Relationship between Major Business Units, Diversification, and Operational Efficiency of Taiwan's Financial Holding Companies: The Role of Corporate Governance

The “Financial Holding Company Law” was enacted in Taiwan on July 9, 2001, came into effect on November 1, 2001, and was amended on January 21, 2009, and September 30, 2015. A financial holding company is a type of company with cross-industry operations. A cross-selling synergy can be achieved by allowing cross-industry operations and integrated sales of different financial products; moreover, customers can enjoy the convenience of “one-stop” shopping. Therefore, the establishment of financial holding companies can help financial institutions compete more efficiently (Lo and Lu 2006). Efficient operation is the primary task for financial holding companies to survive, particularly in small markets with high saturation and competition (Lo and Lu 2006). The potential benefits of financial holding companies include reducing costs and achieving cross-marketing synergies (Chao, Yu, and Chen 2010; Loan and Lu 2006); however, they might not be optimal for resource allocation and management because of extensive and complex business activities, and this may lead to resource inefficiency (Chao et al. 2010). Therefore, a comprehensive evaluation of the operational efficiency of the financial holding companies is a critical concern. The study objectives are as follows: first, to evaluate and compare the relative operational efficiency of financial holding companies in Taiwan by using the data envelopment analysis (DEA) method; second, to examine whether the differences in major business units are a crucial factor influencing the operational efficiency of financial holding companies; third, to examine whether a higher ratio of revenues from the major business unit to the overall revenues of financial holding companies can increase their operational efficiency; fourth, to examine whether diversification can improve the operational efficiency of holding companies; and fifth, to investigate the effect of corporate governance on the relationship between diversification and operational efficiency among Taiwan’s financial holding companies. This study investigates the operational efficiency of 14 financial holding companies operating in Taiwan from 2003 to 2010. The DEA-CCR method developed by Charnes, Cooper, and Rhodes (1978) is used to measure the relative operational efficiency of financial holding companies. The input variables include total assets and operating expenses and the output variables include net sales and net income. The following hierarchical Tobit regression models are used to investigate the determinants of operational efficiency of financial holding companies. 1. The first Tobit model includes control variables: TEit=C β1ASSETit β2BISit β3LIAit ϵit。 (1) 2. The second Tobit model includes control and explanatory variables: TEit=C β1ASSETit β2BISit β3LIAit β4BANKit β5SECit β6OPPit β7DIVit β8Bankit*DIVit β9SECit*DIVit ϵit(2) 3. The third Tobit model includes control, explanatory, and moderating variables: TEit=C β1ASSETit β2BISit β3LIAit β4BANKit β5SECit β6OPPit β7DIVit β8β8Bankit*DIVit β9SECit*DIVit β10BSit β11IDit β12DSVit β13Mit β14Bit β15GOVit β16DEVIit β17DIVit∗BSit β18DIVit∗IDit β19DIVit∗DSVit β20DIVit∗Mit β21DIVit∗Bit β22DIVit*GOVit β23DIVit*DEVIit ϵit (3) The empirical results indicate a 42% improvement in the operational efficiency of the companies is necessary in the study sample. The main reasons for operating inefficiency were pure technical and scale inefficiencies. This study also examines the determinants of the operational efficiency of financial holding companies. The results show that financial holding companies with a major business unit, mainly comprising banks, have lower operational efficiency in comparison with life insurance and securities firms. The ratio of revenues from major business unit to total revenues from the financial holding company positively and significantly affects operational efficiency. The relationship between the diversification level and operational efficiency is significantly positive for the period before the 2008 financial crisis and significantly negative for the period after the 2008 financial crisis. Furthermore, this study analyzes the role of corporate governance and finds that for the period before the 2008 crisis, board size moderates the relationship between diversification level and operational efficiency. However, for the period after the 2008 crisis, board size augments the relationship between diversification level and operational efficiency. However, the shareholding ratio of government has the opposite results of board size. The empirical results of this study provide the following contributions: First, most previous studies examining the operational efficiency of financial holding companies have focused on comparing the operational efficiency of banks and life insurance or securities companies before and after the establishment of the financial holding company. However, some studies have compared the operational efficiency of financial holding companies. Evidence suggests that identifying the factors that influence the operational efficiency of financial holding companies can fill a gap in the literature. Second, this study contributes to the corporate governance literature by investigating the function of corporate governance in the operational efficiency of financial holding companies. Third, the results reveal that the average operational efficiency of financial holding companies in Taiwan is not high and that the factors of the major business unit, the revenue ratio of the major business unit to the overall financial holding company, the diversification level, and the presence of corporate governance mechanisms influence the financial holding company’s operational efficiency, thereby assisting financial holding companies in formulating relevant strategies. Finally, the results suggest that the government can establish relevant guidelines and laws and provide incentives for the development of diversification and corporate governance mechanisms to improve the operational efficiency of financial holding companies.