This paper examines the effects of corporate governance on bank performance in the context of Nepal. Return on assets (ROA) and return on equity (ROE) are dependent variables for bank performance, and board size, female board members, financial institutions, CEO duality, independent directors, firm size, firm age, earnings per share, and the capital adequacy ratio are independent variables for corporate governance.

1. 1
Corporate governance and bank performance: Empirical evidence from Nepalese financial
institution
Abstract
This paper examines the effects of corporate governance on bank performance in the context of
Nepal. Return on assets (ROA) and return on equity (ROE) are dependent variables for bank
performance, and board size, female board members, financial institutions, CEO duality,
independent directors, firm size, firm age, earnings per share, and the capital adequacy ratio are
independent variables for corporate governance. Data are collected from Banking and Financial
Statistics of Nepal Rastra Bank, NRB Directives, legal provisions incorporated in the Companies
Act of 2006, relevant bylaws regarding corporate governance, provisions in the Bank and
Financial Institution Act of 2006, and supervision reports of Nepal Rastra Bank. According to
the results, corporate governance has significant effects on the ROA and ROE of financial
institutions, indicating that various elements of corporate governance, including the presence of
independent directors and firm size, have positive effects on firm performance. However, female
board members, board size, board members, and board member compensation have negative
effects on firm performance based on ROA.
Keywords: Board Size, Board Composition, Duality, Audit Committee, Firm Size, Firm
Performance, Capital Adequacy, Return on Assets, Return on Equity, Listed Firms, Nepal
1. Introduction
Corporate governance is a system by which firms are directed and controlled. If there is no
effective corporate governance, then firms may face some difficulty. Similarly, setting a good
corporate governance policy can produce many benefits at various levels of management and
thus help firms avoid management-level corruption, thereby enhancing firm value and
shareholder value by reducing investment and financial risks. Therefore, a sound corporate
governance policy is a key criterion in investing in a firm (Shen, Shu, & Chen, 2006).
Jensen and Meckling (1976) identify a theoretical relationship between corporate governance
and firm performance by combining elements of agency theory, property cost theory, and finance

2. 2
theory for a theory of a firm’s ownership structure. They clearly define the firm, the agency cost,
and property rights, analyze the agency cost of equity and debt, and find that a decrease in the
manager’s ownership claim reduces his or her incentive to make efforts to maximize the firm’s
value, thereby increasing the agency and reducing the firm’s net value. That is, an increase in the
manager’s ownership percentage increases firm value.
Considering the Korean banking industry for the 1994-2000 period, Weon (2005) examines how
the effectiveness of managerial ownership is affected by regulatory regimes in the industry and
banks’ moral hazard incentives and finds that bank managers in the high-moral-hazard group are
more likely to have the incentive to collimate their interests to those of stockholders by taking on
a higher level of risk with an increase in managerial ownership. However, the period is relatively
short, and therefore the agency problem of a bank is characterized by changes in its holdings or
ownership structure when the bank has more moral hazard incentives and faces lax banking
regulations. In addition, the model reveals that the higher the risk taken, the worse the bank
performance.
Corporate governance can be defined as relationships between shareholders, the board of
directors, and top management in the determination of the firm’s direction and performance
(Wheelen & Hunger, 2006). It may also include relationships between many players (i.e.,
stakeholders) and goals of the firm. Principal players include shareholders, management, and the
board of directors. Other stakeholders can include employees, suppliers, customers, banks and
other lenders, regulators, the environment, and the community at large. Ruin (2001) states that
corporate governance reflects a group of people getting together as one united body with the task
and responsibility to direct, control, and rule with authority. In this regard, Thomas (2002)
describes corporate governance as the means by which the government of a firm (directors) is
made responsible to its electorates (stakeholders).
Mariana (2006) investigates the relationship between ownership concentration and performance
by accounting for effects of hostile takeover threats on this relationship in publicly traded firms
in the U.K., the Czech Republic, and Poland in 1999 by using the generalized method of
moments (GMM) and finds that this concentration is not a significant predictor of firm
performance in both developed and transition countries. Kapopoulos and Lazaretou (2007) use
data from 175 publicly traded firms in Greece to empirically identify any strong evidence of

3. 3
effects of the ownership structure on firm performance measured by profitability and find a
significant positive relationship between profitability and the ownership structure. More
specifically, they suggest that the more the shares are concentrated in outside or inside
shareholders, the more efficient the firm’s management as well as the higher the firm’s
performance.
The corporate governance structure specifies the distribution of rights and responsibilities across
various stakeholders of the firm, including boards, managers, shareholders, and others, and spells
out rules and procedures for the firm to operate on a sound basis. The concept of corporate
governance has become popular with the emergence of the agency problem when the ownership
of the firm is separated from control. Mahfuja and Imam (2007) stated that the need for corporate
governance arises from the potential conflict of interest between participants stakeholders in the
corporate structure. Such conflicts of interest often arise because different participants have
different goals and preferences. In this regard, corporate governance has been introduced to
ensure that agents of owners of a firm control that firm in ways that serve the interest of the
firm’s shareholders.
Delfino (2007) examines the effects of control changes (due to privatization, foreign acquisition
and merger and acquisitions) on efficiency and productivity in Argentina’s banking sector by
using panel data for the 1993–2000 period to construct the regression model and concluding that
state-owned banks are less efficient than private ones, bank privatization provides only short-
term efficiency gains, foreign acquisitions increase the productivity acquired banks (although it
does not affect efficiency), and mergers and acquisitions have a negative impact on bank
performance.
Heiss and Koke (2004) investigate the determinants of changes in corporate ownership and firm
failure for German firms by considering 1,510 German firms for the 1986–1995 period based on
firm performance, the capital structure, the ownership structure, and firm size and show that
many determinants of failure affect ownership changes in the bank-based economy, including
poor performance, weak corporate governance, high leverage, and a small firm size. In addition,
the ownership structure plays a role in both events. Größl and Levratto (2008) examine the
effects of private ownership on bank performance in Bulgaria and Hungary at a theoretical level
by taking into account the principles of corporate governance and find that, in both transition

4. 4
countries, private ownership plays a crucial role, particularly if it is combined with the principles
of good corporate governance, which depends on accepted social norms derived from cultural
values such as rule the of law and accountability. Focusing on Bulgaria and Hungary, which are
different in their value orientation, Grosl and Levratto (2008) conclude that Bulgaria hinders the
privatization process of banks as a result of corruption, the absence of appropriate laws, and the
maximization of owners’ interests, whereas Hungary, which is based more on the Western
system, supports the creation of private banks.
Hallward et al. (2006) examine 1,500 Chinese enterprises in five cities to investigate the
components of the investment climate and their effects on firm performance and reveal that both
the ownership and investment climate measures influence firm performance, more specifically
productivity and growth. In particular, with firm performance as a dependent variable, they find
that it is positively correlated with foreign and domestic private ownership, light regulatory
burdens, limited corruption, technological infrastructure, and labor market flexibility.
Finally, Capon, Farley, and Hoenig (1990) summarize based on a meta-analysis of 320 empirical
studies of the financial performance of industries and firms for the 1921-1987 period by counting
the occurrence of qualitative relationships and conducting an ANCOVA of regression
coefficients associated with eight frequently studied casual variables. They find that most studies
highlight significant positive relationships of firm performance to industry concentration, sales
and asset growth, capital investment intensity (of the industry), and advertising. On the other
hand, they find a negative relationship between firm performance and debt but no significant
relationship between firm performance and size (measured by assets and sales) and firm control
(owners vs. managers).
This paper investigates the relationship between corporate governance and firm performance in
context of Nepal’s banking sector. More specifically, it examines the effects of board size, the
number of female board members, the type of financial institution, CEO duality, the number of
independent directors, firm size, firm age (the year of establishment), leverage, earnings per
share and capital adequacy ratio.
The rest of this paper is organized as follows: Section 2 describes the sample, data, and
methodology. Section 3 presents the empirical results, and Section 4 concludes with a discussion
on important implications.

5. 5
2. Methodological aspects
This paper employs secondary data from 25 financial institutions (20 commercial banks and 5
development banks) in Nepal. The data are obtained from Banking and Financial Statistics of
Nepal Rastra Bank, NRB Directives, legal provisions incorporated in the Companies Act of
2006, relevant bylaws regarding corporate governance, provisions in the Bank and Financial
Institutions Act of 2006, and supervision reports of Nepal Rastra Bank, among others. The data
include return on assets (ROA), return on equity (ROE), board size, the number of female board
members, the types of financial institution, CEO duality, the number of independent directors,
firm size, firm age (the year of establishment), leverage, earnings per share, and the capital
adequacy ratio.
A pooled cross-sectional data analysis is conducted, and the research design involves causal
comparison because it addresses relationships between corporate governance and control
variables for bank performance. More specifically, the paper examines the effects of board size,
female board members, financial institutions, CEO duality, independent directors, firm size, firm
age, leverage, earnings per share, and the capital adequacy ratio on ROA and ROE as the
dependent variables. The data are collected for the period from 2008/2009 to 2012/2013. Table 1
shows a list of commercial and development banks selected for the analysis as well as the
analysis period and the number of observations.
Table 1. Commercial and development banks selected for the analysis
S. No List of Banks Year No. of observation
1 Kist Bank Limited 2008/2009-2012/2013 5
2 Mega Bank Nepal Limited 2010/2011-2012/2013 3
3 Siddhartha Bank Limited 2008/2009-2012/2013 5
4 Bank of Kathmandu Limited 2008/2009-2012/2013 5
5 Everest Bank Limited 2008/2009-2012/2013 5
6 Standard Chartered Bank Nepal Limited 2008/2009-2012/2013 5
7 Laxmi Bank Limited 2008/2009-2012/2013 5
8 Sunrise Bank Limited 2008/2009-2012/2013 5
9 Himalayan Bank Limited 2008/2009-2012/2013 5

6. 6
10 Nepal Investment Bank Limited 2008/2009-2012/2013 5
11 Grand Bank Nepal Limited 2008/2009-2012/2013 5
12 Machhapuchhre Bank Limited 2008/2009-2012/2013 5
13 Nabil Bank Limited 2008/2009-2012/2013 5
14 NMB Bank Limited 2008/2009-2012/2013 5
15 Global IME Bank Limited 2008/2009-2012/2013 5
16 Sanima Bank Limited 2008/2009-2012/2013 5
17 Kumari Bank Limited 2008/2009-2012/2013 5
18 Nepal SBI Bank Limited 2008/2009-2012/2013 5
19 Citizen Bank 2008/2009-2012/2013 5
20 Prime Commercial Bank Limited 2008/2009-2012/2013 5
21 Vibor Development Bank Limited 2010/2011-2012/2013 3
22 Ace Development Bank Limited 2010/2011-2012/2013 3
23 City Development Bank Limited 2010/2011-2012/2013 3
24 Siddhartha Development Bank Limited 2010/2011-2012/2013 3
25 Clean Energy Development Bank
Limited
2010/2011-2012/2013 3
Total # of observations 113
The model
The estimated model assumes that bank performance depends on several corporate governance
and control variables. The variables for corporate governance are board size, female board
members, financial institutions, CEO duality, independent directors, firm size, firm age,
leverage, earnings per share, and the capital adequacy ratio, and the dependent variables are
ROA and ROE:

7. 7
Bank performance = f (CG variables, control variables).
There are various measures of bank performance. Jeon and Miller (2006) measure bank
performance by bank profitability and productivity. This paper measures bank performance as
bank profitability in term of ROA and ROE:
ROE = β0+ β1BS+ β2FI+ β3FBM+ β4DUL+ β5ID+ β6FS+ β7FA+ β8LEV+ β9EPS+ β10CAR + e ,
ROA = β0+ β1BS+ β2FI+ β3FBM+ β4DUL+ β5ID+ β6FS+ β7FA+ β8LEV+ β9EPS+ β10CAR + e .
The following hypotheses are tested:
H1: Board size (BS) is negatively related to bank performance,
H2: Female board members (FBM) are negatively related to ROA and ROE,
H3: CEO duality (DUL) is positively related to bank performance,
H4: Leverage (LEV) is negatively related to bank performance,
H5: Financial institutions (FI) are negatively related to bank performance,
H6: Independent directors (ID) are positively related to ROE and ROA,
H7: Firm size (FS) and age (FA) are positively related to bank performance,
H8: Earnings per share (EPS) are negatively related to bank performance,
H9: The capital adequacy ratio (CAR) is positively related to ROA and negatively related
to ROE.

8. 8
3. Presentation and analysis of data
Descriptive statistics
Table 2 shows the descriptive statistics for effects of various independent variables on bank
performance, including the maximums, minimums, ranges, means, and standard deviations for
all variables.
Table 2. Descriptive statistics
Particular Range Minimum Maximum Mean Std. deviation
ROE 93.52 -31.63 61.89 15.51 12.73
ROA 13.11 -1.28 11.83 1.66 1.73
BS 6.00 5.00 11.00 7.80 1.25
FBM 2.00 .00 2.00 .30 0.58
DUL 1.00 .00 1.00 .85 0.35
ID 2.00 0.00 2.00 .49 0.62
FI 1.00 2.00 3.00 2.26 0.44
FS 9.81 .01 9.82 1.51 2.17
FA 33.00 2.00 35.00 12.55 8.10
LEV 76.45 .00 76.45 1.80 9.15
EPS 120.30 -11.30 109.00 21.34 24.33
CAR 18.37 10.04 28.41 13.66 3.51
As shown in Table 2, ROE ranges from -31.63% to 61.89% (average = 15.51%), and ROA
ranges from -1.28% to 11.83% (average = 1.6605%). BS ranges from 5 to 11 (average = 8), and
the maximum number of FBM ranges from 0 to 2 (average = 1). DUL ranges from 0 to 1 and 2,
and ID ranges from 0 to 2, FS ranges from 0% to 10% (average = 2%), and FA ranges from 2 to
35 years. Leverage ranges from 0% to 76%, and EPS ranges from -11.3% and 109%. The CAR
ranges from 10.04% to 28.41% (average = 13.66%).
Correlation analysis
Pearson correlation coefficients are computed (Table 3). According to the results, FI and FS are
positively related to ROE and ROA. An increase in the ratio of book values to total assets
increases bank performance. FS is positively related to FBM, ID, and FI but negatively related to
BS and DUL. An increase in the net income to total assets increases ROA and ROE, that is, bank
performance. FA is positively related to FBM, ID, FI, and FS but negatively related to BS and

9. 9
DUL. LEV is negatively related to ROE and ROA, indicating that banks do not prefer debt. A
decrease in the ratio of total debt to total equity increases bank performance. There is a positive
correlation between EPS and bank performance. That is, an increase in EPS increase ROA and
ROE, that is, bank performance.
EPS is positively related to DUL, ID, FI, FA and FA but negatively related to LEV. Finally,
CAR is negatively related to ROE. That is, an increase in CAR reduces bank performance. On
the other hand CAR is positively related to ROA, indicating that an increase in CAR increases
bank performance.
Table 3. Pearson correlation matrix
VAR ROE ROA BS FBM DUL ID FI FS FA LEV EPS CAR
ROE 1
ROA .101 1
BS -.039 -.056 1
FBM -.24** -.060 -
2.24*
1
DUL .36** .1 -.104 -
.35**
1
ID .405* .29** .179 -.042 -.047 1
FI .58** .044 -.098 -.038 -.04 .39** 1
FS .151 .040 -
.31**
.200* -
.203*
.106 .312** 1
FA .567** .094 -.149 .101 -.007 .308** .521** .291** 1
LEV -.107 -.070 -.081 -.049 .061 .131 -.100 -.018 -.160 1
EPS .654** .136 -.109 -.114 .157 .526** .517** .337** .315** -
.108
1
CAR -
.400**
.179 -.126 .132 .041 -.040 -
.356**
-.027 -.28** .084 -.2* 1

10. 10
Regression analysis
Table 4 shows the regression of corporate governance and control variables on bank
performance. As shown in the table, the results for ROE show that BS, FBM, and CAR are
negatively related to ROE. That is, an increase in BS, FBM, or CAR reduces ROE, that is, a
decrease in bank performance. DUL, ID, FI, FS, FA, LEV, and EPS are positively related to
ROE (FS, FA, LEV, and EPS are significant at 5%). In addition, an increase in the ratio of book
value to total assets increases bank performance, and an increase in the ratio of total debt to total
equity or EPS increases bank performance.
R-squared value in the table 4 measures the percentage of variation in dependent variable i.e.
ROE by the independent variables. Only 1% of the variance in the ROE is explained by BS.
Whereas 62%, 58.5%, 56.75% of the variance in ROE is explained by FBM, FI, and FA
respectively. But, only 13%, 15.1%, 1.1%, and 16% of the variance is explained by DUL, FS,
LEV, and CAR respectively. While 40.5% of the variance is explained by ID in ROE and 42.8%
of the variability is explained by EPS in ROE. While 53.9% of the variability is explained by BS,
FBM, ID, and FI in ROE. Similarly, 59.9% of the variability is explained by FA, EPS, and CAR
in ROE. But only, 7.1% of the variability is explained by the variables BS, and FBM.
Table 4. Stepwise regression coefficient between ROE and the independent variable
The results are based on pooled cross-sectional data including 113 observations from 25
financial institutions for the period from 2008/2009 to 2012/2013. The models is ROE = β0+
β1BS+ β2FI+ β3FBM+ β4DUL+ β5ID+ β6FS+ β7FA+ β8LEV+ β9EPS+ β10CAR + e.
S.N Inter-
cept
Regression coefficient R2 SEE F
BS FBM DU
L
ID FI FS FA LEV EPS CAR
1 18.55
(2.44)*
-
.389
(.40
5)
.01 12.7
8
.164
2 17.16
(12.9)
-5.43
(-
2.6)*
.62 12.3
9
7.25
3 4.32
(1.44)
13.0
6
(4.0
.13
0
11.9 16.4
2

11. 11
5)
4 11.4
(8.18)
8.2
(4.65)
.40
5
11.6
9
21.6
2
5 -22.50
(-4.40)
16.76
(7.57)
.58
5
10.3
7
57.3
5
6 14.17
(9.7)**
.885
(1.60)
*
.15
1
12.6
4
2.57
8
7 4.33
(2.35)
.891
(7.21)*
.56
7
10.5
4
52.0
72
8 15.78
(-.149)
12.88
(-
1.1)*
.01
1
12.7
2
1.27
5
9 8.20
(6.7)**
.342
(9.06)*
.42
8
9.68
1
82.1
8
10 35.30
(7.905)
-1.4
(-4.0)
.16
0
11.7
3
20.9
1
11 25.11
(3.2)**
-
1.00
(-
1.04
)
-5.92
(-
2.0)*
*
.07
1
12.3
8
4.18
12 11.33
(1.44)
-
1.16
(-
1.37
)
-3.12
(-
1.61)
11.5
8
(3.6
6)
8.798
(5.40)
.33
1
10.6
1
13.0
13 -29.16
(-
3.0)**
-
.124
(.86
4)
-2.08
(-
1.28)
4.44
(2.9)*
*
14.56
(6.9)
.53
9
8.84 24.0
14 -20.94
(-
2.6)**
.34
(.44
4)*
11.92
(4.83)
-.457
(-
.97)*
.594
(4.40)
.44
5
9.66 21.4
9
15 10.69
(2.7)**
.576
(5.55)
.259
(7.49)
-.57
(-2.4)
.59
5
8.22 52.8
6
Note:
 Dependent variable: ROE.
 Figures in parentheses are t-values.
 *and** indicate significance at the 5% and 1% levels, respectively.

12. 12
Table 5 shows the stepwise regression of corporate governance and control variables on ROA.
BS is negatively related to ROA. That is, an increase in BS reduces ROA, that is, bank
performance.
Table 5. Stepwise regression coefficient between ROA and the independent variable
The results are based on pooled cross-sectional data including 113 observations from 25
financial institutions for the period from 2008/2009 to 2012/2013. The models is ROA = β0+
β1BS+ β2FI+ β3FBM+ β4DUL+ β5ID+ β6FS+ β7FA+ β8LEV+ β9EPS+ β10CAR + e.
S.N Interce
pt
Regression coefficient R2 SE
E
F
BS FBM DUL ID FI FS FA LEV EPS CA
R
1 2.265
(2.19)*
-.077
(-
.592)
.00
3
1.7
4
.35
2 1.71
(9.22)
-.180
(-.634)
.00
4
1.7
4
.40
2
3 1.23
(2.841)
.497
(1.0)*
*
.00
1
1.7
3
1.1
2
4 1.25
(6.2)**
.820
(3.2)*
.08
8
1.6
6
10.
63
5 1.26
(1.473)
.17
3
(.46
5)
.00
2
1.7
45
.21
6
6 1.612
(8.018)
.032
(.424
)
.00
2
1.7
45
.17
9
7 1.407
(4.6)**
.020
(.990
)
.00
9
1.7
39
.98
1
8 1.685
(10.6)
-.013
(-.740)
.00
5
1.7
42
.54
8
9 1.453
(6.667)
.010
(1.43)
*
.01
8
1.7
3
2.0
64
10 4.49
(.686)
.089
(1.91
1)
.03
2
1.7
18
3.6
53
11 1.884
(1.712)
-.141
(-
1.10)
.518
(1.164
)
.884
(3.0)*
*
.11
1
1.6
6
4.5
1

13. 13
12 1.443
(4.604)
-.225
(-
.77)**
.023
(.278
)
.020
(.935
)
.01
4
1.7
5
.52
9
13 1.329
(4.384)
.881
(3.25)
-.005
(-
.23)
-.022
(-1.23)
.10
1
1.6
71
4.0
33
14 -.810
(-.552)
.017
(.131)
.025
(1.19
)
.012
(1.72
6)
.129
(2.59
)*
.08
0
1.6
98
2.3
37
15 -.138
(.705)
.871
(2.88)
.005
(.067
)
-.024
(-1.37)
.001
(.090)
.102
(2.16
9)
.14
1
1.6
49
3.4
86
Note:
 Dependent variable: ROA.
 Figures in parentheses are t-values.
 *and** indicate significance at the 5% and 1% levels, respectively.
FBM and LEV are negatively related to ROA, indicating that an increase in FBM and LEV
reduces ROA, that is, bank performance. This suggests that banks should reduce FBM and LEV
to enhance their performance. DUL, ID, FI, FS, FA, EPS, and CAR are positively related to
ROA. That is, these variables enhance bank performance. This suggests that banks should
increase DUL, ID, FI, FS, FA, EPS, and CAR to enhance their performance. DUL is significant
at 1%, whereas ID and EPS are significant at 5%.
R-squared value in the Table 5 measures the percentage of variation in the dependent variable
i.e. ROA as explained by the independent variables. Only 0.3% and 0.4%of the variance in ROE
is explained by BS and FBM respectively. Whereas only 1%, 8.8%, 0.2% of the variance in ROE
is explained by DUL, ID, and FI respectively. While 1.8% of the variance is explained by EPS in
ROE and only 0.5% of the variability is explained by LEV in ROE. While 11.1% of the
variability is explained by BS, DUL, and ID in ROE. Similarly, 14.1% of the variability is
explained by ID, FS, and LEV, EPS, and CAR in ROE. But only, 1.4% of the variability is
explained by the variables FBM, FS, and FA.
4. A summary and conclusions
This paper employs data on 25 financial institutions (20 commercial banks and 5 development
banks) in Nepal for the 2009-2013 period for commercial banks and for 2010/2011-2012/2013

14. 14
period for development banks. The paper employs descriptive analysis, correlation analysis, and
the multiple regression methods to measure bank performance based on ROA and ROE.
Noteworthy is that BS is negatively related to both ROA and ROE. That is, an increase in the
number of board members reduces bank performance. FBM is negatively related to ROA and
ROE, indicating that an increase in the numbers of the females on the board of directors reduces
bank performance. Likewise, DUL is positively related to ROA and ROE, indicating that bank
performance is better when the chairman is different from the CEO, that is, when decision
makers are different. ID is positively related to ROE and ROA, indicating that professional
directors on the board enhance bank performance. In the case of commercial banks in Nepal,
there is no CEO duality.
CAR is negatively related to ROE but positively related to ROA. That is, an increase in CAR
reduces bank performance in terms of ROE but increases it in terms of ROA. LEV is positively
related to bank performance, indicating that banks pursuing leverage are more likely to perform
better than those using their own capital. In sum, these results suggest that financial institutions
should emphasize corporate governance for better performance.
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