Integrating Effect of Corporate Governance, Corporate Diversification And Earnings Management on Firm Performance: Empirical Evidence from Pakistan

Abstract

This study examines the impact of corporate governance practices, capital management, corporate diversification and earnings management on firm performance in the financial sector of Pakistan. For the purpose, the study incorporates a sample of 91 listed Pakistani financial firms for the period from 2005 to 2015. Data of the variables was collected manually from annual reports of the listed financial institutions. Study in hand is incorporates seven elements of corporate governance to develop Corporate Governance Index (CGI). These seven elements include: board size, audit committee size, inside director, independent directors, non-executive directors, CEO’s duality and board of directors meetings. Specifically, research objectives are (i) to identify the impact of CGI on the financial performance of the firm (ii) to examine the effectiveness of corporate diversification on a firm’s performance (iii) to ascertain the effect of earnings management on a firm’s performance of financial sector (iv) to investigate the impact of capital management on a firm’s performance in the financial sector (v) to examine the impact of firm size on firm performance. Contributions of the study are first, corporate diversification with the combination of capital management, CGI and its impact on performance has never been studied earlier. In addition the selection of the financial sector for the investigation of corporate governance practices and diversification is another distinctive point of the study in hand. Considerable work is done in the manufacturing sector of Pakistan regarding corporate governance compliance but the financial sector is totally ignored. Financial sector as a whole has been ignored by researchers regarding corporate governance and corporate diversification whereas, post-global financial crisis the importance of financial institutions have emerged, and researchers have noticed the importance of this segment. Thirdly, this study has considered the impact of the Basel policies on firm performance and lastly the study investigated viii the role of global financial crisis in shaping the governance mechanism. To achieve the objectives Random effect and fixed effect have been applied for analysis but to avoid the problem of endogeneity, a dynamic generalized moment model (GMM) and diagnostic tests have also been used to obtain the results. Results show that when an organization has a strong corporate governance structure it leaves less room for directors and managers to apply manipulative earnings management techniques. It is seen that globally diversified firms have better investment opportunities compared to their counterparts; it sends a message among the investors that the firm is growing which helps the firm to flourish financially. Capital management shows a weak link with the firm’s performance as it bounds the financial firms to maintain a minimum reserve that restricts them from further investment. Corporate governance index has a significantly positive impact on performance therefore, policy makers should upgrade the standards and codes of governance. Regulatory authority should improve the level of compliance with strong legal enforcement. According to the findings of accruals, policy makers should focus on sound internal controls through rigorous audits because it decreases manipulation of earnings management and makes it transparent through periodic information disclosure.