| Increased corporate failures worldwide have brought corporate governance back into the spotlight.However,there have been disputes and disagreements about whether corporate governance procedures assist firms in achieving higher performance levels or are counterproductive.A lot of corporate scandals,the closure of businesses,the financial crisis,and the declining industrial contribution to GDP in the context of the revision of codes by the Securities and exchange commission of Pakistan(SECP)and the organization for economic cooperation and development(OECD)necessitated research into the subject.It is also necessary to conduct this study because corporate governance is vital to a company’s success.This research investigates how corporate governance increases firm financial performance through the intervening role of abnormal cash(composed of excess/ deficit cash).As per the tradeoff model(1999),firms have an optimal cash level at which the marginal benefit of keeping cash equals the marginal cost.If companies have an optimal level of cash,deviation from this optimal upside(excess cash)or downside(deficit cash)should negatively affect a firm’s financial performance.Cash is directly responsible for investments,financing,payouts,operations,and firm performance(FP).Businesses would face costs and uncertainties if they deviate from optimal cash and have abnormal cash(deficit or an excess of cash).When a company has an excess of cash on hand,this does not guarantee that the company’s managers adhere to a corporate plan that safeguards shareholders’ and other investors’ interests;they may increase overinvestment in negative NPV projects and use the extra cash for personal benefits because of separation of ownership and control.In order to reduce the likelihood of unethical behavior by managers,better corporate governance should be instituted to align management with the interests of shareholders better and reduce cash flow towards optimal.If a firm is holding deficit cash,managers overlook transaction motives and increase the chances of bankruptcy risk,so governed firms enhance firm financial performance by shifting abnormal cash towards optimal to align management with the interests of shareholders better.Therefore,the mediating role of abnormal cash(excess/deficit)in the governance-firm financial performance association is investigated in detail,which is a more concerning issue for shareholders.Moreover,the moderating role of firm life cycle stages in the nexus between corporate governance and firm financial performance is examined.As per Miller and Friesen(1984)distinct stages make up a firm’s life cycle: birth,growth,maturity and decline.Cash flow patterns are used to measure firm life cycle stages as a reliable measure given by dickindon et al.,(2011).This enhances our understanding of how governance impacts firms’ financial performance as they move through their life-cycle stages(introduction,growth,maturity,and decline).Further,we also conducted additional analysis to show that in the case of excess cash,whether firms,through effective governance,utilize it for investment purposes,dividend payments,and retiring debt or increase working capital and in case of deficit cash,either governed firms manage cash by cutting dividends,capital expenditures,reducing working capital or increasing debt.In addition,for the detailed examination of the adoption of corporate governance practices,the overall corporate governance index and sub-indices have been developed,along with individual governance variables.Instead of considering single corporate governance characteristics,the current research also developed a composite corporate governance index(CGI).A few sporadic attempts to create a corporate governance index have been made in Pakistan.Therefore,this study suggests an index with the capability of enhancing performance by including board composition(BCOSI),board characteristics(BCSI),board activity(BASI),audit committee structure(ACSSI),governance disclosure(GDSI)and board financial expertise index(BFESI)based on most relevant and repetitive provisions of Pakistan’s corporate governance code(2002,2012,2017)and relevant literature to investigate the role of effective corporate governance towards firms’ performance.The study used panel data from 2009 to 2017.A total of 243 companies are included in the study.Accounting and market-based proxies are used to analyze the firm’s financial performance.These proxies include return on assets and Tobin’s Q.A generalized method of moment is used to analyze the data to resolve econometric issues.It is confirmed from the study findings that the corporate governance index positively impacts the firm financial performance.Therefore,firms with appropriate institutional governance mechanisms can manage corporate affairs effectively and efficiently.Moreover,the study sub-indices,including the board composition sub-index,board characteristics sub-index,board activity sub-index,audit committee structure sub-index and the governance disclosure sub-index,also confirmed the positive association with financial performance.Furthermore,the finding revealed that the corporate governance index negatively impacts abnormal cash,which indicates that,with better monitoring and advising,firms reduce the cost of excess cash and uncertainties of deficit cash.Additionally,the study found that corporate governance subindices are negatively associated with abnormal cash except for the board activity sub-index,indicating that increasing the number of board meetings and board attendance isn’t associated with reducing abnormal cash.Further,findings also confirmed that abnormal cash negatively impacts firm financial performance,indicating that the cost and uncertainties associated with excess and deficit cash negatively impact firm financial performance.Regarding the mediating role of abnormal cash between the composite corporate governance index,sub-indices and firm financial performance,the results indicated composite corporate governance index has an indirect influence on corporate performance(ROA and Tobin’s Q).Furthermore,the study found that abnormal cash partially mediates between the governance index-firm financial performance linkage,board composition-firm financial performance linkage,board characteristics-firm financial performance linkage,and audit committee structure-firm financial performance linkage and has no mediation between board activity-firm financial performance linkages.Moreover,abnormal cash fully mediates between board financial expertise-firm financial performances linkages.Regarding the moderating role of firm life cycle stages between governance and firm financial performance,it is concluded that the corporate governance index has a significant positive impact on firm financial performance at the introduction,growth,maturity and decline stages of the firm life cycle.These results demonstrated companies that following governance stricter regulation fits the needs of the organization at each stage of the life cycle,while board composition,board activity,and audit committee structure increase firm financial performance only at the growth and maturity stage,and governance disclosure has increasing impact on firm financial performance only at maturity stage.Further,study finds that firms with effective governance utilize excess cash on dividend payment,retiring debt and increasing working capital and overcoming deficit cash by increasing debt and reducing working capital.The current study concluded that a corporate governance mechanism is essential when companies attempt to improve their performance.Further abnormal cash is a channel through which governance can increase the firm performance by reducing its abnormal cash by taking into consideration of precautionary,transaction,speculative and agency motives of firms and making a balance at which the cost of cash holding reduces its benefits(Opler,1999).The research findings support the themes emerging from the trade-off and agency theory.As a result,the study has many policy implications,including investors should consider companies with good corporate governance as they have the optimal cash holdings,demonstrating that good governance helps firms manage both the upside and downside associated costs with cash,firms exposed to higher performance reduce their abnormal cash,more focus on enhancing financial experts on board,align board composition with governance code,more focus on board characteristics: more females on board,chairman/CEO role separation,better audit structure,tightening governance regulations because the existing ones appear to have only a cosmetic effect.Also,policymakers should customize corporate governance policies for each stage of the firm’s life cycle to achieve sustainable financial performance throughout the firm’s life.Reforms in this area are urgently required,and policy formulation may be used to support reforms.The code may be amended to include oversight of the company stage and more strict disclosure obligations. |
