Implimentation Of Corporate Governance In Pakistan

Published Date: 02 Nov 2017

CHAPTER 1 INTRODUCTION

1.1 Overview:

Corporate governance is a term that refers generally to the regulations, processes, or set of laws by which businesses are operated, regulated, and controlled. It also refers to internal factors defined by the officers, stockholders or constitution of a corporation, also includes external forces such as consumer groups, clients, and government rules and regulations (UK Cadbury Code, 1992).

UK Cadbury Code (1992) further explains clear and enforced corporate governance gives a system that, at least in the theory, works for the goodness of everyone concerned by ensuring that the enterprise sticks to the accepted ethical standards and best practices as well as to proper set of laws and to what extent organizations have been made at the regional, national, and global scenarios. Key features of the governance are transparency, participation, accountability and predictability.

It has been observed that in the past years, corporate governance has achieved more consideration due to high-profile scams together with misuse of corporate power and, in some cases, alleged immoral activity by corporate officers. Corporate failures includes Enron, WorldCom, One-Tel, Ansett, Parmalat and Pakistani company’s scandals includes; Taj Company, Cresent Bank, Mohib Textile Mills Ltd, PTCL, Engro group of companies, Mehran Bank etc.

Since the inception of corporate governance in 1999, the SECP has paid attention to its regulatory procedures on fostering investor’s self-confidence to support good corporate governance to make sure of the transparency and accountability regarding the business zone and safeguard the interests of all its investors, especially of minor shareholders. In March 2002, Pakistan’s first code of corporate governance was finalized. Overall the endorsement of Corporate Governance principles has upgraded the organization by ensuring transparency & accountability in reporting framework (Rais & Saeed, 2005).

Corporate governance on one side is about setting up a system of entrusting the directors and managers with responsibilities in relation to running corporate affairs and on the other hand it is concerned with accountability of those directors and managers.

1.2 Significance of the Study:

Pakistan has passed the first stage of signing up the code of corporate governance. Our pace is adequate and we are making improvement. Down the road of challenges are : to design appropriate evaluation and monitoring mechanisms, to enforce accountability and to have warning systems which automatically triggers prompt corrective actions.

The need is to provide the board of directors and management with adequate powers to exercise in clearly defined lines of responsibilities so that they stand accountable to the shareholders in the pursuit of maximization of value of money.

To make the corporations, feel the need of good corporate governance in globalized world, where perception of both international and local investor is driven by management structures and credibility of business. In such a situation, organizations must proactively plan their culture specific codes and keenly implement instead of sitting and waiting for rules to be forced from external constituents.

Corporate governance has turn out to be a question of universal significance. The development of corporate governance is widely acknowledged as one of the main component in firming the foundation for the enduring economic enactment of the nations and governments.

1.3 Objectives of the Study:

To empirically examine the corporate governance mechanics practiced in Pakistan.

To investigate the extent to which these mechanics are being followed by chemical sector in Pakistan.

CHAPTER 2 LITERATURE REVIEW

Companies with good governance and more transparency are valued higher in the stock market due to the investors’ confidence that they would end up with their unbiased share of companies’ profits. The positive impact of good governance on the company’s value is stronger in countries with fragile legal systems. On another hand, good governance should be valued more in the countries where it is rarely named, in weak legal governments (Durnev and Kim, 2007).

Corporate governance is gradually becoming more important to investors, because well-governed firms and companies having lesser risks and smaller amount of unexpected events can safe guard shareholders rights and endow with better assurance that administration will act in the benefit of the company and shareholders (La Porta, Lopez-de-Silanes, Shleifer and Vishny, 1997 and 1998).

Lin Chen et al. (2008) emphasized three different elements of the Board of Director’s characteristics.1- Presence of outside directors on the board. 2- Chief Executive Officer (CEO) duality 3- Board meetings.

2.1 BOARD SIZE:

Board of directors was deliberated as one of the key mechanisms of corporate governance which offers an effective guiding and monitoring device to reduce the agency issues. As a result, there were added provisions to the stakeholders and other (Saad, 2010).

Gov-Score was organized for the firms in US which were a comprehensive degree of Corporate Governance by Brown and Caylor (2004) and their results specified that well governed firms are comparatively more cost-effective, valued and could reimburse greater amount of cash to their stakeholders. They also found that firms consisting board sizes stuck between 6 and 15, yields greater ROE and more net profit margins than the firms are having different board sizes.

Most companies also have a representative of minority shareholders on board that is not usually increased with increasing board size (Drobetz et al., 2004b). Brown and Caylor (2004) also suggest that a board size between 6 to 15 members is ideal to enhance the firm performance. Yermack (1996) predicted that those firms which had small board size used to have greater stock market worth. He found a negative relation among the firm worth and board size and he used a section of large United States corporations. Kathuria and Dash (1999) claimed that the firm's performance rises if the size of the board is increased but the involvement of an additional member drops as the board size is increased. Boards with weak members can lead firms to lower profits (Eisenberg, Sundgren and T. Wells, 1998). Mishra et al. (2001) indicated that small size of the board helps to draw the conclusion more rapidly.

2.2 BOARD COMPOSITION:

The presence of non-executive directors helps in raising the capital and diminishes the uncertainties regarding the companies but on the other hand existence of large numbers of non-executive directors escorts to higher debt levels (Pfeffer and Salancick, 1978). Jensen (1986) and Berger et al. (1997) are in line with the results. On the other side, Wen et al. (2002) studied that there was a significant inverse relation among leverage levels & number of external directors.

Board members at the same time approve and monitor management’s performance; these are the roles of board members which have been defined by Fama and Jensen in 1983. Demsetz (1983),

The study by Bathala, C. T. and Rao, R. P. (1995) examined the interrelationship among the board composition and parameters that seizure numerous agency and economic magnitudes of the company. The literature on agency suggested that non- executive board of directors provided significant observing purposes in an effort to determine, or at least to alleviate agency problems among controlling head and stakeholders.

The literature on agency issues indicated that other tools such as dividend payments, debt leverage and managerial equity ownership also assist as main strategies in decreasing agency problems in the company. This study argued and documented that a negative relation existed among the percentage of outside board members and dividend payout and debt leverage. Board composition was also determined to be analytically connected to the number of other parameters together with CEO tenure, growth institutional holdings and volatility.

Essen, J. Hans and Carney (2012) examined that the dominance of ownership deliberation in companies situated in Asia experimented the agency theory grounded on the role of the boards in the firm. In this study they developed and tested the assumptions about board traits and company performance that revealed Asian recognized structures. They documented the major meta-analysis of regarding the relation among board traits and enactment of Asian companies using a diverse system of meta- analytical procedures based on 86 studies consisting 9 Asian countries.

The organizations that practice good corporate governance are more cost-effective and affluent. While earning more, these organizations also compensate more to the shareholders. Lawrence also associated good corporate governance with directors and executives. Beside this, he also revealed that the businesses which were followed by the charter and laws are more linked to the poor performance. The answers to this study lead to insignificant but direct association among the corporate governance provisions and company performance. All executives appeared in at least 75% of the board meetings, board strategies were in every proxy announcement. It has also been seen that corporate governance boosts the firm value such as transparency and justness (Lawrence et al., 2004).

Kee et al (2003), Hutchinson and Gul (2003) analyzed that the existence of outside directors in a Board of Directors reduces agency cost. That’s why the way companies structure their boards is very important as far as corporate governance is concerned. Fama and Jensen (1983) argued that outside directors ensure the effective running of firm and monitor the management to protect their reputation in the market.

Dare (1998) record that non-executive directors were active observers of the firm's strategy associated problems. O'Sullivan and Wong (1999) stated that NED directors on the board turn out to be less operative if they stay with the unchanged board for several years.

Baysinger and Hoskisson (1990) found that nonexecutive directors and part-time employed board members which limited their scope in understanding the complexities entailed in making informed decisions.

2.3 CEO/CHAIRMAN DUALITY:

Significant discussion is also found on CEO duality. That is when the responsibilities of Chairman and CEO are held by the same person. Fama and Jensen (1983) first started this discussion. Fosberg (2004) found that firms in which CEO duality is present have lower debt to equity while in the firms where these two positions are held by two different people the debt to equity is high. CEO compensation has also been discussed as a characteristic of corporate governance with capital structure in the literature. Leland and Pyle (1977) gave a positive association among CEO compensation and financial leverage while inverse relation was found by Friend and Lang (1988) and Friend and Hasbrouk (1988).

CEO/Chairman duality is a vital characteristic of corporate governance. They effect directly with the decisions of the company regarding capital structure. Fama and Jensen (1983) argued that position of CEO should not be the same as of the chairman in the firm, as CEO is the main decision management authority & chairman is the main decision control authority. Fosberg (2004) founded higher leverage levels with separate CEO & chairman decision powers. Abor (2007) stated a direct association among capital structure and CEO duality.

The split-up of chairman and CEO responsibilities greatly influences the firms’ performance for the reason that when one person takes both positions more agency problems are faced by the firms. Firms are more valued when CEO and chairman responsibilities are distinguished (Yermack, 1996). Core, et al. (1999) found that reimbursement of CEO is less when CEO and chairman designations are not operated by the same person.

As depicted by the agency theory, the adversaries (Levy, 1981; Dayton, 1984) proposed that CEO duality reduces the observing characteristic of the board of directors over the decision-making executive, and this in turn may have a negative effect on corporate performance. Besides this, Donaldson and Davis (1991) stated that stewardship theory focused on the unity of command by the CEO that takes us to explicit management on the dependents and therefore, encourages active decision-making. CEO duality causes information problems as he determines the agenda and information to the board (Jensen 1993).

2.4 OWNERSHIP CONCENTRATION:

Berle and Means (1932) and Jensen & Meckling (1976) gave a model for corporate governance assuming a major tension among stockholders and corporate managers. Whereas the goal of an organization’s stakeholders is to earn maximum return on the asset, executives have many other targets, as the authority and esteem of organizing a enormous and dominant body. In these circumstances, managers have upper hand and they have access to the confidential information and shareholder do not have power and they are dispersed (Fama and Jensen, 1983).

When assessing corporate governance mechanisms and shareholder protection for minorities, ownership concentration is considered one of the significant variables. Majluf et al. (1998) in his study described the structure of 5 Chilean groups, and gave some aggregate indicators of ownership structure and concentration.

Kose John, Lemma W Senbet (1998) focused on the corporate governance mechanisms and their role in improving agency problems initiating from the conflicts between , equity holder and capital contributors, managers and equity holders. They also examined the changeover between internal and external corporate governance mechanisms.

Demsetz and Lehn (1985), and Shleifer and Vishny (1986) presented that shareholders and institutional investors are essentially the managers of equity agency issues and their amplified shareholdings could reward them better incentives to observe the firm’s performance and administrative behaviors. In essence this will help stop the "free rider" problems associated with ownership dispersions.

2.5 DIVIDEND POLICY:

There is very broad study on dividend policy decisions in Anglo Saxon Corporate Governance Regimes (K. Gugler, B.B Yurtoglu, 2003). In transitional economies like Pakistan, the topic of dividend policy decision has not been widely discussed with respect to corporate governance. Dividend policy is a strategic decision in which governance plays a very important role. Whether minority shareholders can motivate the managers to announce dividends or not in those setups where ownership is mostly concentrated can become a big problem. In this study, an effort has been made to solve the puzzle over whether the governance matters for dividend policy in the countries like Pakistan where investor protection is weak (Laporta 2000).

The study of Khaled Hussainey, Khaled Aljifri, (2012) examined the effect of corporate governance mechanisms on corporate financial decisions in one of the emerging economies, United Arab of Emirates (UAE). They inspected the degree to which internal and external corporate governance mechanisms affect UAE firms’ capital structure. UAE managers should be aware of the benefits of the implementation of effective internal and external corporate governance mechanisms while embracing international corporate governance standards. An effective implementation of the codes of corporate governance should improve the efficiency and effectiveness of UAE firms.

2.6 AUDIT COMMITTEE:

April Klein (2000) argued that audit committees are the most important part of a corporate governance system. Kam C. Chan and Joanne Li (2008) concluded that existence of audit committees on boards enhances the value of firms.

CHAPTER 3 RESEARCH METHODOLOGY

Data collection:

The figures for this study are collected from the secondary source which was taken from the prominent Pakistani companies’ annual reports listed on the KSE from 2006-2010. Companies’ annual reports were sufficient for collecting the information regarding corporate governance mechanisms.

Sampling:

This study is aiming to explore the relation among corporate governance mechanisms of 43 non-financial leading Pakistani companies from the chemical sector, which is registered on the KSE from 2006 to 2010. Financial companies are omitted because they are governed by different rules and regulations. To make sure concerning the reliability of data, merely those firms with available and legal data for the appropriate duration have been taken into consideration. Each firm in the sample should also satisfy two standards: they all should be registered in the Karachi Stock Exchange in 2006 and no one of them was omitted for the duration of 2006-2010. Keeping in view the accessibility the sample size consists of 15 firms that were publicly registered on the Karachi Stock Exchange.

TO INVESTIGATE THE IMPLIMENTATION OF CORPORATE GOVERNANCE MECHANISMS IN PAKISTAN, EIGHT VARIABLES HAVE BEEN TAKEN

3.1 Board size:

The boards of directors are the most significant body in the company set up, which plays an essential part in a company’s tactical decisions similar to financial mix. Board size is determined by the number of board executives whether independent or non-executive.

3.2 Board composition:

Existence of non-executive members on a firm’s board gives indication to the market that firm is being examined proficiently so creditors conclude that the firm is of more financial value. In turn, this makes the firm at ease to advance long term reserves through leverage. Board composition denotes the proportion of non-executive directors and is determined by the no. of non-executive directors divided by total no. of directors.

In Pakistan, Code of Corporate Governance has restricted listed companies that non-executive Directors must not be more than 75% of total board size; also encourage the representation of minority shareholders and independent directors.

3.3 CEO/Chair Duality:

If a person represents both the positions of CEO and chairman of the company than it may create agency problems. Greater level of control by CEO may lead to professional adaptable act and can provide less gearing levels in accordance to entrenchment postulate. It is postulated that CEO/Chair duality is inversely associated to debt levels. CEO/Chair duality is included as a dummy variable. The value is taken as 0 if CEO is chairman as well; or else it is taken as 1.

3.4 Board meeting:

Board meetings are conducted so that the members of the board of directors can make decisions regarding the trend of the company. Often board meetings should be held openly, though regularly only the board members attend these meetings. Board of directors meets once every quarter in a year. Frequency and notice of board meetings should be in compliance with the Code of Corporate Governance. Lin Chen et al. (2008) highlighted different fundamentals of the Board of Director’s features comprising of board meetings.

3.5 Audit committee members:

Every listed company should have audit committee and it should be answerable for endorsing to the directors the nomination of outside auditors by the registered company’s stakeholders. The board should consist of an audit committee having minimum 3 members.

3.6 Company Chairman in audit committee:

As founded by Bukhari & Ansari (2010) 73% of organizations were not having company chairman as members in their audit committee.

3.7 Dividend:

Under the companies ordinance a company has no implied authority to distribute dividends even if it has earned a profit the directors have the power to recommend the dividend to general meeting. Dividends can be declared only at AGM when the company has divisible profits and its financial position is such as to permit it to distribute a dividend. Under the listing rules dividends are to be paid at least once in every five years. Firms that do not meet this condition are located on the "defaulters count".

CHAPTER 4 ANALYSIS

This chapter provides the descriptive analysis of the data and discusses the empirical findings in the light of evidence. This chapter includes 1- Descriptive analysis. 2- Discussion.

DESCRIPTIVE ANALYSIS:

The descriptive analysis of each variable of the sample companies in relations of mean, maximum, minimum, standard deviation is prepared to understand the variation in the data for chemical industry of Pakistan.

Table: Descriptive Analysis

AM

BC

BM

BS

CEO

CH_IN

AC

DIV

 Mean

 3.507

 0.706

 4.893

 8.627

 0.200

 0.173

 0.773

 Median

 3.000

 0.750

 5.000

 8.000

 0.000

 0.000

 1.000

 Maximum

 5.000

 0.900

 7.000

 13.00

 1.000

 1.000

 1.000

 Minimum

 3.000

 0.370

 4.00

 7.000

 0.000

 0.000

 0.000

 Std. Dev.

 0.623

 0.147

 0.967

 1.858

 0.403

 0.381

 0.421

 Skewness

 0.818

-0.359

 0.666

 0.874

 1.500

 1.726

-1.31

 Kurtosis

 2.658

 2.156

 2.261

 2.708

 3.250

 3.979

 2.705

 Jarque-Bera

 8.719

  3.839

  7.251

 9.807

 24.489

40.231

  21.583

 

Probability

 0.013

 0.147

 0.027

 0.007

 0.000

 0.000

 0.000

4.1.1 Results:

No. of audit committee members in overall industry is around 4.

71% of the board directors consist of non-executive directors.

About 5 board meetings were held during the year.

Board of directors consisted of 9 members on average.

20% of the companies were having CEO as their chairman as well.

17% of the organizations of the overall industry are having company chairman in audit committee.

77% of the companies declare dividend.