International Journal of Management (IJM)
Volume 12, Issue 3, March 2021, pp.155-164, Article ID: IJM_12_03_014
Available online at http://www.iaeme.com/IJM/issues.asp?JType=IJM&VType=12&IType=3
ISSN Print: 0976-6502 and ISSN Online: 0976-6510
DOI: 10.34218/IJM.12.3.2021.014
© IAEME Publication
Scopus Indexed
CORPORATE GOVERNANCE
CHARACTERISTICS AND FIRM
PROFITABILITY: EMPIRICAL EVIDENCE
FROM EMERGING EQUITY MARKET
Muhammad Husnain*
Assistant Professor, Department of Business Administration,
University of Sahiwal, Sahiwal 57000, Pakistan
Muhammad Mudassar Anwar
Assistant Professor, Department of Commerce
University of Kotli Azad Jammu and Kashmir, Kotli, Pakistan
Filza Hameed
Assistant Professor, Department of Business,
University of Kotli Azad Jammu and Kashmir, Kotli, Pakistan
Muhammad Tasnim Khan
University of Management & Technology (UMT), Lahore, Pakistan
*Corresponding Author
ABSTRACT
Firm profitability is the capacity of any business to acquire benefits. A benefit is the
left of income that business produce after it pay all direct and indirect expenses related
to the generation of revenue. Recently, firm profitability increase consideration in the
modern research literature. In developing countries like Pakistan, firm profitability is
a main and important element to support its budgetary demands. Therefore, this study
tries to find the impact of corporate governance on firm profitability of listed firms in
Pakistan stock exchange. The time frame of study is 6 years on annual bases started
from 2013 to 2018. It is found that corporate governance mechanism i.e. board size,
number of independent directors, gender diversity has significant association with firm
profitability. Besides that, it uses firm characteristics as control variables like leverage,
firm size, capital intensity. Finally, study has policy implication for government, policy
makers, investors and other stakeholders in Pakistan.
Key words: Board Size, Firm Profitability, Corporate Governance, Pakistan Stock
Exchange
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Corporate Governance Characteristics and Firm Profitability: Empirical Evidence
from Emerging Equity Market
Cite this Article: Muhammad Husnain, Muhammad Mudassar Anwar, Filza Hameed
and Muhammad Tasnim Khan, Corporate Governance Characteristics and Firm
Profitability: Empirical Evidence from Emerging Equity Market, International Journal
of Management (IJM), 12(3), 2021, pp. 155-164.
http://www.iaeme.com/IJM/issues.asp?JType=IJM&VType=12&IType=3
1. INTRODUCTION
Corporate governess is the system of rules practices and methods by which firms are directed
and controlled. Corporate governess essentially involves balancing the company’s interest in
many stakeholders, such as shareholders, management customers, supplier’s financiers,
government and the community. Corporate governance is a big range of participants which is
explained as a network of relationship that includes not only an owner of the company its owner
but also includes all other networks such as Stakeholders, Employees, Customers, People and
Society etc.
The historical governance has used in dissimilar framework such as good governance,
wicked governance, native governance and corporate governance. However according to Pacy
Sifuna, (2012) corporate governance is the arrangement by which corporation is absorbed and
measured. The element of corporate governance is altered from country to country or firm to
firm. Apart from New Zealand security commission (2003) has set the edifice by which
company is concentrating and managed. In accumulation in an inland European country it
brings up to all participant and in the Anglo American it positioning on stakeholder estimation.
The perception of corporate governance as it correlated to the public limited companies is an
outlet of the agency disputes (Ajagbe & Ismail, 2014) which in the appropriate command is
an outcome of gulf amid possession and administration of the establishment (Cheng, 2008).
Respectable corporate governance enactment is essential to fascinate nominees, to decrease
peril and to realize long term strategic objective to gratify creditors, workers and contractors by
shielding apprehension of bondholders and Enlightening effectiveness of the company. The
superlative practice of corporate governance clues to better enactment of the company and also
elevation cognitive process of the company. Consequently, a good governance devoted to the
little expropriation of the companies reserves by the managers of the company which clues to
better application of assets and improved presentation of the firm.
The flora of relation between the corporate governance edifice and the ownership edifice
has become primary subject in the corporate governance prose in these days. According to
firm’s standpoint, ownership edifice discovers the firm’s profitability which appreciated by
different stake holders of a company. Ownership structure is a self-motivated device which
diminish agency cost allied with the parting of ownership and management, which can be used
to shield the firms’ stuff privileges (Barbosa & Louri, 2001). In this paper enactment of firm’s
profitability investigated over corporate governance because conferring to the different
researchers it is said that enactment of the firms realizing by enthusiastic good corporate
governance rules and principles. Correspondence between firm’s profitability and corporate
governance athwart the countries in a systematic ways restrained by the national system of
corporate governance. Gedajlovic and Shapiro examine significant difference in the association
between ownership concentration and firm’s performance across nation in a study related to
Canada France, Germany, UK and the USA (1998). Thomsen and Pedersen, (2000) also found
the relationship between possession structure and corporate governance in a study casing twelve
European countries. The form of ownership absorption believed to be a procurator for slanting
to display organizational containers across the states (La Porta et al., 1999; Ramaswamy et al.,
2002).
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Firm profitability will be scrutinized through corporate governance. Allowing to different
researchers it is said that firm profitability is exaggerated by practicing good corporate
governance strategies. Firm Profitability is a measurement of proficiency to create income and
what is left from income after all expenditures revenue are the business income. In Pakistan
corporate governance is on preliminary phase so the proper application of corporate governance
is not existing at this moment in Pakistan. So this research aim behind this effort is aware to the
people of Pakistan about the rewards of good corporate governance so the people of Pakistan
bright to compete both national and international level.
2. UNDERLYING THEORY
Main theories which provides support to this research are agency theory and resource
dependence theory.
2.1 Agency Theory
According to Berle & Mean, 1932 the concept of paring of ownership and control let the agency
theory be originated. The theory explains the relationship principal-agent shareholders and
managers Jensen & Meckling (1976). The Shareholders or Owners of the companies select
Diractors and CEO’s for their business that persons control all operations in good faith. Shleifer
& Vishny, 1997 says when the diractors and CEO’s action are diverted from the prime interests
of Shareholders, there comes the agency problem. The agency problem sits down when interests
or risk taking appetite of owners and managers differ from other and when there is lack of
communication due to asymmetric information system (Afza & Nazir, 2014). Instead, the
shareholders naturally importance on the wealth and interests of the organizations under their
control, so firm profitability decrease. Thus, the firm profitability is associated with the type of
ownership Fama, E. F. (1980). The firm profitability typically implies the need to involve in
actions that ambiguous the underlying determined of the transaction, it consider at the same
time provide a protection for managers engaging in a different diversionary events that increase
their expenditures of shareholders. Agency theory explains the relationship to the extent when
firm profitability and manager diversion or rent removals are complementary.
2.2 Resource Dependence Theory
Resource Dependence Theory (RDT) is the study in which that explain how the external
resource of company that affect the behavior of the company. Pfeffer, (1972) studies that
Resource dependence theory (RDT) highlights for successful business there are various
resource that can be very important to make business successful. RDT one of the dominant
theoretical rationales that defining why firms engross in mergers and acquisitions maybe second
phase one transaction costs economics (Yin & Shanley, 2008; Haunschild, 1993). RDT argues
an externally focused perception of why firms acquire additional firms (Haleblian, Devers,
McNamara, Carpenter, & Davison, 2009). Theory suggest that top management CEOs, or board
of directors is the single link between the firms and the outside world (Pfeffer, 1972) full of
resource important for the firms existence and success. This studies have faith in resource
dependence theory which explain the firm performance as the function of resource mix of the
firm (Post, Rahman & Bear, 2010). According to RDT corporate governance or have
significance impact with the technical decision making like firm profitability and this study is
to find out existence of such association.
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3. LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT
3.1 Board Size & Firm Profitability
Board size of any company is the total numbers of directors on each board according to study
of corporate liability most board members range from 3 to 31numbers the board is responsible
to the shareholders and is supposed to govern a company. The studies that board size of any
organization is very vital component in the characteristics of Directors. To decrease of any loss
in organization shareholders and consequently control the agency problem in between
shareholders and managers, better decision making that separate the management
(implementation and initiation) and control (monitoring and ratification) at all levels of the
organization are very important (Jensen & Fama, 1983). The board of directors get its authority
for management internal control and other decision making from the company’s shareholders.
The size of board of directors should be definite in such a way as to confirm that large members
are present to answer the duties and complete numerous activities of the board of directors. The
board of directors in large size reduction functional activities of managers in different programs
and decisions (Richardson & Lainis, 2011).
In the planning process Board size is also found to be related to strategic change in an
organization. From this perspective, smaller boards are assumed to have inadequate recognition
of the need to initiate or support strategic change, a lack of clear understanding of alternatives,
and/or lack of confidence in recommending strategic change (Goilden & Zajac, 2001). An
alternative explanation relates this relationship to board composition. Larger boards could
consist of more outsiders who foster more careful decision-making policy in firms since the
reputation cost, if the firm fails, is likely to be high in comparison with their private benefit if a
project turns out to be profitable. This basically refers to the difference in risk preference of
inside and outside directors (Eisenberg et al., 1998).
At the very least, Topak, (2011) examined in family faction’s consensus will have to be
forged. Within the board it may make it informal for qualified managers to exert their influence
(Dalton et al., 1999). On the basis of previous research literature this study assumes the
following hypothesis;
H1. There is a significance positive impact of board size on firm profitability.
3.2 Proportion of Females (Gender Diversity) on Board & Firm Profitability
The presence of women on corporate boards has increased a lot of importance due to their active
role in monitoring managerial performance. Female directors do their best to balance the
answerable behaviors of firms toward society and shareholders. Women make a better
understanding in decision making process rather than men to promote the transparency of
financial reports (Baldry, 1987). Vinnicombe, Terjesen and Singh, (2008) investigate that
human capital profiles of haring women on board of directors and found that they are more
probable to bring international diversity. Additionally, women do have important experience as
a board of directors of small or large firms while less likely as CEO’s (Daily, Certo & Dalton,
1999). Researchers investigate that the presence of women on board of directors will enhance
CSR due to more need on ethics, by this means contributing to changes firm profits Ruegger &
King (1992). In US Fortune 500 companies are highly qualified of actual women directors as
male directors Perterson and Philpotm, (2007). Srinidhi, B., Gul, F.A. & Tsui, J (2011)
examined 94 firms sample selection from S&P COMPUSTAT, Corporate Library’s Board Analyst, and IRRC databases for the period 2001–2007 and get a result female director in corporate
board will significantly promote the transparency of financial statements and increase the firm
profits. So, it is a good news to find that women can integrate into board of directors at a faster
rate than male complements (Hillman, Cannella & Harris, 2002). Researchers investigates the
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presence of women in corporate boards can bring economics benefits like CSR to companies
Sepasi, S & Abdoli, L. (2016). These findings indicate that women on corporate boards
positively impact the financial performance and improving firm profitability.
H2: There is a significance positive impact of gender diversity on firm profitability.
3.3 Outside Independent Directors and Firm Profitability
Researchers investigate and provides opposing theories mixed results impact of independent
directors and firm profitability. Corporate governance is a maximum vital constituent for the
firm performance and for the general development of the country (Alon Brava et al., 2006).
Corporate governance is all about showing that the investors of the firm reception the moral
return and business is running well (Magdi & Nadereh, 2002). Business governance answer to
two altered problems, one of the straight governance which are related to the controlling
shareholder and unfriendly shareholder and other is perpendicular governance which is
interrelated to the reserved shareholders and managers. According to dissimilar researchers it
is said that the impression of corporate supremacy on firm’s profitability are poised some
investigators had drawn undesirable result and there are many other results which vary variable
another. Cremers and Nair, (2005) stress that corporate governance whichever is internal or
outside it plays a very imperative role in increasing the firm profitability and value. Corporate
governance is a field in economics that examine how to except the effective management by
using appliance (Mathiesen, 2002).
In Pakistan and other emerging markets has high ownership concentration, with different
family controlled firm along with many foreign state controlled firm’s presence an individuality
of the corporate sector (Chakrabarti, 2005). The owner of the company higher outside
independent directors is to minimize the agency cost due to different ownership attentiveness
and the presence of large inside stakeholders. Researchers investigate that the firm profitability
may depreciate due to the higher power concentration in the authority of inside directors due
significant agency cost arising between inside directors and marginal shareholders (Cho &
Kim2007).
Therefore, the study provides empirical evidence that outside independent directors are
connected with firm profitability, or at extremes have a marginal effect on firm profitability,
but the results seem unpredictable with respect to the course of the association. Hence, the
literature review provides mixed results of outside independent directors and firm profitability,
follow the hypothesis with respect of outside independent directors and firm profitability.
H3: There is a significance impact of outside independent directors on firm profitability.
4. RESEARCH METHODOLOGY
4.1 Sample Selection & Data Collection
In this study researchers use 150 listed companies on Pakistan Stock Exchange (PSX) on the
basis of availability of data. The study propose the time frame of 6 years 2013 to 2018 annual
basis. In this study for data collection 10 sectors selected are as follows, fertilizer, food and
personal care products, glass and ceramics, jute, oil and gas marketing companies, power
generation and distribution, woolen, synthetic and rayon, textile weaving, sugar and allied
industries. Financial sector will be excluded from this sample selection as they belong highly
regulated industries and face different requirement for firm profitability. The data of corporate
governance mechanism like board size, number of independent directors and gender diversity
(female proportion on board) financial statement analysis (FSA) of State Bank of Pakistan and
sample 100 firm’s corporate governance annual reports. These source are secondary data are
considered as reliable for Pakistani Companies.
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4.2 Variables & Measurement
In this study firm profitability selected as dependent variable that measure by the profit before
tax divided by the average assets and this measurement previously used by (Ling Cen et al.,
2016) it is considered more reliable with Pakistani companies. In this research the explanatory
variables are bored size, number of independent directors (outside independent directors) and
gender diversity (proportion of females on board). Firm profitability is not just provisional upon
proportion of board size (lnDIR), outside directors (IND) and gender diversity (FD) but also
influenced by several firm characteristics like leverage (LEV), firm size (lnFS) and capital
intensity (CINT). In this study that variables included in the regression model used as a control
variable. The table. 1 shows all variables explanation and measurement.
Table 1 Measurement of Variables
Variables
Abbreviation
Measurement of Variables
Firm Profitability
FIRM.PRO
The profit before tax divided by the average total assets
Board Size
lnDIR
Log of total number of directors
Number of Independent
IND
The percentage of independent directors on the board
Directors.
(No of outside directors / board size)*100
Gander Diversity
FD
No of female directors on board / board size
Leverage
LEV
The long term debt divided by the total asset
Capital Intensity
CINT
The sum of property, plant and equipment divided by total
asset (Hairul Azlan et al., 2014).
Firm Size
lnFS
The natural log of total asset (Lina et al., 2017).
4.3 Model Specification
In this study researchers use OLS regression equation to econometrically analyze the impact of
corporate governance on firm profitability.
𝐹𝐼𝑅𝑀. 𝑃𝑅𝑂𝑖 𝑡 = α + 𝛽1 𝑙𝑛𝐷𝐼𝑅𝑖 𝑡 + 𝛽2 𝐼𝑁𝐷𝑖 𝑡 + 𝛽3 𝐹𝐷𝑖 𝑡 + 𝛽4 𝐿𝐸𝑉𝑖 𝑡 + 𝛽5 𝐶𝐼𝑁𝑇𝑖 𝑡 + 𝛽6 𝑙𝑛𝐹𝑆𝑖 𝑡 + 𝜀𝑖 𝑡
4.4 Empirical Analysis
In this study use different econometrical tools to authenticate, analysis and diagnose the data
and validate the hypothesis. The descriptive statistics table provide easiest interpretation of the
data. To investigate the relationship between the variables this study uses co-relation analysis.
Finley researcher use OLS regression analysis to validate the hypothesis.
5. EMPIRICAL RESULTS AND DISCUSSION
5.1 Descriptive Statistics
Table. 2 demonstrates the results of descriptive statistics of Pakistan listed companies, the
average percentage of board size (LNDIR) is 7.9 and that of outside directors (IND) is 0.81
percent. That result clearly shows that most of company’s higher majority of non-executive and
independent directors. The percentage of female directors (FD) is 1.13 this percentage show
gender diversity exist in many companies.
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Table 2 Descriptive Statistics
Mean
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis
CINT
0.472
1.000
0.000
0.226
-0.036
2.366
FD
1.131
5.000
0.000
1.091
0.779
2.931
FIRM_PRO
0.097
1.207
0.000
0.101
2.768
17.417
IND
0.818
7.407
0.000
1.167
2.182
9.129
LEV
0.234
1.471
0.000
0.209
1.102
4.532
LNDIR
7.935
15.00
0.000
1.520
1.625
9.537
LNFS
3.544
5.565
1.243
0.700
0.016
2.945
5.2 Co-relation Analysis
Table.3 presents the results of correlation matrix. Correlation analysis shows the relationships
between the dependent, control and explanatory variables. It also discusses the strength and
direction of relationship. However, it is considering as a weak measure because it does not talk
about any cause and effect. The result shows negative relationship between firm profitability
with firm size, outside directors, leverage and capital intensity. On the other hand, board size
positive relationship with firm profitability.
Table 3 Co-relation Analysis
CINT
FD
FIRM_PRO
IND
LEV
LNDIR
LNFS
CINT
1
0.15
-0.21
0.12
0.22
-0.12
-0.04
FD
FIRM_PRO
IND
LEV
LNDIR
LNFS
1
0.01
0.24
0.07
-0.04
-0.21
1
-0.05
-0.09
0.06
-0.04
1
0.09
0.08
-0.03
1
-0.10
-0.02
1
0.34
1
5.3 Regression Analysis
Table. 4 show the result of OLS Regression Analysis. The OLS results show dependent, all
explanatory and control variables are significant different from main findings. The board size
and capital intensity show highly significant different (r=0.000, p>0.1), (r=0.007, p>0.1) and
(r=0.008, p>0.1). This result show there are positive relationship between board size and capital
intensity with firm profitability. The results are consistent with other Asian countries and
Pakistani studies which have also significant connotation with the presence with board size,
independent directors and gender diversity. The Durbin-Watson statistics show the result are
(1.638) that show there are no autocorrelation between the variable’s. On the other hand, the
result of probability F statistics also significant deferens that show all variables have significant
association with firm profitability.
Table 4 Regression Analysis
Variable
Coefficient
C
0.142
CINT
-0.090
FD
0.004
IND
-0.004
LEV
-0.020
LNDIR
0.004
LNFS
-0.009
R-Square 0.056 F Stat 20.71
Std. Error
t-Statistic
0.015
9.273
0.010
-9.100
0.002
1.971
0.002
-1.985
0.011
-1.930
0.002
2.629
0.003
-2.656
Prob (F Stat) 0.0000 DW stat 1.63
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Prob.
0.000
0.000
0.049
0.047
0.054
0.009
0.008
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Corporate Governance Characteristics and Firm Profitability: Empirical Evidence
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6. CONCLUSION
On the base of data available the result shows that board size, outside directors and gender
diversity has influence on firm profitability. It exposes that family own firms have high
profitability and high earning on per share as compared to non-family firms. Correspondingly
board size shows important results. Its shows that board size have effect on the performance of
a firm. So here our hypothesis of positive relation of board size to firm profitability. The purpose
of this study is to investigate the effect of Corporate Governance mechanism on firm
profitability practices based on the 100 listed company’s data source Balance Sheet Analysis
by State Bank of Pakistan over a time frame 2013-2018. We find that Corporate Governance
mechanism board size, independent outside directors and portion of female on board (gender
diversity) has significance impact on firm profitability. Future research in firm profitability
might emphasis on the significances of those aggressive practices for market participants. We
are suggested such recommendation for future research in firm profitability different ownership
structure work needs to be done like institutional investors or managerial ownership would
decrease or improve firm performance practices in weakly protected investor’s environments.
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