CORPORATE GOVERNANCE AND FINANCIAL

PERFORMANCE OF THE FIRMS:

EVIDENCE FROM PAKISTAN’S FOOD & PERSONAL
CARE (FPC) AND CEMENT SECTORS
RESEARCH PAPER BY: MOHSIN PATEL
 INTRODUCTION:
CORPORATE GOVERNANCE
Corporate governance is defined as “the system by
which companies are directed and controlled”
(Cadbury Report, 1992).

After the high profile fraud cases like Adelphia, Enron, Parmalat and WorldCom were revealed

to this world; corporate governance became the focal point of researchers, with reports being

published by both academics and in practitioners alike. Some of the major reports were:

the Ramsay Report (2001), Sarbanes-Oxley (2002), Turnbull Committee (2003), Higgs (2003),

Bebchuk, Cohen and Ferrell (2009).

 INTRODUCTION:
CORPORATE GOVERNANCE
The topic of corporate governance is much more important for emerging
economies, like Pakistan. In this regard, SECP issued its first ever Code of
Corporate Governance in 2002.

Research Objective:
The study’s objective is examination the importance of governance in the corporate world
and its effect if shown on financial performance of companies, listed in food & personal
care and cement sectors of Pakistan. Our research will help the stakeholders of companies
to make informed decisions regarding structuring.
 LITERATURE REVIEW
The issue of governance is created mainly due to the fact that
large organizations like public limited companies, are operated
by people who usually are not the actual owners. This
separation leads to a conflict of interests among them (Lemmon
& Lins, 2003). Which is also referred to as ‘agency theory’
(Jensen and Meckling, 1976).
 LITERATURE REVIEW
Board Independence
Board seems to be independent when it has the presence of outside directors. The boards in
which there is participation of non-executive / outside directors improves its workability
(Ghosh, 2006). This will lead to better performance of the company (Adams & Mehran,
2003).

Managerial ownership and firm performance

According to Gul, Sajid, Razzaq and Afzal (2012), agency costs can be reduced by higher
director and institutional level ownership. Researches previously done in this area have
shown mixed results. Research by Morck, Shleifer, and Vishny (1988), executives who
have shares ownership from 0 to 5% will take decisions which will be of benefit to both the
parties. But as this shareholding increases from 5% and ranges between 5% and 25%, this
will lead to influencing their decisions; moving towards entrenchment. Similar results were
shown in the study done by Lasfer and Faccio (1999).
 METHODOLOGY
3.1 Research Approach
 
To conduct this study; quantitative research methodology will be used. This
methodology will help us uncover the relationship between ownership structure
of firm and its financial performance.
 
3.2 Research Sample
 
This study is conducted using two sectors of the industry namely; food and
personal care and cement sector. There are 14 active companies listed in the
cement sector and whose data is completely available. Similarly, there are 8
active companies listed in the food and personal care sector, whose required data
is completely available. The period for study is 2010 to 2015 i.e. 5 years.
 METHODOLOGY
3.3 Statistical Technique
 
E-views software package is used for conducting the tests. For testing the
correlation between the variables Pearson’s correlation is used to test the
hypothesis as both the variables.
 
3.4 Research Model
 
We will be using the following regression model for testing the relationship:
ROE it = αi + β1 (% IND)it +β2 (% of Director shares)it + β3 (% of Five largest
shareholders)it + μit
 METHODOLOGY
3.6 Dependent & Independent Variables defined:

Dependent variables used and its description:

ROE (Return on Equity) = Net Profit after tax / Stockholders Equity
 
Independent variables used and its description:
Insider Ownership = % of shares held by directors, CEO, their spouse and minor
children out of the outstanding shares
Percentage of Ind. Directors = Independent directors / Total number of directors on
the board
Ownership Concentration = % of shares owned by the largest 5 shareholders
 DATA ANALYSIS
4.1 Findings and Interpretation of the results
The following are the results of regression and their interpretation:
 
Table 4.1: Regression results:
The F-stats value is more than 4 and its probability is less than 0.10 so the overall
model is fit for the purpose. Negative significant relationship is shown between the %
of independent directors and firm performance depicted by ROE. This is significant
at 10% level of significance, showing probability value of 0.0021 which is less than
0.10. Its coefficient value is also –0.735 which presents an inverse relationship.
Similarly, the % of shares held by directors is also significant, at prob. value of less
than 0.10, having a p-value of 0.029. The coefficient value is –0.048 which presents a
negative relationship.
DATA ANALYSIS
 DATA ANALYSIS
Table 4.2: Applying Fixed Effect model:
Table 4.3: Applying Random Effect model:
 DATA ANALYSIS
Table 4.3: Applying Random Effect model:

The % of independent directors and the % of shares held by the directors are both
shown to be significant having p-value of less than 0.10.
Positive relationship is found between ROE and % of shares held by large
shareholders. However, it is not significant.

We have conducted Fixed effects and Random effects test. Now, we need to select
which of the above test is appropriate; so we use the Hausman’s test.
Table 4.4: HAUSMAN’S test:
 DATA ANALYSIS
Table 4.4: HAUSMAN’S test:

The null hypothesis is that Random effects model is more appropriate. The prob.
Value in the above results table shows 0.6631, which is more than 0.10, thus
suggesting that we fail to reject our null hypothesis. So we can conclude that random
effects model is appropriate for our analysis.
 CONCLUSION
From overall results, we can conclude that there is significant negative relationship between
firm’s performance and ownership of shares by directors, CEO & their spouse and minor
children; so if the directors’ ownership increases the performance of the companies goes down.
Some of our results are also consistent with previous studies like, Nishat and Mir (2004); Shah,
Butt and Saeed (2011). Similarly, there is a significant negative relationship found between
performance of companies and percentage of independent directors. which may be due to the
inability of the independent directors to perform efficiently and effectively in the cultural
environment of Pakistan. However, there is an insignificant relationship found between
performance and concentration i.e. % of shares held by the five largest shareholders. Thus, from
our study it seems that concentration of the share ownership in five largest shareholders does not
seem to show any significant impact on the dependent variable performance.
THANK YOU!