Eurasian Econ Rev

https://doi.org/10.1007/s40822-018-0102-8

ORIGINAL PAPER

Role of governance on performance of microfinance

institutions in Bangladesh

Tanweer Hasan1 · Shakil Quayes2   · Baqui Khalily3

Received: 1 December 2017 / Revised: 16 March 2018 / Accepted: 4 April 2018

© Eurasia Business and Economics Society 2018

Abstract  Using a sample of sixty-eight microfinance institutions (MFIs) from

Bangladesh, this study investigates the possible impact of various governance attrib-
utes on their financial performance. Our results show that powerful CEOs do have
a positive impact on financial performance of MFIs, and that gender diversity in
board can only have a positive impact when it is also augmented by gender diversity
in management. However, the correlation between financial performance and board
size was not statistically significant in our empirical analysis.

Keywords  Governance · Financial performance · Microfinance institution

JEL classification  G29 · G39 · O16

This research was conducted while Hasan and Quayes were visiting fellows at the Institute of
Microfinance (InM), Bangladesh. Preliminary findings from this research were presented at a
seminar organized by InM in Dhaka, Bangladesh in 2011 and then, in 2012, the first draft of this
paper was presented at the “5th International Research Workshop on Microfinance Management and
Governance” in Oslo, Norway. The authors gratefully acknowledge the comments from the seminar
participants in both Bangladesh and Norway. Akib Khan provided excellent research assistance.

* Shakil Quayes
shakil_quayes@uml.edu
Tanweer Hasan
thasan@roosevelt.edu
Baqui Khalily
bkhalily51@gmail.com
1
Heller College of Business, Roosevelt University, 430 Michigan Avenue, Chicago, IL 60605,
USA
2
Department of Economics, University of Massachusetts Lowell, One University Avenue,
Lowell, MA 01854, USA
3
Institute of Inclusive Finance, 2/1 Block D, Lalmatia, Dhaka 1207, Bangladesh

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 Eurasian Econ Rev

1 Introduction and motivation

Microcredit has emerged as a feasible financial alternative for poor people with no
access to credit from formal financial institutions, where its objectives include ame-
lioration of poverty by fostering small-scale entrepreneurship, through simple access
to credit. With its rapid expansion, governance of Microfinance Institutions (MFIs)
has received increasing attention, particularly in view of its managements’ efficiency
pertaining to financial performance and social outreach. MFIs are quasi-formal
financial institutions that primarily provide small loans to poor borrowers. Over
time, they have expanded their range of services into asset building, consumption
smoothing, remittances, and risk management by offering savings schemes, short-
term loans, money transfer, and insurance. The MFIs in our sample are not for profit
organizations but are expected to attain financial self-sufficiency, and as such, gov-
ernance issues play an important role in their financial performance. By the 1980s,
microfinance was able to attain global prominence as a poverty alleviation tool and
as a viable alternative to existing development finance models. The lack of success
of the traditional development finance models, e.g., subsidized rural credit in the
1950s–1980s encumbered by high default rates and inherent inefficiency, allowed
microfinance to establish itself as a feasible tool in reducing poverty, with high
loan repayment. Microfinance is accepted as an effective poverty alleviation tool
around the globe and is very high on the priority list of the public agenda of various
countries and donor agencies. While the primary objective of MFIs is reaching the
poorer strata of the population, long-term profitability or sustainability1 of MFIs is
also critical for this quasi-formal or alternative development finance model to con-
tinue to have a lasting impact.
However, against the backdrop of a rapid global growth of the microfinance sec-
tor, a recent report identified institutional governance as one of the principal con-
cerns facing the microfinance sector, jeopardizing its role as both a business and a
social service (Centre for the Study of Financial Innovation or CSFI 2008). Gov-
ernance, in microfinance, refers to the mechanisms through which equity investors,
partner institutions, and donor agencies ensure that their funds are utilized according
to their intended purpose. With the increased competition for funding, sustainable
MFIs look particularly attractive to donors, equity investors, and other providers
of fund. An MFI may signal quality and transparency through various governance
mechanisms like board size and composition, board independence, audited financial
statements, good internal control measures, etc.
In addition to playing a pioneering role in microfinance, Bangladesh has by far
the largest and most extensive microfinance program in the world, with approxi-
mately 16.3 million active borrowers and USD 3.7 billion gross loan portfo-
lio. This sector manages USD 2.7 billion worth of deposits from 17.4 million
depositors who are often referred to as members (www.mixma​rket.org/mfi/count​
ry/Bangl​adesh​). The extensive network of over six hundred MFIs have provided

1
  Sustainability means an MFI can meet all the administrative costs and loan losses from its operating
income.

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Eurasian Econ Rev

to access to financial service to 77% of the population. Furthermore, according

to the microfinance regulatory board, conclusions drawn from an analysis of
the microfinance governance issues in Bangladesh can be generalized for entire
industry.
In the context of a firm, shareholders (the Principal) are the residual claimant
of profit (or loss) and also bear the residual risk of the firm (Jensen and Meckling
1976) while the management (an Agent) is entrusted with making the decisions
that pertain to running the firm, but it does not have residual claim over the firm’s
wealth. The principal-agent theory provides an explanation as to why it is incentive
compatible for shareholders, to design a pay structure for managers and workers that
is partially based on performance. If it were possible to design a complete and com-
prehensive contract that covers future periods in a costless fashion, it would deem
the agency theory redundant in providing a role for corporate governance structure.
However, such contracting costs may be quite large, and the absence of a complete
contract necessitates additional measures of ownership control including corpo-
rate governance (Fama and Jensen 1983). The literature has identified three such
transaction costs as being important—(i) the cost of taking into account the various
contingencies that may arise over the period of the contract, (ii) the financial and
non-pecuniary costs of negotiating with relevant parties about such future plans and
contingencies, and (iii) the cost of formulating such plans so that the clauses can be
enforced by a third party in case of a dispute (Hart 1995). Given these transaction
costs associated with reducing the principal-agent problem, the parties often prefer
a contract that is incomplete rather than being comprehensive. Governance structure
is a mechanism that minimizes agency costs and covers aspects that have not been
specified in the contract. This study focuses on the importance of governance mech-
anisms such as, ownership structure, CEO (manager) and director (board member)
remuneration, board structure (size and composition), auditing, information.
Majority of MFIs operate as nonprofit organizations and are often accountable
to multiple entities some of whom may not even fall under the traditional defini-
tion of a principal. Although there are more than fifty variations of the definition of
Stakeholder Theory (Friedman and Miles 2002; Miles 2012) in the organizational
modeling the relationship between MFIs and the set of stakeholders, especially their
donors and other funding agencies. We can also apply the resource dependence the-
ory to the behavior of MFIs since these organizations heavily rely on external fund-
ing and other resources. While some donor agencies require transparent and strin-
gent governance mechanisms, others simply require a nominal level of governance;
most of the MFIs fall somewhere in between. On the other hand, many MFIs may
also have internal motivation for highlighting an organization with well-functioning
governance to attract more funding by demonstrating their success. The underlying
reason for governance stems from the asymmetry in resource dependence, between
the donor-supported organizations and their donors. While majority of the MFIs are
registered as Non-Governmental Organizations (NGOs), a large number of MFIs
are registered as commercial banks, cooperatives, credit unions, nonbank financial
institutions, or rural banks. MFIs depend on their donors for funds and the donors
depend on MFI’s for reputation and to some extent attaining their social goals (Ebra-
him 2002, 2003; Hudock 1999; Perera 1997).

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 Eurasian Econ Rev

The key mechanisms of an effective governance framework include ownership,

board size and board structure, board diversity, independent directors, board com-
mittees, executive pay, etc. Academic researchers and practitioners have advocated
for incorporating the best practices of governance in the corporate world into the
microfinance industry (Rock et al. 1998; Otero and Chu 2002; Helms 2006). How-
ever, given the duality of the mission of sustainability and outreach, variation stake-
holder structure, and the diverse ownership structure (non-profits, cooperatives,
credit unions, etc.) it may not be easy to supplant typical governance mechanisms
from the formal financial sector into the microfinance industry. While practitioner-
based organizations (e.g., C-GAP) have laid out some broad measures of govern-
ance, very little academic research has been done in this area, primarily due to dearth
of relevant data. To our knowledge, there are only seven studies on governance
issues pertaining to the microfinance sector—Hartarska (2005), Hartaska and Nad-
olnyak (2007), Mersland and Strøm (2009), Strøm et al. (2010), Merslnad (2011),
Galema et al. (2012), and Quayes and Hasan (2014). The first two studies focus on
the governance issues of MFIs in Central Asia, Eastern Europe, and the Newly Inde-
pendent States (former republics of the USSR). Of the remaining four, three studies
use panel data across countries compiled from the risk assessment reports from vari-
ous rating agencies under one umbrella (www.ratin​gfund​2.org) to look into various
aspects of MFI governance, while Merslnad (2011) makes a historical analogy of
governance of MFIs with the governance of savings banks. It is worthwhile to note
that there is an inherent selection bias in the database used in these three studies, as
their sample uses only larger MFIs.2 Quayes and Hasan (2014) use a large sample
of MFIs and show that better disclosure and financial performance have a positive
correlation.
The present study investigates the possible impact of various governance attrib-
utes on the financial performance, using a sample of sixty-eight microfinance insti-
tutions (MFIs) from Bangladesh. Our results show that powerful CEOs have a posi-
tive impact on the financial performance of MFIs, and gender diversity in board can
have a positive impact if it is also augmented by gender diversity in management.
The rest of the paper is organized as follows. Section 2 provides an overview of
extant literature on governance of MFIs; Sect.  3 describes the research methodol-
ogy; Sect. 4 contains the empirical analysis of the impact of governance structure on
MFI performance, and finally, Sect. 5 comprises of some concluding remarks.

2 Literature review

A very limited amount of empirical research on governance in the microfinance

sector has been done to date; this short list includes Hartarska’s (2005), Hartaska
and Nadolnayk (2007), Mersland and Strøm (2009), and Merslnad (2011). Hartar-
ska’s (2005) study on governance and performance of microfinance institutions in

2
  To become eligible the total volume of MFI’s credit portfolio must range between US$1 million and
US$1.5 million dollars.

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Eurasian Econ Rev

Central Asia, Eastern Europe, and the Newly Independent States is the first of its
kind for the microfinance sector. The data used in the study came from three sur-
veys conducted in 1998, 2001 and 2002, and the sample of MFIs used in the vari-
ous estimation models ranged from 22 to 41. Results reported in the study indicate
that while external governance mechanisms play limited a role on outreach they do
not have any impact on sustainability. The results indicate—(i) MFIs with a work-
ing board perform better than those without one, (ii) there is a negative relationship
between board size and performance, (iii) board independence and performance are
positively related, (iv) board diversity has a positive impact on both performance
and outreach, (v) representation of clients and borrowers on the board has a posi-
tive impact on sustainability, and (vi) lower remuneration of managers negatively
affect outreach. A major (limiting) assumption made in the study is that the relevant
governance variables for the sample MFIs have remained unchanged over the entire
time-period under consideration.
Since MFIs facilitates creation self-employment by way of lending and has a
social impact by providing credit to poor households who have no access to credit,
confidence in its financial functionality is very important (Klobukowska 2013).
Ngo et al. (2014) found no tradeoff between breadth of outreach and efficiency of
MFIs but also found depth of outreach has a negative relation with cost. Nurmakh-
anova et al. (2015) did not find any evidence of tradeoff between financial sustaina-
bility of MFIs and either their depth of outreach or their breadth of outreach. Quayes
(2012, 2015) found a positive relationship between depth of outreach and financial
sustainability.
Mersland and Strøm (2009) investigate the impact of governance on MFI perfor-
mance and outreach using 278 MFIs from 60 countries between the years 1998 and
2007. In contrast to Oxelheim and Randøy (2003), they find that international direc-
tors have a negative effect on the performance of MFI’s by way of inflating their
costs. On the other hand, local directors and internal auditors linked to the board
have a positive effect on MFI performance. They also find that female CEOs have a
positive effect on performance, confirming previous findings by Welbourne (1999)
and Smith et  al. (2006). In addition, they find that outreach increases with CEO-
Chair duality but decreases with individual lending (as opposed to group lending),
and find no difference in performance and outreach between non-profit organiza-
tions and shareholder firms. Furthermore, bank regulations did not seem to have any
impact on either the performance or the outreach of MFIs. According to Syriopoulos
and Tsatsaronis (2012), CEO separation from the board of chair has a positive effect
on financial performance of shipping firms.
Given the findings that female CEOs have a positive impact on performance
(Mersland and Strøm 2009), Strøm et  al. (2010) investigate (i) institutional char-
acteristics of MFIs that lead to female leadership, (ii) whether female leadership is
associated with better governance, and (iii) the relationship between female leader-
ship and performance. Using 379 MFIs across 73 countries over the time period of
2001 to 2008, their empirical results indicate that female leadership is associated
with larger boards and increased outreach to female borrower and clients. Female
leadership has a negative relationship with governance indicators but a positive rela-
tionship with MFI performance. Consequently, the authors suggest that the positive

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 Eurasian Econ Rev

relationship between female leadership and performance does not originate from
a positive relationship between female leadership and governance. Studies have
demonstrated that diversity in management and governance results in better perfor-
mance. Although there is no reason as to why females CEOs would lead to better
performance per se, we can make a logical argument that female CEOs ensure better
diversity, not just in nominal or token form of a high percentage of female employ-
ees and female managers, but in terms of effective participation of women in man-
agement decisions. Effective level of participation cannot be properly quantified by
simply observing the percentage of female managers. As such, female CEOs capture
the positive impact of such unobservable diversity.
Utilizing stakeholder and agency theory, Merslnad (2011) delineates a histori-
cal parallel found in savings banks to the current governance lessons for non-profit
MFIs, and shows that monitoring by bank associations, depositors, donors, and
local communities was important in securing the survival of savings banks. He also
argues that a broader and more stakeholder-based understanding of corporate gov-
ernance is necessary.
In the context of the agency theory depicted by Jensen and Meckling (1976)
increased decision-making discretion by a CEO exacerbates the likelihood of weak
governance (Brown and Sarma 2007). When the CEO is also the chairperson of
the board, it accords the CEO with more power compromising the effectiveness of
governance by the board (Combs et al. 2007; Jiraporn et al. 2012; Liu and Jiraporn
2010; Veprauskait and Adams 2013) and can often create a moral hazard problem
(Adams and Ferreira 2007) and increase the compensation at the cost of reduced
shareholders’ wealth (Morse et  al. 2011). Recent studies examining the impact of
powerful Chief Executive Officers (CEOs) on financial performance have not been
able to confirm its negative impact. A CEO is defined as a powerful CEO when the
CEO is also the chairperson of the board. Adams, Almeida, and Ferreira (2005) and
Adams and Ferreira (2007) find that when CEOs have high power it leads to vari-
able financial performance over time, while Morse et al. (2011) argue that powerful
CEOs may manipulate their compensation in line with more favourable measures
of performance. On the other hand, Kang and Zardkoohi (2005) observe that CEO-
Chair duality results in a positive impact on a firm’s financial performance. Galema
et al. (2012) investigate the impact of powerful CEO on performance variability of
MFIs using a sample that covers 280 MFIs from 60 countries over the period 2000
to 2007. They argue that powerful CEOs of nongovernmental MFIs have more free-
dom in decision making than powerful CEOs of other types of MFIs. This induces
them to make more extreme decisions that increase risk. Furthermore, the decision-
making freedom that powerful CEOs have in nongovernmental MFIs appears to lead
to poor decisions, since MFIs having powerful CEOs are associated with poorer
performance.

3 Description of data and variables

Palli Karma-Sahayak Foundation (PKSF) is an apex microfinance organization in

Bangladesh, which had 227 partner organizations (POs) as of June 2010. All MFIs

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Eurasian Econ Rev

in our sample are Partner Organizations (POs) of PKSF. PKSF provides funds to
various organizations for their microcredit programs with the objective of helping
poor people who cannot offer any collateral. Such assistance to the poor is provided
by PKSF through different non-governmental, semi-government and government
organizations; voluntary agencies and societies; local government bodies; institu-
tions; and groups, which are generally known as Partner Organizations. A survey
questionnaire, primarily related to the governance structure, was prepared and sent
to all 227 POs accompanied by a letter of support from PKSF in June of 2010. Of
these, 105 POs responded to the survey. However, based on the information pro-
vided and due to missing information in the response from the MFIs, only 68 MFIs
could be included in the final sample for empirical analysis. The financial data, for
the fiscal year 2008–2009, were obtained from three sources—(i) Annual Reports of
individual MFIs, (ii) Bangladesh Microfinance Statistics 2009, published jointly by
Credit and Development Forum (CDF) and Institute of Microfinance (InM), Bangla-
desh, and (iii) desk-reports of POs maintained by PKSF.
A sustainable MFI is expected to meet all administrative costs and loan losses
from its operating income. Operating income consists of revenues from the loan
portfolio and other financial assets in the form of interest and fees. An MFI is
deemed to be sustainable if its Operational Self-Sufficiency (OSS) is 100% or
more, where OSS is defined as Operating Income divided by the total of Financial
Expense, Loan-Loss Expense, and Operating Expense. In this study, we use OSS to
measure the financial performance of a MFI.
The role of executive board size (BSZ) on MFI performance is ambiguous and
is subject to some debate. The critics of large board size argue that larger size may
induce some members to shirk their monitoring responsibility, allowing the CEO
greater independence. Supporting this view, Jensen (1993) argues that small boards
are more effective. Larger boards may also inhibit productive discussions, leading
to a bureaucratization of the functioning of the board and may result in adversely
affecting the ability of the firm to make speedy and timely policy decisions. Lip-
ton and Lorsch (1992) argue that it is difficult to express all ideas and opinions
in the limited time available to boards with many members. Yermack (1996) and
Eisenberg et al. (1998) detect a negative relation between board size and firm per-
formance in their empirical analysis of publicly listed companies. In the context
of microfinance, Hartarska’s (2005) reports that larger board sizes have a negative
impact on MFI performance. However, Mersland and Strøm (2009) failed to show
that MFI performance improves with a smaller board. The proponents of merits of
large board size argue that the mere size itself might enhance corporate governance
by reducing CEO domination and by providing broader oversight (Singh and Hari-
anto 1989). Klein (1998) finds that monitoring improves with an increase in board
size as it allows distribution of workload over a larger number of observers.
Higher education level is considered an excellent proxy for higher level of knowl-
edge base and intellectual competence (Hambrick and Mason 1984). It is expected
that a higher educational level of board members will lead to better and more effi-
cient governance, translating into better performance for the firm. Educational back-
ground of board members (EDB) is measured as the percentage of members in the
board with at least a college degree.

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 Eurasian Econ Rev

Members serving in the board with prior experience in MFI operations are
expected to be more prudent diligent in providing guidance to a MFI. A higher per-
centage of board members with prior MFI experience would indicate a higher level
of collective ‘wisdom’ and consequently, should lead to improved performance. The
percentage of board members with prior MFI exposure to the board size is used as a
proxy for prior MFI experience of board members (PEB).
MFIs focus primarily on women customers and approximately two-thirds of all
microcredit borrowers in the world are women. In our current study, eighty-nine
percent customers of the MFIs in our sample are women. It is hypothesized that a
female board member would be able to better identify with the customer base as
opposed to her male counterpart, leading to more efficiency and higher profitability.
We use the percentage of female members in the board (FDB) to capture the impact
of female directors on the board.
We do not have any a priori expectation about the relationship between the
gender of the chief executive officer and the sustainability of a MFI. The focus of
microfinance and an important reason for its success has been its targeting of female
customers. Female customers dominate MFI client population across the world and
consequently, it seems logical to conjecture, that a female CEO would, and may be
able to reduce information asymmetry. Mersland and Strøm (2009) makes such an
argument to explain the positive impact of female CEOs on firm performance. We
define female CEO (FCEO) as a dummy variable, where it takes the value one when
the CEO of an MFI is female and zero otherwise.
We also use an interaction variable to capture the joint effect of female board
members when the CEO of an MFI is female. Female CEO with Female Directors
on Board (FCFB) is calculated as FCEO dummy times the proportion of female
directors on the board (FDB). This would represent diversity in both governance
and management and as such, should have a positive impact on the financial perfor-
mance of a MFI.
When the CEO is also operating as the chairperson of the board (powerful CEO),
the CEO wields substantial power in policymaking and management. Adams et al.
(2005) show that if CEOs are more powerful, they are likely to take more extreme
decisions, which results in more variable firm performance. CEO-chairperson dual-
ity may also be a sign of CEO entrenchment (Hermalin and Weisbach 1991, 1998),
in which the CEO can pursue policies that yield private benefits. Governance rec-
ommendations (Cadbury 2002) warn against mixing the CEO and Chair roles con-
centrates too much power in the hands of a single person, inhibiting the board’s
oversight. CEO-Chair duality (CEOD) is a dummy variable where it takes the value
one if the CEO and Chair of a MFI is the same person, and zero otherwise. Impact
of CEOD on sustainability can be either positive or negative.
The longer an MFI has been in operation, the higher the likelihood that the MFI
has achieved better operational efficiency and economies of scale. Consequently,
longer operational history of MFIs is expected to have a positive impact on the
financial performance. The age of an MFI (OH) is the number of years since estab-
lishment of the MFI. In general, we expect the size of the firm to have a positive
association with financial performance of an MFI. We use total assets in million
Taka (USD 1 = Taka 69 in 2009) to measure the size (SZ) of an MFI.

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Eurasian Econ Rev

Table 1  Descriptive Statistics
Variable Mean Standard deviation Minimum Maximum

MFI performance (OSS) 1.23 0.29 0.25 2.08

Board size (BSZ) 8.21 3.08 5.00 25.00
Educational background of board members (EDB) 0.81 0.21 0.14 1.00
Prior MFI exposure of board members (PEB) 0.29 0.37 0.00 1.00
Female in the board (FDB) 0.29 0.20 0.00 0.87
MFI age (OH) 20.88 6.85 5.00 39.00
Female CEO 0.17 0.37 0.00 1.00
CEO-chair 0.10 0.31 0.00 1.00
MFI size (SZE) 425.84 726.33 5.07 3760.00
MFI risk (RISK) 0.02 0.03 0.00 0.17
N 68

We measure the MFI’s risk to exposure to default by its loan-loss reserve ratio
(RISK). Loan loss reserve ratio (computed as loan-loss reserve as a percentage of
loan portfolio) is an indicator of anticipated loss from defaults, and hence it should
have an adverse effect on financial performance. Loan-loss reserve ratio is total
loan-loss expense divided by its total loan outstanding.
Table 1 provides a summary of the state of MFI governance and some of the rel-
evant variables. The average operational self-sufficiency of the 68 MFIs in our sam-
ple is 1.23 (or 123 percent) and although the maximum operational self-sufficiency
is as high as 2.08, there are MFIs with OSS less than 1.00 and even as low as 0.25.
On an average, the MFIs in our sample have been in operation for approximately
21 years, with every MFI in our sample being in operation for 5 years or more.
The average board size is slightly over eight and while some MFIs have smaller
board sizes, the largest board size is 25. The representation of women is as high as
87% in some boards, but the average composition of female board members is less
than thirty percent with some MFIs having no female representation at all. Twelve
MFIs or sixteen percent of the MFIs in our sample have female CEOs.
In terms of education, most of the board members have a college degree since on
an average the MFIs in our sample have 81% of their board members who have at
least a college degree. It should be noted that some MFIs include a certain number
of their borrower members in their board following the Grameen Bank convention,
who seldom have a college degree, explaining the low percentage of college edu-
cated members in some of the MFIs. The boards comprise of 29% of members with
prior experience in the microfinance industry. We had expected this percentage to be
much higher than what we observed.
Table 2 provides pairwise correlation between all the relevant variables consid-
ered in our study. While the negative correlation between loan loss reserve ratio and
operational self-sufficiency is what one would expect, we also see a small but nega-
tive correlation between board size and financial performance. Of particular note is
the negative correlation between financial performance and both female composi-
tion of boards and female CEO. It is also interesting to observe a positive correlation

13


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Table 2  Pair-wise correlation
Variable OSS BSZ EDB PEB FDB FCEO FCFB CEOD OH SZE RISK

OSS 1.00
BSZ − 0.03 1.00
EDB 0.03 0.03 1.00
PEB − 0.02 0.11 0.10 1.00
FDB − 0.14 0.09 − 0.06 − 0.09 1.00
FCEO − 0.14 0.21*** 0.13 0.02 0.38* 1.00
FCFB − 0.02 0.18 0.06 0.08 0.56* 0.88* 1.00
CEOD 0.10 0.10 − 0.20*** − 0.08 − 0.17 − 0.02 − 0.05 1.00
OH 0.01 0.26** − 0.07 − 0.14 0.22*** − 0.08 0.02 0.01 1.00
SZE 0.06 0.17 0.22*** − 0.05 0.15 0.13 0.23*** − 0.08 0.41* 1.00
RISK − 0.46* 0.02 − 0.14 0.06 − 0.10 − 0.00 0.01 0.40* 0.06 − 0.09 1.00
*
 Indicates significance at 1% level, **indicates at 5% level and ***indicates significance at 10% level
Eurasian Econ Rev
Eurasian Econ Rev

between CEO power (measured by duality of CEO and Chairperson) and perfor-
mance. Some of estimated correlation coefficients are not statistically significant.
Finally, several of the explanatory variables in our model show varying degree of
correlation but we do address (and rule out) the possibility of multicollinearity by
running a battery of diagnostic tests.

4 Model and empirical results

In view of the important role that governance and management style can play on
performance, it would be interesting to analyze how these factors affect the financial
performance of an MFI. To this end, the following ordinary least squares model is
estimated to investigate the impact of governance attributes on the financial perfor-
mance of an MFI:
OSSi =𝛼 + 𝛽1 ln BSZi + 𝛽2 EDBi + 𝛽3 PEBi + 𝛽4 FDBi + 𝛽5 FCEOi + 𝛽6 FCFBi
+ 𝛽7 CEODi + 𝛽8 OHi + 𝛽9 ln SZEi + 𝛽10 ln RISKi + 𝜀i

where, OSS = Operating Income divided by the Total of Financial Expense, Loan-

loss Expense, and Operating Expense, BSZ = Total Number of Members in the
Board, EDB = Percentage of Board Members with a College Degree, PEB = Per-
centage of Board Members with Prior Experience in an MFI, FDB = Percentage
of Female Members in the Board, FCEO = 1 if the CEO is Female, 0 otherwise
(Dummy Variable), FCFB = FCEO times FDB (Interaction Variable), CEOD = 1 if
the Chair and the CEO of a MFI are the same person, 0 otherwise (Dummy Varia-
ble), OH = Number of Years since Establishment of MFI, SZE = Total assets, in Mil-
lion Taka, RISK = Loan-Loss Expense divided by Total Loan Outstanding, ε = Error
term.
The variance inflation factor (VIF) ranges from 1 to infinity and VIFs greater
than 10 are generally seen as indicative of severe multicollinearity. We compute the
VIFs for all the independent variables in our regression model and since none of
them indicates a VIF greater than 10, we rule out any serious problem of multicol-
linearity in our model. The range of VIF runs from 1.15 to 6.73, where all variables
except for FCEO (which has a VIF equal to 5.45) and FCEB (which has a VIF equal
to 6.73) have a VIF value below 2. To test for the null hypothesis of homoscedastic-
ity, the Breusch–Pagan test yielded a p value of 0.70, while the Cameron-Trivedi test
yielded a p-value of 0.16. Hence, we can rule out the presence of heteroskedasticity
in our model.
The results from our estimated regression model are reported in Table 3. Board
size does not have any statistically significant effect on the performance of MFIs.
While the coefficient of educational background of a board member has the wrong
sign and the coefficient of prior experience of a board member in microfinance has
the correct sign as per expectation, neither of these two coefficients are statistically
significant at any reasonable level.
Our estimated results indicate that an increase in the percentage of female
composition of board members has a negative impact on financial performance.

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Table 3  Financial performance: ordinary least squares model

Variable Expected sign and impact Coefficient
on sustainability

Intercept 1.54* (3.53)

Board size (BSZ) ± − 0.02 (− 0.16)
Educational background of board members (EDB) + 0.07 (0.49)
Prior MFI exposure of board members (PEB) + − 0.03 (− 0.33)
Female in the board (FDB) ± − 0.52** (− 2.75)
Female CEO (FCEO) ± − 0.60* (− 3.34)
Female CEO with female directors on board (FCFB) + 1.32* (3.52)
CEO-CHAIR duality (CEOD) + 0.31** (2.88)
MFI age (OH) + 0.06 (0.60)
MFI size (SZE) + − 0.01 (− 0.49)
MFI risk (RISK) − − 7.18* (− 5.38)
Adjusted ­R2 36.10%
F-statistic 4.79*

t-statistics are reported in parentheses below the coefficient estimates

*
 Indicates significance at 1% level, **indicates at 5% level and ***indicates significance at 10% level

Approximately two-thirds of all borrowers in the microcredit industry are female,

and hence increased presence of female members in the board may result in over-
emphasis on better outreach that may often adversely affect financial performance.
Often, as in the case of Grameen Bank, a certain number of member borrowers (who
are often female) are included in the board for representation. The negative impact
of increase in female board members on performance may be an indirect impact of
such inclusion.
The management literature has empirical evidence of a negative impact of female
CEO on financial performance of the firm. Over time, some studies have also shown
that having a female CEO does not have any statistically significant impact on the
performance of a firm; the latter result seems intuitively more palatable. Keeping
these findings in view, we are not surprised by the statistically significant negative
coefficient on female CEO.
Diversity plays an important role in the performance of a firm and in the case
of microfinance where large majority of customers are female, diversity can be
expected to play in even more important role. Woolley et  al. (2010) provided evi-
dence that the collective group intelligence was higher when (a) social sensitivity
of the individual group members was higher, (b) there was a more even distribu-
tion in the conversation between individual group members, and (c) there were more
women in the group. McKinsey and Company (2007) has looked at the impact of
gender diversity in the workplace and identified nine key criteria: (i) control and
corrective action, (ii) efficient communication, (iii) expectations and rewards, (iv)
individualistic decision making, (v) inspiration, (vi) intellectual stimulation, (vii)
participative decision making, (viii) people development, and (ix) role model,
that characterize an effective leader. It argues that women apply five (expectations

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Eurasian Econ Rev

and rewards, inspiration, participative decision making, people development, and

role model) of these nine leadership behaviors more frequently than men do. We
believe that a larger percentage of female members in the board, reinforced by a
female CEO would indirectly represent better diversity in management and govern-
ance of an MFI. Hence, the positive impact of the interaction variable suggests that
increased overall diversity is not only a socially desirable outcome, but it also has a
positive impact on the financial performance of MFIs.
Galema et al. (2012) find evidence of negative impact of powerful CEO on the
performance of MFIs that are nongovernmental organizations. Identifying CEOs
who also serve as the chairperson of the board as powerful CEOs, we find evidence
that financial performance of MFI with powerful CEOs have a better operational
self-sufficiency level than MFIs with separate CEO and chairperson. This result is
statistically significant at the five percent level. PKSF does not require the CEOs of
its partner MFIs to adopt the role of the chair of the board, nor does it explicitly pro-
hibit such provisions. PKSF or other donor agencies may find it preferable to adopt
of policy of powerful CEOs to improve the future outcome of the MFIs since such a
dual role can result in effective policies. Our results are in line with similar finding
by Kang and Zardkoohi (2005). An important explanation for such a result can be
the fact that in many cases, MFIs where the CEO and the chairperson is the same
person, it is also true that the same individual played an important role in the forma-
tion of the MFI, and hence the person was more committed to its success.
We used age of an MFI to measure the impact of learning on performance, and to
our knowledge, so far no study has found its effect on performance or outreach to be
statistically significant. The estimated coefficient exhibits the expected positive sign,
but it is not statistically significant. The estimated coefficient of size, measured by
total assets, is negative but it is not statistically significant.
As expected, the risk factor measured by loan loss reserve ratio, has a statistically
significant negative impact on financial performance of MFIs.

5 Conclusion

Given the paucity of detailed information on financial statement and extensive infor-
mation pertaining to governance, this study made a relatively successful attempt
at collecting complete information on 68 smaller MFIs. The scope of our current
study was limited to documenting the impact of board and CEO characteristics on
the performance of an MFI. To this end, our results show that powerful CEOs do
have a positive impact on financial performance of MFIs and gender diversity in
board has a positive impact when it is also augmented by gender diversity in man-
agement. However, we were not able to establish any statistically significant correla-
tion between financial performance and board size or the other attributes of board
members.
Despite the large variation in the size of the MFIs in our sample, size does not
have any statistically significant impact on performance. The size of the board does
not appear to have any effect on performance either. An important aspect of our
study was to analyze the role of powerful CEOs for the MFIs in our sample and we

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find that powerful CEOs have a positive impact on the financial performance. Future
research is required to investigate the effect of powerful CEOs on social outreach of
MFIs. If CEO compensation or reputation is tied to expansion of branches or finan-
cial performance instead of outreach, a powerful CEO may be able to manipulate
the distribution of loan disbursements to ensure better financial performance at the
expense of lesser outreach.
The general consensus in the literature is that diversity in board and management
can lead to better governance and better financial performance but the impact of
a female CEO has been either shown to be negative or statistically not significant.
Our conjecture was that the combination of female board members and a female
CEO would capture the unobserved nascent diversity in management. Part of the
weakness of our results can be directly attributed to the relatively small size of our
sample, which can be easily overcome in the future by including a larger number of
MFIs that also includes ones that are not partner organizations of PKSF.
More extensive analysis can be carried out as more detailed data is available over
a larger number of MFIs. We are already in the process of collecting more detailed
governance related data from a much larger sample of MFIs, including ones that are
not partner organizations of PKSF. This will allow us to carry out a more in depth
analysis of various aspects of governance, especially pertaining to the variation in
the governance role played by different set of stakeholders. Furthermore, it will
allow us to assess the impact of special relationship that the partner organizations
have with PKSF in contrast to the MFIs which are not PKSF partner organizations.
Future research can also look at the upward accountability in terms of an MFI’s
relationship with its donors, foundations, apex funding agencies and governments.
Downward accountability in terms of its relationship with its members and the com-
munity served could be analyzed by member and local representation in the execu-
tive board. Finally, it would be important to analyze how outreach measures of an
MFI are correlated with governance measures (such as board structure, board com-
position, and board quality) and management structure (such as quality and diver-
sity). While the lack of data on depth of outreach does not allow us to include the
analysis in our current study, analyzing the effect of female CEOs on the depth of
outreach is part of our future research agenda.

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