How does corporate governance affect performance of banks in Palestine?

Transcription

1 How does corporate governance affect performance of banks in Palestine? Submitted by Asma Ahmad As part of the degree Master of Business Administration School of Management University of Bath Graduation Year 2010 This project may be made available for consultation within the University library and may be photocopied or lent to other libraries for the purpose of consultation. Word count: words 1

2 Abstract: One of the important elements of the corporate governance that has received attention is the structure of the board of directors and ownership concentration. Although many studies attempted to find any association between good governance and firm s performance, little convincing evidence has been provided about the beneficial effect of good corporate governance on firms value and performance. To address this issue, this study seeks to explore the factors that influence the relation between corporate governance and performance of banks operating in Palestine relying on financial ratios, namely ROA. The statistical analysis applied is the Generalized Least Squares regression (GLS) through which a Cross sectional and Time series data are investigated using Panel Regression. The primary findings indicate that the board size, CEO duality, internal ownership, and the bank age have positive impact with statistical significance on the performance of the sampled banks; meanwhile, the board hierarchy, family ownership, bank size and debt ratio have a significant negative relationship with performance. Moreover, it is found that both the board size and the internal ownership have the most considerable influence on the performance of banks in Palestine. 2

3 Contents: Abstract:... 2 Chapter 1: INTRODUCTION Background: Objective: Value of this study: Scope: Structure:... 9 Chapter 2: LITERATURE REVIEW Corporate governance concept and indicators: Corporate governance for banks: Theoretical framework: CHAPTER 3: BANKING INDUSTRY IN PALESTINE Banks in Palestine: CHAPTER 4: FORMER STUDIES CHAPTER 5: METHODOLGY Sample description: Data collection: Model presentation: CHAPTER 6: RESULTS AND DISCUSSION Descriptive analysis of the data: Statistical analysis of the data: Chapter 7: CONCLUSION Implications for practise: Limitations: Directions for future research: Appendix A: Results of Statistical Analysis References

4 List of figures: Figure 1: A corporate governance framework: the internal and external architecture Figure 2: Agency theory Figure 3: Stewardship theory Figure 4: Stakeholder theory Figure 5: Banking Industry in Palestine nowadays. Figure 6: The boost up in the number of banks operating in Palestine. Figure 7: The increase in the number of branches of banks operating in Palestine. Figure 8: Variables considered for governance studies List of tables: Table 1: Branches of banks in Palestine Table 2: Increase in the number of branches during Table 3: Information related to banks operating in Palestine. Table 4: Descriptive analysis of all variables (governance and controlling variables) Table 5: Descriptive analysis of variables for national and foreign banks. Table 6: Independent Samples t-test of the ROA Table 7: Relationship between board size and ROA Table 8: Relationship between board hierarchy and ROA Table 9: Relationship between CEO duality and ROA Table 10: Relationship between internal ownership and ROA Table 11: Relationship between family ownership and ROA Table 12: Relationship between bank size and ROA Table 13: Relationship between bank age and ROA Table 14: Relationship between age and ROA for national banks 4

5 Table 15: Relationship between debt and ROA Table 16: Results of regression model analysis Table 17: Results of regression model analysis excluding the controlling variables Table 18: Results of regression model analysis for foreign banks (regional banks included) Table 19: Results of regression model analysis for foreign banks excluding controlling variables Table 20: Results of regression model analysis for national banks Table 21: Results of regression model analysis for national banks excluding controlling variables Table 22: Results of regression model analysis for the period of (Israeli invasion period) Table 23: Results of regression model analysis for the period

6 Chapter 1: INTRODUCTION For the last decades, there has been a growing awareness of the corporate governance in both the advanced and developing economies. The high-profile collapses of a number of large U.S. firms such as Enron Corporation and MCI Inc. (formerly WorldCom) in 2001, stimulated governments and international organizations to set regulatory principles for private and public companies (CFA Institute 2005). These policies are intended to support corporate management- and hence restore the public confidence in corporate governance -, and to ensure stock markets efficiency which contributes to economic stability as confirmed by the World Bank, International Monetary Fund, and Organization for Economic Cooperation Development. 1.1 Background: Companies have a major role in building and empowering the national economy, as an economy s progress is measured by the performance of companies in which operates (Monks and Minow 2008). Particularly, banks are a model, of which private companies consider, as banks are public limited companies that separate its shareholders from its board of directors and management. In view of the fact that banks are the main source for finance, that makes banks a competent tool towards making a change of applying and adopting corporate governance principles and basics through assuring transparency, information disclosure and accountability (Cornwall 2007). On the other hand, as banks operate 6

7 in a different sphere from private companies and trades its stocks in markets, which assures the risk correlated with the type of business banks provide, and emphasizes the importance of having an efficient regulatory system. Palestine, as other developing countries, has started recently to give attention to corporate governance, as there were conferences and workshops have been taken place to promote for corporate governance practises. Unfortunately, many obstacles appear to stop these initiatives, one of challenges is that there is no clear legal frame in which Palestinian firms operate, and there is no homogenous among these regulations, which substantially undermined the initiatives taken by the regulatory organizations in the region (Awartani 2005). After 2006, the stable political situation promoted for developing a number of local organizations within the scope of monetary regulation. One of these organizations is the Palestinian Capital Market authority which was established in 2005 as a body to monitor operations pertaining to securities trading in the securities exchange market, including the underwriting process of shares and bonds. Another organization is the Palestinian Monetary Authority, as a body to assist in the maintenance of the stability and effectiveness of the Palestinian financial system. In 2006, PMA has published a manual for principles of corporate governance for banks in Palestine (Abdeen 2009). Given that the corporate governance has been introduced for less than a decade in Palestine, many questions arise about the relation between corporate governance and banks performance in the financial industry in Palestine and particularly; are banks in Palestine committed to any of the corporate governance policies? And if 7

8 yes, is there any relation between these policies and banks performance? If a relation exists, what factors influence this relation? Does this relation differ for local banks from foreign ones? If it is different, then in which context? 1.2 Objective: This study seeks to assess how the adoption of corporate governance structures affects the performance of banks in Palestine. The study aims to investigate how corporate governance s customs and policies affect the growth and profitability of the banks in Palestine. The study intends to reveal the effect of the nationality of a bank on this relation, and to explore the relation from two perspectives, for banks in Palestine in general and then differentiates between the national banks and the banks with foreign and regional ownerships. Finally, the study attempts to shed the light on which of the corporate governance practises have major influences on the banks performance. 1.3 Value of this study: This study is considered one of the few that explores the corporate governance practises for banks in Palestine. Despite the increasing awareness of the corporate governance in Palestine, studies have so far focused on the private sector, with no statistically significant picture of corporate governance of the banking industry institutions. This study is intended to contribute to the understanding and knowledge related to the level of corporate governance adoption for banks in Palestine as it takes into account the interaction between different governance practises and performance. If the results of this study are taken into consideration by banks executives to be reflected in the future strategies and policies of banks, it is expected to shield 8

9 shareholders and employees interests, to strictly decrease the opportunistic behaviours of the executives, and to thrive the investments and hence maximize the profits which in turns create more job opportunities (Abdeen 2009). As this enhance the clients understanding of the banking industry where quality becomes the ground of the relationship, and drives banks to apply corporate governance standards and principles as a major criteria of the service quality. 1.4 Scope: The study targets the sample of all banks operating in Palestine; compromising of 22 banks, 11 of which are national banks (established and registered in Palestine), and the rest are 11 regional banks with branches operating in Palestine (externally established and registered in Arab countries) and one foreign bank (externally established and registered in a foreign country). The sampled banks are 18 banks of which the data on financial performance and corporate governance indicators were available either through the annual financial reports or through interviews with the management of the banks. The model considered for this study is basically based on Generalized Least Squares regression (GLS) between corporate governance application and the performance variable. The idea that we try to exploit, is that firms specific characteristics can influence, with governance characteristics, firms performance. 1.5 Structure: The work is divided in two parts. In the first part, we present, the theoretical framework as an introduction to the concept and indicators of corporate governance referring to the international organizations frameworks, and considering the governance standards for banks (Chpater2), provide an overview on the current 9

10 status of corporate governance adoption for banks in Palestine (Chapter3), and a revision on former studies that test the relation between corporate governance and performance and specifically discuss the impact of different corporate governance indicators on enhancing firms performance (Chapter 4). In the second part, we explain the methodology employed for the study and present the statistic model adopted (Chapter 5), as well as different results obtained (Chapter 6). The remaining of the paper concludes the discussion, the recommendations for banks in Palestine, and the implications of the results for further research (Chapter 7). 10

11 Chapter 2: LITERATURE REVIEW Corporate governance can be defined in different ways; depends on the way it is handled or discussed, but broadly it is a term refers to the rules, processes, or laws by which businesses are operated, regulated and controlled. Corporate governance has been exposed to a great level of discussion and interest as part of economy efficiency and responding to high profile of scandals involving abuse of corporate power, at the management level as well as the board intervention, by which restrains enterprises growth. 2.1 Corporate governance concept and indicators: OCED, Organisation for Economic Co-operation and Development, defines corporate governance as set of relationships between a firm s management, its board, its shareholders and other stakeholders (OECD 2004, p.13). Corporate governance, as OECD believes, provides a structure through which the objectives of a firm are set and the means of attaining those objectives are determined. To ensure an efficient corporate governance system, according to OECD, a contribution from all market participants is required; appropriate legal regulatory system besides self-regulation, and voluntary standards by firms, which consequently improves the transparency and reputation of a firm, moreover, enhances investor confidence and thus contributes to a sustainable economy efficiency and growth. According to OCED (2004, p.13), good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the 11

12 interests of the firm and its shareholders and should facilitate effective monitoring, thus, the presence of an effective corporate governance system, within an individual firm and across an economy as a whole, helps to provide a degree of confidence that is necessary for proper functioning of a market economy. As the result, the cost of capital is lower and firms are encouraged to use resources more efficiently, thereby, underpinning growth. However, what constitutes corporate governance is still a topic of debate, from a corporation s perspective there is a need for boards of directors to balance the interests of shareholders with those of other stakeholders employees, customers, suppliers, investors, communities in order to achieve long-term sustained value. From a public policy perspective, corporate governance is about nurturing enterprise while ensuring accountability in the exercise of power by firms. The role of public policy is to provide firms with the incentives and discipline to minimize the divergence between private and social returns and to protect the interests of stakeholders. Iskander and Chamlou (2002) articulate what forces good corporate governance might entail; referring to the World Bank framework (figure 1) which reflects interplay between internal incentives and external forces. 12

13 Internal Shareholders Board of Directors Monitors Reports Management Operates Core functions Private Stakeholders External Reputational agents Accountants lawyers credit rating investment bankers financial media investments advisors research Regulatory Standards Accounting Auditing Other Laws and regulations Financial Sector Debt Equity Markets Competitive factor Foreign direct investment Corporate control Figure 1: A corporate governance framework: the internal and external architecture- Adopted from Iskandar and Chamlou, The internal architecture defines the relationship among the key players in the corporation (figure 1). It is a set of internal arrangements that characterize the relationship between the shareholders and managers. That includes the way tasks and responsibilities are assigned to various players at the firm, and major decisions are taken, besides the hierarchal relationship between general assembly, board of directors and executive management with the regulatory approach that controls and organizes this relationship in a way that mitigate the conflict of interests between the three and to protect the interests of the firm. The center of this system is the board of directors; as it is responsibility to assure the long term viability of the firm, and provide oversight of management. As the role of the board varies between countries; from approving the firm s strategies and major decisions related to hiring, monitoring and replacing management to ensuring consistency with regulations and laws, and being answerable to different stakeholders, shareholders, employees and 13

14 in some countries for creditors; yet its main duty is to protect the firm s interest rather than shareholders interests. The governance issues that might arise within this scope vary depending on the ownership structure. At one end is the publicly traded firm with widely dispersed shareholders with dominating management and the challenge to select an independent board properly to monitor management s performance. At the other end is the closely held firm with a controlling shareholder and the challenge facing the outside shareholders to prevent the controlling shareholders from extracting excess benefits. While internal mechanisms for corporate governance regulate the relationship between players within a firm, external forces provide a level playing field and keep players in line (figure 1). They are notably policy, legal, regulatory, and market that together govern the behaviour and performance of the firm. External forces create some sort of legal framework for competition policy, the legal machinery for enforcing shareholders rights, systems for accounting and auditing, a well-regulated financial system, the bankruptcy system, and the market for corporate control. These external indicators enhance good corporate governance, and contribute to competitiveness of firms. Yet, there is no single model of corporate governance. It is an overview of market structure, legal systems, traditions and cultural and societal values; the framework may vary by country and sector and even for the same corporation over the time, but it shapes the agility, efficiency and profitability of all corporations. Meanwhile, and in 1999, OECD laid a foundation for good corporate governance practises, as well as guidance on implementation, which can be adapted to the 14

15 specific circumstances of individual countries and regions (OECD 2004, p.17). These principles were a subject of a review process in 2004, in which it embraces eight principles that ensure efficient corporate governance. Noting that the principles were developed to address a wide spectrum of governance issues arise from the separation of ownership and control, the power of certain controlling shareholders over minority shareholders, and other issues relevant to a firm s decision-making processes, such as environmental, anti-corruption or ethical concerns. OECD articulated that corporate governance is significantly influenced by the relationships among participants in the governance system (OECD 2004, p.15); such as controlling shareholders, which may be individuals, family holdings, or alliances, investors who may ask for a voice in corporate governance, individual shareholders who are highly concerned about protecting their interests against controlling shareholders selfdealing, creditors can serve as external monitors over corporate performance, and employees who contribute to the long-term success and performance of the corporation, while governments establish the overall institutional framework for corporate governance. The roles of those participants are subject to voluntary adaptation and market forces that in turns reflect each market s own economic, social, legal and cultural circumstances, and hence develop their own practices. As the purpose of the principles is to be a reference point rather than binding rules, the principles are evolutionary and should be reviewed in case of any change in the market circumstances. To sustain its competitiveness, a firm should adapt its corporate governance practices so it can meet new demands and grasp new opportunities; equally, governments have significant role in shaping an effective 15

16 legal framework that provide a sufficient flexibility to allow firms to respond to expectations (Monks and Minow 2008). The level of which firms can achieve of sound corporate governance, substantially influence investment decisions. As mentioned earlier that good corporate governance enhances firms and markets reputations, which in turns contribute partially to shape the international character of investment. Subsequently, enhanced transparency of markets increases the flows of capital which enable companies to access financing from a much larger pool of foreign investors as well as domestic investors which reduces the cost of capital, underpins the good functioning of financial markets, and ultimately induces more stable sources of financing. Therefore if countries plan for long-term patient capital, corporate government practises must be clear, well understood and communicated among its participants and adhere to internationally accepted principles. According to international organizations including OECD, the corporate framework should promote transparent and efficient markets, be consistent with the rule of law and clearly articulate the division of responsibilities among different supervisory, regulatory and enforcement authorities (Monks and Minow 2008). For countries to ensure an effective corporate governance framework, it should be developed considering its effects on overall economic performance, and incentives it creates for market participants to attain the practises. Legal requirements of the corporate governance practises should adhere to the rule of law, and be transparent and enforceable. The division among different authorities of the regulatory framework of the governance system should be clearly explained, besides allocate the resources 16

17 that support the supervisory authorities to fulfil their duties in a professional manner. Furthermore, the corporate governance framework should protect and facilitate the exercise of shareholders rights. Basic shareholder rights should include the right to secure methods of ownership registration; convey or transfer shares; obtain relevant and material information on the corporation on a timely and regular basis; participate and vote in general shareholder meetings; elect and remove members of the board; and share in the profits of the corporation (OECD 2004, p.20). The framework should facilitate the shareholders right to be sufficiently informed on decisions related to major corporate changes such as releasing additional assets and any extraordinary transactions that may affect the sales of a firm. Shareholders should be informed about the voting procedures that govern general shareholder meeting including date, location and agenda of general meetings, with the right to propose resolutions and adjustments to the agendas. The framework must facilitate the effective participation by shareholders in the nomination and election of board members. The equity component of compensation schemes for board members and employees should be subject to shareholder approval. Information concerning mergers and sales of substantial portion of the firm s assets should be disclosed to shareholders in an efficient and transparent manner, and transactions should take place at transparent prices that guarantee the interest of shareholders. Furthermore, the framework should guarantee the exercise of ownership rights of all shareholders including institutional investors, and allow shareholders to consult with each other on issues regard their basic rights. 17

18 Additionally, the framework should ensure an equitable treatment of all shareholders including minority and foreign shareholders (OECD 2004, p.20). That implies that all shares should carry the same rights, all investors should be updated on the rights attached to all series and classes of shares before they purchase, changes in voting rights should be approved by the classes of shares. All shareholders should have the opportunity to obtain effective redress for violation of their rights, as well as an opportunity to protect their legal rights and voting for major decisions. Therefore, minority shareholders should be protected from abusive actions by the controlling shareholders and chances of self-dealing should be strictly eliminated. Key executives and board members should disclose whether they have an interest in any transaction or any matter that influence the firm s value. The role of stakeholders should be recognized as well as part of the framework, which is established by law or through mutual agreements and encourage active cooperation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises (OECD 2004, p.24). Stakeholders should have the opportunity to obtain effective redress for any violation of their rights; and to have access to relevant and reliable information on timely basis. The framework should enhance employees participation, and promote employees and their representative bodies to openly and freely communicate their concerns about illegal practises to the board. Ultimately, the corporate governance framework should ensure disclosure and transparency are made on all material matters regarding the corporation, including firm objectives, major share ownership, voting rights, the financial situation, 18

19 operational results, foreseeable risk factors, issues regarding employees and other stakeholders, and governance structure and policies of the firm (OECD 2004, p.24). Information and reports should be delivered in accordance with high quality standards, besides an annual audit should be carried out by an independent and qualified auditor to provide an external assurance that the financial statements precisely represent the financial position and performance for the firm. Channels for disseminating information to relevant users should offer equal and cost efficient access. Finally, the framework should ensure as well, the effective monitoring of management by the board, and the board s accountability to the firm and the shareholders; that implies that the board should treat different shareholder groups fairly, applying high ethical standards (OECD 2004, p.24). The board is entitled to monitor the effective of the corporate governance practises and carry adjustments when they are required, to ensure transparent selection and nomination of its member, and to review all major plans, risk policy, annual budgets, and setting performance objectives of the firm. 2.2 Corporate governance for banks: Banks have a vital and inevitable contribution to build a solid infrastructure for the growth of any national economy; as banks acts as financial intermediary between those who have capital (such as investors or depositors), and those who seek capital (such as individuals wanting a loan, or businesses wanting to grow).besides, commercial banks, nowadays, are the backbone of national economies as they provide guarantees and assurance to execute huge investment national enterprises, in addition to other basic financial services of which banks offer to a broad segment 19

20 of the population such as bank transfers, cheques and bills collection, salaries payment, and access to payments systems (Cornwall 2007). Banks are different from private companies since they provide credit and liquidity which in turns affects the demand and supply on cash and capital in the market, and hence influence the monetary policies. Moreover, the importance of banks to national economies is underscored by the fact that banking is virtually universally a regulated industry and that banks have access to government safety nets. Consequently, any instability or underperformance of the banking sectors may cause the private sector to wane, financial system to deteriorate, and other negative consequences on the national economy level; therefore it is significantly vital to have effective and corporate governance at every banking organization. Following the financial crisis, of which the world witnessed end of the twentieth century especially Asian countries, alongside with the substantial development in financial markets and technology; there has been a great deal of attention given to the issue of corporate governance for banking organizations in various national and international fora. That awareness was translated into what Bank for International Investment (BIS) has initiated in 1999; to help ensure the adoption and implementation of sound corporate governance practices by banking organizations worldwide. BIS, represented by Basel Committee, issued guidance on corporate governance for banking and financial organisations, which is drawn from the OECD principles of corporate governance issued in earlier in the same year. In 2005 and 2006, Basel committee revised and updated these principles, confirming that from a bank industry perspective, corporate governance involves the manner in 20

21 which the business and affairs of individuals institution are governed by their boards of directors and senior management, affecting how banks to set objectives (including generating economic returns to owners), to run day-to-day operations of the business, to consider the interest of stakeholders, to align activities and behaviours of a corporate with expectations that banks operates in a safe and sound manner, and in compliance with applicable laws and regulations; and to protect interest of depositors. (BIS 2006, p.6). The papers, of which Basel committee issued, highlighted seven general practises confirming the fact that these strategies and techniques, which are basic to sound corporate governance, should be viewed as critical elements of any corporate governance process, as they were suggested by supervisors based on their experience with corporate governance problems at banking organizations and propose type of practises that could help to avoid these problems. The committee highlighted the fact that there are no universally correct answers to structural these governance issues, since different structural approaches to corporate governance exist across countries, even laws need not be consistent from country to country, so what the paper promotes for general principles that can be practised regardless of the form used by a banking organisation (BIS 2006, p.7). Four important levels of oversights should be included in the organizational structure of any bank in order to ensure sound corporate governance, which are also beneficial to government-owned banks; oversight by the board, oversight by individuals not involved in day-to-day activities, direct line supervision of different business activities, risk management and audit functions. 21

22 One of the eight practises is to ensure that board members are qualified for their roles and positions, aware of their contribution to achieve sound corporate governance, and are not subject of undue influence from either management or outside concerns. As the board of directors supervises the operational and financial soundness of the bank to satisfy shareholders expectations, an effective qualified number of board members are more capable to develop independency and objectivity that avoid conflict of interest, and empower the board to question management (BIS 2006, p.9).qualified external directors can become a substantial source of expertise that might help banks in crisis time and bring new perspectives from other businesses that may improve the strategic direction of the bank. For the board to accomplish this role, regular meetings with senior management and internal audit are substantially mandate, firstly to establish policies and secondly to asses and monitor progress toward corporate objectives, without being involved in day-to-day management activities of the bank. In a number of countries, bank boards have found it of assistance to form specialized committees that help banks to provide a close oversight to attain their objectives. These committees are risk management committee that receives periodic information form senior management on risk exposures and risk management activities in the bank such as activities in managing credit, market, liquidity, operational, legal and other risks of the bank. Another committee which is an audit committee that provides an oversight of the bank s internal and external auditors by reviewing audit scope, reports and making sure that senior management is taking appropriate corrective actions to address control weaknesses and any other 22

23 problems triggered by the auditors. It is preferred to have external board members o this committee with banking or financial expertise. A compensation committee that keeps an eye on the criteria and manners for payments of senior management and other key personnel and make sure that they are a compliant with the bank s culture and objectives. Lastly, is a nomination committee that regulates and controls the process of renewing and placing board members (Kim and Nofsinger 2007). Another practise that contributes to sound corporate governance is establishing strategic objectives and a set of corporate values that are communicated throughout the banking organisation (BIS 2006, p.11). The board of directors are strictly responsible for setting the strategic direction of the ongoing activities in the bank, and approving corporate values for itself, management team and other employees. These values are meant to ensure the timely and open discussion of problems and diminish corruption and bribery in internal dealings and external transactions. To avoid the senior management overly involved in business line decision making, an appropriate oversight by senior management is required. The board of directors should ensure that senior managers have the prerequisite skills and knowledge to fulfil their duties and to exercise full control over employees. As the board provides checks and balances to the senior management, senior management should consider line managers in specific areas, that s the reason a key management decision should be made by more than one person ( four eyes principle ) (BIS 2006, p.11). Senior management consists of a core group of officers responsible for the bank such as the chief financial officer, division heads and the chief auditor. These individuals must have the necessary skills and appropriate control over the key individuals in these 23

24 areas. Despite the fact that senior management is responsible for creating a hierarchy for accountability for the staff, they are ultimately responsible to the board for the performance of the bank. In addition to these practises, an effective utilising of the work conducted by internal and external auditors, does contribute to lay a solid foundation of good corporate governance in a bank. Board of directors utilize the auditors contributions as an independent check on the information received from management on the operations and performance of the bank (Kim and Nofsinger 2007). The board of directors and senior management should recognize the vital role of auditors in the corporate governance process and communicate this throughout the bank, taking measure to enhance the stature of auditors, and acting in regard to auditors findings such as timely correction by management of problems identified by auditors. Furthermore, the board of director should ensure that compensation approaches are consistent with the bank s ethical values, objectives, strategy and control environment. Compensation of senior management and key personnel should be aligned with the strategic direction of the bank and be consistent with the bank s culture and values, and not to be overly associated with short-term performance and trading gains; that way employees will be motivated to act in the best interests of the bank and its long-term growth (BIS 2006, p.13). Moreover, the board of directors is inevitably required to set and enforce clear lines of responsibility and accountability for themselves, as well as senior management, and finally, conducting corporate governance in a transparent manner where the 24

25 board of directors and senior management provide sufficient information on the structure and objectives of the bank with which stakeholders and general public can judge the effectiveness of the board and senior management in governing the bank. (BIS 2006, p.14). So, disclosure is required and desirable on various areas of the bank operations; board structure (size, membership criteria, qualifications, skills), senior management structure (roles, qualifications, reporting lines), basic organizational structure and hierarchy including incentive structure and policies and information on any other transaction that may affect the bank value. However, applying these principles is not a guarantee for sound corporate governance. The Basel Committee sheds the light on the significance of providing a supportive environment of sound corporate governance which is not merely associated with boards and senior management of banks, but also compromised of other parties that have ultimate contribution to enhance corporate governance such as governments through enforcing laws and regulatory frameworks, banking industry associations through initiatives to impose industry principles and communicate them to the public, stock exchanges though listing requirements and disclosure, and auditors through setting standards on delivering reports to directors and management (BIS 2006, p.15). Bear in mind, that corporate governance can be constantly improved through periodic review and adjustments responding to changes within the circumstances in the market, and addressing a number of legal issues, such as the protection of shareholder rights; clarifying governance roles; and aligning the interests of managers, employees and shareholders. All of these can 25

26 help promote healthy business and legal environments that support sound corporate governance in banks (BIS 2006, p.16). 2.3 Theoretical framework: Theoretical underpinnings for the research in corporate governance came from the classic thesis; The Modern Corporation and Private Property by Berle and Means (1932) that discusses the separation of ownership and control for large corporate in the United States (Abor and Biekpe, 2005), in which shareholders rely on the board of directors to stimulate action that fulfils their expectations of value maximization, senior managers run higher level of positions with a potential possibility of significant discretion over the corporate resources overlooking the interests of the shareholders. The study underlined the fact that when senior management on large companies pursue high level of personal interest of which affects the economy efficiency and wealth distribution among different segments in the United States (Fama and Jensen 1983). Moreover, Berle and Means studied the importance and consequences of the separation of ownership and control (board of directors and executive management); as businesses grow and shareholders increase in number, any shareholdings that directors have will be proportionally smaller capital stake, accordingly; directors' income will derive mostly from return on their labour as directors, not from their capital investment; therefore, a guarantee to accomplish shareholders interest, is to have on board number of board members who are not profit-seeking controlling group. These efforts have drawn emphasis on the shareholders rights to vote in general shareholder meetings, and on ensuring the transparency in a firm by maintaining proper bookkeeping and accounting practices 26

27 and information disclosure which come in a compliance with the practices that the World Bank, OECD, and other international organizations have confirmed earlier. Since Berle and Means thesis, different theories have been discussed in explaining the corporate governance issue. These include the agency theory, the stewardship theory, the resources dependence theory, and the stakeholder theory. Although former theories have contributed to the conceptual theory of governance, Jensen and Meckling (1976) efforts have influenced the current perspective of governance. As they articulated the agency relationship by defining the agency costs and showing its relationship to the separation and control issue. They define an agency relationship as contract under which one or more persons (principal) engage another person (agent) to perform some service on their behalf, which involves delegating some decision-making authority to the agent (Jensen and Meckling 1976, p.4). As agent will not always act in the best interests of the principal, agency problem takes place where the agent may extract perks out of a firm s resources and become less interested to pursue the principal s interests. However, the principal can diminish or strictly limit the divergence from his interest by incurring positive monitoring and bonding costs (non-pecuniary as well as pecuniary) and establishing appropriate incentives. As agency costs include expenditure of auditing, budgeting, control and compensation systems, bonding expenditures by the agent and residual loss are due to divergence of interests between the principal and the agent (Tricker 2009). However, it is generally impossible to avoid some diversion between the agent s decisions and those decisions which would maximize the welfare of the principal. 27

28 This provides an introduction to view the linkage between good corporate governance and corporate performance (efficiency), where the board of directors controls the capital invested by the principals (shareholders) and oversights the agent (senior management). Principals (Shareholders) Direct and steer Board of Directors Oversights and supervises Agents (top management) Figure 2: Agency theory While Agency Theory assumes that agents might be opportunistic and self- serving (individualistic), Stewardship Theory depicts them as pro-organizational and trust worthy (Donaldson and Davis 1991); since the aim of management is to maximize the firm s performance. Stewardship Theory suggests that managers are not motivated by individual goals, but rather are stewards whose motives are aligned with the objectives of their principals; which clearly replaces the lack of trust to which the agency theory refers with the respect for authority and inclination to ethical behaviour. Thus the role of the board of directors is not only limited to oversee the performance of management of seeking the objectives of the firm, but 28

29 also to act as a cooperative party that supports the Chief Executive Director to handle his managerial responsibilities. While the Agency Theory emphasizes on the necessity of the separation of control and ownership, where the chair of the board is not held by the CEO, to safeguard shareholder interests, the Stewardship Theory provides a different insight of which stresses on setting a structure within the firm to empower the CEO with complete authority over the firm; which ultimately assist him to attain a superior performance. When CEO significantly contributes to achieve superior returns to shareholders, his identification with the firm promotes a merging of individual ego and the corporation, thus melding individual self-esteem with corporate prestige (Tricker 2009). Thus, stewardship theory focuses not on motivation of the CEO but rather facilitative, empowering structures, and this situation is attained more readily where the CEO is also chair of the board. Accordingly, variation of the firm performance is explained by whether or not the firm structure helps the executive to formulate and implement plans for high corporate performance; but the question arises of how far executives can achieve the good corporate performance to which they aspire. 29

30 Principals Board of Directors Supports Empowers Management Figure 3: Stewardship theory On the other hand, the Resources Dependence Theory lays emphasis on the fact that the ability of a firm to protect itself against the external environment and to reduce uncertainty can be enhanced by the non-executive directors on board (Casciaro and Piskorski 2005). The resource role is played by board of directors mainly through leveraging their social and professional networks, advise, legitimacy, reputation, and channels of communications to reduce the uncertainty of outside influences to ensure the availability of resources necessary to their survival and development (strategic resources). The board is hence seen as one of a number of instruments that may facilitate access to resources critical to firm success. In order to secure these strategic resources, the firm relies on individuals and organizations within its external environment which are called Stakeholders. This theory suggests that a firm excels to maximize shareholders value and to satisfy stakeholders interests. Therefore, the firm picks for its boards selective members Supporters who are capable of investing their counsel, knowledge, and channel of communication with 30

31 external organizations, to gain preferential access to commitments or support from important actors outside the firm. Similarly, Stakeholder Theory considers the main role of the board members is the provision of resources. Accordingly, the board should comprise representatives of all parties that are critical to a firm's success. This will result in the firm's ability to build consensus among all critical stakeholders. That creates some sort of necessary cohesion and mediates the conflict of interest (Tricker 2009). A mandate to guarantee effective corporate governance is to have representations of various stakeholders groups; customers, suppliers, employees, the national community and shareholders are deemed to also have a stake in the business of a firm. Stakeholders (employees, lenders, investors, customers, suppliers, the local community and shareholders) Representative Board of Directors Provision of resources Support Management Figure 4: Stakeholder theory Drawn from the earlier discussed theories and literature, principal practises of corporate governance for firms have been derived related to either the board indicators including board size, board skill level, or ownership, if it is internal, family, or foreign ownership (Abor and Biekpe 2007, p.290). In some countries, bank boards 31

32 have found it useful to establish number of committees to oversee various managerial soundness of the bank. Other researchers consider indicators related to the committees and their compositions to assess the corporate governance practises in a firm (BIS 2006, p.7); such as Audit Committee that provides oversight of the bank s internal and external auditors, Nomination Committee that assess the board effectiveness for renewing and replacing board members, and Compensation Committee that ensures that rewards and payments of senior management and other key personnel are compliant with the bank s culture, objectives and control environment. The board related indicators will be considered for assessing the adoption of corporate governance practises of Banks in Palestine, for data availability purposes. There is a view that larger boards enhance the corporate governance practises, considering the diversity of the board s expertise which in turns enriches the managerial decision process and strictly limits the CEO s domination (Abor and Biekpe 2007, p.291). Jensen (1993) argues that the effectiveness of the boards and CEO s support improved by decreasing the number of members on board; since for big boards, higher level of communications and efforts for facilitation are required to coordinate among the members on one hand, and between the boards with the CEO on the other. As it becomes difficult to coordinate when a board gets too big, as this often creates problems, and makes it difficult to respond timely during the crisis and emergency time; moreover it reduces the accountability of individual directors and increases the possibility of free riding, as for the big boards, the main role for managing and overseeing the bank is overtaken by a group of the members, while 32

33 the rest will not have an efficient contribution, giving them the chance to take the advantage of the first group. Even Jensen went to strict the number of directors for the operating companies of no more than eight people as an element of six principles to improve a governance structure within a firm(1993, p. 869). Another indicator that could be of an interest for researchers is to assess the governance structure within a firm is the board composition and control. Despite the researches have investigated this issue so far such as the study delivered by Wyatt and Rosenstein (1990), there is no clear conclusion of whether directors should be employees (inside directors) or outsiders. The researchers support having inside directors, argue the fact that the inside directors are more familiar with the firm s activities and have the chance to advance into positions to outperform incompetent executives which in turns enhances the firm performance. Opponents to this view, argue that non-executive directors may act as professional referees, and stimulate actions aligned with the firm s objective of maximizing shareholder value as the independency of the board increases as the proportion of their non-executive directors increases (Abor and Biekpe 2007, p.291). Bahgat and Bolton (2006, p.7) shed the light on the positive correlation of stock ownership of board members with the firms performance, they articulated this correlation as It is plausible that an independent board or board members with appropriate stock ownership will have the incentive to provide effective monitoring and oversight of important corporate decisions...; hence board independence or ownership can be a good proxy for overall good governance this conclusion supports what Han and Suk (1998) find that the 33

34 level of insider ownership is positively related to stock returns but they warn of the the problem associated with managers' entrenchment. However, Buckland (2001) did not find any clear correlation between the independency of the board with agency problem or cost. Additionally, the level of training and educational qualifications among board members and managers has a substantial influence on the firm s performance (Abor and Biekpe 2007, p.291). This positive correlation is due the ability of higher educated directors to invest their knowledge and skills to gain access to external information, develop networks and more detailed monitoring systems, and make use of consultants. Although higher-level management qualifications may be useful to firms, some researchers have still some doubts as to their relevance to good corporate performance; moreover, others went to argue that there may even be a negative effect on firm performance as a result of the occupational and professional affiliations of highly qualified managers which may encourage increased agency cost and opportunistic behaviour. Abor and Biekpe (2007, p.292) argue that effectiveness of the board to oversight the top management is diminished by the duality of the CEO. They define CEO duality as concentration of decision management and decision control in one individual. For the systems where the CEO also acts as chairman of the board that often increases the possibility of conflict of interest and agency problems. Fama and Jensen (1998) considers that CEO duality limit the efficiency of the board to provide monitoring and control over the top management; thus giving preference for the system where the CEO s role is separated from that of the board chairman. While other researchers 34

35 reported that companies with CEO duality have stronger financial performance relative to other companies. Finally, the ownership is one of the significant indicators of governance within a firm, including inside ownership, family business and foreign ownership. This indicator specifically has got the attention of international organizations and researchers to lay the foundation for corporate governance practises; bear in mind its substantial contribution to protect the interests and rights of minority shareholders, employees and creditors of firms. Some researchers found that high level of board and insider ownership has a positive effect on the performance of the firm as they are more familiar and aware of the internal policies, operations and systems which enable them to make right and appropriate decisions. Consequently, it reduces outside owner s intervention to monitor and control the behaviour of the firm s leadership, which reduces the value of the firm. It is often argued that family led businesses create an atmosphere of love and commitment toward the firm, and higher level of trust and altruism that enhance communications between employees and managers and consequently reduces the agency cost. However, other studies indicated that managers tendency to be engaged in entrenchment increases in family firms resulting in weaker performance. While foreign ownership ensures better access to the investment opportunities (by having large foreign institutional investors who actively monitor the actions of management), and facilitate stronger monitoring of managers. But some researchers agree on limiting the managers and board ownership as a high level of insider ownership is not efficient, given that managers will pursue policies to 35

36 their own advantage instead of aiming at innovative entrepreneurial opportunities and shareholder value maximization (Monks and Minow 2008). 36

37 CHAPTER 3: BANKING INDUSTRY IN PALESTINE Lately, corporate governance has been one of the topics that acquired major consideration in Palestine, as noticed that workshops and conferences have been taken place to advocate organizations applying corporate governance practises. Unfortunately, these initiatives were restrained by obstacles that substantially undermined the value of regulatory organizations contributions in the region; as Sulivan (2005), believes that corporate governance of the private sector in Palestine is fragile; highlighting various aspects of the vulnerability of the corporate governance structure which are briefed as follows: maintaining board members of chambers of commerce on charge for more than fifteen years, which implies no elections have taken place for this period of time, weakness of the hierarchal structure of the boards and its mechanism, chaos of the legal frame in which Palestinian companies operate as some of its regulations lacks homogeneity, besides monopolies spread by governmental organizations as well as private institutions. Few attempts have been initiated to overcome these obstacles and empower the governance structure of the Palestinian firms, represented by the International Finance Corporation (IFC) project to lay the foundation for corporate governance principles that comport with the Palestinian law and regulatory frames; considering the instability of the situation in Palestine; however, and after the Palestinian election in 2006, these efforts were impeded and hindered. On the other hand; the stable political situation followed the 2006 elections, has enhanced other attempts formed by local organizations. Such as the project 37

38 commenced by Palestinian Capital Market Authority (PCM) to revive the efforts of dedicating a national committee that works on developing corporate governance principles that suit the criticality of the Palestinian situation. The national committee of governance has been formed which reports to the PCM; and it has on board organizations and individuals with interest to develop a Palestinian constitution of governance that assesses the suitability of these principles with the international criteria for governance. The committee is still working to publish the governance principles once they are approved by related organizations in charge. Furthermore, the Palestinian Monetary Authority (PMA) has drafted a Corporate Governance Code for banks to ensure that banks in Palestine adopt sound corporate governance practises which enhance public trust and confidence in the Palestinian banking sector, and hence ensure the proper functioning of the bank sector (PMA, 2006). PMA articulates the aim of issuing the code as follows: enhance banks awareness of good corporate governance practise and develop some sort of approval on the importance of applying the principles properly to gain what they are developed for, craft a regulatory structure for banks governance complying with legal requirements of related laws, and provide instructions and guidance for banks on how to achieve the best commitment with the practises. The code has been set at high standards and derived from the international best practises of the OECD principles of 2004, Basel Committee on Banking Supervision's paper on enhancing corporate governance for banking organizations. The code covers two sets of rules, instructions which represent complimentary good governance practises which are drawn up from the Banking Law of which banks are 38

39 required to comply with, and guidelines where banks are subject to the "comply or explain" approach with regard to; however, it is possible that the guidelines will turn into instructions in the future. 3.1Banks in Palestine: In 1967, Israeli authority closed all Palestinian banks operating at that time; to be replaced by six Israeli banks with 39 branches offering their banking services in both West Bank and Gaza (PMA, 2006 and Bank of Palestine, 2008). In 1981, Palestine Bank won a case against the Israeli court, which enabled the bank to commence its operations in both West Bank and Gaza strip (PMA 2006 and Bank of Palestine 2008). Following the success of the Peace Process in 1994, Palestinian National Authority (PNA) became in charge of the bank sector in terms of issuing regulations and related appropriate legislations. In 1995, the Palestinian Monetary Authority was initially established by a presidential decree to be an independent body to assist in the maintenance of the stability and effectiveness of the Palestinian financial system, and later by an act of the Palestine Legislative Council PMA Law Number (2) of 1997 which outlined the full authority and autonomy of the PMA. PMA was formed to deliver responsibilities listed within Paris Economic Protocol (PMA, 2006) of licensing and regulating financial institutions and overseeing a payment system. Since then, the number of operating banks in Palestine, especially national banks, has increased gradually, from only two operating banks with nine branches, which are Bank of Palestine P.L.C and Cairo Amman bank. 39

40 Bank Industry in Palestine nowadays, compromises of Palestinian commercial banks and foreign commercial banks that have branches in Palestine, and Palestinian Monetary Authority that plays substantial supervisory role on banks (look appendix A). There are 22 banks operating in Palestine till 2009, eleven are with foreign and regional ownership (non Palestinian ownership) as follows: Eight Jordanian banks including Arab Bank, Cairo Amman Bank, Jordan Bank, Jordan Commercial Bank, Jordan Ahli Bank, Housing Bank, Jordan Kuwaiti Bank, and Union bank for Saving. Two Egyptian banks: Egyptian Arab Land Bank, and Principal Bank for Development and Agricultural Credit One foreign bank which HSBC Middle East National banks are eleven: Bank of Palestine (PLC), Commercial Bank of Palestine, Palestinian Investment Bank, Arab Islamic Bank, Al Quds Bank for Development and Investment, Palestine Arab Investment Bank, Palestine International Bank, Palestinian Islamic Bank, Al Aqsa Islamic bank, The Palestinian Banking Corporation (PBC), and Raffah Bank. Figure 5 shows the current banking industry in Palestine. 40

41 Banking Industry in Palestine National Banks Figure 5: Banking Industry in Palestine nowadays. The branches of the national banks represent 52.5% of the total branches in Palestine, while the branches of the banks with regional (Arab) and foreign ownership count for 47.5%, table 1 shows the branches for all banks operating in Palestine: National banks Number of branches Regional and foreign ownership Number of branches Bank of Palestine (PLC) 28 Arab Bank 23 Commercial Bank of Palestine 5 Cairo Amman Bank 16 Palestinian Investment Bank 9 Jordan Bank 8 Arab Islamic Bank 8 Jordan Commercial Bank 3 Al Quds Bank for Development and Investment Palestine Arab Investment Bank 11 Jordan Ahli Bank 5 Housing Bank 7 Palestine International Bank 4 Jordan Kuwaiti Bank 2 Palestinian Islamic Bank 11 Union bank for Saving 1 Al Aqsa Islamic bank 2 Egyptian Arab Land Bank 7 The Palestinian Banking Corporation (PBC) 2 Principal Bank for Development and Agricultural Credit 1 Raffah Bank 2 HSBC Middle East 1 Table 1: branches of both national, regional (Arab) and foreign banks operating in Palestine- (PMA, 2006) 41

42 Figure 6 shows the increase in the number of the banks operating in Palestine between 2001 and 2007: The boost up in the number of banks operating in Palestine National Jordanian Egyptian Foreign Figure 6: The boost up in the number of banks operating in Palestine- (PMA, 2006) Figure 7 and table 2 demonstrate the increase in the number of the branches of those banks, and it is clear that the number of branches of national banks has increased and become more than the branches of the regional and foreign banks after the year National Banks Jordanian Banks Egyptian Banks Foreign Banks All Banks Table 2 Increase in the number of branches during (PMA, 2006) 42

43 The boost up in the number of banks operating in Palestine National Jordanian Egyptian Foreign Figure 7: The increase in the number of branches of banks operating in Palestine Finally, table 3 illustrates some information related to some banks operating in Palestine; noting that for regional and foreign banks, the year of establishment point out the year of which the first branch was opened in Palestine: Year of establishment Size of Asset Debt ratio Number of board members CEO duality Bank of Palestine yes (PLC) Commercial Bank of Palestine No Palestinian Investment Bank Yes Arab Islamic Bank No Al Quds Bank for Development No and Investment Palestine Arab Investment Bank Yes Al Aqsa Islamic bank No Arab Bank 1930/ Yes Cairo Amman Bank 1960/ Yes Jordan Bank 1960/ No Jordan Commercial Bank 1977/ Yes Jordan Ahli Bank 1955/ Yes 43

44 Housing Bank 1974/ No Jordan Kuwaiti Bank 1976/ Yes Union bank for Saving 1979/ Yes Egyptian Arab Land Bank 1947/ No Principal Bank for Development and Agricultural Credit 1930/ No HSBC Middle East 1946/ Yes Table 3: Information related to banks operating in Palestine 44

45 CHAPTER 4: FORMER STUDIES The relationships between measures of corporate governance and organization performance have been the interest of many researchers over the time, whether organizations are firms or banks, paying more attention to study the internal dimensions of corporate governance, and not considering the sectors in which firms operate. In fact, corporate governance practises are always associated with big businesses, because of the necessity to separate the ownership from control body; bearing in mind that increasing firm size induces firms to set up more articulated governance structures. While small firms were out of the scope for most of the studies on corporate governance, assuming that corporate governance practises are not applicable to the small firms; considering the number of employees and shareholders which influences their unity and commitment and then the level of pressure that they can exert on the board to meet their interests- and most of these firms are family-owned businesses or managed by one of the owners. Therefore; small firms are often assumed not to be complex enough to raise corporate governance issues. While some researchers believe that corporate governance practises should be applied equally and in the same manners regardless of the firm size. Montemerlo (et al. 2008) in his study on corporate governance for SMEs (small to medium-sized enterprises) in Italy, pointed out that small and medium sized enterprises are traditionally assumed to eliminate agency costs because of the fact that relations in family businesses are based on kinship, blood, sentiment, trust and 45

46 altruism; since it counter-balances opportunistic behaviour; however, family nature can bring about special agency costs due to the inconsistency between family and executives goals, lacking market discipline, executives self-control for managerial decisions, and adverse selection as a result of lacking the appropriate experience and qualification which are mandatory to evaluate market options and opportunities. These results explored by Montemerlo s study leads to assume that firms of various sizes incur different level of agency threats whether it is because of the agent or because of the family ownership concentration in a firm; but as the more firms become complex in size and ownership structure, the more it is necessary to delegate tasks to agents (directors and managers) at various level, and the more governance structure need to be articulated accordingly in order to keep agents motivated. The existing framework of governance in banks is defined by dimensions categorized into two sets: variables related to the management including size of the board of directors, hierarchy of the board, qualifications of the board members, qualifications of the executive management and duality of the CEO, and the second set of variables which are related to the ownership concentration compromised of internal ownership, family ownership, and foreign ownership. Some researchers consider a number of controlling variables for their studies of the relation between performance and firm s level of application of governance practises such as debt ratio, size and age of the firm. Controlling variables are subject to be included as part of the studies, to secure some sort of steadiness and reliability of the model and eliminate the implication of debt ratio, size and age on the relation between 46

47 governance and performance. Figure 8 shows the variables considered for corporate governance studies. Ownership Controlling variables board of directors Governance Management and board of directors Figure 8: Variables considered for governance studies Abor and Biekpe (2007) studied how the adoption of corporate governance structure affects the performance of SMEs in Ghana. The study sampled 120 firms with less than hundred employees in both the industrial and services sectors during a six-year period, The data used in the analysis was obtained from the financial statements of SMEs and through interviews from the management of the firms. This study seeks to examine the effects of corporate governance, and the ownership structure on the performance of the firms. Return on assets (ROA) is used as a measure of performance, and it is calculated by dividing profit before interest and taxes by total assets. The independent variables tested to assess the corporate governance practises compromise of variables related to ownership (inside shareholding, family ownership, and foreign ownership), variables related to the board and management structure (board Size, board composition, board skill, management skill), and the existence of CEO duality in these firms. Other variables were included as controlling variables to ensure the robustness of the model, and to minimize specification bias and generalize results for banks and financial institutions 47

48 internally and externally. These controlling variables include size, age, and debt ratio. The methodology used is the regression analysis based on the results of Generalized Least Squares (GLS) to analyze the cross sectional of the data gathered on banks over the period between 1998 and The results show that board size has a significant positive correlation with governance; as firms with larger boards perform relatively better compared to very small boards; which is articulated by the variety of expertise that the larger broads bring out to make better decisions. Results prove that the level of training among board members and mangers could have a strong influence on the performance of the firm. The results of this study indicate a statistically positive relationship between CEO duality and firm performance; 86%of the firms have been sampled for this study were with CEO duality which means that combining the roles of both the CEO and board chairman demonstrate better performance than those with two individuals performing such roles. Inside shareholding, family business and foreign ownership had positive impact on performance which they explained by CEO duality, and the fact that managers who are shareholders seem to understand the business better, to have good knowledge and appreciation of the operations of the firms, and are often in the position to take decisions that are in the interest of maximizing shareholder value instead of engaging in opportunistic behaviour. Moreover, family ownership creates an atmosphere of love and commitment necessary for better performance. The model shows a negative relationship between size, age, and performance. As firms get larger, the agency cost increases and firms focus directed to manage day-to-day issues; and that is why relatively smaller firms perform better than relatively bigger firms. The study suggests that older firms are more likelihood to record higher 48

49 profits as they get more experience to run operational and managerial issues with efficiency, and invest in their long-term relations with customers and hence improve quality of services offered. The results also indicate a negative association between debt ratio and firm performance; as the debt ration increases, it reduces the returns that can be invested in broadening the firms activities; and that s why SMEs with less debt in their capital structure appear to perform better than those that pursue high debt policy. Kahiri with others (Kahiri et al. 2007) studied the association between the efficiency of governance practises and performance of 320 American over the period between 1994 and The sample is extracted from Fortune 500, which includes mainly large firms. The firms operate in eleven different sectors; 17.5% in service sector, 17.8% in the production sector, 15.62% in roughly and detailed sales, 12.5% in consumption services, % in technology sector, 6.25 in energy sector, and the rest operate in financial sector, health, paper and publication, chemistry and transport. The methodology used is the Stochastic Frontier Analysis that integrates the variables to calculate a governance efficiency index of the sample- and on the managerial efficiency-, based on different governance mechanisms. The idea that the study seeks to exploit from the model adopted to compute the indexes, is that firms specific characteristics can influence, with governance characteristics, firms performance. For this study, profitability is used as an indication on the performance, which is measured by return on equity (ROE) and Tobin sq. The governance elements considered for this study composed of independent variables related to ownership structure (executive ownership, major shareholders ownership 49

50 level, executive ownership level, and CEO ownership level), board of director structure(board of directors size, number of independent and foreign members, and CEO duality), and audit committee structure (internal auditing committee, compensation committee and nomination committee). The controlling variables examined by the study are firm size, debt ratio, and dividend yield. Results of the study are in consistent with governance principles, as results show a positive impact of board size, number of independent and foreign members on board, number of periodic meetings have positive impact on performance, while CEO duality has a negative relation with performance. All forms of ownership are negatively linked with performance; meaning that ownership concentration implies control in hands of few members. Meanwhile, internal auditing committee has a positive relation with performance in terms of number of member, number of annual meetings, number of members with finance degrees and qualifications, and number of independent members. Other committees, compensation and nomination, have the same positive relation with performance. However, the existence of the CEO on one of the two committees has a negative impact on performance as it decreases the profitability of the firm, which is consistent as well with the institutional governance principles that mobilizes for the independency of the supervisory committees within a firm to secure the minor shareholders interest against opportunistic behaviour of the CEO and major shareholders. While the study that Shaheen and Nishat (2004) delivered on Karachi Stock Exchange, by creating a summary index Gov-Score as an indicator on governance practices followed by the sampled firms. The data was collected for 226 individual 50

51 firms in 2004, through a questionnaire containing 37 factors as either 1 or 0 indicating whether or not the firm s governance standards are applied, then sum each firm s binary variables to derive the Gov-Score. The questionnaire covered seven corporate governance categories; audit committee, board of directors, CEO education, executive and director compensation, ownership, and progressive practices during the year 2004 of membership duration of board members, oversight on CEO performance, and internal system(charter) and rules that regulate voting proportion, representation and firm s capacity to issue preferred stock. The study considers five performance measures spread across three categories: operating performance, valuation and shareholder payout. The measures on performance are return on equity (ROE), profit margin and sales growth, Tobin s Q, and a single measure on valuation and shareholder pay out which is dividend yield. The methodology triggers the correlation between Gov-Score and firm performance s indicators using Pearson and Spearman Correlations. The study results prove that compensation of executive and director is positively correlated with net profit margin and sales growth, while progressive practices and ownership are positively correlated with the five performance measures and statistically significant. The results demonstrate that the internal ownership of the sampled firms is positively correlated with the five performance measures, and the number of independent directors has significant positive correlation with ROE. The study indicates that the governance categories related to audit and board of directors are highly associated with good performance with no clear evidence on the governance categories related to director s education and charter on good performance. 51

52 In Palestine, very few studies were conducted concerning corporate governance; one of them was delivered by Abdelkarim & Alawneh (2007). The study sampled the most sixteen trading firms at PSE between 2005 and They relate corporate governance and performance for the selected firms by considering ownership concentration as one of governance dimensions, which is defined by the ownership of top 5% shareholders, and Tobin s Q as an indicator on performance. Control variables are considered including annual sales revenue which is considered as an indicator on the firm size, debt ratio, and the growth of net income. The study triggers a negative impact of ownership concentration on the market value for the firms mainly for the year 2006, which in turns weakens the corporate governance and market efficiency all over. The results show a positive impact of firm size and sales return on the firm performance, while growth of the net income has negative relation with performance. Abdelkarim and Alawneh reported that Palestinian listed companies have ownership concentration that affects information disclosure and transparency that have an inverse impact on governance. Finally, Brown and Caylor (2004), created an index of governance composed of 1868 firms for the year of The index is composite of 51 of governance practises that are provided by Institutional Shareholder Services. As some previous studies, Tobin s Q is used as an indicator on performance for this study; while the 8 variables encompassed on governance are : audit, board of directors, charter/bylaws, director education, executive and director compensation, ownership, progressive practices, membership duration of board members, oversight on CEO performance, rules that regulate voting proportion and representation, shareholders right, firm s capacity to 52

53 issue preferred stocks, and state of incorporation. It is found that there is no correlation between audit committees independence (CEO serves on none of the committees) and performance. The results show that there is a positive impact of board in terms of education, number of periodic meetings on commitment level of directors with ownership criteria declared by the ISS. It is found that there is no strong association between directors gaining an advanced managerial training (at least one) and performance. Firm size and age were considered as controlling variables. 53

54 CHAPTER 5: METHODOLGY This chapter includes the description of the sampled banks, the ways data was collected, and the model used for the analysis. 5.1 Sample description: The study considers all banks operating in Palestine whether they are national banks (local ownership), Arab banks (Jordanian and Egyptian), or foreign bank. Currently, 22 banks operating in the Palestinian Occupied Territories (West Bank and Gaza Strip). The study explores a sample of 18 banks out of the 22 banks (population sample). 5.2 Data collection: The variables examined by the analysis model (described later in this chapter) compromised of financial variables and non financial variables. The data for financial variables (related to performance) was drawn from financial annual reports which are announced by some banks either through banks publications or through the online databases at BankScope. While the data on non financial aspects of corporate governance such as ownership concentration, board, and management related variables, was collected directly from authorized representative parties of the sampled banks, in case they are not available through earlier mentioned methods. The period considered for the study is from 2001 till 2006, since during this period, banks in Palestine started to give more attention to apply corporate governance principles (Abdeen 2009). This consciousness was translated into different aspects; a number of the banks included a separate section within their annual publications and promotional materials on achievements and progress have been accomplished 54

55 so far for that year. Besides, financial information for some banks for the years apart from the considered period was not obtainable. Four banks were exempted from the sample for various reasons; Raffah Bank as it is established in 2006, and consequently the bank has no available data to be considered for the study. The Palestinian Banking Corporation was excluded since this financial institution is more a credit agency which is specialized in lending Palestinian small and medium sized enterprises (SMEs) under funding agreements (Palestinian Monetary authority, 2006). Palestine International Bank (PIB) was not considered for the sample; since the bank was seized by Palestinian Monetary Authority (PMA) in 2005 as a result of serious legal loopholes in managing the PIB, which erupted following alleged administrative irregularities by PIB top management (Center for Private Sector Development CPSD, 2006). PMA took the charge of running the PIB operations through a committee that took over the role of the PIB board. PIB was prohibited from trading its stocks at Palestinian Stock Exchange (PSE) in Besides, the bank management and PMA were not cooperative to disclose the required data for the study. Finally, Palestinian Islamic Bank was not included for the sampled banks, because of the inability to gain the related data through both direct and indirect sources. Data for banks either with regional(arab) or foreign ownership were drawn without separating their branches operating in or out of Palestine; based on the assumption that branches operating in Palestine follow the norms and rules set by the headquarter of those banks, which is confirmed by the procedures and 55

56 arrangements that the local branches follow; moreover, those banks announce their financial reports and other related information for the bank in general and without distinguishing local branches from branches abroad. 5.3 Model presentation: This paper follows the tradition of empirical work in corporate governance by examining the performance of the firm in the form of regression analysis. The regression model used is the Generalized Least Squares regression (GLS) between corporate governance variables and profit (performance) variable by applying Panel Regression Model which merges cross sectional data over time series in one model; which helps to get results that cannot be shown by using only part of the data. The idea I try to exploit, from the model adopted, is that governance characteristics can influence, with firms specific characteristics, firms performance. A firm performance can be measured using different indicators such as profitability, efficiency, effectiveness, employment capacity and others, while the profitability is used as an indicator on performance which is measured by return on assets (ROA). ROA is calculated by dividing the net income (before the deduction of interest and tax) by total average assets. This indicator was selected as it shows how profitable a company is relative to its total assets, and it gives an indication on how well a firm is able to transfer the invested capitals into financial revenues. ROA is considered as well as a pointer on the performance of the firm s internal management as it includes investors equity and drawings. Besides; the availability of the data for calculating this indicator for the sampled banks. 56

57 The definition of corporate governance depends on one s purposes; it varies from a broad definition backed with authority to a narrowed one concerning protecting minor shareholders and stakeholders interest (Gill 2002). The definition explored by this study encapsulated of how well a bank is managed and the level of compliance with international standards discussed earlier; that is why the following aspects were investigated; board related variables and ownership concentration variables. The board related variables are size of the board, hierarchy of the board, qualifications of the board members, and duality of CEO. Variables related to the ownership concentration are internal ownership, family ownership and foreign ownership. The way each variable is measured, described below: Variable Board size Hierarchy of the board Qualifications of the board members Duality of the CEO Internal ownership Family ownership Foreign ownership Measures Measured by the number of the members Measured by the percentage of the non executives on the board Measured by the number of members with higher education/qualifications Takes two variables: i. 1- if the CEO is the chairman ii. 0- if not. Measured by the allowances owned or directed by CEO and employees Takes two values: i. 1- If more than 50% of the bank is owned or managed by a family or number of families ii. 0- if not. Takes two values: i. 1- If the bank has an Arab or foreign ownership ii. 0- if it is a national bank(locally established and registered) 57

58 The variable of hierarchy of the board is measured by the percentage of the board members that do not hold any executive managerial position, which in turns keep the board members more disciplined and focused on their supervisory role on the top management of the bank. Duality of the CEO is set to 1 in case that the CEO takes the role of the chairman of the board during the period of time considered for the study. The sample shows that the membership of the boards for the sampled banks did not expire during the time frame considered for the study, highlighting that the membership of the boards does expired by end of the year and not during the year. For the family ownership variable, is considered 1 if the majority of the bank (more than 50%) is owned or managed by a family or group of families. To assure the reliability of the analysis model and to extend its explanatory aptitude, three controlling variables to be considered; firm size, firm age and debt ratio. The variables are measured as described below: Variable Firm size Firm age Debt ratio Measures Measured by assets in logarithms Measured by number of years since the bank is established to the year of considering the sample Measured by debt to capital ratio Noting that those three controlling variables were chosen following the tradition of the models examining the performance of the firm in general. As it is expected to have results similar to the previous studies; firm size and debt ratio are negatively 58

59 correlated with the performance, while firm age has a positive influence on the performance. The model used is: Where: : Variable of bank performance : Constant and has specific value for each bank. : Vector represents board related variables : Vector represents ownership related variables : controlling variables : error term or disturbance As other panel regression models, it is expected to be a subject to Hetroscedasticity, which will be tested by calculating White Hetroscedasticity-Consistent Standard Errors and Covariances. 59

60 CHAPTER 6: RESULTS AND DISCUSSION This chapter includes two sections, the first presents a discussion of the results of descriptive analysis of the data collected (variables), and the second expounds the statistical analysis result of the proposed model. 6.1 Descriptive analysis of the data: Table (4) shows the descriptive analysis of all variables considered for the applied model. It illustrates that the average of returns on assets (ROA) for the sampled banks is 1.2%. While the average number of board members is 10, 92% of which do not occupy executive managerial positions, and 78% of the members has higher education degrees. 58% of the CEOs perform as board chairman. 12% of the total shares are owned by CEOs and executives. 28% of the banks are family-owned banks and 67% of the banks operating in Palestine are with foreign ownership. For the sample, the average of the assets is 330 million Jordanian dinars, average age is 40 years and average debt ratio is 84%. lowest value highest Mean Standard value Deviation Return on assets Board size Board hierarchy Qualifications of the board members CEO duality Internal ownership

61 Family ownership Foreign ownership Firm size/ bank (4.5 Million JD) (18 Million JD) (230 Million JD) Firm Age/ bank Debt ratio Table 4: Descriptive analysis of all variables (governance and controlling variables) The average of the variables for banks operating in Palestine are shown in table 5; separating banks with foreign ownership and others with national Palestinian ownership; for national banks the average of return on assets (ROA) is 1.26% whereas for foreign banks is 1.18%. 48% of the CEOs in national banks perform as board chairman, 65% of the foreign banks is with CEO duality. The internal ownership by management and board varies between.54% for foreign banks and 22% for national banks; whilst 29% of the national banks are family-owned, and 25% of the foreign banks are with family-ownership. The average of the assets is 76 million Jordanian dinars for national banks and 844 million Jordanian dinars, and debt ratio for national banks is lower compared to the foreign banks with 71%, and 91% respectively. Mean for national banks Mean for foreign banks Return on assets Board size Board hierarchy Qualifications of the board members

62 CEO duality Internal ownership Family ownership Foreign ownership 0 1 Firm size/ bank (76 Million JD) (844 Million JD) Firm Age/ bank Debt ratio Table 5: Descriptive analysis of variables for national and foreign banks. Noticed from table 5 that the average of returns on assets for national and foreign banks are significantly close, the variance between both averages was tested by Independent Samples t-test, and table 6 reveals that the return on assets varies for national banks, with no statistical significance, since the significance level (sig 2- tailed) is larger than 5%. Table 6: Independent Samples t-test of the ROA Besides, table 5 shows that the average of board members is 10 for both national and foreign banks, with roughly similar averages of ROA for both categories. The belief that the performance improves as the board has more than 10 members can be supported by the results shown in table 7; as the profitability (ROA) of banks with boards composes of more than 10 members is 18% higher than the profitability of 62

63 banks with boards of less than 10 members, and that applies for national banks, foreign banks (including regional banks), and all banks operating in Palestine. Banks with board of more than 10 members Banks with board of less than 10 members ROA for all sampled banks ROA for national banks ROA for foreign banks Table 7: Relationship between board size and ROA The average of independent board members (hierarchy of the board) as results illustrated in table 4 is 92%, with average of ten members per each board; which implies that each board has 9 independent members. To investigate the relationship between the hierarchy and the return on assets (ROA), table 8 illustrates that as the percentage of the independent members increases (less executive members) the return on assets decreases and that applies for national banks, foreign banks (including regional banks), and all banks operating in Palestine. Banks with board of 90%or more of independent members Banks with board of less than 90% of independent members ROA for all sampled banks ROA for national banks ROA for foreign banks Table 8: Relationship between board hierarchy and ROA 63

64 As mentioned earlier, 62%of banks in Palestine has CEO duality (table 4), as 7 banks of the sample have CEOs who perform as the board chairman, 10 banks with two individuals performing such roles during the time frame considered for the study, and 1 bank had one person combining the roles of both the CEO and board chairman for only 2 years of the years considered for the study. Table 9 demonstrates a positive relationship between the duality of the CEO and the return on assets; as ROA improves with duality of CEO, and decreases for banks that do have two individuals for CEO and board chairman. That supports the belief that when a CEO performs as a board chairman, he has a greater opportunity to positively intervene with the board supervisory and directing role to which the board is entailed; by applying his experience of managing the bank internal operations, and his skills to draw the major plans of the bank. Banks with CEO duality Banks where CEO does not perform as Chairman Total number Mean of the ROA Total Number Mean of the ROA ROA for all sampled banks ROA for national banks ROA for foreign banks Table 9: Relationship between CEO duality and ROA To examine how does the internal ownership influence the performance of banks operating in Palestine, table 10 shows the return on assets for banks with less or more than 12% internal ownership (average of internal ownership of all banks 64

65 operating in Palestine-table 1), revealing that return on asset increases as the proportion of the shares owned by management and the firm employees increases. Banks with internal ownership of 12% or more Banks with board of internal ownership less than 12% ROA for all sampled banks ROA for national banks ROA for foreign banks Table 10: Relationship between internal ownership and ROA Similarly; table 11 illustrates the return on assets for banks with less or more than 28% of family ownership (average of the family ownership for banks operating in Palestine- table 4); showing a positive relationship between family ownership and return on assets, ROA improves as more shares owned by a family or group of families, and this applies for both national and foreign banks (regional included) operating in Palestine. Banks with family ownership of 28% or more Banks with board of family ownership less than 28% ROA for all sampled banks ROA for national banks ROA for foreign banks Table 11: Relationship between family ownership and ROA 65

66 However, size of the banks (measured by the assets) operating in Palestine is not of similar influence on the performance for national, foreign, and all banks. The average calculated for the size of the sampled banks is 330million Jordanian dinars (table 4), table 12 reveals that return on asset for banks with less than or more that the average is nearly the same which is 1.2, while the size of the banks has a negative influence on return on assets for foreign banks (regional banks included), and positive one on national banks. Similarity of the return on assets for all banks can be explained by the rounding of the data entries and calculated averages. While statistical and GLS analysis results contrast the expectations of the positive correlation; which may result from the fact that the average size of the national banks is significantly less than the average size of the foreign banks with 76 million Jordanian dinars and 844 million Jordanian dinars respectively. Bearing in mind that the average size of the national banks is radically less than the average size of all banks, the relationship between ROA and the size for national bank stays positive as the operating expenses are relatively little (the cost of generating the revenue is comparatively little to the revenues generated), consequently when the operating expenses increase, the net income decreases yield to lower ROA and then the relationship turns to be negative. Banks with assets of 330 M or more Banks with assets of less than 330 M ROA for all sampled banks ROA for national banks ROA for foreign banks Table 12: Relationship between bank size and ROA 66

67 Results show that the average age of all sampled banks is 41 years, with 13.5 years for national banks and 58 years for foreign banks (including regional banks), table 13 presents the returns on assets for banks with average age below and over 41 years old. All banks national banks Foreign banks Total Mean of the Total Mean of Total number Mean of number ROA number the ROA the ROA Banks with age of 41 years or less Banks with age of more than 41 years Table 13: Relationship between bank age and ROA when the Egyptian Arab Land Bank is excluded from the sample; which is a government bank that is established 121 years ago (category of over than 41 years), because of its relatively less performance compared to the sampled banks during the time considered for the study, the results of table 13 become consistent with the GLS results with an average of 1.42 for the return on asset. For national banks, comparing the return on assets for banks aged less than the average to the ones aged more than the average, shows a positive influence for age on performance, as the return on assets improves as the age increases, which is explained by the accumulative experience and customer database a bank gains over years. Look at table 14 below. 67

68 National banks with age of 13.5 years or more National banks with age of less than 13.5 years ROA for national banks Table 14: Relationship between bank age and ROA for national banks Finally, the debt ratio of all banks operating in Palestine is 84%, with 71% and 91% for national banks and foreign banks correspondingly. As banks tend to gain revenues and profits on granted loans higher than the interest paid to depositors; therefore, when banks are not able to achieve higher returns on loans to the interest paid to depositors, banks to raise fund by borrowing money from different financial institutions and qualified banks which incurs higher debt ratios, less profits, and may affect banks financial ability to pay the entailed interest payments in case of customers not paying loan payments or paying late. Additionally, in such situation, the central bank or the monetary authority asks for higher reserve rate from the bank, which decreases the available financial resources that can be invested to increase the bank profits and revenues. Table 15 shows the influence of debt ratio on the performance of national, foreign, and all banks operating in Palestine. Mean of ROA for all sampled banks Mean of ROA for national banks Mean of ROA for all foreign banks Banks with debt of % or more Banks with debt of less than 83% Table 15: Relationship between debt and ROA 6.2 Statistical analysis of the data: The statistical analysis method adopted for this study is the GLS to examine how the adoption of sound corporate governance principles affects the performance of banks 68

69 in Palestine. Table 16 shows the general results for the egression model applied. The results reveals that the coefficient of determination (R-squared) is.42, which is interpreted as that 42% of the variations in the performance of a bank (dependent variable), which is measured by ROA, can be explained by variation in the independent variables considered for the model. This result can be considered relatively good compared to former studies; as it was 39% for Abor and Biekpe (2007). F-test indicates how much our model fits the population from which the data were sampled (significance of the model), as the probability of the F-test in our model is 0; less than 5% which is the significance level considered conventionally by many mathematicians and researchers. Table 16: Results of regression model analysis 69

70 The print out shows the p values for the independents variables (last column); indicating whether a relationship has a statistical significance. It is noticed that Family Ownership and Firm Age have no statistical significance as p values of their t- Statistics are.07 and.1 respectively, which are greater than 5%. The table indicates positive sign for coefficients for the variables: Board Size, CEO Duality, Inside Ownership, Foreign Ownership, and Firm Age, while it is negative for the rest of the independent variables; Board composition, Board Skill, Family Ownership, Firm Size, and Debt Ratio. Noting that the sign of the coefficient interprets whether the relationship between the independent variables and the dependent one is negative or positive, as the positive sign indicates positive relationship and the negative sign indicates a negative relationship. The results of the model illustrate that the board size has a positive and significant influence on the performance; which confirms the belief that larger boards have a greater possibility to attain a relatively better performance for the firm compared to smaller boards. This result supports the assumption that larger boards have a wider range of skills and expertise that can be invested to make better decisions. Moreover, the firm benefits from the members networks to develop more solid association with customers and to gain access to external information which enhance the firm to expand its exposure, extend its customer base, and to gain better access to investment opportunities. This finding is consistent with results of previous empirical studies (Abor and Biekpe, 2007). The coefficient value for this 70

71 variable is.96 which indicates that an increase in the board size by 1 lead to an increase in ROA by 96%. While the coefficient of the board composition is -2; an increase in the non executive members by 1% decreases the ROA by 2%, therefore the portion of the board members that does not occupy managerial positions within the firm has a negative significant influence on the ROA. This result is consistent with the results of Buckland (2001) and Khiari et al (2007), but it contradicts with what have been proved by Shaheen and Nishat (2004) and Abor and Biekpe (2007). This result supports the thought that executive board members contributes to enhance the firm effectiveness as they do understand the business better, and have good knowledge and appreciation of the operations of the firms which in turns enlighten the board to make better decisions that are in the interest of the firm and hence uplift the firm productivity. The regression results point out a negative relationship with a statistical significance of the educational level of the board members on the performance; as having one more member with higher education causes a drop off in the ROA by 93%. This result is shown for the analysis of all sampled banks and for foreign banks, but with no statistical significance for local banks. Results of Abor and Biekpe (2007) and Shaheen and Nishat (2004) support this finding. This result can be articulated by the substantial role of the educational level and qualifications of the board members to support the firm attaining an access to the relative required information within the surrounding environment, and the advanced educational findings related to the supervisory and accounting systems to enhance the firm efficiency, so what matters 71

72 is the way the members leverage their knowledge and skills and not the educational qualifications themselves. Regard the CEO duality variable; the regression analysis results reveal a positive significant influence of the CEO duality on the ROA. This indicates that for banks operating in Palestine, the performance enhanced when the CEO perform as the board chairman, as that increases the ROA by 58%. However, this contradicts with the corporate governance principles that promote for separating the CEO s role from that of the board chairman, as the CEO duality often increases the possibility of conflict of interest and agency problems, and limit the efficiency of the board to provide monitoring and control over the top management. Meanwhile this finding is similar with the results of Abor and Biekpe (2007) study. Considering the national banks, the coefficient of the CEO duality is -2 (table 20); indicating a statistical significant negative relationship which confirms the corporate governance principles. Another governance aspect has a positive impact on the ROA is the inside ownership; as the performance and the efficiency improve as the shares owned by either executives or the board increase. As the inside shareholding implies having shareholders who seem to understand the business better, to have good knowledge and appreciation of the operations of the firms, the analysis spots that an increase in inside ownership by 1% causes an increase in the ROA by %4.76, since such employees are often in the position to take decisions that are in the interest of maximizing shareholder value instead of engaging in opportunistic behaviour, as they benefit from the success and financial outperformance of their firm, and this considered one of the motivations for employees to enhance the firm efficiency by 72

73 increasing their belonging to the firm. This finding applies to all banks operating in Palestine, national banks, and foreign banks (look table 20). Another finding that supports the results of both Bahgat and Bolton (2006) and Abor and Biekpe (2007), is that the foreign ownership has a positive impact with high statistical significance, as an increase in the foreign ownership by 1% increases the ROA by 1.71%. This is an evidence that the banks with foreign ownership is more efficient than the national banks as it is more opened to the external environment, and to skills and expertise of others in managerial and supervisory aspects and this diminish the agency costs and subsequently uplift the efficiency and performance of the firm. Finally, the results for controlling variables considered for our model support the governance principles. The size of the bank has a negative relationship with the performance; so smaller banks have better performance compared to larger ones; since larger banks with more assets incurs relatively higher operating expenses compared to the smaller ones, and higher managing and supervisory expenses (agency costs), and it becomes more challenging for the banks to attain or exceed the break-even point and start making profit, and therefore the limited assets of the bank (size) drives the bank to make the best use of its resources and hence enhances its efficiency. The results show a positive impact of the bank age, calculated from the year established to the date the sample considered, has a positive impact on the ROA. As the bank gets older, it gains more experience that enhances its performance; mainly if the bank follows special training programmes for the top management and 73

74 employees. Moreover, the customers base gets expanded as customers prefer to deal with the same bank as long as the relationship is based on a ground of mutual trust and customers belonging to the bank gets stronger overtime. While debt ratio has a negative relationship with statistical significance on ROA, as the debt increases the performance declines, and this result is applicable on all banks, national banks, or foreign banks(including regional banks) operating in Palestine. To precisely examine the impact of the variables related to corporate governance aspects on the performance, the analysis was carried out excluding the controlling variables, and the results came as shown in table 17: Table 17: Results of regression model analysis excluding the controlling variables Results show that variables related to ownership (internal and foreign) and the board structure no longer have a statistical significance. The signs of the coefficients for statistical significant variables did not change; as it stays positive for the board 74

75 size and CEO duality, and negative for the board skills. The same for the values of the coefficients for the board size and the board skills did not considerably change, but it did increase for the coefficient of CEO duality from.584 to.814; which stresses more impact of the CEO duality on the ROA. Those results indicates that more focus should be given to the corporate governance aspects related to the board and its composition, as a major indicator for sound corporate governance and its return on enhancing bank performance. As an attempt to investigate the impact of those aspects on the performance of national banks and foreign banks each on its own, the model took two forms. For the first, the national banks were excluded by setting the foreign ownership to 1; and the GLS analysis was completed for the foreign banks. Results are illustrated in table 15.The model interprets 76% of the variations of the ROA. CEO duality became with no statistical significance, however no major change occurred to the coefficients of the other independent variables. F-test value indicates that the applied model is significant. 75

76 Table 18: Results of regression model analysis for foreign banks (regional banks included) The analysis carried out on the foreign banks illustrate that the signs of the coefficient did not change; but the board composition and the internal ownership have more impact on the performance, as the board composition coefficient increased from -2 to -9 and for the internal ownership from 4.76 to 9; this indicates that those two variables have the greatest impact of the performance of the foreign banks. However, when the controlling variables are excluded for the foreign banks, the board composition lost its statistical significance, and the ownership coefficients became with statistical significance. 76

77 Table 19: Results of regression model analysis for foreign banks excluding controlling variables The second form was completed for the national banks by setting the foreign ownership to 0; to examine the corporate governance aspects on the performance of the national banks operating in Palestine. Table 20 shows the results of this form. The independent variables of this model interpret 66% of the ROA variations. Board size and board skills became of no significant impact on the performance for local banks; while the firm size turned out to be with relatively substantial influence on the ROA, with no major change in the coefficients of other independent variables. Still, the model is significant (f-test value). 77

78 Table 20: Results of regression model analysis for national banks For national banks, the signs of the coefficients did not change except for the CEO duality where it turned to be negative, but the board composition and CEO duality became of greater influence on the ROA, coefficients changed from -2 to -23 and from.58 to -2 for the board composition and CEO duality respectively; indicating that those two variables are of greatest impact on the performance of the national banks operating in Palestine. However, when the controlling variables are excluded, the board composition and CEO duality became of no more significant impact on the ROA. 78

79 Table 21: Results of regression model analysis for national banks excluding controlling variables As the Israeli invasions of the West Bank and Gaza strip took place during the time considered for the study and specifically between 2001 and 2003, where curfews were imposed, organizations, commercial shops and banks suspended from work for periods of times exceeded months (DAI Washington 2007), it is expected that those events yielded to consequences on the performance and the systems of the banks operating in the areas affected by the invasions, and hence on the governance of the banks. Table 22 illustrates the results for the analysis carried out on the period that covers the invasion which is from 2001 to The findings were that the board composition, internal ownership, and foreign ownership have no statistical significance. Comparing those findings with the results of the analysis completed for the whole time period of the study, are almost similar for the coefficients impact 79

80 except that internal ownership became with statistical significance, and for the signs except the CEO duality became with a negative sign. Table 22: Results of regression model analysis for the period of (Israeli invasion period) While table 23 shows the results for the analysis of the period off the invasion time, which is from It illustrates that board composition and the foreign ownership have no statistical significance on the performance. Noting that the coefficients of variables and signs did not change compared to the results for the analysis of the period from (table 16). 80

81 Table 23: Results of regression model analysis for the period