Corporate GovernanceGovernance and microfinance institutionsAnuschka Bakker Jaap Schaveling André Nijhof

Article information:To cite this document:Anuschka Bakker Jaap Schaveling André Nijhof , (2014),"Governance and microfinance institutions", Corporate Governance,Vol. 14 Iss 5 pp. 637 - 652Permanent link to this document:http://dx.doi.org/10.1108/CG-03-2014-0032

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Governance and microfinance institutions

Anuschka Bakker, Jaap Schaveling and André Nijhof

Anuschka Bakker is aPrincipal ResearchAssociate based at IBFD,Amsterdam, TheNetherlands.Jaap Schaveling is anAssociate Professorbased at NyenrodeBusiness Universiteit,Breukelen, TheNetherlands.André Nijhof is anAssociate Professorbased at EuropeanInstitute for BusinessEthics, NyenrodeBusiness Universiteit,Breukelen, TheNetherlands.

AbstractPurpose – This paper aims to determine the influence of governance mechanisms on sustainabilityand outreach of microfinance institutions (MFIs). Corporate governance has been identified as a keybottleneck in strengthening MFIs’ sustainability (financial performance) and increasing their outreach(social impact).Design/methodology/approach – First, a literature study to give insight in the microfinance sector isprovided. Subsequently, the data research has been performed based on the statistics of one of thefunds of a Dutch independent investment manager, which is focused on responsible investments indeveloping countries. Hierarchical multiple regression analyses were conducted to examine theassociation between governance mechanisms and the respective dependent variables.Findings – The results show that boards of a MFI with insiders (for example, employees) are asignificant predictor of sustainability. Regulation impacts sustainability significantly in a negative way.Overall, the study shows that only a limited number of variables influence the sustainability and outreachof an MFI.Research limitations/implications – The limitation of the studied investment fund is that it invests inexpanding and mature MFI’s. So the results of this research can only be generalized to expanding andmature MFI’s.Practical implications – The governance mechanisms that are recommended in the industryguidelines and which are studied here are often not relevant in respect to sustainability and outreach ofMFIs. The approach to microfinance governance should be broadened by focusing more onstakeholders and the decision making process in an MFI.Social implications – Good governance is key for the microfinance institutions and even morecomplicated than for regular companies that do not have a double bottom line (sustainability andoutreach). to be successful in the future, and for clients to reach the best end result, it is essential thatthe governance mechanisms that influence the bottom line are determined.Originality/value – Not much research has been done with respect to the governance mechanisms,which have impact on the sustainability and outreach of MFIs.

Keywords Governance, Corporate governance, Financial performance

Paper type Research paper

Introduction

The topic of the present study is impact investing and, more particularly, microfinance.Impact investments are investments made in companies, organizations and funds with theintention of generating measurable social and environmental impact alongside a financialreturn[1]. In essence, impact investing is a way to unlock capital and place it in businessesand projects that generate real social and environmental benefits for people who needthese benefits. To illustrate the point, the underlying idea could be to create more andbetter jobs, for instance, and to provide people with access to affordable housing, cleanwater and education while, at the same time, generating a financial return to the investor.Here, the key to success lies in microfinance, a resource to make certain banking servicesavailable for people or groups who have so far been unable to profit from these services.

Received 3 March 2014Revised 7 August 2014Accepted 25 September 2014

DOI 10.1108/CG-03-2014-0032 VOL. 14 NO. 5 2014, pp. 637-652, © Emerald Group Publishing Limited, ISSN 1472-0701 CORPORATE GOVERNANCE PAGE 637

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Microfinance is a special type of impact investing and can be defined as “the provision offinancial services to poor and low-income clients who have little or no access toconventional banks” (Rosenberg et al., 2009). Pioneered by Muhammad Yunus andGrameen Bank, microfinance has greatly increased in terms of its visibility in themarketplace. The concepts of microfinance and microcredit have spread to all regions ofthe world and have generated an enormous social impact (Bugg-Levine and Emerson,2011). The many definitions of microfinance in use today have one thing in common: theaim to achieve a positive societal, environmental or sustainability impact through capitalinvestment (WorldBank, 2013; Karlan and Goldberg, 2011; Cull et al., 2006). Besidesfinancial return, microfinance institutions (MFIs) providing this type of financial service arealso focused on social impact.

Most people will agree that today’s world knows many social and environmental challengesthat urgently need to be addressed, but what is new, according to Bugg-Levine andEmerson (2011), is that impact investors are optimistic about the role that business can playin advancing the common good. Although they are aware that market-based strategieshave their limits when it comes to bringing about social change, they also see that awell-functioning impact investing industry has the potential to complement government andphilanthropy by unlocking significant resources. In addition, an increasing awareness ofthe escalating disparity in the way in which wealth is distributed (WorldBank, 2007) incombination with unequal access to opportunities and mounting concern for theenvironment have led to increased pressure to solve these seemingly intractable problems.Although initiatives for environmental and social change are traditionally undertaken bygovernments, there have been some developments in this regard: the role of governmentshas changed. First, governments have been lowering their budgets to make room for freemarket ideologies. This has been the case since the 1980s (Nicholls, 2006). This moreneoliberal approach has led to shrinking funds, resulting in fewer and altered interventionsby the public sector. Second, it is also increasingly recognized that progress in alleviatingpresent-day ills requires much more than government intervention alone (The Economist,2010).

It goes without saying that the above developments have had a considerable impact on theposition of MFIs. In view of the fact that MFIs will receive less funds from governments dueto the latter’s restricted budgets and the fact that MFIs seem to become more dependenton other financiers for achieving their goals, it is vitally important for MFIs to show theirsuccess in achieving their two goals: being sustainable and having outreach, the doublebottom line. Because governance has been widely shown, by many researchers, to be acritical issue for any entity’s performance, this is exactly where governance mechanismscome into play. The purpose of this study is to uncover the role of governance mechanismsin the performance of MFIs, that is to say in terms of being sustainable (financial return) andhaving outreach (social impact). Our research question asks what the influence ofgovernance mechanisms would be on the sustainability and outreach of MFIs. Ourinvestigations are expected to contribute to a better understanding of the governancemechanisms that positively or negatively impact the performance of MFIs and that can orcannot help impact investors and MFIs to perform well.

Theoretical background

Sustainability and outreach of MFI’s

In academic research, little attention has so far been paid to the actual measurement of thesocial impact generated by MFIs (Hudon and Sandberg, 2013), but a number of negativereports about the microfinance industry have recently led scholars to start to question theprecise relationship between microfinance efforts and poverty alleviation, or at least todemand further empirical evidence (Hudon and Sandberg, 2013). Although socialperformance indicators are beginning to become more standardized in the sector, they are,in no way, fully developed. Currently, the Dutch parties active in the microfinance sector are

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using the scope and depth of outreach as indicators to test for differences between Dutchdonors, microfinance investment vehicles (MIVs) and investors (ING, 2012).

Sustainability refers to financial return and was measured in this study by return on assets(ROA), operational self-sufficiency (OSS) and financial self-sufficiency (FSS) ratio. ROAmeasures how well the MFI uses its total assets to generate returns, also termed adjustednet operating income after taxes/average total assets. In measuring financial results acrossdifferent countries, ROA is more appropriate than ROE (Mersland and Strøm, 2007, p. 4).OSS is defined as operating revenue/(financial expense � loan loss provision � operatingexpense). OSS measures how well the MFI can cover its costs through operating revenues.In addition, FSS is used. This is a measure of an institution’s ability to generate sufficientrevenue to cover its costs. FSS is defined as adjusted operating revenue/adjusted (financialexpense � loan loss provision expense � operating expense).

Outreach (the social benefits of microfinance for poor clients) refers to social impact andcan be measured in different ways, for instance, with the help of the framework proposedby Schreiner (2002). Available literature elaborating this framework puts a main focus onscope and depth, which is not surprising as data on scope and outreach are more readilyand publicly available (Barry and Tacneng, 2011) than other data. Other aspects such asworth to clients may be difficult to measure and they may also be subjective. For thisreason, the current research study investigates scope and depth.

The scope of outreach refers to the number of active borrowers that an MFI reaches withits loan portfolio. Because the number of poor people throughout the world is estimated tobe an impressive 2.7 billion, expanding access to MFIs for as many people as possible isconsidered an admirable goal and has been a main driver in the growth of the microfinancesector. The indicator should be interpreted as follows: the higher the number of borrowersan MFI reaches, the better the situation will be in terms of social performance. This studyfocuses on loan (credit) clients. The number of credit clients was measured by the numberof active borrowers, that is to say the number of borrowers with loans outstanding, adjustedfor standardized write-offs in rural areas.

Depth of outreach indicates how society values the net gain from microfinance. In thisstudy, depth was measured by three indicators:

1. the average loan balance measured as gross portfolio divided by the number of activeborrowers;

2. the percentage of the outstanding portfolio lent to women (number of active womenborrowers/number of active borrowers); and

3. the percentage of loans concluded in rural areas (percentage of active borrowers).

Corporate governance

The research question seeks to determine which governance mechanisms influence thesustainability and outreach of MFIs. The OECD provides the following definition ofcorporate governance:

Corporate governance involves a set of relationships between a company’s management, itsboard, its shareholders and other stakeholders. Corporate governance also provides thestructure through which the objectives of the company are set, and the means of attaining thoseobjectives and monitoring performance are determined (OECD, 2004, p. 11).

Good governance is of crucial importance. The Centre for the Study of FinancialInnovations (CSFI) 2008 and 2009 surveys of the commercial microfinance industry warnedthat poor corporate governance poses a serious risk for microfinance organizations(Augustine, 2012). The importance of good governance for MFIs has also been confirmedby the Microfinance Banana Skins survey (CSFI, 2011, 2012). In addition, the 2012Microfinance Banana Skins survey shows that the top concern of investors in microfinanceis the quality of their corporate governance of MFIs. In fact, corporate governance has been

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identified as a key bottleneck in strengthening MFIs’ financial performance and increasingtheir outreach (Mersland and Strøm, 2007), especially seen in the light of recentdevelopments such as budget constraints imposed by governments, the decrease of fundsto be received from donors and a number of negative reports about microfinance (i.e.overlending, high interest rates). Last but not least, good governance is essential in view ofthe increased scrutiny of stakeholders at MFI level, the changing marketplace and growingpublic expectations and demand for accountability.

The main challenge inherent to the complex reality of MFIs lies in the practicalimplementation of a promising, “social” idea into a plausible and operational businessmodel. Responsible finance is the key word here. Because their clients are highlyvulnerable with respect to their life situations and knowledge about finances, MFIs need tobe mindful of these vulnerabilities (Sinha, 2012). When a good governance framework andthe right incentives at MFI level are in place, this should result in a better balance betweensustainability and outreach. This will be the case, for example, when the managers of theMFI are stimulated to conclude loan agreements in rural areas and with women instead ofbeing stimulated to conclude as many loan agreements as possible. Here, it is important tonote that the proportion of rural loans and the proportion of loans to women borrowers areindicators of depth of outreach.

Governance has been shown to be a critical issue for an entity’s performance. However,governance is barely mentioned in reports published by players in the field (Freireich andFulton, 2009; O’Donohoe et al., 2010). The tensions resulting from the simultaneous pursuitof diverging goals call for the use of effective governance mechanisms. There is abundantevidence in the for-profit strategic management literature that governance is key to anentity’s financial performance (Bacq, 2012, p. 10). It can therefore be assumed that“corporate” governance mechanisms might be even more important when it comes tosocial entrepreneurial ventures (Bacq and Kickul, 2011).

To describe the ideal of effective MFI governance, several publications provide guidanceand how-to tools (Ledgerwood et al., 2013; Council of Microfinance Equity Funds, 2012). Inthe literature, a distinction is made between internal and external governance mechanisms(Hartarska, 2004; Mersland and Strøm, 2007; Bassem, 2009). This study will take intoaccount internal (ownership of an MFI, board composition) as well as external governancemechanisms (regulated/non-regulated and rated/non-rated). The internal mechanismscomprise the functions of the chief executive officer (CEO) and the board, as well as theownership type. Because these mechanisms are a matter of choice, they are called“internal”. External governance mechanisms are, more or less, determined by externalfactors: the market and the supervisory environment (Mersland and Strøm, 2007).

The existing literature in the field of microfinance governance is discussed below. Attentionwill be paid not only to internal governance mechanisms, i.e. ownership and insiders,women, non-affiliated outsiders and financiers on the board but also to externalgovernance mechanisms, i.e. regulation and rating. Governance mechanisms covered inthe literature that did not show any relation with the double bottom line of achieving financialand social goals have been excluded from this research. Variables mentioned in theliterature but only briefly reported on by the MFIs included in the dataset were alsoexcluded from this research (e.g. wages). Finally, “audited” was not included in this study,as all the MFIs in the dataset were audited.

Ownership

Ownership concerns the distinction between a shareholder-owned firm and a non-profitorganization. Several studies indicate that ownership type does not have a significantinfluence on the performance of MFIs (Hartarska, 2004; Cull et al., 2006, 2009). In theirresearch based on a dataset with information gathered from 200 non-governmental orshareholder MFIs in 54 countries, Mersland and Strøm (2008) conclude that ownership typedoes not influence performance. They state that non-governmental organizations (NGOs)

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are neither more socially oriented than shareholder-owned firms nor areshareholder-owned firms more commercially oriented than non-profit organizations. Incontrast with this, however, Mersland and Strøm (2007) note in their research that non-profitorganizations are often considered weaker structures, as they lack owners with a financialstake in their organization. This would lead to a lower financial performance. Some policypapers claim that the shareholder firm MFIs demonstrate better performance, as theirgovernance is assumed to be better. These papers also mention that those MFIs that arechanged from non-profit to for-profit as shareholder firms perform better than non-profitfirms (Thrikawala et al., 2013). On the other hand, non-profit organizations are assumed tobe better at reaching poor customers.

Comparing NGOs with cooperatives, Barry and Tacneng (2011) note that NGOs performbetter than cooperatives, both in terms of outreach and profitability. They further note thatcooperatives outperform NGOs in terms of OSS. The difference between this study and theresearch carried out by Mersland and Strøm (2008) may be explained by the differencesin regions and the type of MFIs included in the research. The study carried out by Merslandand Strøm (2008) included better performing and more mature MFIs. This study is limitedto more mature MFIs, as will be elaborated below. Therefore, based on the researchreported by Mersland and Strøm (2008), this study expects to find that the type ofownership does not matter to the performance of MFIs.

H1. There is no correlation between the type of ownership (shareholder-owned firm)versus non-profit organization) and MFI sustainability and outreach.

Insiders on the board

The Council of Micro Finance Equity Funds (2012) mentions, among other things, therepresentation of employees and clients on the board. It discusses how this is consideredto be standard practice in some countries, but it does not state how this impacts theperformance of an MFI. Insiders can be defined as the proportion of board members whodo not have an affiliation with any of the other stakeholders of the MFI. It is not unusual forseveral stakeholders to be represented on the board. Next to insiders (employees andmanagers), other major stakeholders of MFIs include donors, equity investors andcreditors. Some MFIs even include clients on their board (Hartarska, 2004). One wouldexpect that including representatives from the group of employees and customersenhances the MFI’s knowledge of the market, for example, and that this would be helpfulfor aligning stakeholders with the MFI mission. This is, in fact, confirmed by Freeman et al.(2007). Hartarska and Mersland (2012), however, found evidence that a board with a largerportion of employees (insiders) will have a negative impact on MFI efficiency. Other studies,too, show that boards with a higher proportion of internal board members have a negativeeffect on MFIs’ social and financial performance (Mori and Olomi, 2012; Hartarska, 2004).Based on the above, the following hypothesis is included:

H2. There is a negative correlation between the proportion of insiders and MFIsustainability and outreach.

Women on the board

Board diversity in terms of gender (or the proportion of women on board) is another issuethat has attracted attention. Corporate governance literature argues that board diversity interms of women and minority representation is potentially positively related to firmperformance (Bassem, 2009). Mori and Olomi (2012) notes that empirical evidence showsthat gender balance has a positive influence on the performance and values oforganizations. In their research, Mersland and Strøm (2008) found that MFIs with femaleCEOs (who are also board members) outperform MFIs with male CEOs. Part of theobjective of MFIs is to focus on female clients, which is an indicator of an MFI’s depth ofoutreach. One could argue here that because MFIs serve mostly female customers, femaleCEOs are better able to obtain relevant information that is useful for making decisions,

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which, in turn, leads to better performance. On the basis of the above, it is expected thatthere is a positive relationship between the presence of women on the board and MFIperformance.

H3. There is a positive correlation between the proportion of women on the board andMFI sustainability and outreach.

Non-affiliated outsiders on the board

The non-affiliated outsiders can be defined as the proportion of board members who do nothave an affiliation with any of the stakeholders of the MFI. Bassem concludes that MFIs withmore independent board members seem to do better than MFIs with fewer independentboard members (Bassem, 2009). Other studies have found positive and negativerelationships between the proportion of outside directors and firm performance (Hartarskaand Mersland, 2012).

H4. The proportion of non-affiliated outsiders on the board will positively correlate withMFI sustainability and outreach.

Financiers on the board

Research mentioned above (Hartarska, 2004) also shows that board members withbanking and financial skills improve sustainability without affecting outreach. On the basisof this research, the following hypothesis is included:

H5. The proportion of financiers positively affects MFI sustainability but does not affectMFI outreach.

Regulation

Many MFIs have their financial statements audited and certified by external auditors.Auditing can be an effective external mechanism because it signals to potential investorsand donors that the manager has complied with standard accounting practices and has notmisrepresented financial information (Hartarska, 2004). For many MFIs, regulation andsupervision by a government agency also serves as an external governance mechanism(Hartarska, 2004). This study includes two external governance mechanisms: regulated/non-regulated and rated/not rated.

Hartarska’s (2004) study indicates that external mechanisms are not effective. Theregulated MFIs have a lower ROA and evidence that the scope of outreach may be relatedto regulation is weak. Still, according to Hartarska and Nadolnyak (2007), the questionwhether and how regulation impacts the performance of an MFI is an important one, as asignificant number of MFIs consider transforming themselves from unregulated toregulated MFIs. In their report, Wiesner and Quien (2010) mention that when MIVs arelooking for fundable MFIs, they are looking for regulated MFIs. Hartarska and Nadolnyaknote that some practitioners worry about the impact of regulation on the poverty alleviationmission. Regulation may lead to what is generally referred to as mission drift, meaning thatMFIs move away from serving their poorer clients in pursuit of commercial viability. Insteadof focusing on poverty alleviation, the institution starts to focus on regulatory requirements,for example, capital requirements. Nevertheless, the study’s main conclusion was thatregulatory involvement does not affect either sustainability or outreach (Hartarska andNadolnyak, 2007).

Research conducted by Bassem shows that regulated MFIs do not reach more borrowers; theyexperience significant and positive ROA and operational self-sufficiency (Bassem, 2009).Mersland and Strøm (2008) find that regulation does not have a significant impact on financialor social performance. Research carried out by Cull et al. (2009) suggests that MFIs that aresubjected to more rigorous and regular supervision are not less profitable than others, despitethe higher costs of supervision. In addition, this type of supervision is associated with largeraverage loan sizes and less lending to women, which indicates a reduced outreach. Barry and

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Tacneng (2011) compared regulated with unregulated MFIs. They state that the regulated MFIsare less profitable but more self-sufficient than non-regulated MFIs. The outreach ofunregulated MFIs is better than that of the regulated MFIs. The unregulated MFIs investigatedin their research (MFIs in Sub-Saharan Africa) cater to more women clients and make smallerloans. The regulated MFIs included in their research generally reach more clients.

On the basis of the above, it is difficult to determine the effect of regulation on MFI performance.Focusing on mature MFIs (as the dataset contains quite mature MFIs, as will be justified below),we are inclined to agree with Hartarska (2004), Hartarska and Nadolnyak (2007) and Merslandand Strøm (2008) that regulation does not have a significant impact on sustainability andoutreach.

H6. MFIs that are regulated do not perform better than non-regulated MFIs onsustainability and outreach.

Rating

According to Mersland and Strøm (2007), MFIs would benefit from ratings in four ways. Ratingsor assessments:

1. increase financial transparency when they are made publicly accessible for allinterested parties;

2. give the opportunity to benchmark an organization with other organizations;

3. indicate where an organization stands and may indicate which aspects of the organizationcould be improved; and

4. give investors and donors the opportunity to compare and monitor information on theirinvestments.

Mersland and Strøm (2007) link rating with a business-oriented way of conducting businessand state that there is a limited number of MFIs which conduct microfinance in abusiness-oriented manner. This is considered a problem in the industry; MIVs are more willingto provide capital to rated/regulated and larger MFIs.

H7. Rating is positively correlated with the sustainability and outreach of MFIs.

On the basis of previous research, a number of control variables have been included that takeinto account the differences in MFIs, differences in the conditions under which they operate anddifferences in economic conditions across countries. In addition, control variables have beenincluded that are focused on an MFI’s individual characteristics (cf. Hartarska, 2004; Merslandand Strøm, 2007; Bassem, 2009). Control variables include the following: MFI size, MFI age,loan methodology and several country-level variables. MFI age is included, as MFIs learnduring their years of existence; with the passing of time, managers gain experience. Cull et al.(2009) used the type of lending methodology since it also influences the performance of MFIsand would uncover trade-offs and tensions. This study therefore includes a variable related tothis fact. With respect to the trade-offs between outreach to the poor and profitability, Cull et al.(2006) concluded that larger loan sizes are associated with low average costs for bothindividual-based lenders and solidarity group lenders. MFIs may have different fractions ofgroup lending and group loans, group and individual lending and individual lending(Armendáriz and Labie, 2011; Mersland and Strøm, 2007; Cull et al., 2006). On the basis ofearlier research (Hartarska, 2004; Bassem, 2009; Barry and Tacneng, 2011; The MicrobankingBulletin, 2005), the following country-level control variables have been included: economy size,measured in a country’s gross domestic product (GDP) in USD, gross national income (GNI)per capita in USD, GDP growth rate in percentages, inflation rate in percentages and, finally,deposit rate in percentages.

Based on the aforementioned literature and covering H1-H7, Figure 1 summarizes theproposed research model.

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Sample and procedure

The data of this study are based on the statistics obtained from a Dutch independentinvestment manager X, focused on responsible investments in developing countries. Xmanages and advises investment funds that target investments in developing countries; Xspecializes in managing and advising microfinance investment funds, each with a specifictarget group and different risk and return objectives. The data stem from one of thesefunds, the flagship fund of X, because the number of MFIs linked to this MFI is sufficient forquantitative research (106 MFIs). The fund invests in expanding and mature MFIs (primarilynon-bank financial institutions and banks, but also NGOs) and operates in countries inAfrica, Asia, Eastern Europe and Latin America that have been designated as OfficialDevelopment Assistance countries by the Organization for Economic Cooperation andDevelopment. Table I presents an overview of these countries and how they arerepresented in the current study.

The Fund offers financial instruments in both hard and local currency. By December 2012,25 per cent of the fund was denominated in local currencies. Exposures were diversifiedamong South America (34 per cent), Central America (15 per cent), Caucasus (15 percent), Central Asia (14 per cent), Asia (10 per cent) and Sub-Saharan Africa (7 per cent).Amounts invested range from €500,000 to €6 million, and investments are priced at marketrates. The equity portfolio consists of 17 investments, making up 14 per cent of the totalportfolio.

Since our study was conducted in 2013, available data concerned the year 2012. Inprevious years, an insufficient number of MFIs were linked to the investment fund, makingit impossible to perform longitudinal research. About 230,000 clients were reached in 2012.X makes its investments by providing loans and equity to MFIs. With this fund, as statedabove, X invests in expanding and mature MFIs (primarily non-bank financial institutionsand banks, but also NGOs). As an open-ended fund, it offers long-term equity andfollow-on investments, along with senior and subordinated debt. The investment fund canbe considered an MIV. The reason for the exclusive selection of X lay in the unlikely chancethat peers of X would be inclined to share their data. Peer organizations declined givingreasons for their refusal other than a lack of resources.

Research was aimed at the level of MFIs, in general, but a limitation of selecting X as oursole investment fund is that it exclusively invests in expanding and mature MFIs. Thismeans that the results of the current study can only be generalized to expanding andmature MFIs. The financial statements of all MFIs linked to the researched investment fundare audited. The results showed that no clients were included on the boards of the MFIs,so these were omitted from our analyses, too. The data showed that the CEO rarelyoperates as the chair of the board (this was the case for only one MFI). As a result, thisvariable was not included in our further analyses.

Figure 1 Research model

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As stated above, 106 MFIs proved to be linked to Fund X. Linking the financial informationto the information related to the independent variables, MFI age and loan methodologyresulted in an overview for 105 MFIs. So, after this exercise had been completed, thepopulation consisted of 105 MFIs. MFIs were included in the dataset when they had aproject ID, meaning that a loan had been granted to that particular MFI or that equity hadbeen granted to this MFI. As a result of this check, the population changed to 104 MFIs.With respect to some of the MFIs, only information on the legal status was known, or onlythe legal status and the board size were known. Only those MFIs were selected for whichat least 50 per cent of the variables had been filled in. Based on this test, the final datasetconsisted of 97 MFIs.

Data collection

For 2012, information on ROA, OSS, the number of active borrowers, the number of loansprovided to women, the number of loans provided in rural areas and MFI country wasprovided electronically. Information related to ownership and board was gathered fromgeneral files, which usually contained the MFI’s deed of incorporation, the articles ofassociation and copies of passports of board members. Information on FSS, more detailedinformation related to the board, whether an MFI is regulated or is being rated, was takenfrom the appraisal sheet. This sheet is drafted by the investment officer when, for example,the MFI has requested a loan.

Table I

Country Frequency (%)

Albania 1 1.0Argentina 1 1.0Armenia 2 2.1Azerbaijan 5 5.2Bolivia 8 8.2Bosnia and Herzegovina 2 2.1Cambodia 4 4.1Cameroon 2 2.1Colombia 3 3.1Costa Rica 3 3.1Ecuador 8 8.2El Salvador 2 2.1Georgia 3 3.1Guatemala 3 3.1Honduras 2 2.1Indonesia 1 1.0Kazakhstan 2 2.1Kenya 1 1.0Kosovo 3 3.1Kyrgyz Republic 3 3.1Mexico 6 6.2Mongolia 1 1.0Nicaragua 4 4.1Nigeria 1 1.0Palestine 1 1.0Panama 1 1.0Paraguay 3 3.1Peru 10 10.3Rwanda 1 1.0Senegal 1 1.0Sri Lanka 1 1.0Tajikistan 4 4.1Tanzania 1 1.0United States of America 2 2.1Zambia 1 1.0Total 97 100

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Measures

Sustainability was measured by ROA, OSS and FSS as described. As mentioned above,outreach is examined mostly in two ways, in line with the literature, namely scope ofoutreach and depth of outreach. Scope of outreach refers to the number of clients beingserved. This research focuses on loan (credit) clients[2]. The number of credit clients wasmeasured by the number of active borrowers[3]. The scope of outreach also refers to thenumber of active borrowers that an MFI reaches with its loan portfolio.

On the basis of research conducted by Hartarska (2004), Mersland and Strøm (2007),Barry and Tacneng (2011), depth of outreach was measured by the following:

� average outstanding loan per client (adjusted gross loan portfolio/adjusted number ofactive borrowers);

� the percentage of women reached. This was measured as the percentage of theoutstanding portfolio lent to women (number of active women borrowers/adjustednumber of active borrowers)[4]; and

� the percentage of loans concluded in rural areas. The percentage of rural loans wasmeasured as the percentage of the active borrowers.

The legal incorporation, or ownership type, may play a role in firm performance (Merslandand Strøm, 2007). On the basis of the aforementioned study, ownership type isoperationalized as non-profit organization, shareholder owner firm and other ownershiptypes, and includes dummies to identify the non-profit organization and theshareholder-owned firm. Shareholder owner firm is coded 1; non-profit organization andothers are coded 0.

The board members were measured as follows. Insiders on the board were measured bythe proportion of employees who are voting board members. Non-affiliated outsiders weremeasured by the proportion of non-affiliated, independent board members. The number ofwomen directors is the proportion of women on the board and financiers are the proportionof members with financial skills.

Regulation and supervision by a government agency were measured by dummies, i.e. adummy that equals one if the MFI is regulated/supervised by a government regulatoryagency and zero otherwise.

The control variables were measured as follows. MFI size was measured by the logarithmof total assets. MFI age was measured in years of commencement (Hartarska, 2004;Bassem, 2009). Loan methodology was measured by measuring the different fractions ofgroup lending (Armendáriz and Labie, 2011; Mersland and Strøm, 2007; Cull et al., 2006),group loans, group and individual lending and individual lending. The country-level controlvariables were measured as follows. Economy size was measured in a country’s GDP inUSD, GNI per capita in USD, GDP growth rate in percentages, inflation rate in percentagesand deposit rate in percentages. All data were gathered from databases compiled by theWorldbank (2013).

Data analysis

Regression diagnostics were performed to check the statistical assumptions of linearity,homoskedasticity, normal distribution of residuals, independence of residuals, andabsence of multicollinearity. The results of these analyses gave no reason to assume thatthese assumptions were violated. In addition, the data were visually checked for outliersand influential cases.

Hierarchical multiple regression analyses were conducted to examine the associationbetween governance mechanisms and the respective dependent variables. Both stepwiseregression analysis with backward elimination and hierarchical multiple regressionanalyses were performed with the control variables as well as the predictors.

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Results

The results of the correlation analysis show that ROA, OSS and FSS are highly correlated(varying between 0.46 and 0.79). To determine whether the three measures of sustainabilitycould be combined into a single measure, the internal consistency of the three variables wasevaluated by calculating Cronbach’s alpha. The coefficient alpha was 0.83, which indicatesthat the three measures can indeed be combined into a reliable scale for sustainability. Thegenerally agreed upon lower limit for Cronbach’s alpha is 0.70.

Table II presents the results of the regression analyses.

Results show that ownership does not significantly influence either sustainability oroutreach. This is in line with studies reported by Hartarska (2004) and Cull et al. (2007).The dataset used by Mersland and Strøm concerned MFIs that were rated and thatrepresented commercial and business-oriented organizations. The dataset of thisresearch concerns expanding and mature MFIs and does not give any reasons to doubtthe results.

Results also show that insiders positively predict sustainability. This is remarkable, asresearch carried out by Hartarska and Mersland (2012) shows that a board with a largerportion of employees negatively impacts MFI efficiency. Insiders have a positiveinfluence on the proportion of female borrowers.

Another remarkable outcome of the current study is that the proportion of women onboard does not significantly predict sustainability and outreach. This is striking, asprevious research (Bassem, 2009 and Mersland and Strøm, 2008) indicated that theproportion of women on board positively influences MFI performance.

Another finding concerns the proportion of non-affiliated board members. This factor isa significant predictor of the proportion of rural loans. However, it is no predictor for theother aspects of outreach and sustainability.

The results related to the proportion of financiers in the board, i.e. the absence ofinfluence on sustainability, are another remarkable finding, since research reported by

Table II Summary of hierarchical multiple regression analysis

Model 1 (stepwise backward elimination) Model 2 (adjusted for control variables)

Hierarchical multiple regression analysis on Sustainability (ROA, OSS and FSS)Ownership (SHF vs. NPO) 0.31 0.18Insiders 0.41** 0.40**Being regulated �0.34* �0.54**

R2 � 0.23 R2 change � 0.26F(3.44) � 4.43, p � 0.01 F(3.36) � 7.01, p � 0.00

Hierarchical multiple regression analysis on Number of active borrowersR Square � 0.00

Hierarchical multiple regression analysis on Average balance per borrowerR Square � 0.00

Hierarchical multiple regression analysis on Proportion of rural loansOwnership (SHF vs NPO) 0.27 0.29Proportion of non-affiliated board members 0.37* 0.38*

R2 � 0.16 R2 change � 0.15F(2.40) � 3.87, p � 0.03 F(2.36) � 3.57, p � 0.04

Hierarchical multiple regression analysis on Proportion of female borrowersInsiders 0.29* 0.11Being regulated �0.25 �0.08

R2 � 0.21 R2 change � 0.03F(3.44) � 3.86, p � 0.02 F(3.36) � 0.94, p � 0.43

Notes: *Significant at the 0.05 level (two-tailed); **significant at the 0.01 level (two-tailed)

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Hartarska (2004) suggests that the proportion of financiers on board improvessustainability.

Regulation significantly predicts sustainability (ROA, OSS and FSS together) in anegative way. This is quite remarkable, as research conducted by Mersland and Strøm(2008) indicates that regulation does not impact sustainability. The dataset used byMersland and Strøm (2008) also included mature MFIs. Bassem (2009) found thatregulation increases sustainability. The result of our research, however, is in line withresearch reported by Hartarska (2004) which showed that regulation negativelyimpacts sustainability. The costs related to regulation are high, and this may explain theresults. Regulation is not shown to be a significant predictor of outreach.

Rating is not a significant predictor of either sustainability or outreach. In their research,Mersland and Strøm (2007) state that a majority of non-profit organizations andcooperatives involved in microfinance are small and not rated. They link rating with abusiness-oriented way of operating, and they note that the number of MFIs whichconduct microfinance in a business-oriented manner is limited. The results generatedin the current study may be explained by the fact that the studied fund focuses on moremature MFIs.

None of the independent variables proves to be a significant predictor of the proportionof the number of active borrowers, the average loan balance per borrower or theproportion of female borrowers.

Conclusion

Our results show that only a very limited number of the variables researched actuallyinfluence an MFI’s sustainability and outreach. Only insiders in the board seem to be apredictor for sustainability and several aspects of outreach. Being regulated and theproportion of non-affiliated board members in the board seem to be predictors for asingle characteristic of outreach only.

The governance of MFIs is often studied from perspectives such as ownership control,board management, regulation and supervision. Still, the research results that havebeen dealt with previously show some variation. Sometimes a variable is a significantpredictor and sometimes it is not; it is not always clear whether or not this is caused bythe dataset. The current study confirms this picture: results show that only a very limitednumber of predictors influence sustainability and outreach of an MFI, and even if this isthe case, influence is merely partial.

Limitations

As indicated earlier, the limitation of the investment fund studied lies in the fact that itinvests in expanding and mature MFIs, which means that the results of this researchcan only be generalized to expanding and mature MFIs.

Measurement of outreach with respect to MFIs is difficult, and only in recent years hasany research been initiated. An important question in this respect is the impact ofmicrofinance on economic poverty. Another important matter is the relationshipbetween microfinance and empowerment. To the best of our knowledge, theserelationships have not yet been mentioned by the literature. More academic research isneeded to cover these aspects.

The current research study concerns data pertaining to the year 2012 and thus offersa mere snapshot of history. To determine the relationship between governancemechanisms on the one hand and sustainability and outreach on the other, longitudinalresearch should be done. This type of study provides data about the same MFIs atdifferent points in time, allowing researchers to track changes at the level of MFIs.Longitudinal studies can also be used to study change in the lives of MFIs.

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Regular corporate governance mechanisms may not be suitable for MFIs, andreference was made earlier to a nascent framework drafted by Labie and Mersland(2011). To further develop this framework, additional research is needed, including anhistoric analysis of the governance mechanisms that have been proven effective andthat have so far helped MFIs to survive and achieve their goals. This should providelessons to be learned for future endeavors.

The framework also mentions stakeholders. More research could be done with respectto topics such as identifying MFI stakeholders and understanding the power of thesestakeholders. What is the role of donors, networks and investors in the governance ofMFIs?

Finally, research has not yet focused on the question which mechanisms should beapplied at which stages of an MFI’s lifecycle. Research in this field may offer additionalinsights into the timely application of relevant governance mechanisms for the benefitof MFIs.

Recommendations

Above, the authors indicated that little research has so far been done with respect to themeasurement of the outreach of microfinance institutions. In addition, certain difficulties areassociated with measuring outreach. In the boards of the MFIs investigated in this study, clientsare not included. Research carried out by Hartarska (2004), however, shows that clients onboards positively affect sustainability. Taking into consideration these findings, it is especiallyimportant to incorporate the voice of clients in the governance structure of MFIs. Such anapproach also seems be more in line with modern business philosophy and practice.

Banking governance is often studied from four perspectives, namely, ownershipcontrol, board management, regulation and supervision and, finally, market pressure(Labie and Mersland, 2011). Labie and Mersland (2011) note not only that studiesrelated to microfinance aim to translate these perspectives to MFIs but also that thesedo not seem to be successful in identifying significant mechanisms. And those that arerecommended in the industry guidelines are often not relevant. The researchers arguethat the approach to microfinance governance should be broadened by:

� looking at history and drawing lessons from it;

� focusing on risk analysis (they note that for most stakeholders, governance is a crisisavoidance tool); and

� adopting a real stakeholder approach which would broaden the governance perspectiveof MFIs.

Proper and reliable insight into the stakeholders and the decision-making process mayincrease the understanding of the way in which MFIs are really managed (Labie and Mersland,2011, p. 292).

Another recommendation might be to use different governance mechanisms to create a moresuitable governance framework for MFIs. These mechanisms should not focus solely on regulargovernance mechanisms such as board and market competition or mechanisms that areemphasized in the literature, such as regulation and supervision. Other mechanisms, forinstance, informal networks or reputation, may have an even more important effect on thedouble bottom line adopted by MFIs. Finally, some mechanisms may play a more or lessimportant role depending on the stage in which the MFI finds itself (i.e. the duration of the MFI’sexistence).

The governance mechanisms that are recommended in the industry guidelines and which arestudied here often lack relevance with respect to the sustainability and outreach of MFIs. Inconclusion, and on the basis of the above, the authors recommend that the approach tomicrofinance governance be broadened by focusing to a greater extent on an MFI’s

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stakeholders and the decision-making process within the MFI. This will likely yield a betterinsight into the way in which MFIs are really managed.

Notes

1. See www.thegiin.org (accessed 21 March 2013).

2. The dataset includes a significant number of NGOs. Because NGOs, in most cases, cannotmobilize deposits due to legal constraints, their number of savings clients should in most cases bezero. On the basis of the above, the authors have decided to exclude saving activities from thisresearch.

3. The definition is: number of borrowers with loans outstanding, adjusted for standardized write-offs.Reference can be made to www.themix.org/sites/default/files/MIX_2005_03_MBB10.pdf, p. 57.

4. Sometimes, the question is also included in research whether MFIs adopt a conscious gender bias,but as the MFIs in the dataset did not report on this, the authors did not include this variable in theirinvestigations.

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Further reading

Hartarska, V. and Nadolnyak, D. (2011), “What external control mechanisms help microfinanceinstitutions meet the needs of marginal clientele”, in Armendáriz, B. and Labie, M. (Eds), The Handbookof Microfinance, World Scientific Publishing, Singapore, pp. 267-281.

Mix (2012), “Measuring governance in microfinance”, available at: www.themix.org/publications/microbanking-bulletin/2012/04/measuring-governance-microfinance

Corresponding author

Anuschka Bakker can be contacted at: a.bakker@ibfd.org

To purchase reprints of this article please e-mail: reprints@emeraldinsight.comOr visit our web site for further details: www.emeraldinsight.com/reprints

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