Roles of Outside Directors in Cooperative Financial Institutions

1. 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

2. 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.

3. 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.

4. Share of the loan market in Japan- At the end of FY 2010 - Other financial institutions

5. Number of depository financial institutions in Japan

6. Governancestructures in credit association Members Candidate for representative council members Selection committee Board Representative council members

7. Samples • Three types of regional financialinstitutions in Japan • Regional banks: • consist of regional banks and regional banks Ⅱ (former mutual banks). • about 80% of them are publicly listed. • Credit associations (Shinkin banks) • Credit cooperatives (Shinkumibanks): • mutual capital structure co-ops. • some differential type of institutions (only for the members of specific business and occupation) are excluded.

8. 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.

9. Analytical framework • Measuring bank efficiency • Test whether a structural cost difference exists among the threetypes of regional financial institutions (regional banks, credit associations, and credit cooperatives). • Measuring the SFA efficiency scores for each sub sampleby 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 threetypes of regional financial institutions.

10. 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). v; iid N(0, σv2) u; iid N+(0, σu2)

11. 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)

12. Descriptive statistics (Cost function)- Pooled data over the period from FY 1999 to FY 2006 - (Unit：Person， Millions of Yen，%）

13. 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)

14. Descriptive statistics (Governance regression)- Average values of cross-sectional data for FY 1999 and FY 2006 - (Unit：Person， Millions of Yen，%）

15. 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.

16. Results- Descriptive statistics on efficiency scores -

17. Results (Governance regression)- Analysis of FY 1999 -

18. Results (Governance regression)- Analysis of FY 2006 -

19. 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.

20. 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?

21. References Weisbach, 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.

22. Thank you for your attention