Relationship between Corporate Governance and Firm Performance: GCC Banking Sector Perspective

Corporate Governance
A critical review of relationship between corporate governance and firm performance: GCC banking
sector perspective
Tamanna Abdul Rahman Dalwai Rohaida Basiruddin Siti Zaleha Abdul Rasid
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Tamanna Abdul Rahman Dalwai Rohaida Basiruddin Siti Zaleha Abdul Rasid , (2015),"A critical review of relationship
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A critical review of relationship between
corporate governance and firm
performance: GCC banking sector
perspective
Tamanna Abdul Rahman Dalwai, Rohaida Basiruddin and Siti Zaleha Abdul Rasid
Tamanna Abdul Rahman
Dalwai, Rohaida
Basiruddin and Siti
Zaleha Abdul Rasid is a
Senior Lecturer all are
based at International
Business School,
Universiti Teknologi
Malaysia, Kuala Lumpur,
Malaysia.
Abstract
Purpose – The purpose of this paper is to evaluate existing studies on the relationship of corporate
governance with firm performance in different regions and address the need for similar analysis for
the Gulf Coperation Council (GCC) sector. The banking sector comprises the conventional and
Islamic banks in the GCC sector and is important due to their ability to bring stability to this region.
Existing studies that measure the relationship of GCC sector conventional banks and firm
performance are limited. This study proposes a need for future research on corporate governance
in the GCC region.
Design/methodology/approach – This paper will review and analyze the different empirical and
theoretical contributions in establishing the relationship between corporate governance and firm
performance.
Findings – This paper will create a focus for future research of measuring the impact of corporate
governance mechanism on firm performance. The regulators will be encouraged to focus on more
research studies for the GCC sector development in the field of corporate governance of the banking
sector.
Research limitations/implications – The existing studies are valid and practicable for the region
under study, and the results need not be applicable for other business environments. In addition,
the evolving business and economic environment have always brought about inconsistent
conclusions; thus, the period of study can always give varied results.
Practical implications – The analysis undertaken in this paper will address the literature gaps for the
GCC banking sector and play an instrumental role for future studies by theoreticians and regulators.
Originality/value – This paper identifies the literature gaps for the GCC region and analyses the most
applicable existing studies that can be useful for the banking sector corporate governance
improvement. This paper will create opportunities for the future researchers.
Keywords Financial performance, Corporate governance, Board of directors, Shareholders,
Audit committees, Chairmen
Paper type Literature review
Introduction
The global financial crisis of 2007 had created ripples in the faith of banking sector. The
reason for this crisis was attributed to financial sectors self – interest behavior. According
to Howard (1997), the term “tragedy of maximisation” was introduced when the firms act in
their self-interest and eventually lead to misuse of shareholder funds. For free markets to
work efficiently, it is important to have elements of accountability, ethics, responsibility and
transparency (Friedman and Friedman, 2010).
Received 24 April 2013
Revised 24 April 2013
Accepted 1 October 2013
PAGE 18 CORPORATE GOVERNANCE VOL. 15 NO. 1 2015, pp. 18-30, © Emerald Group Publishing Limited, ISSN 1472-0701 DOI 10.1108/CG-04-2013-0048Downloaded by SELCUK UNIVERSITY At 12:41 01 February 2015 (PT)

Corporate governance has received considerable attention over the past few decades to
instil confidence in the stakeholders of organisations. But it is not enough to view corporate
governance as a whole but at different levels of importance and applicability. For example,
several authors suggest that corporate governance of financial sector is different than the
non-financial sector because of its opaque nature and heavy regulation (Levine, 2004) .
Some important studies have been undertaken to measure the impact on the
performance of banks during the financial crisis. For example, Qu et al. (2012)
investigated empirically the performance of banks in the BRIC countries (comprising
Brazil, Russia, India and China) during the financial crisis. The period under study was
from 2003 to 2010, and it was found that, from 2007 to 2008, there was a significant
decline in the banking efficiency due to the crisis. They suggested that in such
countries, increase of competition and regulations would improve the banking
efficiency. Similarly when Chan-Lau et al. (2012) studied the impact of the crisis on the
European banks, it was suggested that a stronger capital base and reliance on
deposits would help them cope with any major financial crisis.
Such studies have been the focus of many researchers in developed countries and
many emerging countries as well, but the Gulf Coperation Council (GCC) financial
sector has had inadequate attention. There has been a dearth of research in the GCC
region for the corporate governance practices of financial and non-financial sector
firms. This paper presents the need for future research of corporate governance
mechanisms and its relationship with the firm performance of GCC incorporated banks.
The GCC comprises six countries: Bahrain, Kingdom of Saudi Arabia, Kuwait, Oman,
Qatar and United Arab Emirates (UAE). The growth of this region has been
predominantly from revenues generated through oil reserves. Over the past decade,
this region has diversified its sources of revenue from construction, retail,
manufacturing and tourism sectors. Accenture (2011) conducted a study of the GCC
region that highlights some of its prominent features making it stand out in comparison
to the other emerging and developed markets. The GCC region was able to emerge
from the global financial crisis relatively unscathed due to its policies and regional
development activities. It was noticed that the growth of the GCC region was at par with
the other emerging nation over the past 10 years which is around 5-6 per cent. This
growth has been faster than some of the advanced economies itself. The growth rates
in this region is expected to get stimulus from the government incentives to diversify
in the industrial base, infrastructure and housing investments, thus reducing
dependencies on the revenues generated from the oil and gas sector. The
demographic profile of this region is also an attractive point, as most of the population
is very young. The Accenture group conducted a survey of 47 banks in the GCC region
and found that there is an anticipation of more stricter regulations, more competitive
markets and skills’ shortage by 2015. While the regulations are getting stricter around
the world, the GCC banks are expecting to focus on liquidity management and
compliance with the regulations set by their central banks. One of the most notable
outcomes of this survey was the expectation of changing business models because of
the requirement of stricter corporate governance and risk management requirements.
The GCC has six countries but seven stock exchanges. All countries have one stock
exchange except for UAE that has two stock exchanges, Abu Dhabi Stock Exchange
and Dubai Stock Exchange. For the second quarter results declared at the end of June
2012, it was found that Saudi Arabia and Qatar banks were dominating the growth in the
region. Saudi Arabia banks accounted for 36 per cent and Qatar banks accounted for
20 per cent of the total GCC profit. Kuwait, Bahrain and Dubai witnessed a negative
growth on a year-on-year basis. Thus, four markets witnessed a positive growth on a
year-on-year basis. As future prospects of the region suggests that banks will have to
expand beyond the region and is also showing signs of recovery from the crisis (Global
Banking and Finance Review, 2013).
VOL. 15 NO. 1 2015 CORPORATE GOVERNANCE PAGE 19Downloaded by SELCUK UNIVERSITY At 12:41 01 February 2015 (PT)

The banks of the GCC region have shown considerable resistance during the period of
the crisis and have shown an overall improvement. There have been many reasons
because of which the GCC banks have shown resilience during this period, but the role
of corporate governance and its impact has not been investigated. First, the paper
emphasizes the importance of corporate governance mechanisms. Second, there will
be a review of the most recent research papers on the relationship between corporate
governance mechanisms and firm performance around the world. Third, a review of the
limited research on GCC sector corporate governance practices will be presented.
Finally, the gaps in the existing literature are discussed to present a future course of
focus in the GCC region corporate governance practices.
Importance of corporate governance mechanisms
Corporate governance is a regulatory activity that is enforced through different internal
and external agencies to resolve the agency conflicts and protect the stakeholder
interests of organisations. Corporate governance ensures that firms are run in a
responsible and accountable manner that enhances the overall performance.
Becht et al. (2002) has suggested that the rising interest in corporate governance can
be attributed to five reasons which are:
1. worldwide privatization wave;
2. reforms in pension fund and growth in private savings;
3. the 1980’s takeover wave;
4. deregulation and integration of the capital markets world-wide; and
5. crises.
But corporate governance is not viewed in the same light for financial firms or
non-financial firms. Several studies suggest that because of the nature of financial firms,
the corporate governance mechanisms have to be applied differently. According to
Myers and Raghuram (1998), corporate governance of banks face challenges because
of the features of banks such as tradable assets, changing risk profile of banks and
structuring of assets in a way that conceal risks from outsiders. Kieff and Paredes
(2010) discussed three major problems with the banking sector. First, banks have to
maintain a deposit insurance system to protect the depositors because of the tendency
of continuous lending. Second, banks face several risks such as credit risk, operational
risk and market risk. Finally, the risk of the banks is not diversified but concentric in
nature.
As the banks face unique risks and are different in their business models, the nature of
corporate governance also needs to be customised at the micro and macro level.
Because of the global financial crisis, the corporate governance mechanism such as
executive compensation was a contributory factor to the banking crisis rather than a
regulatory one. For example, according to Turner (2009), the financial crisis in the
banking structures was because of the pay structures of the directors. The directors
focussed more on short-term goals and overlooked the long-term impact of their
decisions. Bebchuk and Spamann (2010) found that the option-based executive
compensation inculcated a risk behaviour in the managers and thus had an
unfavourable impact on the banks’ long-term goals and profitability.
The corporate governance mechanisms are classified into internal and external
mechanisms (Bushman and Smith, 2001; Cremers and Nair, 2005). The internal
mechanisms comprise ownership structure, board of directors, executive
compensation, audit committees and financial disclosures. The external mechanisms
comprise market for corporate control, managerial labour markets, proxy fights,
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