Corporate governance mechanisms and firm performance: evidence from the emerging market following the revised CG code

• DOI: https://doi.org/10.1108/CG-07-2018-0244
• Pages: 158-174
• Date: 25 November 2019
• Published date: 25 November 2019
• Author: Yan Wang,Kaleemullah Abbasi,Bola Babajide,Kemi C. Yekini

Corporate governance mechanisms and

f‌irm performance: evidence from the

emerging market following the

revised CG code

Yan Wang, Kaleemullah Abbasi, Bola Babajide and Kemi C. Yekini

Abstract

Purpose –This study aims to examinethe extent to which board characteristics and ownershipstructure

affect firm performance with specific focus on providing new empirical insights following the revised

corporategovernance (CG) code 2012.

Design/methodology/approach –This study uses a sample of non-financial firms listed on Pakistan

Stock Exchange(PSX)-100 index for the years 2011-2014.Firm performance is measuredby accounting-

based performance indicators (ROA and ROE) and market-based performance indicators (Tobin’s Q

and MTB). This study uses multivariate regression techniques including fixed effects model and two-

stage leastsquares (2SLS).

Findings –The findings show that boarddiversity increases over the two periods (pre-2012 and post-

2012), whereasthere are cases that companies have not fully compliedwith the revised CG code 2012 in

terms of board independence.In addition, the multiple regression results show that firm performance is

negatively and significantly associated with institutional ownership. Nevertheless, the results show that

board size, board independent, boarddiversity and board meetings do not have significant impact on

firm performance. The findingsare fairly consistent and robust across two periods (pre-2012 and post

2012) and a numberof econometric models that sufficientlyaddress the potential endogeneity problems.

Originality/value –To the best of the authors’ knowledge, this is the first empirical study which

investigates the impactof the compliance and implementation of 2012 CG code on firm performancein

Pakistan. This study is different from the most prior studies in that they use independent non-executive

directorsrather than conventional non-executivedirectors to measure board independence.

Keywords Firm performance, Corporate governance, Ownership structure, Board characteristics,

Gender diversity, PSX-100 index

Paper type Research paper

1. Introduction

Existing literature suggests thatbetter governance plays an important role in corporation as

it provides oversight, mitigates scandals, increases a firm’s access to external finance,

ensures efficient allocation of resources and fosters better relationships among

stakeholders (Claessens and Yurtoglu, 2013). Corporations in both developed and

emerging markets have used different corporate governance (CG) mechanisms including

(I) board size; (II) executive compensation; (III) debt; and (IV) the market for corporate

control to ensure company is run effectively and stakeholders are protected. Over recent

years’ calls in academic research,policy and media for reform in CG have intensified. In line

with such calls, corporations such as BlackRock, Vanguard and State Street, which

Yan Wang is an Associate

Professor at the Nottingham

Business School,

Nottingham Trent

University, Nottingham, UK.

Kaleemullah Abbasi is a

Researcher at the

University of Salford,

Salford, UK. Bola Babajide

is a Lecturer at the De

Montfort University,

Leicester, UK.

Kemi C. Yekini is a

Professor at the School of

Finance and Management,

SOAS University of London,

London, UK.

Received 18 December 2017

Revised 26 July 2018

3 March 2019

3 August 2019

1 September 2019

Accepted 15 September 2019

The authors would like to thank

Editor, Professor Eweje,

Associate Editor Dr Sajjad, and

also two anonymous reviewers

for their insightful and

constructive comments.

PAGE 158 jCORPORATE GOVERNANCE jVOL. 20 NO. 1 2020, pp. 158-174, ©Emerald Publishing Limited, ISSN 1472-0701 DOI 10.1108/CG-07-2018-0244

constitutes three of the world’s largest asset managers with about $11 trillion assets,

recently expanded their CG teams to ensure they effectively monitor the activities of the

companies they invest in (Marriage,2017).

Evidence from previous studies has been mixed on the directions of the implication of CG

on firm performance. It is suggested that the effectiveness of CG in emerging markets is

different to that in developed markets, as emerging markets are characterized by firms that

are closely held, lack appropriate mechanisms to enforce shareholders’ legal rights, and

are in need for transparency (Gibson, 2003). To this effect, several studies were instituted

that examined the impact of CG mechanisms on firm performance in the context of

emerging markets. For example, Bhatt and Bhatt (2017) examined the effect of Malaysian

code of CG on the performance of listed firms in Bursa Malaysia. Arora and Sharma (2016)

investigated the impact of CG on firm performance in the context of India. It is evident that

in spite of the attempts at improving the CG in Pakistan, there is limited empirical study

channeled to investigate its effects.

This study seeks to extend as well as make a number of contributions to the extant CG

literature. First, to the best of our knowledge, this is the first empirical study which

investigates the impact of the compliance and implementation of 2012 CG code on firm

performance in Pakistan. Second, there is a requirement for the firms to evaluate the

performance within two years of implementation of CG code 2012 by the SECP. Therefore,

we offer timely evidence by examining whether board characteristics (board size, board

independence, board diversity and board meeting) and ownership structure (managerial

ownership and institutional ownership) may enhance firm performance using a sample of

non-financial firms listed on the Pakistan Stock Exchange (PSX) 100 index following

changes in regulatory environment. Third, different from most prior studies, we use

independent non-executive directors rather than conventional non-executive directors to

measure the board independence. Fourth, we use alternative econometric models to

address the endogeneity problems. Finally, we split our sample into two sub-samples

to investigate whether the CG mechanisms have changed over two time periods and the

revised CG code 2012 has any impact on the firm performance during different sample

periods (e.g. pre-2012 and post-2012).

The reminder of the paper is organized as follow. Section 2 reviews the literature and

develops the hypotheses. Section 3 outlines the methodology and data and section 4

discusses the findings of the paper. Section5 presents the summary and conclusion.

2. The development of corporate governance in Pakistan

Like other countries around the world, Pakistan has been actively pursuing the CG reforms

over the last fifteen years. The original CG code was introduced in 2002 by Securities

Exchange Commission of Pakistan (SECP) and it was made mandatory for all Pakistani

listed firms (Tariq and Abbas, 2013). The main objective of the code is to improve the

confidence of investor in the waya company is operated and to tackle the problems that are

related to developing economies such as failureto pay dividends over a long period (Ashraf

and Ghani, 2005). However, the implementation of this code resulted in de-listing of firms

because they were not able to understand the regulations of the code and in 2006 CIPE

(Centre for International Private Enterprise) conducted a seminar to discern whether firms

understood the code and to determine whether the code required any modifications

(Fudda, 2007). Then, the revised CG code was issued in 2012 which was a vital move to

make directors more accountable (Awan, 2014). Moreover, the Pakistan Institute of

Corporate Governance (PICG) further enhances the awareness of the advantages of

implementing the CG code (Salmanand Siddiqui, 2013).

The earlier CG code 2002 recommended that one independent director should sit on the

board, the executive directors should not be more than seventy-five percent of the total

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