Board characteristics and efficiency of value added by banks: Evidence from an emerging economy

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Abstract

This paper estimates the efficiency of value added by banks using their total resources (physical capital resources and intangible resources) and finds an association between board characteristics and efficiency of value added. The paper is grounded in the theory of resource and knowledge based view of the firm, and agency theory, and tries to establish links between these two theories. This study departs from existing literature of examining the effect of board characteristics on financial performance, corporate sustainability, and corporate environmental responsibility, and tries to understand the relationship between board characteristics and the efficiency of value added by banks through their resources. This is also the first study of its kind to study the relationship between board structure characteristics and value creation in Indian banks using the Value Added Intellectual Coefficient (VAIC) methodology. Using the data for 41 commercial banks in India from 2008 to 2017 and by employing Prais-Winsten Regression, this study finds that board meetings and CEO-Chairman duality significantly and positively influence the efficiency of value added by banks through their total resources and intellectual capital resources. At the same time, independence in the boards negatively influences the efficiency of value added through physical capital resources. Overall, the findings of the paper indicate that board governance influences bank performance measured in terms of efficiency of value added. Policymakers, regulators, and bank managers should frame appropriate policies to ensure more board meetings, and the presence of board duality.

Introduction

Banks as financial intermediaries connect those with surplus funds to the deficit ones. Banks through delegated monitoring in the process of financial intermediation are able to reduce the cost of transactions and information asymmetries (Diamond, 1984, Scholes et al., 1976). The corporate governance is a mechanism to ensure efficient management of resources by the directors (Zingales, 1998). Corporate governance aspect is very important in banks because the major proportion of capital comes from the depositors and excessive risk-taking may pose a threat to the financial stability of the nation. It is well-recognized that one of the reasons for the global financial crisis of 2007–2008 was the weak governance mechanisms in banks that precipitated unnecessary risk taking. Also, financial scandals throughout the world have revoked the debate on identifying appropriate mechanisms to make the management more responsible to the shareholders. The board of directors has always been at the center of this debate. Most of the existing studies on corporate governance exclude financial firms such as banks from the analysis. Therefore, little is known about the efficacy of governance mechanisms such as the board of directors in banks (Adams & Mehran, 2012). The role of the board of directors in a bank is of utmost importance since it is not only responsible to the shareholders but also to depositors and the regulator (Macey & O'hara, 2003). Various guidelines on corporate governance and its aspects highlighted value added as the goal of an enterprise’s board of directors (Ho & Williams, 2003). However, existing studies in literature measured performance in financial terms through ratios and sometimes through corporate sustainability, and corporate environmental responsibility (Frankforter, Berman, & Jones, 2000). This study departs from existing literature and tries to understand the relationship between board structure characteristics and efficiency of value added by banks through their resources. Ho and Williams (2003) argue that a firm’s resources comprise physical resources and intellectual capital resources and different properties of these resources may enable a firm’s management to adopt different approaches for their use. Therefore, the association between board structure and bank performance will also depend on the optimal mix of physical resources and intellectual capital resources.

The reason for focusing on value added by firms is that value added or wealth creation is an important aspect that businesses aim to achieve. As per Clarkson (1994), stakeholders’ wealth creation and maximization is an important objective of any business or enterprise. The rationale for the choice of the banking sector as a context is based on the fact that it is a highly intellectual capital-intensive sector where board-specific corporate governance may play a significant role in influencing value added through banks’ resources. Most importantly our review of the literature highlights that there are no studies that have examined this relationship for the Indian commercial banks. Indian banking industry is intellectually intensive and is regarded as one of the world’s best regulated banking industry that is poised to become third largest by the year 2025 (KPMG International, 2017, Thaker et al., 2021). The industry has undergone several changes in the recent past including governance reforms that have better prepared the industry for future challenges.

The motivation for this study stems from the fact that the board characteristics are expected to affect the decision making thereby impacting banks performance & VAIC. We examine the impact of Board characteristics - board size, board independence, board meetings, CEO-Chairman duality, and boards’ gender diversity on MVAIC (Modified Value Added Intellectual Coefficient). A larger board size may create problems of coordination and control thereby affecting flexibility in decision making (Jensen, 1993). As per resource dependency theory, a larger board size will bring in more human capital and skillsets leading to enhanced quality of supervision and decision making. The presence of independent directors on the board is expected to lessen agency conflicts and improve monitoring and supervision. This in turn may lead to improved earnings quality (Klein, 2002). If boards of firms have independent directors, the cost of debt is lower (Anderson, Mansi, & Reeb, 2004), and it leads to improved credit rating (Ashbaugh-Skaife, Collins, & LaFond, 2006). However, presence of independent directors with insufficient firm-specific knowledge may result in suboptimal decisions (Harris & Raviv, 2008; Raheja, 2005). The greater number of board meetings would mean more supervision of the management, reduced agency conflicts, and improved decision making and performance. Gender diversity in boards may impact board effectiveness. In breaking the glass ceiling women must display additional competencies and capabilities to reach that level and therefore women as directors are highly proficient and competent (Eagly & Carli, 2003). On the contrary, it is also argued it may lead to greater conflicts and lead to slower decision making. Combining the position of CEO and Chairman may lead to a powerful position and consequently result in firm and faster decision making. While the separation of the two positions may lead to greater checks and balances, it may lead to conflicts if the two powerful positions are not in agreement with each other. Thus, there are reasons to believe that board characteristics will influence decision making which in turn will impact VAIC.

This paper adds to the existing body of literature in the following ways: First, to the best of our knowledge, this is the first study of its kind to study the relationship between board structure characteristics and value creation in Indian banks using the VAIC methodology. Most of the existing studies in the literature have investigated the relationship between board governance and financial performance using measures such as financial ratios (Gafoor et al., 2018, García-Meca et al., 2015, Ghosh, 2017, Pathan and Faff, 2013, Sarkar and Sarkar, 2016, Shukla et al., 2020). Unlike accounting based financial ratios, the measure of the efficiency of value added in banks helps us in determining the value added by banks by using their physical resources and intellectual resources. Further, by using this measure we can also examine the impact of board characteristics on the efficiency of value added by banks through their physical resources and their intellectual resources. Second, the banking industry is a very intellectual capital-intensive industry wherein corporate governance occupies a very prominent position due to the nature of banks and their operations. A firm’s intellectual capital can be leveraged and exploited through the use of corporate governance mechanisms (Keenan & Aggestam, 2001). This study combines the critical aspects of intellectual capital and governance in banks. It is well-known that banks create value using their tangible or intangible resources and the board of directors is an important resource for the banks. Third, intellectual capital literature is largely in a consensus that relational capital is a critical component of intellectual capital. A review of the existing literature shows that studies linking board governance and intellectual capital outside the Indian context have not included relational capital in their analysis (Al-Musali and Ku Ismail, 2015, Appuhami and Bhuyan, 2015, Ho and Williams, 2003). This study proposes to incorporate relational capital into the model. Hence, the value of intellectual capital efficiency and subsequently VAIC would change and give a more complete picture since it covers the customer relationship as well which is very important in a service industry such as banking.This work examines how bank resources are influenced by board features. Fourth, the findings of the study would be helpful to bank managers, policymakers, and regulators seeking to identify and measure the value created by banks through their resources. This paper presents a framework to measure the value added by banks through their physical and intellectual capital resources based on their audited financial data. The findings might be useful for other developing countries with a similar banking setup. Policymakers and bank managers may use this framework for measuring value added in banks. At the same time, the findings of the study would help identify the board features that actually contribute to a bank’s value added and accordingly, appropriate policies could be designed to promote and leverage these factors. Section 2 reviews the existing literature, Section 3 describes the sample, data, and methodology, Section 4 presents empirical analysis, Section 5 presents robustness checks, and Section 6 provides the conclusion and directions for future research.

Section snippets

Studies on bank governance

The existing literature highlights several studies on the governance-performance relationship for banking firms outside the Indian context (Aebi et al., 2012, García-Meca et al., 2015, Grove et al., 2011, Pathan and Faff, 2013, Salim et al., 2016, Wang et al., 2012). The literature also highlights some studies on governance and performance relationships for Indian banks (Battaglia and Gallo, 2015, Gafoor et al., 2018, Ghosh, 2017, Mayur and Saravanan, 2017, Narwal and Pathneja, 2016; Pant and

Sample, data and methodology

The sample includes data from 41 public and private sector banks in India from 2008 to 2017. As of 31st March 2017, public and private banks accounted for more than 95% of the total advances of all commercial banks.1 Table 1 in the appendix offers insights about the sample. We didn’t consider period after 2017 due to

Summary statistics

The descriptive statistics presents a considerable variation in our dependent variables. Table 2 also gives the details about descriptive statistics of variables. The study takes value added through the total resources of the banks, value added through their intangible resources, and physical resources as the dependent variables in the regression model. The standard deviation value of 1.056 in the summary statistics shows considerable variation in the efficiency of the value added through total

Robustness checks

For robustness checks, the study uses the alternate VAIC model without considering the component of relational capital. Hence, VAIC variable used for robustness is the sum of human capital efficiency, structural capital efficiency, and capital employed efficiency (excluding relational capital efficiency). The results show board meetings and board duality to be positively significant factors (Table 5 Model 2). The results imply that an increase in board meetings increases the efficiency of value

Conclusion and implications of the study

This study investigates the relationship between board governance and the efficiency of value added in banks. Using a sample of 41 public and private banks in India, this study finds that board meetings and CEO-Chairman duality play a crucial role in determining the efficiency of value added by banks through total resources and intellectual capital resources. At the same time, the efficiency of value added through physical resources is negatively influenced by board independence. Banks should

Conflict of interest

The authors of the manuscript titled, “Board characteristics and efficiency of value added by banks: Evidence from an emerging economy” certify that they have No affiliations with or involvement in any organization or entity with any financial interest (such as honoraria; educational grants; participation in speakers’ bureaus; membership, employment, consultancies, stock ownership, or other equity interest; and expert testimony or patent-licensing arrangements), or non-financial interest (such

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