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Financial distress has been considered as an important area of research for academicians and managers. Despite this, the role of corporate governance in financial distress in Pakistan lacks empirical evidence yet. This research examines the role of corporate governance practices on financial performance and the likelihood of financial distress for a cross section of 146 companies listed at the Karachi Stock Exchange for the period of 2003-2012. The analytical framework is based on the agency and stewardship theories. Corporate governance variables are operationalized in terms of ownership structure, and board structure. Additionally, ownership structure is measured through institutional ownership, insider ownership, foreign ownership, and government ownership. Board independence, board size and CEO duality is used to measure board structure. For firm’s financial performance, accounting-based measures such as return on asset (ROA) and return on equity (ROE), and market-based performance measures such market to book ratio (MBR) and Tobin’s Q (TQ) are used. The Altman Z-score is used as a proxy for financial distress. The dynamic panel generalized method of moment (GMM) is applied to investigate the association between corporate governance practices and firm’s financial performance, while pool logistic regression is deployed to examine the role of corporate governance practices on the likelihood of corporate financial distress. The empirical results reveal positive and significant relationship between institutional ownership, insider ownership, government ownership and financial performance of the selected companies during the period 2003-2012. A positive relationship between the internal corporate governance practices (that is, Board independence and Board size) and corporate financial performance was also observed. The results further reveal that in the presence of board independence, CEO duality has a positive and significant impact on both the accounting-based and market-based financial performance of the sampled companies in Pakistan. Furthermore, we also observed a positive and significant relationship between insiders’ ownership and the likelihood of corporate financial distress. The findings also reveal significant negative impact of foreign ownership and board independence on the likelihood of financial failure. It is also observed that firm-specific variables such as profitability, liquidity and size have a decisive role in determining the likelihood of corporate financial distress. In overall term, this study provides useful information for corporate managers, policy makers and investors about the corporate governance practices, financial performance and the likelihood of financial distress in Pakistan.”
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