Board characteristics, ownership structures and bank profitability: Evidence from Sri Lanka

Abstract

Despite theoretical literature stating that corporate governance mechanisms enhance the banking sector performance, empirical studies over the past decades have inconclusive evidence over the effectiveness of such mechanisms. Several studies argued that some mechanisms led to diminishing banking profitability. Hence, the scope of this study is to investigate the effectiveness of corporate governance mechanisms in driving the banking profitability. The evidence is based on 13 licensed commercial and specialized banks in Sri Lanka during the period from 2011 to 2020. It examines the relationship between profitability indicators such as return on assets (ROA) and return on equity (ROE) against seven variables related to board characteristics and ownership structures through a panel data regression model. Each regression model is initially estimated with pooled OLS method and then tested with fixed and random effects methods based on the Hausman test results. The findings suggest that board size, frequency of board meetings, representation of non-executive directors in boards, gender diversity, directors’ share ownership and economic growth are significant determinants of ROA. In contrast, board size, frequency of board meetings, bank size and economic growth are associated with ROE, summarizing that the shareholders concentrate less on ownership structures in the Sri Lankan banking sector. This broadly supports the stakeholder theory where the corporate governance mechanisms ensure enhanced returns to all stakeholders rather than the shareholders’ returns. The results also suggest that the existing corporate governance requirements for the Sri Lankan banks require careful revisits to further promote their effectiveness.