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Corporate governance and firm value: a comparative analysis of state and non-state owned companies in
the context of Pakistan
Kalim Ullah Bhat, Yan Chen, Khalil Jebran, Niaz Ahmed Bhutto,
Article information:
To cite this document:
Kalim Ullah Bhat, Yan Chen, Khalil Jebran, Niaz Ahmed Bhutto, (2018) "Corporate governance and firm value: a
comparative analysis of state and non-state owned companies in the context of Pakistan", Corporate Governance: The
International Journal of Business in Society, Vol. 18 Issue: 6, pp.1196-1206, https://doi.org/10.1108/CG-09-2017-0208
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1. Introduction
In developed countries, there is vast literature on the investigation of the relationship
between corporate governance and firm value, and researchers have made big debates in
specific areas (Coles and Hesterly, 2000; Pass, 2004). It is also noticed that researchers
have contributed to the literature in emerging countries where big discussions are made on
the role of corporate governance on firm performance for instance by Arora and Sharma
(2016). The need to discuss corporate governance arises as a result of some scams and
collapses in the corporate sector. Anomalies result from having a weak structure of
corporate governance, which gives rise to need for reforms to improve the corporate
Received 7 September 2017
Revised 28 March 2018
governance system (Arora and Sharma, 2016), and it can ultimately help in reducing
21 April 2018 inefficiencies in the corporate sector. Ineffective corporate governance systems play a vital
7 May 2018
30 May 2018
role in the occurrence of accounting scams; thus, corporations having weak governance
Accepted 4 June 2018 are more inclined to anomalies (Berkman et al., 2009).
PAGE 1196 j CORPORATE GOVERNANCE j VOL. 18 NO. 6 2018, pp. 1196-1206, © Emerald Publishing Limited, ISSN 1472-0701 DOI 10.1108/CG-09-2017-0208
Firms having a weak structure of corporate governance are keen to perform poorly because
of the principal and agent conflict; hence, agents of certain firms are more benefited (Core
et al., 1999). From the perspective of agency theory, there is a conflict of interest between
the board of members and shareholders (Letza et al., 2004). It is also suggested in the
agency theory that the objective of corporate governance is to assure the shareholders of
the company that agents are doing their best to maximize the wealth of shareholders
(Shleifer and Vishny, 1997).
From the perspective of stewardship theory, bigger boards can have a positive effect on
firm value by using diverse expertise from large members of a board (Rashid and Islam,
2013). However, companies having bigger board size are supposed to bear huge cost to
coordinate and process problems; thereby, high costs can reduce efficiency (Anderson
and Reeb, 2003; Coles et al., 2008). On the other hand, in case of smaller board size, cost
is reduced and inhibits free-riding and ultimately leads to better performance (Eisenberg
et al., 1998; Yermack, 1996).
Board consisting of independent directors reduces the agency cost which arises as a result
of conflict between principal and agent; on the contrary, it is argued that the limited time
which independent directors spend together may not be meaningful for the interest of
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organization (Vafeas, 1999). However, frequent meetings of the board of directors possibly
lead members of a board to act by shareholders’ interest and ultimately can yield better
performance (Conger et al., 1998). There is a consensus among researchers that return on
assets and market capitalizations have a positive impact on firm performance.
In recent past, the relationship between corporate governance and firm performance has
been highly investigated, and most of the research on specific topics has been done in
developed countries (Barnhart et al., 1994; Bauer et al., 2004; Guest, 2008; Hermalin and
Weisbach, 1991; Judge et al., 2003; Kang and Shivdasani, 1995; Pass, 2004). However, in
the context of developing countries, the empirical work is at infancy level; this is most
probably because of lack of availability of data or because corporate governance is least
practiced in the organizations. There are many studies conducted to investigate the
relationship between corporate governance instruments and firm performance in emerging
economies, for instance (Arora and Sharma, 2016; Nadeem and Zongjun, 2012;
Ramachandra and Rathish, 2017). Although Sarkar and Sarkar (2000) argue that because
of big amount of institutional debt in emerging economies, it is hard to calculate the correct
value of its replacement. Replacement value of institutional debt is not calculated in a proxy
that was recently used in the context of Malaysia for value of a firm (Rashid and Islam,
2013), and authors of the current study adopted the same proxy of TobinQ, which is
appropriate for an emerging economy.
The main objective of Corporate Governance Code 2002 in Pakistan is to bring
transparency and accountability in reporting financial and other corporate matters for both
state-owned enterprises (SOEs) and non-state-owned enterprises (NON-SOEs) (SECP,
2002). Because of government intervention, the implementation of corporate governance
standards in SOEs in Pakistan is doubtful, and the weak performance of public
organizations such as Pakistan International Airlines is linked with inefficient governance.
Empirical evidence can help us to find out how effectively the reforms in corporate
governance are affecting both state- and non-state-owned companies. On the basis of
above discussion, it is concluded that there is a need to have a comparative analysis of how
corporate governance instruments affect the firm value of both SOEs and NON-SOEs in the
context of Pakistan. Hence, the objectives of studies are as follows:
n to investigate the impact of corporate governance instruments on firm value by using an
appropriate proxy of TobinQ for an emerging economy; and
n to examine how corporate governance instruments affect the firm value of both state-
and non-state-owned companies.
improving the firm performance of SOEs. Empirical evidence can help decision-makers to
incorporate findings in the recommendations of decision-making for both SOEs and NON-
SOEs within the framework of corporate governance.
The rest of the paper is organized as follows: Section 2 reviews the literature. Section 3
discusses the data and methodology. Section 4 presents and discusses the results. Section
5 presents the recommendations.
2. Literature review
Many studies have investigated the relationship between corporate governance
instruments, such as board tasks, executive compensation, board size and board
independence, and firm performance in developed countriesfor instance, (Coles and
Hesterly, 2000; Dalton et al., 1999; Elsayed, 2007; Jensen, 1993; Yermack, 1996). However,
in developing countries, some studies have been conducted in recent past to investigate
the impact of corporate governance instruments on firm value, such as the study by Arora
and Sharma (2016). To address the objectives of the current study, we further discuss the
related literature and hypothesis development process in the following section.
It is highly debated in the literature to address in the literature to address the issue that what
should be an appropriate board size for better firm performance (Dalton et al., 1999;
Jensen, 1993; Van den Berghe et al., 2011; Yermack, 1996). Some studies lend support for
a small number of board members (Jensen, 1993; Yermack, 1996). But, there is a contrary
view that favors bigger board size, as it is helpful in monitoring process and leads to
effective decision-making (Anderson and Reeb, 2003; Coles et al., 2008; Klein, 1998).
Jensen (1993) suggests that small board size leads to better decision-making because of
better communication and effective monitoring. Although firms having diversified portfolios
require expert opinions from many experts, for effective decision-making, a bigger board is
preferred (Yermack, 1996). Political influence causes the board size to increase because of
the inclusion of outsiders in the board, and this is one of the reasons a bigger board size
does not affect firm performance positively (Agrawal and Knoeber, 1996). On the basis of
preceding discussion, the following hypothesis is developed:
H1. Board size has a positive impact on firm value.
After the rise of scams in the corporate sector, there is a significant trend of independent
directors in the board of governance. The relationship between the ratio of independent
directors and reaction of stock markets is investigated, where the findings of a study show a
is a consensus in the literature that both variables, i.e. return on assets and market
capitalization, have a positive and significant relationship with firm performance. Many
studies have used return on assets and market capitalization as control variables while
examining the effects of corporate governance instruments on a firm performance (Black
et al., 2006; Rashid and Islam, 2013):
H4. Market capitalization has a positive impact on firm value.
H5. Return on assets has a positive impact on firm value.
Tobin’s Q TOBINQ (Total assets þ market capitalization Rashid and Islam (2013)
book value of equity)/total assets
Board size BS Number of directors in the board Rashid and Islam (2013)
Board IND_D Ratio of independent directors to the total Arora and Sharma (2016)
independence number of directors on board
Board meetings B_MET Frequent meetings Arora and Sharma (2016)
Return on RET_A Earnings before interests and taxes scaled Rashid and Islam (2013)
assets by total assets
Market LCAP Total value of shares in the market Black et al. (2006)
capitalization
4. Results
4.1 State-owned organizations
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4.1.1 Descriptive analysis. Descriptive statistics of the variables for state-owned companies
are reported in Table II. The mean value of TOBINQ is 1.331, mean value of board size (BS)
is 9.28, mean value of board meeting (B_MET) is 8.755, mean value of Independent
directors (IND_D) is 40.04 per cent, mean value of return on assets (RET_A) is 7.013 and
mean value of Log of market capitalization (LCAP) is 4.603.
4.1.2 Multicollinearity. Multicollinearity analysis is conducted in the study to examine
whether there is perfect multicollinearity. If multicollinearity is found to exist, then some
remedial measures can be taken for robustness of results. Variance inflation factor (VIF)
analysis is run in SPSS 18 to detect the perfect multicollinearity.
Multicollinearity analysis results are mentioned in Table III. In the results, it is found that VIF
of board size (BS) is 1.252, VIF of ratio of independent board of directors (IND_D) is l
[0].408, VIF of board meetings (B_MET) is 1.270, VIF of return on assets (B_MET) is 2.344
and VIF of market capitalization (LCAP) is 2.137. Hence, VIF of all variables is less than 5,
BS 0.799 1.252
IND_D 0.710 1.408
B_MET 0.787 1.270
RET_A 0.427 2.344
LCAP 0.468 2.137
4.1.4 Redundant fixed effect test. To investigate that whether panel ordinary least
square (OLS) with fixed effects is appropriate in the current study for accuracy of
results, redundant fixed effect test is applied in the study. As mentioned in Table V, it
is found that p = 0.000, so null hypothesis is rejected here that there are no fixed
effects in the data. Results support the argument that OLS with fixed effects is an
appropriate model to investigate the relationship between independent and
dependent variables.
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4.1.5 Panel least square. Panel least square with fixed effects is applied in the study to
investigate the causal relationship between independent and dependent variables, and
results of the panel least square are mentioned in Table VI. It is found in the results that
board of independence (IND_D) has a positive and significant relationship with firm value
(TOBINQ) at 0.000 significance level. However, board size (BS) has an insignificant positive
relationship with firm value, and board meetings (B_MET) also has an insignificant positive
relationship with firm value. Control variables return on assets (RET_A) and market
capitalization (LCAP) have a positive and significant relationship with firm value, where p-
value for return on asset is 0.06 and p-value for market capitalization is 0.02.
BS 0.853 1.172
IND_D 0.972 1.028
B_MET 0.826 1.210
RET_A 0.982 1.018
LCAP 0.914 1.094
insignificant relationship with firm value (TOBINQ). However, board size (BS) has an
insignificant negative relationship with firm value, and board meetings (B_MET) also has
an insignificant and negative relationship with firm value. Control variables return on assets
(RET_A) and market capitalization (LCAP) have a positive and significant relationship with
firm value, where p-value for return on asset is 0.04 and p-value of market capitalization is
0.000.
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5. Recommendations
As far as the board of independence is concerned, it has a positive and significant
relationship with firm value in state-owned organizations and has an insignificant positive
relationship with firm value in non-state-owned organizations. Decision-makers can
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consider this factor while decision-making, and they should also ensure fair selection of
independent directors to protect shareholders’ rights. Board size has a positive and
insignificant relationship with firm value in state-owned organizations; however, board size
in non-state-owned organizations has an insignificant and negative relationship with firm
value. This study suggests that decision-makers should consider most appropriate board
size so that they can benefit organizations with their diverse expertise. Frequency of board
meetings has an insignificant and positive relationship with firm value in state-owned
organizations; however, it has a negative and insignificant relationship with firm value in
non-state-owned organizations. The study recommends a cost-benefit analysis for
conducting the frequent board meetings, and value addition should also be monitored with
the passage of time.
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Corresponding author
Kalim Ullah Bhat can be contacted at: bhat_dufe@outlook.com
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