Taiwan’s banking industry remains highly fragmented and competitive after a series of financial liberalization and restructuring actions. Starting in the early 1990s, Taiwan’s government embarked on financial reforms to deregulate and restructure the domestic banking industry in order to construct a sound financial system, which is expected to support economic growth and respond to the challenges of powerful competition from international financial groups. Yu (1999) indicated that the financial sector has played a key role in the process of Taiwan’s economic development. To strengthen the efficiency and performance of banking institutions, Taiwan’s financial industry has experienced several important reforms. The first stage in 1991 relaxed the entrance barriers to the financial market when Taiwan’s government announced the Commercial Bank Establishment Promotion Decree. This legislature helped to deregulate barriers and invite private domestic enterprises and foreign investors to participate in domestic banking. Soon afterwards, 27 new commercial banks and mixed ownership banks were set up, and more funds have been attracted into the loanable funds supply market, along with an improvement in banking operation efficiency.
Financial deregulation has also brought about some unsatisfactory effects. An excessive amount of banks make up Taiwan’s banking industry with fierce competition among them leading to several financial crises such as abnormal peaks in the banks’
non-performing loans (NPL) ratio, credit losses, and an inferior capital adequacy ratio. In the second stage, in order to overcome these financial obstacles to sustain industrial competitive advantages, the government decided to embark on various reforms and restructuring programs, referred to as the first financial restructuring (FFR), to reduce bad
debt banking, encourage mergers and acquisitions among banks, and to push for the set-up of financial holding companies (FHCs). Through these polices, Taiwan’s government has successfully controlled banks’ operation costs and risks, seen the sector’s average NPL ratio fall under 5%, the capital adequacy ratio rise above 8%, and approved mergers among some financial institutions as financial holding companies to cope with the problem of over-competition in the overcrowded market.
The third stage involved the second financial restructuring (SFR) in 2004, which continued the reform of the FFR to improve upon the defining characteristics of “too many in number and too small in size” in Taiwan as compared to other Asian countries (Lo and Lu, 2009). The main goals of this stage are to achieve the emergence of one or two particularly large and strong regional financial institutions with a market share of at least 10% each in Taiwan, a reduction of government ownership in financial institutions, and a drop in the number of banking institutions. Although the number of banks in Taiwan fell from 50 in 2004 to 44 at the end of 2006, the goals of the SFR have not been completely achieved and the banking industry still remains highly fragmented and competitive.
With the enforcement of financial liberalization and restructuring, the overall efficiency and competitiveness of Taiwan’s financial industry have gradually improved and several main financial holding companies have gained a greater market share. However, they now face a more dynamic, increasingly intense and highly competitive environment.
Such an environment forces these institutions to develop their capabilities to gain and maintain competitive advantages. Hill and Jones (2004) indicated that a firm’s competitive advantages come from both the resources it has and the capabilities to use them. Thus, financial institutions have to identify the inefficient costs of acquiring funds and the efficient functions of generating profits to enhance their competitive advantages in
responding to external changes, which increases their survival.
Some earlier studies (Giokas, 2008; Pastor et al., 2006; Schaffnit et al., 1997) have indicated that the efficiency enhancement of a financial institution mainly depends on if it can identify the inefficiency source and profit niche for improving its competitive advantages. To confront the dynamic financial domestic market and improve their own performances, financial institutions need to define their competitive advantages and relevant capabilities by using the most effective method and sequentially maintain and improve its competitive advantage to ensure their survival and ultimate prosperity in the Taiwan financial market.
Efficiency has been an important topic in banking research for a long time, with data envelopment analysis (DEA) as one of the methods used to evaluate the efficiency of banks and financial institutions. Major academic journals have published special issues on banking efficiency using the DEA method, including the European Journal of Operational Research in 1997 and the journal of Management Science in 1999. Most previous studies evaluate profitability efficiency of a financial institution according to its operation activities using the production approach (Athanassopoulos and Giokas, 2000; Ferrier and Lovell, 1990; Sherman and Gold, 1985), whereby an operation activity is depicted as the production of services using input resources and expenses to produce desired outputs (i.e.
deposits and non-interest incomes) or using the intermediation approach (Athanassopoulos and Giokas, 2000; Casu and Molyneux, 2003), and they describe the operation activity as a process of transforming deposit costs into income from loans and investments. In light of the efficiency evaluation, the former places emphasis on how to acquire outputs by using minimum resources, while the latter focuses on generating maximum income by using the available resources. However, performance improvement and competitiveness enhancement
cannot rely on either production or intermediation activities alone. These two types of operational activities occur simultaneously and both are crucial for improving the competitive capabilities of a bank and should not be separately evaluated. Thus, a more accurate way for identifying the profitability performance of a financial institution is to consider the complementary production and intermediation activities under the performance evaluation of financial institutions. In addition to profitability activities, the marketability activity also plays a crucial part and should be included in the performance model (Chakravarthy, 1986; Siford and Zhu, 1999; Zhu, 2000; Lo and Lu, 2009). This is particularly true for published and listed companies because their values are ultimately determined by the stock market. The marketability performance represents the ability that a financial institution can transform operating revenues and profits into the earnings of shareholders and market value in the stock market. Moreover, a firm with superior marketability can attract more capital and investments from the financial market. This is because the operating resources for the profitability performance represent a firm’s profitability and marketability activities. A high dependence in a firm’s value-creating process should be integrated together in performance evaluation. Therefore, this study adopts a two-stage series framework to include two types in the profitability and marketability activities for evaluating their contemporary managerial efficiency and sustained competitive advantage. In addition, in the wake of shock of the Asian Financial Crisis, the collapse of Lehman Brothers, the subsequent financial crisis and the subprime lending fiasco, the mechanisms of corporate governance and risk control have become major issues in the operation of financial institutions. Regarding corporate governance, although the previous studies have indicated that a firm with superior governance mechanisms result in better performance, Claessens and Fan (2002) also indicated that
limited investor protection of minority rights in Asia might allow controlling shareholders to expropriate minority shareholders and conventional governance mechanisms may have a limited effect to reduce agency problems. Therefore, this study first examines whether conventional governance mechanisms still have a significant effect on Taiwan financial institutions. Moreover, the auxiliary variables based on the perceptive of investor self-protection also are included to identify the determinant governance mechanisms and their effects for Taiwan financial holding companies. With respect to the effect of risk factors in financial institutions, the Basel Committee divided it into three parts including credit risk, operating risk and market risk and extant studies indicated that that the efficiency of financial institutions is significant influenced by risk factors (Berger and DeYoung, 1997; Ataullah et al., 2004; Chang and Chiu, 2006). However, owing to the phenomenon of being too interconnected into the global financial market, Taiwan’s financial market has been highly integrated with international markets and is also easily impacted by a specific financial distress which occurred in some international markets.
Therefore, for considering the impact of risk factors, this study not only employs credit and market risks to explore their effect on the managerial performance of Taiwan financial institutions, but it also includes the measure of CoVaR to understand the effect of the risk spillover of other financial markets on Taiwan’s financial market and institutions.
The main purposes of this study are to provide sufficient details of managerial performance and competitive advantage for Taiwan financial holding companies and to further explore the relation among the FHC’s managerial performance, governance mechanisms and risk factors. Owing to the complexity of the value-creating process, a multiple-factors performance model based on Seiford and Zhu’s (1999) findings to assess managerial performance and efficiency productivity. Moreover, these efficiency scores are
subsequently employed to identify determinant governance mechanisms and risk factors using the truncated regression model. Finally, the decision-making matrices constructed by the managerial performance and intertemporal productivity as well as the governance mechanism are expected to provide further managerial tools for Taiwan’s financial holding companies.
2. Literature Review