Corporate Governance and Performance of Microfinance Institutions (MFIs): A Comparative Study in Sri Lanka and India
This thesis investigates the impact of corporate governance practices on financial performance and outreach of microfinance institutions (MFIs) in Sri Lanka and India. Guidance and principles developed from prior research which has predominantly focussed on corporate governance relating to corporations in mature financial markets may not be efficacious. There is a need for a more specific approach to identify better governance structures for the microfinance sector which will support MFIs to attain long-term sustainability of the industry. In order to contribute to this debate, this research examines (i) the relationship between corporate governance practices, financial performance and outreach of Sri Lankan MFIs (ii) the relationship between corporate governance practices, financial performance and outreach of Indian MFIs (iii) MFIs’ corporate governance and performance differences between Sri Lanka and India and (iv) the relationship between corporate governance and performance of MFIs based on a combined sample and considering the influence of national governance quality. A study of corporate governance in the microfinance sector is timely and important as unfair practice accusations against MFIs raise questions around what is an appropriate framework for monitoring and control of MFI activities. A well-structured corporate governance practice may reduce the impact of corruption and undue bureaucracy by increasing transparency and accountability of funds utilised in microfinance activities. Even though studies of corporate governance and firm performance in mature markets are largely and rapidly evolving, their impact on MFI performance is little researched and reported. It is argued that MFIs which maintain good corporate governance practices will be financially and socially sustainable. This thesis makes a number of contributions to the existing knowledge of corporate governance and MFI performance in several ways. First, it provides evidence from Sri Lanka and India of what aspects of corporate governance need to be strengthened and how much impact each individual component has on MFI financial performance and outreach. Second, the study identifies the importance of considering differences in institutional values, culture, and the environment of each country and points to the risk of applying normative assertions of corporate governance practices in the microfinance sector. Third, this study, through careful diagnostic testing, uses microeconometric techniques to control endogeneity which may have negated some findings reported in the literature. In particular, unobserved heterogeneity, simultaneity and dynamic endogeneity inherent in the corporate governance–performance relationship studies are eliminated. Finally, in contrast to extant studies in the microfinance sector, this is the first direct study to accommodate corporate governance, financial performance and outreach of MFIs in both Sri Lanka and India. The impact of cross-country differences in government effectiveness, regulatory quality and rule of law on MFI performance is also considered. Data needed to test various hypotheses are sourced from the Microfinance Information Exchange (MIX) database, Lanka Microfinance Practitioners' Association (LMFPA) in Sri Lanka and Sa-Dhan, the microfinance network in India. Furthermore, firm-level corporate governance data are collected from the individual institutions by going through their annual reports, individual firm websites and through personally contacting the individual firms. The sample period for the Sri Lankan and Indian MFIs is 2007 to 2012. Fixed-effect, random-effect and system generalised method of moment (GMM) estimator approaches are used to answer the research questions. In Sri Lanka, female CEO, female chair, larger boards, client representatives on board and internal audit function improve the financial performance of MFIs. When there are more female directors and more international/donor representatives on a board, financial performance declines. The outreach of Sri Lankan MFIs improves when there are more international/donor representatives and fewer client representatives on boards. In the Indian context, the results indicate that international/donor representatives, client representatives and outside directors on board, and an internal audit function statistically significantly positively correlate with financial performance of MFIs. For female chair and number of female directors on the board there is a negative correlation. However, in India, better outreach can be achieved when there is a female chair and when there are more female directors and more international/donor agencies representatives on the board. Female CEOs and larger boards appear to have negative effect on MFI outreach. The findings from Sri Lankan MFIs support the prediction of agency theory regarding the effective monitoring impact the performance of MFIs. But it is contrary to the number of board members as larger boards positively associate with MFI financial performance. This is consistent with resource dependency theory as larger boards provide a wide range of expertise and resources for the institution. In a voluntary organisation costs are reduced when board members are involved in a range of activities or functions that might otherwise have been covered by paid staff. This is also a way of aligning board members with senior management. The issue that arises is the extent to which this goal congruence is tilted toward management aspirations and produces a shadow agency cost. Even though agency theory emphasises the negative impact of duality, from the findings of this study it is difficult to make inferences about the separation of CEO and chair is better for MFI financial performance as well as there is no impact for MFI outreach. Findings of Indian analysis are also consistent with the perspectives of agency theory to a large extent, as diversified boards improve MFI financial performance. Similar to Sri Lanka, CEO/chair duality has no effect on MFI financial performance or outreach, which is not consistent with the predictions of agency theory. Importantly, the results of this study suggest that the impact of corporate governance on MFI performance persists in both countries even after the dynamic nature of the corporate governance and performance relationship is taken into consideration. Financial performance of both countries is improved with larger boards with more client representation. For both countries, more female representatives and outside directors on the board and internal audit function negatively affect MFI financial performance. Outreach in both countries is enhanced with more international/donor representative and fewer outside directors. Notably, the findings of this study indicate that the relationship between current MFI performance and past (one-year lagged) performance is statistically significantly positive for financial performance and outreach variables in both countries, suggesting that the corporate governance – performance relationship of MFIs should be examined in a dynamic framework. This highlights the importance of considering the past performance as an independent variable for current corporate governance and performance studies in the microfinance sector. Furthermore, this study shows the quality of national governance has a statistically significantly positive effect on financial performance and outreach of MFIs in both countries. This research demonstrates that corporate governance practices in for-profit companies have some synergies with the microfinance industry. The results reported in this study reflect a deeper commitment to robustness and micro econometric issues than previous studies and this robustness provides a platform for industry and political policy developments that can significantly enhance the quality of life for the poorest and low income people in Sri Lanka and India. The opportunities for microfinance to make a significant difference to the poorest of the poor in low income countries and emerging economies are not waning. Further research in other countries is required to establish if this is a generalisable trend or unique to Sri Lanka and India. Finally, this research recommends that it is possible to improve corporate governance practices of MFIs in Sri Lanka and India by promulgating a regulatory and supervisory system. The sector needs a strong regulatory framework to strengthen its governance and institutional structures, and to enhance opportunities for the sustainability and development of the microfinance industry.
Corporate Governance, Microfinance Institutions, Financial Performance, Outreach, Sri Lanka, India
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