BOARD GOVERNANCE, EXECUTIVE REMUNERATION AND PERFORMANCE OF INDIAN BANKS

Abstract

The need for good corporate governance has long been advocated to minimize agency costs and an unavoidable self-interested managerial behavior associated with the separation of ownership from control. However, corporate governance holds a unique position in banking firms, owing to their substantial role in lubricating the economy’s growth wheels, and the banking firms’ failure has severe ramifications for the whole economy. The high levels of regulation, heavy leverage, opacity, complexity, information asymmetries, and distress owing to adverse selection in the banking business make corporate governance “special” and “distinct” in the banking sector. The recent array of financial catastrophes has incited the debate over the competence of existing governance mechanisms and stimulated the mounted interest of academicians, economists, and policymakers towards the efficacy of board governance structure in the banking industry. The egregious governance practices, particularly related to the banks’ boards, have gained significant attention during the financial crisis. Though the Indian banking industry has escaped the adversities of the Global Financial Crisis (GFC) but has experienced considerable incidences of bank frauds, violation of code of conduct by bank officials, ineffective board decisions and/or not making all relevant disclosures. Therefore, there is an obligation to learn corporate governance lessons from the GFC and the banking frauds to prevent fraudulent activities and poor practices in the future that might induce an impaired performance of banks and thus handicap the path of nations’ comprehensive growth. Consequently, policymakers have initiated numerous governance policy reforms to review and augment the governance structure of bank boards. But the evolution and efficacy of governance of bank boards are not much known in India. The underlined concern weighs relevance in recent times when the banking industry in India has experienced rising encumbrance due to bad loans and perceptible plunge in their performance levels. The publicly available sources unveil that boards are mainly responsible for this sloppier growth in their balance sheets, especially with India’s advent of the endogenous crisis. Moreover, the ‘dual regulation’ and the interminable political intrusion bring to the forefront the massive governance challenges for state-owned banks and risk to the autonomy of their bank boards. Therefore, the natural setting of Indian banking, offering a mix of public and private banks, motivates us to highlight the potentially decisive role of board governance on various bank outcomes in the industry as a whole, as well as across both widely-held banks (private banks) and concentrated shareholding banks (public sector banks).First, the thesis quantitatively assimilates the inconclusive findings of a comprehensive set of studies investigating the influence of board governance on banking firms’ performance. This research objective is methodically addressed using a quantitative meta-analysis approach and a database of 56 studies conducted from 2007 to 2019. The chapter investigates how board size, CEO duality, outside directors, and female directors on board play a role in determining bank performance. Variations in board-performance nexus that attribute to potential moderators, including the corporate governance system, bank performance measures, the definitions of governance variables, publication-quality, and endogeneity concerns, are also encapsulated. The study shows that bank performance is positively associated with larger boards and a high proportion of outside and female directors, supporting the resource dependence theory. The thesis finds that the moderating variables considerably alter the link between board governance and bank performance and offers ways to enhance board effectiveness by enforcing governance practices in the banking systems based on each country’s legal and institutional framework. Next, Indian banks’ board governance evolution is examined by formulating a composite index for board effectiveness using Principal Component Analysis and four unweighted sub-indices, using comprehensive board characteristics for a sample of Indian banks operating from 2005 to 2018. The analysis shows a considerable improvement in the board practices and reveals that Indian banks have shown optimistic behavior in adopting good governance standards. But private banks fairly outperform public sector banks, depicting that different ownership and regulatory structure brings to the forefront considerable difference in the speed of adoption of governance provisions. The thesis further endeavors to investigate whether the board's effectiveness (both at the aggregate and disaggregate levels) matters for India's bank performance. The chapter extends the analysis to ownership level to investigate if the board-performance nexus differs in India’s public and private bank groups. The econometric exploration is performed using a “two-step system Generalized Method of Moments (GMM) of Blundell and Bond (1998)” to account for the possible endogeneity in the empirical framework, which might arise from three potential sources, including (i) unobservable heterogeneity; (ii) persistence in bank profits and (iii) reverse causality. The findings depict that board governance plays a considerable role in affecting the performance of Indian banks. Specifically, duality, the board size, non-executive directors, nominee directors, busy directors, trained independent directors, board meetings, and board committees influence bank performance significantly. However, banks’ different governance and regulatory structures substantially affect the board-performance nexus at the ownership level. In particular, board governance is noted to exert a more considerable influence on private banks’ performance than public banks. An attempt is also made to empirically explore the convergence phenomenon in the remuneration of executive directors in the Indian banking industry and across ownership groups. The study adopts “Barro, Sala-i-Martin, Blanchard, and Hall (1991)’s σ- and β-concepts of convergence” in the dynamic panel econometric specification and “Phillips and Sul’s (2007, 2009) novel club clustering algorithm” to investigate the convergence in executives’ remuneration. The empirical results show the evidence of β-convergence in remuneration paid to bank executives, implying a catching-up phenomenon in pay level in the Indian banking industry and across ownership groups. However, a significant decline in the dispersion in executive pay is not observed. The club convergence identifies two convergent clubs and one divergent club in the industry. Club 1 forms five banks, and Club 2 includes 26 banks with a considerably massive gap in the average pay in Club 1 and Club 2. Both bank groups exhibit a higher convergence speed than club convergence in the industry at the ownership level. It shows that banks with similar ownership and governance patterns experience higher convergence rates in executive remuneration. Still, there is a substantial difference in the pay contracts of executives of the same ownership group, and PBs are noted to be more heterogeneous. Further, the thesis investigates the role of board governance and bank performance in determining the executive remuneration in the Indian banking industry and explores if the pay-governance relation alters across ownership groups. The chapter also empirically examines if the overall quality of the board significantly influences the remuneration of executive directors. The all-inclusive dynamic pay equation is modeled by adjusting the effect of past remuneration and the past year’s performance and performing an econometric estimation. The findings based on the dynamic pay model using the two-step system GMM approach reveal that starting and past pay levels hold significant predicting power for the future level of executives’ pay, while frequent board meetings and a more significant proportion of female directors on board moderate the executive remuneration packages. The remuneration is significantly responsive to forward-looking market-based performance measures. At the ownership level, the findings infer that the monitoring abilities of the board considerably differ, with board governance playing a more prominent role in private banks. In contrast, bank boards of public sector banks lack adequate autonomy to influence executives’ pay significantly. The results validate the managerial power approach, implying that any sort of weaknesses in governance structure (especially in private banks) might inhibit bank boards from performing their monitoring responsibilities effectively in optimal pay fixation.Finally, the study econometrically inspects the impact of board governance (both at aggregate and disaggregate level) on the dividend payouts of Indian banks. Specifically, an attempt is made to examine if board governance (at both aggregate and disaggregate level) substitutes or complements the dividend payouts. The results of panel Tobit and Logit models reveal a significant favorable influence of overall board quality on the magnitude of payouts, supporting the “outcome hypothesis”. At the disaggregated level, independent directors, female directors, CEO duality, and board meetings significantly influence the dividend policy of Indian banks. The further investigation of the board-dividend nexus at the ownership level shows that this complement relation is only visible in private banks. While the “substitution hypothesis” holds in public sector banks. The results suggest that good governed private banks use dividends as a complementary measure of monitoring mechanism. In contrast, a good governed board of public sector banks takes conservative financial decisions and declares a low dividend. Therefore, the thesis shows that board governance of the Indian banks is not ownership neutral; instead, a substantial difference in the evolution of board governance and how it influences bank performance, executive remuneration, and dividend payouts are observed across the ownership groups. Specifically, it is found that bank boards play more of a monitoring role in private banks and advising in public sector banks. This reflects that differences in the institutional and regulatory structures within the nation and differences in business operations across bank groups significantly moderate the influence of board governance on the performance of banking firms. The study recommends that Indian banks focus on adopting real governance instead of symbolic governance based on complying with the governance codes and ignoring the actual practices. Thus, the research findings of the thesis can assist the policymakers in augmenting the ongoing banking reforms on corporate governance, especially related to boards, in enhancing the board structure and composition so that they can direct banks to achieve financial sustainability.