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Microfinance Institutions in Mediterranean Countries

This paper examines empirically the relation between governance mechanisms and the performance of Euro-Mediterranean microfinance institutions (MFIs) in terms of outreach and sustainability. Specifically, we found that performance-based compensation of managers is not associated with better performance of MFIs. The results identify tradeoffs between MFIs outreach and sustainability depending on larger boards size, and on higher proportion of unaffiliated directors. Moreover, the study shows that the more women there are on a board the better the performance, and reveals that external governance mechanisms help MFIs to achieve better financial performance. This study also allows us to distinguish other factors leading to a better sustainability such as Regulation, the use of individual lending methodology. However, the MFIs active as NGOs seem to be more consistent with their social mission than with their financial performance.

1. Introduction

Microfinance is the provision of financial and non financial services to the poor who are excluded from financial/credit markets because they are considered unbankable. Indeed, microfinance institutions has evolved primarily as a consequence of the efforts individuals and assistance agencies committed to the idea of ensuring that the poor people has access to some form of credit. The majority of MFIs claims having a dual mission of reaching poor borrowers (outreach), and being financially sustainable (sustainability).

While the social goals of reaching the poorest and poverty alleviation are valid, financial sustainability has emerged as one of the core management and governance issues. The shrinking resources base for donor funds to support the increasing demand for grants and soft loans implies that MFIs will eventually have to support themselves (Ledgerwood, 2000). However, their sustainability will focus on governance structures within the industry. Indeed, as M Labie (2000) observes, in the last decade corporate governance principles have imposed themselves as the basic rules for any well Run Company to follow. The trend has however transcended from traditional business companies but is now part of the globalization process often seen as a tool for standardizing the controlling vision for any major organization in the world. The drive towards Governance has been propelled by a number of factors particularly the collapses of some of the major players in the Industry, the influx of private Equity and fall in donor funding.

Governance is about achieving corporate goals. The fundamental purpose of MFIs is to contribute to a country development. This involves reaching out to more clients especially the poor (Helms, 2006; Johnson et al., 2006). Not least but now growing in importance especially among donors is the requirement that MFIs achieve financial sustainability.

Microfinance practitioners assert that good governance is the key to a successful MFI (Campion, 1998; Rock, Otero & Saltzman, 1998; Labie, 2001; CGAP, 2006; Helms, 2006; UN, 2006). In spite of these observations, only few studies have focused on governance and the examination of the linkage of various governance mechanisms and performance (McGuire, 1999). It seems relevant to examine closely the role of various governance mechanisms since MFIs managers control significant resources. Except the study of Hartarska (2005), and those of Mersland, Roy and Strøm, Reidar Øystein (2007), and Cull et al., (2007), no more study attempt to shed light on the link between governance and performance especially in the Euro-Mediterranean countries although it is a very active zone with a microfinance industry quite diverse (NGO, NBFI, Bank) where actors should simultaneously pursue the most effective way of realizing their social objective while achieving superior levels of profitability.

While exploiting recently conducted survey by the authors in order to study the efficiency of MFIs in Mediterranean countries, the annual financial reports of the microfinance institutions and other relevant information collected from Microfinance Information Exchange (MIX), this paper aim to investigate the link between governance and Euro-Mediterranean MFIs performance in terms of outreach and sustainability since governance guides an institution in fulfilling its corporate mission and protects the institutions assets over time. As Rock, R, Otero, M & Saltzman, S (1998) notes it is a key in guiding management in strategic issues and in carrying out the agreed upon strategic plans. The empirical model explores the joint and individual effect of management compensation, board diversity, and external governance mechanisms on both MFI sustainability, and the depth and breath of outreach while controlling for individual characteristics and, as well as country specific factors. The results show that performance-based compensation does not improve performance. MFIs with larger boards seem to do better. More independent boards are more effective however. Board diversity (Higher proportion of women) seems to ameliorate outreach. External governance mechanisms especially auditing and regulation improve the financial sustainability.

The remainder of this paper is organized as follows. Section 2 deals with the research context. Section 3 briefly reviews the few related studies. Section 4 presents the conceptual framework as well as working hypothesis. Section 5 looks at data description and methodology. Section 6 discusses the empirical findings, and Section 7 draws conclusions emanating from the findings.

2. Microfinance in Mediterranean

Experience throughout the world has proven that microfinance help the poor to increase income, built their business, and secure their future by reducing their vulnerability to external shocks. Furthermore, microfinance is often a powerful tool for empowering the poor especially women, to take charge of their economic well-being and those of their families.

The Euro-Mediterranean region consists of 21 countries. The microfinance industry in this zone is young with high growth potential. Currently, it is estimated that there are over sixty microfinance institutions (MFIs & NGOs), and a potential of numerous other producing credit to poor microentrepreneurs (Ben Soltane, 2008). The majority of these programs are south of the Mediterranean (Egypt, Jordan, Lebanon, Morocco, Palestine, Tunisia, and Syria). Programs also exist in Spain, France, Italy, Kosovo, Albania, Bosnia, and Croatia (Figure 1).






Bossel, EKI,

MI-Bospo, MIKRA, Women For Women




FRD, 10 Talenti

Fond S.M.Soccorso

Fond S.G.Moscati






ESED, Lead foundation, DBACD, Al Tadamun








Al Majmoua, Ameen, CHF-AM




P4, Meshtekna,

Grameen Trust

Figure1 essay_footnotecitation">[1] : MFIs delivering microcredit in the Mediterranean.

Euro-Mediterranean MFIs aim to provide financial services to low income households, even the extremely poor in a participatory and non-paternalistic development approach to the great interest of the donor community, policy makers, development researcher and practitioners. According to the so-called “win-win” proposition MFIs should combine the socials goals, such as poverty alleviation and reaching poor households (outreach) with operational and financial self-sufficiency (sustainability) based on access to international financial markets independently from international development agencies. Therefore, MFIs should simultaneously pursue the most effective way of realizing their social objective while achieving superior levels of profitability.

The region’s top MFIs are openly committed to best practice microfinance. In terms of depth of outreach, the sector has generally moved towards serving more and more of the poor clients. According to the FEMIP and Sanabel study, the Mediterranean represents a potential market for the microfinance with nearly 40 million customers, whereas currently only 9 million people profit from the financial assistance of the companies operating in this sector. The number of borrowers increased of more than 43 % per annum between 2004 and 2006, against 20% on a worldwide scale, an indication that the sector as a whole is reaching more of the marginalized in the society. The region’s top MFIs have proven also to have excellent leadership abilities, impressive outreach and growth, as well as a commitment to best practice microfinance. Furthermore, it is estimated that around 85% of the region’s active clients are served by sustainable MFIs.

3. Literature review

Governance in microfinance has been recognized to be an important issue. However, the biggest problem to microfinance practitioners has been balancing the dual mission of outreach and sustainability. The changing of microfinance environment has shown a move towards sustainability ultimately leading to governance issues as donors funds shrink and equity inflows increase in the microfinance sector. Microfinance institutions have therefore embraced boards and adopted principles of corporate governance to ensure their survival.

Investigating the link between good governance and the performance of MFIs in terms of outreach and sustainability is crucial since governance guides an institution in fulfilling its corporate mission and protects the institution assets over the time. However, there is a limited academic studies dealing with this subject, partly due to the lack of data.

While using three surveys of rated and unrated east European MFIs from three random samples in the period 1998 to 2002, Hartarska (2005), investigates the relation between governance mechanisms and financial performance. Financial performance and outreach constitute dependant variable dimensions and governance mechanisms include board characteristics, managerial compensation, and external governance mechanisms such as rating, financial statements audited, and supervision. The author finds that performance-based compensation of managers is not associated with better performing MFIs; lower wages suggested for mission-driven organization worsen outreach. She identify also that a more independent board has better ROA, but a board with employee directors gives lower financial performance and lower outreach. Finally, the author concludes that external governance mechanism seems to have a limited role in the study region.

In a recent study, Mersland, Roy and Strøm, Reidar Øystein (2007), use a self constructed global data set on MFIs spanning 57 countries collected from third-partly rating agencies. The authors study the effect of board characteristics, ownership type, competition and regulation on the MFIs outreach to poor clients and its financial performance. They found that split roles of CEO Chairman, a female CEO, and competition are important explanation. Moreover, the authors found that larger board size decrease the average loan size, while individual guaranteed loan increase it. Finally, they conclude that there is no difference between nonprofits organizations and shareholder firms in financial performance and outreach.

A third study conducted by Cull et al., (2007) looking at MFIs financial performance and outreach as well, with a focus on lending methodology essay_footnotecitation">[2] , controlling for capital and labour cost as well as institutional features. While using data from 124 rated MFIs, the authors found that MFIs that focus on providing loans to individuals perform better in terms of profitability. Yet, the fraction of poor borrowers and female borrowers in the loan portfolio of these MFIs is lower than for MFIs that focus on lending to groups. The study suggests also that individual-based MFIs, especially if they grow larger, focus increasingly on wealthier clients, a phenomenon termed as ‘mission drift’. This mission drift does not occur as strongly for the group-based MFIs. However, no governance variables, such as board characteristics or ownership type are taken into consideration.

The limited academic investigation into the link between governance mechanisms and performance of MFIs in terms of outreach and sustainability, and the fact that other governance mechanisms such as the proportion of women in the board remain unexplored justify the importance of a similar study in the Euro-Mediterranean zone, characterized by a very active and quite diverse microfinance industry, that complete formers studies.

4. Conceptual framework and working hypothesis

While focusing on the microfinance field, the governance can be defined as the process of guiding an institution to achieve its objectives while protecting its assets. It refer to the mechanisms though which donors, equity, investors, and other providers of funds ensure themselves that their funds will be used according to the intended purposes (Hatarska, 2005). The presence of these control mechanisms is crucial either to align the interests of managers and providers of funds since they may have diverting preferences and objectives, or to monitor the performance of managers to insure that they use their delegated power to generate the highest possible returns for the providers of funds. This notion comes from the agency perspective. It found its origins in the work of M. C. Jensen and W. H. Meckling, 1976 who assimilate the firm to a node of contracts. The explanatory model of the structures of financing and shareholding is founded on the assumption of asymmetry of information and conflicts of interests between managers and providers of funds. According to M. C. Jenson and W. H. Meckling, agency relationship is a contract under which ‘one or more persons (principal) engage another person (agent) to perform some service on their behalf, which involves delegating some decision-making authority to the agent’ essay_footnotecitation">[3] . In this case the relation of agency will relate the principal (owner) and his agent (manager), this last being engaged to serve the interest of the first. From these relations emanates the concept of agency costs, costs which result from the potentially opportunist character of the actors (moral hazard) and information asymmetry between the contracting ones (adverse selection). These agency costs represent the loss in value compared to an ideal situation where there is no information asymmetry and conflict of interests. According to the theorist of agency an organisation is considered efficient if it minimise the agency costs. This purpose can be intended though an effective governance mechanism.

According to Keasey et al., 1997, the most important features of an effective governance framework are ownership structure (including institutional and managerial ownership), CEO (manager) and director (board member) remuneration, board structure (size and composition), auditing, information disclosure, and the market for corporate control. Usually, research literature related to this field use partial measures. In other words, governance studies treat separately the impact of each variable such as compensation, board size, independence and diversity, and external market forces on firm performance. However, since latest studies (Hermalin & Weisbach, 2003) identify the complementarities, and the correlation between these mechanisms, this study will investigate the impact of the majority of these mechanisms excluding ownership due to lack of data on ownership structure.

The most important attribute that distinguishes microfinance institutions from other is what has come to be called its dual mission of balancing a social agenda or social impact with its financial objectives. The MFI combine a social development mission (provision of financial services to the lowest income population possible), with a financial objectives that drives the institution to achieve self-sufficiency and thereby accomplish sustained service delivery without dependence on subsidies. These dual objectives (social: outreach, and financial: sustainability) make difficult the study of governance of MFIs, especially with their different types: Non profit, Non-Governmental Organizations (NGOs), For-profit Microfinance Institutions, Credit Unions. This challenge is surmounted by formulating and testing hypothesis based on insights from the literature on corporate governance, formers studies, governance in banks and in non profit organizations, and by estimating the impact of the governance mechanisms on both sustainability and outreach.

4.1. Internal Governance mechanism

The incentives of top management have been characterized as an important mechanism of corporate governance as it ensures the alignment of the management and the shareholders interest (John et al., 2004). In other words, it serves as a mechanism for resolving the conflict of interest among the managers and shareholders. Brick, Palmon and Wald (2006) highlighted that director compensation should also affect performance of a firm. With regards to banking institutions, higher-powered incentives may encourage managers to take higher risks at the expense of depositors, who would suffer if the institution fails; thus low pay-performance sensitivity is suggested (John & John, 1993). In fact, it is proved by Adams & Mehran, 2003; Houston & James, 1995; John & Qian, 2003, that pay-performance sensitivity in banking in lower than other industries.

Since in non-profit firm there is a growing problem of informational asymmetry between clients and managers (i.e., managers possess many crucial information about the product), it seems that the fixed management salaries is the best choice for mission-driven organizations (Easley & O’Hara, 1998). With the fixes salaries, the managers, indifferent between telling the truth or lying, will find it in his benefit to tell the truth. Therefore, if the client and donors find the information provided by non-profit managers more credible, the firm will be better-funded and better-performed.

Hypothesis 1. MFIs whose manager receives a fixed salary will not perform worse than MFIs whose managers receive performance based remuneration.

Most guidelines recognize that the board of directors is the focal point corporate governance. The composition and structure of the board have a direct bearing on corporate governance. Board of directors is designate for the purpose of ensuring the alignment of the firm activities and its specified objectives. The board has the duty for making sure that the top managers are behaving in a way that will provide the optimal value for shareholders (Coles et al., 2001).

There is a view that larger boards are better for corporate performance because they have a range of expertise to help make better decisions, and are harder for a powerful CEO to dominate. However, recent thinking has leaned towards smaller boards. Jensen (1993) and Lipton & Lorsch (1992) argue that large boards are less effective and are easier for a CEO to control. When a board gets too big, it becomes difficult to co-ordinate and process problems. Smaller boards also reduce the possibility of free riding by individual directors, and increase their decision taking processes. Empirical research supports this. For example, Yermack (1996) documents that for large U.S. industrial corporations, the market values firms with smaller boards more highly. Eisenberg et al. (1998) also find negative correlation between board size and profitability when using sample of small and midsize Finnish firms. In Ghana, it has been identified that small board sizes enhances the performance of MFIs (Kyereboah-Coleman and Biekpe, 2005). Mak and Yuanto (2003) echo the above findings in firms listed in Singapore and Malaysia when they found that firm valuation is highest when board has five directors, a number considered relatively small in those markets. In a Nigerian study, Sanda et al (2003) found that, firm performance is positively related with small, as opposed to large boards.

Hypothesis 2. Board size should have an inverse correlation with MFIs performance

A third common monitoring mechanism advocated by the agency perspective is a board composed of a majority of independent directors. These non-executive or “outside” directors are believed to provide superior benefits to the firm as a result of their independence from firm management. Under this organizational design, conflicts of interest can be avoided and executive leaders can be evaluated more objectively.

The literature suggested that increases in the proportion of outside directors on the board should increase firm performance as they are more effective monitors of managers (Adams and Mehran, 2003). The proportions of the outside directors can be measured in terms of the ratio of outside directors to board size. The positive aspect of having board independence was evidenced in a study by Byrd et al (2001) that highlighted the survival of firms in the thrift crisis due greater proportion of independent directors in the board. Kyereboah-Coleman and Biekpe (2005) found also a positive relationship between proportion of outside board members and performance of MFIs in Ghana.

Hypothesis 3. MFIs performance will be affected positively by the proportion of non-affiliated outsiders on the board.

Corporate governance literature argues that board diversity in terms of women and minority representation is potentially positively related to firm performance. Board diversity promotes a better understanding for the market place, increases creativity and innovation, produces mores effective problem solving, enhances the effectiveness of corporate leadership, and promotes effective global relationships (Robinson and Dechant, 1997). Fondas and Sassalos, 2000 argue that diversity in board composition via greater female representation will lead to improved board governance and top management control. In microfinance, the study of Coleman, 2006 show that having women in CEOs on MFI boards enhance performance and also the more the women there are on a board, the better the performance. Furthermore, having a high fraction of women in the board would help the MFI understand its customers better so as to separate the good risk from the bad (Mersland R. et Oystein Strom R. 2007).

Hypothesis 4. Board diversification and the presence of women and minority will lead to a better performance of MFI.

Another principle of effective bank supervision is effective internal audit. Internal audit helps to identify problem areas and to avoid major collapse. The internal board auditor provides independent, objective assessments on the appropriateness of the organization’s internal governance structure and the operating effectiveness of specific governance activities. Reporting of all internal audit reports in an accurate and timely manner is essential for evaluation of the institution’s status and need for any change in strategy. Policy papers for MFIs stress the importance of internal audit and recommend that the internal auditor reports directly to the MFI board (Steinwand, 2000).

Hypothesis 5. MFI allowing their internal auditors to report directly to the board should show higher financial performance.

4.2. External Governance Mechanisms

The external governance mechanism can be implemented as a result of the failure or the weakness of internal governance mechanisms. In the microfinance industry donors and creditors are increasingly relying on information from audited financial statement and rating agencies (Hartarska, 2005). These external governance mechanisms are an important mechanism that provides depositors, creditors and shareholders with credible assurances that they will refrain from fraudulent activities. In other words it reduces informational asymmetries between the different stakeholders and the firm (Healy & Palepu, 2001).

Audited financial statements are an important tool for the assessment of MFIs by regulators and capital markets. They form an important part of the effective corporate governance. The auditor’s role is to provide a disinterested an objective view of the financial statements of the MFI in the line with generally accepted accounting standards. It is a mean to ensure potential investors and donors that an MFI complies with the accounting practices and managers do not misrepresent financial information.

Hypothesis 6. MFIs with financial statement audited achieve better performance than MFIs without financial statement audited.

According to Hartarska (2005), in the absence of developed equity and debt market, donors and investors rely on independent evaluation of MFIs performance. A MFIs rating reflects a rating agency’s opinion of entity’s overall creditworthiness and its capacity to satisfy its financial obligations. The raters evaluate objectively and independently the corporate governance in MFI and rank it on a relative rating scale that would facilitate comparison. Unlike typical rating agencies that rate the riskiness of issued debt, microfinance rating agencies rate the overall performance of the MFI in terms of outreach and sustainability.

Hypothesis 7. Rating helps MFIs to achieve better results

Many MFIs around the world operating as NGOs have increased their assets, reorganized, and transformed into regulated entities that can capture savings deposits. A regulated MFI has more chance to earn customer trust, and by the way to have a higher financial performance. Hence, regulation is crucial for microfinance sector development since it affect MFI performance by changing the internal rule of the organization. It implies the access to an important and low-cost funding source through the right to mobilise savings. Due to this effect, the MFI win the opportunity to increase the number of clients, but also to increase average loan amounts for existing borrowers. Moreover, if demands to fulfill regulatory requirements divert attention away from serving the poor, and hold back innovation in lending technology that has been the driving force behind MFIs’ability to serve even poorer borrowers, regulatory involvement will lead to “mission-drift” (Hartarska, 2007). Therefore, the effects upon depth and breadth in outreach may be uncertain as well, either upon depth or breadth, or a combination of the two (Mersland R. & Oystein Strom R. 2007).

Hypothesis 8. Regulation may guide the MFIs to fulfill better sustainability, but not to achieve better outreach.

5. Data and methodological issues

Data for this study are issued from various sources. The major part comes from a survey conducted by the author in 2006 in order to test the efficiency of microfinance institution in Mediterranean (Ben Soltane, 2008). The performance variables and some governance variables are also obtained from the annual financial reports of the microfinance institutions collected from Microfinance Information Exchange (MIX); a non governmental organization whose object is to promote the exchange of information on the microfinance sector around the world essay_footnotecitation">[4] . All these information are updated and completed by a questionnaire dealing fundamentally with detailed question on governance addressed to the MFIs in the region. The response rate was 58% with 40 institutions.

A special questionnaire was also addressed to the Mediterranean microfinance institutions that don’t figure in the MIX MARKET data base. The response rate for these MFIs was weak and near 20%, with four institutions. Due to missed data, only two institutions are taken into account. The final sample comprises 42 institutions working in 20 countries. Our sample is quite representative of the Mediterranean microfinance industry as well as of the governance mechanisms and the performance of MFIs in the region.

Following Hartarska (2005) works, our empirical model used to test the hypothesis include five major potential groups of determinants and is on the form:

Where is a performance variable for MFI i in country j at time t; are MFI specific variables; are management specific variables; are board-specific variables, are external governance mechanisms; and are the country-specific macroeconomic variables. It is crucial to mention at this level that our choice of a single-equation model is supported by the hypothesis that various governance mechanisms are endogenously determined is not always supported by empirical evidence essay_footnotecitation">[5] .

Since MFIs are special institutions having a dual mission, their performance is measured in terms of outreach and sustainability. Outreach is measured in breath and depth. Breach of outreach (NAB) is the logarithm of active borrowers, depth of outreach (DEPTH essay_footnotecitation">[6] ), is the average loan size on GDP per capita. Sustainability is measured by return on assets (ROA) which is a standard finance literature measure of performance, and by operational self-sufficiency (OSS). This variable measures how well the MFI can cover its costs through operating revenues.

Table 1. Definitions of dependent variables used in analyses

Variable Explanation

Social Performance: Outreach

NAB Logarithm of the number of current borrowers

DEPTH The average loan size on GDP per capita

Financial Performance: Sustainability

ROA Return On Assets

OSS Operational Self-Sufficiency

MFI specific variables () are MFI size measured by the logarithm of total assets, MFI age measured in years sine commencement, and MFI type measured by three dummies (NGO, Nonbank Financial Institution, and bank). Since further studies (Navagas, Conning, & Gonzalez-vega, 2003) show that the type of lending methodology used influences the success of these organization, our study include a variable Individual which is a dummy that takes the value of one if the MFI used individual lending technology.

Variables built-in are Fixed-wage, which is a dummy for pay not based on performance, Experience is used to proxy for a manger’s quality and is measured by the years of work experience. The board-specific variables contains Board-size, measured by the number of board members; Employees measured as the proportion of MFI employees who are voting board members; Independent measured as the proportion of non-affiliated board members; Women measured as the proportion of women in the board; Internal Board Auditor is a dummy variable that takes the value of one if there was an internal auditor with direct access to the board.

The variables included in are Regulation, which is a dummy that takes the value of one if the MFI was supervised by the central bank or other bank supervisory agency; Rated is a variable that indicates whether the MFI was subject to independent evaluation or rating by an outside organization; Audited is a dummy that take also the value of one if there was an audited financial statement in the year t-1.

Since MFI are issued from north and south of the Mediterranean, the dissimilarity in economic conditions across countries are controlled by the size of the economy (Economy size), measured by the logarithm of a country’s GDP, and by the average inflation rate (Inflation), measured by the average consumer price index. These variables are issued from the World Bank Development Indicators. We wanted also to build a variable that take account of the institutional differences between countries but we did not find an adequate measure.

Table 2. Definitions of independent variables used in analyses




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