Roles of Outside Directors in Cooperative Financial Institutions

Roles of Outside Directors in Cooperative Financial InstitutionsInternational conference International competition in banking: theory and practice Sumy, Ukraine, May 2425, 2012

Nobuyoshi Yamori, Nagoya UniversityKozo Harimaya, Ritsumeikan UniversityKei Tomimura, Aichi University1MotivationGovernance 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. 2BackgroundShinkin 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.

3Share of the loan market in Japan- At the end of FY 2010 -

Other financial institutions4Number of depository financial institutions in JapanFY1980 FY1990FY2000FY 2010City banks131296Trust banks7163118Long-term credit banks3330Regional banks63646463Regional banks II 71685742Credit associations461451372271Credit cooperatives4764082811585Governance structures in credit association

BoardMembersSelection committeeCandidate for representative council members Representative council members 6SamplesThree types of regional financial institutions in JapanRegional banks: consist of regional banks and regional banks (former mutual 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. 77Previous literaturesOutside directors in stock companiesThe 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.88Analytical frameworkMeasuring bank efficiencyTest 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.9MethodologyEfficiency measurementStandard 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).

v; iid N(0, v2)u; iid N+(0, u2)10DataBank-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)

11Descriptive statistics (Cost function)- Pooled data over the period from FY 1999 to FY 2006 -VariablesRegional banksCredit associationsCredit CooperativesMeanStd. Dev.MeanStd. Dev.MeanStd. Dev.Total cost (C) 29,01220,9095,1126,1091,7761,980Interest on loans and discounts (y1)34,76427,0065,1906,6491,9052,306Other interest and dividend income (y2)9,87810,4151,5551,942446622Fees and commissions (y3)6,5666,581616809118153The price of labor (w1)8.05951.20307.07400.87956.19271.6614The price of deposits (w2)0.16180.11920.15220.09870.18420.2048The rental price of capital (w3)0.39170.16210.38190.16600.57986.2189Observaions91426001010(UnitPerson Millions of Yen%12DataGovernance 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) 13Descriptive statistics (Governance regression)- Average values of cross-sectional data for FY 1999 and FY 2006 -VariablesRegional banksCredit associationsCredit cooperatives199920061999200619992006Number 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 Observations118108376285163102(UnitPerson Millions of Yen%14Results- 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.15Results- Descriptive statistics on efficiency scores -Regional banksCredit associationsCredit cooperativesMeanStd Dev.MeanStd Dev.MeanStd Dev.19990.93210.02820.9143 0.0385 0.9079 0.0328 20000.93210.02980.9144 0.0349 0.9093 0.0252 20010.93310.02410.9135 0.0372 0.9096 0.0241 20020.93270.02460.9122 0.0418 0.9092 0.0261 20030.93090.02850.9115 0.0437 0.9071 0.0419 20040.93100.02990.9131 0.0416 0.9070 0.0334 20050.93180.02700.9136 0.0362 0.9081 0.0285 20060.92450.04010.9134 0.0388 0.9077 0.0285 All0.93110.02930.9133 0.0390 0.9083 0.0302 16Results (Governance regression)- Analysis of FY 1999 -VariableRegional banksCredit associationsCredit cooperativesEfficiency LevelEfficiency RankEfficiency LevelEfficiency RankEfficiency LevelEfficiency RankCoefficientCoefficientCoefficientCoefficientCoefficientCoefficientConstant0.8277 ***-0.5305 0.9011 ***0.3513 0.9158***0.7605**NS0.0126 0.1561 -0.0058 ***-0.0191 0.00010.0041ODR0.0007 **0.0064 *0.0003 **0.0033 ***0.00020.0019RCM-0.0239 ***-0.2150 ***-0.0001-0.0012CAR0.0008 -0.0075 0.0009 ***0.0089 0.0015**0.0108*BLR0.0004 ***-0.0045 -0.0011 -0.0081 **0.00010.0015LDR0.0004 0.0037 0.0011 ***0.0099 ***0.0004*0.0030LAS0.0021 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 Observations118369 163 17Results (Governance regression)- Analysis of FY 2006 -VariableRegional banksCredit associationsCredit cooperativesEfficiency LevelEfficiency RankEfficiency LevelEfficiency RankEfficiency LevelEfficiency RankCoefficientCoefficientCoefficientCoefficientCoefficientCoefficientConstant1.1261 ***1.7683 **0.8522 ***0.0496 0.8444***0.1880NS-0.0028 -0.0551 -0.0463 ***-0.3168 ***0.00070.0046ODR-0.0002 -0.0005 0.0004 **0.0032 **0.0000-0.0007RCM-0.0327 ***-0.1872 ***-0.0001-0.0010CAR0.0009 0.0010 0.0015 ***0.0113 ***0.00040.0007BLR-0.0047 -0.0323 -0.0009 -0.0074 -0.0015**-0.0156**LDR0.0005 0.0055 0.0017 ***0.0121 ***0.0007**0.0068**LAS-0.0148 ***-0.0969 **0.0175 ***0.1034 ***0.00370.0184MGDM-0.1200 ***-0.5109 ***-0.0823 -0.2494 *0.0013-0.0046Adj-R20.1642 0.0907 0.2670 0.1813 0.1873 0.1633 Observations108285 102 18Summary of resultsThe 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.19Further issuesExamine differences in the results between three types of banksIn particular, what alternative governance factors affect the efficiency for stock-banks? (e.g. listed or unlisted)Examine the effects of regional economic conditionDifferences 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?

20ReferencesWeisbach, 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.

21Thank you for your attention22Graph40.42128842152221916City banks, etc.0.29864335071575074Regional banks0.0832633529439139Regional banks 0.1208005844637114Credit associations0.017889128794349Credit cooperatives0.0643346153393074967592

City banks, etc.Regional banksRegional banks Credit associationsCredit cooperatives

Graph10.42021373520.29315046730.08235893270.12163864260.01786315270.0217062750.0430686049

Graph20.33834540690.20918407090.05630279490.11549416340.01647057410.01598953860.08308450490.1651290446

Graph30.42128842152221916City banks, etc.0.29864335071575074Regional banks0.0832633529439139Regional banks 0.1208005844637114Credit associations0.017889128794349Credit cooperatives0.0643346153393074967592

City banks, etc.Regional banksRegional banks Credit associationsCredit cooperatives

Sheet1FY2009FY201042.0%2,216,248City banks, etc.42.1%222191629.3%1,546,104Regional banks29.9%15750748.2%434,369Regional banks 8.3%43913912.2%641,534Credit associations12.1%6371141.8%94,212Credit cooperatives1.8%943492.2%114,481Other types of financial institutions6.4%33930749675924.3%227,1485,274,097530689933.8%3,440,177City banks, etc.34.5%351072520.9%2,126,910Regional banks21.5%21829395.6%572,467Regional banks 5.7%58396411.5%1,174,304Credit associations11.8%11982121.6%167,467Credit cooperatives1.7%1722651.6%162,576Other types of financial institutions26.4%268348776481058.3%844,77416.5%1,678,97410,167,64810331592

Sheet2

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