Corporate Governance Project

MODERATING IMPACT OF CG ON THE RELATIONSHIP
BETWEEN CAPITAL STRUCTURE AND FINANCIAL

PERFORMANCE:
EVIDENCE FROM MANUFACTURING SECTOR OF PAKISTAN
I
DEDICATED TO
My Family
II
RESEARCH COMPLETION CERTIFICATE
It is to certify that the research work contained in this thesis entitled ‘Moderating
Impact of CG on the Relationship Between Capital Structure And Financial Performance:
Evidence From Manufacturing Sector Of Pakistan’,has been carried out and completed by
“Sabahat Rasheed” under my supervision during her Bachelorin Accounting and Finance.
SairaFarooqi
Head Business Studies Supervisor: Mrs. Farah Amir
III
ACKNOWLEDGEMENT
Thanks to Almighty Allah Whose unending blessings enabled me to accomplish this

gigantic task. This dissertation could not have been completed without the time, effort, and
support of a number of people. Therefore, I wish to acknowledge the contributions of all of
them.
I am grateful to my supervisors, Mrs. Farah Amir for her valuable guidance,
support and encouragement during my research work. Without her help I never would
have been able to gain precision in my work
I express my gratefulness towards my mother, sisters and friends who were always
there to support me at every step.
Sabahat Rasheed
IV
TABLE OF CONTENTS
DEDICATED TO .......................................................................................................... II
RESEARCH COMPLETION CERTIFICATE .................................................... III
ACKNOWLEDGEMENT ....................................................................................... IV
TABLE OF CONTENTS ............................................................................................ V
LIST OF TABLES ..................................................................................................... VI
LIST OF FIGURES ................................................................................................. VIII
LIST OF ABBREVIATIONS .................................................................................... IX
ABSTRACT ................................................................................................................ X
CHAPTER 1: ................................................................................................................ 1
INTRODUCTION ........................................................................................................ 1
1.2 ADVANCEMENT OF CORPORATE GOVERNANCE IN PAKISTAN........ 2
1.3 THEORIES OF CORPORATE GOVERNANCE (CG) ..................................... 4
1.3.1 Principle-Agent Theory ...................................................................................... 5
1.3.2 Stewardship Theory ............................................................................................ 6
1.3.3 Stakeholders Theory ........................................................................................... 7
1.4 MANUFACTURING SECTOR OF PAKISTAN ............................................... 8
1.5 OBJECTIVES OF THE STUDY ........................................................................ 9
1.6 SIGNIFICANCE OF THE STUDY .................................................................. 10
1.7 CONTRIBUTION TO THE RESEARCH ........................................................ 10
CHAPTER 2 ............................................................................................................... 12
LITERATURE REVIEW ........................................................................................... 12
2.1 CORPORATE GOVERNANCE INDICATORS ............................................. 13
Proportion of Executive Director ................................................................................ 13
2.3 CORPORATE GOVERNANCE INDEX ......................................................... 17
2.4 CAPITAL STRUCTURE .................................................................................. 17
2.5 FINANCIAL PERFORMANCE ....................................................................... 18
2.5.1 Return on Asset (RO) ....................................................................................... 18
CHAPTER 3 RESEARCH METHODOLOGY ........................................................ 20
3.1 RESEARCH METHODOLOGY ...................................................................... 20
3.2 RESEARCH PROBLEM .................................................................................. 20
3.3.1 Main Question .................................................................................................. 21
3.4 RESEARCH DESIGN....................................................................................... 21
3.4.1 Population ......................................................................................................... 21
3.4.2 Sample Size ...................................................................................................... 22
3.4.3 Time Span of the Study .................................................................................... 22
3.4.4 Conceptual / Theoretical Framework ............................................................... 23
3.4.5 Research Hypotheses ........................................................................................ 25
3.4.6 Model Equations ............................................................................................... 26
3.4.7 Abbreviation Used in Models ........................................................................... 26
3.4.8 Measurement of Operational Variables and Abbreviations ............................. 28
3.5 VARIABLES ..................................................................................................... 29
3.5.1 Corporate Governance Index ............................................................................ 29
V
3.5.2 Capital Structure ............................................................................................... 34
3.5.3.1 Return on Asset (RO) ........................................................................ 34
3.5.4 Control Variables.............................................................................................. 35

3.6 TOOLS AND ECONOMETRICS TECHNIQUES .......................................... 35
3.6.1 Jarque-Bera Test for data Normality ................................................................ 35
3.6.2 Descriptive Statistic .......................................................................................... 36
3.6.3 Multiple Regression Analysis ........................................................................... 36
3.6.3.1 Fixed Effect Regression Model ......................................................... 36
3.6.3.2 Hausman Specification Test .............................................................. 38
3.6.3.3 Fixed Effect Regression Model Conditions ...................................... 38
CHAPTER 4 DATA ANALYSIS AND INTERPRETATION ................................. 39

4.1 DESCRIPTIVE STATISTICS .......................................................................... 39
4.2 REGRESSION ANALYSIS .............................................................................. 41
CHAPTER 5 ............................................................................................................... 47
RESULT OF HYPOTHESIS ..................................................................................... 47
5.2 SUMMARY OF FINDINGS ............................................................................. 48
CONCLUSION .......................................................................................................... 50
RECOMMENDATION.............................................................................................. 52
LIMITATIONS .......................................................................................................... 53
REFERENCES ........................................................................................................... 54
LIST OF TABLES
VI
Table Title Page
No.
3.4.2 Determine Sample Size 22

3.4.5 Research Hypotheses 25
3.4.8 Operational Definition and Abbreviations of Variables 28
4.1 Descriptive Statistics 39
4.2 Regression Analysis 41
4.2.1 Estimation Results for RO 42
4.2.2 Empirical Results for Model (I) 43
4.2.3 Empirical Results for Model (II) 44
5.1 Result for Hypothesis 46
VII
LIST OF FIGURES
Figure
Title Page
No
1.4 Pie Chart of Listed Manufacturing Sector of Pakistan 8
3.1 General Model 23
3.1.2 Model 1 23
3.1.3 Model 2 24
VIII
LIST OF ABBREVIATIONS
No. Abbreviation Term
IX
ABSTRACT
The major reason for this analysis is to investigate the impact of Corporate Governance on the
connection between Financial Performance measured by Return on Asset, and Return on
Equity and Capital Structure of Manufacturing firms recorded in Karachi Stock Exchange of
Pakistan.
Under the fixed effect model approach, multiple regression method is applied to analyze the
effect of Corporate Governance on the relation between Capital Structure and Financial
Performance on the panel data in this study. Data has been obtained from the annual reports of
the 173 manufacturing firms for the period of 2009 to 2014.
As supported by existing literature the observational outcomes demonstrate that Corporate
Governance improves the firm Performance and execution. The positively significant relation
between capital Structure and Financial Performance is impacted by the incorporation of
Corporate Governance Index (CGI) as a moderating variable. The outcome is by and large
discovered that the majority of Pakistani listed firms in the manufacturing sector seek great
corporate governance system and utilize optimal and ideal level of Capital Mix for improved
financial Performance.
Keywords: Corporate Governance Index, Capital Structure, Financial Performance,

Manufacturing Sector.
X
CHAPTER 1:
INTRODUCTION
The stakeholders who have controlling impact on a firm including shareholders, suppliers,
and creditors are handled by Corporate Governance(Johnson, Boone et al. 2000). Corporate
Governance is helpful for the overall society welfare since it is not only relevant to the
business activities. It is additionally appreciative for the advancement of economy of any
nation. These days, firms have built up another idea/approach, for example, (CSR)
Corporate Social. Corporate Social Responsibility (CSR) reporting is considerable effected
by Corporate Governance(Khan, 2010)&(Sharif and Rashid, 2014). In addition the
outcomes likewise found that corporate social responsibility (CSR) has noteworthy and
negative relationship with the corporate Governance component: Foreign Directors (Sharif
and Rashid 2014(Sharif and Rashid, 2014). Sound and effective corporate governance (CG)
practices brings imperative growth the financial market by increasing shareholders self-
confidence and proper organization of the portfolio investments.
Cases of inefficient, ineffective management and poor corporate governance are

happened in all over the world. In Pakistan the privatization of PTCL was a huge corporate
scandal. The Crescent Bank fraud was also a big fraud. Fraud and irregularities in accounts
were pointed out by the External Auditor in the Crescent Standard Investment Bank, so the
CEO, Mr. AnjumSaleem and entire board of directors (BSS’s) were officially stopped from
running their offices. Moreover, a missing amount of about Rs. 6 Billion has been
anticipated by External Auditor (Dar, Naseem et al., 2011). Generally, the fraud cases are
related with fallacious practices. Moreover, irregularities in accounts, non-compliance with
rules, misuse of minority investors and favoritism were the major malpractice. So, the
extinction of these misdeeds is essential through operative and effective Corporate
Governance for development and financial stability.
Securities and Exchange Commission of Pakistan (SECP) has done a lot of work for
the development of Corporate Governance code 2012. “Pakistan Institute of Corporate
Governance (PICG)” an institute of Corporate Governance has been formed by the
government of Pakistan for the enactment and execution of good Corporate Governance
1
practices, accountability standards and balance demonstration through code of Corporate
Governance 2012.
Previously, the bank credit is the main source of financing of large firms in Pakistan
and equity capital contributed a small share in the capital, while the current situation has
been changed significantly. Usually, a firm may have choose different substitute for capital
structures. A firm can be issue shares or convertible bonds, get loan from banks or other
financial institution, sign forward contracts, arrange lease financing or trade bond and use of
warrants.
Manufacturing Companies facing difficulties due to lack of Good Governance which

lead several miseries such as rising conflicts between principal and agents, poor
transparency, inadequate control, irregularities in accounts and insufficient Disclosures,
leading to loss of profitability, investor confidence and good will.
In fact the Present research work investigates to collect the reply of this question
“whether Corporate Governance has moderating impact on the association between capital
mix and firm Performance of listed manufacturing firms of Pakistan or not. It is
investigating by using Corporate Governance practices components: Corporate Governance
index (CGI), Sub-indices include Board Size (BSS-I), Ownership Structure (OWS-II) and
Disclosure and transparency (DS-III), Capital structure Component: long term debt to
Equity Ratio and Financial Performance components: Return on Equity (RE), Return on
assets (RO) to evaluate the firm Business Performance .
1.2 ADVANCEMENT OF CORPORATE GOVERNANCE

IN PAKISTAN
Different Cases of inefficient, ineffective management and poor corporate

governance are happened in all over the world, especially in developing countries like
Pakistan. In Pakistan the privatization of PTCL was a huge corporate scandal. Fraud and
irregularities in accounts were pointed out by the External Auditor in the Crescent Standard
Investment bank, so the CEO, Mr. AnjumSaleem and entire board of directors (BSS’s) were
officially stopped from running their offices. Moreover, a missing amount of about Rs. 6
2
Billion has been anticipated by External Auditor (Dar, Naseem et al., 2011). Generally, the
fraud cases are related with fallacious practices. Moreover, irregularities in accounts,
regulations and law non-compliance with rules, misuse of minority investors and favoritism
were the major malpractice. So, the extinction of these misdeeds is essential through
operative and effective Corporate Governance for development and financial stability.
In Pakistan the key legislative framework of Corporate Governance (CG) comprises

the Stock Exchange Ordinance (SEO) 1969, the Companies Ordinance 1884, and Stock
Exchange Commission Act of Pakistan of 1997 through which the SECP has been
established to regulate the stock market operations. Stock Exchange Ordinance (SEO) 1969
offers the shield to the stockholders, sock market regulation, makes sure the prevention of
fraudulent trading, controls the listing of securities. Stock Exchange Commission of
Pakistan (SECP) control and regulate the corporate entity and stock market. Furthermore,
Stock Exchange Commission (SEO) of 1997 has forms a strategy and policy board for the
availability of all the guidelines relating to the Corporate Governance matters.
The companies’ ordinance 1984 make the rules and regulations to direct all the firms
regarding their working and listening, while the banks are not regulated by Companies
Ordinance 1984, these are controlled and regulated by Companies Ordinance 1962.
The code of corporate governance 2012 has been issued by the SECP (Security and
Exchange Commission of Pakistan) to produce a framework and mechanism for control and
good governance of firms and SECP (Security Exchange Commission of Pakistan) also
issued guidelines and directions to the Islamabad, Karachi and Lahore stock exchange to
regulate and homogenize the directions of the Code while using its authorities under
section 34(4) of SEO (Security Exchange Commission) 1969. So, the listing rules
and regulations were rightly changed and improved by the stock exchanges. This code has
maintained the rules, regulations and principals which are recognized internationally.
Furthermore, it highlights the importance of accountability, transparency and fair Disclosure
of information of listed companies. The initial step to implement and drive was taken by
Institute of Chartered Accountant Pakistan and Security Exchange Commission Pakistan
(SECP). The listed companies are liable to follow the provisions of code of corporate
governance 2012.
3
Moreover, it is mandatory for listed firms that they should be crystal clear about
their dividend payment and bound to timely notify about changing in board composition. If
any company don’t follow the provisions of code i.e. do not held annual general meeting,
the code takes the action against such company for the safety of investors rights. It is
necessary for all the listed firms to issue a Corporate Governance statement in their annual
report to ensure the compliance of code of Corporate Governance practices.
The stock exchange of commission of Pakistan set forth the decentralization of

Central Depository Committee for the protection of shareholder rights. Shareholders have
voting power for the Election or removal of directors, and also have rights to get
information from the company. For the purpose of corporate asset changes and capital
structure changes shareholders’ approval is obligatory. Central Depository System (CDC)
was incorporated in 1993 maintain Central depository System that is an electronic
transaction recording System but unfortunately its operation was start in 1997. Through
Electronic book entry system the securities transfer from hand to hand effectively. Every
transaction of investors of sock exchange is completed through the institute of CDC because
it is a basic and important institute of regulating the stock market of Pakistan.
The investment finance is a primary source of finance for stock market so it is very
beneficial for such market. Presently, there are three stock exchanges are working in
Pakistan: KSE (Karachi Stock Exchange), ISE (Islamabad Stock Exchange) and LSE
(Lahore Stock Exchange). The Central Depository System of Pakistan is linked with these
stock exchanges, so the transferring of shares is controlled by these stock exchange
atomically. Surprisingly, in last decade the stock market made substantial change in trade
volume and growth that is the results of application and compliance of corporate
governance practices, because corporate governance Code provide the direction for safe and
transparent sale and purchase of shares.
1.3 THEORIES OF CORPORATE GOVERNANCE (CG)
In the viewpoint of corporate Governance practices the primary problem is the

security of investor’s rights against the corruption, misuse, mistreatment and exploitation of
4
management. On this quarrel many theories have been established that specified the
importance of corporate governance system and highlight the designs and procedures for the
achievements of organizational goals. These theories suggest the ways to create an
equilibrium between the interest of investors and management. Four main theories of
corporate are as under below:
1.3.1 Principle-Agent Theory
Agency theory explain the principal and agent relationship i.e. managers and
shareholders. (Jensen and Meckling 1976) Explain this connection is known as agreement in
which the principal involves the manager to perform work / task on their behalf. Agency
theory is helpful to resolve the problems exist in agency relationships. Generally, problem
arises when management take decision for their OSS concern rather than in the favor or best
interest of shareholders.
Commonly there are two problems that agency theory address. Firstly, the problems
that arise when the needs, requirements and desire of the principal and agent are indifferent.
Secondly, the problems that arise when the shareholders and management have diverse
approaches towards risk. Due to different risk tolerance behavior, the shareholders and
managers looking for different actions.
Agency problem is the important issue in the principle agent theory, so to resolve
this issue it is necessary that insider’s Ownership must be separate from the benefactor of
capital to the firm. For the separation of insider’s Ownership a complete background and
proper application of Corporate Governance (CG) practices are necessary to ensure the
investors’ interest. The promoters and follower of principal-agent theories are (Jensen and
Meckling 1976); (Shleifer and Vishny 1997).
Agency theory explore that the agents work for their OSS benefits because as they
have entire access internal information of the firm. Normally, agency theory indicates about
the problems between shareholders and management due to ignoring the benefits and
interest of shareholders and other stakeholders.
5
In conclusion, the agency theory clearly explore that the agents do work in the best
interest of shareholders and firm because they have managerial power so they can easily
make decision for their OSS interest. Therefore, the management must separate from the
Ownership structure of investors. Moreover, this theory provides the grounds by using the
corporate governance practices to check and control on the management work and
safeguard maximum return on the shareholder wealth.
1.3.2 Stewardship Theory
Another theory is Stewardship theory that creates a substitute approach to produce

balance of interest between the shareholders and management. This theory articulates that
management doesn’t have exploitation attitude, so manager carefully work for getting the
goals, maximum profit and rewards for the all stakeholders because they are part of the firm
(Davis, Schoorman et al. 1997). The proponents of this theory mentioned that the managers
are viewed as loyal to the company and work for the best and high interest of company. The
managers perform exactly to accomplish their job due different leading motives.
Stewardship theory is distinguished form the principal-agent theory on the basis of

intentions of the managers. Managers have certain desires in respect of firm and they are
bound to perform their responsibilities in best interest of firm to accomplish these desires.
Moreover, theory also postulate that board structure has significant effect on the association
of principal and agent. So it can say that board insider’s members will struggle to maximize
the shareholders capital. The board executive members perform better for firm as well as for
shareholders if they are free from the influence of Non-Executive directors. In addition, the
insider directors perform better as compared to the outside directors.
Finally the stewardship theory highlights the manager’s behavior those act as the
agent of the principal. Furthermore, the idea of stewardship indicates that harmony about
the attitude of the agents is exceedingly reliant on the firm. So, to achieve the better
company Performance it is important to have good mechanism of corporate Governance
practices.
6
1.3.3 Stakeholders Theory
A stakeholder theory is relates to the balance of interest between shareholders and

firms. It is also relates to the creation of strong relationship between principal and agent of a
firm. The theory makes the pressure on management to design such approaches that have
the capability to serve the firm stakeholders in the best way. The stakeholder includes
shareholders, employees, supplier, customers, government and lenders. So these all
stakeholders can be affected the achievements and objectives of the firm.
Stakeholder’s theory refers to procedures and mechanism for the effective operation
of the firm on behalf of stakeholders. The procedures and mechanism provides the direction
for separation of control from management, which leads to the effective and efficient
control on agency problems.
In future, Corporate Governance practices are anticipated to have impact on the

economic, social, cultural and political environments of the firm. It also provides a healthy
environment to firms to make their goals according to capital for future.
1.3.4 Political Theory
Political theory defines the influence of government through its constituencies and
process and method of distribution of powers and profits among managers, investors and
other stakeholders. It also stresses that the authority and wealth should be distributed
equally among members. The government influences the power of the firm by taken
different directorial steps through securities exchange commission of Pakistan and these
steps delivered a sound corporate Governance structures to the companies. In addition, the
political theory provides the concept which lead to the shareholders for voting powers.
In last, all these mentioned concepts of theories have mostly scrutinized in the
developing countries. But in emerging markets these concepts are expressively different
from the developed countries. So the hypothetical sights of corporate Governance (CG)
must be investigated according to the stock market of Pakistan.
7
1.4 MANUFACTURING SECTOR OF PAKISTAN
Manufacturing sector provides a vital contribution to the Pakistan Gross Domestic product
(GDP), accounts for 13.4 percent of Gross Domestic Product. Unfortunately, it has been
noticed that Pakistan manufacturing sector firms do not follow the governing policies that
are used evaluate their Performance. Approximately 375 manufacturing firms are listed in
the KSE and these listed firms are divided into different groups:
AUTOMOBILE
PHARMA AND TOBACCO
PARTS BEVERAGES
BIO TECH
CHEMICAL
Textile Sector 09% CONSTRUCTION &

10% CEMENT
ELECTRONIC
47% GOODS
14%
FOOD PRODUCTS
FORESTERY PAPER
BOARD
INDUSTRIAL HOUSEHOLD
MATERIAL AND GOODS GENERAL
MINNIGN INDUSTRY
The manufacturing sector has strong contribution to Pakistan exports, especially the
textile sector and it contributes about 50 % in the total GDP of Pakistan. Moreover, it
contribution to world trade is about 2% in 2010. After China, Bangladesh and India,
Pakistan is considered as the largest cotton producer in the world and it contributed 5% in
the international market. Pakistan textile sector comprised of small, mediocre and large size
working units. Currently Pakistan has different small, medium and large working units like
as cotton fabric, weaving and spinning working units at small, medium and large sizes.
8
Numerous manufacturing sectors showing progress during July-March 2015-2016 such as
Automobiles 18.04 percent in 2015-16 as compared
to 0.35% in the previous year, Pharmaceuticals 6.28 percent (as compared
to -0.37 percent last year). On the other hand, the industry data also shows that negative
progress reported during the FY 2015-16 i.e. Tobacco and paper board sector. The large
scale manufacturing sector (LSM) recorded a progress of 4.4 percent during 2015-2016 as
compared to 1.0 percent negative growth of previous year. Automobile succeeded due to
decrease in sales tax on tractors likewise Iron and steel product has display better
Performance due to government bailout package. In leather product, especially an upward
trend is shown in the footwear product while in electronic product the growth is derived
from electric transformer and meters. Similarly, In Pharmaceuticals group, tablets injections
and capsules were the main items having a vital growth.
The manufacturing sector of Pakistan is the back-bone of Pakistan exports, its

contribution to Pakistan exports is about 75%. So it is the basis of large scale employment
contribution in the country.
The manufacturing sector is most susceptible to the aspects like, trade agreements,
government policies, workforce, organization structure, energy supply, FDI foreign direct
investment, and innovations. Government of Pakistan make emphasis on the export of
goods that support to generate value addition and to lift up the manufacturing sector.
According to the Pakistan MPD&R (Ministry of Planning, Development & Reform)

assessment the Pak-China Economic Corridor (PCEC) will lead to rapid industrialization
and greater investment in Pakistan. The Chinese Government has assured $46 billion
investment to Pakistan in future and out of this amount, $11 billion has been spent for
infrastructure work on the corridor, while the outstanding $35 billion will be spent on
energy projects. Hopefully, the effective application of this relation will be a game-changer
for Pakistan in terms of new economic opportunities, which lead to higher returns and
significant developments in the living standards of the Pakistanis.
1.5 OBJECTIVES OF THE STUDY
9
The study has the following objectives:
1. To analyze the moderating impact of corporate governance on the

association between capital structure and firm financial Performance in
manufacturing sector of Pakistan.
2. To evaluate the relationship between Corporate Governance practices,

leverage and financial Performance of manufacturing firms in Pakistan.
1.6 SIGNIFICANCE OF THE STUDY
 Previously, there has been no study that analyzes the moderating role of
corporate Governance. This research will provide an inclusive understanding
about the association between corporate governance practices; financial
Performance and capital mix of listed manufacturing sector of Pakistan.
 The manufacturing sector is an important, significant and valued sector of

Pakistan. Its contribution to Pakistan exports is about 75%. So the main
significance of this research is to search how the good governance and
control is significant for this key sector to support the stock market as well to
economy of Pakistan.
 Lastly, the main worth of this research is to inform the people, shareholders
and stakeholders about their duties, obligations, and rights for a common
purpose in the best interest of corporation in Pakistan business environment.
1.7 CONTRIBUTION TO THE RESEARCH
Heated argument has been conducted on the Corporate Governance (CG), which has
pressed the investigators to investigate the relationship between corporate governance
practices and financial Performance and capital structure and financial Performance.
Previous literature shows the contradictory results from region to region. The objective of
this study is to scrutinize the association between leverage levels and firm Performance with
controlling effect of corporate governance characteristics of listed manufacturing firms of
10
Pakistan. It put focus on the benefits of corporate governance in manufacturing sector of
Pakistan. It indicates about the significance of good corporate governance for the purpose of
financial stability in stock market and appropriate administration of investment.
A comprehensive index of good Corporate Governance (CG) practices has

developed for the listed manufacturing sector firms of Pakistan to fill this gap by providing
the empirical results. The core purpose of this research is to create a new set of indicators by
applying the panel data approach on secondary data collected from financial statements.
Two models has been developed to analyze which element of Corporate Governance
practicing is significant effect on the association between financial Performance and capital
structure.
In addition, this study is aimed to add more knowledge, experience and new results
in literature. Furthermore, it is strives to create and evaluate good corporate governance
mechanisms in manufacturing sector of Pakistan. So, the company having well mechanism
of Corporate Governance lead to more opportunities at right time to gain equity or debt
finance.
Finally, the manufacturing sector of Pakistan has significant importance for the
economy. It contribute about 75 percent to Pakistan exports. The main worth of this
research is to examine how the Corporate Governance (CG) practices is significant for the
manufacturing sector of Pakistan sector to support stock market and as well as to economy
of Pakistan.
11
CHAPTER 2
LITERATURE REVIEW
Plenty of research has been conducted to measure the effect of Capital Structure on
Financial Performance and impact of Corporate Governance (CG) Practices on company
performance. Results of various studies show the different outcomes.
Abor (2007) Suggest the positive relationship between Corporate Governance (CG)
and leverage. Additionally, the firms having a good corporate Governance Practices have
greater chances to get loans through debt financing then those companies, which have not
incorporated the good corporate governance practices, such as the firm able to pay off their
dues, interest and debt on time.
Mitton (2004) Mentioned that good Corporate Governance (CG) practices of

companies have increased dividend payout (DPS) ratio and they are better for rights
protection of all stakeholders. Corporate Governance has positive and significant influence
on CSR reporting. Also the results found that corporate social responsibility (CSR) has
significant and negative association with the corporate governance element: Foreign
Directors (Sharif and Rashid, 2014). Furthermore (Munisi and Randøy 2013) found that a
significant and progressive link between CGI and financial performance.
12
2.1 CORPORATE GOVERNANCE INDICATORS
Board Size
It was stated by Liu (2006) that board is the core element of corporate governance which
has the control and authority to effect on the management planning. Board size have
positive effect on performance measures of firm. It has positive and significant association
with debt ratios (Kyereboah‐coleman and Biekpe 2006). The board of director (BOD) is the
supreme decision making authority of an organization. Board size and capital structure have
positive and significant association and this relationship lead to better financial decision
(Bokpin and Arko 2009). Board is a crucial indicator of corporate governance ie
performance changes in the size of board the performance system change Cheng (2008)
while Lee and Lee (2009) argue that board size have negative association with the value of
corporation. As per to Gill and Biger (2013) large board size have not positively linked with
manufacturing firms and not advantageous to improve the efficiency of working capital
management.
Proportion of Outside Director

The external directors have greater insight experience and knowledge as compared to
internal or dependent director in any organization so they can influence the corporate
governance practices, system and mechanism.
Peasnell, Pope et al. (2005) Suggest that firms that employ independent external
directors and Non-Executive director have more benefit in the market as compared to firms
that don’t employ Non Executive directors. Dunn (2004) found a positive and statistically
significant relationship between financial performance and independent directors. He also
surveyed that there is less ratio of fraud for the firms which have employed a large number
of external directors.
Proportion of Executive Director

A firm has employees of all level and scale, Executive and non-Executive employees. The
executive employees having gross salary of more than five lac rupees per year. As per
corporate governance code 2012 the size of Executive Director must not be more than the
13
75% of the total board members. Khan (2010) Mentioned the negative relationship between
the existence of executive directors and CSR (Corporate Social Responsibility)
CEO Duality
Duality refers when a single person is working as chairman and Chief Executive officer of a
company this is known as CEO duality. The CEO duality is effecting the financial decisions
of the company and leading to the agency problems. Mixed and diverse outcomes have been
reported by numerous researchers relating to this problem. Firms with no CEO duality get a
significant financial results and greater share in the financial market (Brown and Caylor
2009). Abor (2007) Indicate the significant and positive association between CEO duality
and leverage
Ownership Structure
Butt and Hasan (2009) found the insignificant and negative correlation between debt to
equity ratio and Managerial shareholding. Su and He (2012) the firm efficiency and state
ownership is negatively correlated while employee and public share ownership is positively
correlated to the firm efficiency. However, the association between ownership concentration
and firm efficiency is U-shaped, indicating that the major shareholder may involve in
investigating agreements and deeds.
Ownership Concentration
The ownership concentration implies to the right power, ownership of shares and authority
in few hands. Su and He (2012) Revealed significant relationship and correlation between
firm efficiency and ownership attentiveness, which indicate that the increased portion of
shareholders engaged in burrowing deeds. Moreover, highly concentrated firms aim is to
raise capital and wealth and they do not focus on disclosure and transparency which lead to
the bad corporate governance practices. The influence of ownership concentration has also
significant effect on the debt ratio of company.
Managerial Ownership
A company ownership is owned by the external shareholders as well as management.

Managers work for their own benefit and to line up their interest with interest of outsiders
shareholders.
14
Butt and Hasan (2009) established significant and negative association between debt to
equity ratio and managerial shareholding. He further suggested that the managerial
shareholding play an essential and vital role for the determination of financial mix decision
Family Ownership
Family ownership refers to the ownership of shares by the spouse, minor children, or any
nominated person of the director. There are large family shareholders in companies.
Presently, majority of studies have mentioned that non-family firms do well or family firms.
The family ownership is also helpful in controlling of shareholders rights but firm must not
be entirely and completely owned by family ownership. Non-family business is associated
with less profitability and lower performance as compared to active family control firms
Margaritis and Psillaki (2010), while Barontini and Caprio (2006) explore that non-family-
controlled corporations are not different from family firms in terms of profitability and
performance.
Institutional Ownership
The ownership of shares held by the other financial institutions other corporate companies
and Non-financial institutions create a positive impact on ownership structure of company.
Holding Institutional shares have a positive impact on company performance as proclaimed
by (Butt and Hasan 2009). Additionally, Su and He (2012) mentioned that the financial
decision and ownership structure have positive relation
Disclosure of Corporate Governance Practices
Klein (2002) Stated that the firm’s disclosure and transparency lead to the company’s
extraordinary performance. The sub index of disclosure and transparency have shown
positive link with financial performance (Durnev and Kim 2005).
The disclosure of rules and regulations and Corporate Governance practices is imperative
and necessary to gain the shareholders confidence. Through corporate governance
mechanism it puts the pressure on management, which leads to the better investor’s relation.
Corporate governance code 2012 has made it essential that the disclosure of CG practices
must be reported in the annual report of a firm.
15
Disclosure of Ownership
Agency problems are caused by the clash between the managers and shareholders. It is
evident and obvious that conflict between principal and agent arises when management uses
its executive powers to satisfy and fulfill their own interests. It is management’s
responsibility to work in the best interest of firm as swell as the shareholders (principal).
(Jensen and Murphy 1989) Have found that the significant relationship between the board
remuneration and compensation committee.
Ahmed Sheikh and Wang (2012) Director Remuneration motivates the managers
that will work towards the increase and growth of investor’s wealth. Moreover, the
empirical results show the inverse association between capital structure and director
remuneration. Fahlenbrach and Stulz (2011) Mentioned that the positive relationship
between risk-taking and board compensation during the current crisis.
Audit Related Committee
The firm’s board forms a committee to help in creating trustworthy and transparent financial
results. The members of the committee review the financial statements on quarterly basis,
six-monthly or annually. This committee is referred as the audit committee. Lin and Chang
(2012) has found the positive association with firm’s performance. The empirical results
show that indecisive relationship between the financial performance and audit related
governance (Gill and Biger 2013).
An independent and autonomous committee for assessment is helpful for the

application of CG practices (Engel, Hayes et al. 2010). Munisi and Randøy (2013) Declare
that the firm performance and audit committee are positively associated. Audit committee
play a vital role to improve the management control of a firm (Kyereboah-Coleman 2007).
An independent audit committee improves the efficacy of working capital management by
scrutinizing cash accounts, accounts receivable, inventory accounts, accounts payable, and
assets accounts to curtail agency problems (Gill and Biger 2013).
Financial reports are measured as a vehicle for public relationship of a firm. The
convenience and open approach of financial statements on the website will improve the
disclosure of financial data that will improve the investor’s relations. The investors need
16
convenient access of the entire data of firms i.e. past, and present financial reports. They are
vital as these financial reports tells about the reliability of the company. Due to which, the
disclosure and transparency of financial reports have a positive and significant relationship
with firm performance (Munisi and Randøy 2013).
2.3 CORPORATE GOVERNANCE INDEX
There are different empirical results of researchers about the corporate governance
practices, many researcher support the arguments that the firms display well financial
Performance with the implementation of corporate Governance practices, while other not
agree. Dedu and Chitan (2013) developed a corporate governance index and mentioned
corporate governance practices index influenced negatively the bank financial Performance,
there is need to increase and improve the application of corporate governance. On the other
hand Munisi and Randøy (2013) indicate a positive relationship between Index of Corporate
Governance firm financial Performance .
Furthermore, board of director and audit committee sub-index both also have
positive relationship with the firm Performance , but the sub-index of Audit Committee is
associated negatively to the firm Performance as measure by Tobin’s Q. The perception of
good corporate governance and key dimensions are differ from one study to another and
across the countries (Balasubramanian, Black et al. 2010).
(Lehmann, Warning et al. 2004) mentioned that the concept of Corporate

Governance is multidimensional in different ways. It is a mechanism which is used to shield
the interest of stakeholders.
2.4 CAPITAL STRUCTURE
Capital Structure is the mixture of long term debt and short term debt. (Saeed, Gull
et al. 2013)found that it is very difficult to make capital structure decision of any
organization. (Pratheepkanth 2011) indicate that the capital structure and firm’s financial
Performance has positive relationship, whereas (Frank and Goyal 2009)declare that the
capital mix and firm Performance has negative and significant relationship. Capital structure
17
and CEO Duality, board size and board compositions have significant and positive
relationship. Furthermore, the results also indicate that firms pursue high debt policy.
2.5 FINANCIAL PERFORMANCE
Corporate Governance rules, regulations, mechanism and policies have a strong

impact on the Performance of the company. It also takes the perfection in the firm cash
flows that are shared among stakeholders (Black, Jang et al. 2006). The results display a
positive and significant relationship between index of CG characteristics and firm
Performance and negative association between the market valuation and index of corporate
governance practices. Moreover, the results also indicate that the board of directors and
audit committee were positively linked with firm Performance but negative relationship
between audit committee and with market valuation (Munisi and Randøy 2013). The
internal corporate governance practices index have a negative impact on the bank financial
Performance (Dedu and Chitan 2013).
2.5.1 Return on Asset (RO)
RO is used to assess and estimate the effectiveness of resources used by the

company for the generation of profit. Return on Assets (RO) and Capital structure have
negatively associated with each other (Pratheepkanth, 2011). This measure of accounting
base Performance specify and indicate the earnings of a firm by using its funds (Bonn,
Yoshikawa et al. 2004). The effectiveness and efficiency of a firm by using its funds by RO
is the best way of measuring the firm Performance .
2.5.2 Return on Equity (RE)
The prime and core objective of a company is to generate profits and raise the
shareholders wealth. The return on equity (RE) is used for the measurement that how much
profit is generated by the firm capital (Epps and Cereola 2008). It signifies and indicates
about the management efficiency to create yields by using the shareholders wealth.
18
19
CHAPTER 3
RESEARCH METHODOLOGY
3.1 RESEARCH METHODOLOGY
This study is designed to acquire the evidence on relationship between the Corporate
Governance, Capital Structure and Financial Performance. The secondary data has been
collected from the annual reports of listed manufacturing companies. This segment
highlights that how the Multi regression analysis is used through the panel data
methodologies to measure the association between corporate governance, capital structure
and firm Performance. It also describes the research design, research hypothesis, sampling
technique, Research tools and techniques, variables dimension, data analysis techniques and
time period of study.
3.2 RESEARCH PROBLEM
In order to examine the moderating role of Corporate Governance Practices

on the association between Firm Performance and Capital Structure a combined index of
corporate governance practices has developed that is inclusive and comprehensive.
20
3.3.1 Main Question
The Corporate Governance practices index influence on the connection between

capital structure and firm Performance of manufacturing firms or not?
Sub Questions
 What is the association between Capital Structure and financial

Performance?
 What is the association between CG (corporate governance) practices and

firm Performance?
 What is the association between corporate governance practices and capital

structure?
 What is the relationship between control variables: growth, Size of Firm, risk
and financial Performance?
3.4 RESEARCH DESIGN
The prime objective of this research is to empirically explore the moderating effect
of CG Practices on the association between capital structure decision and firm Performance
and secondary to investigate the association between capital structure and firm financial
Performance .
3.4.1 Population
The population of this study comprises of all the listed manufacturing firms in
Karachi Stock Exchange of Pakistan.
21
3.4.2 Sample Size
The total number of listed firms in manufacturing sectors are 378 with 14 sub-
sectors, varies from 3 to 54 in different sectors, with the exception of textile sectors having
180 firms. Those firms are selected as sample which were doing business during the whole
period of study and complete data for the period of 2009-16 which reduced the final sample
to 173 manufacturing firms. Moreover, the firms neither have been delisted by the Karachi
Stock Exchange (KSE) nor merged with any other firm. So, the required secondary data is
acquired from the annual reports of the listed manufacturing firms on the Karachi Stock
Exchange (KSE).
Table 3.4.2Determine Sample Size
Determine Sample Size
Confidence Level:
95% 99%
Confidence Interval: 5%
Population: 450
Sample size needed: 207
3.4.3 Time Span of the Study
Secondary data is acquired from the annual reports of listed manufacturing

companies from the year 2009 to 2016. The financial reports are obtained from the websites
of State Bank of Pakistan, SECP and manufacturing firms.
22
3.4.4 Conceptual / Theoretical Framework
GENERAL MODEL
CAPITAL FINANCIAL
STRUCTURE (IV) PERFOMANCE(DV)
CORPORATE
GOVERNANCE INDEX
(MODERATING VARIABLE)
Moderating variable
Figure 3.1 General Model
MODEL 1
RO H0. 3
H0. 1
(Return on Assets)
Capital
Structure (IV)
H0. 2
RE H0. 4
(Return on Equity)
H0. 5 H0. 6
CORPORATE
GOVERNANCE INDEX
(MODERATING VARIABLE)
Moderating variable
Figure 3.1.2 Model 1
23
MODEL 2
BOARD STRUCTURE H0. 7

(SUB INDEX-1)
H0. 8
RO
H0. 10
(Return on Assets)
OWNERSHIPS STRUCTURE
(SUB INDEX-II) H0. 11
H0. 09
RE
(Return on Equity)
DISCLOSURE&
TRANSPARENCY H0. 12
(SUB INDEX-III)
Figure 3.1.3 Model 2
24
3.4.5 Research Hypotheses
Following hypotheses are investigated in this study.
Table 3.4.5 Research Hypotheses

Research Hypothesis
Sr.No. Hypothesis
Ho.1 Leverage levels and RO do not have a significantly positive relation
leverage levels and firm Performance RE do not have a significantly positive

Ho.2
relation
Ho.3 CGI and RO do not have a significantly positive relation
Ho.4 CGI and RE do not have a significantly positive relation
Corporate governance characteristics and firm Performance RO and leverage

Ho.5
levels do not have a significantly positive relation
corporate governance characteristics and firm Performance RE and leverage
Ho.6
levels do not have a significantly positive relation
Ho.7 Board structure index and firm RO do not have a significantly positive relation
Ownership structure index and firm RO do not have a significantly positive

Ho.8
relation
Transparency & Disclosure structure index and firm RO do not have a
Ho.9
significantly positive relation
Ho.10 Board structure index and firm RE do not have a significantly positive relation
Ownership structure index and firm RE do not have a significantly positive

Ho.11
relation
Transparency & Disclosure structure index and firm RE do not have a
Ho.12
significantly positive relation
25
3.4.6 Model Equations
In order to find out the relationship between different variables (Financial

Performance , Capital Structure and Corporate Governance) the multiple regression
equations are as follow:
We will construct an Index of Corporate Governance by using Exploratory Factor

Analysis
yit= β0 + βxit + eit
1) RO= β0 + β1 (CS ) + β2 (CGI ) + β3(CS * CGI ) + β4 (CV)
2) RO= β0 + β1 BSS+β2 OSS+β3 DS+ β4 (CV
3) RE = β0 + β1 (CS ) + β2 (CGI ) + β3 (CS * CGI ) + β4 (CV)
4) RE= β0 + β1 BSS+β2 OSS+β3 DS+ β4 (CV
3.4.7 Abbreviation Used in Models
CORPORATE GOVERNANCE
CGI: Corporate Governance Index
BSS-I: Board Structure Sub index
OSS-II: Ownership structure sub index
DS-III: Disclosure sub index
FINANCIAL PERFORMANCE
FP: Financial Performance
RO: Return on Assets
RE: Return on Equity
26
CAPITAL STRUCTURE
CS: CAPITAL STRUCTURE
CV: Control Variables are
FS: Firm Size
SG: Sales Growth
VE: Variability of earning for firms (RISK)
27
3.4.8 Measurement of Operational Variables and Abbreviations
Table 3.4.8 Operational Definition and Abbreviations of Variables

Operational Definition and Abbreviations of Variables
Abbrevi-
Variables Measurements
ations
INDEPENDENT VARIABLES (Capital Structure)
Capital
LTD / Total Assets CS
Structure
DEPENDENT VARIABLES (Financial Performance)
Net Income before
RO RO
tax / Total assets
Net Income before
RE RE
tax/ Total Equity
MODERATING VARIABLES (Corporate Governance)
Corporate Aggregate average
Governance score of Corporate CGI
Index Governance index
Aggregate average
Board score of sub index
BSS-I
Structure-I 1 board structure
Aggregate average
Ownership score of sub index
OSS-II
Structure-II 2 Ownership
structure
Aggregate average
Transparency
score of sub index
& DS-III
3 Disclosure &
Disclosure-III
Transparency
CONTROL VARIABLES
Size of the firm
Firm Size SIZE
(log of total assets)
28
Growth in sales for
Firm Growth GROW
firm
Variability of
Risk RISK
earnings for firm
3.5 VARIABLES
3.5.1 Corporate Governance Index
The importance of corporate Governance practices encourage the researcher to examine

about the implementation of corporate Governance (CG) practices which makes a vibrant
and dynamic difference in their Performance as compare to the firms that do not.
The previous literature shows the different empirical results about the corporate
governance practices, some support the opinions that the firms display well financial
Performance with the implementation of corporate Governance practices, while other not
agree. So, there is a literature gap offers the reasons to scrutinize the connection between
corporate Governance, capital structure and firm Performance.
Ahmed Sheikh and Wang (2012) found a positive relationship between corporate
governance index and financial Performance. Corporate Governance practices index is
created on the basis of 12 proxies that is divided in to further three groups known as sub
index of BSS (Board Structure), DISC (Disclosure & Transparency) and OSS (Ownership
Structure). Each sub index has assigned equal weights. The Cumulative Corporate
Governance Index (CGI) score is calculated through the average score of all the mentioned
three sub-index for each manufacturing firm. The detail features of sub-indices is as
mentioned below:
Sub Index 1: Board Structure
Board is the initial sign that has the ability to have influence on the management, but this is
not true and significant when the managers have supremacy on the board. Furthermore, the
board is considered as part of Internal Corporate Governance (ICG).
29
I. Board Size
Bokpin and Arko (2009)&Ahmed Sheikh and Wang (2012) mentioned that the
board of director is the top decision making authority of an organization.
Furthermore, they also declare the positive association between Bard size and capital
structure which lead to better financial decision. (Cheng 2008) indicate that the
board size have positive association with Performance system.
According to (Juan García-Teruel and Martinez-Solano 2007) large board

size have not positively linked with manufacturing firms and not helpful to increase
the efficacy of financial management.
II. Proportion of Outside Director

The board of director of a company who is not a shareholder nor an employee in the
company is known as outside director. The outside director have better Performance
as compare to the inside director: Executive directors, because, they have more have
more insight knowledge and experience so they do not only lead to any organization,
they also can influence the corporate governance practices, mechanism and system.
(Ajinkya, Bhojraj et al. 2005) found the positive association between outside
directors and institutional investment. (Brick, Palmon et al. 2006) found that outside
directors can do more vigilant because they are free from management so they have
better monitoring and supervision.
III. Proportion of Executive Director

A working director of an organization who has a specified decision making role as a
director operation, marketing, finance etc. is known as Executive director.
Moreover, the Executive also retains the shares of the firm that should be reported in
the categories of shareholdings in the annual report of the firm. According to the
Corporate Governance Code 2012 the size of Executive director must not be more
than the seventy five percent of the total board members.
IV. CEO Duality

CEO duality indicate a condition when a CEO (Chief Executive Officer) of a
company also hold the position of chairman of the board at the same time. The CEO
30
duality also effecting the financial decisions and lead to the agency problems. There
are different outcomes have been reported relating to this matter. (Dunn 2004)
mentioned that firms get a significant financial results and greater share in the
financial market if there is no CEO duality while (Baliga, Moyer et al. 1996)
indicate that CEO duality helps in retaining a suitable and significant level of
working capital.
31
Sub Index 2: Ownership structure
There are different kinds of Ownership structure due to variances in shareholder’s cultural
background. These shareholders may be Financial, Non-Financial, Domestic and Foreign
I. Ownership Concentration
This Ownership concentration may be family or specific institutional. (Garcia-Meca
and Sánchez-Ballesta 2010) mentioned the significant association between
Ownership concentration and firm Performance. The Ownership of Authority and
power in few hands is known as Ownership concentration.
II. Managerial Ownership

The Ownership of the company is held by its management is known as managerial
Ownership. The Ownership of a company is held by different stakeholders as the
outside shareholders, institutions and management.(Florackis, Kostakis et al. 2009)
indicate the positive association between managerial Ownership and corporate
Performance. Furthermore, he added that the managers work for best interest of the
company as well as for interest of outside shareholders.
III. Family Ownership

Family Ownership means family business in which decision is influenced by
multiple generations of a family. In other words, the shares of a company held by the
spouse or minor children. (Anderson and Reeb 2003) mentioned that family firms
form better than nonfamily firms.
IV. Institutional Ownership

When the Ownership in company is held by different institutions like as financial
institutions, non-financial institutions, pension funds or financial organizations is
known as institutional Ownership. Normally, these large institutions buy a large
blocks of shares which creates a vital and positive influence on management
decision and management Ownership structure.
32
Sub Index 3: Disclosure.
Three elements of sub index transparency and Disclosure are as follows:
I. Disclosure of Corporate Governance Practices

The Disclosure of corporate governance practices means Disclosure of Ownership
structure, pattern of shareholding, financial reports etc. The Disclosure of Corporate
Governance practices and related rules and regulations is necessary to gain the
shareholders confidence. It also creates the positive image for the company.
According to the corporate governance code 2012 the Disclosure of corporate
governance practices must be report in the annual report of a firm.
II. Disclosure of Executive member Ownership

Executives members are those employees of the company those have gross salary
more than five lac rupees in the year. The corporate governance code 2012 put the
restriction on the proportion of the Executive Directors, according to this the size of
Executive Director must not be more than the 75% of the total board members. It is
also necessary that to show the Ownership of such shares which are held by
executive members.
III. Audit Related Committee

Normally, an audit committee consist of three or five members. These members are
selected by board of directors. The audit committee members of a company's are
responsible to help the auditors during audit process. The committee members
reviews the financial statements annually, six-monthly and quarterly basis. The
purpose of this committee is to increase the investors, banks and stakeholders. The
empirical results shown that inconclusive relationship between the audits related
governance and financial Performance(BrOSS and Caylor 2009).
IV. Availability of financial report on websites

Public relationship of a firm has a dynamic role and financial reports are measured
as a vehicle for such relationship. The accessibility of financial statements on the
website will improve the Disclosure of financial data that will leads to investor’s
relations. The investors need easy access of past, and present financial reports
33
because these financial reports tells about the reliability of the company. Due to
which, the transparency and Disclosure of financial reports have a significant and
positive relationship with firm Performance (Gibson Munisi, 2013).
3.5.2 Capital Structure
The capital structure shows that how a firm control its overall processes by using different
source of resources like equity and debt finance. In simple words it is the mixture of long
term debt and short term debt. (Muhammad Muzaffar Saeed, 2013) found that it is very
difficult to make ccapital structure decision of any organization. Normally, it is calculate
through the garing ratio. Such as long term debt of equity. The best debt to equity ratio for a
firm is that maximizes its value. The optimal capital structure means the balance between
the ideal debt to equity choice thatdiminishes the company capital cost..
Financial Performance
The financial Performance indicate that how well a firm can use its resources and produce
revenue. The corporate governance have great impact on company Performance. (BrOSS
and Caylor 2004) mentioned the negative association between CG and firm Performance.
On the other hand, (Peni and Vähämaa 2012) found the positive relationship between
corporate governance and financial Performance.
The elements of financial Performance is as under:
3.5.3.1 Return on Asset (RO)
The return on assets measure that how a firm use its resources for the generation revenue
and profit. It is the best way for a company of measuring the firm Performance at
accounting base.RO is measuring by the ratio between annual earnings divided by total
assets. Infrequently this is also known as return on investment.
(Finkelstein, 1994) Found that RO is calculated as a proportion of net earnings after

tax to total assets
34
Formula to Calculate RO
Net Earnings After Tax

RO =
Total Assets
3.5.3.2 Return on Equity (RE).

The RE (return on equity) ratio is a profitability ratio that indicate the firm ability to
generate profits from its shareholders investments. Normally, it is calculated by the ratio of
net earnings of firm divided by total equity. The return on equity is used to calculate that
how much profit is generated by the firm capital. RE is measured as the proportion of net
Earnings After tax divided by equity capital (Finkelstein, 1994).
Formula to Calculate RE
Net Earnings After Tax

RE =
Total Equity
3.5.4 Control Variables

The variables that are controlled, neutralized or overlooked to check the relationship
between independent and dependent variables are known as control variables. There are
different types of control variables like as company size, risk and growth these can affect
the company Performance. The control variables are vary from sector to sector however
Large companies have better opportunity of high Performance results because they have
large scale of economic resources (Klapper, 2004).
3.6 TOOLS AND ECONOMETRICS TECHNIQUES
3.6.1 Jarque-Bera Test for data Normality
35
Jarque-Beratest is use through E-Views software to ensure the data normality, whether the
data follow the normal distribution or not. If data follow the normal distribution we reject
the null hypothesis.
3.6.2 Descriptive Statistic

Descriptive statistics is used to summarize and describe data. I make organize descriptive
analysis in which my main focus on central tendency and dispersion coefficient.
3.6.3 Multiple Regression Analysis

I constructed CGI (Corporate Governance Index) by using Exploratory Factor Analysis. For
hypothesis testing we use Panel data methodologies and Multivariate Data Analysis in
which we deploy Multiple Regression Analysis as previously used by (Arshad Hasan,
2009), (Abor, 2007), (Bokpin and Arko, 2009) and (Amarjit S. Gill, 2011).
3.6.3.1 Fixed Effect Regression Model

The key purpose of using the Fixed Effect Regression model is to check and control to
unobservable and omitted variables i.e. behavior of consumer, culture of firm, structure of
firm and tenure of CEO (Hennessy, 1997) that influence the company Performance .
Normally, the fixed effect regression model practice is relating to issue of

heterogeneity. The following model is used for this purpose.
MODEL
The following model equation includes financial Performance as dependent variable, capital
structure independent variable and Corporate Governance Index (CGI) is the moderating
variable. Moreover, it also include the corporate governance sub-index’s i.e. BSS, OSS, DS
and control variables.
(1) FP = β0 + β1 (CS) + β2 (CGI )

+ β3 (CS * CGI ) + β4 (CV) +𝛆𝐢𝐭
36
(2) FP = β0 + β1 BSS+ β2 OSS+ β3 DS+𝛆𝐢𝐭
This technique has been previously used by (Ifrah Sohail, 2013) with the assumption
that all firms are acting good in the financial market so the value of coefficient (β) is similar
for all firms and all the firms doing business during the period of study, while dimension for
time has been ignored. (Hsiao, 2003)mentioned that the issue of heterogeneity is the main
reason to use the Fixed Effect Regression Moles.
37
3.6.3.2 Hausman Specification Test
After the doing the both Fixed Effect Regression (FER) model and Random effect
regression (RER) model the further next step is the selection of one model, Hausman
specification test is used for this purpose. The Hausman Specification technique observed
the expected relationship between the dependent variable and unobservable random effects.
3.6.3.3 Fixed Effect Regression Model Conditions

Random Effect Regression Model is not well-suited in the study if the correlation exists
between the dependent and unobservable variables. Then suggested Fixed Effect Regression
(FERM) Model should be used.
38
CHAPTER 4
DATA ANALYSIS AND INTERPRETATION
To scrutinize the role of Corporate Governance (CG) Practices on the association between
Financial Decisions and Financial Performance quantitative data analysis techniques is used
in this study. Moderating variable i.e. Corporate Governance (CG) is measured by CGI
index distributed into three sub-index. Capital structure (CS) that is dependent variable
defined as the debt ratio. Independent Variable i.e. RE and RO with control variable size,
growth and risk has been used for this empirical investigation model. Descriptive statistics
and multiple regression model techniques are used to get the empirical results in this
research.
4.1 DESCRIPTIVE STATISTICS

Descriptive data analysis in mentioned in Table 4.1 below for the moderating variable i.e.
Corporate Governance Index (CGI), Independent variable i.e. Capital structure (CS) and
dependent variable i.e. RO, RE and control variable i.e. size, growth and risk.
Table 4.1 Descriptive Statistics
39
Descriptive Statistics Summery
Table 4.1 demonstrates and illustrates the summary of the descriptive statistics of the
independent, moderating and control variables. The table shows the typical directions of
variables used in this model. Descriptive results show that the score of CGI for the
manufacturing sector firms of Pakistan ranges from 0.4504 to 1.1118 with mean and median
of the firms is 0.5478 and 0.5702. These ratings shows that the manufacturing sectors firms
of Pakistan have strong a strong compliance and control of corporate governance practices
and corporate governance possibly improves the corporate governance and decision making
process. The maximum score for sub index I of board structure is 14.000 with minimum
score 05.000 and average score is 88% which shows that Pakistani manufacturing firms
have strong and effective board control. The minimum score of sub index II is 18.571 and
maximum score is 89.569 and mean score is 74.12% which indicates that manufacturing
companies are describe the greater concentration of Ownership and those control and voting
power is only control 11% owners.
The sub index III of transparency and Disclosure has range of score from 59 to
87.345 and mean score of 76.270 which indicates that the manufacturing firms do fair
Disclosure and transparency in the annual reports and do compliance with Corporate
Governance Code 2012 and SECP rules.
The average score of moderating variable (second independent) is about 60% which
indicate that corporate governance has positive and strong influence on the capital structure
which leads to high financial Performance.
The mean and median of capital structure / debt ratio (calculated by debt /equity +
debt) of the firms is 0.3017 and 0.150 respectively. This indicates that total debt comprised
about one third of the capital of the firms. It means, about 30 per cent of total assets are
supported by debt while Equity capital consequently signifies 70 per cent. This shows that
most of Pakistani manufacturing firms (listed) use equity capital instead of taking loans
from banks or offering bonds.
Moreover, the dependent variables RO and RE have the average rating of 77.78%,
75.31% and ranges from -21.7185 to 22.322 and -0.7400 to 0.4489 respectively.
40
Finally, the mean growth value is 0.2736. This indicates that, on average growth rate
in sales is 27.36% during the six-year period while the probability of risk is also too much
high in manufacturing sector of Pakistan.
4.2 REGRESSION ANALYSIS

To assess the moderating effect of corporate governance mechanism on the relationship
between capital structure and financial performance multiple regression model have been
used. Control variables i.e. growth, size and risk. Three hypotheses are framed for the
model.
i) Moderating effect of Corporate Governancepractices on the association between

capital structure and Firm Performance
by using the Performance Indicator RO
To check the moderating role of corporate governance on return of assets (RO) and
debt ratio the following model is used with control i.e. size, growth and risk.
Research for Model (I)
RO = β0 + β1 (CS ) + β2 (CGI ) + β3(CS * CGI ) +β4(CV)
Table 4.2 Regression Analysis

Estimation Results for Model (I)
41
The regression results in Table 4.2 shows that corporate governance Index and
capital structure (debt ratio) has statistically significant and positive influence on RO with
the coefficients 0.0439 & 0.291 respectively. The slop coefficient of interaction term 1.360
indicate that the moderating impact of corporate governance Index is also significant and
positive impact on RO as evident from coefficient value. So we reject the null-hypothesis.
In addition, the control variables risk and growth both are also significant but one variable
firm size is not significant as P-value 0.000 shown in the Table 4.2.
Additionally, the value of F-statistics shows that test is appropriate and good as the
evident from the p-value. Coefficient of determination (R-square) value shows that 64%
variation in RO is due to the exploratory variable i.e. good corporate governance practices.
ii) Relationship of Corporate Governance Sub-Indices and Financial Performance

by Using Performance Indicator RO
Research Model (II)
RO = β0 + β1 BSS+ β2 OSS+ β3 DS+ β4 (CV)
Table 4.2.1 Estimation Results for RO
42
It has been found that the model is overall a good fit as R-Square is 0.55805 which
suggests that 56% variation in the dependent variable (RO) has been explain by the change
in exploratory variables, while the 44% variation in RO is due to other factors. Moreover,
the F-statistic also shows that the fitness of test is good as evident from P-value .00004.
The fixed effect regression result shows that the sub-indices of Corporate
Governance Practices, board structure (BSS-I) and Disclosure and transparency (DS-III)
both has positive and statistically significant relationship with RO as the coefficient values
1.32238 & 0.64512 shown respectively. However, the sub index of Ownership structure
(OSS-II) has not significant association with the financial Performance as P-value of this
index is 0.085.
In last, the control variables risk, growth and firm size all are also statistically
significant relationship with explained variable’s RO as evident from P-value and t-statistic.
iii) Moderating effect of Corporate Governance practices on the association

between Capital structure and Firm Performance
Using RE as Performance Indicator
43
To check the moderating impact of corporate governance on capital structure and
return of equity (RE) the following model is used with control i.e. size, growth and risk.
Research Model (I)
RE= β0 + β1 (CS) + β2 (CGI ) + β3(CS * CGI ) + β4(CV)
The following null and alternate hypotheses are to be tested by using regression
model.
Table 4.2.2Empirical Results for Model (I)
The regression results in Table 4.4 shows that corporate governance Index and
capital structure (debt ratio) has positive and statistically influence on RO with the
coefficients 0.75471 & 0.43551 respectively. The slop coefficient of interaction term
1.01225 indicate that the moderating impact of corporate governance Index is also
significant and positive impact on RO as evident from coefficient value. So we reject the
null-hypothesis. In addition, the control variables risk and firm size both are also significant
but one variable growth firm is not significant as P-value 0.06 shown in the Table 4.4.
44
Furthermore, the value of F-statistics indicate that test is appropriate and good.
Coefficient of determination (R-square) value shows that 47% variation in dependent
variable i.e. firm Performance is as a result of the good governance practices.
iv) Relationship of Corporate Governance Sub-Indices and

Financial Performance by Using Performance Indicator RO
Research Model (II)
RE = β0 + β1 BSS+ β2 OSS+ β3 DS+ β4 (CV)
Table 4.2.3 Empirical Results for Model (II)
The empirical result shows that the model is overall a good fit as R-Square is
0.590931 which indicate that 59% variation in the dependent variable (RE) has been explain
by the variation in exploratory variables, while the 40% variation in dependent (RE) is due
45
to other factors. Moreover, the F-statistic also shows that test is appropriate and good as
evident from P-value .000001.
The regression result shows that the sub-indices of Corporate Governance Practices,
board structure (BSS-I) has statistically significant and positive relationship with RO as the
coefficient values 0.25328 shown in the table. However, the sub index of Ownership
structure (OSS-II) and Disclosure and transparency (DS-III) both have not significant
association with the financial Performance as P-value of this index is 0.0760 and 0.0906
respectively.
In last, the control variables risk, growth and firm size all are also statistically
significant relationship with explained variable’s RE as evident from P-value and t-statistic.
46
CHAPTER 5
RESULT OF HYPOTHESIS
Table 5.1 Result for Hypothesis

RESULT OF HYPOTHESIS
Sr.
Hypothesis P-Value Result
No.
Leverage levels and firm Performance RO do not have
Ho.1 0.0060 Rejected
a positively significant relation
Leverage levels and firm Performance RE do not have
a positively significant relation
CGI and firm Performance RO do not have a
positively significant relation
CGI and firm Performance RE do not have a
Corporate governance characteristics and firm
Ho.5 Performance RO and leverage levels do not have a 0.0002 Rejected
Corporate governance characteristics and firm
Ho.6 Performance RE and leverage levels do not have a 0.0050 Rejected
Board structure index and firm RO do not have a
Ownership structure index and firm RO do not have a
Ho.8 0.0850 Accepted
Transparency & Disclosure structure index and firm
RO do not have a positively significant relation
Board structure index and firm RE do not have a
Ownership structure index and firm RE do not have a
Transparency & Disclosure structure index and firm
RE do not have a positively significant relation
47
5.2 SUMMARY OF FINDINGS
For the purpose of empirical investigation of moderating impact of Corporate Governance

Practices on the association between capital structure and firm Performance by RO and RE
of manufacturing sector of Pakistan a composite corporate Governance index (CGI) has
developed. The descriptive analysis and multiple regression estimation give the result about
the impact and significance of relationship. Besides this the relationship between financial
Performance and corporate governance sub-indices score has also been checked and
recorded.
This study empirical result shows that, the CGI score has positive and statistically
significant relationship with accounting Performance. The association indicates that the
listed manufacturing sector firms of Pakistan are working well due to the implementation
and emphasis on Corporate Governance mechanism which leads to the better financial
Performance.
The Corporate Governance Index Moderating effect is also positive statistically

significant on the relationship between Capital structure and financial Performance, that
indicate that manufacturing sector firms are acting well and in a favorable manner by reason
of the implementation and focus on corporate governance practices, which provides the
opportunity to firms to use of good and optimal level of capital structure, which leads to the
high financial Performance.
The sub index I of board structure has significant and positive influence on firm
financial Performance and cause the development in the value of RO and RE. This positive
and significant relationship indicate and suggests that the implementation of independent
board structure, separation of chair of CEO ,proportion of executive and non-executive
director, and efficiency of board with larger size lead to the higher Performance .
The sub index II of Ownership structure do not have significant and positive
association with RO and RE. This is because Pakistani manufacturing firms Ownership is
concentrated and in few hands or describe as family control business. So the result identify
48
that, there must be a stability and equilibrium between the shareholders controlling power
Ownership structure.
The Disclosure and transparency sub index-III also is positively associated with
financial Performance in terms of both RO and RE. It means that, Disclosure of fair and
transparent financial reports, director remuneration, remuneration of director and audit
related party transactions leads to high financial Performance (in terms of accounting
Performance) for Pakistani listed manufacturing firms. On the other hand, most of listed
manufacturing firms have not sufficient capitals and grounds to do full Disclosure.
The capital structure also has positive relationship with both financial Performance
variables i.e. RO and RE. Furthermore, the results also indicate that total debt comprised
about one third of the capital of the firms. It means, about 70 per cent of total assets are
financed by equity capital while debt capital represents 30 per cent. This shows that most of
Pakistani manufacturing firms use equity capital instead of taking loans from banks or
offering bonds.
49
CONCLUSION
To empirically scrutinize the moderating effect of corporate governance practices on the

association between capital structures and firm Performance of manufacture sector of
Pakistan a composite index of corporate governance practices has been developed which
comprised on 12 proxies. For this purpose 173 manufacturing firms listed in the Karachi
stock exchange (KSE) were selected on the basis of availability of data. Furthermore, the
CGI is sub divided into three sub-indices board structure, transparency and Disclosure and
Ownership structure and each comprising four elements. According to code of Corporate
Governance each element of the index has been allotted weight form 100. Zero(0) score was
allocated for no compliance, 50 marks was assigned for partial compliance, for full
compliance 80 marks were assigned and 100 marks were assigned for above the full
compliance. After allocating the marks the average of all sub index were measured and then
get the aggregate marks of these three sub-indices. The data was collected from the annual
reports of these firms for the time period of 2009 to 2014. The independent variable is
capital structure that is measured by the ratio of long term debt to debt plus equity and
Dependent variable measured by RO and RE. Multiple Regression estimation is used which
includes fixed effect and Hausman specification test. Control variables firm size, growth
and risk were also introduce to control the effect of model.
Moreover, the direct relationship of corporate governance index with financial

Performance and capital structure is also tested in this study. The descriptive statistics also
shows the comparative importance of each variable in terms of variations.
This study empirical results specify that, the Corporate Governance Practice Index
(CGI) and firm accounting base Performance is significantly and positively linked. The
association indicates that the listed manufacturing sector firms of Pakistan are working well
due to the implementation and emphasis on Corporate Governance mechanism which leads
to the better financial Performance. The Corporate Governance Index Moderating impact is
also positive and statistically significant on the relationship between Capital structure and
financial performance, that specifies that manufacturing sector firms are performing well
due to the implementation and focus on Corporate Governance Practices, which provides
50
the opportunity to firms to use of good and optimal level of capital structure, which leads to
the high financial Performance.
The Corporate Governance each sub index has also been scrutinized to check their
influence on firm accounting base financial Performance. The coefficient and probabilities
values of each sub-indices indicate that these have significant and extensive impact on firm
Performance as stated in the empirical analysis.
The results indicate that Board Structure of listed manufacturing firms has
significant and positive influence on firm Performance which lead to increase in the value
of RE and RO. The results indicate that the Pakistani listed manufacturing firms is
characterize with large board size, the implementation of independent board structure,
separation of chair of CEO ,proportion of executive and non-executive director, and
effectiveness of board with larger size lead to the higher Performance. However, the
Ownership structure has not positively and significantly associated with firm performance,
because most of Pakistani manufacturing firm’s Ownership is in few hands or describe as
family owned business that results in weak law enforcement and inequality in Ownership
structure and disproportion shareholders controlling power. So the result identifies that,
there must be a balance between the structures of Ownership and shareholders controlling
power.
The transparency and Disclosure is also positively linked to the firm Performance
but due to lack of awareness , resources, and inefficiency of institutions the Pakistani
manufacturing firms are incapable to show the full and fair Disclosure in their financial
statements.
Currently, the understanding about the significance of Corporate Governance

practices is growing is not only in Pakistan and also in other emerging countries. A lot of
work has been done by Securities Exchange Commission of Pakistan (SECP) for the
development Corporate Governance code 2012. But there is a need of good governance and
effective implementation of Corporate Governance Practices in manufacturing sector of
Pakistan, so it is recommended that the Security Exchange Commission of Pakistan (SECP)
should introduce the new reforms in the Corporate Governance Code 2012 depending upon
the need of the country.
51
RECOMMENDATION
Corporate governance (CG) practices have substantial effect on the relationship between
financial Performance and capital structure of manufacturing firms of Pakistan. As the
implementation of good corporate governance, the shareholders and managers of firms as
well as stakeholders are directed by cods and laws which direct the firm towards the growth
and financial stability. Good Corporate governance is essentially involves in fare balancing
of interests of the corporate stakeholders in a corporation. It provides the right direction that
how companies should work and be supervised in the best interest of all stakeholders. In
addition, the main function of the Corporate Governance is to manage all the stakeholders
those have controlling effect on company such as suppliers, shareholders and creditors.
Corporate Governance leading the company to cut down the agency problems and
maximize the investors’ assurance and appropriate administration of investment. Moreover,
the good effective corporate governance practices carries imperative success in the financial
market, increasing the investor belief and proper administration of the portfolio investments.
The empirical results of this research suggest that corporate governance practices
index has core three dimensions i.e. Board structure, Disclosure and transparency and
Ownership structure. These cited elements are differ in their features for both areas i.e.
financial and non-financial. This study exposes the significance of Corporate Governance
(CG) practices in non-financial sector. The board structure of manufacturing sector of
Pakistan is having normally larger board size indicate good and effective configuration of
board. Ownership structure shows the Ownership concentration of larger shareholders,
managerial and family Ownership.
Currently, the most of emerging countries are passing through the financial
management. Now the core requirement is the implementation good corporate governance
mechanism which leads the economy on the way of financial growth and stability.
Therefore the mangers and policy formulator must have a strong insight look into corporate
governance mechanism. The Stakeholders of the companies must also have complete
knowledge and awareness of corporate governance practices.
Future research, should be organize with the application of advance statistical and
econometrics analysis techniques on large sample size for new finding beyond the Pakistani
manufacturing firms.
52
LIMITATIONS
The range and scope of this study is limited to the sample of Pakistan manufacturing
firms. The sample selection is only limited to the non-financial of Pakistan sector while the
financial sector is ignored.
Furthermore, sample size is small and comprised on 173 firms only. The secondary
data is taken from annual report of companies for the period of 2009-2014. The decision
criteria is based on secondary data (past data) while the present and expected data for future
has been overlooked.
The key purpose of this research was to empirically investigate the moderating
effect of Corporate Governance on the association between capital structure and financial
Performance in terms of accounting Performance i.e. calculated by Return on equity and
Return on asset while the market base Performance measure like as. Tobin’s Q is ignored.
Finally, the study is based on the development of corporate Governance index which
is depend upon internal mechanism. The external mechanism like as laws related to market
operations, merger and acquisition and takeover has been ignored.
53
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MODERATING IMPACT OF CG ON THE RELATIONSHIP

BETWEEN CAPITAL STRUCTURE AND FINANCIAL

Impact of CG on the Relationship Between Capital Structure And Financial Performance:

Head Business Studies Supervisor: Mrs. Farah Amir

Thanks to Almighty Allah Whose unending blessings enabled me to accomplish this

3.5.4 Control Variables.............................................................................................. 35

3.6.3.2 Hausman Specification Test .............................................................. 38

3.6.3.3 Fixed Effect Regression Model Conditions ...................................... 38

CHAPTER 4 DATA ANALYSIS AND INTERPRETATION ................................. 39

3.4.2 Determine Sample Size 22

No. Abbreviation Term

Keywords: Corporate Governance Index, Capital Structure, Financial Performance,

Cases of inefficient, ineffective management and poor corporate governance are

Manufacturing Companies facing difficulties due to lack of Good Governance which

1.2 ADVANCEMENT OF CORPORATE GOVERNANCE

Different Cases of inefficient, ineffective management and poor corporate

In Pakistan the key legislative framework of Corporate Governance (CG) comprises

The stock exchange of commission of Pakistan set forth the decentralization of

1.3 THEORIES OF CORPORATE GOVERNANCE (CG)

In the viewpoint of corporate Governance practices the primary problem is the

1.3.1 Principle-Agent Theory

1.3.2 Stewardship Theory

Another theory is Stewardship theory that creates a substitute approach to produce

Stewardship theory is distinguished form the principal-agent theory on the basis of

A stakeholder theory is relates to the balance of interest between shareholders and

In future, Corporate Governance practices are anticipated to have impact on the

1.3.4 Political Theory

Textile Sector 09% CONSTRUCTION &

The manufacturing sector of Pakistan is the back-bone of Pakistan exports, its

According to the Pakistan MPD&R (Ministry of Planning, Development & Reform)

1.5 OBJECTIVES OF THE STUDY

1. To analyze the moderating impact of corporate governance on the

2. To evaluate the relationship between Corporate Governance practices,

1.6 SIGNIFICANCE OF THE STUDY

 The manufacturing sector is an important, significant and valued sector of

1.7 CONTRIBUTION TO THE RESEARCH

A comprehensive index of good Corporate Governance (CG) practices has

Mitton (2004) Mentioned that good Corporate Governance (CG) practices of

Proportion of Outside Director

Proportion of Executive Director

A company ownership is owned by the external shareholders as well as management.

Disclosure of Corporate Governance Practices

Audit Related Committee

An independent and autonomous committee for assessment is helpful for the

2.3 CORPORATE GOVERNANCE INDEX

(Lehmann, Warning et al. 2004) mentioned that the concept of Corporate

2.4 CAPITAL STRUCTURE

2.5 FINANCIAL PERFORMANCE

Corporate Governance rules, regulations, mechanism and policies have a strong

2.5.1 Return on Asset (RO)

RO is used to assess and estimate the effectiveness of resources used by the

2.5.2 Return on Equity (RE)

3.1 RESEARCH METHODOLOGY

3.2 RESEARCH PROBLEM

In order to examine the moderating role of Corporate Governance Practices

The Corporate Governance practices index influence on the connection between

 What is the association between Capital Structure and financial

 What is the association between CG (corporate governance) practices and

 What is the association between corporate governance practices and capital

3.4 RESEARCH DESIGN

Determine Sample Size

Sample size needed: 207

3.4.3 Time Span of the Study

Secondary data is acquired from the annual reports of listed manufacturing