MODERATING EFFECT OF BOARD GOVERNANCE

ON THE RELATIOHSHIP BETWEEN OWNERSHIP

STRUCTURE AND CAPITAL STRUCTURE

MS (BUSINESS ADMINISTRATION)

SUPERVISED BY

DR. FARZAN YAHYA

SUBMITTED BY

FAHAD HUSSAIN

REG. NO: MSBA-023R17P-1

SESSION-2019

DEPARTMENT OF BUSINESS ADMINISTRATION

INSTITUTE OF SOUTHERN PUNJAB

 APPROVAL SHEET

MODERATING EFFECT OF BOARD GOVERNANCE

ON THE RELATIOHSHIP BETWEEN OWNERSHIP
STRUCTURE AND CAPITAL STRUCTURE

By

FAHAD HUSSAIN
REG NO: MSBA-023R17P-1

Supervised by: __________________________________________________________

External Examiner: _______________________________________________________

Head of the Department: ___________________________________________________

Dean Faculty of Management Sciences: _______________________________________

 [[

Declaration of Originality
I hereby certify that I am the sole author of this thesis and that no part of
this thesis has been published or submitted for publication.

I certify that, to the best of my knowledge, my thesis does not infringe

upon anyone’s copyright nor violate any proprietary rights and that any ideas,
techniques, quotations, or any other material from the work of other people
included in my thesis, published or otherwise, are fully acknowledged in
accordance with the standard referencing practices. Furthermore, to the extent that
I have included copyrighted material that surpasses the bounds of fair dealing
within the meaning of the Pakistan Copyright Act, I certify that I have obtained a
written permission from the copyright owner(s) to include such material(s) in my
thesis and have included copies of such copyright clearances to my appendix.

I declare that this is a true copy of my thesis, including any final revisions,
as approved by my thesis committee and the Graduate Studies office, and that this
thesis has not been submitted for a higher degree to any other University or
Institution.

Fahad Hussain
Reg. No: MSBA-023R17P-1
Session: 2019

iii
 Abstract

The current study explores the moderating effect of board governance on the

relationship between ownership structure and capital structure. The study utilized

Ordinary Least Square (OLS), Fixed Effect and Random Effect models, however,

Linear Regression, Correlated Panels Corrected Standard Errors (PCSEs) is used to

resolve the issue of Autocorrelation and Heteroscedasticity. We used a panel of 60

non-financial sector firm listed in Pakistan Stock Exchange (PSX) from 2014 –

2018. The results of the study revealed that, managerial ownership is negatively

and significantly associated with financial leverage while the association of

institutional ownership, foreign ownership, and board independent are insignificant

with financial leverage. The results demonstrate that coefficient of board gender

diversity is negatively associated with leverage, however statistically significant.

The moderating influence of board independent between managerial ownership

and financial leverage is positive. The moderating role of board independent

between institutional ownership and financial leverage is positive and significant.

The moderating effect of board independent between foreign ownership and

financial leverage is positive. The moderating effect of board gender diversity is

negative and significant on the association between managerial shareholding and

financial leverage. The moderating effect of board gender diversity on the

association between institutional ownership and financial leverage is positive. The

moderating role of board gender diversity on the association between foreign

ownership and financial leverage is positive. The findings of the study explain that

for sound corporate governance diversified ownership structure is very important.

iv
The agency conflict cannot align with a single and concentrated ownership. Thus it

is proposed that authorities should force the companies to contain well-diversified

ownership structures. The shareholders who are destroying the firm long term

benefits for getting short term benefits should be monitored carefully.

Keywords: Managerial Ownership, Institutional Ownership, Foreign Ownership,

Board Independent, Board Gender Diversity, Financial Leverage.

v
 Dedication

I dedicate this thesis to Holy Prophet (P.B.U.H.) The Greatest Social Reformer &

my Praise Worthy Mother, Dearly Loved Father, My Wife, My Children Afnan

Rasool and Ayesha Noor and most respectful and supportive my Research

Supervisor DR. Farzan Yahya.

vi
 Acknowledgements

In the name of Allah, the Most Gracious and the Most Merciful

“Oh Allah, increase me in knowledge, but let this knowledge be with sincerity, not

seeking fame, glory, status, material wealth. Let this knowledge serve your cause

in a way that you accept, and let it benefit humanity.

First and foremost, praises and thanks to the Allah, the Almighty, for His showers

of blessings throughout my research work to complete the research successfully. I

am very grateful to Institute of Southern Punjab, Multan and Department of

Business Administration for providing me all the facilities and assistance without

which it would not have been possible for me to complete this journey.

I would like to express my deep and sincere gratitude to my research supervisor,

Assistant Prof. Dr, Farzan Yahya for giving me the opportunity to do research and

providing invaluable guidance throughout this research. His dynamism, vision,

sincerity and motivation have deeply inspired me. My work would not have been

completed if it were not for the help of all the Pakistan Stock Exchange (PSX)

listed companies for facilitating the data for my work.

I am extremely grateful to my parents for their love, prayers, caring and sacrifices

for educating and preparing me for my future. I also would like to thank my wife

who did not tell me that it is going to be easy, she told me it is going to be worth it.

Last but not the least, my deepest gratitude goes to all my friends endless love,

prayers and encouragement. May Allah bless you all with peace, good luck,

happiness, a long life and success in every endeavor of life.

vii
 Table of Contents

Declaration of Originality……………………………………………………….iii

Abstract…………………………………………………………………………...iv

Dedication………………………………………………………………………...vi

Acknowledgements………………………………………………………………vii

Table of Content..……………………………………………………………….viii

List of Tables…………………………………………………………………….xii

List of Abbreviations/Symbols…………………………………………………xiii

CHAPTER 1 INTRODUCTION...........................................................................1

1.1. Introduction of the study .......................................................................1

1.2. Problem Statement ..............................................................................11

1.3. Research Questions .............................................................................15

1.4. Research Objectives.............................................................................15

1.5. Significance of the Study.....................................................................16

CHAPTER 2 LITERATURE REVIEW................................................................17

2.0. Introduction...........................................................................................17

2.1. Underpinning Theories .........................................................................17

2.1.1. Modigliani & Miller Irrelevance Theory…………………...17

2.1.2. Trade off Theory...................................................................18

2.1.3.Pecking Order Theory............................................................18

2.1.4.Agency Theory.......................................................................19

2.1.5.Stewardship Theory….……………………………………..20

2.2. Capital Structure……………………………………………………...21

viii
 2.3. Determinants of Capital Structure……………………………………22

2.4. Corporate Governance and Capital Structure………………………...28

2.5. Corporate governance variables………………………………………33

2.5.1. Managerial Ownership…………………………………...33

2.5.2. Institutional Ownership…………………………………..34

2.5.3. Foreign ownership………………………………………..36

2.5.4. Moderating Effect of Corporate Board Governance on….37

the Relationship between Ownership Structure and Capital
Structure

2.6. Summary of Literature Review……………………………………...41

CHAPTER 3 RESEARCH METHODOLOGY……………………………...42

3.0.Introduction…………………………………………………………...42

3.1.Research Framework………………………………………………….42

3.2. Hypothesis of the study………………………………………………43

3.2.1. Managerial Ownership……………………………………..43

3.2.2. Institutional Ownership…………………………………….44

3.2.3. Foreign Ownership…………………………………………45

3.2.4. Board Independent…………………………………………45

3.2.5. Board Gender Diversity……………………………………46

3.3. Measurement of Variables……………………………………………47

3.4. Sampling……………………………………………………………...48

3.5. Statistical Test………………………………………………………..49

3.6. Operational Model……………………………………………………59

3.7. Operational Definitions………………………………………………50

ix
 3.7.1. Capital Structure……………………………………………50

3.7.2. Managerial Ownership……………………………………..50

3.7.3. Institutional Ownership…………………………………….50

3.7.4. Foreign Ownership…………………………………………51

3.7.5. Board Independent…………………………………………51

3.7.6. Board Gender Diversity……………………………………51

3.7.7. Firm Size…………………………………………………...51

3.7.8. Board Size………………………………………………….51

3.7.9. Return on Equity (ROE)……………………………………51

3.7.10. Audit Quality……………………………………………...52

3.7.11. Board Meetings…………………………………………...52

CHAPTER 4 DATA ANALYSIS AND FINDINGS…………………………53

4.0. Introduction…………………………………………………………..55

4.1. Descriptive Statistics…………………………………………………53

4.2. Regression Analysis………………………………………………….55

4.2.1. Ordinary Least Square Analysis……………………………55

4.2.2. Random Effect Model……………………………………...57

4.2.3. Fixed Effect Model…………………………………………59

4.2.4. Linear Regress, correlated panels corrected standard errors

(PCSEs)…………………………………………………………...61

CHAPTER 5 DISCUSSION AND CONCLUSION…………………………...66

5.0. Introduction…………………………………………………………..66

5.1. Conclusion of the Study……………………………………………...66

x
5.2. Limitation of the Study………………………………………………67

5.3. Future Recommendations…………………………………………….68

5.4. Policy Implications of the Study……………………………………..69

References………………………………………………………………...72

xi
 List of Tables

4.1. Descriptive Statistics…………………………………………………….53

4.2. Pooled Ordinary Least Square Model…………………………………...55

4.3. Random Effect Model…………………………………………………...57

4.4. Fixed Effect Model……………………………………………………....59

4.5. Linear Regression Correlated Panels Corrected Standard Errors……….61

(PCSEs)

xii
 List of Abbreviations

CS Capital Structure

CG Corporate Governance

MANG Managerial Ownership

INST Institutional Ownership

FOR Foreign Ownership

BIND Board Independent

BGD Board Gender Diversity

OS Ownership Structure

FLEV Financial Leverage

BSIZE Board Size

FSIZE Firm Size

ROE Return on Equity

AQ Audit Quality

BM Board Meetings

POT Packing Order Theory

TOT Trade Off Theory

PSX Pakistan Stock Exchange

SECP Security Exchange Commission of

Pakistan

xiii
 CHAPTER 1
Introduction

1.1. Introduction of the Study

Corporate governance (CG) is related with the means by which the providers of the

capital to companies assure themselves of receiving a return on their investment. To

maintain development as well as augmentation of an economy, a strong corporate

governance practices is necessary. The countries that have applied sound CG normally

have a strong growth of the corporate area and grip further capability in attracting funds

to fuel the economy. Furthermore, efficiency of governance not only enhances the

performance of a firm but also increases wealth of shareholder and decrease the cost of

capital (Sheikh & Wang, 2012).

Recent financial crises and corporate frauds in developing and developed economies

across the globe have fortified the CG significance. CG issue bound to international

business attention from virtual darkness after a series of the collapse of high profile

corporations, including Houston, Texas-based energy giant, Enron and WorldCom the

telecom behemoth, shocked the business world with both the age and scale of their illegal

and unethical dealings. (Shleifer & Vishny, 2007).

Strong corporate governance improves the important financial decisions of firm.

According to Masnoon and Rauf (2013), “managers play most important role for firm’s

financial performance they make different corporate decisions and strategies, handle

firm’s assets, leverage and capital in order to make firm profitable”.

1
Financing assets with either debt or equity is important financial decision of a firm.

However, managing capital structure is tricky which needs certain expertise of board and

management.

Capital Structure (CS) is the blending of liability and capital. In developing countries like

Pakistan, firm’s optimal CS is very essential. The same CS does not follow by the

companies as the decision criteria against CS are different from company to company.

The main purpose of an ideal capital structure is to reduce chances of loss, cost of capital

and maximize the profit for shareholders. Consequently, it is very difficult job for the

management of the organizations to make decisions about the investment pattern to

maintain optimal capital structure (Bilal, 2016).

The empirical study mostly has been done in developed countries to analyze the affect of

CG on financial leverage (Fosberg, 2004), while limited studies have found in developing

countries about CG and CS that have distinguish institutional structures (Bokpin & Arko,

2009).

The association of CG with financial leverage (FLEV) can be explained through agency

theory. According to Jensen and Meckling (1976), Agency relation refer to: “a contract

under which one or more persons (the principal(s)) engage another person (the agent) to

perform some service on their behalf which involves delegating some decisions making

authority to the agent”. The conflict of interest occurs due to possible deviation between

shareholders and manager. From agency theory viewpoint, financing through debt as a

helpful governance mechanism in minimizing the disagreement of benefit between

shareholders and manager (Jensen, 1986). Nonetheless, there are certain mechanisms of

corporate governance and their effectiveness vary from country to country. These

2
mechanisms may or may not improve the CS in a financial market. In order to testify

which mechanism is important helpful in Pakistan’s capital market. There are the

influence of ownership structures like managerial shareholding, institutional ownership

and foreign ownership on capital structure alongwith moderating role of board

governance such as Board Independence (BI) and Board Gender Diversity (BGD).

There are diverse views found regarding the impact of CG on financial leverage.

According to several researchers implementation of CG practices put forth positive

impact on financial leverage. Ownership structure (OS) is essential component of CG;

however, investor may have different impact on FLEV.

Capital Structure choice is not only influenced by company attributes but also by the

vision of managers, objectives along with needs, which are effected with managerial

shareholding (Brailsford et al., 2002). The matter of power and control is the base for

explanation of positive effect of managerial shareholding on FLEV. The main concern of

manager is to maintain and enhancing their control as it gives them with tact in decisions

making and access to personal interest. In the meantime, debt is use as a resource to avoid

share dilution. According to Harris and Raviv (1988), rise in debt help out managers to

strengthen their control and refuse to accept takeover. Sometime managers utilize surplus

debt as a temporary device to indicate a promise to sell resources, thus avoiding takeover

attempts from outside investors. Furthermore, with high debt, managers for their personal

interests have additional cash to follow suboptimum investments.

The negative association of managerial shareholding with FLEV is on the basis of

following reasons. First, from agency theory, high managerial ownership can facilitate

company to reduce the agency costs of shareholders and managers, because the interests

3
of principals and agents are aligned (Jensen & Meckling, 1976). Secondly, due to high

managerial shareholding, companies have lower agency cost of equity but have higher

agency cost of debt as benefits of manager are strongly aligned with shareholders as

compared to debt holders.

To mitigate the agency costs, debt and managerial ownership can be considered as

substitute tools. Company managers face high level of non-diversifiable risks as

compared to shareholders. In order to protect their reputation, managers do not take

excessive risk. Accordingly, the high level of managerial ownership decrease their

overall debt level and risk level of the firm (Zhang, 2013).

Institutional ownership also acts as good monitors who actively perform their duties and

maintain the CS optimally. CS theories entail that companies choose their leverage

according to market frictions, for instance agency cost and asymmetric information. In

agency context, institutional owners devote as an external disciplinary mechanism for

administration, reducing the need for internal disciplinary mechanisms, for instance debt.

In the context of asymmetric information, institutional ownership reduce information

asymmetry and decrease the unfavorable or wrong choice of costs of equity, serving to

reduce the amount of debt necessary for signaling equilibrium, and to lesser the cost of

equity related to debt (Michaely & Vincent, 2013).

There are mixed findings on the association of institutional ownership with FLEV For

instance Abdoli et al. (2012) established positive association of institutional ownership

with capital structure in Tehran due to their easy access of distinguish sources of finance

like bonds or credits. Same evidence suggested by Abobaker and Elgiziry (2015). In

contrast, some researchers were found opposite association of institutional ownership

4
with financial leverage such as Aljifri and Hussein (2012), explore significant opposite

association of institutional ownership with leverage, this indicate firms with large

proportion of institutional owners may lead to less use of debt financing. Pecking order

theory supports these results. Same results were found by research of Cinko & Kasaboglu

(2017) and Michaely & Vincent (2013).

There is negative association of institutional owners with financial leverage. For

example, an increase in institutional ownership may cause low firm leverage by more

expected to issue equity and fewer possibility to increase liability (Michaely & Vincent,

2012).

Foreign investment is very essential for the developing nation like Pakistan. An overseas

ownership is a good financial source for companies; thus foreign ownership may affect

the company FLEV. According to Gurunlu and Gursoy (2010), the entry of foreign

investors decreases the requirement for debt financing, so they maintain low FLEV. They

support this effect by causing that the requirement for external finance such as firm

liability decreases due to investment by the foreign owners.

Empirically, earlier studies show the association of foreign investors with financial

leverage. The foreign investors are related to corporate downsizing and resources

diversification leading to better performance (Nakano & Nguyen, 2013). Kocenda and

Svejnar (2002) investigated that the high concentration of foreign ownership augments

profitability for companies by decreasing non labor costs and generate income other than

the income from sales, in addition to lowering leverages. On the other hand, board

governance improves firm’s financial decisions by restricting managers from exploitation

of resources, reducing agency conflicts and protecting the rights of minority shareholders

5
The independent directors are not major shareholders of the firm. They must have

qualification as demanded by board of directors for distinctive nature of firm’s operation.

Because the knowledge of independent directors allow the company have high amount of

firm financial leverage. According to Berger et al., (1997), existence of independent

directors is likely to guide high financial leverage of the firm.

Pecking order theory (POP) forecasted that companies with large percentage of

independent directors have more external sources of financing as compared to internal

sources of financing like retained earnings; have more short term liability than retained

earnings; have long term liability than short term liability; and have more external equity

compared with long term liability. These outcomes are consistent with our assumption

which conjecture that large percentage of independent directors should guide to decrease

asymmetries of information between outside investors and managers and by that means

decrease the cost of issuing more risky sources of financing.

There are mixed finding lying on the association between independent directors and leverage.

The high percentage of independent directors on the board indicates the positive effect on

company leverage. It means that when companies have more non-executive directors, they

augment safeguard against instability and this raises the company capability to increase

external sources of debt (Siromi & Chandrapala, 2017). On the other hand, opposite

association between outside directors and leverage, arguing that majority of the Iranian

independent directors is associated several ways by means of company management (Abdoli

et al., 2012). Likewise, Wellalage and Locke (2011) in Sri Lanka finds significant opposite

association between corporate governance and capital structure, arguing when managers

facing strong corporate governance then they apply low level of debt.

6
The monitoring effectiveness related with board independence is possible to strengthen

the performance effect on the leadership structure in a dynamic environment. The

association between inside and outside board members proposes that companies having

sound governance board require more external directors in a board to reduce the

influence of CEO. Thus it is not shocking that different researcher regarding independent

board and ownership structure as an important corporate governance variables (Raheja,

2005).

Lastly, we assume that the influence of independence board on CEO also accounts for the

moderating role of board independence. Schwartz-Ziv and Weisbach (2013), using

personal facts on complete minutes of board meetings, advocate that boards mostly spend

their time in examining the organization in a latest important paper. According to

Borokhovich, Parrino, and Trapani (1996), explain that the monitoring role of board

improve by independent directors. Even managers believe independence board to be the

key characteristic of a board with high monitoring capability (Adams et al., 2010).

For instance, a few years before, congress, in reaction to the CG scandals, approved

Sarbanes-Oxley Act (SOX) of 2002, demanding that companies should have a majority

of independent directors helping on their boards and therefore justifying our focus on

board independent. The decision regarding the change of CEO is very important

decisions of the board, thus the main purpose of monitoring requires for evaluating CEO

ability and using information in replacement of decision. Accordingly, previous studies

of Weisbach, 1988 found direct association between independent directors and the

possibility of changing a badly performing CEO. Due to dynamic association of the board

of directors with CEO (Hermalin & Weisbach, 1998), we argue that a dynamic model is

7
better able to capture the influence of leverage on this association of OS with outside

directors.

Put in a different way, independent or external directors are mainly concerned about their

reputation in the labor market (Fama & Jensen, 1983), therefore, they restrict managerial

opportunism, fire them from poor performance, protect minority shareholders and oppose

certain types of investors who work in their self-interest. Accordingly, this study

hypothesized that independent directors moderates the association between OS and

leverage.

Agency theory is also in favor of board diversity. The financial decisions of firm can be

improved by the inclusion of female directors. Thus, there is demand to include female

on the board, to access the investment and enhance overall board independence. Better

modes of financing are available for a company as female are more likely to ask

questions as compared to male. Due to gender diversity, it is possible for companies to

perform better than competitors and promotes better understanding of the market (Emoni

& Wandera, 2012).

Women directors are expected to support firm’s management more than male

counterparts by utilizing their expertise and legal knowledge, HR management,

communication, and public relations (Zelechowski & Bilimoria, 2004). The study of

Strøm et al. (2014) collected the sample of 73 firms over the period of 1998-2008 in

countries and discovered that women director on the board will result in better financial

performance.

Next question is whether women directors would try to mitigate company’s leverage so

as to lesser financial risk, thus pointing to the opposite impact of women director on

8
leverage. In contrast, prior studies (Chang et al., 2014; Huang et al., 2015) demonstrate

that numerous companies in developed nations contain lower leverage, the existence of

women directors in companies having lower leverage may push them to have higher

leverage. While companies in developing nations are usually more financially

constrained as compared to those in developed nations, studies anticipate the influence of

women directorship on leverage to be positive for the former and negative for the latter.

Alves et al (2014) find that women on the board decreases short term debt while

increases long term debt. Agency theory also in favor of the moderating role of board

gender diversity and it is based on economic cause.

Theoretical, healthy diversification in CG structures will make sure better safeguarding

shareholders benefits with effective and efficient supervising of activities of the CEO and

other executive directors through people of different background and experiences. In this

regard, the increased monitoring role of female directors will lead to companies more

profitability and economically successful and in that way making worth to the

shareholders. These propose that the influence of women director on the board will make

stronger positive association of CG structure with firm performance (Alabede, 2016).

Likewise independent directors and female directors are also not to show their talent and

superior skills among male dominated societies. Accordingly, they try to improve

financial decisions and restrict majority shareholders from wasting the resources of

minority shareholder. Consequently, they also moderate the association between OS and

financial leverage.

Owing to mixed evidence on the association of CG mechanisms with leverage, this study

seeks to improve and further explore underlying relationships. Academic work on the

association of CG with financial leverage is scarce in Pakistani perspective. Especially

9
earlier researches have not ensured the moderating role of board governance between OS

and financial leverage in Pakistani context. The research explores how board

characteristics restricts or support different kinds of investors to take debt or increase

equity. Therefore, the results of the study may help academicians and policy makers to

set optimal capital structure in the financial market of Pakistan.

1.2. Problem Statement

The prime responsibilities of the company’s manager are to select a best arrangement of

liabilities and equity firm leverage which is leading to raise firm worth. The selection of

ideal CS plays a vital role in firm financial decisions. If company choose debt financing,

which is relatively a cheaper source of finance it increase in company’s comparative

riskiness, decreases financial flexibility of firm, raises opportunity of liquidation and

generally low credit rating among many others. In contrast debt financing have several

benefits like interest on debt is tax deductible (Shah, & Khan, 2017).

The poor control of corporate governance mechanism in Pakistan than advance countries.

In Pakistan, government took many measures to improve this circumstance like in 1991,

give primary importance to overseas shareholders and secondary importance to local

shareholders. For the contribution of economic development of the country, the Security

Exchange Commission of Pakistan (SECP) established sound and well-organized capital

market on January 1, 1991 (Naseem & Malik, 2017). In addition to this, SECP published

the Rules of CG in order to make sure the best practices in the corporate area under the

competent administration of its directors along with safeguarding the rights of its

common stakeholders (Sheikh & Wang, 2012).

Due to poor legal system in Pakistan, there is also weak corporate governance in many

companies as than the firms of developed nations (Javid & Iqbal, 2010; Sheikh & Wang,
10
2012). Independent directors are almost missing (Javid & Iqbal, 2010) and most of the

firms are family owned and they selected less skillful board of directors based on their

own relations in capita market of Pakistan. As a result, agency conflicts happen as board

make decision in support of only a specific group (Shah & Butt, 2009). Thus, it is

believed that the proposed framework can reduced agency conflicts on the context of

Pakistan.

The study focus on moderating role of board governance (board independent and board

gender diversity) on the association between OS and leverage. Limited amount of studies

indicate the effect of corporate governance on the association between leverage and

company has implemented duality approach in explore the associations among the three

studies create: the association of firm value with leverage, the correlation between

leverage and CG and association between CG and firm value. (Lang’at, 2006; Musyoki,

2009; Ngaruiya, 2007). They have disregarded the moderating effect of corporate

governance of these limited studies, as a result failure to provide empirical analysis of

immediate affiliation of these three variables.

Furthermore, the problem of autocorrelation, heteroskadsity and casual relationship have

always been raised in conversation or debate of the association between two of these

variables; between CG and leverage; between CG and firm value or between leverage

and firm value. Therefore, it is vital to empirically examine the interrelationships between

them, as these three variables are extremely significant to corporations, and play an

essential role in corporate decisions making and creations.

Secondly, the studies that have tried to analyze the three variables (for instance Byers et

al. 2008) were conducted in developed countries and the conclusions in these studies may

11
differ if empirical analysis were replicated in the local environment. Therefore there is

need to carry out experiential studies to analyze interrelationships between three

variables.

CS is a CG tool that can protect corporate governance efficiency and safeguard its

stability to build worth but it is forever ignored in the capital structure-firm value studies.

Thus, there is moderating role of board governance on the association between CS and

OS and firm value’s requirements to take directly into account.

In summing up, the research gaps of this subject are: lack of local study that include

concurrent analysis of the three variables; disregarding the moderating role of board

governance in evaluating the association between financial leverage and OS as well as

firm value and the fact that in dual studies of examining the relation among the three

study build up: the association between firm value and leverage or CG, conclusions are

conflicting as well as unconvincing.

This research plan address these gaps by attempting answer the questions: Is there a

moderating role of board governance on the association between OS and financial

leverage?

Numerous mechanisms by which CG of an organization can be measured such as in the

current study independence directors, board gender diversity, managerial shareholding,

institutional shareholders and foreign investors .

Especially, evidence in the context of Pakistan either weak or non-existent, for instance,

Abdoli et al. (2012) find negative association of independent board with financial

leverage. They suggested that Iranian outside directors do not increase the debt of the

organization. In contrast, positive association between independent directors and

12
financial leverage (Najjar & Hussainey, 2012). They argued that independent directors

increase the debt level to enhance the access to credit. Similar evidence found by Sheikh

and Wang (2012) in context of Pakistan. In the context of board gender diversity, Alves

et al. (2014), find that women on the board decrease short term debt while increase long

term debt of the organization. Similar outcomes were found by Emoni and Warden

(2017). According to researcher’s best knowledge, there is no previous study in Pakistani

context on the relationship of female directors with financial leverage. According to

Wellalage and Lock (2012), managerial ownership found significant positive association

between managerial percentage and firm financial leverage in Sri Lankan listed firms.

Conversely, in Pakistan Sheikh and Wang (2012) suggested negative association between

managerial ownership and debt ratio. Similar results revealed by Hasan and But in 2009.

In the context of institutional ownership Abdoli et al. (2012) found positive association

between institutional investors and CS in Tehran due to their easy access of various

sources of financing like bonds or loans. Same evidence suggested by Abobaker and

Elgiziry (2015). In contrast, some researchers were found opposite association between

institutional shareholding and leverage such as Aljifri and Hussein (2012) explore

significant negative connection between institutional shareholding and debt to equity

ratio, indicating that pecking order theory support the large part of the shares owned by

institutional shares the low the use of debt financing. Same results were found by

research of Cinko & Kasaboglu (2017) and Michaely & Vincent (2013). According to

researcher’s best knowledge, there is no previous study found in Pakistan on the

association between institutional shareholding and CS.

13
According to Gurunla and Gursory (2013), there is negative association between foreign

investors and CS. Similar results were suggested by Sivathaasan (2013) and Phung & Le

(2013). However no previous study exists in Pakistan regarding association between

foreign investors and financial leverage.

Thus, investigating the direct and two-way interaction on capital structure may improve

the overall capital market of Pakistan and guide managers in making efficient decisions.

1.3 Research Questions

The research questions of the study are as under:

a. Is there any effect of managerial ownership on capital structure in non-financial Pakistan

firms?

b. Is there any effect of institutional ownership on capital structure in non-financial Pakistan

firms?

c. Is there any effect of foreign ownership on capital structure in non-financial Pakistan firms?

d. Is there any moderating effect of board independent on the relationship between ownership

structure and capital structure?

e. Is there any moderating effect of board gender diversity on the relationship between

ownership structure and capital structure?

1.4 Research Objectives

The objectives of this study are:

a. To assess the effect of managerial ownership on capital structure.

b. To assess the effect of institutional ownership on capital structure.

c. To assess the effect of foreign ownership on capital structure.

d. To assess the moderating effect of board independence on the relationship between

ownership structure and capital structure.

14
e. To assess the moderating effect of board gender diversity on the relationship between

ownership structure and capital structure.

1.5 Significance of the Study

Owing to weak legal structures and legislation making in Pakistani capital market, there

is high uncertainty in this stock exchange. Accordingly, the purpose of the study is to

explore the moderating influence of corporate governance board like board independent

and board gender diversity on the relationship between ownership structure and capital

structure in firms. According to researcher’s best knowledge, studies especially on the

moderating effect of corporate board on relationship between the ownership structure and

capital structure are either scarce or non-existent. Thus, it is expected that this study will

help the policy makers and managers to make better decisions regarding capital structure

of the firm.

The study of the relation would augment our understanding about whether or not

companies that are vulnerable to expropriation issue more debts to have more resources

to use for personal benefits and how this explains into company worth. Researchers may

also desire to utilize result of this study as a basis for further research on these unsolved

issues of best capital structure.

The administration of the public quote companies would advantage from the study as

they require making more knowledgeable financial decisions. Shareholder would also

make use of the findings of this research to be able to make more well-versed decisions,

as they will be aware of the corporate governance structure to anticipate before they

invest in a company.

15
The others advantage would be for financial advisors and academic who intend to

evaluate the content of information contained in financial reports to be able to offer

proper advice to clients on the possible effects of reported corporate governance

compliance levels.

16
 CHAPTER 2
Literature Review

2.0 Introduction
This section examines the prior researches on corporate governance and leverage

and gives practical evidence on corporate governance and leverage. This section

separated into following parts. Section 2.1 examines the underpinning theories.

Segment 2.2 reviews the concept of capital structure (CS). Section 2.3 explores

determinants of capital structure. Segment 2.4 explains the results of CG and CS.

Section 2.5 explains the corporate governance variables and lastly segment 2.6

represents chapter summary.

2.1. Underpinning Theories

2.1.1. Modigliani and Miller Irrelevance Theory

According to Modigliani and Miller (1958), irrelevance theory of CS, the

existence of ideal capital market i.e. in the non-existence of “taxes and

information asymmetries” leverage does not influence price of share of a

company regardless of utilizing whatever combination of liability & capital. But,

actually capital structure does influence the company worth in the world.

According to Miller (1988), due to market limitation or imperfection company’s

worth is affected by leverage. Trade - off Theory (TOT), Pecking order Theory

(POP) and Agency Cost Theory have been recognized respectively in order to

discover the affect of taxes, as asymmetric information & agency problem in

relation to leverage.

17
2.1.2. The Trade - off Theory

Modigliani & Miller (1963) presented TOT of CS which proposes that by

balancing the advantages of reduction of taxes and cost of liquidation there is a

target level of debt that enhances the worth of a share. TOT mostly explicates two

ideas: financial crisis& agency costs. The TOT says that financing through debt is

beneficial as the payment of interest on obligation be tax deductible. Companies

are paying attention in increasing cash flows & so, will favor a high level of debt

at a high rate of tax. Therefore, rate of tax is positively related to leverage.

Nevertheless, the probability of incapability to refund the liability surges with the

increasing of liability beyond the optimum level. Accordingly, a company can

still obtain bankrupt and where as in case of non-payment the ownership shift

from shareholders to holders of the bond. The liquidation expenses consist of

direct and indirect insolvency costs.

2.1.3. Pecking Order Theory

Myers (1984) introduced POT which is opposite to TOT. POT is based on

information asymmetric between internal (shareholders and managers) and

external investors. The asymmetric information suggests that managers have more

information as compare to external parties.

Furthermore, POT explain that the financial decisions of the company based of

financial hierarchy, such as a firm will give preference to internal source of

funding first like accumulated profit, next preference given to debt finance and

equity is final alternative of financing. So, POT suggests an opposite relationship

wherever negative association is suggested like high profitability companies have

18
tend to decrease the amount of debt. This is as companies are able to make their

internal source of finance before looking for external financing and will merely

make use of loan while their internal finances (retained earnings) are low for

profitable investment or pay dividends (Rahman &Arifuzzaman, 2014).

2.1.4. The Agency Theory

The agency cost occurs because of the utilization of debt in a company’s financial

leverage (FLEV). According to Jensen and Mecklin (1976), agency cost occurs

due to internal reasons for example disagreement of benefits between principals

and agents i.e. agency cost of equity and the disagreement of benefits between

shareholders and holders of the debt. Equity-holders want to get high return on

investment projects while holders of the debt performing on behalf of shareholder

in receiving the fixed amount of interest payment. According to Myers (2001),

disagreement of benefits between shareholders and debt holders will occur due to

there is a risk of default. Thus, if there is no risk of default, the income, value, or

risk are not capable to attract the debt holders interest and vice versa in case of the

possibility in default, the managers have a tendency to have an interest of the

shareholders in raise the shareholders wealth (Sheikh & Wang, 2011) and

financial crisis may raise if company taking too much debt financing (Jensen,

1976).

Accordingly, the utilization of FLEV in debt to equity ratio through issuing debt

may decrease agency costs between principals and agent, although it can impact

the prospect cash outflows, resulting in high projected cost of financial problems

and bankruptcy (Dawar, 2014). As the level of leverage is low, rising of debt may

19
alleviate agency conflicts through attractive incentive for managers, whereas at

high level of FLEV, the increase of losses in a company’s project will result in a

negative net present value which can reason of financial crisis and liquidation.

The conflicts of interest between shareholders and directors can be decreased by

utilization of debt (Jensen, 1986). The agency cost can be decreased through

utilization of debt. Since debt plays an important role in examining directors as

using the available of free cash flow.

2.1.5. Stewardship Theory

The Stewardship theory presented and founded by Donaldson and Davis (1991),

based on the assumption that interest of the shareholders and managers are

aligned together and company administration are support to take decisions that

would augment the performance of the company’s in order to raise wealth of the

shareholders and entire worth of the company.

The theory consider that through Stewardship there is better use of firm’s assets in

an reasonable way rather than personal performance and for this reason, at the

same time as the decision of the executive would be increasing the shareholders

wealth as well as to fulfill the personal requirements. The directors are there to

protect the interest and at the same time raise wealth of the shareholders by

improving the company performance (Ranti, 2011). Furthermore, he stated that, to

achieve this goal and harmonizing the benefit of the shareholder after that there is

need to set up an appropriate governance mechanism in term of board

composition, information and authority to easiness the independence of

administration to make decisions and to take benefit of accomplishing

20
organizational goals rather than personal interest. For example, for those Chief

Executive Officers who are in charge steward, their administrative experience and

performance are being applied when the governance system give them high level

of independence and carefulness (Donaldson & Davis, 1991). There are five

mechanisms of executive point of view of stewardship as identified by Davis et

al., (1997) which include long term orientation, trust, empowerment, open

communication and enhancing company performance.

2.2. Capital Structure

Combination of liabilities and capital is called capital structure (CS). It is utilized

by firms to financing long term operation. CS is the blending of different

securities that are utilized to fund an organization’s resources (Brealey & Myers,

2003). Brealey and Myers (2003) also examined that a firm can provide different

security utilizing various combinations but the greatest mixture is one that

increase the market value. According to Akram and Ahmad (2010), the FLEV of

an enterprise comprises of liability and owner’s capital element utilized toward

finance the enterprise. Generally the equity financing supplied through the public

who purchase the shares of the company. The equity finance holders denominated

by the numbers of shares and have a stake in the company.

The cost of capital and required rate of return are used to discount the incomes of

the firm. The decision on the company’s leverage can have an effect on the worth

of the enterprise through either changing the cost of capital and projected incomes

(Pandey, 2002).

21
2.3. Capital Structure Determinants
CS is determined through numerous elements. The objective of this segment is to

observe earlier studies of CS determinants. Various researchers (e.g. Abor &

Biekpe, 2009; Benkraiem & Gurau, 2013; Chadha & Sharma, 2015; Fareed et al.,

2014; Kiong & Lean, 2011; Shubita & Alsawalhah, 2012; Uyar & Guzelyurt,

2015) have considered the association of company’s attributes with firm leverage.

Even so, outcomes are varied. Factors such as quality information, size of firm,

age of firm, asset structure, and profitability are affecting on capital structure.

This section assesses and discusses the previous studies on the above mentioned

attributes.

A small amount of researches encompass the association between quality of

information and FLEV. The research conduct by Caneghem and Campenhout

(2012) and Campenhout and Caneghem (2009) on quantity and quality of

information on CS in Belgium pinpoint that the leverage of the organization will

augment due to high quantity and quality of information. On the other hand, low

quality of information avoid companies from getting external finances, this is

consistent with (TOT) who propose positive association of quality of information

with leverage (Caneghem & Campenhour, 2012). The companies with high

quality of information have a tendency to depend more on debt, which is

consistent with companies contain a low cost of attaining external finance.

Furthermore, the study conducted by Kardan, Salehi and Abdollahi, (2016) of

association between external finance and the financial reporting quality in Iran.

Sample of 152 listed firms was taken from 2010-2013. The conclusion of the

22
research indicates that quality of financial reporting is positively associated with

debt finance.

Firm size can be determined by obtaining total resources or total sales. TOT

proposed positive impact of firm size on FLEV. On the other hand, POT proposes

inverse impact of firm size on FLEV. According to Rajan and Zingales (1995),

big companies give preference to equity financing as of “asymmetric

information”.

Previous studies (e.g. Boateng, 2004; Chadhs & Sharma, 2016; Saarani &

Shahadan, 2013b) have exploited firm size in investigating the CS determinants.

In Malaysia the researcher explore firm size is an important variable related to

FLEV (Hussain et al., 2015; Ibrahim & Masron, 2011; Suhaila & Wan Mahmood,

2008). Though, there are different results on the association of firm size with

FLEV. For example, (Saarani & Shahadan, 2013b) examined the determinants of

CS of Malaysian organizations discovered firm size is insignificant and negative

association with total liability ratio and short term liability ratio, but positively

associated with long term liability ratio.

TOT suggests a comparable association between firm size and FLEV. In order to

get an ideal FLEV, larger companies have tendency to raise their debt level. The

studies of Qaderi, Rasouli, Bakmohammadi and Hamekhani (2015) on CS

determinants of 68 companies listed of Tehran Stock Exchange discovered

positive association between firm size and FLEV. The outcomes show that big

companies have a tendency of more debt because the cash flow of big companies

are more varied as well as more stable, which means that they are lesser prone to

insolvency.

23
The studies of Gomez, Rivas and Bolanos (2014) on CS determinants in Peru, the

results found a positive and significant association of firm size with leverage.

Similar results found of other studies (Ogbulu & Emeni, 2012; Sheikh & Wang,

2011; Sherif & Elsayed, 2013; Zhang, 2010).

Conversely, numerous researches of determinants of CS examined the negative

association between firm size and CS (Alipour et al., 2015; Kariuki & Kamau,

2014; Masnoon & Saeed, 2014). The study of Hussain et al., (2015), examined

significantly negative association between firm size and debt ratio in Malaysia.

This is consistence with (POT) which contended that financial source is based on

preference ranking by using asymmetry information between principals and

agents. The Pecking Order Theory explicates larger companies have more ease of

access to the equity financing source rather than smaller firms, so larger

companies produce large information asymmetry to attract low debt.

According to Ahmad and Wan Aris (2015), there is theoretical doubt about the

definite association of firm’s age with FLEV. Various theories for instance TOT

assumed to a positive association of firm age with leverage and POT assumed

negative association of firm age with financial leverage.

According to Ahmad and Wan Aris (2015), negative association of firm age with

all debt ratio measurements. Likewise, Caneghem and Campenhout (2012)

explained negative association between firm age and FLEV. Furthermore, Ezeoha

and Botha (2012) explained that as the companies getting older the debt finance

level decreases, because the old company may face the asset depreciation

problem, which may erode the firm worth and lastly impact of the firm’s growth.

According to Uyar and Guzelyurt (2015) investigated the affect of company

24
attributes on firm FLEV in Tukey and found negative and significant association

between firm age and long term liabilities. Similar results were found by Ogbulu

and Emeni (2012) and Ari and Mika (2004).

In addition, the study of Forte et al., (2013) on Brazilian firms used the sample of

19,000 Brazilian companies for the year from (1994-2006) and the results show

negative association of firm age and FLEV. Similar results found by Palacin-

Sanchez and Ramirez-Herrera (2013).

Therefore, TOT postulated positive association of firm age with leverage. TOT

says, an ideal FLEV is attained when old company have trend to raise debt level

in order to up quality of company worth. Moreover, old companies can get loan

easily due to the strong association with the lenders as revealed by Chadha and

Sharma (2016) who empirically conducted study on financial leverage in India.

The results show positive correlation of firm age and company worth.

In contrast, a number of studies argued that firm age have no affect on financial

leverage. Prior studies conducted by Mouamer (2011), Zabri (2012) and Zhang

(2010) on CS determinants showed no significance affects of firm age on

leverage.

Furthermore, the studies that gave the mixed conclusions between firm age and

capital structure. Sarrani and Shahadan (2013b) observed the CS determinants in

Malaysia. The study result indicates opposite association of firm age with total

liabilities and long term liabilities however positively associated with short term

liability. According to Saarani and Shahadan (2013a), observed the comparison of

capital structure among Malaysian companies, the study revealed significant and

inverse association of firm age with long term debt ratio.

25
Earlier researches revealed diverse conclusions regarding the influence of asset

structure on leverage, such as, current research investigated by Alipour et al.,

(2015) of non-financial companies in Iran. The research found mixed results

between assets structure and CS. Generally result verify that Iranian companies

try to financial support of their permanent asset with long term liabilities and their

current asset with short term liabilities.

Moreover, a few studies found positive and statistically significant impact of asset

structure on leverage. An empirical study of Chadha and Sharma (2015) on

capital structure determinants in India presents positive and statistically

significant association of asset structure with firm leverage. Similar results were

found by Sanusi (2014) and Zabri (2012).

The TOT argued positive affect of asset structure on leverage. The research of

Myers and Majluf (1984) present companies that possess more resources have

tendency to high debt to equity ratio due to collateral benefit. Usually, companies

have many fixed assets can attain easily financial assistance, because their fixed

asset can be used as security. This argument is support by numerous current

studies that revealed the association between asset tangibility and CS is positive

(Hussain et al., 2015; Kariuki and Kamau, 2014).

On the other hand, POT suggests that tangibility is opposite correlated with

leverage. POT explain that due to high tangible asset a company be likely to use

low debt, when they prefer internal financing instead of external financing since

their final alternate. This theory is supported by numerous studies that found asset

structure negatively associated with leverage (Bereźnicka, 2013; Masnoon and

Saeed, 2014; Psillaki and Saarani and Shahadan, 2013b).

26
Relationship of profitability on FLEV have examined in several studies. POT

assumed inverse affect of profitability on leverage, wherever companies having

high profitability less depend on external financing. The company gives first

preference to internal finance, next debt finance and finally equity finance as last

option. Various current studies investigated negative correlation between

profitability and CS (Abeywardhana, 2015; Ahmad & Wan Aris, 2015; Gomez et

al., 2014; Kariuki & Kamau, 2014; Masnoon & Saeed, 2014; Ramjee &

Gwatidzo, 2012; Ukaegbu & Oino, 2014).

Moreover, numerous studies find negative results on the association between

profitability and FLEV (Fareed et al., 2014; Shubita & Alsawalhah, 2012;

Velnampy & Niresh, 2012). Qaderi et al., (2015) examined company particular

factors on FLEV in Iran and exposed positive association between profitability

and leverage, but have no significant effect on leverage. So little studies

demonstrate no significant effect between profitability and FLEV (Zabri, 2012).

Moreover, there are also studies showed a positive and significant association of

profitability with firm FLEV (Chadha & Sharma, 2015).

Furthermore, TOT postulates the positive relationship of profitability with

leverage. TOT states that company with high profitability should augment their

level of financial leverage, because the companies are trying to get best level of

CS by balancing between cost and benefits. In addition, Liang, Li and Song,

(2014) studied the CS in China found positive association between profitability

and CS. Similar results found by Sherif and Elsayed (2013).

2.4. Corporate Governance and Capital Structure

27
Impact of corporate governance (CG) on firm capital structure (CS) mostly

studied in developed nations. It also defines that “Corporate Governance is

basically associated with the firm’s CS and financing decision” (Litov, 2005).

According to Liao (2012), “Good governance help out the organizations to control

their information more effectively due to which overall cost of capital decreases

and therefore it helps the firm to make effective and faster capital structure

decisions”.

Detthamrong, Chancharat and Vithessonthi, (2017), examine non-financial

organizations in Thailand from 2001-2014 highlight the association of CG with

CS. The research find CG features like board size, independence directors, audit

committee size, women director, CEO duality, ownership concentration and audit

reputation have no influence on firm CS. Earlier studies give various results about

the association of board size with CS. According to Berger et al., (1997), there is

negative impact of board size on CS. In contrast, according to Jensen (1986),

companies due to large board size have high firm capital structure as compare to

those firms which have small board size and propose that companies due to larger

board are more possible to utilize more debt level. The positive association

between board size and capital structure show to maintain idea that companies

keeping more directors might be able to tap into their directors group which

permit them to have good access to external funding.

Independent directors are not major owners in a firm. Independent directors must

have suitable qualification as demanded by board for distinctive nature of firm’s

operation. However, in Thailand, independent directors can give opinion freely in

28
relation to administration work. In this literature board independent has positive

effect on capital structure.

Earlier studies of (Chang et al., 2014) in developed economies show that various

companies have low leverage, existence of women directors in companies with

lower leverage may move forward them to have high leverage. While as compare

to advance countries, more financial constrained in the companies of developing

countries. We anticipate the positive influence of female directors on capital

structure for earlier and negative for the latter. Thus, the study proposes positive

association of female directorship with CS.

The disagreement between principals and agents reduces by ownership

concentration (Suto, 2003). The implications for agency relationship within the

company, the ownership structure (OS) of company can also influence on

financial leverage (Claessens & Fan, 2002). According to Paligorova and Xu

(2012), companies having high ownership concentration have high financial

leverage as compare to those companies that have low ownership concentration.

The results propose that in order to decrease managerial opportunism, ownership

concentration force managers to rise capital structure. This study indicates

positive association of ownership concentration with capital structure.

A good reputable auditor can play vital role in decreasing the information risk of

investor, and so decreasing company’s cost of capital if financial statements give

market participants such as shareholder, potential shareholders through

information, and the data recorded in the financial statements would be accurate

(Azizkhani et al., 2010). Thus we argue and test whether companies get the

29
services of large international auditing firms have high capital structure as

compare to other companies.

More particularly, we can say that a good reputable audit firm plays essential role

in company’s financial leverage. When financial statements of a firm examine by

a good reputed auditors, it would make its reliability and raise its chances to

access to external financing such as debt or equity, which would allow for higher

capital structure. Furthermore, we suggest positive association of audit reputation

with firm capital structure.

Siromi and Chandrapala (2017), empirically examine the listed firms in Sri

Lanka, whether CG mechanisms influence the financial decisions. The sample of

138 non-financial listed firms collected for five year from 2009-2013. The results

showed no significant influence of CG characteristics excluding board

composition and board committee on financial leverage. The board composition

has significant positive impact on leverage and board committee has negative

influence.

The regression findings expose the presence of independent directors and

variables of board committee are significant associated with financial leverage.

Similar results found by Kajanathan (2012). The percentage of independent

directors indicates positive effect on a company debt ratio. It means that when

companies have more non-executive directors, they augment safeguard against

instability and this raises the company’s capability to increase external debt.

Moreover, According to Wellalage and Lock (2012), negative association of

managerial ownership with leverage demonstration that ownership concentration

30
encourages managers to low the levels of gearing but the impact is not significant.

Lastly, this study recognized that excluding board composition and board

committees, other CG variables are insignificantly influence by the leverage

choices. Similar results were found by Somathilake & Udahakumara (2015).

According to Nyakundi (2016), there is association of CG with CS of listed firm

of Nairobi Securities Exchange (NSE) in Kenya. Sample of 33 firms out of total

population of 61 active listed firms in NSE from 2008 to 2012 for five year was

selected. Multivariate regression model was using for analysis in penal data

structure. The results explain negatively association of board size with leverage,

negative association between independent directors leverage. There is positive

association between Government ownership and financial leverage. Moreover,

negative relationship between managerial ownership and leverage which shows

greater managerial shareholding remove the disagreement of benefits between

managers outside shareholders and to reduce agency problems, decreases the role

of debt as an instrument. Positive association of institutional shareholders with

leverage show companies with large ratio of institutional shareholder make use of

debt as a device to decrease the agency problem and, are also able to negotiate

more debt at a low cost. The institutional shareholders implement good corporate

governance structure therefore; they obtain improved acknowledgment from the

debt market. Companies with larger ratio of government shareholding are view as

low risky by the debt supplier and in the event of financial crises, they normally

have state bail out and therefore they will continue to get more external

recognition from debt supplier.

31
According to Hafeez (2017), strong relationship of CG practices with financial

leverage of listed companies in Egypt from 2007-2016 using sample of 50 listed

companies in EGX 100. Experimental outcomes show that there is significant

association between different internal and external corporate governance practices

with firm leverage in Egyptian companies. The internal CG attributes are

characterized by the board size, institutional investors, concentration of ownership

and government ownership, while external CG variable external auditor.

CG internal and external attributes have significant association with short term

and long term finance before investigating the Hausman test. On the other hand,

after investigating the Hausman test, the finding showed that only internal

corporate governance attributes have significant association with short term and

long term debt funding. The internal attribute such as board size has statistically

significant relationship with total liabilities financing whereas it is expelled from

Hausman test. According to Hussainey and Al-Najjar (2011b), corporate

governance internal attribute show that only institutional shareholders have

statistically significant association with leverage companies in UAE.

According to Sheikh and Wang (2012), significant association of board size,

managerial ownership and independent directors with financial leverage. Thus,

compare to this study. In the context of Egypt, we conclude that leverage

decisions obtained through internal and external both mechanisms of corporate

governance. We also conclude that each country has different corporate

governance frameworks with another country so that the legal, social and

32
economic circumstances of every nation play a vital role in establishing the

impact of difference CG practices on leverage decisions from country to country.

2.5. Corporate Governance Variables

2.5.1. Managerial Ownership

Managerial owners could give perquisite to use the optimal level of debt.

According to Abor (2008) if managerial owners consume low debt as compared to

ideal level in the firm financial leverage then managerial owners will bear wealth

losses, just like other shareholder. The result of various studies found that high

debt policy adopted by large part of executive shareholders, for instant the study

of Kim and Sorensen (1986) discovered that high leverage is cause by high

managerial shareholding. The research of Wellalage and Locke (2012) found

significant positive influence of managerial owners on long term debt in Ghana.

According to Sheikh and Wang (2012), disagreement of interest between

principals and agent create agency problems because agents have a tendency to

use more perquisites than optimal level, and use assets at blow the cost of capital

or wasting it on business incompetency. Although managers obtain complete

benefits of these actions but bear less than their share of full costs. So by

increasing the ratio of managerial shareholding in the company may be decreased

agency costs of equity. The findings show negative association between

managerial ownership and long term debt for the period from 2002 to 2008 of

non-financial Pakistani companies list at KSE. According to Naseem et al.,

(2017), there is positive association of managerial shareholding with CS in

Pakistan.

33
2.5.2. Institutional Ownership

The importance of institutional shareholders increases considerably in the capital

market. According to Gregoriou (2012), institutional shareholders have different

benefits as compared to a shareholder and banks. Firstly, due to high trading

volume, diversification can be made. It is a strategy that reduces the risk and to

augment the portfolio through different type of resources. Secondly, securities of

assets and liabilities match by banks. As a result, there is limited investment

facility. Finally, institutions can have better access to knowledge and there is

asymmetry information.

The study of Michaely and Vincent (2012) conclude that “firms in which

institutions have a strong presence tend toward low leverage, and firms in which

institutions strengthen their presence are associated with lower leverage”.

The study found negative association between percentages of institutional

shareholder firm financial leverage. In financial markets institutional shareholders

play vital role and the influence of institutional owners on corporate governance

have been highlighted as a result in emerging countries has been adopted

privatization policy. According to Chidambaran and John (2010), Institutional

owners can reduce agency cost because they have great experience in gathering

and interpreting information regarding firms’ performance. While, empirical studies

get diverse conclusion.

According to Al-Najjar and Taylor (2008), strong opposite association of

institutional shareholding with debt ratio which demonstrates that agency

problems can be decreased because institutional investors have significant

impacts on supervising the company’s managers. According to Hussainey and

34
Aljifri (2012), negative association of institutional owners with financial leverage.

The result indicates firms having large fraction of institutional shareholders are

seems to utilize low level of debt financing, pecking order theory support this

argument.

On the other hand, Abdoli et, al., (2012) in Tehran find positive connection of

percentage of institutional investors with capital structure due to easily access of

institutional investors of different sources of investment. Other researches made

by Bodaghi and Ahmadpour (2010) in Iran, find no significant relation of

institutional investors with CS.

According to Hassan and Butt (2009), in Pakistani context found that the

existence of institutional shareholders in firm facilitates to increase long term

investment at a cost-effective basis. Firstly these institutional shareholders

themselves take action as a source of long term liability because institutional

investors are agreeable to supply debt to a firm more than whose board they enjoy

an influence. Next in the firm’s strategic decisions these institutional shareholders

provide as an effective monitoring tool. Institutional owners get firm’s agency

cost and decrease the managerial opportunism. This provides self-confidence to

the general public and lenders-resulting in favorable terms of borrowing by the

firm. Thus it is postulated that companies with high institutional investment are

probably to have high CS. Institutional shareholder has positive association with

CS which is consistent with CG viewpoint however this relation is not significant.

This may be due to the fact that in Pakistan CG practices are still in an early stage.

2.5.3. Foreign Ownership

35
The effect of foreign investors on organization activities is rising due to

increasing foreign investment inflow in growing markets, (Vol, 2011); other than,

small amount of studies available on the subject of association between foreign

investors and CS.

Mostly study regarding foreign investment and debt indicates negative

relationship excluding the researches of Zou & Xiao (2006) and Gurunlu &

Gursoy (2010). They assume the impact of foreign ownership on financial

leverage is positive; nonetheless, results of the research show opposite to the

prediction, like negative relationship of foreign investors with CS. In emerging

markets foreign owners typically face more severe asymmetry information as

compare to other financiers.

Furthermore, the fraction of foreign shareholding in each company is normally

low due to diversification of portfolio. Thus, foreign owners have not sufficient

powers to monitor management. Therefore, they have a tendency to force

companies to utilize further debt as a more monitoring tool of management.

Nevertheless, examining the financing behavior of Chinese publicly listed firms

for the period of 1997-2000, do not discover the significant effect of foreign

investors with leverage. According to Gurunlu and Gursoy (2010), as compared to

local investors, foreign shareholders generally bear more risks such as country

risk, current risk and company risk. Hence, foreign shareholders are motivated to

reduce their risk by influencing operations of the organizations they have invested

in through bringing not only their capital but also technology and the capability to

access new capital market.

36
Therefore, companies having more foreign owners can make use of more liability

for the reason that foreign owners facilitate them to cheaper debt and more access

from new creditors. However, the study of Gurunlu and Gursoy (2010) discovered

significantly negatively association of foreign ownership is with long-term

leverage. The study explains this outcome with reasoning to the requirement for

debt finance of companies with high foreign ownership declines because of

contribution of investment from foreign owners.

2.5.4. Moderating Effect of Board Governance on the Relationship between

Ownership Structure and Capital Structure

The association between OS and CS is actually explained by board governance,

the moderating variable in the relationship between ownership structure and CS.

This would establish a link by moderating OS between, so indicating a

relationship that otherwise would not be visible. According to Modigliani and

Miller (1958), the association between OS and CS cannot be assumed, but the

relationship is moderated and it is formalized through a basic sequence between

variables in economic sense. In other word, to observe the direct association of

CS with ownership structure is not possible, but in reality, the worth of the

company associated with the impact of CG on CS. Through CG dimension under

control, actual correlation between leverage and ownership structure could be

observed using an economic model (Corbetta, 1992).

The company’s governance forms by independent directors through in internal

governing method (Brown, et al., 2011). According to Cadbury Report (1992), an

efficient board appointed by the shareholders will direct and control all the public

firms. The board supervises and directs the management (Aguilera et al., 2011),

37
formulates strategic decisions for company, gives leadership to the firm and

presents managerial responsibilities through management actions.

According to Ponnu (2008), “the independent board of directors is non-executive

directors through honesty, reliability, skill and freedom to equilibrium the benefits

of various stakeholders”. The inclusion of independent directors in the board is to

take freedom in board decisions and make sure to safeguard the benefits of firm

and minority shareholders.

Agency theory states that agency problem can be decrease with the existence of

independent directors by examining the administration and making sure that the

benefit of shareholders is safeguarded and also facilitate to decrease opportunistic

behavior of administration in that way increasing the company performance

(Jensen & Meckling, 1976).

Furthermore, the effects of independent directors and ownership have not been

completely investigated. The impact of ownership and independent board on

leverage may not be fully explored without the observation of moderating effect.

Therefore investigating with moderating effect of independent directors on the

association of OS with CS, the research expects to fill up this gap. Furthermore,

previous studies inspecting only direct effect of OS and independent directors on

CS. On the other hand, the study of Hsu, Wang and Hsu (2012) indicates specific

moderating role of independent directors on the association between OS and CS

has not been experienced.

Furthermore, conclusion of earlier studies is mixed and demonstrating that further

research is required to examine the indirect effect of independent directors lying

38
on the association of OS with CS. Thus, this study observes moderating effect of

independent directors on the relationship between OS and capital structure.

Finally in a dynamic environment the moderating influence of independent

director is likely to make stronger the association between OS and CS. We argue

that a dynamic model enhanced the impact of leverage on this association of OS

with independent directors.

Businesses around the world need growth and development in an attempt to gain

investments. Before making an investment in a business, the shareholders often

confirm that the business is financially stable and secure in order to generate long-

term profits (Manaseer et al., 2012; Khan et al., 2011). More recently, with the

crash of main corporations such as Enron, Arthur Anderson, World Com,

Commerce Bank, Harris Scarfe, HIH in Europe, United State and other nations,

the importance of corporate governance has increased (Obiyo & Lenee, 2011). As

a result, corporate governance is most important researched topics use as a tool to

decrease the disagreement between principal and agent. Its main purpose is to

protect the investors from opportunistic activities and to make sure that

administration make use of effort to get investors and stakeholders’ interest.

Furthermore, the study explores the moderating impact of female director on the

association of OS with leverage. Earlier studies only examine the direct

correlation of OS with capital structure (Abdurrouf, 2011 ; Manaseer et al., 2012).

Al-Matari et al (2012) describes the association of CG with company performance

is depends on the level of a third variable.

39
Diversity of the board be explicate because the combination in the board of

directors’ composition. There are two types of diversity that is visible and non-

visible. The visible diversity consists of gender, age, race and ethnicity whereas

the non-visible diversity contains knowledge, education, values, perception and

features of personality (Kilduff & Mehra, 2000). Majority of diversity studies and

its impact upon performance concentrate on the demographic type of diversity.

The study of Kang et al., 2007 investigated the stage of diversity of Australian

firms by investigating the smaller amount of women directors’ background and

roles in detail. Furthermore, the conclusions regarding the association between

board structure and firm leverage are still unconvincing. Thus, this study pays

attentions on exploring the moderating role of board gender diversity on the

association between OS and CS. So, third variable strengthens the association of

OS with CS.

Additionally the study needs to observe the moderating role of board governance

(board independent, board gender diversity) on the relationship between OS and

CS and firm worth in Pakistan. On this topic a lot of research has been conducted

in advance countries, but in Pakistan and other developing economies smaller

attention has been given to investigate the said relationship.

2.6. Summary of Literature

The chapter summarizes the literature regarding moderating effect of board

governance on association of ownership structure with capital structure.

Ownership structure comprises of managerial shareholding, institutional

shareholders and foreign investors are independent characteristics whereas

dependent variable is CS. This segment also examines underpinning theories like

40
 TOT, POT, agency theory, stewardship theory and empirical results of earlier

studies on CG and CS. the main theory is agency theory which examines the

association of CG with CS. In this section we also discussed the empirical

literature pertaining to the association between independent and dependent

variables. Through previous literature various knowledge gaps of the study are

identified. Furthermore, the theoretical details of the study have been provided

regarding CG and CS but in this area empirical researches are rare. Moreover, in

previous literature mostly discussed direct relationship between CG and CS in

developing countries and smaller amount of studies available which discuss

indirect effect of board governance on the association between OS and CS. In

view of the suggestion of previous studies, the study anticipated that moderating

role of board governance can strengthen the association between OS and CS and

ultimately alleviate the disagreement of benefits between principal and agent.

CHAPTER 3
Research Methodology

3.0. Introduction

The section explains method utilized in accumulating and evaluating the data in this

study. This chapter is consisted of proposed methodology to follow the further study.

Research methodology is postulated as backbone of the research as it makes stronger the

base of the research. This chapter is separated into numerous parts in order to enhance the

41
transparency and readability. Section 3.1 is associated to research framework in which

theoretical and conceptual model of the study is discussed. In Section 3.2, hypotheses are

developed with theoretical and empirical evidences. Section 3.3 argues the measurement

of variables considered with brief justification. Section 3.4 contains sample and

population of study. Segment 3.5 gives the detail of operational model. Segment 3.7

briefly argues the definition of the variables.

3.1. Research Framework

The research framework looks for relationship of corporate governance attributes for

instance managerial shareholding, institutional shareholders and foreign investors with

capital structure. Independent variables are managerial shareholders, institutional

shareholders, foreign investors and capital structure is dependent variable. There is an

eminence discussion in academic literature to solve the agency issues. According to Core

et al. (1999), sound corporate governance can decrease shareholders and managers

conflict of interest. Scholars have considered board attributes and efficient ownership

structure as the dimensions of sound corporate governance. According to Sun and Cahan

(2009), that boards of directors play a vital role in aligning CG with CS decisions as well

connecting the interest of shareholder with managers. Thus, board governance (board

independent and board gender diversity) is explained as moderating variable of the study.

Independent Variables Dependent Variable

Ownership Structure
Capital Structure
Managerial Ownership

Institutional Ownership Debt to Equity Ratio

Foreign Ownership

42
 Moderating Variables Control Variables
Governance Board Board Size

Board Independent Firm Size

Board Gender Diversity Return on Equity (ROE)

Audit Quality

Board Meeting

3.2. Hypothesis of the Study

3.2.1. Managerial Ownership

“Managerial ownership includes the shares owned by CEO, directors, their spouse

and children”. Managers are probable less to use further perquisites or investing

business assets below cost of capital in case they have shares in company. Agency

problems alleviate through managerial shareholding as of alignment of benefits

between principal and agent (Jensen & Meckling, 1976).

In literature, on this phenomenon there are diverse empirical evidences found.

There is no significant association between CEO and managerial ownership and

debt ratio (Wiwattanakantang, 1999). On the other hand, negative correlation

between CEO holdings with leverage (Fosberg, 2004). The study argued that

CEO will have a preference his private benefits instead of shareholders interest.

According to Bokpin and Arco (2009), significant positive influence of

managerial shareholders with capital structure in Ghanaian listed companies.

Thus, we hypothesize that:

43
H1: A positive association between managerial shareholding and debt to equity
ratio.

3.2.2. Institutional Shareholders

Institutional owners provide facility to increase long term finance at profitable

rate in a firm. Firstly, institutional shareholders are ready to give loan to a firm as

than whose board they enjoy an influence because these institutional shareholders

themselves act as a source of long term liability. Secondly, in firm strategic

decisions, institutional shareholders provide an effective monitoring role.

Institutional shareholders decrease managerial opportunism and also reduce firm’s

agency costs. This provides confidence to the lenders resulting favorable

conditions of taking loan by the company and the general public. Thus, it is

hypothesized that:

H2: Companies having high institutional shareholders are more likely to have a

high leverage.

3.2.3. Foreign Ownership

Although typically research sustaining opposite impact of foreign investors on

leverage. The negative association of foreign ownership with all measures of

leverage (Li et al., 2009) . They explained that higher foreign ownership in firms

would contain more varied finance channels to access funds as compare to others

due to their repute and relationship. Similar results found by Huang et al. (2011)

in Chinese firms.

44
According to Al-Najjar and Taylor (2008), foreign investors have ability to better

access the information, and have better capability of understanding the

information on firm performance. As a result, manager’s overinvestment problem

and agency cost between principal and agent controlled by foreign owners.

Thus, foreign investment and leverage may provide as alternates in controlling

managerial self benefits (Moon, 2001). Therefore, it is broadly decided that

companies having large foreign investment have tendency to employ low debt.

H3 Companies with high foreign ownership are probable to have lower leverage.

3.2.4. Board Independent

Studies also discovered that large no. of independent directors can facilitate in

decreasing agency conflicts. Through this argument, Bebchuk, et al. (2002) argue

about independent directors have more power to restrict the CEOs from rent-

seeking. The current research of Buigut et al. (2015) on UK public limited firms,

founds significant association of decrease in CEO overcompensation with ratio of

independent directors. Furthermore, independent directors efficiently and

effectively observe the opportunistic behavior of managers and associate their

remuneration efficiently with their performance (Chee-Wooi & Chwee-Ming,

2010; van Essen et al., 2015).

From agency theory, this study suggests that independent directors can restrict

managers as well as majority shareholders from rent extraction. These directors

reduce the self-interested behavior of different shareholders and managers to align

their interest with that of firm. Thus, it believed that independent non-executive

directors can influence managers, institutional investors and foreign investors to

45
maintain on optimal level of capital structure. Owing to lack of this evidence

especially in the perspective of Pakistan, following hypotheses are developed to

fill information gap in scholar’s literature:

H4: Board independent significantly moderates the association between

ownership structure and capital structure.

H4a: Board independent significantly moderates the association between

managerial ownership and capital structure.

H4b: Board independent significantly moderates the association between

institutional ownership and capital structure.

H4c: Board independent significantly moderates the association between foreign

ownership and capital structure.

3.2.5. Board Gender Diversity

A diverse board has the people of different environment and different

information, know-how, expertise and is probably to make better involvement in

decision making procedure and monitoring role, consequently which would

encompass large impact on firm financial decision as well as firm performance.

Our argument in favor of the moderating effect of board diversity provides

support to agency theory and it is based on cost-effective basis. Theoretically,

healthy varied governance structures will make sure better safeguard shareholders

interest through efficient and effective monitoring CEO behavior and other

executives through the people of diverse environment and skills. In this

viewpoint, impact of female directorship through better monitoring role of female

director will cause companies to be economically wealthy guiding to larger

46
 productivity and thus generate worth to the investors. This proposed to facilitate

the influence of board gender diversity will positively strengthen the connection

between governance structure and firm financial decisions. Therefore, the

following hypothesis is established to test moderating effect of board gender

diversity:

H5: Board gender diversity significantly moderates the association between

ownership structure and capital structure.

H5a: Board gender diversity significantly moderates the association between

managerial ownership and capital structure.

H5b: Board gender diversity significantly moderates the association between

institutional ownership and capital structure.

H5c: Board gender diversity significantly moderates the association between

foreign ownership and capital structure.

3.3. Measurement of Variables

The study makes use of accounting measures in measuring leverage. Following

variables are measures some prior studies as shown in the table below.

Variable Measurement Sources of measurement

Dependent Variable

Capital structure Total Debt to Total Equity (Nyakundi, 2014)

Independent Variables

Managerial Proportion of equity owned by Hasan & Butt (2009);

Ownership managers Naseem et al. (2017)
Institutional Proportion of equity owned by (Blume & Keim, 2012)
Ownership institutional ownership
[

Foreign Ownership Proportion of equity owned by Sueyoshi et al. (2010);

foreign ownership (Bircan, 2011)
47
Moderating Variables
Board Independence Ratio of independent directors on Sanda et al., (2010);
the board Sheikh & Wang (2012);

Board Gender Ratio of women directors on the Ekadah & Mboya (2012);
Diversity board Alabede (2016)
Control Variables
Firm Size Natural log of total assets Sheikh & Wang (2012);
Hasan & Butt (2009)
Board size Total members of board Shukeri (2012);
Garba &Abubakar (2014):
Return on Equity Total income divided by
(ROE) shareholders equity
Audit Quality Dummy variable 1 used if audit Al-Matari (2017)
from 4 larger firms and 0 used for
other.
Board Meeting Frequency of board meetings Bashir & Asad (2018)

3.4. Sampling

According to Sekaran (1992), an important part of good research is that a cautious

collection of data for analysis. The whole population should be considered in the study

when the population is small (Hair, 2007) On the other hand, for large population, small

sample would be sufficient if carefully select which represents population (Hair, 2007).

This study will collect data from secondary resources like annual reports of firms. Data

obtained from the annual reports were statement of profit and loss account, balance sheet,

cash flow statement and a statement of change in owner’s equity, ownership structure

include managerial shareholding, institutional shareholders, foreign investors,

information about board governance. The data of sixty top performing non-financial

firms will be collected from 2014-2018 in order to fulfill the aims of the study.

3.5. Statistical Test

48
The statistical models of the study are Pooled OLS (Ordinary Least Square), Random and

Fixed Effect Models. To eradicate the problem of Autocorrelation and Heteroscedasticity

in panel data, this study also utilized PSCEs to attain definite results.

3.6. Operational Model

CS = β0+β1MANG+β2INST+β3FOR+β4BIND+β5BGD+β6MANGBIND+β7INSTBIND+

β8FORBIND+β9MANGBGD+β10INSTBGD+β11FORBGD+β12FSIZE+β13BSIZE+β14ROE

+β15AQ+ β16BM+ε

Whereas

CS = Capital Structure

MANG = Managerial Ownership

INST = Institutional Ownership

FOR = Foreign Ownership

BIND = Board Independence

BGD = Board Gender Diversity

MANGBIND = Interaction of Managerial ownership with Board

Independent

INSTBIND = Interaction of Institutional ownership wit Board

Independent

FORBIND = Interaction of Foreign ownership with Board Independent

MANGBGD = Interaction of Managerial ownership with Board Gender

Diversity

INSTBGD = Interaction of Institutional ownership with Board Gender

Diversity

FORBGD = Interaction of Foreign ownership with Board Gender

Diversity

49
BSIZE = Board Size

FSIZE = Firm Size

ROE = Return on Equity

AQ = Audit Quality

BM = Board Meeting

3.7. Operational Definitions

3.7.1. Capital Structure

“Capital Structure means modes of company financing through its assets or

resources with the mixture of equity and debt. Therefore, capital structure can be

used to show the Total Debt to Total Equity”.

3.7.2. Managerial Ownership

“Managerial ownership includes the shares owned by CEO, directors, their

spouses and children” (Akram et al., 2017). However, proportion of equity owned

by managers can be used to indicate managerial ownership.

3.7.3. Institutional Ownership

“Percentage of equity owned by institutional investors can be used to show

institutional ownership” (Blume & Keim, 2012).

3.7.4. Foreign Ownership

“Percentage of equity owned by foreign investors can be used to indicate foreign

ownership” (Bircan, 2011).

3.7.5. Board Independent

50
“Independent board included majority of external non-executive directors have no

or minimum stakes in the corporation and they have no association with top

executive directors of the corporations”. Therefore, independent board showed as

proportion of independent directors in the board ( Hermalin & Weisbach, 2001).

3.7.6. Board Gender Diversity

According to Ekadah and Mboya (2012) “board gender diversity refers to

existence of women directors in the boards”. It is also defines that “Board gender

diversity as a value-driver in organizational strategy and corporate governance in

modern companies” (Marinova, Plantenga, & Remery, 2010).

3.7.7. Firm Size

Firm Size can be determined in term on its assets resources, sales or number of

employees. However, this study have selected nature log of assets to show the

firm size.

3.7.8. Board Size

“Board size is the total number of directors on a board” (Levrau & Van den

Berghe, 2007).

3.7.9. Return on Equity

“Return on equity can be defined as Total income divided by shareholders

equity”.

Formula: ROE = Total Income / Shareholders’ Equity

3.7.10. Audit Quality

“Audit quality is referring to the level of assurance provided by an audit, and is

inversely related to audit failures, being thus defined as the probability that

51
financial statements contain no material misstatements”(Titman & Trueman,

1986)

3.7.11. Board Meetings

“A board meeting is a formal periodic gathering of a Board of Directors. Board

meetings lead managers to work in line with the interests of shareholders, since

more meetings can be seen as active to maximize firm’s value and shareholders

wealth” (Conger et al., 1998).

CHAPTER 4
Data Analysis and Findings

52
4.0. Introduction
This chapter is separated into various components. Section 4.1 describes the descriptive

statistics. Section 4.2 explains the Regression Analysis of the study.

4.1. Descriptive Statistics

The descriptive statistics has been exemplified in The table indicates the highest

scores, lowest scores, average mean values and standard deviation values of

dependent, independent, moderating and control variables from 2014-2018. The

data regarding the total 300 observations of each variable are obtained from the

listed companies in Karachi Stock Exchange intended for five year.

Table 4.1

Variable N Mean Std. Dev. Min Max

LEVERAGE 300 1.364 2.011 -6.562 16.034
MANG 300 0.281 2.889 0 50
INST 300 0.172 0.215 0 0.99
FOR 300 0.106 0.201 0 0.97
BIND 300 0.773 1.186 0 8
BGD 300 0.54 0.827 0 3
BSIZE 300 8.49 1.736 6 15
LnFSIZE 300 17.763 2.019 14.804 24.68
ROE 300 0.171 0.248 -1.398 1.791
AQ 300 0.83 0.376 0 1
BM 300 5.47 1.624 2 13

The mean score of leverage is 1.36 with the lowest score of -6.56 and highest

score is 16.03 which indicate that non-financial firms in Pakistan Stock Exchange

(PSX) use more debt. High debt ratio leads to high risk and instability in incomes

due to high interest payments. The study has discussed three kinds of ownership

such as managerial ownership, institutional ownership and foreign ownership.

53
The minimum value of managerial ownership is 0 and maximum value is 50 and

average is value 0.281. The mean of institutional shareholder is 0.172 percent

with a lowest score 0 and highest score 99%. It means institutional ownership is

the largest ownership in PSX. Foreign Ownership range from 0 to 0.97% and non-

financial Pakistani companies have average value of 0.11 percent. Independent

directors are more or less missing in Pakistan before the implementation of

amended CG Code 2012. The importance of independent directors has been

materializing after the implementation of this Code of CG. However, some firms

still do not include independent director on the board because the range from 0 to

8 percent with the average mean is 0.77 percent. The average score of Board

Gender Diversity is 54% with a minimum score is zero and maximum score is 3.

This indicates that non-financial firms in PSX have low female directors on the

board.

The firm size was measured by natural log of assets. The mean score of firm size

is 17.76 percent with a lowest and highest score is 14.80% and 24.68%

respectively. Board size shows the number independent directors in the board.

The average indicates 9 number of directors on the board with smallest score 0

and greatest score 15 and value of standard deviation 1.79 of non financial

Pakistani companies listed in KSE.

The average value of ROE is 0.18 percent having lowest point -1.40 percent and

highest point 1.79%. The average value of Audit Quality is 83%. Smallest score is

0 and largest score is 1. This result shows that mostly listed firms in PSX

54
 conducted their audit through top audited firms. The mean value of board meeting

is 5.47 percent with lowest score 2 and highest score is 13.

4.2. Regression Analysis

4.2.1. Ordinary Least Square Regression Model

Table 4.2

LEVERAGE Coef. P-Value

MANG -0.013 0.03
INST -0.163 0.78
FOR -0.256 0.67
BIND -0.065 0.57
BGD -0.010 0.00
MANGBIND 0.399 0.7
INSTBIND 0.256 0.05
FORBIND 0.239 0.3
MANGBGD 6.435 0.02
INSTBGD 0.078 0.64
FORBGD 0.05 0.73
BSIZE 0.16 0.02
FSIZE -0.000 0.04
ROE -0.015 0.00
AQ 0.468 0.14
BM 0.125 0.09

R-squared=0.1567 Adj R-squared=0.109 Prob>F = 0

The tables 4.2 indicate the results Ordinary Least Square (OLS). According to the

results of OLS Regression Model, value of R-square is 0.16. It shows that 16% of

deviation in FLEV is explicated through the independent or explanatory variables

under the postulation of OLS Model.

The result shows that Managerial Ownership is statistically significant and

negatively associated with financial leverage (β=-0.0134, P=0.03). The

55
association of Institutional Ownership with FLEV is insignificant. The Coefficient

of Foreign Ownership is insignificant (β=-0.256, p=0.67).

In case of board independent the association between board independent and

FLEV is statistically not significant (β=-0.065, P=0.57). The Coefficient of Board

Gender Diversity is negatively associated with leverage but significant (β=-0.010,

P=0.000).

MANGBIND is the interaction of managerial ownership with independent

directors. The coefficient is positively associated with FLEV but statistically

insignificant (β=0.399, p=0.7). INSTBIND indicate the interaction of institutional

investors with independent directors. The beta coefficient is positively related

with FLEV and significant (β=0.239, p=0.3). FORBIND is the interaction of

foreign investors with independent directors. The positive association of beta

coefficient with LEV but insignificant.

In the case of interaction between MANGBGD, there is negative association of

coefficient with FLEV and statistically significant. While in the case of

INSTBGD and FORBGD, positive association with FLEV.

Furthermore, in case of Control variables Coefficient of Board Size have

positively associated with FLEV and statistically significant (β=0.16, p=0.02).

Coefficient of Firm Size and ROE is negatively related to FLEV and significant.

The coefficient of Audit Quality is positively associated with FLEV but not

significant (β=0.468, p=0.14) while Board Meeting is positively associated with

FLEV and statistically significant β=0.125, p=0.09).

56
 4.2.2. Random Effect Model

Table 4.3

LEVERAGE Coef. P-Value

MANG -0.328 0.63
INST -0.836 0.14
FOR -0.373 0.58
BIND -0.157 0.36
BGD -0.281 0.36
MANGBIND 0.325 0.86
INSTBIND 0.195 0.15
FORBIND 0.216 0.3
MANGBGD -0.019 0.51
INSTBGD -0.144 0.36
FORBGD -0.151 0.29
BSIZE 0.103 0.29
FSIZE -0.000 0.27
ROE -0.011 0.01
AQ 0.415 0.33
BM 0.058 0.41

R-sq: within = 0.0949 between = 0.0431 overall = 0.0787

The table 4.3 presents the outcomes of random effect model. The overall value of

R-square is 0.08 which shows that 8% variation in dependent variable (Leverage)

has been explicated through the variation in independent or explanatory variables

and rest of the 92% disparity in dependent variable (Leverage) due to other

factors.

The results show that mostly variables have negative association with financial

leverage. It is found that independent variables like Managerial Ownership,

Institutional Ownership, and Foreign Ownership negatively associated with

financial leverage (β=-0.328, p=0.63 β=-0.836, p=0.14 β=-0.373, p=0.58). In

case of board independent the coefficient of board independent is negatively

57
related to financial leverage (β=-0.157, p=0.36). The coefficient of board gender

diversity is statistically not significant and have negatively associated with

leverage β=-0.281, p=0.36).

In case of interaction between MANGBIND, INSTBIND and FORBIND the

coefficient of these variables are positively correlated with leverage and

insignificant (β=0.325, p=0.86, β=0.195, p=0.15, β=0.216, p=0.3). Coefficient of

MANGBGD, INSTBGD AND FORBGD are negatively related with leverage and

statistically not significant respectively (β= -0.019, p=0.51, β= -.0144, p=0.36, β=

-0.151, p=0.29). However, coefficient of board size have positively associated

with leverage but statistically insignificant (β=0.103, p=0.29). The association

between Firm Size and leverage is insignificant (β=0.000, p=0.27). The

coefficient of ROE is negatively associated with leverage but significant (β= -

0.011, p=0.01). The coefficient of Audit Quality and Board Meeting is positively

associated with leverage and statistically insignificant respectively (β=0.415,

p=0.33 β=0.544, p=0.58).

Breusch and Pagan Lagrangian multiplier test for random effects is used to

compare the OLS and Random Effect Model. Random Effect Model is better than

Pooled OLS Model because the Prob > chibar2 = 0.0000.

58
 4.2.3. Fixed Effect Model

Table 4.4

LEVERAGE Coef. P-Value

MANG 0.365 0.733
INST -0.013 0.054
FOR -0.173 0.828
BIND -0.23 0.475
BGD 0.238 0.548
MANGBIND 0.974 0.815
INSTBIND 0.184 0.238
FORBIND 0.288 0.227
MANGBGD 0.551 0.877
INSTBGD -0.246 0.172
FORBGD -0.197 0.218
BSIZE 0.027 0.846
FSIZE 0.000 0.774
ROE -0.011 0.024
AQ 0.371 0.542
BM 0.032 0.699
Prob > F = 0.0489

The table 4.4 shows the outcomes of fixed effect model of regression analysis.

According to the results of this model positive association between Managerial

shareholding and FLEV but insignificant (β=0.365, p=0.733). Institutional

Ownership negatively correlated with FLEV and its coefficient is statistically

significant (β=-0.013, p=0.05).

The association of foreign ownership with LEV is insignificant (-0.173, p=0.828).

The association between board independent and LEV is negatively insignificant

(β=-0.23, p=0.475). The coefficient of Board Gender Diversity is positively

associated with FLEV but statistically not significant (β= 0.238, p=0.548).

In the case of interaction between MANGBIND, INSTBIND AND FORBIND,

coefficient of these variables are positively associated with FLEV and statistically

59
insignificant (β=0.974, p=0.815 β=0.184, p=0.238 β=0.288, p=0.277). The

coefficient of MANGBGD is positively associated with FLEV and insignificant

(β=0.551, p=0.877). The relationship of INSTBGD and FORBGD with FLEV is

insignificant (β=-0.246, p=0.172 β=-0.197, p=0.218).

For Control Variables, the coefficient of board size is positively correlated with

FLEV but insignificant (β=0.027, p=0.846). The association of firm size with

FLEV is insignificant (β=0.000, p=0.774). The coefficient of ROE is negatively

associated with leverage but statistically significant (β= -0.011, p=0.02). Audit

Quality and Board Meeting is positively correlated with FLEV and insignificant

respectively (β=0.371, p=0.542 0.032, p=0.699).

Hausman test is evaluated to choose between Random Effect and Fixed Effect

models which model is better for analysis purpose either random effect model or

fixed effect model. Fixed effect model is better than random effect model because

the probability of fixed effect model is less than 0.05.

There is an issue of autocorrelation in the data, p-value < 0.05. Therefore to

eliminate the issue of autocorrelation Wooldridge test has been used to evaluate

the autocorrelation in the results. There is an issue of heteroskedasticity in the

data. Therefore to use the Linear Regression, correlated panels corrected standard

errors (PCSEs) to remove the problem of heteroskedasticity in the fixed effect

regression model.

60
 4.2.4. Linear Regress, correlated panels corrected standard errors (PCSEs).

Table 4.5

LEVERAGE Coef. P-Value

MANG -1.345 0
INST -0.175 0.74
FOR -0.193 0.779
BIND -0.074 0.263
BGD -0.991 0.000
MANGBIND 0.209 0.517
INSTBIND 0.242 0.005
FORBIND 0.226 0.116
MANGBGD -6.231 0.000
INSTBGD 0.072 0.595
FORBGD 0.052 0.78
BSIZE 0.185 0.012
LnSIZE -0.065 0.007
ROE -1.478 0.002
AQ 0.414 0.005
BM 0.135 0.162
R-squared = 0.1477 Prob > chi2 = 0.0000

Table 4.5 shows the result of Linear Regression, correlated panels corrected

standard errors (PCSEs). The model is used to solve the issue of autocorrelation in

a data. According to table 4.5 the value of R-squared is 0.1477. It signifies that

independent or explanatory variables have 0.15% capability to explicate deviation

of the dependent variable and the remaining 85% is influenced by other elements

or factors which are not discussed in this research. Thus, the outcomes of this

model indicate that the corporate governance attributes explicates 15% variation

in FLEV of companies listed in PSX. The finding indicates that the measures of

61
corporate governance are insignificantly effect the decisions of CS of listed firm

in PSX.

The results of the study pin point that coefficient of managerial ownership is

negatively associated with FLEV but statistically significant (β= -1.345, p=0.000).

The result of the study follows the agency theory proposing that the alignment of

interest between managers and shareholders eliminated due to augmentation of

managerial shareholding in a firm and to mitigate the agency conflicts by

decreases the role of debt as an instrument. In addition to this, the results show

that higher leverage is smaller amount of attractiveness to managers as it forced

high risk to managers as compare to public investors. The study of Fosberg (2004)

consistent with the finding of negative association of managerial shareholding

with FLEV.

The institutional ownership and foreign ownership are negatively and

insignificant associated with FLEV. The outcome of the study indicate that the

association of independent directors are negatively with FLEV is insignificant

(β=-0.074, p=0.26). The results advocate that the ratio of independent directors on

the board is low in non-financial Pakistani firm listed in PSX. The outcome

proposes that board with low independent directors cannot examine the board

actively. Furthermore, the findings of the study show that due to low ratio of

independent directors in the board, firm cannot take more loans from the financial

institutions. Furthermore, the conclusion of the study show that low existence of

independent directors on the board decrease the firm creditability which make

62
possible for the company to borrow more loan on positive terms and conditions to

gain the tax shield advantage.

The results demonstrate that coefficient of board gender diversity is negatively

associated with FLEV, however significant and strong (β=-0.991, p=0.000). The

finding shows that female director leads to less debt financing and focus on firm

internal financing. Moreover, the ratio of female directors is less in non-financial

firms list in PSX.

Moderating Effect of Board Independent

The MANGBIND indicates the interaction between managerial ownership and

board independent. The moderating influence of board independent between

managerial shareholding and FLEV is positive (β= 0.209, p=0.517). The results

indicate that due to limited number of independent directors the association

between managerial shareholding and FLEV is not effective. Generally, the

findings proposed that there should be need to increase the appearance and

contribution of independent directors in the firms listed in PSX. Thus the conflict

of interest between managers and shareholders can be aligning by increasing the

number of independent directors on the board.

The INSTBIND indicates the interaction of institutional investor with board

independent. The results of this moderating effect is positive and significant (β=

0.242, p=0.005) which explain that institutional shareholders force the managerial

shareholders and foreign investors to take more loan. The FORBIND shows the

interaction of foreign ownership with board independent. The outcome of the

63
study explains that the moderating effect of board independent is positive and

insignificant (β=0.226, p=0.116).

Moderating Effect of Board Gender Diversity

The MANGBGD is the interaction of managerial shareholding with board gender

diversity. The moderating effect of BGD is negative and significant association

between managerial ownership and leverage (β=-6.231, p=0.000). It means

female directors concentrate on firm internal source of financing than debt

financing and considerable control on leverage.

In the case of INSTBGD and FORBGD positive and insignificant moderating role

of BGD on the relationship of institutional ownership with FLEV and foreign

ownership with FLEV respectively (β=0.072, p=0.595, β=0.052, p=0.78). The

results indicate that owing to limited number of female directors on the board the

relationship between institutional shareholders and FLEV as well as the

association between foreign investors and FLEV is ineffective. In general, the

finding suggested that there should be need to augment the presence and

contribution of female directors in the companies listed on PSX.

In case of control variables the result of board size shows that the coefficient is

positively associated with FLEV and statistically significant (β=0.185, p=0.01).

The findings explain that companies with large board size have high debt

financing. The study concluded that a large board size can examine the

administration in a better way and can take better decisions. This is similar with

the result of Adam and Mehran (2003). Firm Size measured by natural log of

64
assets. The coefficient of firm size is negatively associated with FLEV and

statistically significant (β= -0.065, p=0.007). The result shows that larger firms

uses less debt financing as compare to smaller firms which utilize more debt

financing.

The coefficient of Return of Equity is negatively related with FLEV and

significant (β= -0.015, p=0.002). The results explain that the firms with high

profitability less depend on external financing like debt financing.

The coefficient of Audit Quality is positively associated with company financial

leverage and statistically significant (β=0.414, p=0.005). This result shows that

mostly listed firms in PSX conducted their audit through top four international

audited firms. The result indicates that firms have high FLEV when they employ

top four international audited firms (i.e., KPMG, Deloitte,

PricewaterhouseCoopers and Ernst & Young) for conducting audit as compare to

other firms which are not utilize the services of big four international audit firms.

The coefficient of Board Meeting is positively associated with FLEV (β=0.135,

p=0.162).

65
 CHAPTER 5
Conclusion

5.0. Introduction
This chapter is separated into numerous parts. Section 5.1 gives detail conclusion of the

study. Section 5.2 associated to the limitation of the study. Section 5.3 explicates the

future recommendations and lastly section 5.4 describes the policy implications of the

study.

5.1. Conclusion

The negative association of managerial shareholding with financial leverage (FLEV)

leads to low debt financing; however the association is significant. The negative

association of institutional shareholders and foreign investors with FLEV indicates that

companies with small proportion of institutional and foreign shareholders bears lower

debt level.

The negative relationship of independent directors with FLEV show that board with more

independent directors take less loan on positive conditions due to better control and

effective monitoring. The negative association of board gender diversity with FLEV

demonstrates that ratio of fewer women directors to more debt finance and the more

proportion of female executive guides to low debt financing.

The INSTBIND positively and significantly moderate. The results explain that

institutional shareholders put pressure on managerial and foreign shareholder to use more

debt finance to enhance firms worth and decrease the problem of free cash flow.

66
The MANGBGD is the interaction of managerial ownership with board gender diversity.

The moderating effect of BGD is negative and significant association between

managerial shareholding and FLEV. It means female directors concentrate on firm

internal source of financing than debt financing and considerable control on FLEV.

The positive moderating role of female directors on the relationship between institutional

and foreign investors indicate that owing to limited amount of female directors in the firm

lead to low debt finance and large percentage of women directors utilize more debt level.

The positive association of board size with FLEV explains that companies with large

board size have high debt financing than small firms. The negative association of

company size with FLEV shows that larger firms decrease debt financing as compare to

smaller firms which utilize more debt level. The negative association of Return on Equity

(ROE) with FLEV indicates that firm with high profitability lead to low debt level and

vice versa.

The positive correlation of Audit Quality (AQ) with FLEV shows that those firms which

are audited by four big international auditing companies lead to increase debt level as

compare to those firms which cannot conduct their audit by top four international

auditing firms. In Pakistan 83% companies which are listed in PSX conduct their audit by

big four international companies. The positive association of board meeting with FLEV

demonstrates that companies with large number of board meeting bear more debt level.

5.2. Limitation of the Study

This study attempted to present a logical and better observation of the moderating role of

board governance on the relationship between ownership structure financial leverage.

The restrictions of the study are:

67
  Sample size is small in this study.

 The research is restricted to non-financial companies in Pakistan. As a result, the

conclusion of the research may perhaps be generalized to companies like to those

that were included in this study.

 The present research employs just few corporate governance variables.

 The other limitation of this study is that endogeneity problem has not been

considered which can also affect our results.

5.3. Future Recommendations

The research present critical views on the current stage of this educational text and

recommend logical opinion to direct future study.

In the context of Pakistan, there is need to further research for getting in detail body of

knowledge regarding the CG attributes along with different other moderators.

In this study only few CG variables and incomplete ownership structure was discussed.

Further governance attributes such as CEO compensation, board remuneration, firm age,

board composition etc may be include in future studies.

The other OS like family ownership, state ownership, ownership concentration may be

included in future studies.

In addition to this, the research can be more investigated to other Asian economies to

disclose the applicability of existing model to other capital markets to other Asian

nations. Additionally, within the context of Pakistan sector-wise analysis is possible.

In this study only non-financial sector has been discussed. Financial sector is an essential

part of our country. This sector may be includes in future studies. SME is also the vital

68
for our country. In our research, SME could not be included in our study it should be

studied in future by the researchers.

In this study Pooled OLS model has been used to test the hypotheses. However, for cross-

sectional and time series observations panel data analysis may perhaps give more realistic

behavioral model. PCSEs model is used to overcome the autocorrelation and

heterosketaty issue. Therefore, in order to reduce the potential biases the prospect

research should examine the model of this study with wide range of panel data

techniques. To remove the endogeneity issue 2SLS and GMM model are used for future

study.

5.4. Policy Implications of the Study

There are numerous critical implications of the research particularly for policy makers,

theorist, academia, researchers and regulatory bodies. Thus, the study has separated into

two parts theoretical and practical implications.

Theoretical and practical implication of research is discussed in this section. It has been

recognized that the firms and shareholders both depending on the corporate governance

system.

Agency theory postulates that the association of shareholders with managers may be

subject to inefficiencies, due to discrepancy of interest, which guide to information

asymmetric. In this perspective, the stream of information is effected which in turn raises

the asymmetric information, and so, decreases disclosure and transparence practices.

Numerous earlier researches who examine agency problems typically used various

characteristics of CG like board ownership structure, board remuneration, characteristics

of audit committee to overcome these conflicts within organization.

69
Agency theory viewpoint, higher managerial shareholding can facilitate business to

reduce agency costs. From agency theory viewpoint, institutional investors give as a

peripheral corrective mechanism intended for management, reducing the requirement for

inner disciplinary mechanisms, for instance debt.

In the context of asymmetric information, institutional shareholders reduce information

asymmetry and decline adverse or incorrect selection of costs of equity. POT predicted

that the firms with higher proportion of independent directors have more rely on debt

finance than internal finance.

Moreover, Agency theory is support the board diversity. Addition of women director on

the board gets better the financial decisions of company. Accordingly, there is need to

entry of women on board, to access the investment and boost overall board independence.

Better forms of financing are available for a business as women are more likely to ask

questions as compared to male. Due to gender diversity, it is likely for companies to

perform better as compared to competitors and promotes better understanding of the

market.

Agency theory also supports the moderating influence of female directors and it is based

on economic cause. From theoretical viewpoint, sound diversified CG structures will

make sure better protection for shareholders interest through useful monitoring of the

behavior of the CEO and other decision makers by people of different background and

knowledge.

The SECP was designed and implemented amended Code of CG in 2012 in Pakistan to

build up the governance structures in firms for the improvement and accountability of

capital market. The corporate governance systems can be improved by revised Code of

CG equal to the standards of developed economies.

70
The evidence shows that in developing nations corporate structure, business culture and

legal systems are varies from developed nations and sudden improvement cannot be

made in capital market, but gradually alteration is compulsory in the corporate systems.

In addition to this, the results explain that for sound CG diversified OS is very important.

The agency conflict cannot align with a single and concentrated ownership. Thus it is

proposed that authorities should force the companies to contain well-diversified

ownership structures. The shareholders who are destroying the firm long term benefits for

getting short term benefits should be monitored carefully.

Furthermore, the policy makers, managers, shareholders, practitioner, regulatory bodies

and general public gets understanding and awareness from this research concerning the

estimated result generate from the current corporate governance practices in Pakistani

capital market.

71
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