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CHAPTER III

3. Research Methodology

This chapter deals with the need and objectives of the present study, the scope of the

study, the selection of sample, data collection, statistical tools used in the analysis of data,

organisation of the study and the limitations of the study.

Background of the Research

The subjective evidence of the 1997 Asian crisis showed that poor corporate governance

contributed to the collapse of many banks and corporate firms in Thailand, Malaysia,

South Korea and Indonesia. Since then, there has been a sincere effort to improve

corporate governance in the crisis ridden countries (Gan et al, 2001). The financial crisis

in some Asian countries in late 1990s prompted most of the countries to give improved

corporate governance a priority. “The losses due to weak corporate governance practices

and corruption are estimated at nearly 15 percent of China’s GDP, though the figure may

be much higher”(www.csis.org). An annual collaborative study of the corporate

governance landscape of Asian markets titled "Spreading the World: CG Watch 2004-05"

was undertaken by independent stockbrokers. From this forum the awareness and

importance of corporate governance in Asian countries was realized. Asian countries do

realize that CG practices would not change overnight; hence patience is the key to

success in this field (Bhasin, 2006).

Considering the importance of this subject, Asian Corporate Governance Association

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(ACGA), made a report during 2004-05, on the state of affairs of corporate governance in

Asian markets, emphasizing on some key determinants behind assessing corporate

governance standards such as rules and regulations, enforcement, political and regulatory

environment, the adoption of international accounting standards, and corporate

governance culture.

Corporate governance has been on the top priority of Asian countries with most markets

introducing comprehensive regulations. Although it cannot be called a fully satisfied

accomplishment from the evidence of its achievements, but the ethos of corporate

governance is yet to come out fully. During the same period, the need for corporate

governance was also felt in line with the international trend. The first initiative for

ensuring corporate governance among Indian companies came from the corporate sector

itself. The Confederation of Indian Industry (CII) came up with the Code of Desirable

Corporate Governance in 1998. Then the Securities Exchange Commission of India

(SEBI) which is the regulator of Indian financial market, appointed 'Kumar Mangalam

Birla Corporate Governance Committee'. Most of the recommendations made by the

Committee were accepted and implemented by SEBI in the year 2000.

3.1. Need of the study

The Indian Industries will grow not only in size but also in complexity of financial

engineering as the forces of competition gain further momentum and financial markets

acquire greater depth. The Indian baking sector can no longer afford to ignore better

corporate governance practices. As India gets integrated in the world markets, Indian as

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well as international investors will demand greater disclosure, more transparent

explanations for major decisions and better corporate value. Moreover, in view of the

different scams taking place in the post-liberalization period since 1991, the investors

have become cautious in making investment decisions and better corporate value.

Therefore, there is a need of strengthening corporate governance practices in India to

restore their confidence and to bring down agency costs.

In this context, the study will attempt to evaluate the whole mechanism of the corporate

governance adopted by leading Public, Private and Foreign banks in India. We propose to

unearth the strengths and weaknesses of the present practices, and to make suggestions

for new threats and opportunities.

The term Corporate Governance has become a buzzword these days because of two

factors. The concept of government controlling, the commanding heights of the economy,

has been given up. This in turn has made the market the most decisive factor in setting

economic issues. Another factor is the thrust given to globalization because of the setting

up of the WTO and every member of the WTO trying to bring down the tariff barriers.

Globalization involves the movement of the core parameters namely physical capital in

terms of plant and machinery, financial capital in terms of money invested in capital

markets or in FDI, technology and labor moving across national borders. The pace of the

movement of financial capital has become greater because of the pervasive impact of

information technology and the world having become a global village.

Corporate governance represents the value framework, the ethical framework and the

moral framework under which business decisions are taken. In other words where

investment takes place across the national borders, the investors want to be sure that not

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only is their capital handled effectively and adds to the creation of wealth but the business

decisions are also taken in a manner which is not illegal or involving moral hazard.

It will certainly not be out of place here to recount how issues relating to corporate

governance and corporate control have come to the fore the world over in the recent past.

The seeds of modern corporate governance were probably sown by the Watergate

scandal in the USA. Subsequent investigations by US regulatory and legislative bodies

highlighted control failures that had allowed several major corporations to make illegal

political contributions and bribe government officials. While these developments in the

US stimulated debate in the UK, a spate of scandals and collapses in that country in the

late 1980s and early 1990s led shareholders and banks to worry about their investments.

Several companies in UK which saw explosive growth in earnings in the ’80s ended the

decade in a memorably disastrous manner. Importantly, such spectacular corporate

failures arose primarily out of poorly managed business practices.

This debate was driven partly by the subsequent enquiries into corporate governance

(most notably the Cadbury Report) and partly by extensive changes in corporate

structure. In May 1991, the London Stock Exchange set up a Committee under the

chairmanship of Sir Arian Cadbury to help raise the standards of corporate governance

and the level of confidence in financial reporting and auditing by setting out clearly what

it sees as the respective responsibilities of those involved and what it believes is expected

of them. The Committee investigated accountability of the Board of Directors to

shareholders and to the society. It submitted its report and the associated ‘code of best

practices’ in December 1992 wherein it spelt out the methods of governance needed to

achieve a balance between the essential powers of the Board of Directors and their

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proper accountability. Being a pioneering report on corporate governance, it would

perhaps be in order to make a brief reference to its recommendations which are in the

nature of guidelines relating to, among other things, the Board of Directors and

Reporting & Control.

The Cadbury Report stipulated that the Board of Directors should meet regularly, retain

full and effective control over the company and monitor the executive management.

There should be a clearly accepted division of responsibilities at the head of the

company which will ensure balance of power and authority so that no individual has

unfettered powers of decision. The Board should have a formal schedule of matters

specifically reserved to it for decisions to ensure that the direction and control of the

company is firmly in its hands. There should also be an agreed procedure for Directors

in the furtherance of their duties to take independent professional advice.

The Cadbury Report generated a lot of interest in India. The issue of corporate

governance was studied in depth and dealt with by the Confederation of Indian Industries

(CII), Associated Chamber of Commerce and Industry (ASSOCHAM) and Securities

and Exchange Board of India (SEBI). These studies reinforced the Cadbury Report’s

focus on the crucial role of the Board and the need for it to observe a Code of Best

Practices.

The banking sector is not necessarily totally corporate. Some part of it is, of course, but

a segment of banks is mostly government owned as statutory corporations or run as

cooperatives – just like your bank. Banking as a sector has been unique and the interests

of other stake holders appear more important to it than in the case of non-banking and

non-finance organizations. In the case of traditional manufacturing corporations, the

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issue has been that of safeguarding and maximizing the shareholders’ value. In the case

of banking, the risk involved for depositors and the possibility of contagion assumes

greater importance than that of consumers of manufactured products. Further, the

involvement of government is discernibly higher in banks due to importance of stability

of financial system and the larger interests of the public. Since the market control is not

sufficient to ensure proper governance in banks, the government does see reason in

regulating and controlling the nature of activities, the structure of bonds, the ownership

pattern, capital adequacy norms, liquidity ratios, etc.

Reasons for high degree of oversight:

There are three reasons for degree of government oversight in this sector.

• Firstly, it is believed that the depositors, particularly retail depositors, cannot

effectively protect themselves as they do not have adequate information, nor are they

in a position to coordinate with each other.

• Secondly, bank assets are unusually opaque, and lack transparency as well as

liquidity. This condition arises due to the fact that most bank loans, unlike other

products and services, are usually customized and privately negotiated.

• Thirdly, it is believed that that there could be a contagion effect resulting from the

instability of one bank, which would affect a class of banks or even the entire

financial system and the economy. As one bank becomes unstable, there may be a

heightened perception of risk among depositors for the entire class of such banks,

resulting in a run on the deposits and putting the entire financial system in jeopardy.

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Implementation of corporate governance depends upon laying down explicit codes,

which enterprises and the organizations are supposed to observe. The Cadbury's code in

the United Kingdom was the starting point which led to a number of other codes. In India

itself we have the Kumar Mangalam Birla code as a result of the committee handled by

him at the behest of the SEBI. Earlier we had the CII coming up with the code of

Corporate Governance recommended by the committee headed by Mr. Rahul Bajaj. A

code, however, can only be a guideline. Ultimately, effective Corporate Governance

depends upon commitment of the people in the organization.

3.2. Objectives of the study

The present study has been undertaken with the main objective of making a comparative

analysis of the Corporate governance disclosure practices of the public and the private

sector banking companies and foreign banks in India for the year 2006-07 to 2010-11.

More specifically, the following are the objectives of the study:

1.To study and analyse the contents of the Corporate governance report in the annual

reports of the public and the private sector banking companies of India during the

period under study.

2.To evaluate the adoption of disclosure norms by the Public and Private banks under

study.

3.To make an analytical study of different codes for corporate governance recommended

by different committees in India and their implementation.

4.To examine the disclosure practices, board structure, procedures adopted and board

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committees of the sample organizations to assess the adherence to good corporate

governance by them.

5.To study and compare the extent to which corporate governance codes are being

implemented by the public and the private sector banking companies of India during the

period under study.

6.To examine the impact on the overall value of the bank (Private banks, public banks or

foreign banks) from the view point of corporate governance with respect to the

perception of its investors.

7.To critically evaluate the key elements of corporate governance to unearth their

strengths and weaknesses

8.To provide suggestions to increase the pace of growth in the area under study.

Research Questions

The proposed research will ask some fundamental questions on corporate governance in

banking sector and will try to identify how it helps banks to ensure transparency and

growth.

The questions are:

• How the attributes of corporate governance help banking sector to create a

situation, which can minimize fraud/malpractices in financial matter in banking

sector?

• Whether ownership pattern influences the effective governance and functioning

of a bank?

• Does the declaration of corporate governance in annual report bring more

transparency in their business and how it pays in terms of business?

85

• Does the proper implementation of corporate governance principles create more

public trust and acceptability of a bank as a result give boost to share price?

• Is there any difference in corporate governance practices between Private sector

and Public sector banks?

• To what extent Indian Banking sector has accepted/implemented corporate

governance principles compared to international norms?

• What are the suggestions to banking industry with respect to corporate

governance?

3.3. Scope of the study

As the aim is to examine the major corporate governance practices adopted by all the

Public, Private and Foreign Banks in India, at present only 40 banks are listed in the

Indian stock markets, out of which I have taken total 35 banks, where 19 banks belong to

public sector and remaining 16 banks in the private sector category. In India, the

implementation of corporate governance practices is directly linked with Security

Exchange Board India (SEBI) under clause 49 listing agreement. According to SEBI, the

corporate governance practices are applicable only to banks that are listed in the Indian

stock exchanges hence the foreign banks lay outside the purview of study. I have ignored

the SBI associate banks in my research since I have taken SBI, the parent organization. At

the end of March 2011, the following banks were listed in BSE or NSE:

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Table 3.1: List of banks considered in Research Study

S.no Private Banks Public Banks

1. Dhanalakshmi Bank UCO Bank

2. Axis Bank Union Bank

3. South Indian Bank Vijaya Bank

4. KarurVysya Bank Dena Bank

5. Jammu & Kashmir Bank Central Bank

6. ING Vysya Bank Bank of Maharashtra

7. Yes Bank Corporation Bank

8. HDFC Bank Syndicate Bank

9. Indus Ind Bank Indian Overseas Bank

10. ICICI Bank Indian Bank

11. Federal Bank State Bank Of India

12. City Union Bank Oriental Bank

13. Laxmi Vilas Bank IDBI Bank

14. Kotak Bank Allahabad Bank

15. Development Credit Bank Canara Bank

16. Karnataka Bank Bank Of India

17. Andhra Bank

18. Punjab National Bank

19. Bank Of Baroda

In order to make the inter period analysis of the corporate governance disclosure

practices in both the public and the private sector banking companies, a period of five

years i.e. from 2006-07 to 2010-11 has been selected because it became mandatory for all

the listed firms through revised clause 49 to implement corporate governance disclosure

in the annual reports w.e.f. 31st December 2005, before that since it was not mandatory,

many banks therefore never disclosed the corporate governance in their annual reports.

Hence the research is meaningful only after 31st Dec 05’.

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3.4. Data Collection

The research study is based on both the primary as well as secondary data. A sample of

500 investors was taken from National Capital Region, Delhi on the basis of simple

random sampling in order to know their perception about implementation of Corporate

Governance practices.

For the secondary research, the annual reports of the selected banking companies from

both the public and the private sector were the major source of data collection. All the

annual reports were downloaded from www.reportjunction.com, almost all the reports

were obtained from there except a few which are mentioned below:

Table 2.2: The annual reports cannot be found for the mentioned years

Name of Bank Year in which annual report not found

Laxmi Vilas Bank 2006-07

Central Bank 2006-07

Development Credit Bank 2007-08

Dhanalakshmi Bank 2006-07,2007-08

City union Bank 2006-07,2009-10

However, I have tried to take into account all the possible leading public and private

sector banks but a few were not taken into consideration due to the following reasons:

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Table 3.3: Reasons for not considering a few banks:

Name of the bank

Name of stock exchange, if

listed

Reason for non-consideration

Global trust bank NSE Is Uganda based and OBC took over

Nainital Bank BSE Annual report not found

Nedungadi bank ltd - PNB took over

Bank of madura - ICICI took over

Bank of punjab ltd NSE Based in Lahore

United western bank ltd NSE Merged with IDBI

Saraswat Bank - Since not listed

Tanilnadmerchantile bank

- IDBI took over

Ratnakar Bank - Since notlisted

Times Bank - HDFC took over

Bharat overseas Bank - IOB took over

Catholic Syrian Bank - Since not listed

Sangli Bank - ICICI took over

3.5. Analysis of Data

For the purpose of analyzing the corporate governance disclosure practices of the public

and the private sector banking companies, primary research was undertaken wherein a

simple random sampling was done, a simple random sample is meant to be an unbiased

representation of a group. The questionnaire was filled (Anexure3) by 500 respondents

who happen to be the general investors.

As the aim is to examine the major corporate governance practices adopted by all the

Public, new Private sector and Foreign Banks (at present only 40 banks are listed in the

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Indian stock markets, out of which I have taken total 35 banks, where 19 banks belong to

public sector and remaining 16 banks in the private sector category), I have tried to direct

my research towards discovering firstly, how well the corporate disclosure norms are

being followed by the respective public, private banks and after the analysis have

depicted the same, then secondly if there is any impact/relation between corporate

governance disclosure and performance (through return on capital employed ROCE and

Tobin Q method). Certain items of information were identified after scanning the annual

reports of the banking companies of both the sectors as well as the review of literature. I

have divided the corporate governance codes into four major heads namely, procedure,

disclosure, audit committee and board structure. These major heads have several

corporate governance disclosure variables as discussed throughout in this paper which are

drawn out of the codes described in Clause 49 of SEBI Act. For this purpose corporate

governance index was prepared (as shown in Table 1.1).

Hypotheses

With reference to review of literature of corporate governance, and different types of

banks, this paper develops the following hypotheses for study to test the relationships

between corporate governance practices and performance:

H0 Firms’ performance is not positively related to the quality of its corporate

governance practices

H1Firms’ performance is positively related to the quality of its corporate governance

practices

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Independent variables

The various corporate governance indicators suggested by “Clause 49 of the listing

agreement by sebi” are the independent variables which have bee explained later,

wherein TDL is total disclosure, TBS is total board structure, TAC is total audit

committee, TPRO is total procedures, NBM is no. of board meetings, BS is board size,

NAM is no. of audit meetings, ACS is audit committee size, NOC is no. of committees

and Tobin’s Q is market value of equity over book value of total asset. ROCE is

calculated by dividing earnings before interest and taxes (EBIT) by capital employed,

where capital employed is equity plus reserves and surplus, the latter two happen to be

the dependent variables.

Development of a Corporate Governance Index

A corporate governance index based on annual report disclosures was developed to rate

each bank’s corporate governance quality. Derivation of this index was centered on

corporate governance indicators suggested by “Clause 49 of the listing agreement by

Sebi”. The corporate governance index framework is shown below. The maximum

possible score was 20 (10 disclosure, 3 board structure, 3audit committee, 4 procedures).

Each bank’s corporate governance score (CGSCORE) was calculated by dividing their

total score by this maximum possible score, to express it as a proportion for ease of

comparability.

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DISCLOSURE Maximum

Annual statements contain a statement addressing

corporate governance

If YES, 1 point. If no, 0. 1

Basis of related party transactions disclosed

if Yes,1 point.If NO,0 1

Appointment of a new director or re-appointment

of a director is disclosed

If YES, 1 point. If NO, 0. 1

Members attendance at meetings disclosed

If YES, 1 point. If NO, 0. 1

Bank puts annual financial statements on web

If YES, 1 point. If NO, 0. 1

Bank puts Directors report on web

If YES, 1 point. If NO, 0. 1

Bank puts Annual report on web

If YES, 1 point. If NO, 0. 1

Compensation of Directors (including non-

executives) disclosed

If YES, 1 point. If NO, 0. 1

The disclosures of the compliance with mandatory

requirements and adoption (and compliance)/non

adoption of the non-mandatory requirements shall

be made

If YES, 1 point. If NO, 0. 1

A director is not a member in more than 10

committees or act as Chairman of more than five

committees across all companies in which he is a

director

If YES, 1 point. If NO, 0 1

TOTAL DISCLOSURE 10

BOARD STRUCTURE

CEO not the same person as Board Chairman

If YES, 1 point. If NO, 0. 1

50% independent directors if Chairman is Executive

Director or 33% independent directors if Chairman

is a Non-Executive Director

If YES, 1 point. If NO, 0,Not disclosed 0. 1

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3) Number of meetings

Atleast 4 - 1 point

No meetings - 0 point

Not disclosed - 0 point 1

TOTAL BOARD STRUCTURE 3

AUDIT COMMITTEE

Atleast three directors

If YES, 1 point. If NO, 0. 1

2/3 must be independent

If YES, 1 point. If NO 0, Not disclosed 0 1

Number of meetings during the year

4 or more - 1 point

Less than 4 - 0 point

Not disclosed - 0 point 1

TOTAL AUDIT COMMITTEE 3

PROCEDURES

The Bank has laid down procedures to inform board

members about the risk assessment and

minimization procedures

If YES, 1 point. If NO, 0. 1

Company has Code of Conduct (Ethics)

If YES, 1 point. If NO, 0. 1

Auditor or company secretary compliance with

corporate governance

If YES, 1 point. If NO, 0. 1

Does CEO / CFO certify financial statements

If YES, 1 point. If NO, 0. 1

TOTAL PROCEDURES 4

TOTAL SCORE 20

In addition to this, the following statistical tools have been used to sharpen the inferences

drawn and to test the hypotheses formulated, on the basis of simple description of facts

and to analyze the data:

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1. Mean of Individual Series

It is used to get the average of items disclosed by the banking companies in the

five years of study. The means disclosure value has been calculated by applying the

following formula

Where ∑ X = Sum of all the values of the variable x and

N = Number of observations

2. Standard Deviation

It is used to study the variation in the items disclosed by banking companies in

different years of study. The following formula is used to get the values of standard

deviation of the continuous series:

Where d = Deviation taken from assumed mean

f = frequency

N = Sum of the frequency

As far as the standard deviation of the various items of disclosure is concerned it has

calculated by using MS-EXCEL software on the Computer.

∑X

N X =

S.D. = ∑fd2

N

∑fd

N

2

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3. Correlation

A measure of the strength of linear association between two variables. Correlation will

always between -1.0 and +1.0. If the correlation is positive, we have a positive

relationship. If it is negative, the relationship is negative.

The correlation matrix computes the correlation coefficients of the columns of a matrix.

That is, row i and column j of the correlation matrix is the correlation between column i

and column j of the original matrix. The diagonal elements of the correlation matrix will

be1 since they are the correlation of a column with itself. The correlation matrix is also

symmetric since the correlation of column i with column j is the same as the correlation

of column j with column i.

Correlation(r) =[ NΣXY - (ΣX)(ΣY) / Sqrt([NΣX2 - (ΣX)2][NΣY2 - (ΣY)2])]

where

N = Number of values or elements

X = First Score

Y = Second Score

ΣXY = Sum of the product of first and Second Scores

ΣX = Sum of First Scores

ΣY = Sum of Second Scores

ΣX2 = Sum of square First Scores

ΣY2 = Sum of square Second Scores

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4. Multiple regression analysis

Multiple regression is a flexible method of data analysis that may be appropriate

whenever a quantitative variable (the dependent or criterion variable) is to be examined

in relationship to any other factors (expressed as independent or predictor variables).

Many practical questions involve the relationship between a dependent or criterion

variable of interest (call it Y) and a set of k independent variables or potential predictor

variables (call them X1, X2, X3,..., Xk), where the scores on all variables are measured for

N cases.

Y A B X B X B X' = + + +1 1 2 2 3 3

5. Students t-test

This test is used to study the difference between the mean disclosure values of the public

and the private sector banking companies at 5 percent level of significance. The

following formula is used to calculate the value of (t):

n1σ12 + n2σ2

2

n1 + n2 - 2 =

Where S Σ(X1 –X1)

2 + Σ (X2 – X2)2

n1 + n2 - 2 =

Here X1 = Mean Disclosure of the first sample

X2 = Mean Disclosure of the second sample

n1 = Number of years of study of the first sample

n2 = Number of years of study of the second sample

σ12 = Square of standard deviation of the first sample

σ22 = Square of standard deviation of the second sample

Degree of Freedom (d.o.f.) = n1 + n2 -2

(X1 – X2) S t = %

n1n2 n1+n2

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6. Variance Ratio Test or F-Test

This test is used to study the difference between the variation of items of

disclosure between the public and the private sectors’ banking companies. The following

formula is used to calculate F-Test:

Where : S22> S1

2 then formula becomes

Where:S12 = Square of the standard deviation of the first sample.

S22 = Square of the standard deviationof the second

sample.

7. Tobins Q

Tobin’s Q is a very widely used measure of corporate performance.It is defined as the

ratio of market value of the firm to replacement value of the assets. Interestingly, original

definition of Q has few practical limitations such as availability of timely and accurate Q

date. It is understood that even computational procedure also is difficult to employ.In my

case, since there was no preference share and debentures, Tobin’s Q is market value of

equity over book value of total asset.

= Market value of equity/book value of total assets

S12

S22

F = S12> S2

2

Here : S12 and

Σ (X-X1 )2 n1 - 1

Σ (X2-X2 )2

N2 - 1 S2

2

F = S2

2 S1

2

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8. Return on capital employed (ROCE)

The profitability of an organization is measured through ROCE. It indicates the

effectiveness and efficiency of an organization in generating earnings. It is calculated by

dividing earnings before interest and taxes (EBIT) by capital employed.

= EBIT/capital employed

Where, capital employed = equity + reserves and surplus

3.6 Organization of the Study

The organization of the present research follows conventional chapter plan.The study is

divided into following six chapters:

1. Corporate Governance – An Introduction, Chapter one highlights introduction

of corporate governance, conceptual discussion, objectives, need, benefits and limitation

of corporate governance.

2. Review of Literature, Chapter two narrates the academic literature on

corporate governance and especially corporate governances in banking sector.

3. Research Methodology, Chapter three describes the research problems,

methodology of the research and limitation of the research.

4. Corporate Governance disclosure practices of Banking Companies in India,

Chapter four deals with the current scenario of governance of banks, the principles and

committee recommendations for the implementation of CG practices in Indian banking

sector.

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5. Entrance of Foreign Banks in India and Corporate Governance, chapter five

discusses the framework for presence of foreign banks in India, the Corporate

Governance Guidelines for Foreign Banks to Protect Domestic Interest and the current

status with regard to CG implementation by foreign banks in India.

6. Analysis and interpretation, Chapter five presents the outcome of primary and

secondary research analysis.

7. Conclusion and Suggestions, Chapter six gives concluding remarks on the

research analysis and recommendation to improve corporate governance practices in

Indian Banking sector.

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