the controlling
variables, and the results came as shown in table 17:
Results show that variables related to ownership (internal and foreign) and the
board structure no longer have a statistical significance. The signs of the coefficients
for statistical significant variables did not change; as it stays positive for the board
Table 17: Results of regression model analysis excluding the controlling variables
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size and CEO duality, and negative for the board skills. The same for the values of the
coefficients for the board size and the board skills did not considerably change, but it
did increase for the coefficient of CEO duality from .584 to .814; which stresses more
impact of the CEO duality on the ROA. Those results indicates that more focus should
be given to the corporate governance aspects related to the board and its
composition, as a major indicator for sound corporate governance and its return on
enhancing bank performance.
As an attempt to investigate the impact of those aspects on the performance of
national banks and foreign banks each on its own, the model took two forms. For the
first, the national banks were excluded by setting the foreign ownership to 1; and
the GLS analysis was completed for the foreign banks. Results are illustrated in table
15.The model interprets 76% of the variations of the ROA. CEO duality became with
no statistical significance, however no major change occurred to the coefficients of
the other independent variables. F-test value indicates that the applied model is
significant.
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The analysis carried out on the foreign banks illustrate that the signs of the
coefficient did not change; but the board composition and the internal ownership
have more impact on the performance, as the board composition coefficient
increased from -2 to -9 and for the internal ownership from 4.76 to 9; this indicates
that those two variables have the greatest impact of the performance of the foreign
banks. However, when the controlling variables are excluded for the foreign banks,
the board composition lost its statistical significance, and the ownership coefficients
became with statistical significance.
Table 18: Results of regression model analysis for foreign banks (regional banks included)
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The second form was completed for the national banks by setting the foreign
ownership to 0; to examine the corporate governance aspects on the performance
of the national banks operating in Palestine. Table 20 shows the results of this form.
The independent variables of this model interpret 66% of the ROA variations. Board
size and board skills became of no significant impact on the performance for local
banks; while the firm size turned out to be with relatively substantial influence on
the ROA, with no major change in the coefficients of other independent variables.
Still, the model is significant (f-test value).
Table 19: Results of regression model analysis for foreign banks excluding controlling variables
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For national banks, the signs of the coefficients did not change except for the CEO
duality where it turned to be negative, but the board composition and CEO duality
became of greater influence on the ROA, coefficients changed from -2 to -23 and
from .58 to -2 for the board composition and CEO duality respectively; indicating
that those two variables are of greatest impact on the performance of the national
banks operating in Palestine. However, when the controlling variables are excluded,
the board composition and CEO duality became of no more significant impact on the
ROA.
Table 20: Results of regression model analysis for national banks
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As the Israeli invasions of the West Bank and Gaza strip took place during the time
considered for the study and specifically between 2001 and 2003, where curfews
were imposed, organizations, commercial shops and banks suspended from work for
periods of times exceeded months (DAI Washington 2007), it is expected that those
events yielded to consequences on the performance and the systems of the banks
operating in the areas affected by the invasions, and hence on the governance of the
banks. Table 22 illustrates the results for the analysis carried out on the period that
covers the invasion which is from 2001 to 2003. The findings were that the board
composition, internal ownership, and foreign ownership have no statistical
significance. Comparing those findings with the results of the analysis completed for
the whole time period of the study, are almost similar for the coefficients impact
Table 21: Results of regression model analysis for national banks excluding controlling variables
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except that internal ownership became with statistical significance, and for the signs
except the CEO duality became with a negative sign.
While table 23 shows the results for the analysis of the period off the invasion time,
which is from 2004-2006. It illustrates that board composition and the foreign
ownership have no statistical significance on the performance. Noting that the
coefficients of variables and signs did not change compared to the results for the
analysis of the period from 2001-2006 (table 16).
Table 22: Results of regression model analysis for the period of 2001-2003 (Israeli invasion period)
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Table 23: Results of regression model analysis for the period 2004- 2006
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Chapter 7: CONCLUSION
The definition we consider for our study embraces not only a fair treatment of
minority shareholders but how well a bank is run. Therefore; a sound corporate
governance entails that banks must have a healthy financial system combined with a
broad knowledge and experience of risk management and systems followed in the
firms with good corporate governance; which in turns, supports the firms’ policies,
enhances the trust of investors, and contributes to a more stable investment
environment.
The appliance of corporate governance principles for banks in Palestine was
measured based on variables related to the board, and variables related to the
ownership concentration within the sampled banks. Results of the study illustrate a
positive correlation of the performance of banks operating in Palestine and the level
of corporate governance adoption in those banks, where the variables related to the
board have a statistical significance on the performance (table 14); the board size
has a positive impact and is in consistent with corporate governance principles, as
the increase of the number of the board members brings about a wider variety of
qualifications and skills that subsequently supplement to make better choices and
decisions for the firms interest, and makes more difficult to control the board and its
decisions by either the board members or the CEO. Those results, values and signs,
came substantially in agreement with results of the analysis carried out without the
controlling variables (table 14), and with the results of the analysis carried out for
the foreign banks on its own (table 15), while the value of the coefficient increases
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for the national banks, ensuring the considerable role of the boards for the national
banks, and its contribution to attain a better performance for the banks.
However, for the hierarchy of the board, the results were unexpected, as the
corporate governance principles call up for tasks distribution and not to be
centralized in hands of couple of members, and separation between executive and
supervisory roles. While some researchers in the field found that having executive
board members (as it is in Palestine) yields better performance for the firms, as the
executive members have deeper knowledge and experience with the banks policies
and operations which enables the board to make appropriate decisions that lift up
the productivity of the bank (Khairi et al. 2007 and Buckland 2001). But it lost its
statistical significance when the controlling variables excluded (table 14), for national
banks (table 17) and for foreign banks (table 15), which confirms that the hierarchy
of the board has no impact on the performance for banks in Palestine.
Results show that board skills have negative relationship with performance; but the
impact is relatively low as the value of the coefficient is low, an increase in the
number of members with higher education decreases the performance. This is
articulated by the fact that the increase in the earned profits, entailed as a result of
the broadened qualifications, is lower than the incurred expenses of their increased
salaries, compensation and other related operating expenses (Look Shaheen and
Nishat 2004 and Abor and Biekpe 2007). The analysis excluding the controlling
variables came with the same results (table 16), but the value of the coefficient
increased significantly from -.92 to -2.56 maintaining the negative sign for the local
banks; as 1% increase in the number of members with higher education leads to
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2.56% decrease in the returns on assets. The variables lost its statistical significance
for foreign banks.
Moreover, the results for the CEO duality were unexpected; as the existence of the
CEO duality in a bank lifts up the performance by 58%, which is in consistent with the
corporate governance principles that promote that the chair of the board is not held
by the CEO, to safeguard shareholder interests. Nevertheless, literatures on
corporate governance and primary studies have targeted emerging economies and
small and medium sized firms, came with the same results (Abor and Biekpe 2007).
When the CEO performs as a board chairman, with his deeper knowledge and
experience on the bank policies, operational soundness, market conditions,
competitive banks, and daily arisen issues, becomes more entitled than any non
executive member (who might not have any operational experience)to perform a
supervisory role and handle managerial responsibilities. Excluding the controlling
variables; the value of the coefficient increased from 58% to 81% for banks with CEO
duality, results stay the same for foreign banks, with a coefficient of 97%. While for
national banks the variable has no statistical significance; implying that this indicator
has no impact on the performance of national banks.
While variables related to the ownership concentration, came with a variety of
results depending on the nature of the ownership. For the family ownership, it has
no statistical significance for all sampled banks whether or not the controlling
variables were included (table 16 and table 17), and for national banks as well (table
20); yet the variable has a significant negative impact on the performance for the
foreign banks (table 18), and this result is in harmony with the corporate governance
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literature that promotes not to concentrate the ownership among major
shareholders with family holdings, as those controlling shareholders are self
interested to maximize their profits and interest disregarding the small shareholders’
interests (Khairi 2007 and Abdelkarim and Alawneh 2007).
Whereas for the foreign ownership, the results point out a positive significant
correlation; as the coefficient with a relative high value compared to other variables
(table 16); implying that foreign banks have a comparatively better performance to
national banks, as they are more opened to the foreign external markets and not
limited to the local market outlook, this might indicate that performance of foreign
markets is better, its investors base is wider, access to fund and credit is easier, and
capital market cycle is more active, which could be an indicator that foreign markets
are more economically and financially stable compared to the local market. But the
variable has no statistical significance when the controlling variables are excluded.
The same with the internal ownership, the results illustrate a significant positive
relationship with performance, its coefficient’s value is one of the highest for the
considered model,4.76% for all the sampled banks, 4.27% for national banks, and
7.06% for foreign banks. As the allowances owned or directed by the board
members, top management including the CEO, and the employees inside the bank,
their belonging and responsibility towards the bank increase, wrapped with a desire
to maximize their profits and revenues, which in turns enhances their performances
and the bank performance all over. Having a number of shareholders that are
exposed to the daily operational processes in the bank; improves the level of
supervisory that the board can practise on the bank management, and consequently
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reduces the agency and supervisory costs. Moreover, those shareholders who seem
to understand the business better, and to have good knowledge and appreciation of
the operations of the firms, are often in the position to take decisions that are in the
interest of maximizing shareholder value instead of engaging in opportunistic
behaviour.
Analysis was carried out to examine the consequences of the Israeli invasion of the
West Bank and Gaza Strip, with curfews and political instability that adversely
affected the economic situation. Results of the period 2001-2003 (table 22) were
different from the results of the period 2004-2006 (table 23). The sign of the
coefficient for the CEO duality (with statistical significance) and internal ownership
(with no statistical significance) is negative for the period 2001-2003, while for the
period 2004-2006, is positive. This could be as a result of the Palestinian economy
revival; where the CEOs invested in their networks and relations to get access to the
fund and launched new investment projects to attain higher revenues. The
exceptional mutation of the capital market in Palestine, was a golden chance for
banks to gain more revenues and profits from their investments in this market with
no operating expenses, and this apparently sounds the reason that coefficients of
those two variables are positive and high (1.14 for the CEO duality and 3 for the
inside ownership) while the sign turns into negative and the value of the coefficients
drop down for the period of invasion to be .21 for the duality and 1.15 for the
internal ownership.
The family ownership has variations in its impact on the performance of the banks.
As it has a positive impact with statistical significance; coefficient of.96 for the period
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2001-2003 (table 22) while it is -.56 for the period of 2004-2006 (table 23).
Therefore, and during the invasion period, the family ownership is a reason for
increasing returns and revenues of the banks; the family bonding was a motive to
enhance the performance, and to encourage the management to lift up the bank’s
profits and hence increase their personal and family profits and revenues. While the
CEO duality has a negative impact on the performance for this critical period, and
the inside ownership has no statistical significance for the same period.
Briefly, the factors that influence the relationship of the corporate governance and
the performance for banks in Palestine can be classified into variables related to the
ownership concentration and to the board of directors. Basically, the corporate
governance aspects related to the board of directors such as skills, qualifications and
size of the board can be considered in consistent with the sound corporate
governance principles to lift up the performance of the banks operating in Palestine,
especially for the national and foreign banks, there is a significant and obvious
relation of the board size and internal ownership with performance. As those two
variables found to be with highest coefficients in the model with statistical
significance for the sampled banks, whether they are national or foreign banks.
7.1 Implications for practise:
Hence, management of national and foreign banks should follow the principles of
sound corporate governance to ensure transparency, and accountability through
their daily operational process and procedures with clients, and subsequently
improve the performance, and enhance investors, shareholders, and stakeholders
trust, which contribute to attain the banks goals.
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Since the board composition substantially affect the roles it can play and how
effectively it can play them, banks should pay attention first to how boards get to be
the way they are and what determines who to gets added or taken off (Hermaline
and Weisbach 1988).Once the board members are carefully selected, banks have to
improve the role of the board of directors, as it has a significant importance in
setting out the policies and goals of the banks and in providing an oversight on the
management. One way to have an effective board is to increase the number of the
board members, with both independent and qualified external directors. Attention
should be given to add to the qualifications of the board members and employees
which supplement the bank performance, through providing specialized advanced
trainings on a regular basis and to be available to employees at all levels and not to
be limited to the CEO and board directors.
Banks can invest the last updated educational and theoretical advancements to
improve their daily operational processes, and employees’ and managers’
performance, through applying those theories in compensation, payment, and
retirement systems instead of exclusive reliance on monetary incentives or financial
rewards that ignores other non financial sources of work motivation (Locke 2004).
Non financial motivators include a diverse assortment of activities such as providing
interesting and important work assignments, granting autonomy of how job should
be delivered, providing public contribution of discretionary achievements, engage
workforce to map out. Those non financial motivators substantially increase
employees’ belonging to the bank and their intention to maximize their profits
through increasing the bank all over profits.
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7.2 Limitations:
As mentioned earlier, the first limitation of this study is the limited access to the
financial data of some banks, which led to exclude four banks from the sample,
which might slightly change the results as they count for 18% of the sampled banks.
A second problem is that the study has been conducted on banks operating in
Palestine; studies on banking industry in other countries might show different results
due also to the influence of national culture. Particularly, the family ownership,
where the kinship and altruism might restrain the effectiveness of corporate
governance bodies and practises (Corbetta and Montemerlo, 1999).
7.3 Directions for future research:
A number of issues could be further explored in our study. We find some of them to
be particularly interesting.
A first one concerns tackling other corporate governance aspects such as how much
the non executive board members are independent and not influenced by the
executive management of a bank. To go deeper and verify the independency of the
board, such indicator could help to provide a more statically picture on the level of
supervisory and oversight a board practise on the management, which might entail
an impact on the performance of a bank. But Limitation of both time and
information disclosure might strictly confine the chance of such attempt; as those
indicators are hard to be caught by surveys or other means of primary research.
Another challenging issue could be of an interest for investors, is to investigate the
effect of sound corporate governance on specific financial performance indicators
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such as EPS, which has not been identified so far but would be fundamental to assess
different investment decisions.
Finally, it would be interesting to go deeper into exploring the impact of corporate
governance adoption on financial stability. Bearing in mind that corporate
governance is relatively newly introduced topic into the Palestinian emerging
economy. But financial stability has not yet been precisely defined, it could be
difficult to be measured, meanwhile; financial soundness as a measure factor to
achieve a financial stability (Das et al. 2004). Studying such indicator might help
decision making and policy maker as they are part of the framework of empowering
corporate governance.
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Appendix A: Results of Statistical Analysis
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