Corporate Governance, Financial Distress Cost, and Financial Constraint in PSX Listed Firms

Abstract

Corporate Governance, Financial Distress Cost, and Financial Constraints in PSX Listed Firms Since the aftermath of large businesses like Enron, World Com, and Toshiba in an international context, the Asian Financial Crises (AFC), the stock market crises of 2002, and global financial crises (GFC), the government and regulatory authorities around the globe took corrective measures to revamp their respective corporate governance system to avoid such incidents in future. There is a consensus that a weak regulatory system, poor implementation of the law, and inefficient governance practices are the major contributors to such failures, which eventually lose investors' confidence in the capital market. Developed countries and developing countries take such corrective/initiative measures to safeguard the situation. The present study investigates the role of corporate governance mechanisms on financial distress cost and financial constraints. The first stage investigates the association between corporate governance and financial distress cost; the second stage reports corporate governance's impact on financial constraints. The study used a sample of 215 Pakistan Stock Exchange (PSX) listed firms from 2010 to 2018 to conclude the findings. The study's findings revealed that an effective corporate governance mechanism saves firms from financial constraints and minimizes financial distress cost. The constitution of an audit committee and board mechanism as an effective governance measure is essential for enriched firm progress. The compensation and monetary incentives paid to top executives keep aligning with stakeholders and save firms from financial constraints and financial distress cost. The presence of block holders, foreign ownership, and institutional ownership need to be more strengthened to play its vital role in saving the firm from any unpleasant situation in the future. Additionally, a composite measure of governance index shows a significant inverse association with financial distress cost and financial constraints, which corroborates that the higher the firm's governance quality, the lower the financial distress cost and financial constraints. Finally, the study suggests some practical implications based on findings to investors, policymakers, and managers.