The Outcome of Politically Connected Boards on Commercial Bank Performance in Malaysia

Abstract

This study draws on upper echelon theory (Hambrick & Mason, 1984) to examine whether the demographic
characteristics of politically connected board members affect commercial bank performance in Malaysia.
Interaction effect between age, ethnicity, and the political connections of board directors demonstrates that
commercial bank performance depends on the presence of non-ethnic minority elder directors who have political connections with higher government authorities. The findings have important implications for corporate
governance in commercial banking sectors in Malaysia. Although bank performances are impressive, the
valuable human capital resources of board members who have diverse skills and backgrounds remain
underutilized. Improving corporate governance performance through better use of human capital resources is of
paramount importance for an effective business strategy that facilitates creativity and innovation. Government-Linked Companies (GLCs) should reengineer strategies to support the private sector, instead of crowding out private investment.

Full text

Modern Applied Science; Vol. 7, No. 1; 2013
ISSN 1913-1844 E-ISSN 1913-1852
Published by Canadian Center of Science and Education
35
The Outcome of Politically Connected Boards on Commercial Bank
Performance in Malaysia
Wai-Ching Poon1, Angeline Kiew-Heong Yap2 & Teck-Heang Lee2
1 School of Business, Department of Economics, Monash University Sunway Campus, Jalan Lagoon Selatan,
Bandar Sunway, Selangor, Malaysia
2 Department of Business Studies, Help University, Kompleks Pejabat Damansara, Jalan Dungun, Kuala Lumpur,
Malaysia
Correspondence: Wai-Ching Poon, School of Business, Department of Economics, Monash University Sunway
Campus, Jalan Lagoon Selatan, Bandar Sunway, Selangor 56150, Malaysia. E-mail:
Poon.wai.ching@monash.edu
Received: November 2, 2012 Accepted: November 26, 2012 Online Published: December 12, 2012
doi:10.5539/mas.v7n1p35 URL: http://dx.doi.org/10.5539/mas.v7n1p35
Abstract
This study draws on upper echelon theory (Hambrick & Mason, 1984) to examine whether the demographic
characteristics of politically connected board members affect commercial bank performance in Malaysia.
Interaction effect between age, ethnicity, and the political connections of board directors demonstrates that
commercial bank performance depends on the presence of non-ethnic minority elder directors who have political
connections with higher government authorities. The findings have important implications for corporate
governance in commercial banking sectors in Malaysia. Although bank performances are impressive, the
valuable human capital resources of board members who have diverse skills and backgrounds remain
underutilized. Improving corporate governance performance through better use of human capital resources is of
paramount importance for an effective business strategy that facilitates creativity and innovation.
Government-Linked Companies (GLCs) should reengineer strategies to support the private sector, instead of
crowding out private investment.
Keywords: Malaysia, board characteristic, firm performance, politically connected, commercial banks
JEL Classifications: L25, M21
1. Introduction
The association between the board of directors and firm performance is not easy to explain using a single
governance theory (Nicholson & Kiel, 2007) (Note 1). Hambrick and Mason’s (1984) upper echelons theory has
drawn on the disciplines of organizational behaviour and strategic management. The assertion of upper echelons
theory identifies observable demographic characteristics, experiences, values, personalities, or strategic
behaviours that influence management’s value-added decision making styles, profitability variation and firm
performance in response to environmental changes. Using the social identity principle (e.g.,
attractive-selection-attrition), Tajfel and Turner (1986) and Terjesen et al. (2009) explore how individuals seek to
surround themselves in specific groups (so-called “groupthink”) who share similar demographic profiles,
perceptions and principles, which are then reinforced in intra-group communication. Therefore the portrayer of
observable demographic profiles and the compositions of upper echelons (top executives or top management team)
are determinants of strategic choices and the firm’s performance outcomes (see Bantel & Jackson, 1989; Boeker,
1997).
Diverse human capital (Carter et al., 2010), valuable resources and knowledge of board of directors (Hillman et al.,
2000; Jackling & Johl, 2009) affect board performance. Within the context of corporate governance, firms act as a
socially cohesive group (Westphal & Zajac, 1995) to channel the human capital (Kresner, 1988) and social capital
(Pfeffer & Salancik, 1978) of board directors to facilitate advice, information, legitimacy, communication, and
power sharing. Demographic diversity may affect how boards govern their firms, and may influence group
decisions. We believe that board diversity increases creativity and innovation, produces a more effective
problem-solving approach, enhances the effectiveness of corporate leadership, and promotes more effective global

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36
relationships (Carter et al., 2003), and facilitates information exchange, discussion and group performance (Kang
et al., 2007). We argue that resource dependency, which focuses on access to resources and preferential treatment,
usually shows a positive sign.
Political connections are highly relevant in emerging markets. Malaysia is an appealing setting in this study for
various reasons. It is a multi-ethnic and cultural country with concentration of ownership in the hands of a few
politically connected Government-Linked Companies (GLCs). Ownership of Public-Listed Companies (PLCs) is
identifiable along ethnic lines (Yatim et al., 2006). There are three main indigenous groups in Malaysia, namely
Malays (Bumiputras), Chinese, and Indians. As of the 2010 census, the population of Malaysia was 28.3 million,
and of that number, 50.4% were Malays, 24.6% were Chinese, 7% were Indians, and the remaining 18% were
other natives. Each ethnic group differs economically, culturally and socially. The diverse nature of Malaysian
society has become a competitive advantage for many Malaysian firms. The issues of sustainability and
inter-generational equity are of great concern in order to achieve the Malaysian government’s vision to achieve
developed nation status by 2020. We argue that demographic incidents of shareholder activism significantly
impact politically connected directors’ decisions that ultimately affect commercial bank performance. To what
extent demographic diversities of politically connected directors influence the performance of the firm, both
observable demographic diversity (e.g., age, ethnicity and qualification) and non-observable cognitive diversity
(e.g., education, experience, knowledge, values, perception, affection and personality characteristics), is the focus
of our interest.
We have selected commercial banks in this study due to differences in the regulatory requirements by the Bank
Negara Malaysia (BNM, the Central Bank of Malaysia). Within the context of the commercial bank industry (Note
2), incidents of shareholder activism by local institutional shareholders often take place. If the government has a
direct controlling stake in firm X, this allows them to appoint the Board of Directors (BOD) in firm X.
Consequently the politic-based BOD of this firm may react in favour of the objectives of government policy and
may distinctively influence the firms’ performance. For instance, Employees Provident Funds (EPF, the
government agency social security and pension funds), and Permodalan Nasional Berhad (PNB, the government’s
national capital corporation) held 18.58%2 direct control of the market in the year 2009 in Malayan Banking
Berhad (MBB, the largest local financial group), with EPF: 11.95% and PNB: 6.63% stakes. There were also
substantial indirect stake controls of 50.38% by Skim Amanah Saham Bumiputra (ASB, one of the government
supported Bumiputra agencies) in MBB. This controlling stake exacerbated the crowding out effect and further
aggravated the voting rights of minority investors. It may bring some destructive outcomes in the long term, and
threaten moving towards nationalization instead of internationalization. Therefore, a study that focuses on the dark
side of political connections, emphasizing over-embeddedness and subjective shareholder expropriation is of
value.
Studies of the composition of boards using upper echelon theory in the commercial banking sector have not
received much attention. This study sheds light on the performance of commercial banks’ by examining the
demographic diversity of the politically connected upper echelon BODs within the “groupthink”. We use a fixed
effect panel approach from 2000-2009 and test a lag effect on firm performance that is uncommon in past studies.
Results reveal a positive association between age, size of ethnic minority, qualification (the observable
demographic diversity), and experience (the non-observable cognitive diversity) of the politically connected
directors on firm performance. Interaction effects show that performance gains are greater for elder politically
connected non-ethnic minority directors. This paper shows that the independence of politically connected
directors on decision making has been compromised. The contribution of this study is to expand the relationship
between political connectedness of the governance structures among Malaysian firms, their upper echelons
characteristics, and firm performance to address the corporate governance challenges as important drivers for
decision making in the context of multi-ethnicity and cultural emerging economy.
The remainder of this study is organized as follows. The second section provides the applicable theories and
hypotheses on the relation between board diversity and performance of the firm. The third section discusses the
research methodology, sample, data and variables, followed by a section on model specification. The fourth
section discusses the results. Finally, limitations are identified, and implication and concluding remarks in
section 5.
2. Literature Review
2.1 Politically Connected Directors
A politically connected firm could be a group of large shareholders, such as the CEO, president, vice president,
chairman or secretary, who control at least 10 percent of voting share, and are connected with a politician, party,

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37
minister, or Parliament member (Faccio, 2006). The extant literature documents an association between
politically connected firms and Malay ownership corporations (Faccio, 2006; Fraser et al., 2006; Gomez & Jomo,
2002; Gul, 2006; Johnson & Mitton, 2003), but opinions about the link between political connections and firm
performance have been mixed. Some studies found a positive and significant relationship i) between Malaysian
firm leverage and political patronage (e.g., Fraser et al., 2006), and ii) between politically connected firms and
firm performance (e.g., Fisman, 2001); while others form a different conclusion (e.g., Fan et al., 2007; Chizema
& Kim, 2010).
Empirical evidence has proved that a bank with politically connected high-ranking officials enrich the business
conditions by permeating many barriers (Baum et al., 2008). Politically connected firms receive preferential
treatment from government in the form of cheaper sources of funding, favourable tax treatment and access to
restricted licenses (Mohamad et al., 2007; Niessen & Ruenzi, 2010). Since the implementation of New Economic
Policy in 1970, the non-Bumiputra businessmen have actively solicited and developed ties with politicians or
other special interest groups to influence the allocation of financing (Johnson & Mitton, 2003) and to extract
rents from government (Olson, 1982). Banks with affiliated political entity connections may obtain a licence to
carry out transactions for governmental bodies and public authorities at rents set below-market-rate loans.
Politically well-connected firms enjoy insider governmental informational advantage and find it relatively easier
to win tenders for privatization projects and handling rights for the transactions of governmental institutions that
likely increase the profitability of the connectedness firms (Faccio, 2006; Fisman, 2001; Roberts, 1990).
Therefore, we hypothesize that:
Hypothesis 1: Having a higher percentage of politically connected directors on board is positively related to
bank performance, all else being constant.
Johnson and Mitton (2003) found capital control in September 1998 primarily benefited firms with strong ties to
the Malaysian Former Prime Minister. Furthermore, some evidence has suggested that politically connected
firms were more likely to be rescued from financial turmoil than non-connected peers (Johnson & Mitton, 2003;
Faccio, 2006). However there were adverse effects on politically connected firms at the early stage of the
financial crisis when government cut the subsidies (Johnson & Mitton, 2003). Furthermore, Mitchell and Joseph
(2010) also found that politically connected financial firms performed poorer after the removal of capital
controls. The firms of politically connected directors performed poorly due to low financial transparency
(Bushman et al., 2004), low professionalism and weak governance (Fan et al., 2007), and incompetent operation
as the result of cronyism (Gul, 2006). These findings imply that politically connected firms have a higher
probability of receiving government bailouts (Faccio et al., 2006). Therefore, we posit that:
Hypothesis 2: Firms that have had high levels of political-connectedness over the later five years performed
poorer than the previous years, all else being constant.
2.2 Age of Directors
The age and tenure of the directors “may determine his or her effectiveness in managing the firms” (Cornett et
al., 2008, p.360). Alderfer (1986) argues that top board members with little experience may limit the
effectiveness of firm, as it takes time to gain an in-depth knowledge of the firm and suggests that the more senior
(or the longer the tenure of) the directors, the more likely their knowledge of the industry enhance firm
performance. Age diversity of board members may be considered from various perspectives. Kang et al. (2007)
believe that young board members are more energetic and are therefore more likely to aim for a successful future;
middle board members are suitable to hold important positions in companies because they have the ability to
integrate new ideas and confidence when making decisions; and senior board members can share their wisdom
by giving valuable experience to management and evaluating decisions more accurately. These studies suggest
the more senior the board members and the deeper the knowledge of the firms, the better the firm’s performance,
and hence a senior politically connected director may positively impact firm performance. We also examine the
interaction term to test whether bank performance changes for elder politically connected directors. Based on
these arguments, we posit that:
Hypothesis 3: The age of directors is positively related to bank performance, all else being constant.
Hypothesis 4: The elderly politically connected directors are positively associated with firm performance, all
else being constant.
2.3 Ethnicity of Directors
Theories from interdisciplinary sources provide a relationship between the ethnic board diversity and firm
performance. However, the empirical evidence on this link is mixed. Haniffa and Cooke (2002) examine the

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relationship between board composition, culture and voluntary disclosure in Malaysia and conclude that Malays
are less professional and secretive, and more uniform and conservative in providing disclosures, when compared
to Chinese. In contrast, Ramasamy et al. (2007) claim that Malay CEOs showed higher corporate social
performance than Chinese CEOs. Carter et al. (2010) examines the relationship between ethnic minority
directors in a sample of U.S. boards and firm performance using fixed effect single regression equation, and they
find evidence of a positive and significant relationship between the number of ethnic minority on board and
return-on-asset (ROA), but no significant relationship is found between ethnic minority director and financial
performance. Nevertheless, Erhardt et al. (2003) reveal a significant positive relationship between ethnic
minority on both ROA and return-on-equity (ROE) for U.S. firms. Carter et al. (2003) also find a positive and
significant relationship between ethnic minority directors on the board and Tobin’s Q. Zahra and Stanton (1988),
however, reveal no relationship between ethnic minority on the board and firm performance for U.S. firms.
Based on Carter et al.’s (2010) and Adams and Ferreira’s (2009) conjectures, we argue that ethnic minorities
promote board independence because a board which has a diverse ethnicity background might be a more active
board in considering issues that are not considered by a homogeneously composed board. We extend these
studies by using an interaction term to examine whether bank performance changes for the elderly, ethnic
minority directors with political connections. Therefore, we state the following hypotheses:
Hypothesis 5: The number of ethnic minority directors on the board is positively associated with bank
performance, ceteris paribus.
Hypothesis 6: The elderly politically connected ethnic minority directors change firm performance, all else being
constant.
2.4 Qualifications of Directors
The Malaysian Code on Corporate Governance (MCCG) (Revised, 2007, p.11, Note 3) recommends that all
directors should be equipped with talent, proficiency, and know-how to demonstrate the credibility and
accountability of the management team and to promote the corporate image (Haniffa & Cooke, 2002). Higher
education of top management directors in organizational contexts is positively related to receptivity to
innovation, creativity, and better strategic decision making (Bantel, 1993; Becker, 1970). Therefore innovation
has become a key firm strategy to gain competitive advantage (Hitt et al., 1996) and the qualifications of
directors are positively related to firm performance (Morbey, 1988). This relationship suggests that education
level and a diverse functional background are positively related to organizational performance (Bantel, 1993;
Haniffa & Cooke, 2002), especially in business-related background such as in Economics, Law, Marketing,
Accounting, Management, or Finance. In addition, Gray (1988) and Wallace and Cooke (1990) suggest that
higher education level may increase demand for political awareness and corporate accountability. Hence, less
qualified directors are possibly less effective than directors with business qualifications (Ferreira, 2009).
Drawing on this strand, we put forward the seventh hypothesis:
Hypothesis 7: The qualification of directors with business backgrounds increases bank performance, all else
being constant.
2.5 Experience
The “groupthink” cohort is a group of top managerial teams who have some relevant data in common such as
socioeconomic background, employment and industry, societal experience, functional track, and training, and
have been imprinted on its members and shaped their values and perceptions. While directors are chosen based
on “the old boy” network or “people like us”, they may have their own priorities in decision making, but the
politically connected directors have to support the agenda politically if the director perceives his adherence to the
continued of directorship tenure with a firm. It is generally believed that homogeneous managerial teams,
manifested as cohesiveness and insularity, will make strategic decisions quicker than heterogeneous teams
(Hambrick & Mason, 1984). Janis (1972), however, argues that homogeneity leads to inferior decision making
(cited in Hambrick & Mason, 1984). In a stable environment or routine situation, problem solving is best
handled for a homogeneous group, but in a chaotic environment, problem solving is best managed by a
heterogeneous group since diversity of skill allows more airing of alternatives (Filley et al., 1976). Therefore, the
following hypothesis is posited:
Hypothesis 8: The degree of peripheral-function experience of directors is positively related to the firm’s
performance, all else being constant.

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3. Sample, Variables and Model
3.1 Sample and Variables
The sample consisted of an unbalanced panel of all post-merged domestic commercial banks in Malaysia from
2000-2009 (Note 4). Data was extracted from the companies’ websites, companies’ Annual Reports, and
Bankscope. Panel data analysis was employed to avoid unobservable heterogeneity problems in empirical
analyses.
Dependent Variable. We measured firm performance using ROE, a commonly used accounting-based measure
of firm performance. Following Fich and Shivdasani (2006), we did not use Tobin’s Q because if financial or
liquidity constraints cause some firms to under invest, the potential value of unexploited investments may lead to
a high marginal Tobin’s Q. If underinvestment is pervasive, formulation would erroneously treat a high
market-to-book ratio, which indicates good governance. We obtained the data on ROE from Bankscope.
Explanatory variables. We define politically connected directors (POL) as the percentage of directors serving as
current or former members of a political party, or current or former delegates from the ruling government (Fan et
al., 2007; Niessen & Ruenzi, 2010). Alternately POL could be defined as informal ties between Malaysian
politicians and firms run by Malay, Chinese and Indian (Gul, 2006). We measured age (AGE) as tenure in years
held by directors. Director age captures the level of expertise built up by the top executive regarding the
organization (Alderfer, 1986; Cornett et al., 2008). We expected that senior or longer-tenured directors were less
likely to adversely affected performance. Ethnic minority (EM) was measured using the percentage of minority
directors on the board (i.e., the Chinese and Indian), while qualification (QUA) measures the percentage of
directors with qualifications in business backgrounds (i.e. either in Economics, Law, Marketing, Accounting,
Management, or Finance). Experience (EXP) measures the percentage of directors who have experience in the
banking industry. To allow for the possibility of partial adjustment to changes in other variables, we included a
lagged dependent variable in the performance equation. The one-year lagged firm performance [ROE(-1)] was
employed as stakeholders use previous year firm performance to estimate future performance. It is expected that
higher value creation may lead them to expect satisfaction of their interests (Delgado-Garcia et al., 2010).
Following Bhagat and Bolton (2008), we used the lagged-one value of ROE as an instrument in our estimations,
but we lost data due to the one-year lag. To measure whether there was an association between age,
political-connected directors and firm’s performance, an interaction term POL*AGE was tested. To measure
whether there was an association between age, ethnic minority and political-connected director on the firm’s
performance, another interaction term POL*AGE*EM was used. Other interaction terms, such as
POL*AGE*EXP and POL*AGE*QUA, were also tested, but results were insignificant (results are not reported
here).
Control variables. We controlled for firm and director characteristics through firm fixed effects regression
methods. The effects of size were controlled for using the natural log of total assets, as it is related to market
returns (Fama & French, 1992). We measured firm size using a natural log of the total assets of the firm. We
controlled for board size, measured as the natural log of the number of directors elected on the board. Study
considering the effect of board size and financial performance has developed contradictory arguments. Past
studies have predicted a positive relation between board size and financial performance (e.g. Dalton et al., 1998;
Forbes & Milliken, 1999; Jackling & Johl, 2009). Proponents of this view argue that larger boards provide a
larger pool of information, and greater depth of intellectual knowledge may improve the quality of strategic
decisions that in turn translate into better performance. While larger firms are argued to have better corporate
performance, smaller firms are expected to be less controlled in the distribution of firm value (Delgado-Garcia et
al., 2010), thus reducing firm performance. Nonetheless, evidence supports the assertion that larger boards
encumber communication, coordination and eventually influence the decision-making competencies of the board
(Cornett et al., 2008; Jensen, 1993), and smaller boards are more effective monitors than large boards (Yermack,
1996), suggesting that board size is inversely related to performance. Firm performance may drop as firms grow
older (Loderer & Waelchli, 2010) and older firms tend to be larger after merger and acquisition; takeover
hazards could increase with firm age, while firm size and age are negatively related to takeover hazard (Palepu,
1986). Therefore we controlled for firm age, measured as the number of years since the firm's first incorporation.
The fiscal year-end was controlled for using a dummy variable, with a value of 1 for firms with a 31 December
fiscal year-end and zero otherwise (Gul, 2006). Most firms in the sample had a December year-end and all
commercial banks had been audited by large audit firms.

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3.2 Model Specification
The empirical specification aims to explain the pace in commercial banks’ performance using a wider
demographic board characteristic. The regression used for testing was as follows:
it 0 1 it 2 it 3 it 4 it 5 it 6 it 1
7 8 9it10it11it12itit
PERF POL AGE EM QUA EXP PERF
POL* AGE POL* AGE * EM FS BS FA FY
     



      

(1)
where i equals each firm, t equals time, and it

is the random error for each observation, which is independent
and identically distributed with mean zero and variance σ2.
P
ERF is the financial performance of the firm
measured by commonly used ROE in governance; POL is the percentage of political connected directors in the
board;
A
GE is the average age of the director; EM is a measure of percentage of ethnic minority on board,
i.e., total number of Chinese and Indian directors on the board; QUA is the percentage of qualified directors;
it 1
P
ERF is the lagged value of ROE; EXP is the percentage of directors with prior experience in banking
sector; POL* AGE and POL* AGE* EM are two interaction terms;
F
S is firm size, as the natural
logarithm of the total assets; BS is board size, measured as the natural logarithm of the number of directors on
the board; FA is firm age, measured as the number of years since its operation; FY is the fiscal year, as a
dummy variable of 1 if financial ended 31 December, zero otherwise.
3.3 Panel Regression Method
A linear model of Equation (1) was estimated on a pooled data sample from 2000-2009 with a constant using
fixed effect model estimation using Eview software. The general panel model is written as follows:
it it i t it
PERF X v

 
   i = 1, … , 9; t = 1, … , 10 (2)
where it
P
ERF denotes the dependent variable (ROEit) for country i at period t,

is kXi coefficient vector,
and it
X is the i-th observation on the k number of explanatory variables [k=12, see Eq.(1)]. The term i

is the
cross-sectional unit residual, and the term t
v is the unobservable time specific residual to account for firm
effect and period effect, respectively. The term it

is the usual error term after removing individual and period
effects. These residuals are components of the error term from Equation (1) where it i t it
ev


.
Panel regression offers flexibility in modelling heterogeneity in country-specific behaviour, and temporal
changes in the country’s macroeconomic condition. Pooling both time series and cross-section data provides
more information, greater variation, less collinearity, greater degree of freedom and more efficiency (Gujarati &
Porter, 2009). Fixed-effects models are not without their disadvantages. The constant covariates within
individuals cannot be measured in this setting. The fixed effects model allows the unobserved firm effects to be
correlated with the deterministic variables. If there is a correlation between the fixed effects and the determinants,
the random effects model is preferred. The variance component of the dependent variable can be decomposed
into:
2222
yv




If 2


and 2
v

are zero, Equation (2) is merely a simple pooled regression (with no firm or period effects). If
the firm and period effects are insignificant, both i

and t
v are zero; in this case OLS provides consistent and
efficient estimates for both

and

.
4. Results and Discussion
4.1 Descriptive Statistics and Correlation Matrix
The Malaysian BODs in the commercial banking sector comprised of 6-15 directors, headed by an independent
male “chairperson” and included not more than three female directors. The mean age of BOD is 58.99. Table 1
reports descriptive statistics for all variables. The measures of firm performance indicate that the firms were on
average financially sound over the 10 years period. The log of return of equity (ROE) is 14.54, which suggests
the net income was higher than the book value of total equity of the firm. The average number of ethnic minority
directors (EM) on board was 44.89%, with 22.34% being politically connected directors (POL), 63.77% being
directors with qualifications (QUA) in business, and 70.76% of the directors having background experience
(EXP) in the banking industry over the sample period. For 78% of the sample firms the fiscal year ended on
December 31. The log of the total assets of the firms (FS) is 10.83, with a board size (BS) of 2.29. Table 2
provides the bivariate correlation matrix for variables. The correlation coefficients between the measures of
performance and board characteristic are within the acceptable ranged from 0.0008 and 0.6492. These
coefficients confirm the choice of both deterministic variables and instruments. We found an inverse relationship
for the percentages of ethnic minority and ROE.

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4.2 Unit Root Tests
Augmented Dickey Fuller (ADF) - Fisher chi-square test, PP Fisher, and Breitung t-stat unit root tests were
employed to examine stationarity of the series. The results of the unit root test are reported in Table 3. Results
reveal that all series are I(1) variables, and the unit root test shows that on average pooled data of all variables
are stationary at first difference.
Table 1. Summary statistics, annual data (2000-2009)
Variable Definitions and Unit of measurement Mean S.D Min Max
ROE The log of total income divided by total equity. 14.54 11.46 -63.02 43.88
POL Number of political connected directors (%) 22.34 15.74 0.00 83.33
AGE Average age of the director = Sum of the ages of all directors
divided by the total number of directors (Year)
58.99 4.04 50 67.30
EM Total number of minority (Chinese and Indian, i.e.,
non-Bumiputra) directors on the board (%)
44.89 25.70 0.00 90.91
QUA Total number of directors with qualification either in Law,
Business and Management, or Economics (%)
63.77 26.36 12.50 100.00
EXP Number of directors who have background experience in
banking sector (%)
70.76 36.72 0 100.00
FS Firm size – The natural log of the total assets of the company. 10.83 0.78 9.12 12.38
BS Board size – The natural log of total number of directors on
the board.
2.289 0.20 1.79 2.71
FA Firm age – The natural log of the number of years since its
operation.
21.80 19.45 3.77 48.55
FY Fiscal year as indicator variable, 1 for fiscal year ended 31
December; 0 otherwise
0.778 0.42 0 1.00
Table 2. Correlations matrix
ROE AGE POL EM QUA EXP FS BS FA FY
ROE 1.0000
AGE 0.0215 1.0000
POL -0.0541 0.3794 1.0000
EM -0.0449 -0.4017 0.0008 1.0000
QUA 0.2478 0.0357 -0.2519 0.0608 1.0000
EXP 0.2047 -0.0549 -0.0638 0.1447 0.2774 1.0000
FS 0.1890 0.5189 -0.0196 -0.3800 0.5154 0.1606 1.0000
BS 0.0999 0.0149 -0.0364 -0.0795 -0.1696 -0.209 0.1381 1.0000
FA 0.0702 0.0710 0.0550 0.2199 0.6492 0.3243 0.5181 -0.2980 1.0000
FY -0.2306 0.2019 0.4316 0.0800 -0.3702 -0.2135 -0.3123 -0.1151 -0.3699 1.0000
Notes: The table presents pairwise correlation coefficients between variables. Chinese and Indian are ethnic
minorities.

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Table 3. Results of panel data regression model
ADF-Fisher Chi-square PP-Fisher Breitung t-stat
Level
Constant
with trend
First
difference
Constant
with trend
Level
Constant
with trend
First
difference
Constant
with trend
Level
Constant
with trend
First
difference
Constant
with trend
AGE 16.302 26.891** 16.932 55.69*** -0.9574 -1.257
EM 12.054 19.75 44.843*** 79.18*** 0.9741 -1.788**
QUA 8.3521 18.52 19.611 50.53*** 0.1272 -2.118**
POL 8.8811 15.52 14.543 44.99*** 2.7084 -2.347***
ROE 17.974 41.213*** 21.764 77.57*** 0.4224 -0.299
ROE(-1) 18.007 41.808*** 26.495 74.97*** 0.5382 -0.165
EXP 8.9240 32.49** 23.662* 51.67*** -0.3945 -1.225
FS 8.248 19.416 15.108 51.52*** -0.0436 -2.629***
BS 11.554 26.658** 10.360 95.33*** -1.1116 -1.5405*
FA 18.420*** 153.39*** 165.78*** 151.91*** 4.323 -4.933***
Notes: AGE is the average age of the director, EM is the total number of minority (Chinese and Indian, i.e.,
non-Bumiputra) directors on the board (%), QUA is Total number of directors with qualification either in Law,
Business and Management, or Economics (%), POL is the number of political connected directors (%), ROE is
the natural log of return to equity, EXP is Number of directors who have background experience in banking
sector (%), FS is firm size, measured as the natural log of the total assets of the company, BS is board size,
measured as the natural log of total number of directors on the board, FA is firm age, measured as the natural log
of the number of years since its operation. The null hypothesis is that the series are non-stationary or contains a
unit root. The rejection of null hypothesis for ADF test is based on the MacKinnon critical values. Lag length
selection is based on automatic selection: SIC. Spectral estimation is based on Barlett Kernel, Bandwidth
selection is based on automatic Newey-West. *, **, and *** denote the rejection of the null hypothesis of
non-stationary at p<.10, p<.05, and p<.01 significance level. Probabilities for Fisher tests are computed using an
asymptotic Chi-square distribution. All other tests assume asymptotic normality.
4.3 Analysis
Table 4 reports the fixed effect regression models. The association between firm performance and POL, AGE,
EM, QUA, EXP is tested in both Model 1 (with no control variable) and Model 2 (with control variable - FS and
BS). By adding two interaction terms to Model 1, the interaction effects are tested in Model 3. In Model 4, we
include lag-one firm performance to Model 1 to test the past year effect on today’s performance. In Model 5, we
test all variables in Model 4 plus one interaction term to test the interaction effect between POL*AGE on firm
performance. By including the control variables to Model 5, a robustness test is carried out in Model 7. In Model
6, we include two interaction terms to test the effects e.g., POL*AGE*EM on firm performance, and lastly the
full model is tested in Model 8 (with control variables and interaction terms). The probability of the F-statistic
for the overall regression relationship for all independent variables is at least at p<.05, except for Model 7 at
p<0.1. Overall, results reveal significant and positive signs in the predicted direction for the coefficients for POL,
AGE, QUA, and EXP. The coefficient for POL is positive and significant for all models at p<.05, thereby
providing support for Hypothesis 1. There is evidence suggesting that a higher percentage of politically
connected directors on boards enhance bank performance by 3%, holding all other things constant (see Model 8).
Therefore having politically connected directors would be an important aspect of corporate performance. This
finding implicitly shows that directors representing investors’ interests or non-political professionals might
obstruct politicians’ agendas.
The study reveals age diversity is significant and positively associated with ROE for four out of eight models.
This study reveals that senior directors gain more experience and obtain adequate knowledge in banking industry,
and thus are more effective in managing the firm. However, these senior directors are compromised due to their
political affiliation. Firms with government-linked and politically connected directors need allies on the board to

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43
reinforce their objectives and policies that ultimately lead to better persuasive governance, increase
professionalism and more attractive firm performances. This finding suggests that the more senior the firm’s
director, the greater experience, wisdom and understanding of the banking industry, and the better the firm
performance. This finding provides weak evidence to support Hypothesis 3 that the age of directors is positively
associated with bank performance. Therefore our result is consistent with the assertion that age diversity
increases creativity and problem-solving capability Cornett et al. (2008) and Kang et al. (2007). Senior directors
are more conservative in pursuing a firm’s strategies and tend to focus on business activities that yield immediate
profits in the short term during their service periods, ultimately improving firm performance (see Cox, 1993; Li
et al., 2011; Milliken & Martins, 1996).
The results show a positive relationship between performance and the qualifications of directors. This finding
supports the belief that top management teams who have qualifications in business-related disciplines such as
Marketing, Management, Finance, Law or Economics, improved higher banks performance, and therefore
supports Hypothesis 7. These qualified directors chose to increase firm performance to promote corporate image,
and demonstrate accountability and credibility within the management team. On the other hand, four out of eight
models show that directors with relevant business experience are significantly and positively associated with
performance, weakly supporting Hypothesis 8.
Results, however, reveal neither ethnic minority nor past performance significantly impact firm performance.
We have no evidence to support the notion that firms with directors predominantly by Chinese and Indian
outperform the Bumiputra directors in commercial banking industry. Hence, Hypothesis 5, i.e. the assertion that
the number of ethnic minority directors on a board is positively associated with bank performance, is not
supported. The nature of the relationship between ethnic minority on the board and firm performance is merely a
public policy issue. On the other hand, there is no statistical difference when previous year firm performance is
added to Models 4-8. This finding suggests that they are more likely to be under the control of politically
connected directors for post-merging banks.
For the control variables, results reveal a positive relationship between performance and firm size at p<1. This
finding is consistent with the argument that larger firms are expected to perform better because they are able to
diversify their risks (Ghosh, 1998). In addition, directors are closely monitored by more analysts and thus they
are under more pressure to perform well (Haniffa & Hudaib, 2006). However, there is no evidence to support the
assertion that larger boards hinder communication, coordination and eventually the performance of the firm.
The coefficient of the interaction term of POL*AGE is negative and significant (e.g.,

=-0.754, p<.01 in
Model 8). From Equation (1), the significant coefficient of the sum of 1

and 7

is 2.311 (3.065-0.754),
providing evidence that senior political-connected directors enhance firm performance by approximately 2.3%
compared to non-connected peers (supporting Hypothesis 4). When the ethnic minority factor is taken into
account, the significant coefficient for POL*AGE*EM (

=0.0004, p<.05) of -0.7536 [the sum of

7 and

8,
i.e., -0.754+0.0004 suggests that elderly political-connected ethnic minority director reduces firm performance
by 0.75% (supporting Hypothesis 6). This result suggests that the market does react to the ethnic minority factor.
In other words, expectations about merger-related gains are greater for senior politically connected non-ethnic
minority directors.

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44
Table 4. Fixed effect regression estimates of the relationship between firm performance and board characteristic
Independent
variables
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8
POL 0.0500**
(0.016)
0.0493***
(0.0178)
3.4434**
(1.606)
0.0524***
(0.018)
3.5001**
(1.506)
4.5203**
(1.738)
1.9474**
(0.940)
3.065***
(1.030)
AGE 3.2180
(5.700)
4.4042
(6.153)
18.738**
(9.083)
1.2558
(6.097)
17.527*
(9.196)
21.964**
(9.923)
8.1065
(5.892)
11.073*
(5.772)
EM -0.0206
(0.0188)
-0.0232
(0.0196)
-0.0130
(0.025)
0.0007
(0.023)
0.0042
(0.022)
-0.0205
(0.031)
0.0180*
(0.009)
-0.0113
(0.015)
QUA 0.0404**
(0.016)
0.0415**
(0.017)
0.0461***
(0.015)
0.0301
(0.019)
0.0357*
(0.019)
0.0351*
(0.019)
0.0236**
(0.011)
0.019*
(0.009)
EXP
0.0070
(0.006)
0.0058
(0.007)
0.0107
(0.006)
0.0129
(0.0083)
0.0169**
(0.008)
0.0170**
(0.008)
0.0140**
(0.006)
0.0166***
(0.005)
ROE(-1) -0.0896
(0.1298)
-0.1338
(0.125)
-0.0692
(0.137)
-0.1012
(0.112)
0.0341
(0..105)
POL*AGE -0.8297**
(0.3960)
-0.8427**
(0.3681)
-1.1015**
(0.42897)
-0.4680**
(0.2288)
-0.754***
(0.2543)
POL*AGE*E
M
-0.00003
(0.0002)
0.0003
(0.0002)
0.0004**
(0.0001)
FS -0.7132
(1.2189)
0.7449
(0.5032)
0.7518*
(0.4313)
BS 0.2330
(1.3383)
-0.47318
(1.1498)
-0.7817
(1.0392)
FA
FY
-1.058***
(0.3330)
-1.247***
(0.5196)
-1.162***
(0.3317)
-1.814***
(0.5817)
C -14.3614
(23.07)
-11.891
(23.962)
-78.370**
(37.02)
-7.0096
(24.66)
-74.034*
(37.607)
-91.509**
(40.36)
-37.945*
(22.587)
-47.646**
(22.198)
Cross-section
fixed effects
√ √ √ √ √ √
Period fixed
effects
√ √ √ √ √ √ √
Observations 78 78 78 69 69 69 66 66
Number of
cross-sections
9 9 9 9 9 9 9 9
Sample
period
2000-2009 2000-2009 2000-2009 2001-2009 2001-2009 2001-2009 2001-2009 2001-2009
R2 0.5005 0.5038 0.5543 0.4823 0.5363 0.5501 0.4137 0.3517
Adj.R-squared 0.3007 0.2791 0.3525 0.2348 0.2993 0.3048 0.1716 0.2050
F-statistic 2.5052*** 2.2422*** 2.7472*** 1.9484** 2.2633*** 2.2423*** 1.7087* 2.3970**
Notes: All regressions are estimated using panel least squares. Dependent variable: ROE, the natural log of
return to equity. POL is the number of political connected directors (%), AGE is the average age of the director,

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45
EM is the total number of minority (Chinese and Indian, i.e., non-Bumiputra) directors on the board (%), QUA is
Total number of directors with qualification either in Law, Business and Management, Economics, and etc. (%),
EXP is Number of directors who have background experience in banking sector (%), FS is firm size, measured
as the natural log of the total assets of the company, BS is board size, measured as the natural log of total number
of directors on the board, FA is firm age, measured as the natural log of the number of years since its operation,
and FY is the Fiscal year as indicator variable, 1 for fiscal year ended 31 December; 0 otherwise. Probability
values are based on a t-statistic for a two-tailed test of significance. The first number of each cell is the
regression coefficient and figures in the parentheses are standard errors. R2 is the explanatory power of the
regressor. *, ** and *** denotes statistically significance at p<10, p<.05 and p<.01 level, respectively.
To test whether politically connected firms performed poorer in the later five years, we divided the sample
periods into early years (2000-2004), and later years (2005-2009). Year 2004 has been chosen as the cut-off year
because this was the last year the 4th prime minister held official position in the government. Results in Table 5
reveal that the mean value for low politically connected firms shows significant improvement in performance
during the later years; meanwhile the mean value for high politically connected firm is relatively lower during
the later five years. Hence, we conclude that firms that are politically connected performed poorer in the later
five years, thereby supporting Hypothesis 2. These firms performed poorly due to inefficient operation as a result
of cronyism and the changing hand among politicians.
Table 5. Mean estimates between political connection and period
Connection Early Years
(2000-2004), N=45
Later Years
(2005-2009), N=45
Low politically connection, N=25 1.5291 1.8420
High politically connection, N=65 2.2677 2.0750
Note: Full sample, N=90. If number of politically connected director on board is less than 10 percent, it is
classified as low politically connection, and otherwise. F statistics=2.888**, ** denotes significant at 5 percent.
4.4 Endogeneity Test
The study of the upper echelons board–performance link is plagued with an endogeneity problem, and this
problem may bias the results on firm performance. Instances of firms performing well could be due to the political
connectedness of the upper-echelons. It could also be due to reputation that these delegates only chose the better
performing firms to work for. That is, if the explanatory variable (X) and the error terms were correlated, the OLS
estimate would likely be attributed to the X of some of the variation in the dependent variable that actually comes
from the error term. In this paper we deal with this endogeneity problem by examining the issue of whether
political connectedness affect firm performance or whether firm performance affects political-connectedness.
Therefore, formally testing whether or not these explanatory variables are endogeneous is a matter of pre-requisite.
We attempt to control for the possible reverse causality by using a time-lagged approach between politically
connectedness and firm performance. Specifically, we use the following simple models to determine whether xik in
the model is endogenous or, more precisely, whether it is correlated with the error term ui, where xik is a k-element
row vector whose last element, xk.
yi = xi·β + ui, xik = zi· + vi, i= 1, 2, . . . n
First we test if beta is equal to zero (it means that xi has no predictability to yi), save its residual as the first error
term; and then Xi,t is regressed on Xi,t-1, again save its residual as the second error term. Finally we test if the first
error term is correlated with the second error term. Results reveal that we cannot reject the hypothesis
(coefficient= 0.572, t-stat=1.070, P=0.288), which implies that error terms do not correlate to each other. Hence
the endogeneity problem has been sorted out.
5. Discussion, Conclusion and Policy Implication
This study employs upper echelon theory to examine the impact of governance and demographic characteristics
of politically connected board members on firm performance. We investigate the impact of political connections,
age, ethnic minority, qualification, and experience of board members on commercial bank performance. Results

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46
reveal that bank performance of politically connected firms improves compared to the non-connected peers.
Overall, we conclude that having a relatively higher number of politically connected directors, qualified senior
directors, and peripheral-function experience of directors on the board will lead to higher bank performance,
ceteris paribus. Consistent with upper echelon theory, the directors’ greater knowledge base, creativity and
innovation were a competitive advantage to improve bank performance. Hence, there is a need to legitimise the
selection of directors with higher educational qualifications. Furthermore, diverse group dynamics are likely to
impact controlling function and minimize potential agency issues (Erhardt et al., 2003). The finding in this study
is consistent with the argument by Johnson and Mitton (2003) and Gul (2006). While neither ethnic minority nor
past performance significantly impacts firm performance, the interaction effects show that ethnic minority plays a
role in determining firm’s performance, in which there is a positive association between elder non-ethnic minority
politically connected directors and bank performance.
The findings suggest that corporate governance can be improved through better use of the entire aptitude capital
of the directors. An interaction term that embraces age, ethnic diversity, and political connections is a good
practice and serves as a business strategy for creativity and innovation that could strengthen firm performance.
The innovation needed now is not to eliminate the long implanted special connections practices within directors,
but we need to delve into how politically connected directors can make a difference to improve firm performance
as an injection booster to leap forward onto the next podium of economic growth and position Malaysia to
become a high income nation by 2020. The Malaysian government has embraced an entire new paradigm via
Economic Transformational Program and New Economic Model, particularly focused on private sector’s
accessibility to capital to boost and rejuvenate investment, facilitate modern business, encourage competition,
and attract foreign direct investment in domestic banking institutions.
The results of this study imply that appropriate human capital for directorship brings positive value-added to
boards. Therefore, reengineering GLCs, reenergizing the support to private sector, and creating a competitive
domestic economy are of utmost importance. GLCs should engineer socioeconomic change through wealth
redistribution, and should not crowd out private investment. Trust is an important element amongst different
ethnic groups for fundamental economic network integration. Malaysia’s major obstacle is the absence of fairer
competition to raise competitiveness within the nation. This lack of fairness has caused difficulty for global
foreign investors to invest in the nation. Continuous and significant regulatory framework improvements needs
to be embedded into government practice with respect to transparency, non-discrimination, objective-based and
performance-based criteria, market-based mechanisms and accountability to reap independence, integrity and
soundness of policies and regulations. These informational levels will then be prescribed by mechanisms put in
place within the competitive governance and legal environment to ensure rational management decision making
processes.
Notwithstanding its contributions, this study has limitations. There are only nine commercial banks in Malaysia
in the total population at the time of study, and we have included all nine banks data in this study; this sample
remains too small to substantiate claims and may cause firm-specific bias. However the sample is restricted to
Malaysian commercial banking industry because other industries have different regulation structures, cultural
environments and other factors that may result in different board compositions and firm performances. Future
research may undertake gender perspective in multiple directorships to measure firm performance within
banking industry. Future study may consider both short- and long-term impact of corporate governance reforms
on firm performance.
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Notes
Note 1. Past studies used economic-based theories to investigate the association between board composition and
firm performance in general (Anderson & Gupta, 2009; Kato & Long, 2006; Krivogorsky, 2006; Lefort & Urzua,
2008; Price, Roman, & Rountree, 2011; Switzer, 2007; Yoshikawa & Phan, 2003), and between board
composition-bank performance in particular (Berger & Patti, 2006; Gorton & Schmid, 1999; Kang & Shivdasani,
1999; Lin, Zhang, & Zhu, 2009).
Note 2. The Asian Financial Crisis caused liquidity and insolvency problems for banking industry following
excessive deficient collateral property lending and inattentive exposure to share-based lending, leaving them
burdened with high Non-Performing Loans (NPLs). BNM enforced a merging scheme with the objective to
enhance shareholder value by reinforcing the efficiency and profitability of the financial institutions vis-a-vis to
minimize post-integration costs. BNM announced on 29th July, 1999 that the existing 55 financial institutions
(i.e., 20 commercial banks, 23 finance companies, and 12 merchant banks) were to form six-anchor banking
groups by the end of September 1999 (Poon, 2008). These six-anchor banks were nominated by the central bank
and their selection was politically driven (Mitchell & Joseph, 2010), and linked to allegations of cronyism
(Chong, Liu, & Tan, 2006). Some objections arose pertaining to the composition of the groups. The government
responded by giving flexibility to the banking institutions to form their own merger groups and the number of
groups rose from six to ten, and the merging exercise deadline was extended till the end of January 2000.
Note 3. The guideline for banking sector was published by Basel Committee (1999; 2006), and it lists the
responsibility of BOD on operations and financial soundness of the banks. The independent director requirement
was announced in 1998, and 1999 was the first year when such regulations were enforced. During the last decade,
the government has introduced significant reforms in corporate governance, including the enactment of the
revised Malaysian Code on Corporate Governance (MCCG) 2007 as the “Best Practice Guide” to promote
transparency and encourage self-regulatory behavior among PLCs. “Best practice” advocates that the board
composition should have a majority of independent non-executive directors (MCCG Revised 2007, p.11).
Note 4. There are nine domestic commercial banks in Malaysia in the post-merged era. There are seven firms in
2000, eight firms from 2001-2002, and nine firms from 2003-2009.