Corporate Governance and Effective Central Banking: Cross Country Empirical Evidence Iftekhar Hasan* Loretta J. Mester** * Rensselaer Polytechnic Institute and Bank of Finland ** Federal Reserve Bank of Philadelphia and University of Pennsylvania Dubrovnik, June 28, 2007 1
Motivation The legal and institutional framework governing central banks around the world has undergone significant changes in recent years n Implementation of monetary policy without political influence, including institutional changes to make monetary policy more effective and transparent (e. g. , Reserve Bank of New Zealand, 1989; Bank of England, 1997; Federal Reserve in the U. S. , 2006) 2
Motivation – cont’ There has also been discussion focusing on central bank supervising effectiveness in the context of large corporate bankruptcies with links to the financial sector These issues have increased the interest in better understanding the role of good governance in improving the effectiveness of central banks and yielding improved economic outcomes (e. g. , Lybek & Morris 2007; Frissel, Roszbach & Spagnolo 2007) 3
Motivation – cont’ Recent empirical work suggests a positive association between the quality of central bank regulation and supervision and nations’ economic growth, due to efficient access to and allocation of financial resources (e. g. , Laeven and Levine 2003; Sapienza and Zingales 2003) However, the design of the optimal contract, the possible trade-off between achieving monetary policy goals and financial stability objectives and the link between central bank independence, accountability and supervision performance have received only marginal attention. 4
The purpose of this paper Is there a significant statistical relationship between central bank governance and institutional structure and the economic outcomes that reflect the performance of central banks? Does this relationship differ across countries in different stages of economic development? 5
Our contribution Add to the growing literature on governance, organizational form, and central bank performance n n Determine whether measures of governance and organizational form are associated with better economic outcomes, while literature has focused on developing governance measures for central banks Provide cross country evidence, while literature has focused on developed countries 6
Review of literature Central bank responsibilities and corporate governance – key roles: n Central banks’ key roles: macroeconomic stability (low inflation), stable exchange rates, and the fostering of maximum sustainable growth (See, e. g. , Caprio & Dimitri 1995; Mayes 1997; Leybek 2002; Tuladhar 2005). n Most central banks are responsible for stability of the payment and settlement system (e. g. , Healy 2001). n Several banks have some responsibility for directly supervising and examining commercial banks for safety and soundness. n Many central banks deliver banking services (cash, check, credit etc. e. g. , Flannery 1996) – given the technological change in the payment services has led consolidation of check processing sites within the U. S. Fed has led the Fed to think its corporate governance. n Frisell, Roszbach & Spagnolo (2007) – in a survey of mostly European countries found most frequently cited central bank roles were monetary policy, financial stability, payment system and supervisory objectives. 7
Review of literature – cont’ Why is the governance of central banks more complex than that of other corporations? n n n The multiplicity of central bank goals and the difficulty of measuring performance across the central bank’s goals suggest that transparency may not be easily achieved (Frisell, Roszbach & Spagnolo 2007) There is also intrinsic opaqueness of the banking business that reduces the effectiveness of governance mechanisms (Adams & Mehran 2003; Caprio and Levine 2004) In addition, as a monopoly provider of public goods (a stable currency and a well-functioning payment system), a central bank is insulated from the disciplining forces of product market competition and the market for corporate control (Frisell et al. 2007) 8
Review of literature – cont’ Are there ways to organize the central bank that would lead to better incentives and economic outcomes? n n Numerous studies demonstrate a clear link between political and monetary instability (e. g. , Bagheri & Habibi 1998) Independence from the government might enhance central bank effectiveness (e. g. , Alesina & Summers 1993; Lybek 1999; Fischer 2005; Cukierman 2005) 9
Review of literature – cont’ n n n Monetary expansions driven by political factors seem to be the main cause of high inflation in transition economies (Maliszewski 2000) Severe fiscal imbalances and narrow financial markets lead inevitably to monetary deficit financing (Bagheri & Habibi 1998) Delegating monetary authority to central banks that are highly averse to inflation may reduce ‘inflationary bias’ (Maliszewski 2000) 10
Review of literature – cont’ n n Therefore, institutional devices such as central bank independence and strong governance could potentially impose financial discipline on policy makers and restrict them from short-sighted monetary expansion (Lybek 1999) Board size, tenure length and turnover of the board chair, board independence – evidence exists for corporations, but the impact on central bank performance is not clear a priori and empirically limited (e. g. , Dreher, Sturm & de Hann 2006; Cukierman, Webb and Neyapti 1992) 11
Data Central banks’ websites Information given upon request from some central banks Thomson’s Bankscope database IMF international financial statistics Morgan Stanley-Central Bank Directory (several issues) BIS publications of blue books, orange books, individual annual reports World development indicators Annual data 1996 -2000 Include countries whose central banks were established in 1993 or earlier Classify countries into 3 groups: transition, developing and developed economies 12
Sample by countries Transition Economies: Albania, Armenia, Belarus, China, Croatia, Czech Republic, Estonia, Georgia, Hungary, Kazakhstan, Latvia, Lithuania, Moldova, Mongolia, Poland, Russia, Slovakia, Slovenia, Ukraine (19) Developing Economies: Aruba, Bahamas, Bahrain, Barbados, Belize, Botswana, Brazil, Chile, Columbia, Costa Rica, Dominican Republic, Ecuador, Egypt, El Salvador, Ethopia, Fiji, Guatemala, Haiti, India, Indonesia, Jordan, Kenya, Kuwait, Lebanon, Lesotho, Macau, Malawi, Malta, Mexico, Morocco, Mozambique, Nepal, Nicaragua, Nigeria, Oman, Pakistan, Peru, Philippines, Saudi Arabia, Sierra Leone, South Africa, Sri Lanka, Taiwan, Tanzania, Trinidad and Tobago, Turkey, Uganda, United Arab Emirates, Uruguay, Zambia, Zimbabwe (51) Developed Economies: Australia, Austria, Belgium, Canada, Cyprus, Denmark, Finland, France, Germany, Greece, Hong Kong, Iceland, Ireland, Israel, Italy, Japan, Korea, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, United Kingdom, United States (27) 13
Variables Performance measures (by monetary goal): n Price stability goal INFL – annual CPI inflation rate in country i, year t (based on WDI 2005) ABSINFL – absolute value of annual CPI inflation rate (WDI) STDDEVNFL – standard deviation of annual CPI inflation rate over the previous 3 years H_MONETARY - an index measuring the success of the country’s monetary policy based on the weighted average inflation over the most recent three years and the degree to which a country imposes price controls, as determined by the Heritage Foundation as part of its Index of Economic Freedom (0 -100 scale, higher score is better performance) 14
Variables – cont’ n Real output goal RGDPGR – Real GDP growth (WDI) STDDEVRGDPGR – Standard deviation of real GDP growth over the previous 3 years (WDI) WSDINFLGDPGR - an equally weighted average of the standard deviation of annual CPI inflation over the previous 3 years and the standard deviation of annual real GDP growth over the previous 3 years (WDI) 15
Variables – cont’ n Financial stability goal PROBLOAN - problem loan ratio = dollar volume of problem loans as a percent of dollar volume of total loans (Bankscope database) VAREXRATE – standard deviation of exchange rate (IFS Statistics) 16
Variables – cont’ Central bank characteristics: n n Focus on measures related to governance structure that could potentially affect the effectiveness of the central bank in achieving its goals as reflected in our performance measures INDEPENDENT = 1 if the central bank has autonomy from the government in implementing monetary policy, and 0 otherwise (Individual Websites, E-mails, IFS, and Literature) DIRECTORS – number of directors on the central bank’s board in country i, time t (Morgan Stanley Central Bank Directory, Individual Websites and E-mails) DIRECTORS_DIRS – percentage of outside directors on the central bank’s governing board, country i time t 17
Variables – cont’ Central bank characteristics – cont’: n GOV_TURNOVER = Average rate of turnover of central bank governors since 1993, measured as number of unserved years as percentage of term of the governor divided by total number of governors since 1993 (Websites and E-mails) n GOV_TERM_INDET = 1 if the length of the governor’s term in country i in year t is undetermined and 0 otherwise (Morgan Stanley Central Bank Directory, Individual Websites and E-mails) n GOV_TERM_DET = 0 if the governor’s term is undetermined and = number of years in the governor’s term in country i time t otherwise (Morgan Stanley Central Bank Directory, Individual Websites and E-mails) n SUP_MON = 1 if the central bank has bank supervisory responsibilities as well as monetary responsibilities, and 0 otherwise 18
Variables – cont’ Central bank characteristics – cont’: n AGE – the number of years since the founding of the central bank (Morgan Stanley Central Bank Directory, Individual Central Bank Websites, and Direct Correspondence via email with the Central Banks) (NOTE: we do not use age in the regressions) 19
Results – descriptive statistics MEANS MEAN DIFFS Trans Dvlping Dvlped Trans Vs. Dvlping Trans Vs. Dvlped Dvlping Vs. Dvlped INFL 20. 01 10. 33 2. 19 9. 69** 17. 82*** 8. 14*** ABSINFL 20. 08 10. 52 2. 33 9. 56** 17. 75*** 8. 19*** STDDEVINFL 78. 42 9. 68 0. 88 68. 75** 77. 54** 8. 8* H_MONETARY 49. 49 69. 85 83. 8 − 20. 36*** − 34. 32*** − 13. 95*** RGDPGR 3. 77 3. 56 3. 59 0. 21 0. 18 − 0. 03 STDDEVRGDPGR 3. 51 2. 64 1. 27 0. 87** 2. 24*** 1. 37*** WSDINFLGDPGR 40. 97 6. 28 1. 05 34. 69** 39. 92** 5. 23** PROBLOAN 6. 58 5. 25 3. 82 1. 33** 2. 76*** 1. 43*** VAR_EXRATE 7. 10 34. 51 5. 13 − 27. 41* 1. 97 29. 38** 20
Results – descriptive statistics, cont’ MEAN DIFF Trans Dvlping Dvlped Trans Vs. Dvlping Trans Vs. Dvlped Dvlping Vs. Dvlped DIRECTORS 8. 22 7. 13 9. 48 1. 09*** − 1. 26** − 2. 35*** OUTSIDEDIRS_DIRS 14. 15 27. 17 16. 63 − 13. 02*** − 2. 48 10. 54*** FEMALEDIRS_DIRS 12. 69 8. 07 10. 02 − 4. 62*** − 2. 66 − 1. 96 GOV_TERM_INDET 0. 052 0. 096 0. 111 − 0. 05 − 0. 06 − 0. 01 GOV_TERM_DET 5. 58 3. 94 5. 07 2. 03*** 0. 51** − 1. 13*** GOV_TURNOVER 0. 292 0. 288 0. 15 0. 03 0. 14*** INDEPENDENT 0. 211 0. 077 0. 777 0. 13*** − 0. 57*** − 0. 70*** SUP_MON 0. 421 0. 31 0. 41 0. 11** 0. 01 − 0. 10** AGE 30. 63 44. 46 119. 55 − 13. 83*** − 88. 92*** − 75. 09*** 21
Difference-in-means analysis Price stability goals: transition economies exhibit the highest inflation and inflation variability levels, whereas developed countries exhibit the lowest levels. n Price stability goals were more successfully attained in developed economies Growth goals: growth levels are the highest in transition economies and the lowest in developed countries, but the differences are not significant; developed countries have significantly more stable growth. n Developed economies were more successful in achieving price and output stabilization objectives 22
Difference-in-means analysis – cont’ Financial stability goals: n n Transition economies exhibit the highest rate of problematic loans while developed countries exhibit the lowest rates, but the rates are fairly low in all regions. Exchange rates were considerably less stable in the developing countries compared with transition and developed countries 23
Difference-in-means – cont’ Central bank characteristics: n n Central banks in developed countries tend to be older, with greater supervising responsibilities, greater independence, and a larger number of directors Central banks in developing countries seem to have more outside directors Central banks in transition economies seem to have more female directors Central banks in transition and developing economies seem to have a higher governor turnover than those in developed countries 24
Relationship between central bank characteristics and performance differ across country groups F-Tests Trans = Dvlping Trans = Dvlped Dvlping = Dvlped Trans = Dvlping= Dvlped INFL 9. 01*** 4. 87*** 2. 38** 4. 90*** STDDEVINFL 7. 55*** 6. 66*** 0. 06 4. 34*** ABSINFL 8. 91*** 4. 80*** 2. 45** 4. 87*** RGDPGR 2. 84*** 3. 17*** 0. 90 1. 96** STDDEVRGDPGR 4. 73*** 4. 14*** 0. 90 2. 88*** WSDINFLGDPGR 6. 93*** 6. 18*** 0. 06 4. 08*** H_MONETARY 18. 33*** 12. 73*** 3. 50*** 10. 55*** PROBLOAN 0. 65 1. 03 1. 14 0. 99 VAR_EXRATE 1. 01 0. 02 1. 65 1. 09 25
Results – Regression analysis 26
Price stability goal performance In developed countries, a greater number of directors is associated with an increase in inflation n Consistent with a large board size hindering decision and individual accountability An undetermined (or long) governor term is associated with lower inflation n Consistent with less political dependence and government intervention that might produce better inflation results 27
Price stability goal performance –cont’ Central bank involvement in both supervision and monetary policy might lead to worse inflation outcomes in transition and developed economies. Central bank independence appears to be significantly associated with lower inflation in transition countries and higher inflation in other countries. We find no significant association with inflation volatility. n Unexpected result, contrary to the received wisdom. 28
Results – regression cont’ 29
Output goal performance The better measure may be the variability of GDP growth n Monetary policy cannot affect output level in the long run Bank independence is associated with greater growth stability n n This is opposite of what one might expect if there is a short-run tradeoff between inflation and output variability and the government favors stabilizing output rather than inflation. Our results suggest independent central banks do not act in a way that neglects output stabilization 30
Results – regression cont’ 31
Financial stability There is little significant relationship between central bank characteristics and the problem loan ratio – the adjusted R-squards are very low. For transition countries, the number of directors is positively related to exchange rate variability, while the share of outside directors is negatively related to this measure n Combined with previous findings, these results suggest that for transition countries, more directors may not be helpful to central bank performance, but more outside directors might be conducive. 32
Conclusions-1 We ask two simple questions: n (1) Is there a significant relationship between central bank governance and institutional characteristics and the economic outcomes that reflect performance of central banks? n (2) Do these relationships differ across central banks in operating countries at different stages of economic development? 33
Conclusions-2 (1) Is there a significant relationship between central bank governance and institutional characteristics and the economic outcomes that reflect performance of central banks? n We do find some significant associations, however, we find no strong definitive conclusion that central bank organizational structure has strong correlations with economic performance, either positively or negatively. (2) Do these relationships differ across central banks in operating countries at different stages of economic development? n We find significant differences in the relationship between performance and central bank governance and organizational characteristics across countries at different stages of economic development. 34
Conclusions-3 Central bank independence is not always significantly related to performance and in some cases in developing and developed countries the relationship is the opposite of what one might expect. n n Independence is not significantly related to inflation variability In developed countries, independence is significantly associated with lower output variation and with lower weighted price-and-output variation, but with a higher inflation level. In developing countries, independence is significantly associated with a higher inflation level. In transition economies, independence is significantly associated with lower output variation and a lower inflation level. 35
Conclusions-4 The size of the board and the percentage of outside directors on the board do not appear to have a strong correlation with performance across our performance measures. Central bank involvement in both supervision and monetary policy might lead to worse inflation outcomes in transition and developed economies 36
Conclusions-5 Caution in interpretation: n n Preliminary results – still collecting data Relatively short time frame in our sample So lack of strong significance could merely reflect the lack of a long enough time frame over which there was been enough variation in economic outcomes. Or could provide an explanation of Lybek and Morris’s (2004) finding that there is little consensus among central banks regarding the structure, size, and composition of their governing bodies. n Several of the associations we find are sufficiently surprising as to merit further exploration. 37
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