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The Performance Of Uk Banking Institutions

Literature Review:

Corporate governance covers various different but related economic issues or variables in its definition. According to Shleifer and Vishny(1997) in The Journal of Finance, "Corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment." The variables are guide line or code how a company is directed, controlled which are processes, customs, policies, laws. According to Mathiesen (2002) corporate governance often investigate and has interest in helping efficient management as a result shareholders interest served like company’s financial matters, rate of return. Corporate governance offers efficient institutional and policy framework, various incentives, privatization, contracts, market exit, legislation, insolvency. Those are known as incentive mechanisms and strategy. Corporate governance is about transparency, fairness and accountably of a institute. "Corporate Governance looks at the institutional and policy framework for corporations - from their very beginnings, in entrepreneurship, through their governance structures, company law, privatization, to market exit and insolvency. The integrity of corporations, financial institutions and markets is particularly central to the health of our economies and their stability." (www.oecd.org)

Corporate governance major function is to enhance the operating performances of the firm and also in the fraud prevention (Yeh, Lee, and Ko, 2002). Black, Jang, and Kan (2002) identify that the better the corporate governance of a firm the better they perform in the market then the companies which have poor corporate governance structure. This result is also supported by the Jensen and Meckling, (1976) and Fama and Jensen, (1983). Corporate governance mechanisms give commanding position to the owners to manage corporate insiders and managers.

The Corporate Governance is a wide and important subject that covers a range of issues from accountability and transparency and the relationship between the board of directors, management and shareholders to help in determining the path and performance of the corporation (Hunger & Wheelen, 2007, p. 18). In brief, corporate governance is the system of controls to ensure that investors can assure themselves that they will get their investment back.

Depending on laws, policies and other standard it might vary, but generally Board of Director describes as bellow:

They make the business strategy.

They recruit and sack top management if required.

They monitor management.

They work for shareholder’s interest

They workout with companies resources

According to Fama and Jensen (1983) the corporate boards of directors are playing the major role in the corporate governance systems. According to Mizruchi (1983, P, 433) The companies ultimate control is lies to the board of directors. Walsh and Seward (1990) divide the control mechanism in two ways both internal and external. The internal control is based on the board governance, ownership of equity, compensation etc. And the external control groups are the institutional investors, legal protections and also the individual investors who actively participate in the capital markets.

The variables selected for internal control mechanism are CEO as board chairman, Outsider ratio in the board, Board size, and number of board meetings held. Ownership pattern is also considered as a governance factors towards the performance of the firm. According to Berla and Means (1932) they identify a relationship between the firms performances and ownership. The find out from their study that firms performances is increased as the management being separated from the ownership of the firm. Jensen and Meckling (1976) introduced the agent conflict that explained issues between the ownership and management of the firm. Fama and Jensen (1983) find out that the agency problem can be resolved by systematic dispersion.

Corporate governance now familiar word to many people because of recent credit crunch and economical changes. But corporate governance came into topic in mid 80’s. American companies find themselves in globalisation. Chief executives became more powerful and reckless in making decision, board directors became administrative puppet. Critics call for larger independence for board members so that they can monitor high management and served shareholders interest.

Corporate governance first face criticism by the bankruptcy of ENRON in 2001. Famous magazine FORTUNE labelled ENRON USA’s most Innovative Company of the year, six years in a row since 1996. Corporate body had been blamed for taking high risk, not taking into consider of inappropriate conflict of interest, big compensation, and unpublished off-the-books activity.

Depending on dominance on board this paper found mainly three different kind of corporate governance model around the world. They all have their distinguish styles, for example Management control U.S. policy, UK policy differentiate governance and draw a line with management and separate them. This paper did not found any thing that separate governance from management in European model.

UK Corporate Governance Policy or Model

U.S. Corporate Governance Policy or Model

European Corporate Governance Policy or Model

UK Corporate Governance Policy or Model

UK Corporate Governance model is well renowned and known as complete code of best practice. UK Corporate Governance also known as Combined Code. Many have argued that practice of Corporate Governance policy first started in UK. Specially during the time of Thatcher’s government it developed a lot and had a standard frame of Corporate Governance. Since then these codes of best practice are still developing. UK Corporate Governance model sets the clear relationship between board, management and stakeholders, so that they should act in the interest of company. Main aim of these codes is to save shareholders interest and therefore these codes are not mandatory and guideline only. Board and management have full right to not obligate these codes in the interest of stakeholders. These codes are guide line how a company should lead. The general purpose of corporate governance is accountability and transparency. Corporate Governance emphasizes to protect the assets of the company and save the shareholder’s interest.

The presence of Corporate Governance ensures company must present its accurate assessment, credible decision making policies. And shareholders also expected to comply with considerable judgment on the report. Companies are very consistent publishing this report due to strict codes of best practice. Chief executive and Chairman are separate post in corporate governance, however codes of best practice also allow same person in the both posts. In this special situation corporate governance create an independence board with recognise and senior members. This board should have independent non-executive members. Board set the goals, objectives and monitor the management. And management execute the goals. Board select and sack the executives and proposed the company’s objectives. Hence boards are the centre of corporate governance framework.

UK Corporate Governance model clearly separate the board and the management. Boards are responsible for strategic and long term planning and management execute the boards’ decisions. They are less concern of the company’s long term strategy and emphasize on short term plantings.

U.S. Corporate Governance Policy or Model

U.S. Corporate Governance policy builds on market demands. Management dominate on board in U.S. corporate governance framework. For listed American companies, fundamental governess regulated by The Sarbanes-Oxley Act of 2002(SOX). SOX introduced after the Enron scandal. Management have to publish credible financial report of the company. External Audit Company and management are bound to certify institution’s internal control.

Enron scandal was an alarm for U.S. governance. It was not a matter of one company but the whole system. Governance had been blamed for taking high risk, not taking into consider of inappropriate conflict of interest, big compensation, and unpublished off-the-books activity. Interest conflict mainly blamed for the Enron problem. Agency rating, external accounting, Legal office, investment bank should had been work neutrally while they work with the market flow. They all work for the interest for Enron because that’s how they get benefited. As a result end of 90’s Enron was about to burst and they apply for bankruptcy in 2001. The U.S governance system punishes the external entities severely in the interest of the market. U.S. governance is very efficient for punishing for misconduct.

European Corporate Governance Policy or Model

European Corporate Governance model, many ways opposite to American Corporate Governance. Shareholders with large stake have an important role in European Governance. They participate in the strategy or long term planning. Meanwhile shareholders with smaller stake are spectator who cannot take part in the decision making processes. But the problem arises for clashes between shareholders and management, mainly because internal news held by management. This news asymmetry can cause market failure.

European corporate model is less efficient in term of punishing for any misconduct which demoralised the market. Punishing or taking action against misconducting institutions boost the market confidence. In some cases in Europe, market abusers roam freely where governance or any other controlling body were failed to take proper action. Similar thing happened in Portugal where governance do not take proper action against the companies conducting misconduct, market had negative impact that reflected the in the market confidence.

This paper also found German Corporate Policy or Model

German Corporate Policy or Model

German Corporate Governance separated from European governance policy for its Supervisory Board and Management. Unlike UK governance German management set up the strategy and objectives for the company. Management look after the profitability, accountancy of the company. Management has a Chairman who organise the management like CEO in other country. Supervisory Board are to appoint, supervise and monitor the management. They also advise the management. Supervisory Board are elected in the company’s general meeting by the shareholders. A chairman organise the board of supervisors. It is compulsory, at least one member of the management are present in the supervisory board.

Corporate governance is varied in almost every country depending on a number of factors such as the economic development of the country, the strength of the legal system, the stability of the government but despite this the U.K is decidedly different from that of its neighbouring regions in the E.U. An examination of the history and development of corporate governance and legislation in the U.K may provide some answers to the considerable differences that have occurred in contrast to many other European countries and worldwide.

The U.K corporate governance practices have evolved from an agency perspective and the principal agent theory with a strong bias towards shareholder protection and shareholder rights. The protection of shareholders, in particular minority shareholders is covered by Company Law and is a major reason for the wide shareholder base characteristic of U.K listed companies.

Bank Governance

In case of banking governance the boards of governance are considered as an ultimate governing body for all the affairs. Their main task is to control the flow of operations and monitor them on behalf of the equity holders. According to (Hsiang-Tsai Chiang, 2005) the top executives of the bank are considered as the board of directors and they are responsible for the company’s operations and management supervisions. Basically the banks boards of directors perform a variety of functions such as monitoring and controlling management, approving dividend decisions, deciding business policies, and facilitating development and implementations of corporate strategy. Boards of the banks play an important role in the corporate governance of the firm and they are responsible for the strategic agenda of the company.

Companies act 1956, have made a rule about the amount of employee that needed to be in the board of members. They made the rule that there should have at least three members in case of public limited company and two in case of private. Jensen (1993) from his research find that to work effectively a board should have at least seven members to function and actively part in the decision making process. From the study he also find that the smaller group doesn’t perform better than the large board.(Lange et.al, 2000) on his research says that smaller group seems to have easily come up with a similar ideas rather than the large member of board of member because of their members pools of expertise.

Based on the structure of the company the board of directors seems vary but its really It is hard to arrive optimum number directors for the board. Hsiang-Tsai chiang, (2005) study shows that the firm performances and boards structure have insignificant relationship.

According to Ingrid Bonn (2004) size of the board don’t have any impact on the firm performances. He argued in his study that structure of the board helps in the company performances rather the ration composition of outside directors.Lang.et.al (1999) found from his research that the company operations are easily understand by the inside directors because they know the in and out of the operations rather than the outsiders because they made their decision based on the data or figure, Even though, outsiders helps to creates an control for the internal and that creates a better position to exert control over management.

According to Fama (1980) research he identified that the managing and controlling of the organizations are in better condition in case of independent directors. Some of the previous result shows a contradictory result where it shows that the external pressure have a direct influences on the directors decision making process and overall performance of the organizations. Pearce and Zahra (1982) suggested that the outside members have a influential factors towards the firms performances because of their association with the internal committees. According to the research of Mahajan and Sharma (1985) identified that independent proportion of directors are more effective than the external members.

One of the most common phenomena in banking sectors that the chief executive officer act as a chairman in the board of directors. In many of the research its being a constricting opinion, it being argue that the because of the level of independent among the directors and chairman the effectiveness of the board decision making fall drastically. Where else the chief executive officer plays the ultimate role for the decision making and strategy formulations. Hsiang-Tsai (2005) research found that if the CEO act as a chairman of the overall board the performance became negative because of their attitude of decision making. He also identified that it plays a negative impact towards the performances of the organizations. Fama and Jensen (1996) also came up with similar sorts of conclusion in their research.

Anderson and Anthony (1986) research find a positive effectiveness between the CEO and board of directors. They argued that because of the participation it will reduce the overall level of conflict of the board and helps to effective functions. In case of the corporate governance the board meeting is very important aspect for the performances and there should have number of meeting throughout the whole years.

Because of the long term strategic approaches of the government banks and controlling mechanism is being different from other organizations. Most of the cases the manager are the independent body to control the operations and its shows a positive results towards the firms profitability. But this kind of corporate governance shows an ambiguous result in case of market returns.

Narendar et al (2005) in his research identified that the international banks have shown a better performances then the domestic’s banks. According to Allen et al (2005) research he identified that the government banks performances is long term, but have a drastic improve in performances during the privatizations. La Porta et al (1998) find a positive effect in the controlling and flow of cash in the banking operations.

Corporate governance have came to an dramatically development in the financial system in the UK because of the major scandal of the many financial institutions like Maxwell's Communication Corporation and Bank of Credit and Commerce International (BCCI) where the public corporate structure actually collapsed. The company CEO Robert Maxwell actually aiding the down warding financial condition from the pension funds rather than thinking about the share holder and bypass the auditors. That creates cash problems in the organizations and the major reasons for such problems are considered the uncurbed power of the CEO. This creates problems for the whole financial system of the country and thus they formulate a committee to control the overall corporate governance of the financial institutions named the Committee on the Financial Aspects of Corporate Governance.

Corporate governance have came to an dramatically development in the financial system in the UK because of the major scandal of the many financial institutions like Maxwell's Communication Corporation and Bank of Credit and Commerce International (BCCI) where the public corporate structure actually collapsed. The company CEO Robert Maxwell actually aiding the down warding financial condition from the pension funds rather than thinking about the share holder and bypass the auditors. That creates cash problems in the organizations and the major reasons for such problems are considered the uncurbed power of the CEO. This creates problems for the whole financial system of the country and thus they formulate a committee to control the overall corporate governance of the financial institutions named the Committee on the Financial Aspects of Corporate Governance.

Corporate governance development is mostly depends on the shareholders of the company. According to the principles of Hermas (2002) the shareholder right have a vital role in case of playing the development of the governance systems for the organizations. They also discussed that the company should always concern about the return of the shareholder and there long term growth towards the increase the price of the share. They also mention that all the decision of the firm should be done ethically and efficiently towards the benefit of the shareholder or the stakeholders.

Corporate governance major function is to enhance the operating performances of the firm and also in the fraud prevention (Yeh, Lee, and Ko, 2002). Black, Jang, and Kan (2002) identify that the better the corporate governance of a firm the better they perform in the market then the companies which have poor corporate governance structure. This result is also supported by the Jensen and Meckling, (1976) and Fama and Jensen, (1983). Corporate governance mechanisms give commanding position to the owners to manage corporate insiders and managers.

Agency Problem

Stakeholders in a corporate body are usually shareholders, creditors, management or broker. They all have their own interest in the company and they try hard to achieve their interest. Sometime a conflict arises between management, creditor and shareholders because of their own different interest. This is known as agency conflict. Boards appoint management to run the company and secure the shareholders interest. But management sometime pay more attention to secure their own interest to fill their pocket rather than shareholders interest. Creditors have right to secure their money and they always impose some condition on companies. Creditor has more interest securing companies assets, rather than shareholders interest. Even though management want to act on behave of shareholders, creditors’ condition sometime make them helpless to make some decision. According to Baker and Hall (2004) performance based compensation effective rather than salary for the management to reduce the agency conflict. Jensen and Murphy (1998) suggest stock option for compensation for management rather than cash.

Board’s members in a public limited company and shareholder may also have agency conflict. According to Hall and Liebman (1998), Board members and shareholders may have conflict on investment decision. Board members are independent and well known individuals but investing company’s assets may not be rewarded by direct cash or stock option but they may be rewarded by third party.

Banks performance measurement Indicators

To measure the performances of the financial institutions based on the corporate governance structure are based on two types of indicators, which are the ROCE and Tobin’s Q approach. ROCE is the return of capital employment which actually measure the profitability of the firm based on the capital used in certain period. On the other hand Tobin’s Q measures the book value of loan, market value of the company equity and also the preference shareholder books value with consideration of the total assets of the firm. These measurements for the performances are widely accepted in the financial literature to measure the performances.

Research Methodology

Research Methodology is a systematic way of screening to find out desire fact. Research methodology is a logical and scientific way to find out theories or other findings. Research Methodology has an important role in this dissertation to find out the fact in UK Banking Corporate Governance and sample bank in Royal Bank of Scotland (RBS). Research Methodology conducted by collecting, screening and by analysing data. These data are usually two different kinds

Primary dada

Secondary data

Depending on primary data and secondary data research conducted in two different way and they are known as

Quantitative method

Qualitative method

Selecting Sample

Population represents an area of samples or sets of sample from where the sample is taken. In Research Methodology population do not consider only people it can be an object or abstract. In this paper the population is UK Banking System (Corporate Governance). And Royal Bank of Scotland is sample. Sampling is important because some time it is practically not possible to analyse the whole population, or budget don’t allow to survey on population, or time is short, or data for population is possible but result need quickly. One sample may not represent the population 100 percent accurately but we can have an average picture of the population. According to Henry (1990), sampling has greater chance to get accurate result than population. This is because analysing population required huge amount of data.

Sourse: www.onlinecourses.science.psu.edu

Source: Research Methods for Business Students, Saunders (2009), 5th Edition (Scanned)

Sampling Techniques

Depending of characters, sampling are divides into two categories

Representative or Probability Sampling

Judge mental or Non-probability Sampling

Probability Sampling

Probability sampling use random sampling, where sample represent the population. Strategy base analysis like question air, prefer probability sampling (Henry, 1990). Henry also suggests that if the population size is less than 50, probability technique is not preferable. The process should be under supervising so the random sample representing the population.

Probability process can be broken down in to four parts (Saunders et al, 1990)

Select a suitable sampling frame and the implications for generalizability

Decline on a suitable sample size

Select the most appropriate sampling technique and select the sample

Ensure that the sample is representative of the population

Select a suitable sampling frame and the implications for generalizability

The complete list of all the samples of the population is sample frame. For UK Banking system, the sampling frame for UK Banking system therefore will be created from all existent databases. However Edwards et al (2007) conducted a research on UK multinational companies and point out some misleading information using by existing database. They found out companies are not very much concern about daily basic update of the database, database were often incomplete if it is an individual, for company’s own interest database did hold the inaccurate information. Therefore Saunders et al (2009) suggest to careful about creating a sample frame from databases which should up to date, complete and reliable.

Decline on a suitable sample size

According to Saunders et al (2009) larger size of sample have less risk of accuracy problem. They also find out there are few other factors that matters to research. Time and money spend on sampling, acceptance level of incorrect data, and size of population compromise probability sampling. Normally distribute data is very important for information analyse. Statistician argued that normally distribute data gave accurate and robust result and they also suggest population size of 30 samples or more are very close to standard distribution (normally distribution).

The chart below published by Statistician which represents population and margin of error

Margin of error

Population

5%

3%

2%

1%

50

43

47

48

49

100

78

90

95

98

150

107

131

140

147

200

131

167

184

196

250

150

202

225

243

300

167

233

266

290

400

195

290

342

283

500

216

339

413

474

750

253

439

570

695

1000

277

515

705

905

2000

321

695

1090

1654

5000

356

878

1621

3287

10000

369

965

1935

4898

100000

382

1055

2344

8761

1000000

383

1065

2394

9512

10000000

383

1066

2399

9594

Source: Research Methods for Business Students, Saunders (2009), 5th Edition (p. 219)

Acknowledging the above table Stutely (2003) suggested if the population size is less than 30 than the research should collect all the data from all samples for desire analysis.

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