Capital Structure, Ownership Structure and Banks' Financial Performance: Evidence from the Gulf Cooperation Council Countries

Abstract

<p>This thesis addresses the association between banks’ capital structure, ownership structure and financial performance in the Gulf Cooperation Council (GCC) countries. It concentrates first on the simultaneous relationship between banks’ capital structure and financial performance, and then on the moderating effect of ownership concentration on the relationship between banks’ financial performance and capital structure. These relationships have been researched elsewhere in the world and reported in the literature, yet there is limited and inconclusive evidence for how these relationships operate in financial institutions, particularly in developing countries, such as the GCC nations. This study uses all listed banks in the GCC countries from 2009 to 2017 to examine and clarify the nature of these relationships in that regional economic bloc.</p> <p>To explore the simultaneous relationship between banks’ capital structure and financial performance, the two-stage least squares (2SLS) method is employed as the main method for analysis, while the generalised method of moments (GMM) serves as an additional econometrics method to verify the main findings’ robustness. The results reveal that banks’ capital structure, measured by leverage (book and market), significantly and negatively affects their financial performance and vice versa. Results also illustrate that capital ratio, which was used as an inverse measure of leverage, significantly and positively influences banks’ financial performance. As well, banks’ financial performance has a positive and significant effect on banks’ capital ratio. Thus, an inverse ‘bi-directional’ causality relationship between banks’ capital structure and performance is documented in both Islamic and conventional banks in the GCC, consistent with pecking order theory and the franchise value hypothesis. These findings are consistent with prior empirical studies that document a simultaneous relationship between banks’ capital structure and performance. The results of this study enumerate that Islamic banks are more reliant on capital ratio and less dependent on leverage, compared to their counterpart conventional banks in the GCC countries.</p> <p>To investigate the effect of ownership structure (measured as ownership concentration) on the relationship between banks’ performance and capital structure, the findings reveal that ownership concentration does play a key role in banks’ performance–capital structure relationships. The results demonstrate that, when book and market leverage serve as capital structure measurements, ownership concentration significantly and positively moderates the relationship between performance and leverage. It means that when both concentration and performance interact, the negative relationship between banks’ performance and leverage will weaken. In contrast, when capital ratio is used as an inverse measure of leverage, results show that ownership concentration negatively and significantly moderates the relationship between banks’ performance and capital ratio. Thus, ownership concentration does weaken the positive effect of banks’ performance on banks’ capital ratio. Empirical results of this study reveal that, in the GCC countries, high ownership concentrated banks tend to have high leverage and less capital ratio, regardless of their profitability.</p> <p>The study contributes to a growing body of literature on the relationships between banks’ capital structure, ownership structure and financial performance in an emerging market economy. As a pioneer of this type of study in the GCC countries, the findings documented in this thesis provide new insights about: firstly, the interaction between capital structure and bank performance; and secondly, the moderating effect of ownership concentration on capital structure and performance relationship in developing countries. Moreover, the application of advanced econometric methods offers a way to effectively analyse the endogeneity problem, which has been significantly observed in finance-related research, particularly in studies on capital structure, which could affect the results. The findings of this study are especially important to policymakers and other stakeholders aiming to achieve an ideal bank capital structure system. It also helps develop a better understanding of the role played by large shareholders in banks’ capital structure decisions and financial performance relationships.</p>