Corporate Governance and Risk Taking

Empirical Study on Banks at MENA Countries

Rafat Alaraj*, Alaa Razia and Luis Otero

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ABSTRACT

We analyze to which degree the corporate governance issues affect banks’ risk-taking behavior. Over the period from 2005 to 2012, we regard cross-country and bank-level data from some MENA countries. The evidence is supportive of theories that emphasize that Corporate Governance has a significant and positive impact on risk taking in banks. Furthermore, we explore the relation between the degree of Investor Protection and risk taking in banks, and we found that Property Rights are associated with a significant and positive effect on the risk taking. The results also explain that there is a significant and positive relationship between Islamic banks and risk taking in banks. We show that important family ownership is associated with significant and negative impact on the risk taking. Finally, We analyze the link between important government and institutional investor ownership and risk taking in banks in our sample, Our results in this regard reveal evidence that both of them has no effect on risk taking.

Key Words: Corporate Governance, Risk Taking, Property Rights, Ownership Structure.

JEL Classification: G34, G32, D23.

(1) IntroductionBanks face a lot of challenges, one of the most important is to create and maintain the

requirements of the banking stability which is consider being one of the most important points between its economical and developmental goals. For increasing the stability, safety and soundness of the banking and financial system in common, Central Banks adopt many procedures and directions to contribute in managing and minimizing all kinds of risks faced by banks. One of these is establishing strong Corporate Governance procedures and mechanisms through effective supervision and monitoring for banks activities. Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the firm, such as, the boards, managers, shareholders, and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance (OECD, 2004).

A company committed with good corporate governance has well-defined and protected shareholder rights, a solid control of the environment, high levels of transparency and disclosure, and an empowered board. The interests of the company and those of all shareholders are aligned. Corporate governance arrangements must be credible, well understood across borders and adhere to internationally accepted principles (OECD, 2004). At the same time, Corporate governance is one of the most topical and controversial areas of business and finance (Becht, Jenkinson, & Mayer, 2005). From a theoretical point of view, Corporate governance issues arise due to the

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separation of ownership and management (Krafft, Qu, Quatraro, & Ravix, 2013). Principal-agent theory is the starting point of most discussions of corporate governance (Shleifer & Vishny, 1997). Good governance increases investor trust and willingness to pay more and renders managers’ actions costly and expropriation less likely (Krafft et al., 2013). Good governance means that ‘more of the firm’s profit would come back to (the investors) as interest or dividends as opposed to being expropriated by the entrepreneur who controls the firm’ (La Porta, Lopez-De-Silanes, Shleifer, & Vishny, 2002).

The evidence of excess risk taking is the frequency of banking crises around the world which tends to occur without much warning (A. Angkinand, Wihlborg, C., 2006). Excessive risk-taking is certainly a recurring theme in the current financial crisis (Dowd, 2009). The risk taking behavior of banks affects financial and economic fragility. The notion of a risk-taking culture is an important one (Mehran, Morrison, & Shapiro, 2011). In turn, international and national agencies propose an array of regulations and directions to assist the banks in risk management and other related issues. Corporate Governance is not a new concept for the transition economies of the Middle East, but corporate governance is especially important since these economies do not have the long-established institutional infrastructure to deal with corporate governance issues (BRAENDLE & EMIRATES, 2013). The institutional infrastructures in the MENA countries, such as their economic, political, legal and corporate governance structures; differ from those of the formerly planned emerging countries. A view that has also been noted that some MENA countries are fast developing and implementing variety of best practice measures (Hasan, Kobeissi, & Song, 2014). Between July 2006- July 2007, a recent MENA wide corporate governance survey conducted and published by the International Finance Corporation (IFC) noted a growing awareness about the importance of corporate governance & continuing effort & commitment to improve governance mechanism (IFC, 2008).

Middle East and North Africa (MENA) countries in general perform reasonably well in regulation, supervision and in financial openness. But they need to do more to strengthen the institutional environment. Within the MENA region, progress on financial sector reforms has been uneven. Some countries now have well-developed financial sectors, particularly banking sectors which considered to be well developed, profitable, and efficient, such as the countries of the Gulf Cooperation Council (GCC, comprising Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates or U.A.E.), Lebanon, and Jordan. Others, such as Egypt, Morocco and Tunisia, have made important advances over the past three decades. However, overall, more remains to be done. The importance of our study comes from many things, first, the strong relationship between corporate governance and the stability on the bank level or on the sectorial and country level. Second, there are unique characteristics that makes the banks in MENA countries different from other banks in other countries, such as, the existence of both kinds of banks; Islamic (especially because of its rapid growth and the relative stability showed in the last financial turmoil) and conventional, or other types of bank ownership (Private and Public).

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Third, there isn't so many studies that analyses the effects of corporate governance on the risk taking behavior with concentration on MENA countries.

Two key differences distinguish the governance of banks from that of nonfinancial firms. The first is that banks have many more stakeholders than nonfinancial firms. The second is that the business of banks is opaque and complex and it can shift rather quickly (Mehran et al., 2011). Good governance will decrease the cost of capital since it reduces shareholder’s monitoring and auditing costs (Drobetz, Schillhofer, & Zimmermann, 2004; Errunza & Miller, 2000; Lombardo & Pagano, 1999). Therefore, better corporate governance structure and practice lead to better corporate performance, lower agency costs, and higher stock performance (Krafft et al., 2013).

The study conducts an empirical assessment of theories concerning the different effects on bank risk taking depending on the bank's corporate governance for banks operated in MENA countries. We examine and assess whether bank risk taking varies with the comparative power of shareholders within the corporate governance structure and the shareholder protection rights laws which affect the ability of owners to influence risk. Also we examine the differences in risk taking behavior and incentives in case of the banks being Islamic or conventional, family or nonfamily owned and public or private banks.

This study contributes to the existing literature in several important ways. As far as it could be ascertained, this is one of few studies which show that corporate governance is relevant to bank risk-taking in a way consistent with the segmentation of the corporate governance for both country level and bank level. Another contribution of this paper is to show the impact of investor protection on the risk taking in banks operating in Mena countries. It also contributes to the existing bank risk-taking literature by covering a big sample period (2005-2012), it focuses on Mena Banks considering different effects like Islamic banks, large ownership stakes (family, institutional investor, government). The aim of this paper is to contribute finding answers for the above mentioned questions. Our results should provide guidance to bank regulators and supervisors in Mena countries. Another contribution of our theoretical and empirical analyses is that we provide further insight into how corporate risk taking in contingent on the presence or absence of large shareholders, concentrated ownership and investors protection.

Our study seems interesting:

- To assist central banks for better understanding of risk taking incentives that increase the burden on regulation and supervision for control and monitor banks' risk-taking in order to reduce the likelihood of banking default and crises.

- Useful for central banks to introduce a more new effective regulation, controls on risk taking and corporate governance codes for stability.

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- Assist banks to control risk taking.- Assisting the banks to develop its regulations and internal procedures.- For depositors, shareholders and creditors to know the way that banks is controlled by.- For managers and board members to be aware of the behavior of big and small

shareholders and their effects on risk taking. The paper will be organized as follows: first section, describes related discussions and literature then develops corresponding hypotheses. Section 2 describes the data source and methodologies. Section 3 outlines the received results and discussions. Section 4 presents conclusions and policy implications.

(2)Related Literature and Hypothesis DevelopmentCorporate governance is critical to determine the level of risk taken by financial

institutions. Thus, characteristics like acting on behalf of shareholders (Beltratti & Stulz, 2009); the composition of the Board of Directors (Pathan, 2009); the concentration of power and the participation of institutional investors in the Board of Directors, affects the level of risk assumed by banks (Ibragimova, 2014). According to Laeven and Levine (2009), some potential corporate governance problems associated with risk arise from bank ownership structures. Bank ownership structure can be measured by two dimensions: ownership concentration and nature of ownership (Iannotta, Nocera, & Sironi, 2007). Financial crises may derive from poor corporate governance within the sector; in other words, bank governance is an important endogenous source of system weakness (Ciancanelli & Reyes-Gonzalez, 2000). The studies of regulation and the regulators themselves devote less attention to corporate governance as an endogenous source of systemic risk than it devotes to exogenous or market sources of systemic risk (Ciancanelli & Reyes-Gonzalez, 2000).

Then, we will review the main theoretical contributions relating to corporate governance and risk taking and we establish the hypotheses of our study.

Agency Theory

Under Agency theory, some conflicts of interests arise between the principal and agent because the agent will not always act in the best interests of the principal. So, this conflicts between managers and shareholders will affect risk taking behavior (Jensen & Meckling, 1976). In more precise language, the agency theory predicts that managers will be aware to protect their positions and personal benefits, so they will act in a risk-aversion way, whereas shareholders have incentives to increase bank risks after collecting funds and deposits (Esty, 1998; Galai & Masulis, 1976). In essence, risk-averse managers would like to incur fewer risks than desired by the owners. The agency problem may be mitigated in firms which have strong monitoring for managers, with the possibility to replace them upon their performance (Franks, Mayer, & Renneboog, 2001). But there is another point of view where the conflict of interest are almost inevitable (Esam & Ezzat, 2014). This conflict takes place between the interests of shareholders and the interests of depositors. The owners willing to take higher levels of risk to maximize

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profits and to increase the share value at the expense of the value of depositors (García-Marco & Robles-Fernández, 2008).

These conflicts can be reduced in banks with big shareholders, which can prevent managerial opportunism by being a part of the internal governance mechanisms through monitoring managerial decisions and rein banks’ risk-taking (Iannotta et al., 2007). Proponents of this hypothesis believe that managers of non-concentrated ownership are expected to exhibit lower risk meanwhile they deemed to be risk averse and more disciplined by market participants. At the same time, higher ownership concentration means stricter control over bank managers and thus could leads to moral hazard problem where bank owners have incentives to take riskier decisions because of the existence of deposit insurance (García-Marco & Robles-Fernández, 2008). Alternatively, lower control over manager may leads to owner-manager agency conflict and moral hazard problems if managers are not risk-averse. Agency problems may exacerbate by the opacity of banks (Levine, 2004; Morgan, 2000). Opacity creates extra difficulties for shareholders and debt holders to monitor the behavior of managers.

In the particular case of some banks operating in the Middle East, Esam and Ezzat (2014) appointed another problem, which is recently being underlined by critics to the Islamic Banks. It is the conflict of interest between top management and Shariah boards. As in many Islamic banks, Shariah scholars have been selected by the general assembly. Accordingly, some Shariah scholars may find themselves subject to pressure and threat of losing their position in the Shariah board, and hence forced to approve products and services as Shariah compliant while they are non-compliant. Consequently, this approval could lead to big costs including lawsuit, loss of revenue and not least, affecting the Islamic bank’s creditability and reputational image.

Agency theory indicates that the degree of ownership concentration influences bank performance and risk-taking (Iannotta et al., 2007). Also we focus on institutional ownership and large shareholders because prior studies suggest that they serve important disciplining and monitoring roles (Gillan and Starks, 2007). Laeven and Levine (2009) Compiled data for more than 270 privately owned banks across 48 countries with different regulations and they argue that ownership concentration affects risk taking, because they found in general, that the bank risk is higher in banks that have large owners. In general, managers avoid risk-taking due to career concerns, because they are not able to diversify the risk of their unemployment (Amihud & Lev, 1981; Hirshleifer & Thakor, 1992). This in line with Saunders, Strock, and Travlos (1990) whom found that banks controlled by shareholders take more risk than banks controlled by managers. On the other hand and contrary to managers, shareholders with dispersed ownership have larger incentives to behave risk-neutral (Demsetz & Lehn, 1985; Esty, 1998), because they are going to diversify their risk by engaging in a large number of projects instead of concentrate their fund in one option.

However, regarding the impact of ownership concentration on risk taking, there is no consensus at the empirical level concerning the sign of the relationship. Some studies find a

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positive association (Gropp & Köhler, 2010; Haw, Ho, Hu, & Wu, 2010; Laeven & Levine, 2009; Saunders et al., 1990), which showed that concentrated ownership control is associated with greater risk. In other words, powerful bank owners tend to induce bank managers to increase risk-taking. Also, It is worthwhile to point out that the extremely generous performance based compensation packages given to bank managers may be interpreted as an attempt by owners to force management to increase risk taking (Gropp & Köhler, 2010). The negative effect suggests that banks with concentrated ownership are taking lower risk in terms of credit risk and insolvency risk than banks in diffuse ownership. This result is in line with the findings of (Burkart, Gromb, & Panunzi, 1997; García-Marco & Robles-Fernández, 2008; Iannotta et al., 2007) and contrary to the Agency theory (Jensen & Meckling, 1976) and the results of several studies (e.g., (Saunders et al., 1990)).

However, other researchers (Anderson & Fraser, 2000; Gorton & Rosen, 1995) showed that ownership concentration has a non-linear (U or inverse U) relationship with risk. Overall, we can say that there is a significant effect of ownership concentration concerning the risk taking, although no consensus exits on the sign of this relationship. Caprio, Laeven, and Levine (2007)and Shehzad, de Haan, and Scholtens (2010) argued that in countries with low level of investor protections rights and regulatory control (the case of most MENA countries), ownership concentration reduces bank riskiness. Al-Baidhani (2013) in his study conclude that ownership concentration has a negative and significant effect on bank’s profitability. García-Marco and Robles-Fernández (2008) assumes that in commercial banks, where there is a moral hazard problem affecting the bank risk-taking, greater shareholder concentration will mean greater risk-taking. Gropp and Köhler (2010) found that shareholders prefer more risk relative to managers. The evidence showed that bank managers prefer less risk compared to owners, whether dispersed or concentrated. Moreover that, there is a higher likelihood that their managers are under shareholder´s control. A firm's corporate governance can change as a response to changes in the firm's inside ownership structure (Lel, 2012).

Many studies suggest that firms which are controlled by large shareholders are more likely to engage in increased risk-taking behavior (Amihud & Lev, 1981; Shavell, 1979). Also, Pathan (2009) provides empirical evidence for the period 1997-2004 that US bank holding companies assume higher risks if they have a stronger shareholder representation on the boards. Moreover that Beltratti and Stulz (2012) find that banks with higher controlling shareholder ownership are riskier. In the case of MENA countries Srairi (2013) found that changes in ownership structure are significant in explaining risk differences between banks. The result showed a negative association between ownership concentration and risk. There were no differences related to ownership concentration between conventional banks and Islamic banks.

We think that in the case of concentrated ownership, we will find more risk taking by managers, as a result of the monitoring effort exerted by a big shareholder increased in the direction of pushing them to take more and more risk, Thus, the formal representation of the first & second hypothesizes of this study is as follows:

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H1: Ownership concentration has a significant and positive effect by inducing bank managers to increase risk taking.

The composition of the board

The Basel Committee on Banking Supervision (BCBS) especially advocates in the second pillar of Basel II that the boards of directors are a focal point and integral part of risk management (BasleCommittee, 2006). A firm’s board of directors is in charge of monitoring and evaluating senior management. Thus, the board plays a key role in monitoring managers’ behavior and advising them on strategy identification and implementation (Andres & Vallelado, 2008). As financial institutions become more complex and less centralized organizations, the risks they pose to the financial system also increase. Although regulators clearly have an important monitoring and oversight role, the concomitant role and responsibility of the board of directors cannot be ignored (Macey & O'hara, 2003). Boards of directors, act as shareholders’ representatives in guiding and overseeing management and ensuring that the firm is run in their interests, as well as to ensure that a robust corporate governance framework is in place. Shareholder influence is ensured by their right to vote. On the other hand, in case of weak supervision from shareholders to boards, they may act in managers’ interests rather than those of shareholders (Jensen, 1993).

There are several important aspects relating to the composition of the board: Board composition, institutional investors and size of the board. Board of director’s members should be qualified, have a clear understanding of their duty to the company and all shareholders, and be able to exercise sound, objective, and independent judgment (IFC, 2008). Companies can benefit from having an appropriate mix of executive, non-executive, and independent directors on their boards. We mean by an executive member, the member who holds an operational position in the company, the executives that one typically finds on boards are the CEO and CFO. Non-executive members are board members that do not hold any executive position in the company. The last is an independent member, this member is a director who has no material relationship with the company beyond his directorship (IFC, 2008).

The impact of the board's composition on corporate governance is depending on who occupies this membership. This might always be appropriate, for at least two reasons. First, memberships by CEO, Institutional Investors and Independents might have different effects. Second, at any given level of ownership, some board members might have greater influence on corporate decision making than others. CEO duality defined as the same person holding the positions of company CEO and chairman of the board of directors, which is much more likely in family-controlled firms (Chen, Cheung, Stouraitis, & Wong, 2005). CEO will prefer growth oriented risk taking and may make decisions based solely upon an evaluation of personal gains and loses generated by particular firm strategy and therefore putting the company in higher risk corporate undertakings. The distinction between officers and independent board members can be important for several reasons. Although it is the fiduciary duty of all directors to represent the

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interests of shareholders, independents, in particular, must oversee the performance of the firm's officers (Morck, Shleifer, & Vishny, 1988).

There are some variables related to the board characteristics that can be considered as a proxy for the “strong bank boards” such as: independent directors, board size and less restrictive shareholders rights (Pathan, 2009). Evidently, ‘strong board’ is defined as board effectiveness in monitoring bank managers on behalf of shareholders. So, strong bank board could lead the bank management to take more risk in order to maximize the interests of shareholders. Pathan (2009) conducts a study using more than 1534 observations in a sample of 212 large US bank holding companies over 1997–2004. He finds that bank risk-taking is positively affected by strong bank boards (particularly small and less restrictive boards).

Finally the effect of the size of the board is also an important question. Board size should be big enough to allow the company to benefit from an appropriate mix-of skills and breadth of experience. The size of the board should thus enable a company to hold productive and constructive discussions and make prompt and real decisions (Jensen, 1993). In fact, Andres and Vallelado (2008) focuses his study on the relationship between a bank’s board size and its risk taking. They suggest that there should be a trade-off between advantages of having a larger board (monitoring, advising) and disadvantages (control and coordination problems). Further analysis reveals that greater risk-taking is associated with increased institutional ownership but not with independent boards(Erkens, Hung, & Matos, 2012). Smaller boards, because they tend to be more active and have fewer agency problems, they have a stronger relationship between corporate performance and greater scrutiny over executive compensation (Hermalin & Weisbach, 2003). In this regard, Nakano and Nguyen (2012), say that firms with larger boards may accept less risky investments as indicated by the smaller dispersion in analysts' earnings forecasts. In the case of banks, Pathan (2009) shows that board size is associated with lower return volatility. Thus, we propose the following hypothesis:

H2: The board of director’s size has a significant effect and cause a reduction on risk taking.

Regulations

The risk-taking behavior of banks can have a first-order effect on financial and economic system stability (Laeven & Levine, 2009). To mitigate the destabilizing potential of such risk taking, international and national bodies and organizations have focused on implementing regulations to manage and minimize bank risk and avoid future financial crises. Stronger risk-taking incentives increase the burden on regulation and supervision to control and monitor risk-taking at banks in order to reduce the likelihood of banking crises (A. Angkinand & Wihlborg, 2006). Regulation presents numerous challenges in the area of corporate governance. Regulation can be considered as an additional mechanism of corporate governance, in many cases it reduces the effectiveness of other mechanisms in coping with corporate governance problems. This is the

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case when regulation imposes bank ownership restrictions, or when it restricts some operations, or when it designs a deposit insurance that restricts depositors’ supervision. (Andres & Vallelado, 2008). Theory predicts that banking regulations (such as: capital requirements, deposit Insurance & activity restrictions) influence the risk-taking incentives of diversified owners differently from those of debt holders and non-shareholder managers. For example, one of the goals of capital regulation is to reduce the risk taking incentives of owners by forcing them to place more of their personal wealth at risk in the bank (Kim & Santomero, 1988). Another example, many countries attempt to reduce bank risk by restricting banks from taking part in non-lending activities, such as insurance and underwriting (Boyd, Chang, & Smith, 1998) as with capital requirements, however, these activity restrictions could reduce the utility of owning a bank. Thus, the impact of regulations on risk depends on the comparative influence of owners within the governance structure of each bank. Opacity and complexity play a role in governance in both the interaction between the board and management and the relationship between the bank and its regulators (Mehran et al., 2011). From other hand, Banking regulations restrict the ability of the market for corporate control to discipline banks (Prowse, 1997), as hostile take-overs in many countries are explicitly discouraged. Existing management tends to be protected by regulations on entry, mergers, takeovers and administrative rules (Prowse, 1997).

We suggest that regulation has at least four effects. Firstly, the existence of regulation implies the existence of an external force, independent of the market, which affects both the owner and the manager. Secondly, because the market, in which banking firms act is regulated, one can argue that the regulations aimed at the market implicitly create an external governance force on the firm. Thirdly, the existence of both the regulator and regulations implies the market forces will discipline both managers and owners in a different way than that in unregulated firms. Fourth, in order to prevent systemic risk, such as lender of last resort, the current banking regulation means that a second and external party is sharing the banks’ risk (Ciancanelli & Reyes-Gonzalez, 2000). Bank owners may seek to compensate for the utility loss from stricter activity restrictions by increasing risk on remaining activities, while stricter regulations on capital may have motivated banks to engage in off-balance sheet activities to evade capital regulation (Laeven & Levine, 2009). Furthermore, the key object of the regulator, which is to minimize systemic risk, might come into conflict with the main aim of shareholders, which is to increase share value (Andres & Vallelado, 2008). Regulation might also be considered as an extra external governance force that acts at both the level of individual banks and at the banking industry level as a whole (Ciancanelli & Reyes-Gonzalez, 2000).

Laeven and Levine (2009) executed an empirical study by compiling a data on individual banks from economies with different regulations, yielding a data base of more than 250 privately owned banks across 48 countries. They found that the impact of bank regulations on bank risk depends critically on each bank's ownership structure. The effect of the same regulation on a bank's risk taking can be positive or negative depending on the bank's ownership structure.

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Furthermore, Gropp and Köhler (2010) showed that regulation does not seem to mitigate risk taking by bank owners. Thus we formulate our hypotheses as follow:

H3: Stricter banking regulation has a significant and positive effect on risk taking at banks with concentrated ownership than on banks with no concentrated ownership.

H4: Regulations may induce banks to be more engaged in off-balance sheet activities.

Property Rights/Investor Protection

The protection of shareholders by the legal system is important to understand the patterns of corporate finance in different countries. Investor protection is defined as the extent of the laws that protect investors’ rights and the strength of the legal institutions that facilitate law enforcement (Defond & Hung, 2004). Shareholders' rights is a measure of shareholders' legal protection in a certain country (Srairi, 2013). The majority of studies use the index of the statutory rights of shareholders proposed by (R. L. Porta, Lopez-de-Silane, Shleifer, & Vishny, 1996) which includes six components. The investor protection means that there are certain rights or powers that are generally protected through the enforcement of regulations and laws. The banking theory suggests that effective legal protection of shareholders serves as a substitute of the existence of a large shareholder that monitors management (Magalhaes, Gutiérrez Urtiaga, & Tribó, 2010) and affect the ability of owners to adjust bank risk (Laeven & Levine, 2009). Before moving on, however, it is worthwhile to point out that the investor protection laws alone may not provide effective protection to small shareholders, in light of the higher opacity and complexity of banks (Morgan, 2000). High investor protection has been declared as the most important factor associated with promoting good corporate governance (L. Porta, Lopez-de-Silane, Shleifer, & Vishny, 1998; L. Porta, Lopez‐de‐Silanes, & Shleifer, 1999; R. L. Porta et al., 1996). It creates an environment which prevents managers from opportunistic behavior, minimizes the risk of mismanagement and increases shareholder’s confidence and their willingness to participate in the capital markets (Defond & Hung, 2004).

An important point noting, here, is that shareholders’ protection rights may also conditioning the effect of ownership concentration. Better shareholder rights may enable even dispersed shareholders to exercise better control over management, for example through calling extraordinary meetings or through the ability to take legal steps and actions against management (Gropp & Köhler, 2010; L. Porta et al., 1998; L. Porta et al., 1999). That's consider one of the incentives which make investors pay more for equity, when legal institutions effectively protect their rights (Caprio et al., 2007). L. Porta et al. (1998) argued that differences in the degree of ownership concentration are caused by different levels of investor protection. If investor rights are better protected, shareholders have less need for a large block of shares to control management. Hence, ownership should be more dispersed in countries where shareholder rights are better protected and more concentrated in countries where investor rights are less protected.

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This is in line with prior studies which showed that concentrated ownership is more prevalent in countries with weak investor protection (L. Porta et al., 1999).

However, the relationship between the protection of investors and risk taking is still controversial and there is no consensus upon it. From one hand it can be found a positive association between investor protection and risk-taking (Demsetz, 1983; Demsetz & Lehn, 1985; Demsetz & Villalonga, 2001; Himmelberg, Hubbard, & Palia, 1999; Holderness & Sheehan, 1988; John, Litov, & Yeung, 2008; Morck & Nakamura, 1999; Morck & Steier, 2005; Paligorova, 2010; Roe, 2003; Stulz, 2005; Tirole, 2001). Maybe this positive association is explained because under higher investor protection, the managers feel that they are under effective control pushing managers to be more risk takers.

From the other hand, other arguments state a justification for a negative association between investor protection and risk-taking (Burkart, Panunzi, & Shleifer, 2003; John et al., 2008; Morck & Steier, 2005; Shleifer & Vishny, 1986; Stulz, 2005). We think that this negative association is justified by the fact that when there is less control from the shareholders side, the managers tend to practice their managing behavior upon the agency theory which imply that they will induce to be risk averse in order to protect their positions and their personal benefits.

Gropp and Köhler (2010) empirically finds that banks in countries with better shareholder rights protection incurred greater risks (the sample consists of more than 1,100 banks for 25 OECD countries). Shehzad et al. (2010) find that when shareholder protection rights are weak, the bank ownership concentration reduces bank riskiness. So we can conclude that the effect of stronger shareholder rights on risk taking is still unclear and ambiguous and this leads to the following hypotheses:

H5: Investor protection has a significant and positive impact on risk taking.

Moral Hazard

Moral hazard is a particular incentive problem that often arises from asymmetric information. Superior information may enable one party to work against the interest of another. In general, moral hazard arises when a contract or financial arrangements creates incentives for parties to behave against the interest of others. The skill in devising financial contracts is to limit the potential for moral hazard behavior (Iqbal & Llewellyn, 2002). In other words, moral hazard is something happened when banks excessive risk is taking when another party bears the price of risk. Also moral hazard is where one party is responsible for the interests of another, but has an incentive to put his own interests first. Under this scheme well-established managers of an efficient bank may have the incentive to follow an expository strategy, which ex-post could be shown to be excessively risky (Saeed & Izzeldin, 2014). Moral hazards increase risk-taking, if I can take risks that you have to bear, then I may as well take them; but if I have to bear the consequences of my own risky actions, I will behave more responsibly. Esam and Ezzat (2014) mention that the moral hazard is something particularly relevant to the banking industry and

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arises mainly because the agent’s actions are not publicly observable. García-Marco and Robles-Fernández (2008) assume that if concentration has a positive effect on the likelihood of insolvency, there must be a moral hazard problem, because owners behave in a riskier way.

Deposit insurance can incentive moral hazard, As a result of the existence of deposit insurance, bank managers may be encouraged to take more risk in search for higher profits. Because they know that in case of default a large part of the bank's debts will be covered by the insurance. Further, deposit insurance may exacerbate agency problems, since it increases the incentive of shareholders to engage in excessive risk-taking (Macey & O'hara, 2003; Prowse, 1997). Upon some authors (Barth, 1991; Gorton & Rosen, 1995; Kane, 1988), the moral hazard can be mitigated in banks with high prospects of future gains. Because of the existence of Deposit Insurance, banks have incentives to take on risk that can be shifted to a deposit insurance fund for excessive risk taking. Bank managers, on the other hand tend to deny such incentives exit. However, the incentives need not reveal themselves as deliberate risk-taking. Instead, it is the competitions among banks with the opportunity to finance their lending. These incentives are particularly strong if equity capital is low. The excess risk taking implies a wealth transfer from creditors (or insurers of creditors) to shareholders (A. Angkinand & Wihlborg, 2010).

There are also moral hazard problems created by the lender of last resort. If the central bank is willing to assist an institution that gets itself into difficulties, then institutions have weakened incentives to avoid getting themselves into difficulties in the first place. Traditionally, central bankers have attempted to deal with this problem by threatening to refuse assistance to reckless institutions in future, but such threats have always lacked credibility because bank crises always make big political pressure on central banks for intervention, and they have usually done so. The recent bailouts will have destroyed whatever little credibility those threats might once have had (Dowd, 2009). Mishkin (2005) mention that the “Too-Big-To Fail” policy increases the moral hazard problem for big banks. If a deposit insurance system willing to shut down a bank and pay off depositors only up to the insurance coverage, large depositors would suffer losses if the bank failed. Thus they would have incentives to monitor and follow up the bank’s activities closely and withdraw their money out if the bank is involving in too much risky activities. To prevent such a loss of deposits, the bank would be less likely to engage in activities with high risk exposures. However, once large depositors know that a bank is too-big-to-fail, they have no incentive to monitor the bank because no matter what the bank does, large depositors will not suffer any losses. The result of the too-big-to-fail policy is that large banks are likely to take on greater risks, thereby making bank failures more likely. Indeed, this is exactly what it happen in the United States in the 1980s when large banks took on riskier loans than smaller commercial banks which led to higher loan losses for big banks (Boyd & Gertler, 1993). Bashir (1999) shows that under deposit insurance system, the deposits of large banks are guaranteed by the ‘too big to fall’ policy. Consequently, the bank managers (the agent) risk depositors’ (the principal) funds by making riskier loans. Attention is firmly focused on the management of exogenous shocks to the system through “lender of last resort” support from the government. However, lender of last

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resort operations are inevitably indiscriminate, they bail out all banks, regardless of their previous conduct. In general terms, they shift the cost of risk to all the stakeholders in the system (Ciancanelli & Reyes-Gonzalez, 2000).

The increase in risk-taking arising from the moral hazard problem may counteracted by the owner-manager agency conflict. Where the managers can be reluctant to risk their wealth, their specific human capital or the associated advantages with controlling the firm. This risk aversion may lead them to choose safer investment projects or to operate with higher capital than owners would consider optimal (García-Marco & Robles-Fernández, 2008). Similar studies have been done in Spanish market. García-Marco and Robles-Fernández (2008) examine the risk-taking behavior of Spanish commercial and savings banks. They found that in general, moral hazard problems indicating a stronger relation with risk-taking only in small commercial banks with high ownership concentration. In the recent crisis, governments around the world provided massive support to distressed financial institutions. Maybe that such support was essential to prevent the failure of multiple institutions that would have devastating effects on the real economy (Ratnovski & DellAriccia, 2012). However it is also forceful in pointing out that, in the long run, such support carries significant costs in the form of moral hazard. First, when banks expect to be supported in a crisis, they will behave in a risky way, because they shift some negative results to the taxpayer. Second, banks take greater risk when other banks do so, because support is more likely when there are multiple failures. Third, the expectation of support increases the probability of the kind of systemic crisis that government basically tries to avoid (Acharya & Yorulmazer, 2007; Diamond & Rajan, 2009; Farhi & Tirole, 2011). Excessive risk-taking in an institution may result in bankruptcy, causing repercussions that are soon felt in the rest of the banking sector and, before long, in the economy as whole. One of the commonest forms of intervention is deposit insurance (García-Marco & Robles-Fernández, 2008). According to Ciancanelli and Reyes-Gonzalez (2000), If the risks taken result in a bankruptcy that is perceived to be threat to the system, the owners are bailed out. It has been documented in the bank literature of various countries that some banks are “too big to fail” and regardless of the risky lending behavior engaged in, they are inevitably bailed out because not to do so would threaten the banking system (Goodhart, Hartmann, Llewellyn, Rojas-Suarez, & Weisbrod, 1998; Mishkin, 1992; Vittas, 1992).

We think that there are many elements that can affect big banks to take more risk. For example, as a result of deposit insurance system, moral hazard will affect the banks inducing them to operate on a high level of risk. The same happens for “Too-Big-To-Fail” policy. Based on the above discussion, the coming hypothesis is as follows:

H6: There is a significant and positive relationship between deposit insurance and risk taking.

H7: Bigger banks can be affected by moral hazard linked to financial help in case of bankruptcy.

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H8: Moral hazard increases the risk taking incentives in banks with concentrated ownership more than banks with dispersed ownership.

Types of Banks

Public and Private

Sapienza (2004) stated that in 1995, the average percentage of state ownership in the banking industry around the world was about 41.6%. The nature of bank ownership influences bank performance and risk-taking i.e. private banks are expected to be more efficient than public owned banks. Relating to risk-taking of banks, previous researches associate bank organizational form with its risk-taking behavior (Cordell, Mac Donald, & Wohar, 1993; García-Marco & Robles-Fernández, 2008; Verbrugge & Goldstein, 1981). The social view sees privately and state owned enterprises have a big difference, because the first maximizes profits and the latter maximizes broader social objectives. Iannotta et al. (2007) show that public banks (or government owned or controlled banks) usually pursue industrial policies and provide loans which may not be profitable enough for the private sector. In other words, the effects of polarization of decision making could be divergent; politicians could try to conserve banks existence or, alternatively, to finance non profitable projects increasing bank’s risk. According to (Berger, Clarke, Cull, Klapper, and Udell (2005); Cornett, Guo, Khaksari, and Tehranian (2010); Iannotta et al. (2007)) state-owned banks have poorer loan quality and higher default risk than privately owned banks. This consistent with the view that government-owned banks are run by political bureaucrats and their decisions are dictated by political interests (Iannotta et al., 2007). Furthermore, Eichler and Sobański (2012) argue that public stakes increases moral hazard incentives of banks through implied bail-outs and could tempt managers to accept riskier lending and investment policies. Moreover, in some cases, they have also found that government-owned banks present direct credit for political purposes (Cole, 2004; Sapienza, 2004). Moreover that, individual state-owned banks have relatively low efficiency and high nonperforming loans and therefore a high risk taking and insolvency risk (Barth, Caprio, & Levine, 2004; Berger et al., 2005; Berger, Demirgüç-Kunt, Levine, & Haubrich, 2004; La Porta, Lopez‐de‐Silanes, & Shleifer, 2002).

An interesting empirical study by Iannotta et al. (2007) analyzed the effect of ownership structure on European banks' and their risk level from 1999-2004. The study considers both dimensions of ownership structure "ownership nature and concentration". Privately-owned stock banks (POB) and government-owned banks (GOB) and using different risk proxies it suggests that public sector banks have poorer loan quality and higher insolvency risk than banks with other ownership types. The study argued that GOBs come in line with its role in a country’s banking system this evidence through the role, which usually pursue industrial policies directed at remedying market failures and presenting loans that POBs would not grant. Other studies also

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show the increase of banks fragility when they are owned by the government (Eichler & Sobański, 2012; La Porta, Lopez‐de‐Silanes, et al., 2002). Srairi (2013) investigated the impact of ownership structure on bank risk. He compared risk-taking behavior of conventional and Islamic banks in 10 MENA countries under three types of bank ownership (family-owned, company-owned and state-owned banks) for the period 2005-2009. He found that government banks had greater credit risk than privately owned banks.

We think that governmental banks concentrate on the social and developmental sides more than on maximizing the profits, so we can find this banks suffering from high level of risk taking. Pursuant to the above discussion, the proposed hypothesis is:

H9: There is a significant and positive relationship between banks with large government ownership and risk taking.

Family and Non-Family

The success of family firms connected with the stability of the family, so the stability of the family consider to result in a strength for the firm but the instability of the family consider to be a source of weakness (Pollak, 1985). The type of shareholders could also represent a source of risk in firms. Family companies, for example, may also avoid risk taking because their main objective is to transfer a firm to the next generation (Anderson, Mansi, & Reeb, 2003). As Gomez-Mejia, Haynes, Nunez-Nickel, Jacobson, and Moyano-Fuentes (2007) explain, family owners take into account not only financial interest but also non-economic goals like identity, reputation (Berrone, Cruz, & Gomez-Mejia, 2012), employment for family members (Kellermanns, Eddleston, Barnett, & Pearson, 2008) and a long term view that involve the transmission of the business to next generations and the perpetuation of the family dynasty (Wilson, Wright, & Scholes, 2013). Consequently, they put more interest in the survival of the firm than wealth maximization and they have incentives to reduce the variability of cash flow and the risk of the company (Anderson & Fraser, 2000; Burkart et al., 2003). Indeed, Anderson et al. (2003) and Burkart et al. (2003) observe that firms with more active involvement by the founding family tend to perform better financially.

Traditional agency problems in family firms will be lower than in nonfamily firms because of better alignment of interests. As a result, family principles would be more likely than non-family firm’s principals to avoid strategic choices that carry a significant risk of financial losses because family wealth is heavily tied up in the one firm. Sacristán-Navarro, Gómez-Ansón, and Cabeza-García (2011) said that because of their concentrated ownership, family members also have more power than other shareholders to achieve their goals. Anderson and Reeb (2004) and Shleifer and Vishny (1986) found that large and undiversified shareholders, such as those found in family firms, may include the company's risk aversion by avoiding high risk projects. As a result, family only makes risky investment when it is important to sustain the firm in the future (Miralles-Marcelo, del Mar Miralles-Quirós, & Lisboa, 2014) and in general,

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they present a lower level of long term investment in comparison with non-family ones (Anderson, Duru, & Reeb, 2012; Miller, Breton‐Miller, & Lester, 2011).

Hiebl (2012) shows that risk aversion can be affected by the number of family generations implicated in the management, the share of equity owned, the family firm generation and the fact that the family firm is run by the founder. The presence of non-family managers and non-family directors seems to bear a negative influence on risk aversion (Casillas, Moreno, & Barbero, 2011; Miller et al., 2011; Stanley, 2010). This relationship is explained by non-family professionals bringing more risk appetite to the family firm (Stanley, 2010).

Some also analyzed the personal characteristics of the family member managing the business and his influence on risk-taking behavior. The age and tenure of the family manager lead to higher risk aversion (Xiao, Alhabeeb, HONG, & Haynes, 2001). These findings are explained by older family members not wanting to risk the family firm's fortunes in the last few years of their active working lives. The size of the company may also be a factor affecting the risk aversion of the family firm. Most of studies show that larger family firms have a higher propensity for taking risks (Casillas et al., 2011; Xiao et al., 2001). The results concerning ownership concentration are also contradictory. While Bianco, Bontempi, Golinelli, and Parigi (2013) show that the existence of a large individual shareholder fosters risk aversion, Nguyen (2011) argues that a high level of ownership concentration fosters risk taking.

The existence of owning families can adversely affect the company performance and consider that family controlled businesses (FCB) suffer from some problem such as a lack of professional management (Claessens, Djankov, & Lang, 2000; Schulze, Lubatkin, & Dino, 2003), expropriation of minority shareholders (Morck & Yeung, 2003), inadequate capital structure due to its growing number of family members (Chandler, 1990), and skepticism by financial markets (Claessens, Djankov, Fan, & Lang, 2002).

There are even fewer studies on the relationship between family ownership and bank risk (Lin & Wu, 2010). Family banks have incentives to take less risky projects (Anderson et al., 2003). In family banks, executive managers are limited to family members. This causes alignment with the risk preferences of managers and owners, leading to overall decrease in bank's risk. Also, Naldi, Nordqvist, Sjöberg, and Wiklund (2007) and Barry, Lepetit, and Tarazi (2011) find that family controlled businesses generally exhibit lower risk than non-family businesses. However, other studies (e.g. (Laeven (1999); Nguyen (2011); Villalonga and Amit (2006)) find that family-controlled banks are associated with significantly higher risk. In empirical study of Srairi (2013), the results reveal that family owned banks appear to assume lower risks. For this type of shareholders, the results suggest that family Islamic banks have a lower level of credit risk compared to conventional or commercial banks. Also it shows that Family conventional banks tend to have relatively higher levels of credit risk compared to family Islamic banks.

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The effect of corporate governance on risk taking also is affected by the presence of large investors. In particular, the presence of institutional investors1 has been analyzed by several papers (Davis, 2002). Erkens et al. (2012) define institutional ownership as the percentage of shares held by institutional money managers. The overall objective of institutional investors is to create the maximum level of return to their beneficiaries, given a certain level of risk. This puts pressure on corporate managers to make the company look attractive to institutional investors and to create more shareholder value (Hellman, 2005). The institutional investors can be considered a measure of how much potentially oversight management is subject to active large shareholders. A larger number would indicate more oversight and hence better corporate governance (Dittmar & Mahrt-Smith, 2007). Institutional investors can be active participants in the corporation’s governance; they can provide monitoring of a firm’s strategies to insure responsiveness and exercise significant voting power and they can exerted a significant, positive influence on risk taking. Moreover, the presence of institutional investors and venture capital firms were found to exert pressure on the family firm management team to take on more risk to enhance performance (George, Wiklund, & Zahra, 2005). Also, Setiyono and Tarazi (2014) argued that the presence of institutional investors as a second stage block holder in family controlled banks tends to reduce risk-taking and improving performance. Apart from this speech, recently there are a new point of view says that the institutional investors usually have short term objectives and take decisions without looking long term, this can supposed to increase the risk in order to obtain greater short term benefits, and may be they will collect there short term and rapid earnings and leave the companies.

We can touch that family banks may pay their attention for the banks policies and investments to make sure that the bank is operated at a low level of risk taking because the want to let their banks continue for the coming generations of their family, so the priority is not to maximize the profits, it’s to protect the bank. Thus, the hypotheses to be tested as follows:

H10: There is a significant and negative relationship between banks with large family ownership and risk taking.

H11: There is a significant and positive relationship between banks with large institutional investor ownership and risk taking.

Islamic and Non-Islamic

The first signs of an Islamic banking system appeared in the early 1970s in the United Arab Emirates (Said, 2012). Thereafter, many private and semi-private commercial Islamic banks were created in Saudi Arabia, Egypt, Sudan, Kuwait, and Bahrain after 2005 (Iqbal & Molyneux, 2005). Esam and Ezzat (2014) argue that Islamic financial institutions becomes of utmost importance in light of the enormous growth rates experienced in the industry. Islamic banks are operating and providing Islamic banking services in more than 57 countries all over

1 Such as: pension funds & plans, insurance companies, mutual funds and bank trusts.

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the world (Fayed, 2013). Furthermore, Ernst & Young World Islamic Banking Competitiveness Report (2013-2014) also shows that  their annual growth rate of 17.6%, this considered among the highest industry growth rates in the world and its rapid growth has been noted by academics, policy makers, industry professionals and practitioners (Beck, Demirgüç-Kunt, & Merrouche, 2013; Čihák & Hesse, 2010; Sundararajan & Errico, 2002). Abedifar, Ebrahim, Molyneux, and Tarazi (2014) mentioned that The Shariah compliant services now sum-up to a global industry amounting to around $2 trillion in assets, of which 80% is accounted for by Islamic banks (or Islamic windows of conventional banks), 15% Sukuk (Islamic bonds), 4% Islamic mutual funds and 1% Takaful (Islamic insurance). According to the Islamic Financial Services Board (2013), Iran is the biggest Islamic banking market (accounting for around 40% of global Islamic banking assets) followed by Saudi Arabia (14%), Malaysia (10%) and the United Arab Emirates (UAE) and Kuwait (both with 9% shares).

While Islamic banking and financial assets comprise under 1% of total global financial assets (given Credit Suisse’s (2013) estimates of world financial assets) it is a sector that has grown faster than conventional (Western) finance since the 2007/8 banking crisis, and this trend is expected to continue into the near future (Abedifar et al., 2014). Čihák and Hesse (2010) defined Islamic or Shariah-compliant banking as the provision and use of financial services and products that conform to Islamic religious practices, the rules of Shariah, known as Fiqh al-Muamalat (Islamic rules on transactions) and laws. The basic principle of Islamic banking is the sharing of profit-and-loss (PLS) and the prohibition against the payment and receipt of interest at a fixed or predetermined rate (ribá) (Esam & Ezzat, 2014). PLS is defined as a contractual arrangement between two or more transacting parties, which allows them to pool their resources to invest in a project to share in profit and loss (Dar & Presley, 2000). In PLS modes, the rate of return on financial assets is not known or fixed prior to undertaking the transaction (Čihák & Hesse, 2010). So instead of banking activity which based in (ribá), we can find others, like profit-and-loss sharing arrangements (PLS) or purchase and resale of goods and services form the basis of contracts. The most important feature of Islamic banking is that it promotes risk-sharing between the provider of funds (investor) and the user of funds (entrepreneur) (Dar & Presley, 2000). Amongst the common Islamic operations used in Islamic banking are profit sharing (Mudharabah), joint venture (Musharakah), cost plus (Murabahah) and leasing (Ijarah). The absence of interest of any kind of these transactions is based on a Shariah principle that considers the charging of interest as usury (ribá) and forbids the practice for Muslims (Ariff, 2006). So it's clear that avoiding pre-established interest payments in all transactions is the main difference between Islamic banks and Conventional or Commercial banks.

The Shariah Supervisory Board (SSB) is another difference in the governance structure between Islamic banks and Conventional banks, It exists in addition to typical bank board governance structures, but its functions are mainly to certify (ex-ante) and to monitor (ex-post) all financial contracts, transactions and further activities of a bank on behalf of shareholders,

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stakeholders and clients to ensure that they are compliant with the Shariah (Alman, 2012). Moreover that and upon several studies (El-Hawary, Grais, & Iqbal, 2007; Grais & Pellegrini, 2006; Van Greuning & Iqbal, 2007; Warde, 2000), protecting the interests of the depositors from excessive risk-taking on the asset side is also a function of SSB.

Before moving on, however, it is worthwhile to point out that Islamic banking has the same purpose as conventional banking which is making profit. From other hand the difference between Islamic banks and Conventional banks is more apparent in another area (moreover the prohibition of pre-determined interest rate, PLS and etc.) which is risks and risk management. The distinct nature of the relationship with clients and different kinds of financing and investing activities entail unique risks besides generic risks faced by the Islamic banks. The common risks faced both by Islamic and Conventional banks are credit risk, market risk, operational risk and liquidity risk. However, Risks unique to Islamic banks arise from the specific features of Islamic contracts, as follow: Shariah non-compliance risk, Rate of return risk, Displaced Commercial risk, Equity Investment risk, Inventory risk (Helmy, 2012). Concerning the risk taking incentives in banks, we can find that according to the agency theory, the Islamic bank acts as an agent in investing the depositors' funds, while the depositors are the principals. The moral hazard problem that arises from this relationship will give the bank incentives to take risk (Bashir, 1999). And also we can think in another approach which says that since the Islamic banks offer no fixed returns nor guarantee the nominal values of their deposits, bank managers have less incentives to pursue risk-taking behavior (Bashir, 1999).

Srairi (2013) finds that state Islamic banks tend to be more stable than state conventional banks. Islamic banks have a lower exposure to credit risk than conventional banks. Čihák and Hesse (2010) assessed empirically the Islamic banks’ impact on financial stability, based on evidence covering individual Islamic and commercial banks in 18 banking systems with a substantial presence of Islamic banking, they found that (i) small Islamic banks tend to be financially stronger than small conventional banks; (ii) large conventional banks tend to be financially stronger than large Islamic banks. Hassan and Mollah (2011) executed an empirical study using a paired-sample of 84 Islamic and conventional banks from Bangladesh, Bahrain, Malaysia Pakistan, Saudi Arabia, United Arab Emirates and United Kingdom over the period of 2006-2009, they found that the corporate governance and financial disclosure indices emerged as the key driving forces for risk-taking for Islamic banks.

Upon the fact the Islamic bank works as an agent for investors to make investment for the investors interest upon the PLS policy, we think that makes managers not to be fully care for their decisions and the level of the risk that they accepting it, so we may find that Islamic banks take an aggressive funding decisions and policies which mean exposing the bank for high risk. These arguments lead to the coming hypothesis to be tested as follow:

H12: There is a significant and positive relationship between Islamic banks and risk taking.

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Corporate governance quality

The Basel Committee on Banking Supervision (BCBS) has payed attention to understand, and improve the corporate governance of financial entities. The core of The Basel Committee on Banking Supervision (BCBS) message is the persuasion that good corporate governance increases monitoring efficiency. Moreover, the Committee considers that corporate governance is necessary to guarantee the soundness of financial system (BasleCommittee, 2006).

Good corporate governance ensures that companies use their resources more efficiently, protects minority shareholders, leads to better decision making, and improves relations with workers, creditors, and other stakeholders. It is an important prerequisite for attracting the patient capital needed for sustained long-term economic growth (WorldBank, 2009). Studies have shown that good corporate governance practices have led to significant increases in economic value added (EVA) of firms, higher productivity, and lower risk of systemic financial failures for countries (WorldBank, 2009). The enhancement of corporate governance practices remains instrumental to better protect investors, enhance company oversight, and increase confidence in capital markets (WorldBank, 2009).

The conflict of interest between shareholders and creditors of banks and the problem of excessive risk taking depends on the governance structure of banks. High quality of banks governance implies that shareholders' objectives have a large weight in managers' incentives. Manager’s interest, on the other hand, can be assumed to be more oriented towards their own reputation and job security. Managers can be expected to be less willing to take risk if their own interests weight stronger than shareholders' (A. Angkinand & Wihlborg, 2010). We employ multiple measures of internal and external corporate governance including country level and bank level measures. These governance measures are collectively examined in many international corporate governance literature and collectively suggest internal and external dimensions for governance. Thus, these measures capture some of the most important elements of governance that are likely to affect the risk taking behaviors, incentives and decision making.

Many authors (Klapper & Love, 2004; Shleifer & Wolfenzon, 2002) have suggested that under certain conditions firms were able to adjust their internal governance mechanisms in effort to compensate for a weak legal environment and enhance investors’ protection. Klapper and Love (2004) implemented an extensive study ranking 495 from 25 emerging countries found an evidence that the quality of corporate governance mattered more in countries with poor legal environment.

Meanwhile that high corporate governance means that shareholders' objectives have a large weight in managers' behaviors and they will manage the bank in a way that involve in accepting high level of risk for maximizing the profits and the returns for shareholders. Also, good corporate governance mitigate the agency problem because the board is good monitoring for managers, with the possibility to replace them upon their performance (Franks et al., 2001).

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Laeven and Levine (2009) bank risk is higher in banks that have large owners. In addition, we think that the corporate governance is a very important in affecting the level protection of shareholders rights and investors properties. This may come because that corporate governance means more enhancing for company oversight, internal company control mechanisms and leads for better decision making, and this may result in better investor’s protections. Hence, the first formal hypothesis to address in this study is as follows:

H13: Corporate governance at country level, has a significant and positive impact on risk taking.

H14: Corporate governance at bank level, has a significant and positive impact on risk taking.

H15: Countries with high level of corporate governance has a high level of investor protection.

The HypothesisAccording to our previous literature analysis, we suggest the following hypotheses

regarding Corporate Governance and other related issues, as it’s appear in the following table No.1:

Table 1 the Proposed Hypothesis

Agency Theory H1: Ownership concentration has a significant and positive effect by inducing bank managers to increase risk taking.

Composition of the board H2: The board of director’s size has a significant effect and cause a reduction on risk taking.

Regulations H3: Stricter banking regulation has a significant and positive effect on risk taking at banks with concentrated ownership than on banks with no concentrated ownership.H4: Regulations may induce banks to be more engaged in off-balance sheet activities.

Property Rights / Investor Protection

H5: Investor protection has a significant and positive impact on risk taking.

Moral Hazard H6: There is a significant and positive relationship between deposit insurance and risk taking.H7: Bigger banks can be affected by moral hazard linked to financial help in case of bankruptcy.H8: Moral hazard increases the risk taking incentives in banks with concentrated ownership more than banks with dispersed ownership.

Public and Private H9: There is a significant and positive relationship between banks with large government ownership and risk taking.

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Family and Non-Family H10: There is a significant and negative relationship between banks with large family ownership and risk taking.H11: There is a significant and positive relationship between banks with large institutional investor ownership and risk taking.

Islamic and Non-Islamic H12: There is a significant and positive relationship between Islamic banks and risk taking.

Corporate Governance quality H13: Corporate governance at country level, has a significant and positive impact on risk taking.H14: Corporate governance at bank level, has a significant and positive impact on risk taking.H15: Countries with high level of corporate governance has a high level of investor protection.

A point which should be mentioned in this regard that we are not going to test all of these hypothesis upon the inability to reach for the needed data to test these variables, so the hypothesis which we are going to test are as in the following table No.2.:

Table 2 the Tested Hypothesis

Property Rights / Investor Protection

H1: Investor protection has a significant and positive impact on risk taking.

Moral Hazard H2: There is a significant and positive relationship between deposit insurance and risk taking.

Public and Private H3: There is a significant and positive relationship between banks with large government ownership and risk taking.

Family and Non-Family H4: There is a significant and negative relationship between banks with large family ownership and risk taking.H5: There is a significant and positive relationship between banks with large institutional investor ownership and risk taking.

Islamic and Non-Islamic H6: There is a significant and positive relationship between Islamic banks and risk taking.

Corporate Governance quality H7: Corporate governance at country level, has a significant and positive impact on risk taking.H8: Corporate governance at bank level, has a significant and positive impact on risk taking.H9: Countries with high level of corporate governance has a high level of investor protection.

(3)Data and Methodology

This paper tries to investigate more finely if there is an effect for Corporate Governance and interrelated factors on the risk-taking behavior in banks operating in some MENA countries for the period of 2005-2012. In order to determine and measure empirically the effect of

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corporate governance on risk taking during the last mentioned period, we will apply a dynamic panel data analysis. After revising the existing theoretical and empirical available literature, we will obtain our data from two sources. The first one is BankScope International Bank Database maintained by Fitch/Bureau Van Dijk, which provides information for financial institutions worldwide. The other one was hand collecting corporate governance data from the annual reports to complete the absence of relevant information in Bankscope database.

To conduct our analyses, we build a database on bank ownership, and other bank-specific and country level variables. The data sample comprises 165 banks gathered from MENA countries as follows: Bahrain 26, Egypt 19, Iran 2, Jordan 16, Kuwait 16, Lebanon 12, Libya 4, Oman 9, Qatar 10, Saudi Arabia 12, Sudan 13, Syria 7 and finally United Arab Emirates 19. There are some countries like Algeria, Iraq, Israel, Morocco, Tunisia, and Yamen where we couldn’t obtain their data either from the Bankscope database or by hand collecting, so we couldn’t to include it in the analysis. From other hand, as a result of the lake of our limitations on disclosure in some banks in MENA countries, it can be noticed a low number of banks in some other countries, like Iran and Libya. BankScope does not have a sufficient number of observations for banks for Palestine, so Palestine was excluded from the database. The distribution of banks by specialization shows that most banks are classified either as pure conventional banks (106) or as pure Islamic banks (48) or as a mixed-banks (11) which presents both conventional and Islamic banking services. The final sample contains about 1320 bank-year observations from 13 countries and it is a balanced panel set of 165 firms. A breakdown of the sample distribution across countries is reported in Table No3 . There is a point under this regard should be mentioned, that all banks operated in both Sudanese and Iranian Banking systems are pure Islamic banks, so these two banking systems are fully Islamic operated banks.

Table 3 Sample distribution across MENA countries

COUNTRY Totalwith large

family shareholder

With large government shareholder

With large institutional

investor

With Pure Islamic banks

With Pure conventional

banks

With Mix-Islamic and conventional

banksBahrain 26 9 4 21 12 14 0Egypt 19 4 4 17 2 17 0Iran 2 0 1 1 2 0 0

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Jordan 16 7 0 15 3 13 0Kuwait 16 2 2 16 6 10 0

Lebanon 12 9 1 9 0 12 0Libya 4 0 4 1 0 4 0Oman 9 4 1 8 0 9 0Qatar 10 1 3 9 3 7 0Saudi

Arabia12 2 1 11 4 1 7

Sudan 13 4 7 11 13 0 0Syria 7 4 1 7 1 6 0

U.A.E. 19 10 8 16 3 11 5165 56 37 142 49 104 12

Measures of Dependent variables

Risk-TakingOur main measure of bank risk taking is Z-Score, The z-score has become a popular

measure of bank soundness (see, e.g., (Boyd & Graham, 1986; Boyd & Runkle, 1993; Čihák & Hesse, 2010; Worrell, Maechler, & Mitra, 2007). It is used frequently in many of the research papers discussed in our literature review as a measure of bank insolvency risk and serves to determine the financial stability and risk taking of an entity. We primarily measure bank risk using the z-score of each bank. The z-score provides an objective measure of soundness because it focuses on the risk that a bank runs out of capital and reserves. This measure is calculated as determined in the following way: 𝑍 ≡ (µ + k)/σ where: μ is the ROAA (Return on Average Assets), k is the balance of capital relative to total assets of the entity (Equity / Total assets), and σ is the standard deviation (volatility) of ROAA. The z-score measures the distance from insolvency or the distance to default, with larger values indicating lower overall bank risk (e.g. (Beltratti & Stulz, 2012; Boyd & Runkle, 1993; Houston, Lin, Lin, & Ma, 2010; Laeven & Levine, 2009)). Thus, “Z” indicates the number of standard deviations that a bank’s ROA has to drop below its expected value before equity is depleted. A higher Z-score indicates that the bank is more stable and lower probability of default risk.

Variables Definition Source

Z-score Measure of Insolvency risk Z-score=(ROAA+Equity / Total Assets)/σ ROAA

Authors’ calculations based on BankScope data.

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Measures of Independent variables

1- Corporate GovernanceCorporate Governance, in common, has two main parts: country-level as well as firm-

level mechanisms. The former include laws, culture and the institutions that enforce the laws. The latter is relative to internal mechanisms that operate within the firm. Each one of these two levels of corporate governance has its own way to be measured, as follows:

A -Corporate Governance–Country Level

As proxies for country-level governance, we use the country-level indicators of (Beltratti and Stulz (2009); Čihák and Hesse (2010); Erkens et al. (2012); Kaufmann, Kraay, and Mastruzzi (2009)). This index is commonly known as The Worldwide Governance Indicators (WGI). The Worldwide Governance Indicators (WGI) are a research dataset summarizing the views on the quality of governance provided by a large number of enterprises, citizens and experts survey respondents in industrial and developing countries. These data are gathered from a number of survey institutes, think tanks, non-governmental organizations, international organizations, and private sector firms. The Worldwide Governance Indicators project constructs aggregate indicators of six broad dimensions of governance: political stability, absence of violence/terrorism, government effectiveness, regulatory quality, rule of law, control of corruption and the extent to which a country’s citizens are able to participate in selecting their government. The six aggregate indicators are based on 31 underlying data sources reporting the perceptions of governance of a large number of survey respondents and expert assessments worldwide. The WGI counted on annual base for all countries all over the world since 1996 till now. We follow Kaufmann, Kraay, and Zoido (1999) and we consider the mean of the six variables for each country. Then we construct a single index per country. This index captures cross-country differences in institutional developments that might have an effect on banking risk and that’s why it called “Institutions Index”; a higher value of the index indicates better institutions.

B -Corporate Governance–Firm “Bank” Level

We follow Lel (2012) in measuring the firm-level internal governance index. The index was built taking into account two dimensions considered important by the literature in accessing corporate governance quality: (1)ownership structure, namely ownership concentration and the identity of the major shareholders (wedge between cash flow/voting rights, differential voting right, institutional and family large ownership and state ownership), and (2)board matters (separation of chairman/chief executive officer roles). This index is comprised of seven widely used governance measures hand-collected from the firms’ annual reports. In particular, this index is constructed as follows:

1. A firm earns one additional point if the role of CEO and chairman are separated (e.g., (Jensen (1993); Yermack (1996)),

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2. A firm earns one additional point if there is no wedge between cash flow and voting rights of the largest managerial shareholder (e.g., (La Porta, Lopez‐de‐Silanes, et al. (2002); Lins (2003)). According to Caprio et al. (2007) the wedge equals the difference between control rights and the cash flow rights of the controlling owner. The wedge equals zero if there is no controlling owner,

3. A firm earns one additional point if there are no stocks with differential voting rights (e.g., Doidge (2004)),

4. A firm earns one additional point if there is at least one non-managerial and non-institutional large shareholder (e.g., (Mitton (2002); Shleifer and Vishny (1997)),

5. A firm earns one additional point if there is an institutional large shareholder (e.g., (Allen and Gale (2000); Gillan and Starks (2000)),

6. A firm earns one additional point if there is no large family shareholder (e.g., (Faccio, Lang, and Young (2001); Shleifer and Summers (1988)),

7. finally, a firm earns one additional point if there is no state ownership (e.g., (Boycko, Shleifer, and Vishny (1995); Shleifer and Vishny (1997)).

Following Chang (1998), we define block holder or large shareholders as a beneficial owner of 5% or greater of outstanding shares. Also, most of the stock exchange markets in MENA countries consider a 5% of ownership as a major or large shareholder (e.g. Saudi Stock Exchange, Qatar Central Securities Depository). This index ranges from 0 to 7. Consistent with the literature, the degree of monitoring of managerial activities is expected to increase with higher values of this index. So high degree means high corporate governance and vice versa.

2- Property Rights/Investor ProtectionFor measuring the property rights, we follow Hasan, Kobeissi, and Song (2011). They use

property rights from heritage economic freedom index to measure country-level investor protection and construct the variable Property Rights. The Index of Economic Freedom is an annual index and ranking created and published by The Heritage Foundation and The Wall Street Journal in 1995 to measure the degree of economic freedom in the world's nations. They measure economic freedom based on 10 quantitative and qualitative factors, grouped into four broad categories, or pillars, of economic freedom, every one of these four main points measured by some sub-titles, as follow: Rule of Law (property rights, freedom from corruption), Limited Government (fiscal freedom, government spending), Regulatory Efficiency (business freedom, labor freedom, monetary freedom) and finally Open markets (trade freedom, investment freedom, financial freedom). Each of the ten economic freedoms within these categories is graded on a scale of 0 to 100. A country’s overall score is derived by averaging these ten economic freedoms, with equal weight being given to each.

3- Nature of OwnersWe construct this variables by hand collecting data from its annual reports during the

period from 2005 till 2012. We use the same criteria explained before based on Chang (1998). According to Davydov (2015), Several institutional ownership measures are used based on the literature (e.g., Parrino, Sias, and Starks (2003) and (Burns, Kedia, and Lipson (2010)). Block-holders are shareholders that own at least 5% of a company’s total shares outstanding. The same 5-percent cutoff was used by L. Porta et al. (1999), Claessens et al. (2000), Sarkar and Sarkar (2000) and Faccio et al. (2001). So we highlight banks with family ownership, state ownership and institutional investor ownership.

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4- Size of Ownership

In order to gauge it, we differentiate between two variable, Large Shareholders and Concentrated Ownership. We construct the large shareholder dummy variable by considering a bank as having a large owner if the shareholder has direct and indirect voting rights that sum to 10% or more, following to Maury and Pajuste (2005). So we create the variable as a dummy variable equal to 1 if a firm has a large owner with voting rights greater than 10%, if not it will equal to Zero. Regarding the Concentrated Ownership we follow Laeven and Levine (2008) by using a 20% cutoff to define a Concentrated Ownership. They defined ownership concentration as the share of equity held by the owners when he controls directly or indirectly more than 20% of the shares. While direct ownership involves shares registered in the shareholder’s name, indirect ownership involves bank shares held by entities that the ultimate shareholder controls. The 20% threshold is used here following the corporate control literature which suggests that 20% ownership is often sufficient to control a company (Cornett et al., 2010). So we create the variable as a dummy variable equal to 1 if a firm has a Concentrated Ownership with voting rights greater than 20%, if not it will equal to Zero.

5- Deposit insurance coverage limit/GDP per Capita:It is the ratio of the coverage limit to per capita GDP, expressed as a percentage, and

based on the statutory coverage limit. We obtain this variable by dividing the deposit insurance coverage limit for every country in different years, by the GDP per Capita for every country on annual base, we follow most of studies related for this subject such as Demirgüç-Kunt, Kane, and Laeven (2014) & Barth, Lee, and Phumiwasana (2006).

Measure of Other Country-Level VariablesConcerning macroeconomic variables, we include a number of variables that take on the

same value for all banks in a given country. We include three macroeconomic variables which consider the impact of the macroeconomic cycle. First, we introduce GDP growth to monitor the effect of fluctuations in the business cycle and the trend of economic growth in general. Second, we follow John et al. (2008) by using the variable GDP per capita as an indicator of the general level of economic development. According to Demirgüç-Kunt and Huizinga (2010), banks in developed countries get less return on assets, and have less risk than in developing countries. Third, we control for inflation.

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(4)Descriptive Statistical Analysis and Main Variables

We start by reviewing our sample statistics. Table No.4 provide the descriptive summary statistics for the main variables in the sample used in the regressions. Our sample includes 165 banks from 13 countries. Statistics are based on the annual data for the period 2005-2012. We have got around 1320 bank-year observations. The aforementioned table presents several descriptive statistics regarding our variables interest.

Table 4 Descriptive statistics of main regression variables

Variable Obs. Mean Std. Dev. Min MaxBank LevelZ-Score 1203 24.39 25.26 -7.76 238.36logZscore 1196 2.82 0.91 -2.08 5.47CGFL 1319 5.80 0.75 4 7BanImpFamSt 1320 0.34 0.47 0 1BanImpGovSt 1320 0.22 0.41 0 1BanImpInsInvSt 1320 0.86 0.35 0 1IslBank 1224 0.32 0.47 0 1ROAA (%) 1201 2.05 4.82 -37.98 31.11TotAss (mil) 1203 8355.31 13894.40 28.35 100784.00ImpLoan 798 286.76 645.31 0 9151.42NetLoaTotA (%) 1137 44.30 21.51 0 98.19CosToInc (%) 1111 46.02 18.36 15.69 120GrowGroLoa (%)

1037 17.98 25.55 -39.31 126.88

EquAss (%) 1203 0.22 0.21 -0.13 0.99LoanlossTA(%) 1036 0.01 0.01 -0.06 0.15ImpLoanTA(%) 798 0.04 0.06 0 0.72

LoLoPro(%) 1036 49.94 131.51 -185.52 1486.53Country LevelWGI “CGCL” 1320 -0.19 0.62 -1.62 0.79ProRigIndex 1064 46.94 12.79 10 70DIClim/GDP per capita (time)

640 3.67 5.23 0.32 36.24

GDPgro (%) 1306 5.54 7.93 -62.08 104.48GDPperCap ($) 1306 22280.17 22376.16 751.42 99731.10Infl (%) 1306 6.13 5.59 -4.87 35.55

Source: Bankscope database, Banks annual reports, Authors’ calculations based on BankScope data and annual reports, Authors’ calculations based on the Worldwide Governance Indicators (WGI), Property Rights from heritage economic freedom index, IMF publications.

The variables are subdivided in two groups, Bank level and Country level variables. The first group “Bank Level” variables, Bank level variables are mainly constructed from both the Bankscope database and manually collected data from the annual reports of the banks. We use

29

the natural logarithm of z-score in our regressions because the distribution of z-score is highly skewed. An average bank in the sample has a logzscore of 2.82 and this result is similar to Anginer, Demirguc-Kunt, and Zhu (2014) which was 3.5 in their sample countries over the time period 2004- 2009, the mean value is 2.82, with standard deviations of 0.91. CGFL shows that banks in our sample have a high CGFL score with a mean value of 5.80. These primary results help in the interpretation that the corporate governance on the bank level is good2. In addition, in 34% of the banks in the sample is important the presence of family ownership but the standard deviation evidence important differences between countries and institutions. Something similar happens in the case of the State participation in banks' capital, since in 22% of the sample public participation is significant, although again there are significant differences between countries3. Moreover, institutional investors have a strong presence in our sample. In fact, about 86% from our sample have an institutional investor with important stake4. Also, the presence of Islamic banks in the whole sample is important (32%) but with important differences between countries. This differences arise because in some countries all the banks are Islamic (Iran & Sudan), in other cases like Saudi Arabia banks operated by both conventional and Islamic ways and, finally, there are some countries without the presence of any Islamic banks like Lebanon and Libya5. About 2% is the average of economic profitability measured by the “ROAA”. this measure is a very important one because a higher profitability rate means that such banks can raise extra equity capital at lower transaction costs, which enables them to generate larger growth in equity and assets and eventually to become larger (Barry et al., 2011). The average of the total assets for banks in our sample about 835 Millions $. The average of the total assets that are invested in the loan portfolio (by Net) is 44%. The CosToInc, as an efficiency measure and it is affected not only by banks’ costs, but also by variations in incomes, it has an average of 46% in our sample, its good if compared to some other developing countries banking sector like Kenya which estimated by 68% for the period between 1998 to 2007 (Mathuva, 2009). The banks in our sample have a distinguished growth level of gross loans GrowGroLoa with an average of 18% but when we take the standard deviation which is equal to 26% we can imagine the big gap between the banks inside the sample especially when we found the minimum value is -39 and the maximum one is more than +127, this can justified by the differences in the business environment for countries inside the sample. The equity on assets average is 22% which shows the banks have a good level of capital comparatively with their assets, even that the standard deviations is 21% which shows that there are serious differences between the banks within the countries.

The second group which is “Country Level” contains the following variables, WGI is a variable obtained from the Worldwide Governance Indicators as a corporate governance country level measure “CGCL”, its average value -0.19 with standard deviation of 0.62, which shows

2 In gathering CGFL we found that: (1) the vast majority of the banks have an equal voting rights and cash flow rights. (2)There is no shares with differential voting rights. (3)Most of banks shareholders structure is tends to be stable, so you will find it almost the same big shareholders for most of the years.

3 We consider “Central Banks” as governmental shareholder. Central Banks stakes in banks ownership are considered as Governmental ownership.

4 We consider the “Investment Funds” which owned by Governments, as “an Institutional Investors” and Also, Sovereign wealth funds (SWF) were considered as Institutional Investors.

5 Most of banks operated in Saudi Arabia are operating by both ways the conventional (Commercial) and Islamic.

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that there is some differences between countries, this differences scattering between -1.62 and 0.79. The mean value of ProRigIndex (Property Rights Index) is 46.94 with a standard deviation of 12.79, we can notice that there are some differences between the level of investors protection (minority shareholders protection) within the countries inside the sample (from 10 to 70) and this off course reflects the level of differences between countries in the main pillars which comprise the index like rule of law, regulatory efficiency and open markets. DIClim/GDPpercapita is the Deposit Insurance Coverage limit divided by GDP per capita, its average is 3.67 and measured by times and we can see the large variances between countries within our sample as that the range is appeared between less than half time to more than 36 times.

The average GDP Growth is 5.54% with standard deviation up to 8%, this average tend to appear fair enough but regarding the extreme maximum and minimum values, it refers for Libya during the years of revolution and civil war especially in the years of 2011 (-64%) and 2012 (104%). GDPperCap is the GDP per capita of the respective country measured in thousands of $ U.S., its annual average is $22280 with a range between $751 (like Sudan) and $99731 (like Qatar) which reflects the serious gap between the countries in our sample. Infl is Inflation rate, its annual average for all countries compromise the sample is %6.13, and also it shows that there is a large difference between countries in this rate as appeared in the distribution of the values between the minimum -4.87 (Qatar) and the maximum 35.55 (Sudan) which reflects the large and strange differences between the economies and conditions of the countries compromised the sample.

Upon the abovementioned results regarding the country level indicators and factors, we can attribute that there are big differences in all macroeconomic variables and considerable variation across countries in the current circumstances and conditions for the countries forming the sample such as the implications of the Arab spring on some countries and unstable situation for some of them.

By reviewing Table No. 5, its shows the z-score for countries in our sample, we can notice that Bahrain came on the last position in 2005 with a 2.36 score and Qatar on the top with 3.52. Also, we notice that there are many fluctuations in z-score during this period for most of countries included in sample, except Kuwait scores which reflects the impact of the financial crises 2008, especially from 2008 to 2010, and then the score started to increase gradually. There are some other countries, called Arab spring countries, where we notice that its z-score started to decrease at the same time of starting its revolution, such as Libya which its z-score started to decline from 2011. The rest of countries relatively maintain its stable z-score during the period such as Sudan, Saudi Arabia and Jordan.

Table 5 Evolution of Log Z-Score by Country

Country 2005 2006 2007 2008 2009 2010 2011 2012Bahrain 2.37 2.46 2.51 2.43 2.49 2.36 2.49 2.54

Egypt 2.54 2.77 2.67 2.80 2.89 2.85 2.77 2.84

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Iran 2.41 2.32 2.51 2.17 2.17 2.56 -- --

Jordan 3.30 3.31 3.34 3.34 3.35 3.28 3.27 3.38

Kuwait 2.40 2.30 2.28 1.92 1.73 1.85 2.05 2.17

Lebanon 3.48 3.75 3.78 3.80 3.78 3.80 3.77 3.83

Libya 2.89 3.02 2.70 2.62 3.14 3.13 2.58 2.52

Oman 3.24 3.17 3.14 3.04 3.06 3.15 3.00 3.01

Qatar 3.52 3.55 3.34 3.32 3.32 3.27 3.35 3.27

Saudi Arabia

2.73 2.80 2.63 2.69 2.67 2.68 2.67 2.64

Sudan 2.80 2.91 2.95 3.14 3.03 2.99 2.94 2.72

Syria 3.46 2.61 2.31 2.44 2.15 2.14 2.98 2.81

Emirates 2.89 2.67 2.61 2.46 2.56 2.58 2.54 2.57

Source: Authors’ calculations based on BankScope data and annual reports

Table No. 6, presents the distribution of property within banks by different owners of various countries in our sample. We classified it in 3 main categories which are Banks with important Family, Government or Institutional Investor stake. We can notice that there is a high percent of important family property rights in banks of some countries like Lebanon, Syria, Emirates, Qatar and Jordan, while none of the Iranian and Libyan banks in the sample have any important family stake. From the other hand, all of Libyan banks have an important government share and contrary to that, we can find that Jordan have not any government stake. Also, about half of the banks in Emirates and Sudan have an important government ownership. By taking a look to the banks in the sample, we find that in some countries all of its banks have an institutional investor like Kuwait and Syria and the vast majority of the other countries have an institutional investor in more than half of its banks.

Table 6 Distribution of the ownership nature by CountryCountry Banks with

Important Family Stake

(BanImpFamSt)

Banks with Important Government Stake

(BanImpGovSt)

Banks with Important Institutional Investor

Stake(BanImpInsInvSt)

Bahrain 0.35 0.15 0.81Egypt 0.21 0.21 0.89Iran -- 0.50 0.50

Jordan 0.44 -- 0.94Kuwait 0.13 0.13 1.00

Lebanon 0.75 0.08 0.75

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Libya 0.00 1.00 0.25Oman 0.44 0.11 0.89Qatar 0.10 0.30 0.90Saudi Arabia

0.17 0.00 0.92

Sudan 0.31 0.54 0.85Syria 0.57 0.14 1.00

Emirates 0.53 0.42 0.84Source: Authors’ calculations based on annual reports

Cross-country comparisons of fundamental variables are listed in table No. 7, concerning The World Governance Indicator “WGI” which consider being a measure for Corporate Governance at the Country level “CGCL”. It shows that Qatar has the higher WGI with a 0.589 value and Sudan came in the last position in the WGI by -1.564. Also we can note that the most of the Arab spring countries have a negative WGI (Egypt -0.393, Libya -0.393, Syria -1.040). From other hand, most of Arab Gulf Countries, generally known as GCC Countries have a positive index value (Bahrain 0.090, Kuwait 0.181, Oman 0.228, Qatar 0.589, Emirates 0.494), except Saudi Arabia -0.353. Consistent with this low score for Saudi Arabia, the study of Al-Janadi, Rahman, and Omar (2013) provides evidence on the need of Saudi Arabia listed companies to adopt and implement better practices of corporate governance.

Relating the Corporate Governance Firm Level “CGFL”, appears that Saudi Arabia has the highest score with 6.5 and Libya has the lowest score with 5, while the remaining countries came in between these two values. Relating to the different scores for Saudi Arabia between CGCL and CGFL, we can see that the latter findings are consistent with the world bank report’s on the corporate governance country assessment for Saudi Arabia (2009), where it is mentioned to that many of the laws and regulations are still comparatively new and untested; awareness of the significance of good corporate governance is low. The report also presents some recommendations to continue the process of bringing the corporate governance in line with international best practices, including some recommended adjustments to the corporate governance regulation and more steps to turn the “law on the books” into practice, the same was mentioned in Harabi (2007) they noted that while some MENA countries have generally complied with OECD principles of good corporate governance, their compliance was only theoretical and tended to deviate in practice. From the other hand, because of that most of Saudi banks have an international bank as a strategic partner and this partner participate in both the board of directors and the executive management of the banks (e. g., Saudi British Bank, Banque Saudi Fransi, Saudi Hollandi Bank), this help Saudi banks to follow and implement the best practices corporate governance and other related banking best practices. Moreover, the banking sector which is regulated and supervised by the Saudi Arabian Monetary Authority (SAMA) imposes on banks many corporate governance mechanisms, procedures and Basel Committee issuances. In addition, most of Saudi banks hired and recruited international professional bankers in its key positions, Which was clear in one of the recent exploratory study focusing on governance in Egypt and Saudi Arabia found that corporate boards tend to be dominated by

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outside directors in Saudi Arabia and by inside directors in Egypt (Piesse, Strange, & Toonsi, 2012). All of these reasons resulted in good score for corporate governance on bank level.

In addition, Property Rights Index “ProRigIndex”, shows that Bahrain has the highest score with 62 and Libya & Iran came at the last position whereas this score drops to around 10, while Sudan has no score available for it. Finally, Deposit Insurance Coverage limit/GDP per capita “DICl/GDPpercapita”, shows that there is a considerable variation between countries. We can notice that 7 countries out of our 11 countries sample have not explicit deposit insurance system, while the remaining 6 countries ranking as follows: Libya by 20.926, Jordan 7.045, Oman 2.946, Bahrain 1.841, Sudan 1.373 and finally at the last position Lebanon with 0.431.

Table 7 By Country, Corporate Governance (County Level & Firm Level), Shareholder Rights and Deposit Insurance

Country WGI CGFL ProRigIndex DICl/GDPpercapita

Bahrain 0.090 5.745 62.143 1.841

Egypt -0.393 5.605 42.143 -

Iran -1.074 5.688 10 -

Jordan -0.020 6.008 52.857 7.045

Kuwait 0.181 6.078 50.714 -

Lebanon -0.664 5.250 29.286 0.431

Libya -1.038 5 10 20.928

Oman 0.228 6.111 50 2.946

Qatar 0.589 5.800 55 -

Saudi Arabia -0.353 6.505 46.429 -

Sudan -1.564 5.538 - 1.373

Syria -1.040 6 30 -

Emirates 0.494 5.737 46.429 -

Source: Authors’ calculations based on banks annual reports, the Worldwide Governance Indicators (WGI), Property Rights from heritage economic freedom index, IMF publications

(5)Estimation of Econometric Model

In the econometric estimation of the model we use the Generalized Method of Moments (GMM), through STATA package. The results are shown in Table No. 8. GMM estimation was formalized by Hansen (1982) and become one of the most widely technique used in testing empirical economic and finance models. The GMM estimators developed by (Arellano and Bond

34

(1991); Arellano and Bover (1995); Blundell and Bond (1998); Holtz-Eakin, Newey, and Rosen (1988)) and are designed for situations with “small T, large N” panels such as ours. Our regression model is estimated using Generalized Method of Moments (GMM), we obtained estimators using the moment conditions generated by lagged levels of the dependent variable. The advantage of GMM over other techniques is that the estimator only needs a set of moment conditions, with no needs for imposing restrictions on the distribution of the variables. The model can be expressed as a linear Dynamic Panel Data (DPD), which can be estimated directly by GMM.

In empirical applications, GMM has been preferred due to the structure of the problem and the availability of data and with an appropriate set of instruments. GMM estimates are robust to the presence of autocorrelation and heteroscedasticity, both of which one would expect to find in this type of data. GMM estimators are unbiased. Arellano and Bond (1991) Using simulations, they found that GMM estimators exhibit the smallest bias and variance. Estimates may be biased because we are not controlling for omitted variables, we therefore think that we may construct more efficient estimates by applying system GMM model. In this paper, we use GMM to estimate a risk taking model with corporate governance and other issues using MENA country’s firms (banks) level panel data. The explanatory variables used in this study might not be strictly exogenous. Accordingly, it is reasonable to consider that the main variable in our models is an endogenous variable as in previous studies on bank governance (e.g. (Anderson and Reeb (2004); Claessens and Yurtoglu (2013)).

In examining the impact of some corporate governance issues on risk taking, we estimate a model in the form of:

Y ¿=α +β Y ¿−1+γ [X ]¿+δ [C]¿+∑t=1

8

Year t+ε¿ (1)

Where {Y} rsub {it} is a dependent variable representing risk measures of a particular entity, “i” in period “t” and {Y} rsub {it-1” is its one period lag. and “X” it is a set of independent variables (CGFL: corporate governance firm level; WGI: corporate governance country level; ProRigIndex: property rights index; Islbank: Islamic bank; BanImpFamSt: bank with important family stake; BanImpGovSt: bank with important government stake; BankImpInsInvSt: bank with important institutional investor stake, DICL/GDPperCapita: Deposit insurance coverage limit/GDP per Capita, and “C” it is a set of control variables (Logtotass: log total assets; EquAss: equity to assets; NetLoanTotA: net loans to total assets; GrowGroLoans: growth of gross loans; CosToInc: cost to income ratio; GDPgro: gross domestic product growth; Infl: inflation rate) and year fixed effects. ε} rsub {it} ¿ represents the error term, whereas “α”, “β” and “γ” denote the parameters to be estimated.

Equation 1 model - Z-score

[ logZscore ]¿=α +β1 [ logZscore ]¿−1+β 2 [CGFL ]¿+β 3 [WGI ]¿+β 4 [ ProRigIndex ]¿+β 5 [ Islbank ]¿+β 6 [ BanImpFamSt ]¿+β 7 [ BanImpGovSt ]¿+β 8 [ BankImpInsInvSt ]¿+β 9 [ DIClim /GDPpe rCapita ]¿+γ 1 [ Logtotass ]¿+γ 2 [ EquAss ]¿+γ 3 [ NetLoanTotA ]¿+γ 4 [ GrowGroLoans ]¿+γ 5 [CosToInc ]¿+δ 1[GDPgrowth ]¿+δ 2 [ Inflation ]¿+∑t=1

8

Year t+ε¿

(2)

Where:

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LogZscoreit - log of Z-score of bank i in period t and log of Z-scoreit-1 is its one period lag

CGFL – CGFL as a corporate governance ‘bank’ firm level measure. WGI – WGI index as a corporate governance country level measure “CGCL” ProRigIndex – ProRigIndex as a property rights/Investors protection country

level measure Islbank - Islbank as proxy for Islamic banks BanI mpFamSt - BanImpFamSt as proxy for banks with important family stake BanImpGovSt - BanImpGovSt as proxy for banks with important government

stake BankImpInsInvSt – BankImpInsInvSt as proxy for banks with important

institutional investor stake DIClim/GDPperCapita – Deposit insurance coverage limit/GDP per Capita Logtotass - natural log of total assets, as a measure of bank size EquAss – (Equity/Assets) ratio measures the proportion of the total assets that are

financed by stockholders NetLoanTotA – (Net loans/Total Assets) as a measure of control for extent of

bank’s involvement in lending activity for the current period GrowGroLoans - Growth of Gross loans CosToInc - Cost to Income Ratio GDPgrowth and Inflation – GDP growth and inflation rate as macroeconomics

variables

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Table 8.- Estimation Results

LogZ CGFL WGI ProRigIndex IslBank BanImpFam

StBanImpGov

StBankImpInsIn

vStDIClim/

GDPperCapitaL1. 0.821*** 0.839*** 0.855*** 0.810*** 0.817*** 0.836*** 0.824*** 0.868***

CGFL -0.109***

WGI -0.045**

ProRigIndex -0.004***

Islbank -0.18***

BanImpFamSt 0.145*

BanImpGovSt -0.007BankImpInsInvS

t -0.177

DIClim/GDPperCapita 0.002

Logtotass -0.016 -0.005 -0.038*** -0.025 -0.009 -0.017 -0.035 -0.022

EquAss 0.034 0.161 0.141 -0.033 0.060 0.024 0.004

NetLoanTotA -0.000 -0.001 -0.001 -0.002 -0.002 -0.002 -0.001 -0.001

GrowGroLoans -0.001*** -0.001***

-0.001*** -0.001*** -0.001*** -0.001*** -0.001*** -0.001***

CosToInc -0.001*** -0.001***

-0.001*** -0.001*** -0.001*** -0.001*** -0.001*** -0.001***

GDPgro 0.001 0.001 -0.001 0.001 0.001 0.001 0.001 0.000

Infl -0.004 -0.005 -0.001 -0.001 -0.002 -0.003 -0.003 -0.003

yr2006a -0.008 -0.004 -0.036 -0.006 -0.015 -0.013 -0.007-0.009

yr2007a 0.010 0.007 -0.003 0.003 0.009 0.010 0.0010.005

yr2008a 0.014 0.006 0.033 0.023 0.024 0.013 0.0230.017

yr2009a 0.032 0.032 0.046 0.035 0.032 0.036 0.0360.037

yr2010a -0.023 -0.026 -0.020 -0.029 -0.031 -0.031 -0.026-0.038

Cons 1.551*** 0.600*** 0.960*** 1.003*** 0.702*** 0.775*** 1.081**0.017***

Arellano-Bond test for AR(2) 0.712 0.659 0.109 0.871 0.748 0.754 0.743 0.761

Hansen test 0.999 0.999 0.935 0.998 0.981 0.985 0.991No. of

Instruments 217 220 173 202 202 202 202 253

No. of groups 156 156 144 144 156 156 156 156No. of

observations 926 926 747 843 926 926 926 926

NOTE: Table reports the panel data estimates for the system Generalized Method of Moments where the dependent variable is the Log of Z-score [logZ] and GMM style lag limits (1 3) and estimates are robust. Year dummies are included. Hansen is a test for over-identifying

restrictions, asymptotically distributed.

KEY: CGFL: corporate governance firm level; WGI: corporate governance country level “world governance index”; ProRigIndex: property rights index; Islbank: Islamic bank; BanImpFamSt: bank with important family stake; BanImpGovSt: bank with important government stake;

BankImpInsInvSt: bank with important institutional investor stake; DIClim: deposit insurance coverage limit; Logtotass: log total assets; EquAss: equity to assets; NetLoanTotA: net loans to total assets; GrowGroLoans: growth of gross loans; CosToInc: cost to income ratio;

GDPgro: gross domestic product groth; Infl: inflation rate. ∗ Indicates significance at 10% level. ∗∗ Indicates significance at 5% level. ∗∗∗ Indicates significance at 1% level.

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(6)Empirical Results and Discussions

Table No.8 presents regression results of different regression models using The GMM. We begin by examining the relationship between risk taking and corporate governance. The primary measure of corporate governance is WGI and CGFL, where WGI is an index for countries called “Worldwide Governance Indicators”, so it’s a measure for corporate governance country level “CGCL”, and CGFL is a Corporate Governance Firm (bank) Level. At the same time, governance is either an internal firm-level or external country-level proxy for the strength of governance. There are two benefits of employing an external country-level governance measure. First, it delivers an alternative measure of how strictly managerial activities are monitored. Second, it is less endogenous to corporate financial policies (Lel, 2012). We examine if better corporate governance is associated with greater risk taking or not. The main findings are as follows.

With regard to z-score, it is calculated for each fiscal period and larger z-score values indicate lower overall bank risk taking (e.g., (Anginer et al. (2014); Beltratti and Stulz (2012); Boyd and Runkle (1993)). At the same time, a higher z-score means less insolvency risk. Our results shows that if the Corporate Governance Firm Level “CGFL” increased by one unit, z-score will decrease by 10.9%. In other words, CGFL has a significant and Negative impact on z-score and a significant and positive impact on the risk taking. The variable WGI; which measure the corporate governance at the country level; has a significant and negative impact on z-score and a significant and positive impact on the risk taking (-4.5%). Both effects of corporate governance measures are in line with the findings of Hassan and Mollah (2014). They analyze data for 84 banks (59 Islamic banks and 25 Conventional Banks) from Bangladesh, Bahrain, Malaysia, Pakistan, Saudi Arabia, the United Arab Emirates, and the United Kingdom over the 2006-2009 periods. The results show that the CGI is highly significant, indicating that corporate governance is a main driving force for risk taking in Islamic banks. Similarly, the full-sample finds positive (significant) results for CGI. In addition, the regression results identify corporate governance index (CGI) as one of the main variables explaining risk taking in Islamic Banks. This result support our two hypothesizes No. 7 and No. 8, which say that Corporate Governance has a significant and positive impact on risk taking in banks on both bank level and country level. Also we can find that Erkens et al. (2012) obtained results suggest that corporate governance had an important impact on firm performance during the crisis through firms' risk-taking and financing policies. From our point of view this result is explained by many reasons like, first, most of banks in our sample have a separation between the CEO and the Chairman of the board, and this allow boards to exercise freely more and more pressures to induce the management to be more risk takers even if this gives the bank an extra point in computing the Corporate Governance Bank Level. Second, as a result of concentrated ownership, the high risk appetite of the board of directors for banks in these countries which, by default, affects all policies, procedures and decisions therefore resulted in high risk even they have well or even moderate range of corporate governance culture. Third, the early stage implementing the

38

corporate governance codes in most of MENA countries, where building such an environment is still an ongoing process, as mentioned in many of surveys implemented by accredited institutions like world bank report’s on the corporate governance country assessment for Saudi Arabia (2009) and in many papers like Setiyono and Tarazi (2014), they said that corporate governance initiatives and reforms are still ongoing in Asian banking sectors. and also the same was mentioned by Harabi (2007).

Concerning Property Rights Index, the findings points out that if the PRI increased by 1% z-score will decreased by 0.4%. This means that PRI has a significant and negative impact on z-score and a significant and positive impact on the risk taking. Our findings supports our hypothesis No. 1 which says Investor protection has a significant and positive impact on risk taking in banks. This positive association relationship between the protection of investors or property rights and risk taking was emphasized before by Gropp and Köhler (2010), when they empirically find that banks in countries with better shareholder protection incurred in greater risks. Consistent with this, many researches point out the same and show that better protection of property rights has a positive effect on corporate risk-taking, like (Demsetz, 1983; Demsetz & Lehn, 1985; Demsetz & Villalonga, 2001; Himmelberg et al., 1999; Holderness & Sheehan, 1988; John et al., 2008; Morck & Nakamura, 1999; Morck & Steier, 2005; Paligorova, 2010; Roe, 2003; Stulz, 2005; Tirole, 2001). Notwithstanding the above, other arguments state a justification for a negative association between investor protection and risk-taking (Burkart et al., 2003; John et al., 2008; Morck & Steier, 2005; Shleifer & Vishny, 1986; Stulz, 2005). We think that this can be precisely justified by the fact that countries with high investor protection enable shareholders to exercise control over management and may be this provide them with a power in inducing the management to maximize the profits and not to be risk averse as managers prefer to be, so managers will operate banks in order to make high profits. From other hand, the existence of investor protection acting as if there is a concentrated ownership, in our sample we can noticed that both of high investor protection and concentrated ownership are existed and this will result in as a double impact in pushing the banks management to be more risk takers, that’s why we found that there is a positive relationship between investor protection and risk taking behavior in our sample in MENA countries. From other side, we find a strong evidence support our hypothesis No. 9, which say that countries with high level of corporate governance has a high level of investor protection. This was clearly noticed in the correlation matrix which showed that there is a strong correlation between them equal to 0.637.

Regarding Islamic Bank variable, the regression implies that if the bank is an Islamic bank the z-score will decrease by 18%. This means that Islamic bank has a significant and negative impact on z-score and a significant and positive impact on risk taking, consistent with Čihák and Hesse (2010) findings. They find that large Islamic banks are less stable (more risky) than conventional banks. This finding support our hypothesis No.6 which says that there is a significant and positive relationship between Islamic banks and risk taking in banks. According to this result, we think that risk in Islamic banks could increase due to many factors as follow: the complexity of the Islamic models and contracts of finance (Srairi, 2013), limited default penalties and moral hazard incentives caused by PLS contracts or operational limitations on investment and risk management activities. All of these factors could make them less stable

39

(more risky) than conventional banks (Abedifar et al., 2014). In line with this, we can mention also that, while interest is forbidden in Islamic banking, those institutions that compete with conventional banks may be forced to mirror their pricing behavior and as such may be subject to (indirect) interest rate risk which means more risk (Abedifar et al., 2014).

Concerning the banks with important family stake, there are even fewer studies on the relationship between family ownership and bank risk (Lin & Wu, 2010). Our results show that if the bank has an important family stake the z-score will increase in 14.5%. This means that banks with important family stake have a significant and positive impact on z-score and significant and negative impact on the Risk taking. This findings support our hypothesis No.4 which says that there is a significant and negative relationship between banks with large family ownership and risk taking in banks. These findings are in concordance with Anderson et al. (2003) when mentioned that family banks have incentives to take less risky projects. Also, Naldi et al. (2007) and Barry et al. (2011) find that family businesses generally exhibit lower risk than non-family businesses. In the empirical study of Srairi (2013), the results reveal that family owned banks appear to assume lower risks. However, other studies (e.g. (Laeven, 1999; Nguyen, 2011; Villalonga & Amit, 2006) find that family-controlled banks are associated significantly with higher risk. Setiyono and Tarazi (2014) show that the presence of multiple shareholders (i. e., family combined with institutional ownership) is a possible solution to effectively improve bank performance and reduce risk taking.

The results also show that both banks with important government stake and banks with important institutional investor’s stake, are not significant for the z-score and therefore for risk taking. This result doesn’t support our hypothesis No.3 which says that there is a significant and positive relationship between banks with large government ownership and risk taking in banks. May be this because the motivations for government intervention in the economy and governments' risk-taking preferences are typically different from those of private investors (Faccio, Marchica, & Mura, 2011). Other reason may justified this result that this was as a result of the low interventions of the governments in managing the banks which it has an important stake in it, these banks started to work independently by creating its procedures and policies on the base of the business concept in making profits and faraway from the any other governmental special aims. Also, the same for hypothesis No.5, which says that there is a significant and positive relationship between banks with large institutional investor ownership and risk taking in banks, it’s not supported by our findings. May be the latter result come partially in consistent with Cheng et al. (2011) point out that the net effect of large institutional investors is indeterminate, and they let the data determine whether to accept or reject the large institutional shareholder hypothesis. However, the results of our investigation in this regard, do not support our 2 hypothesis. So we finds that, neither important government ownership, nor important institutional investor ownership does affect the risk taking in banks in our sample at MENA countries. From our point of view, this result can be interpreted as a result of the presence of the family big shareholders in most of the banks in our sample, so these kind of shareholders play a

40

big role in managing the bank in a risk averse policies even if these banks have a big governmental or institutional investors.

(7) Robustness Checks:In order to check for the robustness of our GMM estimation findings and to identify trends

within other banks’ risk determinants we re-estimate z-score using random effect and pooled OLS, and we also use other two alternative measures of risk in our analysis. In particular, we estimate risk determinant factors against credit risk indicators such as Impaired Loans and Loan Loss Provisions. We obtain credit risk as an alternative bank risk measure since credit risk is considered the biggest principle bank risks and has a direct influence on bank solvency. At the same time we conducted an estimation for the period of 2008 – 2012 which is known as the period of the global financial crises.

(1) Baseline model estimations (Random Effects and Pooled OLS) with dependent variable Z-score:

The preliminary results of the baseline model with pooled OLS regression show that banks ‘Z score significant and decreased with the corporate governance bank level [CGFL], with the corporate governance country level [WGI], with Islamic bank [Islbank], with banks with important family stake [BanImpFamSt], with growth of gross loans and with cost to income. And at the same time, banks ‘Z score significant and increased with the banks with important institutional investor stake [BankImpInsInvSt]. In general, the vast majority of signs are consistent with what we expected, but as we mentioned above, the problem in applying OLS is that 𝑙𝑜𝑔𝑍𝑠𝑐𝑜𝑟𝑒𝑖𝑡−1is correlated with the fixed effects in the error term which causes “dynamic panel bias” (Nickell, 1981) violating an assumption necessary for the consistency of OLS.

The random effect model shows most of the coefficients is significant and fairly consistent with the pooled OLS model and in line with our hypothesis. It shows that banks ‘Z score significant and decreased with the corporate governance bank level [CGFL], with the corporate governance country level [WGI], with Islamic bank [Islbank], with growth of gross loans and with cost to income. Table N 9 presents the results of the baseline regressions with dependent variable Log of Z-score [logZ] by using Random Effect and Pooled OLS.

Table 9 estimations (Random Effects and Pooled OLS) with dependent variable Z-score:

LogZ R.E. PooledL1. 0.870 0.924

CGFL -0.063*** -0.070***WGI -0.067*** -0.072***

ProRigIndex -0.001 -0.000Islbank -0.109*** -0.088***

BanImpFamSt -0.027 -0.039**BanImpGovSt -0.039 -0.046

41

BankImpInsInvSt 0.075 0.083***DIClim 0.004 0.002

Logtotass 0.001 0.001NetLoanTotA 0.000 0.000

GrowGroLoans -0.001*** -0.001***CosToInc -0.001*** -0.001***GDPgro -0.001 -0.001

Infl -0.001 -0.001yr2006a -0.007 -0.012yr2007a -0.027 -0.031yr2008a -0.048 -0.054yr2009a -0.013 -0.019yr2010a 0.022 0.014

Cons 0.784 0.657NOTE: Table reports the panel data estimates for Pooled OLS and Random Effect where the dependent variable is the Log of Z-score [logZ] and estimates are robust. Year dummies are

included. Legend: * p<.1; ** p<.05; *** p<.01

(2) Baseline model estimations with dependent variable impaired Loans/Total Assets:

By using GMM estimation method, the effect on dependent variable is as we hypothesized. Corporate governance bank level [CGFL] has a negative sign and is statistically significant and also the GDP growth [GDPgro]. From other hand, the Bank with important institutional investor stake [BankImpInsInvSt] has a positive sign and statistically significant and the same for net loans to total assets [NetLoanTotA]. The effect of corporate governance country level is no longer significant and the same for Islamic banks [Islbank]. Table 10 presents the results of the baseline regressions with dependent variable impaired loans.

Table 10 estimations with dependent variable impaired Loans/Total Assets:

Log Z GMM

L1. 0.723***

CGFL -0.011***

WGI -0.002

ProRigIndex -0.000

Islbank -0.007

BanImpFamSt -0.003

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BanImpGovSt 0.006

BankImpInsInvSt 0.019***

DIClim 0.000

Logtotass -0.002

NetLoanTotA 0.000**

GrowGroLoans -0.000

CosToInc -0.000

GDPgro -0.001***

Infl 0.000

yr2006a -0.005

yr2007a 0.005

yr2008a 0.002

yr2009a -0.002

yr2010a -0.004

Cons 0.076

Arellano-Bond test for AR(2) 0.492

Hansen test 85.06

No. of Instruments 205

No. of groups 108

No. of observations 475

NOTE: Table reports the panel data estimates for the system Generalized Method of Moments where the

dependent variable is the impaired Loans/Total Assets [IL] and GMM style lag limits (1 3) and estimates are robust. Year dummies are included. Hansen is a test

for over-identifying restrictions, asymptotically distributed. Legend: * p<.1; ** p<.05; *** p<.01

(3) Loan Loss Provisions: Baseline model estimations with dependent variable Loan Loss Provisions /Total Assets:

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The last robustness check dependent variable representing bank credit risk is Loan Loss Provision (LLP). LLP is a key accounting indicator which directly effects the volatility and cyclicality of bank earnings. In banks’ financial reports it reflects the risk of loan portfolios. Table 11 presents the results of the baseline regressions. The corporate governance bank level [CGFL], corporate governance country level [WGI] and Islamic bank [Islbank] are not significant. While properity rights index [ProRigIndex] and bank with important government stake [BanImpGovSt] is positive statistically significant. The bank with important family stake [BanImpFamSt], deposit insurance coverage limit [DIClim], growth grow loans [GrowGroLoans] and GDP growth [GDPgro] is negative statistically significant.

Table 11 estimations with dependent variable Loan Loss Provisions /Total Assets:

LogZ GMM

L1. 0.309***

CGFL -0.000

WGI -0.001

ProRigIndex 0.000***

Islbank -0.000

BanImpFamSt -0.003**

BanImpGovSt 0.004**

BankImpInsInvSt 0.001

DIClim -0.000**

Logtotass -0.000

EquAss -0.003

NetLoanTotA 0.000

GrowGroLoans -0.000***

GDPgro -0.000**

yr2006a 0.001

yr2007a 0.002

yr2008a -0.000

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yr2009a -0.002

yr2010a 0.000

Cons 0.002

Arellano-Bond test for AR(2) 0.735

Hansen test 97.59

No. of Instruments 218

No. of groups 122

No. of observations 513

NOTE: Table reports the panel data estimates for the system Generalized Method of Moments where the

dependent variable is the Loan Loss Provisions /Total Assets [LLP] and GMM style lag limits (1 3) and estimates are robust. Year dummies are included. Hansen is a test for over-identifying restrictions,

asymptotically distributed. Legend: * p<.1; ** p<.05; *** p<.01

(4) Model Estimation for the period 2008 to 2012:In order to check for the robustness of our z-score findings, we include Table 12

which reports the baseline model results of our dependent variable Log of z-score [logZ] by using GMM estimation method for the period of 2008-2012 which consider to be the period of global financial crises. We can notice that the corporate governance bank level [CGFL] is negative statistically significant and also the same for Islamic banks [Islbank] and for banks with important government stake [BanImpGovSt].

Table 12 Estimation for the period 2008 to 2012

Log Z GMM

L1. 0.795***

CGFL -0.188***

WGI -0.057

ProRigIndex -0.001

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Islbank -0.334***

BanImpFamSt 0.024

BanImpGovSt -0.262**

BankImpInsInvSt 0.166

DIClim 0.008

Logtotass 0.044

NetLoanTotA 0.001

GrowGroLoans -0.001

CosToInc -0.001

GDPgro 0.000

Infl -0.002

yr2006a -0.030

yr2007a -0.015

yr2008a 0.050

yr2009a 0.027

yr2010a -0.035

Cons 1.326

Arellano-Bond test for AR(2) 0.186

Hansen test 115.03No. of Instruments 200

No. of groups 131

No. of observations 568

Table reports the panel data estimates for the system Generalized Method of Moments where the dependent

variable is the Log of Z-score [logZ] and GMM style lag limits (1 3) and estimates are robust. Year dummies are

included. Hansen is a test for over-identifying restrictions,

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asymptotically distributed.

(8) Conclusion Remarks

The objective of this study was to examine the relationship between corporate governance and the level of risk taking in banks, we consider a sample of 165 banks in MENA countries during the 2005-2012 period. Using methodologies following Boyd and Graham (1986), Čihák and Hesse (2010), Beltratti and Stulz (2009), Lel (2012), Davydov (2015) and Hasan et al. (2011). This topic remain crucial to understand the role of corporate governance in driving bank risk taking behavior, especially in MENA countries, where building a good corporate governance environment is still an ongoing process. Our results corroborate empirical findings from other studies (e.g.(Hassan & Mollah, 2014), proving the effect of corporate governance on the risk taking behavior in banks, our findings that Corporate Governance has a significant and positive impact on risk taking in banks. We also prove the role of the investor protection in driving the risk taking incentives in our sample by proving that Investor protection has a significant and positive impact on risk taking in banks consisting with Gropp and Köhler (2010) and Paligorova (2010) findings. In addition, the effects Of Islamic banks induces high risk taking so there is a significant and positive relationship between Islamic banks and risk taking in banks, this consisting with Čihák and Hesse (2010).

We also test the effects of important family ownership on the risk taking incentives at banks in our sample, we determine that the big or important ownership when the family owner has 5% or greater of outstanding shares following to Parrino et al. (2003) and Burns et al. (2010). In turn, Lin and Wu (2010) said that there are few studies highlighting this relationship. Our empirical result show that banks with big family ownership have a significant and negative impact on the Risk taking and this result come in consistent with our hypothesis. And also These findings are in concordance with Anderson et al. (2003) when mentioned that family banks have incentives to take less risky projects. Finally, the main findings regarding the effects of both important ownership for government and institutional investor’s on risk taking behavior suggest that both of them are not significant for the Z-score and therefore for risk taking, However, the results of our investigation in this regard, do not support our 2 hypothesis. So we finds that, neither important government ownership, nor important institutional investor ownership does affect the risk taking in banks in our sample at MENA countries. However, it appears that the data also suggest that important of the presence of government and institutional investors plays a no significant role in attenuating or increasing the risk taking.

The benefits of large shareholding are highlighted under the `convergence-of-interest' and the `efficient monitoring' hypotheses, which argue that large shareholders are likely to be more efficient than small and dispersed shareholders in monitoring company management, as the

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former: (a) have substantial investments as well as significant voting power to protect these investments; (b) are likely to mitigate the collective action problem present among dispersed shareholders; and (c) are likely to engage in relational investing and be more committed to a company in the long run.

 

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Table 13 Correlation matrix of main regression variables

logZsc~e ImpLoa~A Loanlo~A WGI ProRig DIClim CGFL ROAA TotAss Equ NetLoa CosToI CreTot EquAss GDPgro Infl

logZscore 1.000ImpLoanTA -0.053 1.000LoanlossTA -0.206 -0.056 1.000WGI -0.092 0.014 -0.002 1.000ProRigIndex -0.133 0.003 0.070 0.637 1.000DIClim 0.019 0.069 0.021 -0.042 -0.418 1.000CGFL -0.016 -0.104 0.008 0.142 0.175 -0.039 1.000ROAA 0.113 0.060 -0.315 0.092 0.099 -0.040 0.050 1.000TotAss 0.084 -0.182 0.002 0.103 -0.053 0.095 0.092 -0.023 1.000Equ 0.081 -0.196 -0.008 0.168 0.027 0.057 0.178 0.020 0.933 1.000NetLoamTotA 0.101 0.126 0.134 0.342 0.232 -0.028 0.296 0.052 0.215 0.241 1.000CosToInc -0.149 0.139 0.079 -0.154 -0.015 -0.122 -0.118 -0.455 -0.166 -0.169 -0.197 1.000CreTotAss 0.090 0.287 0.143 0.333 0.214 -0.018 0.266 0.051 0.197 0.214 0.985 -0.194 1.000EquAss -0.046 0.309 0.079 0.214 0.308 -0.161 -0.091 0.199 -0.258 -0.134 -0.213 0.212 -0.196 1.000GDPgro 0.095 -0.124 -0.148 0.105 -0.059 -0.116 0.004 0.147 0.016 0.026 0.038 -0.086 0.029 0.023 1.000Infl 0.035 -0.006 -0.034 -0.442 -0.345 -0.010 -0.091 0.018 -0.104 -0.163 -0.095 -0.037 -0.083 -0.129 -0.082 1.000

This table provides the correlations between the main regression variables. Sample consists of 165 banks from 13 countries. Statistics based on annual data for the years from 2005 till 2012.

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Appendix 1 Prior empirical research on the Corporate Governance and other related issues: basic data

Author(s) Data analysed

Period of study

Type of bank’s measure Conclusions

Esam and Ezzat (2014)

105 banks in 8 Arab

countries2005 – 2009

(A)Country Governance Level, World Bank Governance indicators database

(B)Shareholder Rights, Doing Business Data (2014), IFC, World Bank

- Changes in ownership structure are significant in explaining performance and risk-taking behavior of banks- Conventional banks with concentrated ownership have lower performance compared to a better performance in Islamic banks- Banks located in countries with stronger shareholder rights, tend to adopt less-risk taking behavior, with no significant difference between Islamic and conventional banks

Srairi (2013)131 banks,

MENA Countries

2005 - 2009 Risk-Taking, bank’s z-score

- Banks with concentrated ownership have lower insolvency risk and lower asset risk.- No differences related to ownership concentration when we analyse conventional banks and islamic banks separately.- Family owned banks appear to assume lower risks.- Family islamic banks have a lower level of credit risk compared to conventional banks.- No differnces were found between the islamic and conventional banks in terms of Z-score.- Government banks had greater credit risk than privetly owned banks.

Barry et al. (2011)

249 european commercial

bank from 16 1999 - 2005 Z-score, Boyd and

Graham (1986)- Changes in ownership structures are significant in explaining risk differences

50

country

Lel (2012)253 firms from 30 country

1990 - 1999

Corporate Governance Firm Level, Internal Governance (7 Measures)

Strongly governed firms tend to use currency derivatives to reduce their currency exposure and weakly governed firms appear to use derivatives for managerial reasons

Hasan et al. (2011)

1921 non financial

public firms in the MENA

regions

2005 - 2009

Property_Rights,Heritage economic freedom index

By establishing credible investor protection provisions, firms can - to a certain extent - take matters into their own hand and affect their performance

Čihák and Hesse (2010)

77 banks from 19 country

1993 - 2004

(A)Z-score, a measure of individual bank risk

(B)Governance, The governance indicator Kaufmann et al. (2009)

- Large commercial banks tend to be financially stronger than large Islamic banks- Small Islamic banks tend to be financially stronger than small commercial banks

Beltratti and Stulz (2009)

98 banks from 20 country

middle of 2007 to the end of 2008

(A)Country-level governance, use (i)Kaufmann et al. (1999) the six variables for each country and (ii)the country-level indicators of Kaufman and Kraay (2008),

(B)Banking Regulation, indices

- Banks from countries with stronger regulators had worse performance, but this might result from greater intervention by these regulators during the crisis at the expense of shareholders- bank governance and regulation before the crisis are all helpful in understanding bank performance during the crisis

51

of Caprio et al. (2007) Official, Capital, Restrict & Independence

Laeven and Levine (2008)

296 banks across 48 countries

1996 - 2001

(A)Banking Regulation, Barth et al. (2004) database

(B)Investor Protection, L. Porta et al. (1998) index of the statutory rights of shareholders

- Bank risk is generally higher in banks that have large owners with substantial cash-flow rights- The relation between risk and regulation depends critically on each bank’s ownership structure- Shareholder protection laws do not exert a direct effect on bank risk

John et al. (2008)

data for 39countries 1992 - 2002

Investor Protection Variables the quality of accounting disclosure standards (ASR), the rule of law (RL) and an index of anti-director rights(ADR)

- Significant positive relationships between various firm- and country- level risk-taking measures and measures of investor protection- Corporate risk-taking is positively related to the quality of investor protection

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Appendix 2 Summary of Variables

Variable Description Source

Z-score Defined as Z ≡ µ+kσ

, where k is equity capital as percent of assets, μ is average return as percent of assets, and σ is standard deviation of return on assets as a proxy for return volatility. Measures the number of standard deviations a return realization has to fall in order

to deplete equity, under the assumption of normality of banks’ returns.

Authors’ calculations based on BankScope data.

Corporate Governance–Country

level

Average of the six governance measures- voice & accountability, political stability, government effectiveness, regulatory quality, rule of law and control of corruption-

across the years 2005-2012 into one single index per country.

Authors’ calculations based on The Worldwide Governance Indicators

(WGI), following Kaufman and Kraay (2008), Beltratti and Stulz (2009) and Čihák

and Hesse (2010)Corporate

Governance–Firm level

The index was built taking into account two dimensions (1) ownership structure, namely ownership concentration and the identity of the major shareholders (wedge between cash flow/voting rights, differential voting rights, institutional and family

large ownership, and state ownership), and (2) board matters (separation of chairman/chief executive officer roles). This index is comprised of 7 widely used

governance measures.

Authors’ calculations based on, Lel (2012) in

measuring the firm-level internal governance index

by hand-collected data from the annual reports of

banksConcentrated Ownership

We construct the large shareholder dummy variable by considering a bank as having a large owner if the shareholder has direct and indirect voting rights that sum to 10% or more, So we create the variable as a dummy variable equal to 1 if a firm has a large owner with voting rights greater than 10%, if not it will equal to Zero. WE defined ownership concentration as the share of equity held by the owners when he

hand-collected data from the annual reports of banks.

following to Maury and Pajuste (2005), Laeven and Levine (2008) and (Cornett

53

controls directly or indirectly more than 20% of the shares. While direct ownership involves shares registered in the shareholder’s name, indirect ownership involves bank shares held by entities that the ultimate shareholder controls. So we create the variable as a dummy variable equal to 1 if a firm has a Concentrated Ownership with voting rights greater than 20%, if not it will equal to Zero.

et al., 2010)

Banking Regulation and Supervision

(i) Official Supervisory Power, Whether the supervisory authorities have the authority to take specific actions to prevent and correct problems.(ii) Capital Regulatory Index, Initial and overall capital stringency

(iii) Overall Restrictions on Banking Activities, The extent to which banks may engage in some aspects and activities.

(iv) Independence of Supervisory Authority-Overall, The degree to which the supervisory authority is independent from the government and legally protected

from the banking industry.

Barth, Caprio Jr, and Levine (2013), they

provide data and measures of bank regulatory and

supervisory policies in 180 countries from 1999 to

2011. The dataset includes original survey responses and the construction of 52 indices. The data include

and the measures are based upon responses to hundreds

of questions.Property

Rights/Investor Protection

The Index of Economic Freedom is an annual index and ranking created and published by The Heritage Foundation and The Wall Street Journal in 1995 to

measure the degree of economic freedom in the world's nations.

Property Rights from heritage economic freedom index to measure country-level investor protection

and construct the variable Property Rights, Hasan et

al. (2011)Moral Hazard We follow Demirgüç-Kunt and Levine (2000), they include an indicator of the

generosity of the deposit insurance regime (MORAL HAZARD) since more generous deposit insurance policies may increase moral hazard. Generosity of

Deposit Insurance is an indicator of moral hazard associated with deposit insurance schemes.

Authors’ calculations based on Coverage limit /

GDP per Capita (in %) data. (Demirgüç-Kunt and

Detragiache (2002))Nature of Owners We highlight banks with large family ownership, large state ownership and large

institutional ownership.We construct this variables

by hand collecting data

54

from its annual reports. Following to (Chang

(1998)), we define block holder or large

shareholders as a beneficial owner of 5% or greater of outstanding shares.

GDP growth as Macroeconomics

Variable

Growth rate of nominal GDP, adjusted for inflation (in local currency), GDP Growth is measured as the percentage change in GDP per capita in two adjacent

Years, which measures the business cycle of a country.

IMF (International Financial Statistics)

GDP per capita as Macroeconomics

Variable

Annual GDP per capita, which measures a country’s overall economic status IMF (International Financial Statistics)

Inflation as Macroeconomics

Variable

Inflation Year-on-year change of the CPI index (percent) IMF (International Financial Statistics)

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Appendix 3 List of Variables in the Main Database

 Variable name  It’s Short name

Z-Score 2005-2012 Z-Score 2005-2012

Worldwide Governance Indicators (WGI) 2005-2012 WGI 2005-2012

Property Rights Index 2005-2012 ProRigIndex 2005-2012

Deposit Insurance Coverage limit $ / GDP per capita $ (in %) 2005-2012

DIClim/GDPperCapita 2005-2012

CGFL2005-2012 CGFL 2005-2012

Most Frequent CGFL2005-2012 MoFreCGFL

Banks with important Family stake (more than 5%) BanImpFamSt (+ 5%)

Banks with important Government stake (more than 5%)

BanImpGovSt (+ 5%)

Banks with important Institutional Investor stake (more than 5%)

BanImpInsInvSt (+ 5%)

Islamic Bank IslBank

Return on Average Assets (ROAA) % 2005-2012 ROAA% 2005-2012

Total Assets mil USD 2005-2012 TotAssmil$ 2005-2012

Net Loans / Total Assets % 2005-2012 NetLoa/TotAss% 2005-2012

Growth of Gross Loans % 2005-2012 GrowOfGroLoa% 2005-2012

Cash and Due From Banks mil USD 2005-2012 Cas&DueFroBanmil$ 2005-2012

Total Revenue 2005-2012 TotRev 2005-2012

Credit/Total Assets2005-2012 Cre/TotAss 2005-2012

Equity/assets2005-2012 Equ/Ass 2005-2012

Other Operating income/TR2005-2012 OthOpeInc/TR 2005-2012

TR/Total Assets2005-2012 TR/TotAss 2005-2012

56

GDP growth 2005-2012 GDPgro 2005-2012

GDP per Capita 2005-2012 GDPperCap 2005-2012

Inflation 2005-2012 Infl 2005-2012

57

List of Tables

Table 1 the Proposed Hypothesis..........................................................................................21Table 2 the Tested Hypothesis................................................................................................22Table 3 Sample distribution across MENA countries..............................................................24Table 4 Descriptive statistics of main regression variables.....................................................29Table 5 Evolution of Log Z-Score by Country.........................................................................31Table 6 Distribution of the ownership nature by Country......................................................32Table 7 By Country, Corporate Governance (County Level & Firm Level), Shareholder Rights and Deposit Insurance............................................................................................................34Table 8.- Estimation Results....................................................................................................37Table 9 estimations (Random Effects and Pooled OLS) with dependent variable Z-score:.....41Table 10 estimations with dependent variable impaired Loans/Total Assets:........................42Table 11 estimations with dependent variable Loan Loss Provisions /Total Assets:...............44Table 12 Estimation for the period 2008 to 2012...................................................................45Table 13 Correlation matrix of main regression variables......................................................49

58

List of Appendixes:

Appendix 1 Prior empirical research on the Corporate Governance and other related issues: basic data................................................................................................................................50Appendix 2 Summary of Variables..........................................................................................53Appendix 3 List of Variables in the Main Database.................................................................56

59

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