Activity-based diversification, corporate governance, and the market valuation of commercial banks in the Gulf Commercial Council

Abstract

This article examines the effect on market valuation of both corporate governance and the diversity of activities conducted by GCC commercial banks. It shows evidence on the endogenous effect of corporate governance and the characteristics of the banking industry in determining the diversification level of a bank. Empirical findings show a bias in results using ordinary least squares regressions. When controlled for endogeneity, they indicate a negative (but weak) association between the diversification index and the market valuation-consistent with the agency-based hypothesis. Interestingly, foreign banks and corporate shareholders are effective monitors who invest in more diversified GCC banks with higher valuation multiples. Conversely, domestic corporate shareholders-related by a complex web of relationships-invest in less diversified banks with a lower market valuation. In addition, diversified commercial banks with either subsidiaries in developed countries or involvement in market-based activities have higher market valuation. The latter may be explained by the effect on performance of the recent bubble in the Arab stock market. © 2007 Springer Science+Business Media, LLC.