There is a large body of empirical research that has assessed the impact of corporate governance on firm performance for the developed markets. Studies have shown that good governance practices have led the significant increase in the economic value added of firms, higher productivity and lower risk of systematic financial failure for countries. The studies by many researchers and philanthropists who a significant importance of Corporate Governance. Most of the empirical work for exploring possible relationship between corporate governance and firm performance is done for single jurisdiction.
Shleifer and Vishny (1997), John and Senbet (1998) and Hermalin and Weisbach (2003) provide an excellent literature in this area. It has now become an important area of research in emerging markets as well.
There are many empirical studies that analyse the impact of different corporate governance practices in the cross-section of countries.
Mitton (2001) has done a noteworthy research with sample of 398 firms Korean, Malaysian, Indonesian, Philippines, data Thailand have found that the firm-level variables are related to corporate governance has strong impact on firm performance during East Asian Crisis in 1997 and 1998. The results suggests that better price performance is associated with firms that have indicators of higher disclosure quality, with firms that have higher outside ownership concentration and with firms that are focused rather than diversified.
Brown and Caylor (2004) have measured the Corporate Governance’s impact, he analyze it with 51 factors, 8 sub categories for 2327 US based firms with the help of Institutional Shareholder Service (ISS) dataset. They infer that the firms having better governance are more profitable, more valuable and they were very good in their payout to to their shareholders.
Gompers, Ishii, and Metrick (2003) use Investor Responsibility Research Centre (IRRC) data. They indicate that firms with fewer shareholder rights have lower firm value and lower ROE. They classify 24 governance factors into five groups: tactics for delaying hostile capture, selection civil rights, principal/official guard, other conquest suspicion, and position law. Most of these factors are anti-takeover measures so G-Index is effectively an index of anti-takeover protection rather than a broad index of governance. Their findings show that firms with stronger shareholders rights have higher firm value, higher profits, higher sales growth, lowest capital expenditures, and made fewer corporate acquisitions.
Lipton and Lorsch (1992); Jensen (1993) conduct an extensive research on the Corporate Governance. They concluded that, It is expected that by limiting board size firm performance could be improved. but the benefits attained from larger boards were outweighed by the poorer communication and decision-making of larger groups.
Yermack (1996) conduct a study and provides an inverse relation between board size and profitability, asset utilization, and Tobin’s Q. According to him with the increase in the Board size the firm performance reduced and resultantly the profitability and payout to shareholders reduced.
Anderson, et al. (2004) analyze and present their result as the cost of debt and board size has the inverse relationship, according to them the cost of debt is lower for the firms having larger boards, because financers view these firms as they are having more effective control and decision making of their financial accounting processes.
Brown and Caylor (2004) show an extensive research and add to this literature by showing that firms having board sizes between 6 to 15 were performing very well and those firms have higher ROE and higher profitability as compare to other firms having different board size. They also conclude that independent audit committees are positively associated with dividend yield, but negatively related to the operating performance or firm valuation. They also find that the consulting fees paid to auditors less than audit fees paid to auditors are negatively related to company performance and company policy of auditor rotation is positively related to return on equity.
Fosberg (1989) study the relationship between the proportion of outside directors, a proxy for board independence, and firm performance. He concluded that there is no relation between the proportion of outsider directors and various performance measures.
Hermalin and Weisbach (1991) also find no association between the proportion of outsider directors and Tobin’s Q; and Bhagat and Black (2002) find no linkage between proportion of outsider directors and Tobin’s Q, return on assets, asset turnover and stock returns.
In contrast, Baysinger and Butler (1985) and Rosenstein and Wyatt (1990) show that if the firm appoint outside directors then the stakeholders trust them more and that’s why bankruptcy cost theory and trade off theory is in the favor of outside directors, which resulted into low cost, better competitive position and profitability.
Brickley, Coles, and Terry (1994) find a positive relation between the proportion of outsider directors and the stock market reaction to poison pill adoptions; and Anderson, Mansi and Reeb (2004) show that the cost of debt, as proxied by bond yield spreads, is inversely related to board independence. Studies using financial statement data and Tobin’s Q find no link between board independence and firm performance, while those using stock returns data or bond yield data find a positive link.
Hermalin and Weisbach (1991) and Bhagat and Black (2002). Brown and Caylor (2004) do not find Tobin’s Q to increase in board independence, but they come up with the result that ROE of the firm increases with the independent boards, along with that independence of board is closely associated with the higher profit margins, larger dividend yields, and larger stock repurchases. They concluded that board independence is associated with almost all other important measures of firm performance except Tobin’s Q.
Klein (2002) finds a negative relationship between earnings management and audit committee independence, and Anderson, et al. (2004) conclude that entirely independent audit committees have lower cost of financing.
Frankel, et al. (2002) come up with a negative relationship between earnings management and auditor independence (based on audit versus non-audit fees). Whereas, Ashbaugh, et al. (2003) and Larcker and Richardson (2004) come up with a contradictory evidences.
According to Kinney, et al. (2004) there is no association between earnings and fees paid for monetary in order system plan and achievement or inside audit services.
Agrawal and Chadha (2005) come up with similar conclusion, he state that the financial performance is independent of quality and expensiveness internal control and Internal Audit.
Yermack (1996) by analyzing a sample of 452 U.S. public firms between (1984 and 1991) shows that firms in which CEO and chairman are two separate individuals, those firms perform better as compare to those firms in which both positions were hold by the same person. Same person sitting on both seats will cause higher agency problem affects firms’ performance negatively. Firms were more valuable when the CEO and board chair positions are separate.
Core, et al. (1999) finds that CEO compensation is lower when the CEO and chairman of the board are separate. Brown and Caylor (2004) conclude that firms are more valuable when the CEO and chairman of board are separate.
Botosan and Plumlee (2001) find a material effect of expensing stock options on return on assets. They use Fortune’s list of the 100 fastest growing companies as of September 1999, and compute the effect of expensing stock options on firms’ operating performance.
Fich and Shivdasani (2004) find that firms with director stock option plans have higher market to book ratios, higher profitability and they document a positive stock market reaction when firms announce stock option plans for their directors.
Brown and Caylor on the other hand come up with a contradictory conclusion and find no evidence that operating performance or firm valuation is positively related to stock option expensing. They also concluded that operating performance does not relate to the executive compensation, or to directors receiving some or all of their fees in stock.
Omran M.M, Bolbol A, Fatheldin A. (2008) analysis a sample of 304 firms from different sectors of the economy, from a representative group of Arab countries (Egypt, Jordan, Oman and Tunisia). They concluded that ownership structure has no significant effect on the firm performance they state that ownership concentration is an endogenous response to poor legal protection of investors, but seems to have no significant effect on firms’ performance.
During the ancient period little time, corporate governance has turn into an important area of research in Pakistan. In his noteworthy work Cheema (2003) suggests that corporate governance can play a significant role for Pakistan to attract foreign direct investment and mobilize greater saving through capital provided the corporate governance system is compatible with the objective of raising external equity capital through capital markets. The corporate structure of
Pakistan is characterised as concentrated family control, interlocking directorships, cross-shareholdings and pyramid structures. The concern is that reforms whose main objective is minority shareholder protection may dampen profit maximising incentives for families without providing offsetting benefits in the form of equally efficient monitoring by minority shareholders. If this happens the reform may end up creating sub optimal incentives for profit maximization by families. They argue that a crucial challenge for policy makers is to optimize the dual objectives of minority shareholder protection and the maintenance of profit-maximising incentives for family controllers.
There is a need for progressive corporations to take a lead in the corporate governance reform effort as well.
Rais and Saeed (2005) study the Corporate Governance Code 2002 in the light of narrow Impact Assessment (RIA) structure and its enforcement and request in Pakistan in arrange to recognize the dynamics of public decision making and charge the efficiency of the directive policy of SECP in the ground of corporate governance. The study shows that although the listed company are gearing themselves up to take on the Code, there are a number of constraint, and reservations regarding the method it was draft and implement.
Ghani, et al. (2002) examine business group and their contact on corporate governance in Pakistan for non-financial firm listed on the Karachi Stock Exchange of Pakistan for 1998-2002. Their proof indicate that investor view the business-group as a device to appropriate marginal shareholders. On the other offer, the relative financial routine outcome suggest that industry groups in Pakistan are well-organized economic planning that alternate for missing or wasteful outside institution and markets.
Ashraf and Ghani (2005) analyzes the start, increase, and the growth of accounting practice and disclosure in Pakistan and the factor that unfair them. They certificate that lack of shareholder protection (e.g., minority rights defense, insider trade protection), judicial inefficiencies, and weak enforcement mechanisms are more dangerous factors than are civilizing factors in explanation the state of accounting in Pakistan. They close that it is the enforcement mechanism that are supreme in improving the excellence of accounting in developing economies.
There is an growing interest in analysing concern of corporate governance on stock market in Pakistan but many issue in this area are exposed. In particular, firm-level corporate governance score and its affect on the assessment of the firm which is inner issue of this region needs in strength research. It is in this viewpoint this study aims to make giving in the literature on corporate governance.
Before proceeding further, it would be pertinent to have a macro-level glance over the multifaceted corporate governance regime in Pakistan, that is to say, the laws that impact the issues of good governance of a company. Such laws may be categorized as follows:
The corporate laws, i.e., the general laws relating to companies and their business;
The rules and regulations made under the corporate laws;
The listing regulations and the byelaws of the stock exchanges;
A body of general civil laws, i.e., enactments providing remedies forseeking declarations, enforcement of claims and recovery;
A body of general criminal law, i.e., legislations outlining prosecution and trial for criminal breach of trust, fraud etc.; and
Special prosecution under the National Accountability Ordinance, 1999 for corporate frauds and misappropriation.
In view of the above legislative spectrum, a consolidated review of the relevant laws would offer the foundational perspective to understand Pakistan’s superstructure of corporate governance. Transforming this understanding, along with SECP’s vision,15 can truly envision the future of corporate governance in Pakistan- as isolated reforms with regard to any one of the above legislative spheres is not likely to ensure the expected results.
The Code is a first step whereby principles of good governance are envisioned to be systematically implemented in Pakistan. According to the project report published by the SECP after the formulation of the Code:
"The Code of Corporate Governance mainly aims to institute a system whereby a company is directed and controlled by its director in compliance with the best practice enunciated by the system so as to safeguard the welfare of diversify stakeholders. It propose to restructure the work of the board of director in order to begin symbol by minority shareholders and broad-based sign by executive and non-executive directors. It seek to achieve the objectives of good corporate governance by recommend rise of corporate working, internal manage system and outside audit requirements. The Code emphasizes openness and clearness in corporate relationships and the decision-making process and requires directors to release their fiduciary tasks in the better notice of all stakeholders in a clear, up to date hard-working, and timely manner."
Following the enforcement of the Code of Corporate Governance (the "Code") in March 2002, reluctant corporations consider the implementation of the new regime not only expensive to comply with but also practically difficult to implement. While on one hand there is a regulatory pressure to enforce the Code, on the other, there is, among others, an admitted lack of relevant expertise that can assist in the enforcement of the essence of corporate governance in Pakistan. In the present work, recommendations for future indigenous reforms will remain in focus, as against the discussion in respect of the evolving international practices. Such recommendations include:
effective grievance and redress mechanism for minority shareholders;
best practices for the frontline regulators; and
expansion of the audit committee to include the legal expertise, etc.
The Companies Ordinance, 1984 and the Code do not recognize minority shareholders with a shareholding below 10%. The minimum threshold for seeking remedy from the Court against mismanagement and oppression requires initiation of the complaint by no less than 20% of the shareholders.28 Shareholders representing 10% can apply to SECP for appointment of inspector for investigation in to the affairs of the company.29 No effective redress is available to shareholders representing less than the 10% of the shareholding (the "minority shareholders") upon being aggrieved.
The minority shareholders are left with the sole civil remedy to sue for the tortious loss in accordance with the general laws for enforcement of a claim. There is a visible increase for bringing such actions especially in the wake of increasing shareholders’ activism. In routine, such claims seek interim and permanent injunctive relief against the management. Pending final adjudication of the matter, interim relief is invariably granted, resulting in the hindrance of a company’s business.
To channelise shareholders’ activism in a direction that provides the minority shareholders with an effective remedy with no or minimal hindrance to the company’s business, an internal grievance and redress mechanism should be considered for listed companies. In this regard, SECP may formulate a list of maintainable grievances with a direction to listed companies to establish a ‘grievance and redress committee’ consisting of executive and independent directors. The minority shareholders may have an appellate remedy before the relevant frontline regulator, and thereafter to SECP. This will essentially entail expansion of quasi-judicial functions of the stock exchanges and SECP.
In order to make the reporting and disclosures more reliable, SECP should encourage the minority shareholders to report any noncompliance with the applicable laws directly to the Audit Committee, with a copy to the relevant stock exchange.
We recently experienced an unprecedented surge of investment in the public stocks. Unfortunately, it was followed by a sudden market crash. Huge market losses triggered a public debate on a more active role for the frontline regulators. The best practices set out in the Code are expected to ensure a self-sustaining mechanism that provides financial transparency to, mainly, safeguard the investments.
A better-governed stock exchange would, thus, ensure safer investment opportunities. Accordingly, SECP should consider introducing appropriate guidelines for the stock exchanges so as to ensure their better governance, or applicability of the Code thereto.
Introduction of internal and external audit mechanism can be considered as one of the most prominent achievements in the evolution and development of global corporate governance initiatives. The SECP has benefited from and enriched the Code with the international experience in this regard.
In general, the main function of the internal audit committee is to assist the board of directors whereas the external audit committee addresses the concerns of the shareholders at large. In both respects, it is only the financial and accounting expertise that is being made available to a company. The concern that the business and affairs of a company should be run and managed in accordance with the applicable laws cannot be adequately addressed either by the internal or external auditors due to unavailability of professional legal expertise with them.
The Code requires not only compliance with the Code and the Companies Ordinance, 1984 but also requires certification in relation thereto.32 Although, the existing provisions in the Code do not require a company’s certification for compliance with other applicable laws, however, a proper certification as to the compliance with the Companies Ordinance, 1984 and the Code can only be done on the basis of professional legal advice.
Additionally, a deficiency in the Code for requiring compliance with law, and its certification, should be made good. Although such compliance would expand the corporate governance regime but, for all intents and purposes, would be in consonance with the purposes for which the issuance of the Code was considered appropriate. Such certification will lead to the company’s (somewhat partial) adherence to the Corporate Social Responsibility ("CSR"). Accordingly, the Code may become instrumental in introducing CSR for the listed companies, and thereby making them more attractive for local and international investments. In addition, the compliance with law certification would, inter alia, help to discourage the transaction between the associated companies.
In order for the Code to achieve the above, SECP should consider expanding the scope of internal and external audit to include the legal expertise for evaluating the company’s business and the affairs with the legal perspective. In this respect, the following initiatives may be taken:
One of the independent non-executive directors may be a professional lawyer. In this regard, the companies may consider retaining services of their legal advisors appointed pursuant to the Companies (Appointment of Legal Advisors) Act, 1974 and may alternatively, be deemed to be a member of the board;
One of the non-executive directors on the audit committee34 should be the professional lawyer/legal advisor;
With the assistance of the professional lawyer/legal advisor, the audit committee should certify company’s compliance with the applicable laws; and
Upon availability of the legal expertise, the Audit Committee should be empowered to entertain (and decide) the grievances lodged by the minority shareholders, as discussed above.
The code requires the director to "bring out their fiduciary duty with a sense of purpose judgment and freedom in the best benefit of the corporation". However, the expression "fiduciary duties" is not defined in the Code. SECP may consider listing out the fiduciary duties to make this provision more certain and, thus, effectively enforceable. In this regard, SECP may include the list of fiduciary duties from the Manual of Corporate Governance,36 which SECP does not consider to be a legal document.
As has been suggested earlier by an expert,38 the non-compliance "should be strictly followed in the process of a "comply or explain principle". Accordingly, the companies should be strictly required to ensure compliance with their ‘Statement of Ethics and Business Practices’,39 in addition to the existence of such statement. In this regard, SECP should provide a general specimen setting out the minimum contents for ‘Statement of Ethics and Business Practices’ and, additionally, require the companies to expand their own Statement on the basis thereof.
In addition to the above, the Audit Committee’s "Terms of Reference" should expressly provide for review of the company’s outsourcing policy, so as to ensure that the company is getting the best available services at the most competitive rates.
The most profound challenge that the corporate governance regime is likely to face is the vindication of penal liability for non-compliance of mandatory disclosure and certification requirements by senior executives against the constitutional touchstone of self-incrimination. The contemporary drive to integrate ethical codes of corporate governance into legislative instruments incorporating punitive sanction, the best example of which is the Sarbanes-Oxley Act, though are hailed as a quantum leap in structuring a transparent governance regime, if examined in the rich constitutional tradition of upholding civil liberties, may appear hollow in the corpus. Concerns like uplifting of "standards of financial reporting and accountability"40 to boost the business growth are supplemented today by considerations of curbing money laundering and white-collar crimes. It may not, perhaps, be farfetched to expect a paradigm shift enabling detection of flow of funds, particularly to eliminate financing of terrorism.
Expansion of the scope of corporate governance regimes appears inevitable, thus, creating an unprecedented jurisprudential challenge to extant constitutional notions. The above and several other aspects require in-depth examination and analysis, including: what would be the repercussions of over-institutionalising internal corporate structures (by forming committees and sub-committees)? Would externalization of the board result in cost overruns and otherwise cause greater administrative and organizational expense and what alternatives may be recommended to minimize such costs without compromising due effectiveness, transparency and similar underlying considerations? Would good faith presumption in favor of the management be reversed? Would corporate jurisprudence evolve other ethically tested modes of corporate conduct, including a new corporate vehicle in place of the existing structure of a corporate entity? With the incorporation of the Pakistan Institute of Corporate Governance and SECP’s continued strive to reforming the capital market in Pakistan, we hope to have a more effective response to the challenges highlighted above, and to those that would follow
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