Corporate Governance and Banking Performance: a Comparative Study between Private and State Banking Sector in Sri Lanka (original) (raw)

The main objectives of this study are to find out the relationship between corporate governance and banking performance and also find out the impact of corporate governance on banking performance. This study focused on four aspects of corporate governance namely; Board Size (BS), Board Diversity (BD), Outside Directors Percentage (OSDP) & Board Meeting Frequency (BMF). Banking performance has been measured through Return on Equity (ROE) and Return on Assets (ROA). The results revealed that all variables of corporate governance are positively correlated with ROE in state banks as well as, in private banks except BD and BMF other variables have strong negative relation with ROE, which is significant at 5percent level of significance. Similarly, except BMF other variables have negative relationship with ROA in state banks. Private Banks also show same relation except the variable BD. BD have strong negative relationship with ROA in state banks which is significant at 5 percent level of significance, but in private banks; positive relationship is denoted by BD which is not significant. Further corporate governance has a moderate impact on performance of both private and state banks. INTRODUCTION Corporate governance can be defined as the relationship among shareholders, board of directors and the top management in determining the direction and performance of the corporation (Wheelen and Hunger 2006). It also includes the relationship among the many players involved (the stakeholders) and the goals for which the corporation is governed. The principal players are the shareholders, management and the board of directors. Other stakeholders include employees, suppliers, customers, banks and other lenders, regulators, the environment and the community at large (http://en.wikipedia.org). Ruin (2001) stated that corporate governance as a group of people getting together as one united body with task and responsibility to direct, control and rule with authority. On a collective effort, this body is empowered to regulate, determine, restrain, curb and exercise the authority given to it. However, corporate governance describes the set of processes, customs, policies, laws and institutions affecting the way a corporation is directed, administered or controlled (http://en.wikipedia.org). Shleifer and Vishny (1997) argued that corporate governance is the way in which suppliers of finance to corporation ensure themselves of getting a return on their investments. Nonetheless, Melvin and Hirt (2005) described the concept of corporate governance as referring to corporate decision-making and control, particularly the structure of the board and its working procedures. It is also sometimes used very widely, embracing a company's relations with a wide range of stakeholders or very narrowly referring to a company's compliance with the provisions of best practice codes. In addition, Thomas (2002) described corporate governance in the ways and means by which the government of a company (the directors) is responsible to its electorate (the shareholders).Corporate governance can also be stated as the set of rules and procedures that ensure that managers do indeed employ the principles of value based management (Brigham & Ehrhardt ,2005). On the other hand, Low (2003) viewed as corporate governance as dealing with mechanisms by which stakeholders of a corporate exercise control over corporate insiders and management in such a way that their interests are protected. Nevertheless, corporate governance comprises a country's private and public institutions, both formal and informal, which together govern the relationship between the people who manage corporations (corporate insiders) and all others who invest resources incorporations in the county (Oman, Charles, Fries, Steven & Buiter, & Willem, 2003). Researcher focus is on the relationship between governance and performance. There are several reasons to expect that better governed banks may have more efficient operations and better performance. First, governance may reduce the incidence and amounts of related parties' transactions and other " self-dealing " practices. Since such transactions are usually sub-optimal from the efficiency point of view, the reduction in such transactions should translate into improved performance. Second, better governed banks may have lower cost of capital, especially if they employ subordinated debt financing. Third, better governance may translate into more efficient and streamlined operations, as the supervisory board and management functions are separated and modernized. Corporate governance initiatives in Sri Lanka commenced in 1997 with the introduction of a voluntary code of best practice on matters relating to the financial aspects of corporate governance. Voluntary codes of best