FINANCIAL PERFORMANCE AND CORPORATE GOVERNANCE DISCLOSURE IN INDIAN AND NEPALESE COMMERCIAL BANKS HIMAL BHATTRAI 1 Dr SHINU ABHI 2 Dr U.M PREMALATHA 3 1 Research Scholar, Reva University, Bangalore, India 2 & 3 Research Supervisors, Reva University, Bangalore, India ABSTRACT Corporate governance brings challenges and opportunities at a time for business organization. It can be the strategic tool to gain competitive financial performance. This study aims to measure the relationship between the Financial Performances and Corporate Governance Disclosure (CGD) of commercial bank of India and Nepal. The study is based on the secondary sources of data that are abstracted from the annual reports a n d w e b s i t e s o f the respective banks in a sample size of 30 commercial banks that includes 23 Nepalese commercial Banks and 7 Indian commercial Banks. Reference period has been taken from fiscal year 2011/12 to 2015/16. Hence a total of 150 observations have been drawn to analyze the relationship between financial performance and corporate governance. Financial performance is measured by Return on Investment and Corporate Governance is represented by the level of disclosure made in the annual report of commercial banks. Based on the financial and nonfinancial disclosure, Index has been calculated and corporate governance disclosure index has been defined. Finally, the relationship between corporate governance disclosure index and financial performance is measured and a set of relationship is established. The result shows that financial performance is positively correlated with the corporate governance. This study provides the empirical observation to policy maker of corporate governance in Indian and Nepalese commercial Banks. Keywords: Corporate Governance, Corporate Governance Disclosure, Corporate Governance Disclosure Index, Financial Performance. Introduction Corporate governance is the process of governing the business of the organization that can be viewed both from managerial as well as economic perspectives. The managerial perspectives opt for establishing the strong leadership and control with the help of governance practices. Corporate governance is a system of leadership and control of the company and its foreseeable sustainability (Adhikari, 2008). While economic perspectives aim at maintaining the efficiency and productivity through governance mechanism. Corporate governance is one of the key factors that determine the health of the financial system and its ability to survive economic shocks (Bollard, 2003). Governance factors in the Banking and financial organization come into in force with the establishment of the transparent, accurate and corruption free working mechanism and environment. Corporate governance in the banking industry is more important than other industries, particularly in less-developed countries because economic development and growth is dependent to a large extent on well-functioning, stable and soundly managed banking system (Imam, 2006). Corporate governance system in the Bank is reflected by the corporate governance disclosure practices. Financial disclosures are the statutory requirements while most of the nonfinancial disclosures are optional in nature. The underlying reason of larger firms disclosing more information is that the www.icmrr.org 117 icmrrjournal@gmail.com
managers of larger companies are more likely to realize the possible benefits of better disclosure and small companies are more likely to feel that full disclosure of information could endanger their competitive position (Watson et al., 2002). Return on Investment (ROI) is the reliable indicator of financial performance that the stakeholders generally takes into account. There are various variables affecting the financial performance of commercial Banks and corporate governance disclosure is one of the major variables among them. This study deals with ascertaining the relationship between financial performance and corporate governance disclosure in commercial Banks of Nepal and India. Objectives The objective of this study is to establish the relationship between financial performance and corporate governance disclosure in the commercial bank of India and Nepal. Significance This study basically focuses on examining the relationship between the two promising variables of organization i.e. financial performance and corporate governance. Hence, this study is of great importance for reasons: The study highlights the relationship between financial performance and corporate governance by the private sector banks of Nepal and India. The study provides the insight to develop governance guidelines. The study is insightful for the policy maker of commercial banks to make the necessary adjustment in financial and nonfinancial disclosure. Limitations INTERCONTINENTAL JOURNAL OF FINANCE RESEARCH REVIEW This study has limitation based on sample, applicability, scope and data. The following are the major limitations of this study. The study takes only private sector bank into account. The study considers only five years of data. The results may differ across different years if multiple years are considered for analysis. Review of literature The need to operate in a highly competitive market has increased the application of risky and unethical business practices to gain higher profit, has ultimately raised the risk in the overall national economy. To control such intentional risk from unfair investment to raise profit, corporate governance has proven to be a risk eliminator tool for sustainable profit, sustainable growth and sustainability of the organization. Corporate governance safeguards the interest of the stakeholders by transferring the corporate behaviours in more honest, open, transparent and disclosed manner. The importance of corporate governance for financial institutions such as banks remains ever crucial that banks will operate in a safe and sound manner, and will comply with applicable laws and regulations while protecting the interests of depositors (Watson, 2002). Good governance means the little expropriation of resources by managers or controlling shareholders, which contributes to better allocation of resources and better performance (Imam, 2006). Corporate governance variables do influence firms' performance. CEO duality, the proportion of non-executive directors and leverage has the negative influence and board member as chair of audit committee, proportion of institutional ownership has positive influence on firms' financial performance (Amba, 2011). According to the study conducted by Bhagat and Bolton (2008) in the US, corporate governance has an impact on firm performance and good governance has a positive impact on corporate performance. www.icmrr.org 118 icmrrjournal@gmail.com
There are various literatures that advocate the negative relationship between financial performance and corporate governance. While measuring the relationship between financial performance and corporate governance, Kusumawati, (2006) finds that there is negative relationship between profitability and corporate governance voluntary disclosure level. This means to say that, when companies are facing decline in profitability, they tend to disclose more information on corporate governance. The finding of this study is in line with the finding of the study conducted by another scholar. No significant association is found between corporate profitability with aggregate disclosure level (Ahmed and John, 1999). These study acclaimed for lower disclosure of organizational information for the better performance of the organization. The positive relationship between financial performance and corporate governance is discussed in many literatures. The agency theory implies that companies increase disclosure in order to mitigate conflicts between shareholders and managers. In addition, companies wishing to enhance their firm value may do so by increased disclosure (Lobo and Zhou, 2001). A firm s profitability is positively associated with its corporate governance disclosure level (Karim, 1996). Similarly, another study conducted by Rouf, (2011) advocates that higher profitability of the firm is positively correlated to the level of corporate governance disclosure. Samir et al., (2003) argue that higher profitability motivates management to provide greater information because it increases investors confidence, which in turn, increases management compensation. According to the study conducted by Bhagat and Bolton (2008) in the US, corporate governance has an impact on firm performance and good governance has a positive impact on corporate performance. While many studies are conducted in the international arena, regarding the relationship between financial performance and corporate governance, very little or none of the studies is conducted to measure the relationship between financial performance and corporate governance in Nepalese and Indian Bank. This study will lessen the gap of the same study area. The study aims to address the following research question: Is there any relationship between financial performance and corporate governance of private sector bank of India and Nepal? Methodology The study focuses on the descriptive and causal research designs to deal with the issues raised as well as the inferential analysis to support the significance of the relationship between corporate governance and financial performance. The study has covered only private sector bank for the specific result. Precisely speaking, all the private sector bank of Nepal that are listed in Nepal Stock Exchange and all the new private sector bank of India that are listed in Indian stock exchange is the sample of this study. A total of 23 private sectors Banks of Nepal and 7 private sector banks of India have been considered for the analysis purpose with observation period for 5 years starting from fiscal year of 2011/12 to 2015/16. A total of one hundred and fifty observations have been made from the Indian and Nepalese private sector Bank. The data are derived from the published annual reports of selected banks and disclosure on websites of the banks. Similarly, books, magazines relating to the banking sector, published paper, report, articles, newspapers, bulletins, other journals like monthly review of Economy and websites relating to banking sector are used to collect the relevant data and information. The data are analyzed with respect to statistical and econometric models such as correlation, regression, inferential analysis along with the descriptive analysis. www.icmrr.org 119 icmrrjournal@gmail.com
Disclosure index calculation mechanism Corporate governance index is the basic research instrument for this study. The study has used the disclosure index developed by the UN secretariat for the nineteenth session of International Standards of Accounting and Reporting (ISAR) entitled "Transparency and disclosure requirements for corporate governance" and the twenty-second session of ISAR, entitled "Guidance on Good Practices in Corporate Governance Disclosure". The study has referenced the guidelines as prescribed in the ISAR issues and reports for calculating the corporate disclosure index. These reports have presented the lists of various financial and nonfinancial disclosure index. With the help of the list of disclosure issues, the annual reports of the banks are examined. A dichotomous procedure is followed to score each of the disclosure issues. Each bank will be awarded a score of 1' if the bank appears to have disclosed the concerned issue and 0' otherwise. The score of each bank will be totalled to find out the net score of the bank. A corporate governance disclosure index (CGDI) is then computed by using the following formula: CGDI = Total Score of the Individual Company 100 Maximum Possible Score Obtainable by the Company The model The general regression model can be presented as follows: Y = a+b 1 X 1 +e The equation can be expressed as: ROI = a+b 1 CGDI+e Where, ROI = Return on investment a = Constant term b = Coefficient of variable CGDI = Corporate Governance Disclosure Index e = error term Hypothesis The following hypotheses are developed in line with the objectives: H0 1 : There is no significant relationship between Return on Investment (ROI) and Corporate Governance Disclosure Index (CGDI) of private sector bank of India H0 2 : There is no significant relationship between Return on Investment (ROI) and Corporate Governance Disclosure Index (CGDI) of private sector bank of Nepal Correlation between financial performance and corporate governance Pearson Correlation coefficients for the variables have been computed to show the degree of relationship between financial performance and corporate governance. Table 2: Correlation between financial performance and corporate governance in Indian and Nepalese commercial Banks Indian Commercial Banks Variables ROI FDI NFDI CGDI ROI 1 FDI 0.69* 1 NFDI 0.84* 0.39* 1 CGDI 0.80* 0.69* 0.69* 1 www.icmrr.org 120 icmrrjournal@gmail.com
Nepalese Commercial Banks ROI 1 FDI 0.82* 1 NFDI 0.76* 0.63* 1 CGDI 0.54* 0.71* 0.61* 1 (*) significance at 5% and (**) significance at 10% Table 2 shows the correlation matrix of financial performance and corporate governance in Indian and Nepalese commercial Banks. There is high degree of positive correlation between Return on Investment (ROI) and Financial Disclosure Index (FDI) and the relationship is significant at 5%. Similarly, ROI is positively correlated with nonfinancial disclosure index (NFDI) and the relationships are significant at 5%. ROI is positively correlated with corporate governance disclosure index (CGDI). The relationship between ROI and CGDI is significant at 5% rejecting the null hypothesis stating the significant relationship between financial performance and corporate governance disclosure in Nepalese and Indian commercial Banks. Effect of corporate governance on financial performance The regression of corporate governance disclosure on the financial performance of Indian and Nepalese commercial banks has been analyzed by defining the financial performance of bank in terms of return on equity and nonperforming loan. Table 3: Effect of corporate governance on financial performance in Nepalese and Indian Commercial Banks Indian Banks Coefficient (ROI on FDI, NFDI and CGDI) Commercial Sig. Nepalese Commercial Banks Coefficient (ROI on FDI, NFDI and CGDI) (Constant) 5.18 0.00 2.10 0.00 Financial Disclosure Index 1.72 0.00 1.72 0.00 Nonfinancial Disclosure Index 0.03 0.00 0.01 0.00 Corporate Governance Disclosure 0.02 0.00 0.07 0.00 Index Standard Error 1.23 0.92 R Square 0.51 0.55 Table 3 depicts the regression model of financial performance on corporate governance of Indian commercial bank. The table represents the beta coefficient for ROI on FDI, NFDI and CGDI. The beta coefficients are positive for FDI, NFDI and CGDI. This indicates the significant positive relationship between financial performance and corporate governance in Indian commercial private sector Bank. Table 3 also depicts the regression model of financial performance on corporate governance of Nepalese commercial bank. The table represents the beta coefficient for ROI on FDI, NFDI and CGDI. The beta coefficients are positive for FDI, NFDI and CGDI. This indicates the Sig www.icmrr.org 121 icmrrjournal@gmail.com
significant positive correlation between financial performance and corporate governance in Nepalese commercial Bank. Conclusion Corporate governance is related to the management and control of the organization. It is also related to maintaining the every detail of transparency in the business. Corporate governance has now become a global issue and global trend in most of the commercial industries of public concern than ever before. Corporate governance is of more significance in this century to address the concern of stakeholders on the ground of transparency, accountability and integrity. Corporate governance maximizes the value of the firm in long run by establishing a reliable corporate system in the organization. The study revealed that the ROI is positively correlated with financial disclosure and the relationship is statistically significant. Similarly, ROI is positively correlated with nonfinancial disclosure and the relationship among these dependent and independent variable is statistically significant. In addition to this, the study further highlighted the positive relationship between ROI and CGDI and the relationship is statistically significant. The results explain that higher disclosure in Nepalese and Indian bank leads to better financial performance. The computation of CGDI for commercial Banks of Nepal and India demonstrated in this paper has opened the room for further research that adopts the similar governance pattern in other areas as well. This will help to assess the status of governance practices in commercial Banks of India and Nepal by all the stakeholders including, investors, trader, depositors and lender. The better governance index leads to the better performance of the Banks. References INTERCONTINENTAL JOURNAL OF FINANCE RESEARCH REVIEW 1. Adhikari P. (2008), Auditors Role in Corporate Governance The Nepal Chartered Accountant, January-March 2008 issue of the Journal of the Institute of Chartered Accountants of Nepal. 2. Ahmed and John (1999). Associations between Corporate Characteristics and Disclosure Levels in Annual Reports: A Meta-Analysis. British Accounting Review. 31, 35 61 3. Amba, S. M. (2011). Corporate governance and firms financial performance. Journal of Academic and Business Ethics. New York Institute of Technology, Bahrain. 4. Bhagat, S. and Bolton, B. (2008). Corporate governance and firm performance. Journal of Corporate Finance, 14(3), 257-273. 5. Bollard, A. (2003). Financial system regulation in New Zealand. Reserve Bank of New Zealand Bulletin 66 (3), 47-53. 6. Imam, A. (2006). Firm Performance and Corporate Governance through Ownership Structure: Evidence from Bangladesh Stock Market. Paper Presented in 2006 ICMAB Conference. 7. Karim, A.K.M.W (1996). The association between corporate attributes and the extent of corporate disclosure. Journal of Business Studies. University of Dhaka, 17(2), 89-124. 8. Kusumawati, D. N (2006). Profitability and Corporate Governance Disclosure: An Indonesian Study, Simposium Nasional Akuntansi, 14, 1-19. 9. Lobo, G.J., Zhou, J (2001). Disclosure quantity and earning management, Working Paper. Asia Pacific Journal of Accounting and Economics, Symposium in Hong Kong. 10. Rouf, A. (2011). The Financial performance (profitability) and corporate governance disclosure in the annual reports of listed companies of Bangladesh. Journal of Economics and Business Research. 17(2), 103-117. www.icmrr.org 122 icmrrjournal@gmail.com
11. Samir, M. et al. (2003). An Empirical Investigation of Corporate Voluntary Disclosure of Management s Responsibilities for Financial Reporting, Lubin School of Business Faculty Working Papers, Pace University. Annex A: Financial disclosures as per guidelines for good governance S.N. Disclosures Item Financial Disclosures 1 Directors' Report 2 Auditors Report 3 P & L Account & Balance Sheet & Cash Flow Statement 4 Schedules forming part of B/s & P & L Account 5 Statement pursuant of Co. Act 6 Consolidated Financial Statements 7 Notes to account 8 Significant Accounting Policies 9 Related Party Transactions 10 Corporate Reporting Framework 11 Risk & Estimates in Preparing & Presenting Financial Statements 12 BASEL - II Disclosures 13 Dividend [Dividend History/ Details] 14 Other Financial Performances [Ratios/Charts/Graphs] www.icmrr.org 123 icmrrjournal@gmail.com
Annex B: Nonfinancial disclosures as per guidelines for good governance practices Sr. No Disclosure Item Non-Financial Disclosure Company Objectives 1 Message from the Chairman 2 Letter from MD & CEO 3 Vision & Mission Statement Ownership & Shareholders' Rights 4 Ownership/ Shareholding Structure/ Pattern 5 Shareholders' Rights Governance Structure & Policies 6 Statutory Details of the company Size of the Board 7 [Minimum 10 members] 8 Composition of Board 9 Chairman & CEO Duality 10 Information about independent Directors 11 Role & Functions of the Board 12 Changes in the Board Structure Audit Committee 13 [Minimum 5 members, one of them must be CA] 14 Remuneration & Nomination Committee 15 Investors' Grievance Redressal Committee 16 Other Committees 17 Composition of the Committees 18 Functioning of the Committees 19 Organizational Code of Ethics Member of the Board & Key Executives 20 Biography of the Board Members 21 Number of Directorship hold by each Member Number of Board Meetings 22 [At least 3 in a year] Attendance in Board Meetings 23 [Minimum 80%] 24 Director's Stock Ownership 25 Director Remuneration Material Issues Regarding Employees, Environmental & Social Stewardship 26 Employee Relation/ Industrial Relation 27 Corporate Social Responsibility 28 Environmental Responsibility 29 Financial Inclusion Norms/ Policy Material Foreseeable Risk Factors 30 Internal Control System www.icmrr.org 124 icmrrjournal@gmail.com
Independence of Auditors 31 Auditor Appointment & Rotation 32 Auditor Fees Annual General Meeting 33 Notice & Agenda of the AGM Timings & Means of Disclosure 34 Separate CG Statement/ Section 35 Annual Report through Internet 36 Green Initiative Practices [for 2010-11 only] Best Practices for Compliance with CG 37 Compliance Certificate for CG 38 Philosophy on Code of CG 39 Best Practices Recognition/ Award for CG www.icmrr.org 125 icmrrjournal@gmail.com