Impact of corporate governance compliance and board attributes on operating liquidity in pre- and post-corporate governance reforms

• Published date: 02 October 2020
• Date: 02 October 2020
• Pages: 1329-1347
• DOI: https://doi.org/10.1108/CG-04-2020-0156
• Author: Javed Khan,Shafiq Ur Rehman
• Subject Matter: Strategy,Corporate governance

Impact of corporate governance

compliance and board attributes

on operating liquidity in pre- and

post-corporate governance reforms

Javed Khan and Shafiq Ur Rehman

Abstract

Purpose –This study aims to investigatethe impact of corporate governance compliance, governance

reformsand board attributes on operating liquidityof Pakistani listed non-financial firms.The study further

tests howthese relationships vary in the pre- and post-corporategovernance reforms.

Design/methodology/approach –Fixed-effect regression modelis used on 10 years panel data from

2007 to 2016 for a sample of170 firms listed on the Pakistan Stock Exchange. Two-stage least squares

model is usedfor addressing the endogeneity problem.

Findings –The findings reveal that governance compliance and governance reforms negatively affect

operating liquidity. Among the board attributes, board meet ings, directors’ remuneration, board foreign

diversity and boardgender diversity are significantly related to operating liquidity.Further exploration indicates

that internal governance mechanisms are less effective to safegu ard shareholders from expropriation during

weak external governance. This suggests that strong exter nal governance is inevitable to the effectiveness of

internal governancemechanisms. Overall, the study findings support the agency theory.

Practical implications –The findings provide valid recommendations to policymakers interested in

safeguarding the investors to focus on macro-level governance for making the micro-levelgovernance

effective. Further,the results provide the executives with an insight to improve the compliancelevel with

the code ofcorporate governance.

Originality/value –Unlike prior studies, this study examines the impact of corporate governance

compliance and novel board attributes –directors’ attendance at board meetings, number of board

committees, directors’remuneration and board foreign diversity on operatingliquidity. Further, the study

subdivides its sample periodinto pre- and post-corporate governance reforms to examinehow external

governanceinfluences internal governanceeffectiveness.

Keywords Board meetings, Board attributes, Corporate governance compliance,

Governance reforms

Paper type Research paper

1. Introduction

Operating liquidity is an important facet of the overall firm’s management, which is the

balance between current assets and current liabilities (Goela et al., 2015). It helps firms to

cover cash shortfalls in times of financial distress and financing profitable investment

opportunities (Nikolov et al., 2019;Uyar and Kuzey, 2014). However, keeping more assets

in liquid form deteriorates the profitability of the firm (Opler et al.,1999), because more

liquidity means more assets lie idle (Rocca and Cambrea, 2019), resultantly, their lower

return rate and tax disadvantage pull down the overall profitability of the firm (Opler et al.,

1999). Further, liquid assets are easy to be misappropriated by opportunistic managers

Javed Khan and

Shafiq Ur Rehman are both

based at the Department of

Commerce and

Management Sciences,

University of Malakand,

Chakdara, Pakistan.

Received 12 February 2020

Revised 6 July 2020

Accepted 7 September 2020

The authors are thankful to the

Editor, Professor Eweje,

Associate Editor Dr Sajjad, and

also two anonymous reviewers

for their insightful and

constructive comments.

DOI 10.1108/CG-04-2020-0156 VOL. 20 NO. 7 2020, pp. 1329-1347, ©Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 1329

(Dittmar et al., 2003). Hence, instead of using them for financing the firm’s growth

opportunities, these will be used by managers for personal benefits (Ammann et al., 2010;

Jensen, 1986).

Existing literature on the determinants of operating liquidity indicates that various

characteristics of the firm affect the level of operating liquidity. These firm-level

characteristics can be quantified into internal factors, such as growth opportunities, firm

size, financial constraints and credit ratings (Opler et al.,1999;Ozkan and Ozkan, 2004;

Uyar and Kuzey, 2014), and external factors such as institutional environment, investors

protection and financial system efficiency (Dittmar et al.,2003;LaPorta et al.,2000). In this

study, we investigate the impact of corporate governance on operating liquidity,particularly

to answer the question: Do corporate governance compliance, governance reforms and

board attributes determine operatingliquidity of the firm?

Examining corporate governance as the determinant of the firm’s operating liquidity started

two decades ago, but most of the studies arecarried out in the developed markets such as

the USA, the UK, France and Japan (Boubaker et al.,2015;Gill Amarjit and Biger, 2013;

Harford et al.,2008;Luo and Hachiya, 2005;Ozkan and Ozkan, 2004). The results of these

studies cannot be generalized to the emerging market of Pakistan for the following reasons.

Firstly, the markets and organizational settings of emerging economies are different from

developed markets (Ghosh, 2006). Secondly, emerging economies have weaker

governance structures than developed markets (Akhtar et al., 2018;Wang et al.,2019).

Thirdly, Pakistan has adopted the Anglo-American model of corporate governance, while

the ownership structure of Pakistani listed firms is different thanfirms in the UK and the USA

(Fayyaz, 2016). Fourthly, great focus by policymakers on improving the corporate

governance in Pakistan makes it imperative to investigate its effectiveness in mitigating the

agency problem. To this effect, few studies have focused on examining the impact of

corporate governance on operating liquidity in Pakistan (Khan et al.,2016; Masood and

Shah, 2014;Ullah and Kamal, 2017), but the scope of these studies is very limited and do

not cover all aspects of corporate governance, particularly corporate governance

compliance, novel boardattributes and external governance remain unexplored.

This study contributes to the existing literature in a number of ways. Firstly, it extends the

existing literature related to the boardeffectiveness by examining the impact of novel board

attributes (such as board foreign diversity, directors’ remuneration, directors’ attendance

and the number of board committees) on operating liquidity. To the best of the authors’

knowledge, this is the first study to investigate these novel board attributes from the

perspective of Pakistan and thus the results will add new insights. Examining the impact of

corporate governance compliance on operating liquidity is the second objective of this

study, which has not been tested before in the context of Pakistan, and therefore, is a novel

contribution. The outcome of this objective will highlight the importance of compliance with

the code of corporate governance for firms in emerging economies. Thirdly, following

considerable focus by the policymakers to improve the governance environment, this is the

first study that seeks to investigate its effectiveness by examining the impact of corporate

governance reforms of 2012 on operating liquidity of Pakistani firms. The outcome of this

objective will add to the literature on external governance–liquidity relationship from an

emerging market perspective. Fourthly, the study divides its sample period into two sub-

periods to investigate the impact of internal governance on operating liquidity before and

after the corporate governancereforms of 2012. This outcome will offer new insight into how

the level of external governance affects the relationship between internal governance and

operating liquidity.

The rest of the paper is organized as follows. Section 2 reviews the relevant theoretical

literature briefly and then empirical literature in its subsections, where hypotheses are

developed. Section 3 discusses sample selection, data sources and models used. The

results of the study are discussed in Section4, while Section 5 concludes the paper.

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