‘Welcome on board’: resource dependency and agency theoretic evidence from the South African life insurance market

• DOI: https://doi.org/10.1108/CG-12-2019-0375
• Published date: 13 January 2021
• Date: 13 January 2021
• Pages: 626-644
• Subject Matter: Strategy,Corporate governance
• Author: Abdul Latif Alhassan,Kalwani Zyambo,Mary-Ann Afua Boakye

‘Welcome on board’: resource

dependency and agency theoretic

evidence from the South African

life insurance market

Abdul Latif Alhassan, Kalwani Zyambo and Mary-Ann Afua Boakye

Abstract

Purpose –This paper examines the role of corporate governance on the financial performance of life

insurers in SouthAfrica. Specifically, the paper tests two competinghypotheses on the role of boards as

effective monitorsof opportunistic behaviour of executives, as prescribedby the agency theory or as an

effectiveresource, as advocated by the resource dependencyview.

Design/methodology/approach –The paper estimates both static and dynamic panel data of 68

insurers from 2007 to 2014 usingrandom effects, panel corrected standard error ordinary leastsquares

and generalized method of moment’s estimation techniques. Board size, audit committee size, board

independence and audit committee independence are used as the governance indicators while

profitabilityis measured as returns on assetsand equity.

Findings –The findings support boththe resource dependency and agency theoretic views of boards.

Specifically, the results indicate that large board and audit committees improve financial performance

which supports the view of boards as effective resources for insurers. In addition, the role of non-

executive directors in addressing agency conflict is reflected in the positive effect of board

independenceon financial performance. However, the long-runcausal positive effect is only reported for

audit committee size on return on assets. In addition, the paper also finds evidence of profitability

persistence in the life insurance market. Finally, reinsurance usage, insurer size and market

concentrationwere found to have a negative effecton financial performance.

Practical implications –The findings re-enforce the important role of boards in their oversight

responsibilitiesand as effective resourcesin the operations of highly specializedinsurance businesses.

Originality/value –As far as the authors are concerned, this empirical analysis documents the first

evidence of the linkages between governance mechanisms and financial performance of an insurance

marketin Africa.

Keywords Financial performance, Prof‌itability, Corporate governance, Insurance, South Africa

Paper type Research paper

1. Background to the study

Similar to the release of governance guidelines in the UK (the Cadbury Report, 1992)and

US (the Sarbanes-Oxley (SOX) Act, 2002), South Africa has witnessed over two decades of

governance reforms since the firstrelease of the King report in 1994. The continuous review

of these guidelines[1] underscores the importance of monitoring and controlling the ever-

changing dynamics associated with the exercise and abuse of executive powers. The

South African insurance sectorhas had on-going reforms to align its regulatory environment

to Solvency II (EU insurers) and RBC (US insurers). These reforms have resulted in the

Solvency and Assessment Management (SAM) framework for the prudential regulation

Abdul Latif Alhassan and

Kalwani Zyambo are both

based at the Development

Finance Centre (DEFIC),

Graduate School of

Business, University of

Cape Town, Cape Town,

South Africa. Mary-Ann

Afua Boakye is based at the

Department of Accounting,

Walter Sisulu University,

Mthatha, South Africa.

Received 11 December 2019

Revised 29 April 2020

20 July 2020

17 October 2020

18 October 2020

16 November 2020

24 November 2020

Accepted 8 December 2020

The authors are grateful for the

comments from two anonymous

reviewers which grateful

improved the initial draft of the

paper. We are also

appreciative of the Financial

Services Conduct Authority

(FSCA) formerly the Financial

Services Board (FSB) for

granting access to the data for

this study. All caveats apply.

PAGE 626 jCORPORATE GOVERNANCE jVOL. 21 NO. 4 2021, pp. 626-644, ©EmeraldPublishing Limited, ISSN 1472-0701 DOI 10.1108/CG-12-2019-0375

(including guidelines on governanceand risk management) of the insurance sector in South

Africa.

According to agency theory, boards are recognized as an effective mechanism for

shareholders to oversee executive management to address agency conflicts (Jensen and

Meckling, 1976;Spremann, 1987). Specifically, board characteristics such as board

independence and composition of the audit committees represent key attributes, which

checks the exercise of executive powerin the operational activities of a firm. For example, a

highly independent board structure has been theoretically argued to improve firm

disclosure and transparency and an increase in firm value and performance. This assertion

has received support in the empirical literature (Hsu and Petchsakulwong, 2010;Hardwick

et al.,2011

;Kader et al., 2010,2014;Baldenius et al., 2014;Karbhari et al.,2018)[2].

However, studies by Wang et al. (2007) and Karbhari et al. (2018)[3] have found evidence

to support the negative impact of non-executive directors on firm performance. These

findings support the assertion that executive members of the board have a comparative

informational advantage(Adams and Jiang, 2016).

In South Africa, studies by Ntim et al. (2012a,2012b), Ntim and Soobaroyen (2013),Ntim

et al. (2013,2015)andMuniandy and Hillier (2015) have examined the role of the King

Report induced governance mechanisms and guidelineson corporate outcomes. However,

these studies have mainly been limited to listed firms, excluding firms in the financial

services industry, owing to the unique attributes of the industry. Despite the documented

role of governance on corporate failures in the 2007 financial crisis (Kirkpatrick, 2009), it

appears that there is limited evidence on the role of governance mechanisms on corporate

outcomes in the insurance market in developing economies, especially in Africa. Against

this background, the paper explores the role of the agency and resource-dependency

theories to explain how governance attributes affect the financial performance of life

insurers in South Africa. The paper estimates a panel data set on 68 life insurers from 2007

to 2014 using a return on assets and equity as proxies for financial performance while board

size and independence and audit committee size and independence are used as proxies

for corporate governance.

The South African life insurance market presents an interesting case for this empirical

analysis for the following reasons. Firstly, the on-going regulatory reforms under the SAM

have led to the development of the governance and risk management framework (GRMF).

This framework has led to reforms in the governance structures of insurers in the insurance

industry. Additionally, under Pillar II of the SAM, the governance component of the GRMF

covers provisions related to the composition of the board of directors, roles and

responsibilities of directors and boardof directors’ sub-committees. Some of the provisions

include the appointment of non-executive directors and an independent Board Chair. In

addition, insurers are required to set up risk and remuneration sub-committees, with a

minimum membership of three (Alhassan, 2016; p. 18). These underline the importance of

governance in the organization of the insurance business and necessitates an evaluation of

the on-going reforms on the corporate bottom-line. Secondly, as the largest insurance

market in Africa with a market share of 71% of total insurance premiums underwritten in

2018 (Swiss Re, 2019, p. 10), the gross premiums underwritten in the life sub-sector

accounted for 10.27% of the gross domestic product in 2018 (Swiss Re, 2019;p. 43). This,

together with the higher concentration of its portfolio on the investments business line

(Boakye, 2018, p. 13), reflects a well-developed market that is responsible for the

investment decisions for a large number of policyholders. Therefore, the governance of the

industry, therefore, becomes critical to the efficient management and protection of

policyholder contractualclaims.

The research contributes to two broad themes in the literature in developing economies.

Firstly, under the insurance literature in Africa, studies on the drivers of financial

performance by Akotey et al. (2013),Alhassanet al. (2015) and Asare et al. (2017) have not

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