CONTENTS
Volume 02, Issue 02, 2013
Current Developments in
New Zealand Capital Markets
Current Developments in the
New Zealand Stock Exchange
02
By Tim Bennett
NZX Joins the Race to Minimise
Tick Size
04
By Hamish D. Anderson
Impact of Corporate
Governance on Financial
Practices of New Zealand
Companies
12
By Hardjo Koerniadi
Light-handed Regulation in
New Zealand Banking and
Financial Services:
Has it worked?
By David Tripe
18
Current Developments in the New Zealand
Stock Exchange
Current Developments in the New Zealand
Stock Exchange
By Tim Bennett
Tim Bennett is the Chief Executive Officer of the New Zealand Exchange
New Zealand’s capital markets are riding on the crest of a wave. But unlike past peaks in
the equity market that have been few and far between, the wave we are currently riding
is the first in a set of breakers that will transform our capital markets and support a step
function change in New Zealand’s economic growth.
1. Introduction
It has been a tremendous past 12 months for the markets.
Going forward, net inflows into the market will be
We are therefore – if the stars remain aligned – at the
The NZX 50 Index is up 23.5% in the year to September 30;
underpinned by growth in New Zealand managed funds.
beginning of a series of waves that will rebuild our capital
trading volumes are up 38.6%; and capital deployed into the
These are now almost entirely driven by KiwiSaver funds,
markets. New Zealanders are saving more, in particular
market from IPOs, secondary capital raising and sell downs
which are projected to increase by some 12% to 15% per
through KiwiSaver, and are investing in equities in a well-
by strategic investors have totalled $3.3 billion. Given similar
annum over the next decade. Supporting this level of
regulated marketplace, a trend that should continue
numbers from other markets globally, it would be easy to
demand will require a continued growth in listings, some of
for many years to come. This in turn is supporting the
suggest that our market is merely riding on the interest rate
which is evident already and some of which will develop
development of a growing financial services sector
fuelled equity boom that we have seen globally.
through new market structures, such as the small-cap
(advisors, fund managers and brokers), which combined
market NZX is developing. More new markets targeting
with increasing net funds inflow and improved liquidity,
different segments of the investor base and companies
provides the infrastructure required to encourage more
at different stages of the business lifecycle are likely to
companies to utilise the capital markets to fund their
develop, made possible by the recently passed Financial
business growth.
But if we delve deeper into the numbers, we see the
signs of a series of well-planned structural changes in the
capital markets beginning to appear. In the year to June
30 2013, retail investor ownership in the market rose by
3.1% to 26.4%. This is the first sizable jump since 2006 and
Markets Conduct Act.
while driven partly by the interest rate environment, is also
This expected growth in our capital markets will underpin
the result of the Government’s share offer programme;
New Zealand’s economic growth through a broader range
a number of attractive listings; and a renewed interest in
of capital raising options and a lower cost of capital. Of
equities as an asset class. This has been supported by an
course, the reverse is true as well: a vibrant equity market is
improved regulatory environment, in particular through the
dependable on a sound economy.
introduction of the Financial Markets Authority, which has
begun to restore trust in our financial markets.
Fortunately, New Zealand is a strong position on this front
as well. Our global competitiveness has increased to 18th
Overall, New Zealand ownership of NZX listed companies
in the most recent World Economic Forum survey (ahead
has increased by 2.1% to 66.9% in the year to 30 June as
of Australia for the first time); we have a relatively strong
foreign investors sold down stakes in companies such as Sky
middle class which will drive consumptive growth; six of our
TV and Trade Me, reversing the trend we saw in the 2000s,
top 10 exports are soft commodities with growing Asian
where foreign majority owners tended to take companies
demand; and we have a tourism industry also supported
private.
by proximity to the largest and fastest growing region in the
world.
04
APPLIED FINANCE LETTERS | Volume 02 - ISSUE 02 | 2013
05
NZX Joins the Race to Minimise Tick Size
limit orders thereby reducing trading activity (Harris, 1997).
The final pool of 17 firms eligible to trade at half-cent
Ahn, Cao, and Choe, (1996) find no change in trading
increments include some of the NZX’s largest, most
activity in AMEX stocks, while Hsieh, Chung and Lin (2008)
frequently traded stocks such as Telecom and Auckland
find significant declines in trading activity in Taiwan when
Airport through to small, illiquid stocks like Kermadec
tick size is reduced.
Property Fund and CDL Investments (see Appendix for the
In addition, research also reveals that the liquidity
benefits of lowering tick size are not shared equally by
firms. Larger firms with higher trading volume and those
NZX Joins the Race to Minimise Tick Size
that consistently trade at spreads equal to the minimum
tick size prior to the change enjoy the greatest liquidity
improvement (Chung, Charoenwong, and Ding, 2004). In
contrast, smaller firms with low trading volumes experience
a worsening of liquidity (Aitken and Comerton-Forde, 2005).
By Hamish D. Anderson
complete list of eligible stocks). Understanding the impact
of reducing the minimum tick on stocks exhibiting these
varying size and liquidity characteristics can inform future
policy decisions. This paper shows that not all eligible firms
enjoy the same liquidity improvements. Smaller stocks and
those with greater illiquidity prior to the tick change tend
to fare worse after the reduction in tick size compared to
larger more liquid stocks.
Hamish Anderson is an Associate Professor in Finance at Massey University, New Zealand
2. Data & Method
In 2011, the New Zealand Exchange (NZX) reduced the minimum tick size from $0.01 to $0.005
for seventeen dual-listed and property stocks, with the stated objective of boosting NZX liquidity.
After controlling for firms matched on similar liquidity characteristics, both spread and depth
significantly decline, and there is some evidence of higher turnover. However, smaller firms do
not enjoy the same liquidity benefits as larger firms. For example, smaller firms and those with
greater illiquidity prior to the tick change, experience deterioration in turnover after the change.
The three main liquidity variables used to explore the
stocks in the pre- and post-periods are reported in Table 1.
change in tick size impact in this paper are: percentage
Given the relatively small sample sizes, the Wilcoxon signed
quoted spread, depth and turnover. The percentage
rank test measures the statistical significance between pre-
quoted spread is calculated as follows:
and post-period differences for each liquidity variables.
To control for possible market wide liquidity changes over
(1)
also matched with a stock that is not eligible to trade at
Keywords: Tick size, Liquidity, Spread, Depth, Turnover
half cent increments. For each eligible stock, an ineligible
1. Introduction
In March 2011, the NZX joined a world-wide race
to minimise tick size. Tick size, the smallest incremental
change in a share price has been sliced and diced by
numerous stock exchanges around the world over the last
two decades. The American Stock Exchange initiated this
trend in 1992 by reducing tick size from 1/8th in a dollar to
1/16th for low priced stocks, before progressively rolling
the period examined, each eligible stock in the sample is
where Bidj,t and Askj,t are the closing bid and ask quotes
rather than NZX. As the head dealer for Craigs Investment
Partners stated,
for stock j on day t. Depth is the dollar value of depth at
the best available bid and ask quotes immediately prior to
each trade. Daily depth is then calculated for each stock
“Having to leave half-a-cent in Australia is detrimental
by averaging the depth immediately prior to all trades in
to New Zealand liquidity”. And this is “one of the major,
a given day. The third measure, turnover, is the aggregate
but unspoken reasons why the scheme was introduced.”
dollar value of all trades in a stock on a given day.
(Krupp, 2011)
An event study method similar to Ahn, Cao, and Choe,
it out all stocks by 1997. The New York Stock Exchange
Investors are likely to be interested in bid-ask spread
(1996) compares the daily average for a liquidity variable
whose tick size had remained unchanged for more than
and depth as these directly impact on their total trading
by stock over the 120 trading days prior to the effective
200 years adopted the 1/16th tick size in 1997, which was
costs and ability to trade at the best available prices.
date (pre-period) of the tick change with 120 trading days
further reduced to one cent in 2001. The race to ever lower
International empirical studies typically show conflicting
after this date (post-period). The average across all eligible
tick sizes has been joined by numerous stock exchanges
liquidity impacts when tick size is reduced, with spread
around the world, including those in Australia, Canada,
narrowing
United Kingdom, Tokyo, Taiwan and Hong Kong.
Aitken and Comerton-Forde, 2005) but depth at the best
(Chung,
Charoenwong,
and
Ding,
2004;
stock is selected that is matched on size and liquidity
characteristics. Wilcoxon-Mann-Whitney z-score is used to
test whether the difference of differences is significant.
The daily closing stock prices, market capitalisation,
turnover and closing bid and ask prices are obtained
from the NZX Company Research Database. Depth at the
best bid and ask prices immediately prior to each trade is
obtained from Securities Industry Research Centre of AsiaPacific (SIRCA) for each stock.
3. Findings
available prices declining (Goldstein and Kavajecz, 2000;
This section first discusses the liquidity metrics that
Table 1 reports the pre- and post-period averages for the
Pan, Song and Tao, 2012). In contrast to investors, stock
investors are likely to be concerned with, followed by the
three liquidity variables, along with the difference between
exchanges’ key motive for changing tick size is to boost
liquidity metric stock exchanges are most interested in. As
these two periods. Panel A and B show the averages for the
“…the reduced price steps had a positive impact on
turnover as a significant portion of their income is derived
previously mentioned, investors are likely to be concerned
eligible and ineligible matched control stocks respectively,
liquidity in the (initial five) selected stocks, which is good
from turnover. However, the theoretical and empirical
with the cost of trading (spread) and their ability to execute
while Panel C highlights whether the difference of
news for the companies, for investors and our wider markets.
literature surrounding turnover changes is mixed. On one
their orders at the best available prices (depth). In contrast,
differences between these two samples is significant.
… We expect to see the same positive liquidity impact for
hand, reducing spreads and therefore lower trading costs
stock exchanges will be more interested in turnover which
these (additional 12) stocks too.”
may encourage investors to trade more, thereby boosting
is a key determinant of their revenue.
When extending the initial pilot scheme in October, 2011,
Mark Weldon (former CEO of NZX) announced:
The scheme matches a similar 2005 ASX half-cent tick
change that made it attractive for institutional investors
to transact dual-listed stocks such as Telecom on the ASX
06
turnover. While on the other, liquidity providers may place
orders further from the best available prices to protect their
return or simply discontinue providing liquidity in the form of
APPLIED FINANCE LETTERS | Volume 02 - ISSUE 02 | 2013
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NZX Joins the Race to Minimise Tick Size
Table 1: Changes in Stock Liquidity Characteristics
Panel A: Eligible Stocks Pre-period
Percentage Quoted Spread
Difference
Signed Rank p-value
1.62%
1.15%
-0.47%
0.000
***
$141,893
$70,844
-$71,049
0.000
***
$2,061,335
$2,667,746
$606,411
0.089
*
Dollar depth
Turnover
Post-period
Panel B: Ineligible Matched Control Stocks
Pre-period
Percentage Quoted Spread
Difference
Signed Rank p-value
1.26%
1.43%
0.17%
0.081
*
$31,039
$27,996
-$3,043
0.045
**
$1,872,075
$2,171,774
$299,699
0.644
Dollar depth
Turnover
Post-period
Eligible Stocks
Percentage Quoted Spread
Control Stocks
Difference
z-score
-0.47%
0.17%
-0.64%
-4.33
***
Dollar depth
-$71,049
-$3,043
-$68,006
-3.89
***
Turnover
$606,411
$299,699
$306,712
1.38
In the period leading up to the tick change, the average
capture over 90% of these trading cost savings (8 of the
quoted spread for eligible stocks was 1.62% and this drops
17 stocks are characterised as large based on a market
to 1.15% when half-cent tick size is allowed. While the
capitalisation over $500 million).
0.47% decrease in spread is statistically significant, it also
represents an economically significant reduction in investor
trading costs. Multiplying each stock’s change in spread by
its average daily volume after the tick reduction reveals an
average daily saving of $108,937 or more than $27 million
per annum. However, investors trading in the larger firms
impact on depth Figure 2 shows average depth over 12
their orders at the best available prices. Lower depth
fortnightly periods on either side of the half-cent effective
means that investors may have to go deeper into the order
date. Average depth immediately prior to a trade falls
book when seeking to fill market orders. Table 1 highlights
substantially during the first two weeks of the half cent tick
that average depth in the post-period is less than half that
change as shown on the vertical line. However, depth
in the pre-period. Reduction in depth remains significant,
consistently falls throughout the six month post-period
even after controlling for a possible general market related
examined. In fact, depth in the last month examined, is
reduction in depth as shown in Table 1, Panel C.
approximately a quarter of the average pre-period depth,
However, one could reasonably expect depth to halve,
given the halving of the tick size. This analysis can’t rule
out the possibility that the combined depth within one
cent range on the bid and ask is not significantly different
Panel C: Difference of Eligible less Matched Control Stocks
Investors may also be concerned with the ability to fill
to the pre-period depth. To gain further insight into the
making it increasingly difficult for investors to fill orders at the
best available prices. This would imply that investors would
have to split their trades into smaller parcels to ensure they
execute their orders at the best price available. And this is
what happened. The average trade size in dollars dropped
by 19% on average during the post-period.
In contrast to those stocks eligible to trade at half-cent
increments, the ineligible matched stocks experienced a
marginal significant increase in spreads of 0.17% over the
same period. As such, the eligible stock spread reduction is
not due to some market wide effect.
Figure 1 graphically shows the average quoted spread over 24 fortnightly intervals centred on the effective tick size
change period (represented by the vertical line in Figure 1). The graph clearly highlights an immediate reduction in
quoted spread after stocks became eligible to trade at half cent increments, and these smaller spreads persist for the
next six months.
Figure 1: Average Quoted Spread
As mentioned in the introduction, the NZX’s primary
motivation to reduce tick size would be to boost turnover as
this directly impacts on their revenues. We find that average
daily turnover across all eligible stocks is 29.4% higher after
the change. Figure 3 shows the average daily turnover
for eligible stocks during fortnightly intervals. We see that
after an initial boost in turnover immediately after the
tick change, turnover then slumped before recovering to
higher than pre-period levels during the 3-6 month period.
08
APPLIED FINANCE LETTERS | Volume 02 - ISSUE 02 | 2013
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NZX Joins the Race to Minimise Tick Size
Amihud (2002) is significantly negatively related to turnover.
period depth enjoy significant improvements in post-period
That is, stocks with lower pre-period illiquidity (i.e. are more
turnover.
liquid) enjoy greater improvements in turnover in the
post-period. Also, larger firms and those with greater pre-
4. Implications
This paper helps shed light on the impact of tick
size in its securities markets, raising the possibility of larger
size changes on firms with differing size and liquidity
minimum tick size increments for some stocks. It is hoped
characteristics. Relatively smaller stocks and those with
that increasing tick size will increase the spread between
less liquidity did not enjoy the same liquidity improvements
the bid and ask quotes. Wider spreads would enhance
after the minimum tick size was reduced to half-a-cent.
market makers’ profitability and encourage them to
The economically substantial transaction cost savings
increase quote size; thereby potentially improving market
are predominantly captured by investors trading in larger
depth and turnover. Further, the higher profits may revive
stocks, and these larger stocks also enjoy significantly higher
interest in funding analyst research on small stocks, which
turnover comparative to small stocks. This has important
may lead to increased interest and liquidity in these stocks.
implications for future policy decisions regarding tick size
changes, and care should be taken when determining
which stocks are eligible for any future tick changes.
However, the matched ineligible stocks also experienced
firms’ turnover. Figure 4 which shows the relative average
a 16% increase in turnover, and after controlling for the
daily turnover of the large stocks compared to small stocks,
general market improvement in turnover, the increase is
highlights the improvement (deterioration) in turnover for
no longer significant. This though assumes that the change
larger (smaller) eligible stocks. In the pre-period, large firm
in turnover is uniform across all stocks. In unreported
turnover is under 11.8 times that of small firms on average.
analysis, eligible small firms (less than $500 million market
This jumps to an average to more than 26 times in the
capitalisation) actually experience a decline in turnover,
subsequent six months. Therefore, it is the larger firms that
but this decline is not evident in the ineligible matched small
experience the greatest improvement in turnover.
In unreported bivariate regression results2, where change
confirm that smaller and less liquid stocks do not enjoy
in turnover is the dependent variable and pre-period stocks
the same liquidity benefits as their larger counterparts.
characteristics are the independent variables, these also
For example, a common illiquidity measure proposed by
10
In May 2013, the Spread Pricing Liquidity Act of 2013
(known as the Tick Size Bill) was introduced in the House
by Congressman David Schweikert. The bill if passed into
This research also supports the current United States
law, would give issuers of less than US$500 million and an
debate surrounding tick size, particularly for smaller less
average daily trading volume under 500,000 shares, the
liquid stocks. While tick changes have been a one-way race
ability to elect to have their stocks trade at either 5 or 10
to miniaturisation over the last two decades, the Securities
cent increments. So perhaps the race for ever smaller tick
Exchange Commission (SEC) is currently reviewing the tick
size has been run.
APPLIED FINANCE LETTERS | Volume 02 - ISSUE 02 | 2013
11
NZX Joins the Race to Minimise Tick Size
References
Ahn, H., Cao, C. Q., and Choe, H. (1996), Tick size, spread,
and volume. Journal of Financial Intermediation 5, 2-22.
Notes
liquidity provision on NYSE. Journal of Financial Economics
56, 125-149.
Aitken, M., and Comerton- Forde, C. (2005), Do
Harris, L. E. (1994), Minimum price variation, discrete bid-
reductions in tick size influence liquidity? Accounting and
ask spreads, and quotation sizes. The Review of Financial
Finance 45, 171-184.
Studies 7, 149-178.
Amihud, Y. (2002), Illiquidity and stock returns: cross-
Hsieh, T. Y., Chuang, S. S., and Lin, C. C. (2008), Impact
section and time-series effects. Journal of Financial Markets
of tick-size reduction on the market liquidity-evidence from
5, 31-56.
the emerging order-driven market. Review of Pacific Basin
Anderson, H.D. and Peng, Y. (2013). From cents to halfcents and its liquidity impact. Pacific Accounting Review,
Forthcoming.
Chung, K. H., Charoenwong, C., and Ding, D. K. (2004),
Penny pricing and the components of spread and depth
changes. Journal of Banking and Finance 28, 2981-3007.
Goldstein, M. A., and Kavajecz, K. A. (2000), Eighths,
sixteenths, and market depth: changes in tick size and
1.
This article is in part based on Anderson and Peng (2013).
2.
Available from the author on request.
Financial Markets and Policies 11, 591-616.
Krupp, J (2011), NZX adds stocks to half-cent club,
Sunday
Star
Times.
www.stuff.co.nz/sunday-star-times/
business/5831353/NZX-adds-stocks-to-half-cent-club
Pan, W., Song, F. M., and Tao, L. (2012), The effect of a tick
size reduction on the liquidity in a pure limit order market:
evidence from Hong Kong. Applied Economics Letters 19,
1639-1642. Appendix: Institutional Background
The NZX announced on February 23, 2011 a pilot
include 12 further stocks comprising a mixture of stocks listed
programme to reduce the minimum tick size from one-
on both the NZX and ASX, plus property stocks whose share
cent to half-a-cent for five stocks as shown in the table
price was less than $2.50. The 12 additional stocks shown in
below. Trading on the new lower tick size was effective
the table below could trade at the half-cent minimum tick
from the March 10, 2011. Then on October 23, 2011, the
size from November 7, 2011.
NZX announced that it would extend the programme to
March 10, 2011 Effective Change in Tick Size
Auckland International Airport
Fisher & Paykel Appliances
Guinness Peat Group
Kiwi Income Property Trust
Telecom
November 7, 2011 Effective Change in Tick Size
Air New Zealand
AMP NZ Office
Argosy Property Trust
CDL Investments
DNZ Property Fund
Goodman Property Trust
Infratil
Kermadec Property Fund
National Property Trust
New Zealand Oil & Gas
Property for Industry
Vital Healthcare Property Trust
Corresponding Author:
Hamish Anderson, School of Economics & Finance, Massey University
Private Bag 11222, Palmerston North New Zealand.
Email H.D.Anderson@massey.ac.nz
12
APPLIED FINANCE LETTERS | Volume 02 - ISSUE 02 | 2013
13
Impact of Corporate Governance on Financial
Practices of New Zealand Companies1
Impact of Corporate Governance on Financial
Practices of New Zealand Companies1
listed companies. Employing a more comprehensive
This study is the first to look at the firms’ financing policies
measure of corporate governance mechanism instead of
using the Fama and French (1999) model. This approach
focusing only on one particular component of corporate
not only enables a comparison of financing patterns of firms
governance is expected to mitigate possible substitution
with strong and weak corporate governance scores, but
or complementary effects of one particular corporate
also allows us to examine the effects of different corporate
governance variable with another (Klapper and Love,
governance mechanisms on firms financing policy as
2004). The impact of corporate governance on firm
well as on their costs of capital. There is as yet limited
financing policy is examined by observing whether firms
empirical work on this issue; this study fills this void, albeit
with strong corporate governance mechanisms have
for a country with small stock exchange. The remainder of
different financing policy than those of firms with weak
the paper is organised as follows. Section two describes the
corporate governance. By focusing on these two extreme
methodology and the data. Section three discusses the
groups of firms, inference from the results on the effects of
empirical findings, and section four concludes the paper.
corporate governance on financing policy can be drawn
By Hardjo Koerniadi
Hardjo Koerniadi is a Senior Lecturer at the Faculty of Business and Law, Auckland University of Technology, New Zealand
This study examines the effects of firm level corporate governance on financing policies
of New Zealand firms. Using a unique self-constructed corporate governance index and
employing the methodology of Fama and French (1999) of financing of firms, we can report
that firms with weak corporate governance generally issue more debt and have significantly
higher cost of capital than do firms with strong governance. It is further observed that
corporate governance does not have significant impact on dividend policy in New Zealand.
more unequivocally.
2. Methodology and Data
In this study, a New Zealand Corporate Governance
directors provides them with incentives for deeper strategic
Index is constructed by creating three sub-indices for
involvement with the firm and Kren and Kerr (1997) offer
the following corporate governance mechanism: board
evidence consistent with the view that share ownership of
composition, compensation policy, and shareholder rights.
directors provides them with incentives to rigorously monitor
The total index is the sum of the values of the three sub-
managerial performance. Finally, shareholder rights are
indices. The criteria used to construct the sub-indices are
measured based on the re-election of directors, existence
similar to those of McFarland (2002), Klein et al. (2005) and
of dilutive employee stock options and the presence of
Koerniadi et al. (2013). A clear benefit of constructing this
subordinate shares. These features reduce shareholder
governance indicator is that it is able to capture a wide
rights vis-a-vis managers. As such, firms with high scores on
variety of governance features specific to New Zealand
this sub index are considered to be investor friendly. The
firms. A potential drawback of this approach is that the list of
negative impact of the existence of dilutive stock options
incentives to their firm market value, effective monitoring
corporate governance features and the weights assigned
and subordinate shares will exacerbate poor performance
of financing investments, setting its capital structures and
by a more independent board, preventing the dilution of
to each feature may be considered arbitrary. However, this
of the firm under condition of economic stress. Adjaoud
their cost of capital, are affected by agency problems
firm value through excessive stock options granted to their
criticism could be applicable to any constructed index,
and Ben-Amar (2010) provide empirical results that suggest
managers, or a combination of these approaches.
whether for professional or academic purposes. On the
when shareholder rights are strong, shareholders can use
whole, this detailed scoring system takes into account a
their power to force managers to pay higher dividends
wide range of aspects of firm governance and therefore
instead of using them for private benefit. Thus containing
provides a realistic score. The board composition sub-index
managers’ opportunistic behaviour is likely to make the firm
measures board independence, CEO duality, busyness of
less risky, ceteris paribus. On the whole, these three major
the directors and the number of annual board meetings.
components of corporate governance are aggregated
This provision is an important governance feature (Fama
into an overall score.
Keywords: corporate governance; financing policy; cost of capital
1. Introduction
The financing policies of a firm, comprising of its method
generated by the separation of ownership and control.
Empirical results supporting this notion, for example, are
De Jong and Veld (2001) and Berger et al. (1997) who
find that firms with entrenched management, i.e., with
weak governance, are more likely to issue equity than
debt to protect themselves from external corporate
control forces such as takeovers. Stulz (1988) however,
argues that entrenched managers may increase leverage
in an attempt to shield their firm from takeovers. This is
more consistent with a recent study by John and Litov
(2010) that finds firms with entrenched management are
generally associated with higher leverage. Despite the
reported conflicting empirical results, the effect of the
agency problem (in which managers follow self-interested
objectives at the expense of shareholders) on firm value
is real. When managers choose a less than optimal debt
level in their capital structure decisions, their sub-optimal
financing decisions will lower firm value and/or increase
cost of capital. Well-governed corporations, however, are
Prior studies on the association between corporate
governance and firms’ financing decisions usually use a
specific corporate governance provision, such as the ratio
of outside directors, board size, or antitakeover provisions,
as a proxy for the level of corporate governance (see for
example, Berger et al., 1997; Wen et al., 2002). The results
of the extant studies are inconclusive. For example, while
Berger et al. (1997) report a positive relationship between
the presence of outside independent directors and
leverage, Wen et al. (2002) find the opposite, and yet
another study find that outside directors have no significant
effect on leverage (Mehran, 1992). Similarly, Berger et al.
(1997) report a negative correlation between firms with
entrenched management and leverage, but John and
Litov (2010) find that firms with entrenched management is
associated with higher leverage.
This study proceeds by employing a comprehensive
and Jensen, 1983). The main responsibility of the board is
to monitor managers’ performance and reduce agency
costs. Autonomy is measured by board independence,
and by the independence of audit, compensation and
nominating
committees.
Independent
directors
are
of meetings and the separation of CEO/ Chair positions.
where Yt is defined as the sum of income before
extraordinary items, interest, income statement deferred
option plans of the directors. This sub-index captures the
taxes and depreciation. Dept is the depreciation expenses.
alignment between the interests of the directors and those
corporate governance mechanism as linking managers’
corporate governance components of New Zealand
consistent with the view that the equity holding by
14
(1)
The next sub-index is related to the share ownership and
expected to alleviate these problems by implementing such
on
how a firm finances itself:
also contains measures of board effectiveness, number
of the shareholders. Chatterjee (2009) presents evidence
based
methodology. The following equation is used to observe
than inside directors (Fama and Jensen, 1993). This sub index
several
index
capital, this study adopts Fama and French’s (1999)
expected to be able to monitor managers more effectively
corporate
governance
To observe a firm’s financing pattern and its cost of
∆St is the net newly issued shares, which balances the cash
flow. ∆LTDt is the change in the book value of the long-
term debt. It is the change in book capital from t-1 to year
APPLIED FINANCE LETTERS | Volume 02 - ISSUE 02 | 2013
15
Impact of Corporate Governance on Financial
Practices of New Zealand Companies1
t, plus depreciation. Intt is the total interest expenses paid
above. FS, FB and TV are the dollar amounts of the shares
To examine whether firms with weak governance have
well governed ones. The difference in the level of leverage
to creditors. Divt is the total dividends paid to shareholders.
issued, buybacks and the market value capital of the firms,
different financing patterns relative to firms with strong
is statistically significant across different governance
All of the variables are deflated by the value of the year-
respectively; r is the firm’s (implied) cost of capital.
governance, firms are sorted based on the values of the
mechanisms, except when sorted according to board
total index and of each index of the corporate governance
composition index (Panel B). One possible explanation for
subsets. Then the samples are divided into three parts and
the insignificant difference in the latter category could be
firms are classified as strong (weak) corporate governance
that not all independent directors are truly independent or
firms if they are in the top (bottom) 33 per cent of each
have the necessary skills and knowledge to effectively carry
index.
out their monitoring duties (Koerniadi and Tourani-Rad,
beginning book assets. The change in short-term interest
bearing liabilities is not included in this equation because
data for this variable are not available. As a result, ∆St could
be slightly overstated. However, as the change in short-term
interest bearing liabilities is usually small, this omission should
not have a significant impact on ∆St. To measure implied
cost of capital of firms in our sample, for each year, the
Next firms are sorted according to each sub index as
well as the overall index to observe whether firms in the top
33% of each index which are defined as firms with strong
corporate governance, have a different financing pattern
than that of firms in the bottom 33%, defined as firms with
weak corporate governance.
Financial data and corporate governance variables are
following equation is estimated:
collected from the annual reports of firms listed in the NZX
Deep Archive and Reuter DataStream databases for the
period 2004 to 2008. In total, 88 non-financial firms are in the
final sample. Observations that do not have the necessary
(2)
where IVt-1 is the initial market value of a firm’s capital
in the sample at year t-1. The market value of a firm is
calculated as the sum of its equity plus the book values of
short-term and long-term debts. Y, I and LTD are as defined
variables for the regression analysis are excluded from the
sample and extreme firm variables that are below the 1st
percentile and above the 99th percentile are trimmed to
avoid the effects of outliers. The final sample consists of 319
firm year observations.
3. Results
Table 1 provides descriptive statistics of the capital
investments that average 14 percent of their book capital.
structures and financing components of all firms in the
In addition, firms also make substantial payments to security
sample during the period from 2004 to 2008. On average,
holders. Average dividends and interest expenses account
the equity of the firms (as a percentage of either market or
for 5 percent and 2 percent of book capital, respectively.
book capital) is larger than their long-term debt. Common
Firms also reduce their long-term debt by 2 percent. These
equity as a percentage of market (book) capital is 0.65
cash outlays are not fully supported by cash earnings
(0.56) and long-term debt as a percentage of market
however, as total cash earnings, Y + Dep, account for only
(book) capital is 0.16 (0.19). Firms in the sample make gross
11 percent of book capital.
AVERAGE
0.65
0.16
0.56
0.19
0.07
0.04
0.12
-0.02
0.05
0.02
0.14
other provisions may act as substitutes. When managerial
and book capital that is organised based on the total index
incentives are aligned with shareholder interests through
and its sub-indices. Taken as a whole, the results suggest
the firm’s compensation policy, the need for the board to
that poorly governed firms have more leverage than are
monitor management is reduced (Ward et al., 2009).
Table 2. Long term debt sorted according to the value of each index
Panel A. Total Index
Component of Market Capital
STRONG
WEAK
0.14
0.18**
Panel B. Board Composition
Component of Market Capital
STRONG
WEAK
0.15
0.16
Panel C. Compensation Policy
Component of Market Capital
STRONG
WEAK
0.13
0.19***
Panel D. Shareholder Rights
Component of Market Capital
STRONG
WEAK
0.12
0.18***
Component of Book Capital
STRONG
WEAK
0.19
0.22
Component of Book Capital
STRONG
WEAK
0.19
0.19
Component of Book Capital
STRONG
WEAK
0.18
0.21*
Component of Book Capital
STRONG
WEAK
0.16
0.21**
Notes: A firm’s market capital is the sum of the market value of its common stock plus the book value of its short-term and
long–term debts. A firm’s book capital is the sum of the book value of its common equity plus the book value of its short-term and
Table 1. Descriptive statistics
Equity1
LTD1
Equity2
LTD2
Y
Dep
∆S
∆LTD
Div
Int
I
2012). Another possible reason is that board monitoring and
Table 2 reports firm leverage as a component of market
SD
0.19
0.14
0.19
0.15
0.14
0.04
0.35
0.28
0.06
0.02
0.25
MIN
0.08
0.00
0.07
0.00
-1.11
-0.07
-0.48
-0.77
0.00
-0.05
-0.47
25TH
0.54
0.02
0.41
0.03
0.05
0.01
-0.11
-0.22
0.02
0.01
0.02
MEDIAN
0.67
0.14
0.58
0.19
0.08
0.03
0.08
-0.01
0.04
0.02
0.09
75TH
0.76
0.25
0.69
0.30
0.13
0.06
0.33
0.18
0.07
0.03
0.21
MAX
0.99
0.59
1.00
0.57
0.43
0.17
2.43
0.80
0.44
0.10
1.55
Notes: Equity1 is the market value of equity as proportions of a firm’s market capital. LTD1 is the book value of long-term debt as
proportions of a firm’s market capital. Market capital is the sum of the market value of its common stock plus the book value of its
short-term and long–term debts. Equity2 is the book value of equity as proportions of a firm’s book capital. LTD2 is the book value
of long-term debt as proportions of a firm’s book capital. Book capital is the sum of the book value of its common equity plus the
book value of its short-term and long–term debts. Y is defined as the sum of income before extraordinary items, extraordinary
item, interest, income statement deferred taxes and depreciation. Dep is depreciation expenses. ∆S is the net new issues of
shares which balance the cash flows. ∆LTD is the change in the book value of long-term debt. I is the change in book capital
from t-t to year t, plus depreciation. Int is total interest expenses paid to creditors. Div is total dividends paid to shareholders. These
long–term debts. Firms in the top (bottom) 33% sorted based on the corresponding corporate governance index are classified
as strong (weak) governed firms. *,**,*** denote significantly different from their counterparts at 10%, 5% and 1% respectively (for
two-tail tests).
Table 3 focuses on how firms with different corporate
related literature such as Chen et al. (2009) who find that
governance levels finance their investments. Panel A
firm-level corporate governance quality has a significantly
shows that firms with stronger governance invest around 12
negative effect on the cost of equity capital in countries
per cent of book capital and pay dividends and interest
with weak legal protection of investors. Financing patterns
expenses of 5 percent and 2 percent of book capital,
of strong and weak governance firms are similar when
respectively. Because cash earnings, Y + Dep, are not
sorted according to their board composition index (Panel
sufficient to finance these cash outlays (11 percent), these
B).
firms are likely to issue equity rather than debt to finance
their expenditures. These financing patterns however,
are not statistically different from those of firms with weak
governance.
When firms are ranked according to the compensation
policy index (Panel C), firms that have a better alignment
among their managers’ incentive with those of shareholders
are observed to finance their cash shortages by issuing
The costs of capital of poorly governed firms are observed
equity, whereas firms with a low compensation policy index
to be significantly higher than those of strong firms with high
are likely to have issued more debt. Similarly, firms with
governance scores. This is in accordance with the previous
weak shareholder rights are more likely to issue debt to
variables are deflated by the beginning of year book assets. There are 319 firm-year observations from 2004 to 200
16
APPLIED FINANCE LETTERS | Volume 02 - ISSUE 02 | 2013
17
Impact of Corporate Governance on Financial
Practices of New Zealand Companies1
finance their investments (Panel D). Cash earnings of firms
and Ben-Amar, 2010; Jiraporn and Ning, 2006) that find
with higher governance scores exceed investment outlays.
positive effect of corporate governance on pay-out policy.
Cash earnings average 13 percent and gross investments
A possible explanation to this finding is that, as New Zealand
average 11 percent of book capital, respectively. It is further
adopts a dividend imputation tax system, pay-out policy in
noted that firms with low governance scores do not have
New Zealand is likely to be motivated more by tax purposes
sufficient cash for their expenditures and rely significantly
rather than driven by corporate governance.
References:
Adjaoud, F. and Ben-Amar, W. (2010). Corporate
Koerniadi, H. and Tourani-Rad, A. (2012). Does board
governance and dividend policy: Shareholders’ protection
independence matter? Evidence from New Zealand.
or
Australasian Accounting Business and Finance 6, 3-18.
expropriation?
Journal
of
Business
Finance
and
Accounting 37, 648-667.
Koerniadi, H. and Tourani-Rad, A. (2013). Corporate
on issuing debt to cover their cash shortages. An interesting
Berger, P.G., Ofek, E., & Yermack D.L. (1997). Managerial
governance, financing patterns and the cost of capital:
finding is that the dividend policies of both types of firm are
entrenchment and capital structure decisions. Journal of
Evidence from New Zealand companies. International
similar. This result is inconsistent with prior studies (Adjoud
Finance 52, 1411-1438.
Journal of Economics & Business Research, forthcoming.
Chatterjee, S. (2009). Does increased equity ownership
Koerniadi, H., Krishnamurti, C., & Tourani-Rad, A. (2013).
4. Conclusion
lead to more strategically involved boards? Journal of
Corporate governance and risk-taking in New Zealand.
Business Ethics 87, 267 – 277.
Australian Journal of Management. Advance online
This
paper
examines
the
effects
of
corporate
than are firms with strong governance mechanisms. As
governance on financing policy of New Zealand firms.
New Zealand adopts a dividend imputation tax system, the
Cost of capital of firms with a high corporate governance
insignificant effect of corporate governance on dividend
score is observed to be significantly lower than that of firms
policy suggests that dividend policy in New Zealand could
with a low governance score. Furthermore, firms with weak
be due to other reasons such as tax purposes.
corporate governance mechanisms are more leveraged
Chen, K.C.W., Chen, Z., & Wei, K.C.J. (2009). Legal
protection of investors, corporate governance, and the
Kren, L. & Kerr, J.L. (1997). The effects of outside directors
cost of equity capital. Journal of Corporate Finance 15,
and board shareholdings on the relation between
273-289.
chief executive compensation and firm performance.
De Jong, A. and Veld, C. (1999). An empirical analysis of
Table 3. Cash inflows and outflows as percentages of beginning of year book capital of strong and weak
governance firms
Panel A. Total Index
STRONG
WEAK
Yt
Dept
∆S
∆LTDt
It
Divt
Intt
COC
Yt
Dept
∆S
∆LTDt
It
Divt
Intt
COC
0.07
0.04
0.10
-0.01
0.12
0.05
0.02
0.18
0.05
0.04
0.12
0.02
0.16
0.04
0.03*
0.31**
Panel B. Board Composition
STRONG
WEAK
Yt
Dept
∆S
∆LTDt
It
Divt
Intt
COC
Yt
Dept
∆S
∆LTDt
It
Divt
Intt
COC
0.07
0.04
0.08
0.00
0.12
0.05
0.02
0.14
0.07
0.04
0.15
-0.02
0.16
0.06
0.03*
0.31
Panel C. Compensation Policy
STRONG
WEAK
Yt
Dept
∆S
∆LTDt
It
Divt
Intt
COC
Yt
Dept
∆S
∆LTDt
It
Divt
Intt
COC
0.07
0.05***
0.17***
-0.09
0.13
0.05
0.02
0.24
0.06
0.03
0.05
0.06***
0.14
0.05
0.02
0.25
Panel D. Shareholder Rights
STRONG
incremental capital structure decisions under managerial
entrenchment. Journal of Banking & Finance 25, 1857-1895.
Yt
Dept
∆S
∆LTDt
It
Divt
Intt
COC
Yt
Dept
∆S
∆LTDt
It
Divt
Intt
COC
0.08**
0.05**
0.15
-0.1
0.11
0.05
0.02
0.24
0.04
0.03
0.12
0.02***
0.14
0.05
0.02
0.3
Notes: Yt is defined as the sum of income before extraordinary items, extraordinary item, interest, income statement deferred
taxes and depreciation. Dept is depreciation expenses. DSt is the net new issues of shares which balance the cash flows. ∆LTDt is
Accounting and Business Research 27, 297 – 309.
McFarland, J. (2002). How ROB created the rating system.
The Globe and Mail, 7 October 2002, B6.
Fama, E. and French, K. (1999). The corporate cost of
Mehran, H. (1992). Executive incentive plans, corporate
capital and the return on corporate investment. Journal of
control, and capital structure. Journal of Financial and
Finance 54, 1939-1967.
Quantitative Analysis 27, 539-560.
Fama, E. and Jensen, M.C. (1983). Separation of
Stulz, R. (1988). Managerial control for voting rights:
ownership and control. Journal of Law and Economics 26,
Financing policies and the market for corporate control.
301- 325.
Journal of Financial Economics 20, 25-54.
Jiraporn, P. and Ning (2006). Dividend policy, shareholder
Ward, A.J., Brown, J.A., & Rodriguez, D. (2009).
rights, and corporate governance. Journal of Applied
Governance
Finance 16, 24-36.
substitutability
John, K. and Litov, L. (2010). Corporate governance and
financing policy: New evidence. Working paper, New York
WEAK
publication. doi: 10.1177/0312896213478332
University.
bundles,
and
firm
performance,
complementarity
of
and
the
governance
mechanisms. Corporate Governance: An International
Review 17, 646-660.
Wen, Y., Rwegasira, K., & Bilderbeek, J. (2002). Corporate
Klapper, L. and Love, I. (2004). Corporate governance,
investor protection, and performance in emerging markets.
Journal of Corporate Finance 15, 703-723.
the change in the book value of long-term debt. It is the change in book capital from t-1 to year t, plus depreciation. Intt is total
Klein, P., Shapiro, D., Young, J. (2005). Corporate
interest expenses paid to creditors. Divt is total dividends paid to shareholders. COC is cost of capital. Firms in the top (bottom) 33%
governance, family ownership and firm value: the Canadian
sorted based on the corresponding corporate governance index are classified as strong (weak) governed firms. *,**,*** denote
evidence. Corporate Governance: An International Review
significantly different from their counterparts at 10%, 5% and 1% respectively (for two-tail tests assuming unequal variance).
13, 769-784.
governance and capital structure decisions of the Chinese
listed firms. Corporate Governance: An International
Review 10, 75-83.
Note
1.
This article is based on Koerniadi and Tourani-Rad (2013)
Corresponding Author:
Hardjo Koerniadi, Department of Finance, Auckland University of Technology
PO Box 92006, Auckland 1142,, New Zealand.
Email: hkoernia@aut.ac.nz
18
APPLIED FINANCE LETTERS | Volume 02 - ISSUE 02 | 2013
19
Light-handed Regulation in New Zealand
Banking and Financial Services: Has it worked?
from banking regulation. Deposit insurance can give rise
to moral hazard, as depositors no longer have to ascertain
whether the bank they deal with acts prudently so that it
can repay deposits as required. Another version of moral
hazard arises when large banks get to be classed as too big
to fail: incentives for prudent behaviour are undermined.
Another potential problem is looting, which we discuss
the expense of small shareholders and depositors.
The rest of this paper proceeds as follows. We next look at
the process of deregulation that occurred in New Zealand,
and then at the reregulation that occurred after around
2000. After that we come back to look at governance
issues and their interaction with regulation. We conclude
by asking whether New Zealand regulation has, in the end,
Light-handed Regulation in New Zealand
Banking and Financial Services: Has it worked?
further below: managers may seek to enrich themselves at
New Zealand’s regulatory framework began to be eased
The election of the fourth Labour Government in 1984
By David Tripe
a little in the 1970s, with changes such as banks being given
provided the opportunity for much of the previous regulatory
David Tripe is an Associate Professor of Banking at Massey University and is the Director of the Centre for Financial Services
greater freedom to set their own interest rates on lending,
structure to be dismantled. Over a short period, interest rate
and Markets
and permission to offer new products. These were often in
restrictions, foreign exchange controls, the fixed exchange
response to changes in the global economic environment
rates, mandatory liquid assets holdings (through the reserve
which meant, for example, that there was a demand for
asset ratio system) were abolished, as were restrictions on
foreign-exchange hedging, not previously necessary while
private foreign borrowing.2 Later in 1985, proposals were
all exchange rates globally were fixed relative to each
advanced for allowing new banks to enter the market;
other.
this and a number of other changes were codified in
This paper reviews banking regulation in New Zealand from the deregulation of the
1980s through to the present day. It focuses on the effects of light-handed regulation
that was introduced as part of the deregulatory process and examines its effectiveness
for protecting depositors and at preventing the (potential) looting of New Zealand
banks by their foreign owners. It notes the extent of reregulation now being undertaken.
Keywords: Banking regulation, New Zealand, bank failure management
2. The Process of Deregulation
Also in response to this environment, new institutions and
new classes of institutions were established to offer new
products and services, from which existing institutions might
have been barred. Regulatory frameworks often struggled
1. Introduction
This paper provides an overview of some recent history of
banking and financial services regulation in New Zealand.
This is of interest because, particularly during the latter
part of the 1980s, the New Zealand banking and financial
system was deregulated very swiftly, according to a
different set of regulatory principles, to become one of the
most lightly regulated financial systems in the world. Barth
et al (2001) included New Zealand among a small group
of countries that permitted the widest latitude in terms of
the activities banks might undertake. This light-handed
been very effective.
to keep up with these new institutions, and when some of
classes of financial institutions specialising in different types
them got into difficulty, some social disruption occurred as
of loans and other products.
these institutions were dealt with under standard insolvency
In a broader context, Spong (2000) identifies four
legislation. A response to this was the Securities Act 1978
main strands to justify the regulation of financial services
and accompanying regulations, which set out the process
firms: protection of depositors, monetary and financial
for issuance of the prospectuses required for solicitation of
stability, an efficient and competitive financial system
funds by entities other than banks, savings banks, building
and consumer protection. Depositor protection (often
societies and credit unions. This was intended to ensure that
addressed by deposit insurance) addresses depositors’
investors received standard format information on what
inability to look after themselves. Monetary and financial
they were investing in.
a 1986 amendment to the Reserve Bank Act. Opening
up the market to new banks necessitated developing a
set of rules for registration of banks, replacing a previous
system which had required individual acts of parliament.
The only quantitative requirement for registration was a
minimum capital level of $15 million. This was all intended
to promote a more efficient and competitive banking
market. Requirements were codified further in the Reserve
Bank of New Zealand Act 1989 (Dawe, 1990). Throughout
the process, major changes were also made in respect
of monetary policy and its implementation, including the
adoption of inflation targeting.
A consequence of deregulation was that the banking
sector was no longer as disadvantaged in offering financial
services and competing with other financial institutions.
stability is concerned with protection of the payments
In an attempt to control inflation, the re-elected Muldoon
system and the avoidance of systemic banking crises, and
government in 1981 imposed wide-ranging wage and price
costs that such disruptions or crises would impose on society
controls. It moved in 1982 to extend these to the financial
more broadly. An efficient and competitive financial
sector, on the basis that the financial sector should be seen
The regulatory structure that existed from the 1930s to
system will be able to support more financial intermediation
as sharing the burden of restrictions in the battle against
the 1980s for the New Zealand banking and financial sector
at lower prices, and be able to respond better to changing
inflation. These were primarily effected through setting
was particularly pervasive.1 Developed following the great
economic conditions and technological advances. It also
maximum interest rates on various classes of loans, although
depression of the 1930s, it generally reflected a preference
reduces the costs of trading goods and services. Consumer
there were also restrictions on bank lending growth, with
for managing the economy to achieve broader objectives
protection is concerned with preventing abusive practices
regulatory powers continually extended as financial
around economic growth and development: finance
and ensuring fair access to financial services for all. Spong
institutions found ways to circumvent them. By the time the
The overarching principle to be applied to regulating the
should be the servant of this process. Markets were not
also argues that banking regulation should not be directed
Muldoon government lost office in July 1984, the mesh of
banking sector was set out in an article in the May 1987
seen as important, with a feeling in some circles that it
at preventing bank failures, at providing for governments
regulation had become extensive, and the financial sector
Reserve Bank of New Zealand Bulletin (Staff, 1987).4 This
was markets that had engendered the great depression,
to override bankers’ decision-making, or favouring certain
was quite constrained in providing financial services. In this
proposed that the Reserve Bank should not be concerned
and that markets should be prevented from repeating this
groups over others. Prior to 1984, regulation in New Zealand
regulated environment, access to borrowing from banks
about the failure of individual institutions, but only with the
process. With no particular role for markets, regulation also
was not generally consistent with Spong’s principles.
was something of a privilege, with the less privileged having
failure of multiple institutions through a systemic financial
to utilise the services of other institutions
crisis. Moreover the object of policy should be failure
regulation persisted through the 1990s and subsequently,
although since around 2000 steps have been taken to put
more power into regulators’ hands.
lead to a segmentation of the financial sector, with different
20
Prior research also identifies negative consequences
Some previous classes of institutions, such as official shortterm money market dealers,3 disappeared, while other
non-bank financial institutions converted to bank status.
This meant that the numbers of participants within some
classes of financial institutions, such as building societies
and finance companies, were considerably reduced, while
the savings banks all converted to bank status and looked
to broaden the scope of activities they undertook.
APPLIED FINANCE LETTERS | Volume 02 - ISSUE 02 | 2013
21
Light-handed Regulation in New Zealand
Banking and Financial Services: Has it worked?
management, designed to limit the disruption caused by
failures, rather than failure prevention, with occasional
failures being perceived as desirable as a way of spreading
the message about market discipline (Doughty, 1986). The
scope of regulation was to be prudential: in other respects,
the market was seen as being the most appropriate
source of regulation for the New Zealand financial system
(Grimes, 1998), although this could be supplemented by
the broader legislative framework such as the Companies
Act and Financial Reporting Standards. The concern for
the financial system was subsequently affirmed by White
(1990, 1991), who stressed the importance of protecting the
payments system.
This view of regulation has regarded deposit insurance
schemes, a standard international response to individual
bank failures, as something to be avoided. Deposit
insurance is seen as undermining depositors’ incentives
to monitor banks, leaving banks to take greater risks than
they might otherwise – a phenomenon described as
moral hazard (White, 1990). In such a situation, it is possible
global financial system.
Within such a context the Reserve Bank deemed it
appropriate to adopt the Basel Committee’s guidelines
on bank capital adequacy. There was a view that this was
driven primarily by a desire to conform to international
applied to reporting market risk exposures, as per Harrison
ultimately protect their deposits.12 At least for retail deposits,
(1996), although the Reserve Bank chose not to follow the
there is no obvious indication that interest rates are sensitive
Basel Committee’s guidelines, and did not require capital
to (agency) credit ratings. The Reserve Bank continues to
against market risk.
identify the disclosure regime as the basis for prudential
9
Reliance
on
disclosure
was
most
unorthodox
supervision (Fiennes & O’Connor-Close, 2012), although
they now require significant amounts of information to be
norms (and to avoid the costs of not doing so), but stated
internationally, with most countries preferring to apply
views have generally been to the effect that more capital
specific prudential regulation on exposures, and to have
was better for promoting bank safety and soundness (and
programmes for specific examination of banks.10 Consistent
under the 1988 Basel I rules, New Zealand and Australia both
with Spong’s principles, it is common to adopt deposit
imposed a capital requirement for holdings of government
insurance schemes to protect unsophisticated retail
Another distinctive feature of the New Zealand approach
securities).
depositors, whereas the Reserve Bank of New Zealand has
to banking regulation is the absence of any process
no specific objective to protect bank depositors per se.11
for on-site visits to banks by the monetary or supervisory
A further development in the prudential supervision of
banks was the introduction of a bank specific disclosure
Despite the disclosure regime having been publicised
regime, which came into effect at the beginning of 1996.5
by the Reserve Bank, research has found relatively limited
This requires banks, every quarter, to publish a balance
public awareness of how it operates, with many people
sheet and year–to-date income statement, along with
believing that the government or the Reserve Bank would
reported directly to them by the banks, other than via their
quarterly disclosures, meaning that they can no longer
claim to be no better informed than the general public.
authorities, such as commonly occurs in other jurisdictions.
The Reserve Bank will from time to time meet with a bank’s
management, but verification of a bank’s condition is
otherwise undertaken only by external auditors.
other financial and non-financial information6: on the basis
of this, depositors are supposed to be able to assess the
soundness of banks with which they place their funds, and
3. The Attempts at Reregulation
to exercise market discipline by withdrawing their funds if
Towards the end of the 1990s, it was becoming apparent
boards of directors, which should be more responsive to
they decide that the risk profile of the bank has changed
that light-handed regulation of banks might not provide
New Zealand needs than the directors of a foreign bank
adversely, putting their deposits at risk. A further principle
the best outcomes for New Zealand or bank depositors,
operating a New Zealand branch (Chetwin, 2006). It was
was that the Reserve Bank would get the same information
particularly with the extent of foreign bank ownership. The
also argued that having a New Zealand-incorporated
as was made available to the general public. If they had no
Reserve Bank took some initiatives to allow it to take greater
entity made matters clearer for creditors (depositors in
Immediately following initial deregulation, there was
better information than the general public, they could not
control over what banks were doing, although these were
particular), when statutory managers were appointed to a
an economic boom, seen particularly in a booming stock
then be said to be in a position to have acted to prevent
not always easy to implement. Among a series of changes
failing bank.16
market and property development activity, followed by a
a bank failure, and could not then be responsible for losses
made were some revised rules on corporate governance,
bust, a key element in which was the 1987 share market
incurred by depositors (Brash, 1997a).
to provide for more genuinely independent directors,
that bank losses could be aggravated at the expense
of taxpayers, who would be likely to be the ultimate
underwriters of a deposit insurance scheme. The Reserve
Bank has continued to uphold this argument.
crash. The bust in property development impacted
severely on the banks that had supported it, leading in due
course to the failure of the (formerly government-owned)
Development Finance Corporation (DFC) in 1989, and to
two bail-outs of the formerly government-owned Bank of
New Zealand. This lead the Reserve Bank to give further
consideration to issues around the prudential supervision of
banks, a topic they had been able to overlook in former
times when banks were much more restricted in the
activities they undertook, and when competition between
the banks was more limited.
During the late 1980s and 1990s we also saw a substantial
increase in the proportion of foreign ownership of the New
Zealand banking sector, in some cases reflecting a lack
of financial strength of the New Zealand owners, but also
in response to the deregulated market. Previously New
Zealand-owned entities such as the Post Office Savings
There was also a view that the need for banks to report
including New Zealand resident directors.13 Obtaining and
publicly every quarter would make them more cautious
reporting of ratings from a credit rating agency approved
about their risk exposures (Brash, 1997b; 1998). In this respect,
by the Reserve Bank was made mandatory. The desire
the bank’s board of directors was seen as particularly
to maintain credit ratings and keep funding costs down
important, with their responsibilities to individually sign
accordingly is likely to have caused banks to act in a more
off on the disclosure statements making them liable to
conservative fashion.
In response to concerns about the risk profile of New
Zealand bank funding, which were exacerbated during
the depths of the global financial crisis in September and
October 2008, we have also seen the reintroduction of
specific rules on bank liquidity. The mismatch and core
funding ratios apply to short and long term liquidity and
funding risks respectively, and came into effect on 1 April
2010 (Hoskin et al, 2009). This approach is broadly consistent
penalties if there was anything misleading or untrue in
Rules were also adopted to control banks’ outsourcing
with what has since been mandated internationally as
the disclosure statements.7 It was also envisaged that the
activities, with the objective that the Reserve Bank (or
part of Basel III, and is also consistent with what the banks
disclosure statements would be reviewed and commented
statutory managers) should have access to banks’
appeared to be doing anyway as they sought to reduce
on by journalists and banking experts, who would highlight
computer systems,
problems, for the public benefit.
into difficulty, while the Reserve Bank also got the power
Foreign ownership of the New Zealand banking system
was also relevant, with the argument advanced in some
14
in New Zealand, if parent banks got
to regulate payment systems (which had previously been
wholly under the control of the banks themselves).
the riskiness of their funding portfolios (Tripe & Shi, 2012).
A more problematic area of reregulation has been in
developing a process for dealing with banks in financial
distress. One proposal is for a system of open bank
circles that New Zealand did not need to regulate its banks
We also saw steps taken to get the Australian-owned
resolution (OBR), which would see bank deposits having a
as they were almost all subject to the oversight of foreign
Westpac Banking Corporation (Westpac), in particular, to
haircut applied to them, to provide funds to recapitalise a
regulators.8
establish a New Zealand incorporated subsidiary. This was
failing bank. Following the haircuts, funds remaining in the
Bank, the Bank of New Zealand and most of the trustee
The protection provided to the public under the
seen as of particular importance because of a concern
accounts at the failing bank would then be guaranteed
savings banks become part of international (predominantly
disclosure regime provided a justification for the Reserve
that Australian depositors in the branch might be given
(Hoskin & Woolford, 2011). A key outcome of the OBR is
Australian) banking groups. Deregulation made it easier
Bank to remove some previously applied quantitative
priority in repayment of New Zealand deposits (reflecting
to reduce the social costs of financial institution failure by
for international banks to participate in the New Zealand
restrictions, with exposure limits replaced by requirements
the priority under the Australian Banking Act).15 This was
getting a bank re-opened promptly after the hair-cut has
market, while it also became more important for them to
to report large exposures to individual counterparties and
part of a local incorporation policy, designed to ensure
been applied, so that the payment system can resume
do so as New Zealand became more integrated into the
open foreign exchange positions. A similar approach was
that larger and systemically significant banks had local
operations (not necessarily possible under standard
22
APPLIED FINANCE LETTERS | Volume 02 - ISSUE 02 | 2013
23
Light-handed Regulation in New Zealand
Banking and Financial Services: Has it worked?
insolvency practices).
Although the banks have been required to establish
computer systems to allow OBR to be implemented,
debate over whether this is the most sensible approach
to resolving failing banks has been limited. OBR relies on
small depositors) rather than imposing the costs of failure
most obvious source would be to repay those borrowings
The second, more important factor is a desire to preserve
on those counterparties who might be better positioned to
(which would be quite legal), but which might well deprive
a profitable business to receive an ongoing stream of returns
bear them. Moreover, other countries provide some form
the New Zealand bank of the liquidity needed to maintain
into the future. Owners would be incentivised to loot a bank
of deposit insurance or guarantee for retail depositors, a
operations.
only if they regarded its future prospects as poor. Moreover,
protection which is absent in New Zealand.
17
The question then arises that, if the looting of a New
an assumption that depositors should have been able to
OBR might have been reasonable in a simpler
Zealand bank is simple, why it has not been done already.
protect themselves through the knowledge that deposits
environment such as existed in the 1980s, and is certainly
Why have the Australian banks not already removed the
were not guaranteed, and that they could review disclosure
consistent with the philosophy of light-handed regulation.
resources from their New Zealand business and supplied
statements to identify banks at risk.
There is an expectation that depositors should bear some of
these to their Australian parents? There are two main
the cost of a failure because of their own failure to monitor
reasons why this has not happened. The first factor is the
the bank with which they do business. It is, however, less
governance regime applying at parent company level: this
clear as to how effective OBR can be in the more complex
is clearly much more robust for the major Australian banks,
banking environment that now exists.
reflecting the influences of APRA and the ASX, than it was
We now see approaches internationally where, if banks
are failing, bond-holders and other wholesale depositors
may be bailed in and required to contribute to losses. There
are some suggestions that the OBR is similar to this, but
for New Zealand finance companies.
there are differences. The OBR proposals treat all creditors
we know from the goodwill paid for acquisitions that the
market value of New Zealand banks is generally substantially
in excess of book values (of equity): any looting of banks
would rapidly dissipate that surplus market value. Related
to this is the general reluctance by banks to abandon their
foreign subsidiaries, because of the potential effect on their
perceived creditworthiness, and thus their agency credit
ratings. The desire to maintain credit ratings is a factor
which is likely to have contributed to more conservative
bank behaviour, such as banks holding capital in excess of
regulatory minima.
equally (although there may be scope to exempt some
5. Concluding Thoughts
4. The Effect of Regulation
We have reached an interesting position. New Zealand
An additional key rationale for regulation is the corporate
them. We saw how complicated this was for the finance
governance problem, as set out by Shleifer & Vishny (1997):
company sector in New Zealand since 2006: to take action,
“How do suppliers of finance get managers to return
some of the profits to them? How do they make sure that
managers do not steal the capital they supply or invest it in
bad projects?” (p 737).
This is even more of a challenge in financial services
than in other areas, in that electronic money is hard to
trace, and can be diverted to a wide range of other uses.
Where financial services firms are managed by owners,
such as with foreign-owned banks or closely held finance
companies (and it has been argued that this was a
particular problem in the New Zealand finance company
sector, where depositors/investors incurred substantial
the authorities needed to establish that there was some sort
of criminal culpability, and then try to find money that might
still be available to repay the depositors who entrusted it to
the institutions in the first place.
financial markets have, since the deregulation of the
1980s, been relatively lightly regulated, consistent with an
approach that has required regulation to be justified, rather
than the alternative view that might have required the
argument to remove regulation. In such an environment,
the more domestically focused parts of the New Zealand
financial system have not fared particularly well, an effect
In banking, the sums involved are relatively much larger
which can be seen with the New Zealand Stock Exchange,
than for non-banks, reflecting the much greater significance
which has a much smaller capitalisation relative to GDP
of banks in New Zealand financial intermediation. The issue
than for example, Australia (although this difference cannot
of concern from a regulatory perspective would be that
be attributed solely to regulatory effects).
resources at New Zealand banks might be transferred to a
foreign parent and that the New Zealand bank might act
in the foreign parent’s interests, rather than those of the
bank’s business in the New Zealand market.
The part of the financial system that seems to function
best is the largely foreign-owned banking system, which
is significantly governed by foreign regulators. Even here,
however, the ability of the Reserve Bank to prevent foreign
losses), this can be even more of a challenge, as scope for
Much regulatory effort since the late 1990s has been
owners looting New Zealand banks is not especially strong.
independent oversight may be limited to periodic external
directed at this issue. There was a view that, with Westpac
That this has not happened is, in the author’s view, more a
audits. Against this background, regulation, which should
incorporating a subsidiary in New Zealand, the New Zealand
matter of good luck and the constraints applied in banks’
be part of broader corporate regulation, has to ensure that
system was somehow protected, in that any transfer of funds
home countries than anything else. We should not rely
financial institutions are run consistent with their supposed
from a New Zealand bank that made the New Zealand
solely on Australian regulators because, as Kane (2006)
purposes, and that the funds are not looted (in the sense
bank insolvent would mean that the directors, particularly
notes, they are responsible to Australian rather than New
of Akerlof & Romer, 1993). In the financial sector, regulation
New Zealand resident directors, could be prosecuted. This
Zealand taxpayers.
is particularly important because of the roles that financial
also justified a stronger role for independent directors.
institutions play in a modern society, and their privileged
position in terms of the means of payment that society uses.
At the same time, the process of bank liquidation has
become more complex, with the value of assets as per
banks’ financial statements increasingly differing from
what might be available to repay depositors. As Bertram
& Tripe (2012) have noted, categories of assets that might
disappear could include cash borrowed from a parent
bank, assets subject to repurchase agreements (potentially
including residential mortgage backed securities), loans in
covered bond pools, intangibles and deferred tax. It would
be easy to see 40% of a bank’s assets disappearing by the
time a statutory manager intervened!
Looking at matters from a longer term perspective, the
1980s were characterised by a rush to remove previous
regulation, and a regulatory structure was developed
which was directed at the not especially globalised world
of the 1980s. Since that time globalisation and new financial
products have made financial markets and financial
institutions a lot more complex, and the simple approaches
to the resolution of failing institutions that might have
worked in the 1980s would be likely to be overwhelmed by
the much more complex financial institutions that exist in
the 2010s.
The disclosure regime is becoming less effective as a
It is doubtful that this would really afford much
vehicle for protecting depositors’ interests. A key reason is
protection to New Zealand if the Australian parent bank
that bank financial statements have become increasingly
What are the constraints that apply to the management
was in difficulty. Would managers on secondment (from
complex, reflecting both the increasing complexity of
and owners of financial institutions to discourage them from
Australia) and Australian-based directors and owners really
banks’ business and the adoption of the International
looting the resources, deposits, with which they have been
care that much about New Zealand directors? Moreover,
Financial Reporting Standards (IFRS). The process has not
entrusted? As the Reserve Bank and others have noted,
one needs to be mindful of the typical structure of New
always been helped by changes to required disclosures,
this is more complex in New Zealand because the banks
Zealand subsidiary balance sheets, which usually have
made in response to changes in regulation and to assist
are predominantly foreign-owned: if the owners seek to
significant borrowings from parent banks. If a foreign owner
the banks by reducing the burden (and hence cost) of
appropriate resources to other uses, it is difficult to recover
was looking for resources that could be repatriated, the
disclosure. Relatively little effort is now being directed at
24
trying to comment on what is reported in banks’ disclosures.
The New Zealand experience is of international relevance
as well, particularly with the greater frequency of significant
foreign ownership of banking systems. Foreign ownership
poses challenges for host country regulators, and in some
environments, such as the European Union, regulators’ roles
in overseeing the local operations of foreign-owned banks
can be quite limited. Gaining control of a banking system to
encourage it to operate consistent with a national interest,
but also within the confines of the invisible hand, can be a
challenging process.
APPLIED FINANCE LETTERS | Volume 02 - ISSUE 02 | 2013
25
Light-handed Regulation in New Zealand
Banking and Financial Services: Has it worked?
Acknowledgements
The author would like to thank audiences at the New
2013 Conference of the Financial Engineering and Banking
Zealand Finance Colloquium, Dunedin, the 2103 New
Society, Paris for comments on earlier versions of this paper.
Zealand Capital Markets Symposium, Auckland, and the
Grimes, A. (1998). Liberalisation of financial markets
underworld of bankruptcy for profit. Brookings Papers on
in New Zealand. Reserve Bank of New Zealand Bulletin 61,
Economic Activity, 1-60.
291-306.
Barth, J. R.; Caprio, G. & Levine, R. (2001). Banking
systems around the globe: do regulation and ownership
affect performance and stability? Chapter 2 in Mishkin,
F. (ed), Prudential Supervision: what works and what doesn’t.
(pp 31-95). Chicago: NBER.
Bertram, G. & Tripe, D. (2012). Covered bonds and bank
failure management in New Zealand. Policy Quarterly, 8,
38-43.
Bollard, A. (2003). Corporate governance in the financial
sector. Reserve Bank of New Zealand Bulletin 66, 35-41.
(2004).
Promoting
strong
New Zealand Bulletin 67, 27-29.
Brash, D. (1997a). Banking soundness and the role of the
market. Reserve Bank of New Zealand Bulletin 60, 9-17.
Economics 71, 105-125.
Financial System. Wellington: RBNZ. (pp 205-231).
Shleifer, A. & Vishny, R. W. (1997). A survey of corporate
Brash, D. (1997b). The implications of the global financial
Bulletin 60, 315-321.
Brash, D. (1998). In a world of open capital markets,
how can central banks best help banking systems remain
strong? Reserve Bank of New Zealand Bulletin 61, 122-128.
(2006).
The
Reserve
Bank’s
Harrison, I. (1996). Disclosure of registered banks’ market
risks. Reserve Bank of New Zealand Bulletin 59, 146-154.
Heffernan, S. (2005). Modern Banking. Chichester: John
Wiley & Sons.
implementation and effects. (5th Edition). Kansas City, Mo:
Federal Reserve Bank of Kansas City.
Staff.
(1987).
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policy
White, B. (1990). Why are banks supervised? Reserve Bank
of New Zealand Bulletin 53, 379-388.
White,
B,
(1991).
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policy
in
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141- 151.
Wilson, W.; Rose, L. & Pinfold, J. (2012). Moderating risk
in
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deregulated
environment. Reserve Bank of New Zealand Bulletin 50, 9-15.
in New Zealand retail banks: disclosure as an alternative
regulatory regime. Journal of Banking Regulation 13, 4-23.
Tripe, D. & Shi, J. (2012). Liquidity regulation: lessons from
New Zealand. JASSA, the Finsia Journal of Applied Finance.
Issue 3, 37-41.
Hodgetts, B. (1992). Chronology. Appendix 1 in Grimes,
A. (ed). Monetary Policy and the New Zealand Financial
System. (3rd Edition). Wellington: RBNZ. (pp 232-253).
Hoskin, K.; Nield, I. & Richardson, J. (2009, December).
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Kane, E. (2006). Confronting divergent interests in
cross-country regulatory arrangements. Reserve Bank of
New Zealand Bulletin 69, 5-17.
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supervision in New Zealand. Annals of Public and Cooperative
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Spong, K. (2000). Banking Regulation: its purposes,
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Reform. Chapter 7 in Financial Policy Reform. (pp 111-123).
Wellington: Reserve Bank of New Zealand.
Evans, L., & Quigley, N. (2002). An Analysis of the Reserve
Bank of New Zealand’s Policy on the Incorporation of Foreign
Banks. New Zealand Institute for the Study of Competition
and Regulation.
Fiennes, T. & O’Connor-Close, C. (2012). The evolution
of prudential supervision in New Zealand. Reserve Bank of
Kaufman, G. (2004). Bank regulation and foreign-owned
banks. Reserve Bank of New Zealand Bulletin 67, 65-74.
McIntyre, M.; Tripe, D. & Zhuang, X. (2009). Testing for
effective market supervision of New Zealand banks. Journal
of Financial Stability 5, 25-34.
Mortlock, G. (1996a). New disclosure regime for registered
banks. Reserve Bank of New Zealand Bulletin 59, 21-29.
Mortlock, G. (1996b). Banking supervision: placing a new
emphasis on the role of bank directors. Reserve Bank of
New Zealand Bulletin 59, 323-329.
Mortlock, G. (2002). Corporate governance in the
financial sector. Reserve Bank of New Zealand Bulletin 65,
12-25.
Ng, T. (2007). The Reserve Bank’s policy on outsourcing
by banks. Reserve Bank of New Zealand Bulletin 70, 32-36.
Nicholl, P, W. E. & King, M. F. (1985). Financial institutions
and markets in New Zealand. Chapter 3 in Skully, M. T (ed),
Financial Institutions and Markets in the Southwest Pacific.
(pp 160-244). New York: St Martin’s Press.
New Zealand Bulletin 75, 5-13.
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APPLIED FINANCE LETTERS | Volume 02 - ISSUE 02 | 2013
27
Notes
1.
See Quigley (1992) for a review of financial regulation in earlier periods.
2.
See Hodgetts (1992) for a more detailed chronology of some of the relevant events. Evans et al (1996) suggest that the
financial sector was an area where deregulation proceeded most rapidly.
3.
See Nicholl & King (1985) for a more extensive discussion of the role of official short-term money market dealers.
4.
Although, as we are reminded by Grimes (1998), there had previously been no system for the prudential supervision of
2013 Auckland Finance Meeting
15-17 December 2013, Auckland, New Zealand
New Zealand banks.
5.
Banks had been required to issue Securities Act-type prospectuses if they wished to accept retail deposits following
www.acfr.aut.ac.nz/conferences-and-events/2013-auckland-finance-meeting
the passage of the 1986 amendment to the Reserve Bank Act, but the disclosure requirements under the new regime
were more specifically directed at the risks banks faced, and were required to be produced quarterly (rather than
6-monthly, as previously) by all banks (and not just those which sought retail deposits).
6.
hosting its third Auckland Finance Meeting on 15-17 December 2013. The main focus will be on Empirical/Econometric
More information on the data required to be disclosed under the disclosure regime, and the principles that underpinned
studies in Finance. Topics include (but are not limited to): Asset Pricing; Behavioral Finance; Derivative Markets; Empirical
it, are provided in Mortlock (1996a). There have been changes to the detail of what is required to be disclosed since
Corporate Finance; Financial Econometrics; Financial Markets; International Finance; Market Microstructure; Risk
the scheme’s introduction, but the principles remain the same.
Management; Volatility Models. Papers will go through a double review process.
7.
This is discussed at greater depth by Mortlock (1996b, 2002)
8.
See, for example, Heffernan (2005), p 178 (footnote 7) and Turner (2000), although Brash (1997a) specifically argued
against this proposition.
9.
The Auckland Centre for Financial Research at the Faculty of Business and Law, Auckland University of Technology is
SPECIAL ISSUE:
A Special issue of the Journal of Empirical Finance on Financial Markets and Uncertainty will be dedicated to papers
presented at the 2013 Auckland Finance Meeting
This changed with the adoption of Basel II in 2008, following which banks are now required to hold capital against
market risk.
10.
Reserve Bank monitoring is generally focused on making sure that banks comply with the disclosure rules.
11.
See Bollard (2003) for further discussion of these issues.
12.
See, for example, McIntyre et al (2009). Wilson et al (2012) could not find evidence for the effect of market discipline,
KEYNOTE SPEAKERS:
Market Rules (Prof. Hendrik Bessembinder, University of Utah, US)
Yesterday’s Tomorrows: Past Visions of Future Financial Markets (Prof. Robert I. Webb, University of Virginia, US)
although they did find evidence for banks exercising self-discipline in response to the disclosure regime.
BEST PAPER AWARDS:
13.
See, for example Bollard (2004). A further set of rules following a review were announced in December 2010.
NZ Superfund Best Paper Award $2,000
14.
See Ng (2007) for more detail on this.
Z Superfund Runner Up Award $1,000
15.
The other major banks already conducted the majority of their New Zealand business through New Zealand
CFA Asia Capital Markets Award US$1,000
incorporated subsidiaries. The Reserve Bank had been going through a process of setting conditions under which
banks would not be allowed to operate as branches, but only as subsidiaries (see Mortlock, 2003). These conditions
To register for this event:
implied change only for Westpac (although they may have discouraged other banks from taking retail deposits). The
Please contact Tracy Skolmen
policy would also have been likely to have impacted on Australian-owned AMP Banking, but they chose to sell their
tskolmen@aut.ac.nz
business and withdraw from the New Zealand market.
16.
See Evans & Quigley (2002) for a more extensive discussion of the relevant issues.
Meeting Organizer
17.
Kaufman (2004) questions whether it makes any difference if a local bank operates as a branch or as a subsidiary of
Bart Frijns
a holding company.
Professor of Finance, AUT University
We Thank our Sponsors
Corresponding Author:
David Tripe, School of Economics and Finance, Massey University
Private Bag 11-222, Palmerston North, New Zealand 4442
Email D.W.Tripe@massey.ac.nz
28
APPLIED FINANCE LETTERS | Volume 02 - ISSUE 02 | 2013
ACFR Symposium on the New Zealand Capital Market
To be held in Auckland on 10th April 2014
www.acfr.aut.ac.nz/conferences-and-events/nzcms-ii-fund-management
The Auckland Centre for Financial Research at the AUT Business School is hosting its second New Zealand Capital
Market Symposium, with a focus on Fund Management on 10 April 2014. The symposium will bring together leading
New Zealand practitioners, policymakers, and academics to openly discuss issues around fund management in New
Zealand. The event will consist of a keynote address, various presentations from academics and practitioners and a
panel discussion. The presentations and discussions will focus on:
• Performance of Kiwisaver funds
• Style investing in the fund industry
• Passive vs active management
• Issues related to fees and disclosure
The event is jointly hosted by the ACFR, INFINZ and Morningstar.
To register your interest in the event, or for more information, please visit the symposium website or contact:
Ms Tracy Skolmen – tskolmen@aut.ac.nz
Symposium Organisers
Prof. Bart Frijns
Prof. Alireza Tourani-Rad
Ms Annie Zhang