Corporate governance and default probability: The moderating role of bank's efficiency

Ullah, Saif; Nobanee, Haitham; Kemal, Muhammad Ali Article Corporate governance and default probability: The moderating role of bank's efficiency Cogent Economics & Finance Provided in Cooperation with: Taylor & Francis Group Suggested Citation: Ullah, Saif; Nobanee, Haitham; Kemal, Muhammad Ali (2023) : Corporate governance and default probability: The moderating role of bank's efficiency, Cogent Economics & Finance, ISSN 2332-2039, Taylor & Francis, Abingdon, Vol. 11, Iss. 2, pp. 1-18, https://doi.org/10.1080/23322039.2023.2266318 This Version is available at: https://hdl.handle.net/10419/304225 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ Cogent Economics & Finance ISSN: (Print) (Online) Journal homepage: www.tandfonline.com/journals/oaef20 Corporate governance and default probability: The moderating role of bank’s efficiency Saif Ullah, Haitham Nobanee & M. Ali Kemal To cite this article: Saif Ullah, Haitham Nobanee & M. Ali Kemal (2023) Corporate governance and default probability: The moderating role of bank’s efficiency, Cogent Economics & Finance, 11:2, 2266318, DOI: 10.1080/23322039.2023.2266318 To link to this article: https://doi.org/10.1080/23322039.2023.2266318 © 2023 The Author(s). Published by Informa UK Limited, trading as Taylor & Francis Group. Published online: 13 Oct 2023. Submit your article to this journal Article views: 1390 View related articles View Crossmark data Full Terms & Conditions of access and use can be found at https://www.tandfonline.com/action/journalInformation?journalCode=oaef20 FINANCIAL ECONOMICS | RESEARCH ARTICLE Corporate governance and default probability: The moderating role of bank’s efficiency Saif Ullah 1 *, Haitham Nobanee 2 and M. Ali Kemal 3 Abstract: There is a need to explore the moderating role of banks’ efficiency in the relationship between corporate governance (CG) and default probability in Pakistan. Such attention is required due to poor bank governance, which threatens banks’ stability. This empirical study’s objective is to ascertain the impact of CG on bank default probability by considering banking efficiency as a moderating factor for the period spanning 2012–2020 by using secondary data from banks in Pakistan. The results, estimated using System GMM regression—whose robustness was confirmed through Driscoll and Kraay’s standard error approach findings—show a significant relationship between banks’ CG and bank efficiency. Banks’ better CG practices will improve bank efficiency toward financial soundness in Pakistan. Moreover, the current study puts forth certain implications, i.e. that the banks still need to improve the mechanism they use to implement corporate governance attributes to compete properly on the international stage. Subjects: Economics; Finance; Business, Management and Accounting Keywords: corporate governance; banks’ efficiency; profitability; Z-Score; bank risk; pooled OLS 1. Introduction Better corporate governance (CG) confirms that the business environment is transparent and all firms are independent, whereas weak corporate governance leads to mismanagement and corruption. Indeed, CG quickly changed and gained more attention after corporate scandals such as the Saif Ullah ABOUT THE AUTHOR Saif Ullah is a Self-Driven, Passionate and Experienced Professional with more than 15 years of experience in industry and academia as a practitioner, faculty, facilitator, trainer, supervisor, researcher and editor of Research Journals. Currently, He is an Assistant Professor of Finance at Ziauddin University Karachi. He has published more than 30 Research Papers (Total Impact Factor 100+) in reputed Journals indexed in WoS/SCOPUS/ABDC/ABS and more than 1350+ Citations as per Google Scholar. His Research Interests include Corporate Governance, Bank Efficiency, Financial Stability, Banking and Finance and ESG. Ullah et al., Cogent Economics & Finance (2023), 11: 2266318 https://doi.org/10.1080/23322039.2023.2266318 Page 1 of 18 Received: 13 December 2022 Accepted: 29 September 2023 *Corresponding author: Saif Ullah, Department of Management, Technology, and Information Science, Ziauddin University, Karachi, Pakistan E-mail: [email protected] Reviewing editor: David McMillan, University of Stirling, UK Additional information is available at the end of the article © 2023 The Author(s). Published by Informa UK Limited, trading as Taylor & Francis Group. This is an Open Access article distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/by/4.0/), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. The terms on which this article has been published allow the posting of the Accepted Manuscript in a repository by the author(s) or with their consent. Enron and WorldCom incidents. A CG perspective requires banks to be managed in an excellent manner so that they can engage in expanded activities. Banks with strong CG can expand their product offerings, profitable activities, and services (Barine & Minja, 2023; Deb & Chandra, 2023). Bank CG is more important than in other industries. A financial crisis can occur due to banks in a specific country losing the confidence and ability of the market through poor CG (Alabdullah et al., 2018; Balagobei, 2019). Claessens and Fan (2002), and later Crisóstomo et al. (2020), reported the cost of transactions and capital leading to capital market efficiency due to better CG. De Haan and Vlahu (2015) demonstrated how financial companies differ from non-financial companies. Financial and non-financial firm differences may also influence management structures and compensation schemes. Banks want to use stock options within limits because such stock options are highly leveraged and may disturb those banks’ debt-issuing costs and the CG market. Moreover, similar measures have been emphasized by Mongid et al. (2020) to address financial firms’ CG, debt risk and efficiency. According to Ahmed et al. (2020), the purpose of a firm declaring bankruptcy as a default rule is to serve and build confidence, which can undermine banks’ financial stability and soundness to creditors. To guarantee the bank’s stability, the regulator can ensure liquidity, but the bank’s risk will result in overall financial stability objectives. Depositors and savers can help to avoid systemic collapse, financial contagion, and hardship. Indeed, a liquidity problem was the leading cause of the financial crisis; this problem is vital to developing countries. Jan et al. (2021) studied the nexus of Islamic CG and sustainability performance in financial institutions, focusing on the key elements of Islamic CG, namely Shariah board attributes and ownership structure, by examining its impact on the economy, society, and environment. Jan et al. (2022) investigated CG, risk management, and overall performance to ensure corporate sustainability in developing countries. Government involvement among banks, depositors, and shareholders is high. Therefore, in a bank’s governance, the external CG mechanism plays a vital role and reduces the risk-taking behaviour of commercial banks by implementing the capital adequacy requirement (Fanta et al., 2013; Ullah, 2020). The CG process of banks in Pakistan is new, as the CG code of the Securities and Exchange Commission of Pakistan (SECP) was revised in 2019. Strategic valuation, such as assessing bank efficiency improvements or decreases in bank defaults, is necessary; however, the available information is insufficient. Bank efficiency can lead to a bearing of the debt burden and can benefit the well-being of depositors and routine people. This may be vital in shaping a buoyant economy and help achieve efficient economic progress. Less research has been conducted to examine the CG and efficiency of banks in developing countries. Therefore, investigating the relationship between CG and efficiency is essential (Proença et al., 2023). Better governance reduces the overall taxpayer burden by lowering essential borrowing costs. Hence, it is necessary to explore the roles of CG and bank default risk in developing countries (Mili & Alaali, 2023). CG is considered the backbone of the financial system, leading to financial soundness in Pakistan. It can directly and indirectly influence banks’ default probabilities through unnecessary and extra risk-taking practices, which can harm Pakistan’s economy. Therefore, the critical research questions that need to be addressed are: What is the role of banks’ corporate governance in identifying bank efficiency and impact on bank default? Moreover, what is the moderating role of banks’ efficiency with corporate governance in determining default probability? The current study addresses this gap by considering the factors linked to CG and bank efficiency that affect default. Hence, this study contributes in multiple ways. First, it identifies the impact of banks’ CG on the banks themselves by preparing a composite index based on board size (the number of board of directors), managerial ownership for internal control, board independence, transparency, Chief Risk Officer (CRO) or chairman duality, and audit committee members. Second, we explore the Ullah et al., Cogent Economics & Finance (2023), 11: 2266318 https://doi.org/10.1080/23322039.2023.2266318 Page 2 of 18 moderating role of the banking efficiency PCA index by ascertaining profit and management efficiency from EPS, operational efficiency, technical efficiency and cost efficiency of banks. Third, we investigate banks’ default and risk-taking practices with CG using a comprehensive set of financial soundness measures, namely the Z-score model. Moreover, bank-specific regulatory variables, such as the capital advocacy ratio, bank size, liquidity risk of advance to total deposits and capital advocacy ratio as risk management, are explored to contribute to this knowledge. Fourth, the current study employs a traditional approach in which financial ratios are used to assess banks’ default probability, and the relationship is tested through System GMM and D-K standard error regression analyses. The remainder of this paper is organized as follows. Section 2 provides a brief review of the literature on the topic. In this chapter, we tried to explain the theoretical and empirical relationships between corporate governance, efficiency and bank default. Section 3 unveils data availability, construction of variables, and model and estimation procedure selection. Section 4 explains the results obtained, whilst Section 5 concludes the study. 2. Literature review The triangle gap model assumes that bank owners are only concerned about wealth maximization or investment returns and that business people are usually risk-averse. Tandelin, Kaaro, Mahadwartha, & Supriyatna, () put forth three points in their study to elaborate on the triangle gap model. First, it shows the ownership structure of corporate governance practices. Second, gaps exist between risk management and corporate governance, corporate governance and bank efficiency, and risk management and bank efficiency. Third and lastly, the different bank ownership structure has different risk management implications (Tandelin, Kaaro, Mahadwartha, & Supriyatna, 2014; Ullah et al., 2023). CG relates to the board of directors, top and senior managers, executives who govern the organization, minority shareholders, and other stakeholders. The Cadbury Report (1992) defines CG as “the process to direct and control the companies,” whilst Ullah (2020) endorses studies on CG. Moreover, Rodrigues et al. (2020) reported that CG is a collection of tools that external investors can use to protect themselves from expropriation caused by insiders. Efficiency refers to the value created by rational capital (Onumah & Duho, 2020). Efficiency becomes important mostly when, with governance changes, the deregulation of state control is moderated. The economic efficiency of banks dominates their institutional stability (Burki & Ahmad, 2010). Moreover, “Risk” is the possibility of any incident or unfavorable occurrence/event disturbing the attainment of an organization’s aims or goals (Ullah et al., 2023). 2.1. Corporate governance Better CG is the outcome of the internal and external CG tools that are essential for decreasing bank agency problems. Better CG in banks can improve risk valuation, initial threat processes, and risk protection (Ullah, 2020). The internal CG system is wide and not only bound to the hierarchy of the board of directors and their value in observing a bank’s management. By contrast, external CG mechanisms include government rules, principles, directions, and the market for corporate control (Fanta et al., 2013; Ghadamyari & Eslami Mofid Abadi, 2020). In Pakistan, the CG of recognized markets is characterized by less support from outside investors and capital markets but stronger support from financial institutions and large inside investors to attain efficiency in the corporate sector. Smaller (external) shareholders face the risk of expropriation when capital is transferred to more significant shareholders (Javid & Iqbal, 2010; Nazir & Afza, 2018). From the banking sector perspective, reported by Basel in 1999, the constitutional process of CG, in which the relationships of individual institutions and businesses are decided by their board of directors and senior management, manipulates how banks set corporate objectives. This includes generating economic returns to shareholders, business affairs, and day-to-day operations of the running process, considering stakeholders’ interests and placing corporate activities (Hopt, 2020). Higher institutional ownership, part of CG, entails more risk before a financial crisis, so more significant shareholders may encounter larger losses if a crisis occurs (Hong & Linh, 2023). Ullah et al., Cogent Economics & Finance (2023), 11: 2266318 https://doi.org/10.1080/23322039.2023.2266318 Page 3 of 18 Moreover, Vafeas (2005) claimed that corporations with larger CG boards may have lower earnings excellence. Pakistan’s Corporate Governance Code of 2010 recommends a minimum independent management ratio of approximately 50%. Additionally, Bouaziz et al. (2020) reported the link between managing profit and CG as board independence; an undesirable link exists between the two. Gruszczyński (2020) contended that board independence is the most frequently discussed aspect of board structural relations. Board directors are responsible for accepting, auditing, and rejecting business recommendations from management teams. In addition, when directors in the company have the right to make decisions, most of them may hardly reject the proposals submitted by each director. Companies effectively monitor their proportion of independent directors. Zhu et al. (2020) studied the roles of Chinese Chief Executive Officer (CEO) and reported that management with good expertise is better supervised and is an extra helpful guide for upper-level executives. Furthermore, CG components such as board size represent the total number of directors (Nuswantara et al., 2023). The board’s directors are the banks’ supreme governing bodies. They are responsible for setting a planned way of working for the bank and overseeing risk management policies (Boachie, 2023). Appointing senior management and establishing operational policies are the board’s responsibilities when conducting a bank’s business. The firm’s shareholders appoint the directors of the board. A strong, independent, skillful, knowledgeable, and experienced board should be appointed to perform its duties effectively and efficiently. Boards ought also to be actively involved in banking activities. In bad times, the bank’s active and involved board can help achieve survival and stability if it can evaluate problems and take corrective actions to solve them (Fernandes & Fich, 2023). In addition, with regard to attaining better CG, the addition of outside directors improves management monitoring. As the theory forecasts, this reduces conflicts of interest between investors. It also supports the argument, as per the results, that the board size, the financial company’s proficiency, and the performance are dissimilar (Bouteska, 2020). From the CEO in control perspective, larger boards are less effective because it is challenging to manage, coordinate, process, and deal with an organization’s strategic issues (Vitolla et al., 2020). Likewise, as a good CG component, transparency can strengthen the firm/banks (Liu et al., 2023). Another component of CG, namely Chief Executive Officer (CEO) duality, occurs when the CEO is also the board chairperson (Boachie, 2023). If we conclude the power divide, then the person operating as both the CEO and chairman of the board should not recommend a perfect CG system (Berhe, 2023). Javid and Iqbal (2010) and Tahir and Sabir (2015) found that foreign and family owners adopt healthier governance and monitoring practices, consistent with agency theory. Moreover, De Haan and Vlahu (2015) claimed that the main drawbacks of CEO duality are recognized in the literature as per the CEO/chairman split rules, which include a negative impact on the board’s monitoring activity and increased executive power to affect board decisions. Moreover, Gupta and Mahakud (2020) and Gontarek and Belghitar (2020) discovered that the same person providing services as the chairman of the board and CEO for banks may result in lower returns on assets and cost efficiency. Fang et al. (2020) showed that the CEO’s control of the board’s decision-making ability, including CEO duality, is challenging due to the risk procedures of all banks used and is statistically significant. In addition, CG components, such as managerial ownership and internal controls, refer to banks’ organizational and operational structure rules and governing controls, such as the process of reporting, risk-controlling functions, compliance, and internal inspection of the system (Waris & Haji Din, 2023). The main elements of CG are top management and expertise, whereas the board of directors provides a check-and-balance system for senior managers. Similarly, senior managers must adopt ethical methods for line managers, particularly business zones and activities. According to the four-eye management principle, significant decisions should be made through the communication and collaboration of more than one person. This principle should be implemented even in small banks (Basel, 2006; Naqvi & Jones, 2020). Nazir and Alam (2010) stated that better internal controls increase bank performance, whilst Westman (2011) and Rashid (2020) Ullah et al., Cogent Economics & Finance (2023), 11: 2266318 https://doi.org/10.1080/23322039.2023.2266318 Page 4 of 18 declared that ownership by management and board members contributes to bank profitability. For non-transparent banks, managerial ownership as an indicator of good CG is essential because it is challenging to monitor CG as an outsiders. Agency theory proposes that ownership distribution plays a significant role in a firm’s control. From a CG ownership structure viewpoint, many countries have banking sectors with different ownership types for internal controls and shareholding ownership patterns. Therefore, in the case of the augmented version model, it was discovered that credit indicators would improve the efficiency of the central bank and that the private sector would demand responses to looser monetary conditions and shift their credit origination towards riskier borrowers (Bakhit & Bakhit, 2014, 2014). 2.2. Banking efficiency Banks can expand and strengthen their activities, funds, profitability, and quality by improving their CG. This development reflects the improved rivalry between banks and the banking sector to ameliorate efficiency (Basharat et al., 2014; Zainal et al., 2020). Corporate governance, like board size, can play an active role in determining efficiency (Forbes & Milliken, 1999; Heemskerk, 2019). The CG factor independent and non-executive board directors’ results show more improvements in the bank’s efficiency because independent and non-executive board directors can make fair judgments and carry out risk management at the required volume level, which can lead to banking profitability and efficiency (Ullah, 2020). Moreover, asset growth, earnings price per share, and expense-to-assets ratio describe management efficiency within a company. Increasing efficiency (management) increases banks’ profitability (Ginesti & Ossorio, 2020). The efficiency of banks in Pakistan is higher than that of other firms (Burki & Niazi, 2010; Ullah, 2020; Zaman & Bhandari, 2020). The overall banking efficiency has been increasing over time in terms of technical, cost efficiency, and income efficiency (Sardari et al., 2013). Berger and De Young (1997) argued that cost efficiency and risk management have a fundamental relationship in controlling comprehensive management as a CG role for endorsing the protection and reliability of banks. Indeed, Hayat (2011) stated that very few studies on profit efficiency also examine banks’ technical efficiency. Profit and technical efficiency have improved over the years, and efficiency analysis provides a fair idea because it maximizes the firm’s profit from the given input resources. In comparison, cost efficiency is hampered by government interference and the primary use of funds. Jan et al. (2022) declared that banks’ overall reporting performance improved over time, which may result from implementing business plans for the 2030 agenda in Malaysia. Moreover, Rustam and Rashid (2015) and Talpur (2023) found improvements in bank efficiency in Pakistan. 2.3. Probability of default Risks signify actions with an undesirable impression which can decrease the current worth and stop development worth. Actions with hopeful impressions may offset adverse impressions or signify probabilities. IN HIS REVIEW OF CG for UK banks and other financial industry entities, Sir David Walker recommended that financial service organizations use risk-committee boards. The role of risk management in controlling and governing bank defaults in the financial sector was revolutionized in the 1970s when financial risk management became a priority for many smalland large-scale firms, such as banks, non-financial enterprises, and insurance companies, to reveal price variations. According to Lee (2023), executives allocate more time to risk-taking than to the operational level because the importance is likely to control practices at the strategic level. During the past decade, risk management’s ability to control and govern banks, linked to developing a healthy and robust banking system, has also gained substantial consideration in developed and developing countries. Quintyn (2007) claimed that banks, shareholders, and stakeholders have both interest and risk, which are complex. Indeed, risk management has become Ullah et al., Cogent Economics & Finance (2023), 11: 2266318 https://doi.org/10.1080/23322039.2023.2266318 Page 5 of 18 more complex and different compared to standard CG practices through the supervision and regulation of governance. Pathan (2009) studied financial companies’ board independence, efficiency, and Z-score, revealing that 212 large US bank holding companies (BHCs) from 1997 to 2004 used the percentage of independent directors and systematic risk. Asset return risk, total risk, idiosyncratic risk, and the Z-score as dependent variables resulted in the opposite relationship. Farmer (2014) determined that companies were less involved in subprime lending, which is related to CG in terms of different gender-diverse boards, and later found that a larger ratio of female board members is related to increased risk-taking. Similarly, Farag and Mallin (2018) confirmed and endorsed the Chinese market by investigating the influence of CEO demographic characteristics on corporate risk-taking. Elamer et al. (2020) observed substantial progress in bank efficiency when considering risk and quality governance factors. They examined the Z-score and bank default probability to determine the impact of risk. In addition, we find that banks with less risky assets are more efficient. This also indicates that banks with well-capitalized efficiency perform better. Therefore, better CG, risk, and quality factors can improve bank efficiency. Besides the aforementioned, investors and stakeholders are interested in banks; therefore, banks’ risk involvement is complicated because all beneficiaries have influential power and high-interest rates (Cotugno et al., 2020; Quintyn, 2007). 2.4. The theoretical framework In this study, a self-developed framework was used based on the literature. The rationale of the aforementioned framework is to identify the relationship between CG and bank-specific variables and the impact that the former has on the latter. Indeed, bank-specific variables are important for all banks for the regulator, so ascertaining their impact on efficiency variables and bank default is crucial. The framework is as follows in Figure 1: 3. Data and methodology This study examined the nexus of CG, efficiency, and default probability of Pakistani banks. The study uses data from 21 banks registered in the State Bank of Pakistan based on data availability from 2012–2020, collected from their financial reports (Appendix A). The advantages of the positivist perspective include objective data interpretation and research conclusions that are generally calculable, noticeable, and repeatable (Collins, 2011). The independent variable is corporate governance, composed of the board of directors/board size, executive, managerial ownership for internal control, chairman/chief executive officer (CEO) duality, board independence, and transparency. The corporate governance index is calculated using De Haan and Vlahu (2015), whilst Ullah (2020) studied the corporate governance index = board independence + CEO is chairman/duality + board size/board of directors + transparency + managerial ownership for internal control. Appendix B presents the variables and indicators used for the measurements. Moreover, the moderating dependent variable is the bank’s efficiency index based on PCA of profit efficiency, management efficiency (EPS), technical, operational efficiency and cost efficiency. In addition to this is the bank’s default probability of seeing insolvency and financial soundness, which comprises the bank’s Z-score as the dependent variable. Moreover, Capital Advocacy Ratio (CAR), liquidity risk (LR), risk-taking practices (RTP), and bank size (BS) are the control factors. Liquidity risk is proxied by total advance to total deposit, and risk-taking practices (RTP) are proxied by total loan to total assets. The research design follows a positivist viewpoint and a deductive methodology. Banking data often exhibits dynamic behavior where the past values of variables Corporate Governance Banks Efficiency Banks Default Figure 1. Theoretical framework. Ullah et al., Cogent Economics & Finance (2023), 11: 2266318 https://doi.org/10.1080/23322039.2023.2266318 Page 6 of 18 influence the current and future values. System GMM allows researchers to incorporate lagged values of the dependent variable, helping to model this dynamic behavior accurately. System Generalized Method of Moments (System GMM) is a statistical technique used in banking panel research to address endogeneity issues and estimate dynamic panel data models. Its key advantages include handling endogeneity, using efficient instrumental variables, accommodating heterogeneity, ensuring consistency and efficiency of estimates, modeling dynamic behavior, handling short panel data, overcoming endogeneity bias, conducting instrument validity tests, and working with non-stationary data. System GMM helps address endogeneity by using lagged values of the dependent variable and instruments to control for unobservable factors. System GMM allows for heterogeneous effects across individuals and periods. In banking panel research, this is valuable as banks may have different responses to economic shocks or regulatory changes, and these heterogeneous effects can be captured in the analysis. System GMM models is developed using the following equation: The Driscoll and Kraay (Newey-West) standard error method is a valuable tool in econometrics for dealing with heteroskedasticity and autocorrelation in data, allowing for more accurate statistical inference in regression analysis. D-K regression equation is: Where, DFI represents the default probability index through Z-Score. CG means corporate governance index, and BEI indicates banking efficiency index. i indicate the country while t-1 is the time indicating lag. While control factors are represented throughδjZit. Moreover, ε it describes error term and φt refers to the fixed year effect i.year of common shocks. Moreover, α, β0, β1 and, β2 are to be estimated, unknown parameters are α, β0, β1 β2 and β3. 4. Result and discussion The descriptive statistics of all examined variables were assessed using Stata-15 and included mean, median, maximum, minimum, and standard deviation. Moreover, the total number of observations was calculated for all variables in the total 189 observations for 21 banks in Pakistan. The outcomes show that the data is normally distributed. The detailed descriptive statistical results are reported in Table 1. 4.1. Correlation matrix and variance inflation factor analysis A correlation matrix was used to check for correlations between variables. The results show that CG, BEI and an interaction term of CG*BEI are significantly positive related to bank default at the significance level of 5%, 1% and 1% respectively. The bank efficiency is the highest correlation, at 27.5%, whilst CG and CG*BEI are also strongly correlated. We consider the control factors such as risk-taking practices and banking size which showed mixed correlation with default probability. The detailed results are presented in Table 2. Variance inflation factor (VIF) is a useful tool for diagnosing multicollinearity and making informed decisions about how to improve the stability and interpretability of regression models. In practice, a common rule of thumb is to consider a VIF value of 5 or greater as a sign of problematic multicollinearity. Hence in this case there is no multicollinearity as all variables value is less than bench mark in Table 3. Ullah et al., Cogent Economics & Finance (2023), 11: 2266318 https://doi.org/10.1080/23322039.2023.2266318 Page 7 of 18 Citation information Cite this article as: Corporate governance and default probability: The moderating role of bank’s efficiency, Saif Ullah, Haitham Nobanee & M. Ali Kemal, Cogent Economics & Finance (2023), 11: 2266318. References Ahmed, T., Binte, M., Khan, Z. 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The Corporate Governance Variables Measures of Corporate Governance Group Indicators (Measurement) Explanation (If needed) Corporate Governance Index Board independence Percentage of outside directors on the board per bank, Dummy variable: 0 if less than 60% of directors are independent and 1 if 60% or more directors are independent. CEO is chairman/duality Chairman same as CEO, if not any lead director per bank. When the CEO is also the chairperson of the board, it is known as CEO duality; Dummy variable: 0 if the CEO is a chairperson of the board and 1 if the CEO is not the chairperson of the board. Board size/board of directors Total number of directors per bank, Dummy variable: 0 if greater than the median of the sample and 1 if less than the median of the sample. Transparency When the bank publishes its financial statements quarterly, semi-annually, and annually, Dummy Variable: 0 if financial statements are not published and 1 if financial statements are published. Managerial ownership for internal control Percentage of shares held by intellectual capital (executive director and senior management) divided by the total number of shares per bank, Dummy Variable: 1 if percentage is less than the sample median and 0 if percentage is greater than the sample median. Ullah et al., Cogent Economics & Finance (2023), 11: 2266318 https://doi.org/10.1080/23322039.2023.2266318 Page 17 of 18 Table B2. The efficiency/profitability variables To measure efficiency and profitability (here we use some profitability variables also because ROA and ROE are linked with banks’ effectiveness and can cause bank default) Group Indicators (Measurement) Explanation (If needed) Profit Efficiency Profit after tax to TA Profit After Tax/Total assets Operational Efficiency Non-interest expenses/net bank revenue Net bank revenue = interest income + other income-interest expenses. Management Efficiency Earnings per share (EPS) We considered the banks’ earnings per share, which is a proxy for the bank’s management efficiency and the bank’s earnings and market share. Banks’ cost efficiency Total assets (input)/total loans and the growing non-lending activities (other earning assets) (Output) TA to NPL+ TA or TL Total costs (personnel expenses + other administrative expenses + interest paid + non-interest expenses) total Assets/NPL+ total advances or total loan Technical efficiency Input/output Inputs are no of employees,no of branchesadmin expenses, noninterest expense and loan loss provision. Outputs are net interest income,net commission, and total other income. Table B3. The bank default probability and financial soundness To measure bank default probability and financial risk soundness index Group Indicators (Measurement) Explanation (If needed) To measure the bank’s default probability Z-score model Z= (ROA+E/A) banks Sd. of ROA E/A is its equity-to-asset ratio Liquidity risk and risk-taking practices (RTP) proxied by total loan to total assets. proxied by total advance to total deposit Risk-taking practices RTP proxied by total loan to total assets. Bank Size Log of total assets CAR Capital adequacy ratio: the ratio of capital to risk-weighted assets (credit, operational, market). Ullah et al., Cogent Economics & Finance (2023), 11: 2266318 https://doi.org/10.1080/23322039.2023.2266318 Page 18 of 18