The impact of corporate governance on financial distress likelihood: an empirical evidence

Abstract

Present study examines the role of corporate governance on the likelihood of financial distress for a sample of 1810 firm-year observations of Pakistan Stock Exchange (PSX) listed companies over the period 2010-2018. Panel Logistic Regression technique is used to conduit the relationship between CG and financial distress after confounding effects of leverage, net profit margin and management efficiency. Altman Z-score is used to measure the financial distress of sample firms as it measures financial distress inversely. The higher the value of financial distress lower will be the probability of financial distress. Result reveals that audit committee size and audit committee independence shows significant positive while external auditor’s quality shows significant negative association towards financial distress. Among board governance variables; board size and CEO dominance have significant negative relationship while duality found negative associated with financial distress. Ownership structure variables show significant negative association with financial distress except ownership concentration that shows positive relationship with financial distress. An evidence of significant negative relationship found between governance index and the likelihood of financial distress, higher the governance index lower will be the probability of financial distress. To the best of the author’s knowledge, this is one of the first empirical attempts at providing evidence on the relationship between corporate governance and the likelihood of financial distress by incorporating an audit committee structure, board structure, ownership structure and a composite measure of governance index simultaneously in Pakistan.