Impact of corporate governance on risk : emperical evidence from insurance and takaful operators in Malaysia

Abstract

Over the past couple of decades, the failure of big corporations especially the financial institutions have brought the issue of ineffective and weak corporate governance in the corporate world. Especially, during the last decade the collapse of big corporations across the globe like Merlyn Lynch, American Insurance Group (AIG), Enron, Lehman Brothers and so on, have made the issue more acute. As a matter of fact, most of these corporate failures took place in banking and finance industry (insurance industry is one its components). With a growing complexity of the banking and financial institutions’ operations, these corporations are exposed to enormous amount of risk; especially the insurance industry, the very nature of which is taking risk by providing protection to individuals and businesses against various risks they are exposed to. Due to this reason it has become essential to conduct study on these institutions’ leadership (that is, board of directors) to find out the effectiveness and ability of the board in managing enterprise resources efficiently and protecting these corporations from any catastrophe. Therefore, this research paper intends to study the corporate governance (more particularly related to board of directors) role in managing risk of insurance and takaful companies in Malaysia. More precisely, it is to find out the extent to which corporate governance impacts risk of these financial institutions. In order to study this relationship mainly four components of corporate governance have taken. These components are: separate role of board Chairman and Chief Executive Officer (CEO), frequency of board meetings, percentage of independent non-executive directors and board size. On the other had three areas of risk are analysed, that is, liquidity, underwriting and operational risk. For the purpose of quantifying these risks, financial ratios have been taken. In regards to the sample data, total 25 companies were shortlisted (including both conventional insurance and takaful) out of which 21 companies have been analysed. The sample data was collected from 2007 to 2011. As the sample data was parametric (panel data) in nature, therefore the empirical model selected for this study was regression analysis. The empirical findings showed that selected components of corporate governance have significant impact on risk of insurance and takaful companies. It means any change in these components of corporate governance, whether positive or negative will either increase or decrease the risk of insurance and takaful company significantly.