The present literature review aims to address the academic knowledge gap within the framework of this paper and determine which areas require further analysis. It is claimed that stock price constitutes many factors, including corporate governance and risk management variables. Thus, there is a need to identify literary sources that establish the link and nature of the relationships between them.
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Corporate Governance Variables
Board of Directors Size and Stock Price
The number of members in the board of directors appear to correlate with the stock price in a variety of ways. Chambers, Harvey, Mannion, Bond, and Marshall (2013) argue that the size of the board influences a range of company performance measurements, including stock performance. They also note that no unified theory could be applied in order to measure each characteristic and variable simultaneously as they are rather diverse.
Earlier research suggests that board size has little or no effect on stock performance. Regarding stock price relationships, Bennedsen, Kongsted, and Nielsen (2008) testify to the opposite but note that the positive effect of board size on shares subsides as the number of members exceeds 19. They connect such a tendency with the coordination, communication, and decision-making difficulties that arise as the board grows in size. Variance regression analysis performed by Page and Abdullah (2009) demonstrated little to no significant consistency between board size and share performance.
However, the study conducted by Sayumwe and Amroune (2017) contradicts such findings. They suggest that a large size of the board actually contributes to creating viable long-term strategies to increase the share price and create value for shareholders. They further argue that the size of the board should match the size of the company in order to produce a positive effect (Sayumwe & Amroune, 2017).
The data from the Ghana stock exchange analyzed by Isshaq, Bokpin, and Onumah (2009) suggest that there is a significant positive correlation between share prices and board size. The authors used multiple regression analysis to companies listed on the Ghana stock exchange. Mak, Tan, Tan, and Tee (2003) argue that during an IPO it is more beneficial for the prices of shares to have a small board. Interestingly, family ventures tend to be more dependent on the size as their coordinated decision-making becomes the crucial aspect of their survival on the market and, therefore, the price of their shares.
McReynald (2013) provides evidence from the Philippines that identifies the negative effect of larger board size on stock performance. He suggests that due to the peculiarities of Asian corporate governance, the results require confirmation by an international study, which substantiates the need for current research. In accordance with research performed by Walker (2013), the stock price performance is influenced by multiple corporate governance variables, including board size. He argues that the effects of this governance are visible in the short term, yet significant changes in any parameter would invariably be reflected on share performance.
Balasubramanian, Black, and Khanna (2011) report that if viewed collectively within a corporate governance index, board size along with other markers is associated with share prices in a statistically significant manner. Larmou and Vafeas (2009) indicate that larger boards are associated with better stock performance. They also point out that research concerning board size is not consistent and variation between the results of different studies is great due to a variety of measurement tools and settings employed.
One of the most recent studies conducted by Mezhoud, Sghaier, and Boubaker (2017) who employed regression analysis demonstrated no statistically significant relationships between board size and stock performance. Thus due to the conflicting nature of the findings both older and recent, there is a reason to believe that further research is required with larger samples and reliable methodology. Preliminary results demonstrate that the corporation size and the market environment are vital attributes of a share price that require consideration.
Board of Directors Composition and Stock Price
The research evidence is conflicting when it comes to the composition of the board and its relation to stock performance. Rosenstein and Wyatt (1990) identify a moderate increase in share prices with outside directors. However, in the subsequent study, they note that inside managers with significant stock ownership, once appointed, positively influence share stock prices (Rosenstein & Wyatt, 1997).
Carter, Simkins, and Simpson (2003) suggest that a mixed board represented by both inside and outside directors produce the most effect on the stock price. Dahya and McConnell (2007) argue that there is a significant positive correlation between stock prices and the board of directors’ composition. Extensive employment of outside directors in times of vulnerability often leads to changes in stock prices, yet the effect is sometimes obscured by if observed in the cross-section. As a result of the study that included more than 400 large U.S. corporations, Dobbin and Jung (2011) propose that gender composition does not significantly affect stock prices. In addition, the appointment or dismissal of a woman does not devalue stock or have any other negative consequences.
As to the number of indent members, the data provided by various researchers are often contradictory. Thus, the study conducted on 30 Pakistani listed companies indicates that share price is positively affected by the higher number of independent board number, yet the percentage is varied across countries (Yasser, Entebang, & Mansor, 2011). According to Malik (2012), within a corporate governance index, board independence correlates positively with the stock price when the number of independent directors is between 5 and 16.
However, the board must consist of independent members by more than 75%. The study by Rashid (2018) reveals that no statistically significant link can be established between board independence and share performance. Such findings, the academic explains by the absence of universal decision that would be acceptable to all companies.
Black and Kim (2007) identify that if the board is composed of at least 50% independent directors, the performance of shares increases, as evidenced by companies listed on Korean stock markets. The qualitative study performed by Yermack (2006) reports that investors prefer to allocate funds with companies the boards of which are represented by a larger number of independent directors. Independent directors within the board’s composition, as he argues, provide more confidence to the small shareholders and represent their interests more effectively, which, in turn, affects share performance.
This argument is supported by data provided by Bhana (2016). She adds that the share prices on stock markets in Johannesburg react to the board composition significantly and regularly. Securities were observed to be reacting significantly to retirement and appointment announcements (Bhana, 2016).
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On the other hand, there are also reports of stable performance in firms where boards are represented mostly by family members. Thus, Spizzirri and Fullbrook (2013) reveal that in Canadian stock exchange, shares of family-controlled boards demonstrate better long-term performance in juxtaposition to non-family ones. They find that such board composition appears to be more effective in perspective due to the durable commitment, proneness to change, and ability to sustain growth.
Swan (2016) also believes that an independent board is likely to undermine share performance stability. He relies upon the standard deviation analysis of the share prices falling after the introduction of the new corporate regulations in Australia, requiring companies to increase the percentage of independent board members. Singhchawla, Evans, and Evans (2011) reveal that hiring independent board directors is tied with poor share performance. The study conducted among 25 largest European banks also suggests that share performance is only to a certain extent, depends on the independence of the boards (Ladipo & Nestor, 2009). Thus, it could be concluded that conflicting evidence is produced and international practice varies greatly. However, multiple researchers argue that board size needs to vary in accordance with the size of an organization and be optimal for decision-making in order to be positively related to stock price.
The Frequency of Meeting and Stock Price
No unity of opinions is observed in regard to the frequency of board meetings and their relationships with share performance. Earlier studies based on the data of 307 companies suggest that the number of meetings negatively influences stock performance (Vafeas, 1999). However, he notes that in firms who suffered from adverse management, frequent meetings could mean corrective action, and, in these cases, the stock price often rises. Bistrova and Lace (2011) report that meeting frequency increases the share performance. The optimal number of meetings, according to their data, constitutes 6 to 8 annual meetings. Yet, too few or too many meetings could be detrimental to the company’s market value (Bistrova & Lace (2011).
Hahn and Lasfer (2007) suggest that fewer meetings result in falling stock prices as internal governance is an important mechanism that helps the firm to perform effectively. Additionally, they point out that the member diversity and meeting infrequency might become problematic for the company governance, which in turn could negatively affect the share price. Charitou, Louca, and Vafeas (2007) identified new evidence that suggests that the frequency of meetings is a predictor to de-listing and, consequently, a rapid decline in share performance.
Frederic W. Cook & Co., Inc. (2010) report that on average, firms listed on NYSE meet more frequently than those in NASDAQ and the share prices in the companies appear to better-performing in the former judging from the market capitalization. Kakanda, Salim, and Chandren (2016) also support the opinion that stock performance is negatively affected by frequent meetings. Yet, they note that the political and economic landscape may change, which can reverse the correlation.
The frequency of board meeting appears to be one of the least developed performance-related variables. The amount of evidence and quality research in this sphere is not sufficient and requires an update. As evident from what has been uncovered so far, it could be hypothesized that overly frequent meetings negatively affect share performance. Many researchers tend to rely more on ROA rather than on stock price or performance. Therefore, there is a need for academics to focus their research initiatives in this area. Preliminary literature review results suggest that an optimal number of annual meetings depend on the market situation and company share performance. Thus, if a situation is favourable and shares are stable, fewer meetings might be required.
Risk Management Variables
Bank Credit Risk and Stock Price
Lin, Lou, and Zhan (2014) suggest that credit risks and company stock price are tightly related, which is why it is necessary to use various models to predict possible fluctuations. Farruggio, Michalak, and Uhde (2011) state that high stock performance is associated with actions that decrease the credit risk such as securitization. On the other hand, securitization of the risks by a bank may also trigger a decrease in share performance.
If the bank-issuer retains first-loss position and shareholders could anticipate that, the price of shares may drop (Riddiough, 1997). Östlund and Hyleen (2009) indicate that share price and credit risk are connected through the capital asset pricing model, which lets one calculate a rate of return and simplify decision making in regard to the portfolio. Should a return be calculated as low, the price of a share is likely to decrease and invoke credit risk on the issuers.
The stock price is the primary variable in many models that are used in the insurance and banking sectors. According to Powell and Allan (2009), share price helps determine the credit risk and predict major crises, which is why they use Conditional Value at Risk model that identifies industries in danger of financial perturbations. Perera and Morawakage (2016) also note that shareholders are always motivated to have their share price increased, and the credit risk to be minimal. According to WorldWide Asset Management (2016), shares and their price reflect future opportunities of a company.
Depending on how much shares yield profit depends on the interest to them from investors. If any negative news about the organization surface, the price of shares might decrease because the credit risk will increase (WorldWide Asset Management, 2016).
Hancock and Kwast (2001) report that banks similar to other financial institutions, employ instruments to continually assess and monitor credit risks. The share price is one of the most crucial indicators of market stability that is used in many assessment tools. Usage of this indicator as a variable in a particular index provides banks, regulators, and investors to monitor and grade risks with better success (Hancock & Kwast, 2001).
Kuwait Financial House and Subsidiaries (KSCP) as one of the major financial institutions in the country recognizes its role in managing credit risks. In its annual report, it states that risks are raised by the firms and within them as well as other bank customers who may become unable to pay. This, as KSCP (2016) argues, may happen as a result of financial trends that may as well decrease share prices.
Wu and Michailidis (2014) in their work, discuss the power of news and announcements of large financial events that can provoke a substantial share performance response. Such events, as they argue, may be the announcements of credit rating, which is the creditworthiness of shares or assets of a company or a government. Wu and Michailidis (2014) argue that credit rating agencies who assign these ratings can significantly influence share prices on the market.
By assessing and publishing their assessments, the project and, to a certain extent, control credit risks and share prices. These findings suggest a strong relationship between stock performance and credit risks. All in all, there appears no evidence of bank credit risk not to be associated and be mutually dependent with share prices. The identified evidence suggests that volatility of the share price may significantly affect credit risks and the vice versa.
Bank Capital Risk and Stock Price
Capital risk or capital adequacy ratio (CAR) seems to negatively affect stock performance in large banks worldwide, while smaller banks seem to be positively affected by this tool. Jheng, Latiff, Keong, and Chue (2018) suggest that there is a statistically and economically meaningful relationship between CAR and stock price within the banking sector. The study employed linear regression to measure the correlation between the identified variables in the sample consisting of eight local commercial banks in Malaysia. The research revealed that no statistically or economically significant effect is produced by CAR on stock performance (Jheng et al., 2018).
The study was consistent with previous research that stated that the capital adequacy framework within banks produced either negative or neutral result on share price (Eyssell & Arshadi, 1990). The negative reaction was also observed in the international study performed by Cooper, Kolari, and Wagster (1991). In their research, the authors used a two-index regression model and applied it to large international banks in The U.S., Canada, UK, and Japan. For all banks except those in Japan, the correlation was negative. Rizzardi’s (2011) research of the Basel III revealed that similar to other versions of the regulation, it negatively affects the share price.
The more recent research seems to confirm the earlier findings. Estrella, Park, and Peristiani (2002), who measured CAR in conjunction with the U.S. bank failures in 1988-1993, note that the evidence of its effectiveness is rather limited and inconclusive. Chia, Yahya, and Muhammad (2015) attempted to measure the eight largest national banks in Malaysia, including its central bank. Basel III, the most advanced banking regulation, was tested under linear regression and revealed that CAR had no effect on stock performance, unlike financial distress indicator.
Having analyzed Indian bank reports and applied multiple regression analysis to the key performance factors, Rawlin, Shanmugam, and Bhat (2015) capital adequacy was rendered ineffective for share prices. Instead, they found that the critical factor that influenced the latter was asset usage efficiency.
Lu, Shen, and So (1999) report the opposite results in regard to small banks. Positive share reaction was observed, which was possibly due to excessive capital reserve prior to the intervention. The latest research from Indonesian banks suggested that the capital adequacy ratio influenced stock prices significantly (Rosyid & Noor, 2018). The Danamon bank chosen by the authors for analysis counts as a small bank as its assets are 3-4 times fewer than those of the top five. The positive results confirm the theory that CAR is rather effective at influencing stock performance in small banks.
A more comprehensive study of 31 Indonesian banks performed by Sujarwo (2015) revealed that CAR within the CAMEL (Capital adequacy, asset quality, management quality, earnings, liquidity) framework, developed by author demonstrated the statistically significant influence on the bank share price. However, it appears that the framework is subject to bias, as it is impossible to determine the value of each CAMEL component because he used linear regression instead of multiple ones (Sujarwo, 2015). Given all the research results discussed above, it could be hypothesized that the effectiveness of CAR in relation to share performance depends on the size of the bank.
Bank Liquidity Risk and Stock Price
Liquidity risks are the risks of the bank that make it vulnerable to short-term liabilities. In relation to the stock price, the research is inconclusive as to whether the liquidity risks influence share prices positively or negatively. Thus, Karolyi and Martell (2006) argue that market liquidity reflects the share prices and their future growths or falls. In times of distress, the liquidity becomes at risk, and stock prices react negatively. This is also evidenced by bank sector analysis performed by Muchiri (2014). Upon applying quantitative methods, the author identified a significant negative correlation between share returns, in turn, fully affected by stock price, and liquidity management.
Evidence provided by Nzioka (2012) who studied Nairobi companies listed at local stock exchange demonstrated other results. By applying multiple regression analysis to the data collected for a five-year period from 56 firms, it was uncovered that liquidity risks positively influence share price. As only large companies were included in the sample, small and medium-sized corporations were omitted.
Nonetheless, it is noteworthy to mention that in different sectors the results are dissimilar. Thus, in agriculture, positive correlation was demonstrated whereas in automobile sector it was negative. Commercial, to which banks fall, and construction sectors also developed a statistically significant positive correlation between stock price and liquidity risk. The data collected by Chen and Siems (2002) suggest that liquidity risks aggravated by cataclysmic events lead to market price fluctuations. However, the economy of the U.S. became more stable and resistant to such occurrences despite rapid news traveling.
In earlier studies, Campbell, Grossman, and Wang (1993) found out that at-risk corporations tend to massively buy shares, which leads to dramatic price swings. Chordia, Sarkar, and Subrahmanyam (2004) testified to that with new evidence gathered from observation on the New York stock exchange, revealing that liquidity risks affect not only share prices but also monetary policy. One of the most vivid and comprehensive studies uncovered within this literature review was performed by Warrad (2014). She drew and analyzed using simple regression six years of data on 14 banks listed on Aman stock exchange. The author’s results suggested that quick ratio liquidity risks affect stock performance significantly. The author included in the sample both large and small banks.
The evidence is further expanded by Maaka (2013) who suggests that liquidity risks significantly impede banks’ financial performance in the variety of measurements. Here the relationship between stock price and liquidity gap is implicit and demonstrated through the fact that challenging times cause fluctuations on the stock market. In general, the research evidence seems to be conflicting, and the number of studies dedicated to the relationship of stock price and liquidity gap is limited. Preliminary literature review results here suggest that there is a significant correlation between liquidity risks and stock performance, yet there is also evidence of the negative correlation.
In the course of this literature review, it became possible to identify certain gaps in knowledge. In particular, it was observed that there is a lack of academic studies dedicated to the relationships between the frequency of meeting and stock performance. In addition, in many variables, there is a plethora of conflicting evidence that will hopefully be addressed by this study.
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