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Roles of Outside Directors in Cooperative Financial Institutions

International conference

“International competition in banking: theory and practice” Sumy, Ukraine, May 24 25, 2012‐

　　 Nobuyoshi Yamori, Nagoya University　　 Kozo Harimaya, Ritsumeikan University　　 Kei Tomimura, Aichi University

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Motivation

• Governance in cooperative financial institutions

• Examine the relationship between governance structure and performance for cooperative financial institutions (co-ops) .

• In particular, whether the existence of outside directors in credit associations have an impact on management performance?

The Financial Services Agency recommended appointing outside directors at board as a means for strengthening governance for co-ops.

• Also, examine the differences between co-ops and stock banks.

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Background

• Shinkin banks (credit associations)

• Cooperative regional financial institutions serving small and medium enterprises and local residents.

• Playing a substantial role in the Japanese banking markets.12.0% loan market share and 11.6% deposit market share at

the end of FY 2010.

• Many co-ops failed after the 1990s bubble burst in Japan.

• The FSA has been promoting region based relationship banking since FY 2003.

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Share of the loan market in Japan- At the end of FY 2010 -

Other financial institutions

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Number of depository financial institutions in Japan

FY1980 FY1990 FY2000 FY 2010

City banks 13 12 9 6

Trust banks 7 16 31 18

Long-term credit banks 3 3 3 0

Regional banks 63 64 64 63

Regional banks II 71 68 57 42

Credit associations 461 451 372 271

Credit cooperatives 476 408 281 158

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Governance structures in credit association

Board

Members

Selection committee Candidate for representative council members

Representative council members

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Samples• Three types of regional financial institutions in Japan

• Regional banks: consist of regional banks and regional banks (former mutual Ⅱ

banks). about 80% of them are publicly listed.

• Credit associations (Shinkin banks)

• Credit cooperatives (Shinkumi banks): mutual capital structure co-ops. some differential type of institutions (only for the members

of specific business and occupation) are excluded.

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Previous literatures

• Outside directors in stock companies

• The role of outside directors are positively evaluated given a certain set of circumstances.

Weisbach (1988), Daily and Dalton (1992), Byrd and Hickman (1992), Shivdasani (1993), Barnhart and Rosenstein (1994), Brickley et al. (1994), Kiel and Nicholson (2003), etc.

• Very little research has been conducted for co-ops.

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Analytical framework• Measuring bank efficiency

• Test whether a structural cost difference exists among the three types of regional financial institutions (regional banks, credit associations, and credit cooperatives).

• Measuring the SFA efficiency scores for each sub sample by using the pooled data from FY 1999 to FY 2006.

• Effects of governance on efficiency

• Examine whether governance structure (inc. outside directors ) have significant influences on efficiency by using the data for FY1999 and FY 2006.

• Compare the estimated results for the three types of regional financial institutions.

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Methodology• Efficiency measurement

• Standard translog functional form in the stochastic frontier modeling.

• Inefficiency term (u) is assumed to be half-normally distributed.

• To obtain yearly efficiency measures of each bank, pooled data set is used (not employed panel data analysis).

i k

kiikjj

ji

ii yywyC lnln2

1lnlnln 0

t

tti j

jiijljj l

jl DTwyww lnlnlnln2

1

vu v; iid N(0, σv2)

u; iid N+(0, σu2)

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Data• Bank-specific financial variables (Cost function)

‐ Output:

interest on loans and discounts (y1), other interest income (y2), and commissions and fees (y3)

- Input prices:

personnel expenses/number of employees (w1), interest expense/deposits (w2), non- personnel expenses/book value of fixed assets (w3)

- Cost:

sum of three input expenses (operating and interest expenses)

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Descriptive statistics (Cost function)- Pooled data over the period from FY 1999 to FY 2006 -

VariablesRegional banks 　 Credit associations 　 Credit Cooperatives

Mean Std. Dev. 　 Mean Std. Dev. 　 Mean Std. Dev.

Total cost (C) 29,012 20,909 5,112 6,109 1,776 1,980

Interest on loans and discounts (y1) 34,764 27,006 5,190 6,649 1,905 2,306

Other interest and dividend income (y2) 9,878 10,415 1,555 1,942 446 622

Fees and commissions (y3) 6,566 6,581 616 809 118 153

The price of labor (w1) 8.0595 1.2030 7.0740 0.8795 6.1927 1.6614

The price of deposits (w2) 0.1618 0.1192 0.1522 0.0987 0.1842 0.2048

The rental price of capital (w3) 0.3917 0.1621 0.3819 0.1660 0.5798 6.2189

Observaions 914 　 2600 　 1010

(Unit ： Person ， Millions of Yen ， % ）

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Data

• Governance related variables (Governance regression)

‐ Main variables:

　 number of directors (NS), the ratio of outside directors to all directors (ODR), and the size of representative council members (RCM)

- Other control variables:

capital asset ratio (CAR), bad loan ratio (BLR), loan to deposit ratio (LDR), log of total assets (LAS), and dummy variable for merged banks (MGDM)

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Descriptive statistics (Governance regression)- Average values of cross-sectional data for FY 1999 and FY 2006 -

VariablesRegional banks 　 Credit associations 　Credit cooperatives

1999 　 2006 　 1999 　 2006 　 1999 　 2006

Number of board members (NS) 15.3051 14.0000 13.8378 13.1228 13.9816 13.0294

Ratio of outside board member (ODR) 2.4924 5.6109 34.4006 29.0188 55.1256 46.8770

Number of representative members (RMB) - - 103.6995 111.9263 124.6135 128.5196

Capital adequacy ratio (CAR) 8.9059 10.3583 10.6383 13.0509 8.3206 10.3278

Bad loans ratio (BLR) 6.1856 4.6263 9.6259 8.1530 13.9420 11.9081

Loan-deposit ratio (LDR) 78.3189 75.5026 64.8038 54.7754 67.6241 57.2643

The logarithm of total assets (LAS) 14.2387 14.4190 12.0778 12.4406 10.8907 11.2397

Observations 118　 108　 376　 285　 163　 102

(Unit ： Person ， Millions of Yen ， % ）

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Results- Differences in cost structure -

• First, we examined the differences in cost structures between regional banks and co-ops (including both of credit associations and credit cooperatives).

• Next, we further examined the differences in cost structures between credit associations and credit cooperatives.

• Since F-test rejects the null hypothesis of equal variances at the 1% level, cost structures are significantly different between regional banks, credit associations, and credit cooperatives.

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Results- Descriptive statistics on efficiency scores -

　Regional banks 　 Credit associations 　 Credit cooperatives

Mean Std Dev. 　 Mean Std Dev. 　 Mean Std Dev.

1999 0.9321 0.0282 0.9143 0.0385 0.9079 0.0328

2000 0.9321 0.0298 0.9144 0.0349 0.9093 0.0252

2001 0.9331 0.0241 0.9135 0.0372 0.9096 0.0241

2002 0.9327 0.0246 0.9122 0.0418 0.9092 0.0261

2003 0.9309 0.0285 0.9115 0.0437 0.9071 0.0419

2004 0.9310 0.0299 0.9131 0.0416 0.9070 0.0334

2005 0.9318 0.0270 0.9136 0.0362 0.9081 0.0285

2006 0.9245 0.0401 0.9134 0.0388 0.9077 0.0285

All 0.9311 0.0293　 0.9133 0.0390 　 0.9083 0.0302

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Results (Governance regression)- Analysis of FY 1999 -

Variable

Regional banks 　 Credit associations 　 Credit cooperatives

Efficiency Level

Efficiency Rank

Efficiency Level

Efficiency Rank

Efficiency Level

Efficiency Rank

Coefficient　 　

Coefficient　 　

Coefficient　 　

Coefficient　 　

Coefficient　 　

Coefficient　

Constant 0.8277 *** -0.5305 0.9011 *** 0.3513 0.9158*** 0.7605**

NS 0.0126 0.1561 -0.0058 *** -0.0191 0.0001 0.0041ODR 0.0007 ** 0.0064 * 0.0003 ** 0.0033 *** 0.0002 0.0019RCM -0.0239 *** -0.2150 *** -0.0001 -0.0012CAR 0.0008 -0.0075 0.0009 *** 0.0089 0.0015** 0.0108*

BLR 0.0004 *** -0.0045 -0.0011 -0.0081 ** 0.0001 0.0015LDR 0.0004 0.0037 0.0011 *** 0.0099 *** 0.0004* 0.0030LAS 0.0021 0.0280 0.0046 *** 0.0347 -0.0042* -0.0529**

MGDM -0.0186 ** -0.2782 *** -0.0907 -0.2269 -0.1569** -0.4389***

Adj-R2 -0.0053 -0.0102 0.2664 0.1866 0.3614 0.1085 Observations 118 　 369 　 163

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Results (Governance regression)- Analysis of FY 2006 -

Variable

Regional banks 　 Credit associations 　 Credit cooperatives

Efficiency Level

Efficiency Rank

Efficiency Level

Efficiency Rank

Efficiency Level

Efficiency Rank

Coefficient　 　

Coefficient　 　

Coefficient　 　

Coefficient　 　

Coefficient　 　

Coefficient　

Constant 1.1261 *** 1.7683 ** 0.8522 *** 0.0496 0.8444*** 0.1880NS -0.0028 -0.0551 -0.0463 *** -0.3168 *** 0.0007 0.0046

ODR -0.0002 -0.0005 0.0004 ** 0.0032 ** 0.0000 -0.0007RCM -0.0327 *** -0.1872 *** -0.0001 -0.0010CAR 0.0009 0.0010 0.0015 *** 0.0113 *** 0.0004 0.0007BLR -0.0047 -0.0323 -0.0009 -0.0074 -0.0015** -0.0156**

LDR 0.0005 0.0055 0.0017 *** 0.0121 *** 0.0007** 0.0068**

LAS -0.0148 *** -0.0969 ** 0.0175 *** 0.1034 *** 0.0037 0.0184MGDM -0.1200 *** -0.5109 *** -0.0823 -0.2494 * 0.0013 -0.0046

Adj-R2 0.1642 0.0907 0.2670 0.1813 0.1873 0.1633 Observations 108 　 285 　 102

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Summary of results

• The governance structure including outside directors have a significant effect on cost efficiency for credit associations.

The findings support the recent Japanese government guidelines for improving governance with regard to co-ops.

However, such governance variables have no significant effect on cost efficiency for credit cooperatives.

• Also, outside directors have no significant effect on cost efficiency for regional banks in the recent sample year.

For the listed ones, market-related governance factors are considered to affect any impact on cost efficiency.

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Further issues

• Examine differences in the results between three types of banks

In particular, what alternative governance factors affect the efficiency for stock-banks? (e.g. listed or unlisted)

• Examine the effects of regional economic condition

Differences in industry structure, loan market competition, etc.

• Extended global comparative analysis (if possible…) 　

Did the recent financial crisis reveal severe shortcomings in corporate governance for co-ops in Europe or US?

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ReferencesWeisbach, M.S. (1988) “Outside Directors and CEO Turnover”, Journal of Financial

Economics 20, 431-460.Daily, C.M. and Dalton, D.R. (1992) “The relationship between governance

structure and corporate performance in entrepreneurial firms”, Journal of Business Venturing 7, 375-386.

Byrd, J.W. and Hickman, K.A. (1992) “Do outside directors monitor managers?“, Journal of Financial Economics 32, 195-221.

Barnhart, S.W. and Rosenstein, S. (1994) “Firm performance and board composition: Some new evidence”, Managerial and Decision Economics 15, 329-340.

Brickley, J.A., Coles, J.L., and Terry, R.L. (1994) “Outside directors and the adoption of poison pills”, Journal of Financial Economics 35, 371-390.

Kiel, G.C. and Nicholson, G.J. (2003) “Board Composition and Corporate Performance: how the Australian experience informs contrasting theories of corporate governance”, Corporate Governance 11, 189-205.

Shiidasani. A. (1993) “Board composition. ownership structure and hostile takeovers”, Journal of Accounting and Economics 16, 167-198.

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Thank you for your attention