Impact of Corporate Governance on

Financial Reporting Quality:

Evidence from Pakistan
By

Aroob Zia
(MMS-151055)

MASTER OF SCIENCE IN MANAGEMENT SCIENCES

(FINANCE)

DEPARTMENT OF MANAGEMENT SCIENCES

CAPITAL UNIVERSITY OF SCIENCE AND TECHNOLOGY
ISLAMABAD
2017

i
 Impact of Corporate Governance on
Financial Reporting Quality:
Evidence from Pakistan
By

Aroob Zia

(MMS-151055)
A research thesis submitted to the Department of Management Sciences,
Capital University of Science and Technology, Islamabad
In partial fulfillment of the requirements for the degree of

MASTER OF SCIENCE IN MANAGEMENT SCIENCES

(FINANCE)

DEPARTMENT OF MANAGEMENT SCIENCES

CAPITAL UNIVERSITY OF SCIENCE AND TECHNOLOGY
ISLAMABAD
2017

ii
 Copyright © 2017 Aroob Zia

All rights reserved. No part of the material protected by this copyright notice may be
reproduced or utilized in any form or by any means, electronic or mechanical,
including photocopy, recording or by any information storage and retrieval system
without the permission from the author.

iii
 CAPITAL UNIVERSITY OF SCIENCE AND TECHNOLOGY
ISLAMABAD

Islamabad Expressway, Kahuta Road, Zone-V, Islamabad

Phone: +92 51 111 555 666, Fax: 92 51 4486705
Email: info@cust.edu.pk, Website: http”//www.cust.edu.pk

CERTIFICATE OF APPROVAL

Impact of Corporate Governance on Financial Reporting Quality:

Evidence from Pakistan
By

Aroob Zia

(MMS 151055)

THESIS EXAMINING COMMITTEE

S No Examiner Name Organization

(a) External Examiner Dr. Sumayya Fatima Chughtai IIU, Islamabad
(b) Internal Examiner Dr. Arshad Hassan CUST, Islamabad
(c) Supervisor Shujahat Haider Hashmi CUST, Islamabad

________________________________

Shujahat Haider Hashmi

Thesis Supervisor
October, 2017
______________________________ ___________________________
Dr. Sajid Bashir Dr. Arshad Hassan
Head Dean
Department of Management Sciences Faculty of Management and Social Sciences
Dated : October, 2017 Dated : October, 2017

iv
 Certificate

This is to certify that Aroob Zia bearing Registration No. MMS151055 has
incorporated all observations, suggestions and comments made by the external
evaluators as well as the internal examiners and thesis supervisor Shujahat Haider
Hashmi at Capital University of Science and Technology, Islamabad. The title of her
Thesis is: “Impact of Corporate Governance on Financial Reporting Quality:
Evidence from Pakistan”.

Forwarded for necessary action

____________________

Shujahat Haider Hashmi

(Thesis Supervisor)

v
 Dedication

This work is dedicated to my parents who encouraged and supported me in achieving

this milestone and my respected mentor/ supervisor Dr. Arshad Hassan who has been
a constant source of knowledge and inspiration for me.

vi
 ACKNOWLEDGEMENT

I start with the name of Allah, the most beneficent and the most merciful. First of all I
would thank ALLAH, the Almighty for everything. I am thankful and grateful to my
supervisor Shujat Haider Hashmi for providing me with the valuable guidance at each
step that enabled to render my efforts in the right direction from start till the end of
thesis. I owe a deep debt of gratitude to university for giving an opportunity to
complete this work by providing with a healthy environment and means by which I
have studied and completed my degree. I am thankful to my parents and all those who
have encouraged and motivated me throughout my academic career.Lastly, I would
like to take this opportunity to say warm thanks to all my friends, who have been so
supportive along the way of doing my thesis.

Aroob Zia

Reg no: MMS151055

vii
 Table of Content
Chapter 1.Introduction:……………………………………………………...………..1

1. Introduction :…………………………………………………………………...…. 1

1.2 Problem Statement………………………………………………………..…….. 4

1.3 Research Questions…………………………………………………….…..…..…5

1.4 Research Objectives……………………………………………………………...5

1.5 Significance of the study:………………………………………………..…...…..6

1.6 Organization of Study:……………………………………………………......…..6

Chapter 2. Literature Review:……………………………………………………..….7

Literature Review:………………………………………………………………...…..7

Chapter 3.Data and Methodology:………………………………………………...…32

3. Data and Methodology:……………………………………………………..…….32

3.1.1 Descriptive statistics …………………………………………………………..32

3.1.2 Corelation Analysiis …………………………………………………………..32

3.1.3 Panel regression Analysis ……………………………………………………..32

3.2 Model Specification …………………………………………………………….33

3.2.1 Pannel Regressiom model……………………………………………………..33

3.3 Description of variables …………………………………………………..…….33

Chapter 4. Results & Discussion………………………………………………..…...37

4. Results & Discussion……………………………………………………….….….37

4.1 Results & Discussion……………………………………….….. ……….………38

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Chapter 5. Conclusion…………………………………………………………..…..46

References…………………………………………………………………….…….48

Appendix ……………………………………………………………………………60

ix
 Abstract

This study investigates to find out corporate governance mechanism impact on

financial reporting quality of financial sectors in Pakistan. A deeply investigation

made by including the corporate governance mechanism structure and financial

reporting quality. The data is collected of 26 financial firms listed in Pakistan and the

time frame is 2005 to 2014. Penal regression technique is used in this study. The

results of panel least square regression analysis show that: board independence has

positively and insignificant relationship with financial reporting quality. INST has

negative and significant relationship with financial reporting quality. But BS, ISO,

CEO duality, firm size, leverage have no significant relationship with FRQ.

Key words: corporate governance mechanism, financial reporting quality, penal

regression.

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 Chapter 1

Introduction
Management of a company is responsible to prepare financial information which is
used by decision makers to predict the outcomes of present operation or rectify their
expectations (Hassan and Bello, 2013). There are many cases observed in the world to
record fake financial information or manipulate information to hide financial losses
by over or underestimating the value of assets. In the 1st decade of 21st century had lot
of hurdles about financial and accounting scandals. The most highlighted scandals of
financial statements of manipulation involves Satyam, Lehman Bros, Bernie Madoff,
Beekes to AIG, HealthSouth and Enron (great finance and accounting scandal, 2015).
It is necessary for all companies to prepare a quality financial information report.
FRQ (Financial Reporting Quality) is considered most appropriate factor in financial
process. Generally it’s observed that some factors of the firm have an influence on the
quality and high level of financial reporting disclosed.
So, there are different characteristics which considered the effect of quality and high
level of financial reporting are differ firm to firm. Past researches have shown that
firms engaging in earnings management activity are often with lower performance,
less Board composition, less liquidity, low leverage, small audit firm size, small firm
size and less share dispersion.
In last decades many mainstream corporate scandals are observed by poor financial
reporting (Lobo & Zhou, 2006), shareholders demanded high quality reports
(Chhaochharia & Grinstein, 2007). Now the researchers shows that the companies or
firms adopt high quality external and internal governance tools and also adopt higher
quality auditors (internal and external) to develop high quality financial report for
shareholders (Srinidhi, He & Firth, 2010, PuchetaMartínez & GarcíaMeca, 2014
Cohen, Krishnamoorthy & Wright, 2004). But, the corporate governance mechanisms
vary country to country, reflecting changes in the legal and business environments
(Claessens & Yurtoglu, 2013).

This study investigates whether corporate governance mechanisms positively affect

financial reporting quality in developing countries, such as Pakistani, where
governance is voluntary and the context is unique.

1
According to Agency theory the ownership and management ownership is the cause
of agency problems and the information went wrong among stakeholders (Jensen &
Meckling, 1976). Governance mechanisms reduce these agency costs, with high
quality of corporate governance resulting in better check and balance behaviour
(Shleifer & Vishny, 1997), improved FRQ (Cohen et al., 2004) and reduced wrong
information between a firm’s agents and principles (Healy & Palepu, 2001; Scott,
1997). Therefore, shareholders and investors can rely upon solid and reliable financial
report to make investment decisions (Healy & Palepu, 2001).

Internal and external governance factors affect financial reporting quality, while the
efficiency of firm’s governance is related to the high level of these Internal and
external governance factors. These factors includes board independence, board size,
firm size, institutional shareholders, institutional shareholders ownership, CEO
duality, audit committee independence, and leverage. Different characteristics of
business present different effectiveness of government mechanism (La Porta et al.,
1999).

Many studies have been examined on Financial reporting quality in reset of the world,
and it show difference and variation in results (La Porta et al., 1999). Since the
governing investors hold significant income rights, it is normal that they will
substitute legitimate safety and require large amounts of observing and controlling
with a specific end goal to lessen administration's seizure and enhance the
association's execution (Shleifer & Vishny, 1997).

It is found in governance literature that governing body of governing

shareholders can depend on high level of external auditors to limit administration
confiscation through enhancing the nature of FRQ (Fan & Wong, 2005; Cohen et al.,
2004). Meckling and Jensen (1976) said, external audit’s cost is must bear by the
owners to remove the agency problem. Information reduces by auditing
asymmetrically outsiders and management (Knechel & Sundgren, 2008; Francis &
Wilson, 1988). Cohen et al's. (2004) studied the relationship between governance
mechanisms and audit quality and found that firm’s performance is linked with high
level external auditing. Collier and Gregory (1999) studied that if the board members
are independent then the auditing committee is more affective in firm with the high

2
level of auditors. Francis and Wilson (1988) studied the relationship between high
level auditor and agency cost where firms chose high auditors to reduce agency cost.
Defond’s (1992) explore that management ownership and leverage presents agency
cost. Best auditors have ability to reduce agency problem.
In developed countries many studies conducted on corporate governance and
financial reporting quality but there is literature gap in developing countries. So this is
an effort to address this gap in context of financial firms of Pakistan.

1.2 Problem Statement

The recent accounting scandals happened internationally has increased criticism on
FRQ (Brown et al., 2010; Agrawal and Chadha, 2005). Different mainstream firms
were involved in this corruption like WorldCom, Parmalat, Marconi etc. The financial
disclosure failure has created the need to improve the FRQ and also need strong
managers control for a strong governing structure (Brown and Caylor, 2006; Beekes
and Brown, 2006; Firth et al., 2007; Beekes and Brown, 2006; Karamaou and Vafeas,
2005). Actually, financial information assists to capital investors in investment
decisions process. It is helpful for regulators, creditors, owners and firm partners,
because it not only shows the past performance of firm but also determine firm’s
future prediction about profitability (Bushman and Smith, 2001; 2003).
The relationship between corporate governance and FRQ has been strongly explored
in developed countries. They emphasis on specific governance factors like board
independence, concerted shareholding, director shareholding and audit performance
(Ballesta and Meca, 2007; Bradbury et al., 2006; Beekes et al., 2004; Petra, 2007;
Han, 2005 and Yeo et al., 2002). Now the researchers focused to explore the
relationship between corporate governance and FRQ in developing countries which
are growing rapidly (Firth et al., 2007; Dimitropoulos and Asteriou, 2010; Bradbury
et al., 2006). This study investigates the relationship between corporate governance
and FRQ in financial firms in context of Pakistan. Pakistan’s market is expending day
by day so it necessary to investigate this relationship. This study is an effort to fill the
gap in Pakistan financial literature.

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1.3 Research Questions
This thesis aims to explore the relationship between corporate governance mechanism
and financial reporting quality in context of Pakistan. It will investigate the roles of
independent board members (non-executive board members), Board size, AUDIT
Committee Independence, Institutional shareholders, Insider shareholders, MTB,
LBV, Size and the CEO (CEO duality). Thus on the basis of the variable discussed
above this research will endeavor to answerer the following research questions:
 What is the impact of board independence on FRQ?
 What is the impact of board size on FRQ?
 What is the impact of firm size on FRQ?
 What is the impact of CEO duality on FRQ?
 What is the impact of leverage on FRQ?
 What is the impact of institutional shareholders on FRQ?
 What is the impact of insider shareholders ownership on FRQ?
 What is the impact of Audit committee independence on FRQ?
1.4 Research Objectives
To examine the association between Corporate Governance mechanisms and financial
reporting is the main objective of this study. Further, this study has some sub
objectives which will help us to reach the major objective of the study, the sub
objectives are listed below:

 To examine the impact of board independence on FRQ.

 To examine the impact of board size on FRQ.
 To examine the impact of firm size on FRQ.
 To examine the impact of CEO duality on FRQ.
 To examine the impact of leverage on FRQ.
 To examine the impact of institutional shareholders on FRQ.
 To examine the impact of insider shareholders ownership on FRQ.
 To examine the impact of Audit committee independence on FRQ.
1.5 Significance of the study
This study makes a contribution to increase the finance literature about corporate
governance and FRQ. Unlike the past researches which conducted on highly

4
developed markets (countries) like USA, UK, Japan etc, this study implies on
emerging country. Pakistan has poor account regulations, poor transparency and poor
governance practices.
And past researches mostly only focus in auditing regulatory environment but this
study will endeavor to investigate the impact from a holistic point of view as we have
focused on eight mechanisms of CG.

1.6 Organization of Study

This study contains four sections. The second section is Literature Review, in which
this study explores by all this by reviewing previous studies. Third section is Research
Methodology, in which all the variables name, data collection methods and
methodology includes. Fourth section is Results contains the results tables with
interpretation. Fifth and last section of this study is Conclusion in which the final
remarks are concluded by reviewing the results and compare it with previous studies.

5
 Chapter 02
Literature Review
2.1 Literature Review
The value of financial accounting is generally determined by its quality
(Pounder,2013). The central concept of financial accounting quality is that some
accounting information is better and more reliable than other accounting information
in relation to its characteristic of communicating what it purports to communicate.
That is why; accounting quality is of great interest to several types of users involved
in the financial reporting chain. The term of financial accounting quality has no
single, widely accepted definition.
We can find a large amount of definitions, which vary significantly across individuals,
projects, companies and organizations, depending also on the purpose for which the
financial information is to be used. Studying the literature, we can see that on the one
hand, accounting quality can be seen as the precision with which the financial reports
convey information to equity investors about the firms expected cash-flows (Biddle,
Hilary and Verdi 2009).
On the other hand, reporting quality refers to the extent to which financial reports of a
company communicate its underlying economic state and its performance during the
period of measurement. (Elbannan, 2010).
Biddle, Hilary and Verdi (2009) defines financial accounting quality as the precision
with which financial reports convey information about the firm’s operations, in
particular its cash flows, in order to inform the equity investors.

Tang, Chen and Zhijun (2008) define financial reporting quality as the extent to which
the financial statements provide true and fair information about the underlying
performance and financial position. Anyway, a commonly accepted definition is
provided by Jonas and Blanchet (2000), who argue that quality financial reporting is
full and transparent financial information that is not designed to obfuscate or mislead
users.
The role of financial reporting is complex and, according to financial accounting
standard board (FASB), it aims to provide even handed financial and other
information that together with information of other sources facilitates the efficient

6
functioning of capital and other markets and assists the efficient allocation of the
scarce resources in the economy.
Therefore, the concept of financial accounting quality is broad and includes financial
information, disclosures and non-financial information useful for decision
making(Tasios and Bekiaris, 2012).
Many times, accounting quality is defined using its characteristics. In this context,
prior literature research shows that key determinants of financial reporting quality
include legal system, source of financing, characteristics of the tax system,
involvement of the accounting profession, economic development and accounting
education.
The quality of financial reporting is a broad concept which has a series of diverse
measurable attributes. Anyway, one property of accounting which is frequently
mentioned in support of harmonization is comparability.
It cannot be clearly concluded if harmonization results in significantly greater
comparability across countries. That is why, this aspect is intensively studied and the
results are still very different, causing diverse points of view upon this subject.
We will try to clarify what are the characteristics of financial accounting information
that makes it of good quality. In order to have a certain degree of quality, financial
statements should meet certain qualitative criteria.
These criteria are stated by both boards of IASB and FASB in their conceptual
frameworks, where they conclude that high quality is achieved by adherence to the
objective and the qualitative characteristics of financial reporting information (IASB,
2008).
The traits of corporate governance were helpful to shareholders in signaling the level
of management’s manipulations Beasley (1996). This study investigates the relation
by providing awareness on reliability of earnings based on indications, such as the
mechanism of good governance. In prior studies, the literature shows some
association of corporate governance attributes and its relation with earnings
management. Nine attributes had quoted out of several available in literature.
There are certain authors that study the size of board of director’s associate with a
good quality of financial reporting. Few numbers of directors implies a higher degree
of communication and cooperation among them and managers. (Jensen, 1993). The
study of Vafeas (2000), Ahmed et al. (2006) and Bradbury et al. (2006) reveals that

7
information contents of income and intensifies the earning management decrease with
the large board size for American, Singapore, and New Zealand companies. However,
certain authors finds that large number of directors ensures the relevance of financial
statements (Byard et al. 2006), while other authors did not confirm this association
(Firth et al. 2007).
There is a view that larger boards are better for corporate performance because they
have a range of expertise to help make better decisions, and are harder for a powerful
CEO to dominate. However, recent thinking has leaned towards smaller boards.
Jensen (1993) and Lipton & Lorsch (1992) argue that large boards are less effective
and are easier for the CEO to control. When a board gets too big, it becomes difficult
to co-ordinate and process problems. Smaller boards also reduce the possibility of free
riding by, and increase the accountability of, individual directors. Empirical research
supports this. For example, Yermack (1996) documents that for large U.S. industrial
corporations, the market values firms with smaller boards more highly.
In very recent times, researchers began to look at how board diversity might enhance
corporate governance and firm performance (Fields & Keys 2003). In probably the
first research of its kind, Carter et al.(2003), in a study of Fortune1,000 firms, find
significant evidence of a positive relationship between board diversity, proxies by the
percentage of women and/or minority races on boards of directors, and firm value,
measured by Tobin’s Q (Chung & Pruitt 1994). They also find that firms making
commitment to increasing the number of women on boards also have more minorities
on their boards and vice versa, and that the fraction of women and minority directors
increases with firm size but decreases as the number of inside directors increases.
Adams & Ferreira (2002), in using U.S. data, find that gender diversity of corporate
boards provides directors with more pay-for-performance incentives and that the
boards meet more frequently. Though not directly looking at board diversity, Keys et
al. (2003) present empirical evidence supporting a relationship between diversity
promoting activities of firms and expected future cash flows. Specifically they find
filing of discrimination of lawsuits produce a negative and significant stock price
reaction. In a study on Indian firms, Ramaswamy and Li (2001) find evidence that
greater foreign directorship appears to be able to influence firms by discouraging
unrelated Diversification.
The main purpose of any audit committee is to supervise the process of financial

8
reporting of a firm, and also oversee the financial statement integrity, effective
internal control and the performance of external and internal auditors. Pincus, et al
(1989) argue that in depended member increase ability of board of directors to
perform as an agent of the firm to provide the accurate and understandable
information of financial statement of a firm. The audit committee is additionally
anticipated that would assume a part as judge amongst administration and external
auditors since these two gatherings may have honest to goodness contrasts of
supposition in how to best apply bookkeeping measures (Klein, 2002).The external
auditors and the management is monitored by the audit committee because their
different opinions about applying accounting standards (Klein, 2002). Thus, the audit
committee independence helps the external auditors and the management to make a
high quality financial report. DeFond and Jiambalvo (1991) studied and found that
that the presence of audit committee is probably avoid financial reporting errors. They
studied the occurrence of accounting errors exposed by prior period changes for 41
US listed firms and found that those firms which have audit committees are fewer
overstatements.
Dechow et al. (1996) examine the U.S firms which were enforced by Securities and
Exchange Commission to accounting actions which have less audit committee or less
auditor independence.
But, Beasley (1996) also studied and fails to find that any significant relationship
between the occurrence of audit committees and the possibility of financial fraud by
studding 75 US companies which were involved in financial fraud. Beasley study
result was rational because audit committees were designed voluntarily in the starting
years and there was significant indication that many, if not most, audit committees are
performing what are normally supposed as their fiduciary responsibilities.
Klein (2002) conducted a empirical research to examine the in depended audit
committee impact on financial reporting quality. Klein (2002) collect the 692
company’s financial data of S&P 500 for the period of 1992-1993. And find
significant and negative relationship between audit committee independence financial
reporting qualities.
Carcello and Neal (2003) explorer the practice of corporate governance and collect
the 138 US non-financial firms that face the financial distress situation for the period
of 1994 they also found the negative and significant impact of audit committee

9
independence and account information using the MD&A (Management Discussion &
Analysis).Utilizing hand-gathered board information from 139 firms in Singapore and
113 firms in Malaysia, Bradbury et al. (2006) find that the connection between audit
committee interdependence and accounting quality when the irregular accruals are
income expanding. The previous empirical evidence found that the audit committee
play a vital role in disclosure of financial information and also improve the quality of
reporting in US and UK. But Pakistan and other country such as Australia, China need
to be more number of in depended member in audit committee.

According to Fama and Jensen, (1976) and Shleifer and Vishny, (1997) the
relationship between corporate governance practices and presence of independent
directors, have a significant impact on reporting quality and also decrease the agency
problem. Above all if we pay special attention to large companies, where management
and ownership are separated, and therefore, owners are unable to control all the
movements made by managers or agents. There is a certain tendency for managers to
manipulate the outcome to their own benefit. However, the problems associated with
the separation of ownership and control was not so relevant or didn't catch the
attention of researchers until the 1930's, when publications by Berle and Means
(1932) and Coase (1937) came to light. Moreover Garcia, (2003) argue that optimistic
behavior of management increase the agency problem because of delegations of
authority and they try to peruse the personal interest and shareholder only seek only
monetary advantage. However, the practices of corporate governance and audit
committee independence enhance the co-interest of principle and agent and also
decrease the informational gap. With all this we present the agency theory as the
theoretical framework on which further evidence is later based.

The agency theory includes proposals for reform within the Board to include a certain
percentage of independent directors. Undoubtedly this is a preferable step of in
depended board of director will enhance not only outside aspect of firms as well also
increase the performance of internal management particular from the chief executive.
Furthermore, transparency must be the main principle behind the Board's activities in
order to build trust and improve the quality of financial information for external users.
In this way, it helps companies portray a trustworthy image. Ultimately, the agency

10
theory sees the Board as the primary mechanism for management control, which
implies that the majority of its directors must be independent of management and the
main objective of these directors must be their control over managers. Following that
we will present the results of that line of research which has studied the relationship
between audit committee interdependence and the financial information quality.

As per Fame (1980) and Jensen et al. (1983), empirical evidence the Board is a tool
for monitoring managers, highlighting the presence of independent directors as a
mechanism that enhances the effectiveness of the supervisory role of the Board, as
they provide balance and help limit possible opportunistic management behavior. The
idea behind this study is that the structure of the Board should be made up mainly of
independent directors and not employees or people close to them. This way, the
elaboration of accounting information in favor of the interests of those on the inside,
in order to obtain benefits, can be avoided. In short, the authors found a positive and
significant association between corporate governance characteristics of the Council,
composed mainly of independent audit committee directors, and the preparation of
financial information.

Mace (1986) frames his research among those who see in the independent directors
the capacity to enhance the disclosure of financial information. Moreover, the
interdependence of board of directors becomes major role of supervisory on
management, not only by assuming independence from those that govern, but also by
decisions made based on their experience and knowledge. In this sense, the author
tries to show the positive effects of a large number of independent boards of directors
on financial reporting quality. Mace (1986) concludes that the presence of
independent board of directors gives more relevance and credibility to financial
information, on the understanding that as the presence of the same on the Board is
increased, higher quality financial reporting and transparency will be reflected.

Along the same lines, Weisbach (1988) hypothesized that Boards with a greater
presence of in-dependent directors have a positive and significant effect on financial
reporting quality, increasing it. The conclusion reached by the author strengthens this
hypothesis, since the independent directors put greater pressure on managers, i.e.
these counselors are considered a disciplinary measure on management.

11
However, unlike the findings obtained through empirical evidence mentioned above,
we can see how the results are not always conclusive. Not all empirical evidence
shows that Boards with a higher ratio of independent directors positively influence the
quality of financial accounts. Here, MacAvoy et al. (1983) hypothesized that the
quality of accounting information isn't positively related to the proportion of external
directors, particularly independent ones. The results show that neither the percentage
of directors who do not hold an executive position in the company, nor the percentage
of independent directors are significantly related to greater integrity of financial
information. Thus, we may reason out that the increased presence of independent
directors on the Board does not increase the efficiency and quality of accounting data.

Shleifer et al. (1986) begin their research predicting that the directors forming the
Board assume the role of traditional owners of the company and exercise more direct
control over management, thus reducing the agency problem. However, they stress
that among some of the features of external advisers, like their ownership of the
company or time spent on the Council, help to reduce fraudulent accounting practices
and thereby improve the quality of accounting information. Thus Shleifer et al. (1986)
hypothesized that the increased presence of independent directors on the Board
decreases the level of manipulation, and thereby increases the quality of financial
information. In contrast to what has been observed in an Anglo-Saxon context, and
which served as a basis for the recommendations of the Olivencia Report (1998), the
results did not confirm the hypothesis raised by Shleifer et al. (1986), as it disclosed
that the presence of independent directors was positively and significantly related to
the level of manipulation. Therefore, the authors concluded that independent directors
improve the quality of financial information.

Eisenberg et al. (1987) argue that Board compassion include the independent directors
does not affect the quality of financial information, making this as the hypothesis
under comparison. And found the insignificant and negative impact of larger number
of independent director on financial reporting quality. In short, they document that
what really sustains a positive result, increasing the quality of accounting information
is the higher part of executive managers. According to the authors, external directors
are required mainly for independence from management, while internal executives or
directors are those who are genuinely well informed about the company. In short,

12
these authors characterize independent directors as those members of the Board with
the ability or the power to help oversee and facilitate financial information.

Accordingly, the evidence within a continental environment like that of Fernandez

Alvarez et al. (1998), reason how special supervisory work of the external directors is
enhanced by their independence from management and by the incentives for carrying
out their role, which includes protecting their reputation and possible legal
implications arising from inefficient supervision. Therefore, the hypothesis posed is
whether the independence of the Board favours the quality of accounting information.
The authors document a positive and substantial relationship between the projects
done by independent directors and the quality of accounting data, while the purpose of
the Audit Committee on the quality of financial data is irrelevant.

Continuing with the literature review, we consider it relevant to name Vafeas (1999),
who pointed out from the outset that there is a positive association between the
activities performed by independent directors and the quality of accounting
information. Furthermore, he adds that the independent directors on the Board should
take a more active position with respect to the other directors improve the accounting
information. In this sense, Vafeas (1999) sets a contrasting hypothesis whether the
influence of the independent directors might enhance the quality of published
financial information. After the results were obtained it was shown that the fact of
integrating more independent audit committee directors in the Board composition has
a positive and significant effect on financial reporting quality. Many author justifies
this result on the grounds that independent directors are not linked to the ownership of
the company and therefore do not tend to manipulate information to their own
benefits.

In relation to the previous evidence revealed by Vafeas (1999), it seems relevant to

incorporate the empirical theory contrasted by Kasnik (1999), which basically stresses
manipulative practices. Specifically, he says that those factors of good corporate
governance which lead to higher quality accounting information will be considered as
those that limit the freedom of action of management, reducing the use of
manipulative practices. Kasnik (1999) documented that good corporate governance
mechanism and presence of independent director in board improve the quality of

13
accounting information within the same line of research. Peasnell et al. (2001) argue
that independent audit committee decreases the probityof information manipulations
particularly when there are incentives to do so. And finding of the study suggest that
the goof practices of corporate governance may reduce the ambiguity of financial
reporting and improve the quality of financial information. And also argue that
independent director have significant impact of reporting quality. Having an audit
committee does not appear to directly affect such manipulation, but the independent
directors are more efficient when the company has an audit committee.

Similarly, Klein (2002) and Xie et al. (2003) documented that Audit Committee
interdependence and the Board tends to reduce the manipulation of profits, thereby
achieving to publish more quality financial information. After empirically contrasting
the hypothesis, evidence reveals that both counselors and independent audit
committees reduce manipulation, particularly when most of the members are
independent (but not necessarily all of them). Therefore, the authors conclude that the
presence of institutional investors (proprietary directors) in a lesser proportion than
the independent directors also helps to reduce manipulation and improves the
presentation of accounting information.

Similarly, Anderson et al. (2004) hypothesized in their work that the Board
independence increases the financial reporting quality. That research suggest that the
higher level of independent director in board have no association with reporting
quality in the contrast of the prominent role that literature, both theoretical and
empirical (mainly Anglo-Saxon), attributes to the independence of the Board. That is,
the evidence revealed by these authors confirms that a Board composed of
independent directors is considered an instrument to safeguard the quality of
accounting information. It is possible that this evidence derives from the presence of
executives or proprietary directors, and the lack of revolution of directors or both
causes simultaneously, among other issues. Anderson et al. (2004) and Carcello &
Neal (2000) documented the negative impact of the existence of independent directors
in the Board composition on improving accounting quality. Carcello and Neal (2000),
in contrast to Anderson et al. (2004) attribute the failure of the supervisory role of
independent directors to the fact that these are not independent to the management of
the business. Thus, these authors conclude that the existence of independent board of

14
director will only raise the accounting information quality when they have no links
with the management of the organization.

Bedard et al. (2004) propose that those companies that include solely independent
directors on their Board will not be effective in carrying out their tasks of supervision
and control. Therefore, Bedard et al. (2004) developed their research insisting that
among some of the measures of good corporate governance, and in particular 100%
independent directors, are not always a good determinant in monitoring managerial
activity. Moreover, the authors also defend that a Board which consists entirely of
independent directors is not an adequate measure for increasing the quality of
published information or the credibility of such. The hypothesis that the authors
present is the idea of the incidence of independent directors on the Board reduces the
financial reporting. The results support the hypothesis, it is documented that the trend
towards greater number of independent directors, helps in low levels of quality and
transparency in financial reporting, due to the concentration of so many external
directors.

Farber (2005) tries to ratify how weak corporate governance structures, based on a
larger number of executive directors, are a necessary ally of fraud or manipulation of
accounting information. Hence, several of the firms involved in accounting scandals
in the United States exhibit little independence and activity on boards and committees
and a weaker presence of experts on these supervisory and control bodies. The author
also notes that in many large US companies the CEO of the Board is also the chief
executive. From these findings, the author tries to corroborate that a large number of
executive directors is associated with an increase in the manipulation of company
accounts and thus less transparency and quality of financial information. The results
confirm their hypothesis, documenting that the manipulation of accounting
information is greater when number of board of director connected to the top manager
of the firm.

It is also interesting to add to this study the accurate reflection of Pope (2001) and
Young et al. (2005), who suggest that the effectiveness of the Board in the monitoring
and supervision of the accounting function depends largely on the ability of the
external directors to understand issues of accounting techniques. So it is hoped, since

15
a significant proportion of external directors, especially independent ones, have held
management positions in large companies or have developed long academic careers as
auditors or advisors. In the Spanish case, according to the annual report by Spencer
Stuart (2007) for 2006, 19% of independent directors in Spanish listed companies are
entrepreneurs, 19% come from being chief executive at another company, 24% are
retired executives, 20% are freelancers, and 7% are academics and 2% ex-politicians.

Now, relating this assessment to corporate governance practices and its impact on the
consistency and disclosure of financial information, it is emphasized that the results
presented for the Spanish context and those obtained in previous studies in an Anglo-
Saxon context, primarily in terms of the role of the independent directors, do not lead
to similar results, but differ substantially, establishing the United States and the
United Kingdom as the main references in the Anglo-Saxon context. According to
Recalde (2003), this is because business culture, the ownership structure of our
companies and institutional characteristics are different.

Unlike the previous research work, we continue with the literature review presenting
the evidence provided by Osterland(2004) and Ajinkya et al. (2005), which
documented that the higher existence of independent directors provides the
opportunity to monitoring the management and the financial information. The role
that such directors should adopt within the Board is to advocate transparency of
information between shareholders and managers, which is one of their main
responsibilities. Similarly, they focused the empirical test stating that a higher ratio of
independent directors is associated with higher quality and quantity of accounting
disclosure to interested groups. Ultimately, Osterland (2004) and Ajinkya et al. (2005)
have validated the link between the two aspects, contrasting that the effectiveness of
the Board represented by a larger number of independent directors is positively
associated with the disclosure of quality financial information.

However, it seems appropriate to introduce as a second point of view some of the

evidence which pointed to beliefs which were totally opposed to those previously.
Furthermore many studies did not find the significant impact of board independence
on quality of financial information. (Rammer et al. 2006, Teitel et al. 2008 and Davila
et al. 2009 al.) on their Boards with respect to reporting and accounting manipulation.

16
Therefore, the hypothesis on which they focus tries to show evidence of how directors
on the Board, and especially independent ones, do not increase the quality of
information. The results do not confirm the hypothesis since they reveal that the
independence of the Board contributes to the council acting on the recommendations
of good corporate governance, and in turn publishing less harmful accounting
information. Therefore, the high degree of independence of the Board highlights two
key issues: first, it leads to greater control over the company's activities; secondly, it
contributes to greater transparency due to the desire to maintain a good reputation.

Following this evidence, the research carried out by Duchin et al. (2010) states that
when the Executive Director of the company, hereafter referred to as CEO, belongs to
the nomination committee, or when no such committee exists, the listed companies
will tend to hire fewer independent directors and more proprietary directors on the
Board. Thus, the hypothesis raised by these authors is that the larger number of
proprietary independent directors has a significant and positive impact on financial
information, when existence of independent directors has no effect on it. Once the
corresponding empirical analysis was concluded, Duchin et al. (2010) confirmed the
hypothesis. The authors justify these results indicating that increasing the number of
independent directors has insignificant impact on accounting reporting quality, since
the Executive Director of the Company (CEO) dominates the selection process of the
candidates and uses it to place his allies on the Board. In this case, the directors take
on a decorative role, away from any monitoring task, helping the CEO to take hold in
office.

Next we can see more recent empirical findings of Barros et al. (2013) &Ho et al.
(2011). one hand, the theory developed by Ho et al. (2011) predicts that the greater
number of independent director is negative related to the level of manipulation and
therefore to the quality of accounting information. To prove this hypothesis, the
authors try to reason the various types of knowledge that an independent director may
have of the organization to which he is director in order to determine whether they
contribute or not to increasing the quality of accounting information. It is true that the
independent director is not usually aware, to the same degree, of the problems that can
frequently arise within the company in comparison to executive directors, in other
words they are not aware of those small particular details of the organization as

17
directors would be. But we can say that their role is different from the other directors
on the Board. According to Ho et al. (2011), the independent directors may provide
perfection in the accounting reporting quality with their knowledge about the sector,
with their strategic vision, overseeing the work of the executives or ensuring social
interest, among other issues. In addition, before making any major decision, the
independent director is required to inform in detail of all its possible consequences
and implications for each part of the business. For this reason you cannot and should
not generalize that independent directors lack the knowledge necessary to make
important decisions within the organization. Ho et al. (2011) conclude that both
executive and non-executive directors and independent directors in particular,
contribute to the management and improvement of the disclosure of accounting
information.

Moreover, regarding the empirical evidence by Barros et al. (2013) it is assumed that
the inclusion of independent directors on boards will improve the performance of the
company given the recommendations of good corporate governance, and in turn, that
this measure will provide better quality accounting information. Indeed, after the
corresponding analysis of this assessment, a significant and positive impact on the
percentage of independent directors on the accounting information can be seen. Thus,
the authors conclude that the presence of independent directors in comparison to other
directors is an important control mechanism, since they provide security with regards
to the interests of retail shareholders. In conclusion, an increased presence of external
directors, particularly independent directors, counteracts the temptation of internal
directors or executives to make decisions focused on their own personal benefit,
putting a stop to the manipulation of accounts and therefore, leading to enhance the
reporting quality.

The top managerial staff is viewed as the most astounding control system that is
responsible for checking the moves made by the best official of the firm (Fama and
Jensen (1983b). In spite of the fact that they fulfill various administrative
prerequisites they exist basically in light of irreconcilable circumstances they help to
address (Hermalin and Weisbach, 2003).
The activity of the capacity of observing by the governing body is associated with its
piece. Fama and Jensen (1983b) and Popularity (1980) demonstrate that its

18
arrangement is a vital factor to fabricate a committee to screen under powerful mode
the activities created by the administration.
These creators attest that it is regular that the more prevailing individuals from the
board are the individuals who are additionally inside supervisors, since they have
particular and quantifiable data about the exercises of the association The connection
between the sort of money related data introduced by a firm and the extent of its top
managerial staff has been the objective of a few examinations.

The relationship between the BS (board size) that oversees the general public
predetermination and the accounting data quality displayed by the organization will
lead us to define the principal speculation of research. The exploration created by
Jensen (1993) and Lipton and Lorsch (1992) demonstrate that vast sheets of chiefs are
less manageable to successful checking and less demanding to control by the
President. The examination done by Xie, Davidson and DaDalt (2003) found a reverse
connection between the number of the governing body and the nature of money
related detailing.
The exact confirmation gave by Anderson, Mansi and Reeber (2004) linked with the
theory that the number of the governing body will impact the cost of obligation
financing. The outcomes got demonstrate that the more prominent is the extent of the
board the lower the cost of financing acquired by the firm. Eisenberg, Wells and
Sundgren (1998) and Yermack (1996) additionally found a noteworthy negative
connection between the span of the board and the estimation of the organization. The
examination of Beasley (1996) likewise demonstrates that there is an expanded
inclination frequency of extortion associated with the more noteworthy size of the top
managerial staff. In any case, the confirmation beforehand found is not decisive, as
there are a few examinations that discovered proof the restricting way.
The studies of Klein (1996) and Peasnell, et al (2005) demonstrate outcomes about
that report a positive connection between the number of the directorate and the
bookkeeping quality. This proof is clarified as coming about because of the way that a
more prominent number of executives permit a more noteworthy capacity for
observing with respect to chairmen, bringing about lower bookkeeping optional speak
to a higher bookkeeping quality.

19
In an investigation identified with the U.S. market, Hermalin and Weisbach (2003)
discovered outcomes proposing that the piece of the top managerial staff and the
corporate execution are not associated. Additionally Bhagat and Dark (1999) and
Roman (1996), while breaking down the connection between the synthesis of the
board and organization execution, did not get decisive outcomes about the presence,
or not, of a causal relationship.

Because of expanding the quantity of individuals from the directorate, the matter of
the organization develops and the capacity to screen the board ought to likewise
increment. This thus makes the conditions to maintain a strategic distance from more
noteworthy bookkeeping prudence and along these lines advance a higher nature of
bookkeeping data of the organization. Situated in this, we can express our first
research theory as takes after

Top managerial staff assume an essential part in observing and prompting directors
and adjusting their interests to the interests of investors (e.g. Armstrong et al, 2010).
Truth be told, sheets of executives, as corporate administration instruments, influence
supervisors' basic leadership with respect to various parts of a company's execution,
for example, monetary revealing (Srinidhi et al, 2011). To comprehend the
components that influence chiefs' capacity to play out these parts, there is currently a
line of studies exploring how executives' qualities, either ordered (e.g., freedom) or
not (age, involvement, sexual orientation), influence their execution (e.g. Armstrong
et al, 2010).2 as of recently, most research concentrates on the commanded features of
board assorted qualities, for example, freedom (e.g. Klein, 2002). For instance, firms
with a higher rate of free executives have a predominant profit quality and a superior
data condition (e.g. Armstrong et al, 2010).

There is broad research on the impact of board sex assorted qualities on various parts
of firm execution including monetary revealing quality. Be that as it may, the
outcomes are blended up until now. For example, Ye, Zhang and Rezaee (2010) don't
locate any noteworthy connection between top administrators sexual orientation
differences and income quality in a Chinese setting. Along a similar line, Sun, Liu and
Lau (2011) don't locate any noteworthy relationship between nearness of female
chiefs on the review advisory groups of U.S. firms and profit administration,

20
measured by unusual accumulations. Interestingly, Srinidhi et al., (2011) find that
nearness of female chiefs on a board is related with higher profit quality in a U.S.
setting. Moreover, Gul et al., (2011) find that sexual orientation assorted sheets are
related with higher stock cost education.

Alam et al (2013) locate that female chiefs are grouped in real metropolitan territories
in the U.S. also, this thus, makes ladies live more remote than men in respect to a
corporate home office. They additionally find that organizations with female
executives depend more on stock cost for CEO remuneration and Chief turn over.
They contend that organizations with female chiefs are harder screens not in light of
sexual orientation contrast clarification, but rather because of their higher separation
to a firm area. They likewise locate a positive stock value response when a ladies who
lives near an organization is selected on a board.

Sexual orientation assorted qualities writing depends on the possibility that ladies
convey distinctive attributes to the board which thusly improve them in checking
supervisors' basic leadership. As contended by Srinidhi et al., (2011), ladies are freer
in basic leadership, less tolerant of untrustworthy conduct and they go out on a limb.
This thus may help them to be better screens over chiefs' basic leadership including
money related detailing quality.

The blended outcomes in regards to the impact of load up sexual orientation

differences might be because of the way that these examinations have been done in
various time allotments and also in various nations with various administration
components at firm and nation levels. Consequently, speculation of discoveries
starting with one setting then onto the next may not be fitting. As contended by Alam
et al., (2013) it might likewise be because of ladies' separation to firm areas.
Likewise, we outline our third theory in invalid frame:

This examination likewise planned to find the connection between the Chief duality
and review quality. The CEO duality alludes to non-division of parts amongst Chief
and the executive of the board. In the ordinary circumstance, sheets with CEO duality
are seen inadequate on the grounds that an irreconcilable situation may emerge. This

21
normal for corporate administration is typical in Pakistani circumstance. It might be a
result of the idea of family possesses business in creating nations like Pakistan.

It demonstrates that huge sizes of organizations that different individual for the two
capacities ordinarily exchange at the higher cost to book duplicates (Yermack, 1996)
and have higher profit for resources and cost productivity proportions (Pi and Timme,
1993). It is normal that within the sight of an overwhelming Chief duality, the
organization plans to lessen the push to secure quality evaluator. It trusts that
corporate administration is better without Chief duality in the partnership. This
training is additionally suggested by different codes of corporate administration,
including those accessible created nations. A few investigations (O'Sullivan, 2000;
Salleh et. al., 2006) did not show significant confirm on the connection between Chief
duality and review expenses. In an investigation identified with the U.S. market,
Hermalin and Weisbach (2003) discovered outcomes proposing that the creation of
the top managerial staff and the corporate execution are not associated. Additionally
Bhagat and Dark (1999) and Roman (1996), while examining the connection between
the synthesis of the board and organization execution, did not get decisive outcomes
about the presence, or not, of a causal relationship.

Because of expanding the quantity of individuals from the directorate, the matter of
the organization develops and the capacity to screen the board ought to likewise
increment. This thus makes the conditions to maintain a strategic distance from more
noteworthy bookkeeping caution and along these lines advance a higher nature of
bookkeeping data of the organization. Situated in this, we can express our first
research speculation as takes after

Directorate assumes an essential part in observing and exhorting supervisors and

adjusting their interests to the interests of investors (e.g. Armstrong et al, 2010).
Actually, sheets of executives, as corporate administration components, influence
directors' basic leadership with respect to various parts of a company's execution, for
example, money related revealing (Srinidhi et al, 2011). To comprehend the elements
that influence executives' capacity to play out these parts, there is currently a line of
studies examining how chiefs' qualities, either commanded (e.g., autonomy) or not
(age, involvement, sex), influence their execution (e.g. Armstrong et al, 2010).2 as of

22
recently, most research concentrates on the commanded features of board assorted
qualities, for example, autonomy (e.g. Klein, 2002). For instance, firms with a higher
rate of free chiefs have a predominant income quality and a superior data condition
(e.g. Armstrong et al, 2010).

There is broad research on the impact of board sexual orientation differences on

various parts of firm execution including monetary announcing quality. Be that as it
may, the outcomes are blended up until this point.

For example, Ye, Zhang and Rezaee (2010) don't locate any critical connection
between top administrators sex differences and income quality in a Chinese setting.
Along a similar line, Sun, Liu and Lau (2011) don't locate any huge relationship
between nearness of female chiefs on the review advisory groups of U.S. firms and
income administration, measured by unusual gatherings. Conversely, Srinidhi et al.,
(2011) find that nearness of female chiefs on a board is related with higher income
quality in a U.S. setting. Likewise, Gul et al., (2011) find that sexual orientation
various sheets are related with higher stock cost education.

Alam et al (2013) locate that female executives are grouped in real metropolitan
ranges in the U.S. furthermore; this thus, makes ladies live more remote than men in
respect to a corporate central station. They likewise find that organizations with
female executives depend more on stock cost for CEO pay and Chief turn over. They
contend that organizations with female executives are harder screens not as a result of
sex contrast clarification, but rather because of their higher separation to a firm area.
They additionally locate a positive stock value response when a lady who lives near
an organization is designated on a board.

Sexual orientation assorted qualities writing depends on the possibility that ladies
convey distinctive attributes to the board which thus improve them in observing
supervisors' basic leadership. As contended by Srinidhi et al., (2011), ladies are more
autonomous in basic leadership, less tolerant of untrustworthy conduct and they go for
broke. This thus may help them to be better screens over supervisors' basic leadership
including monetary announcing quality.

23
The blended outcomes in regards to the impact of load up sex differences might be
because of the way that these examinations have been done in various time periods
and additionally in various nations with various administration systems at firm and
nation levels. Subsequently, speculation of discoveries starting with one setting then
onto the next may not be proper. As contended by Alam et al., (2013) it might
likewise be because of ladies' separation to firm areas. As needs be, we outline our
third speculation in invalid shape:

This investigation likewise planned to find the connection between the CEO Duality
and review quality. The CEO duality alludes to non-detachment of parts amongst
Chief and the executive of the board. In the ordinary circumstance, sheets with Chief
duality are seen ineffectual on the grounds that an irreconcilable circumstance may
emerge. This normal for corporate administration is ordinary in Pakistani
circumstance. It might be a direct result of the idea of family possesses business in
creating nations like Pakistan.

Following are the hypothesis of this study:

H1 Board independence has significant impacton FRQ

H2 Board size has significant impacton FRQ
H3 Firm size has significant impacton FRQ
H4 CEO Dualityhas significant impacton FRQ
H5 Leveragehas significant impacton FRQ
H6 Institutional shareholders havesignificant impacton FRQ
H7 Insidershareholders ownership has significant impacton FRQ
H8 Audit committee independence has significant impacton FRQ

24
 Chapter No 3

3.1 Data and Methodology

To achieve the objective of this study the variables data collected from the banks of
Pakistan (financial firms). The study taken data from the annual reports of financial
firms and firm’s sites. SECP (security exchanges commission of Pakistan) is used as
main source of data. The data is collected of 26 financial firms listed in Pakistan and
the time frame is 2005 to 2014. Penal regression technique is used in this study.
Brooks (2008) said panel data provide information about both space and time.
Importantly, a panel keeps the same individuals or objects and measures some
quantity about them over time. The data analysis is undertaken by using Eveiws8 and
it run the descriptive statistics, Correlation Matrix analysis and panel data regression.

3.1.1 Descriptive statistics: It is used to check the nature of data and explain the
variables used in the study, in terms of average and variation among the cross-section.
It include mean, minimum, maximum, and standard deviation for all variables.

3.1.2 Correlation analysis: It is conducted to see the relationship among the

dependent and independent variables. This would help to get an initial picture as to
the nature of the relationship among the variables before proceeding to regression
analysis.

3.1.3 Panel regression analysis: It is used to determine the significant relationships

between the dependent and independent variables. It is undertaken by using common
effect model, fixed effect model and random effect model. The objective of this
analysis was to make a prediction about the dependent variable based on its
relationship with all the concerned independent variables.
3.2 Model Specification
This study used the data from financial firms listed in Pakistan that include financial
statement from 2005 to 2014. The nature of data allows the researcher to use panel
data model, which is deemed to have advantages over cross sectional methodology.
The study tested the three most important panel data techniques, Common, Fixed and

25
Random effect models. This model contain independent and dependent variable. The
dependent variable of financial reporting quality is measured by McNicholos model.
The independent variables are board size, audit committee independence, board
interdependence, CEO duality, Institutional shareholder ownership, leverage and firm
size.
3.2.1 Pannel Regression Model

FRQi,t= β0 + β1ACIi,t+ β2BIi,t+ β3BSi,t + β4 CEODi,t + β5INSTi,t+β6INSDi,t

β7Leveragei,t+ β8FSi,t + €i,t

3.3 Description of variables

Independent variables

3.3.1 Board Size

The board of directors is a group of individuals that are elected as, or elected to act as,
representatives of the stockholders to establish corporate management related policies
and to make decisions on major company issues. Every public company must have a
board of directors.Here board sizes mean the total board members or board of
directors, (Bulan et al. 2009). It has significance impact on FRQ.

3.3.2 Audit Committee independence

The audit committee is a selected number of members of a company's board of

directors whose responsibilities include helping auditors remain independent of
management. The committee provides independent review and oversight of a
company's financial reporting processes, internal controls and independent
auditors.For this we did used the proxy audit committee independent directors are
divided by the board members (Bulan et al. 2009). It has significance impact on FRQ.

3.3.3 Board independence

An independent board is a corporate board that has a majority of outside directors

who are not affiliated with the top executives of the firm and have minimal or no
business dealings with the company to avoid potential conflicts of interests.Proxy for

26
this measurement used total number of board independence members divided by the
total board members, (Bulan et al. 2009). It has significance impact on FRQ.

3.3.4 CEO duality

CEO duality refers to the situation when the CEO also holds the position of the
chairman of the board. The board of directors is set up to monitor managers such as
the CEO on the behalf of the shareholders. If the CEO is chairman and president than
we considered the “1” otherwise we consider “0” (Bulan et al. 2009). It has
significance impact on FRQ.

3.3.5 Institutional shareholder ownership

The amount of a company's available stock owned by mutual or pension funds,

insurance companies, investment firms, private foundations, endowments or other
large entities that manage funds on the behalf of others.For this we did used the proxy
total numbers of institutional shareholder’s ownership divided by the total number of
shares or outstanding shares. It has significance impact on FRQ.

3.3.6 Leverage of the firm

Leverage, as a business term, refers to debt or to the borrowing of funds to finance the
purchase of a company's assets. Using debt, or leverage, increases the company's risk
of bankruptcy. It also increases the company's returns; specifically its return on
equity. Proxy for the leverage did used total debt divided by total assets, (Tan et al.
2013). It has significance impact on FRQ.

3.3.7 Firm Size

It refers to the speed and extent of growth that is ideal for a specific small business. In
here we took the log for all total assets of the firms, (Tan et al. 2013). It has
significance impact on FRQ.

3.3.8 Measurement of the Financial Reporting Quality

To measure the FRQ, McNicholos (2002) modelis used in this study. It considers the
standard deviation of the residuals or the error terms as a measure of reporting quality.
Large values of the model residuals mean a considerable level of discretionary

27
accruals and so a poor quality of the financial information. Following is the model
equation:
ACCRit /TAit-1 =βo + β1 CFOt-1/TAit-1 + β2 CFOt/TAit-1 + β3 CFOt+1/TAit-1 +
β4 ΔRev/TAit-1 + β5 PPEt/TAit-1 + €t

ACCR: total current accruals

CFit: operating CF of the current period,
CFit-1: operating CF of the previous period,
CFit+1: operating CF of the next period,
ΔRev: change in revenue and
PPEit: level of plant, property and equipment.

All the variables are scaled by lagged TAt-1

28
 Chapter 4
Results & Discussion
In the following chapter, this study analyzes the data by using different
statistical tools. It has two sections. The first section presents results
which includes descriptive statistics, correlation and panel regression
analyses. The second section is includes the discussion.
4.1 Results & Discussion

Table 4.1.1 Descriptive statistic

Mean Maximum Minimum Std. Dev.

FRQ 0.00041 0.001691 -0.00156 0.000378

C 1 1 1 0

ACI 0.302151 0.571429 0.142857 0.09598

B_I 0.702928 0.923077 0.181818 0.180251

BOARD_SIZE 8.357447 13 4 1.54971

CEO_DUALITY 0.144681 1 0 0.35253

FIRM_SIZE 18.76203 21.56231 15.20795 1.412534

INST 0.293745 3.046097 -0.2008 0.564118

ISO 0.08619 0.5105 0.0103 0.062368

LEVERAGE 0.100883 0.387 0.0023 0.068642

According to the results shown in table 4.1, dependent variable financial reporting
quality (FRQ), have a mean value of 0.00041 and standard deviation of 0.000378
which indicates that during the study period the financial firms have normal accrual.
And the maximum and minimum value of 0.001691 and -0.00156 indicates that the
financial firms have maximum FRQ is 0.001691and minimum FRQ is -0.00156.

29
Audit Committee independence has a minimum and maximum value is 0.142857 and
0.571429 respectively. And the stranded deviation is 0.09598 with mean value of
0.3021.
Board independent mean value is 0.702928, minimum and maximum values of
financial companies are 0.181818 and 0.923077 respectively. Standard deviation is
0.180251 presents the average spread from the mean value of manufacturing
company’s board of director’s composition.
The mean value of Boardsize0.702928 and 0.180251 is Std. deviation and the
maximum and minimum values of Board independent are 0.923077 and 0.181818
respectively. CEO duality mean value is 0.144681 with the standard deviation value
is 0.35253. And on the other hand maximum value and minimum values are 1 and 0.
INST mean value is 0.293745 with the standard deviation value is 0.564118. And on
the other hand maximum value and minimum values are 3.046097 and-0.2008.
Institutional shareholder ownership mean value is 0.08619 with the standard deviation
value is 0.062368. And on the other hand maximum value and minimum values are
0.5105 and0.0103.
Leverage minimum and maximum value is 0.0023 and 0.387 respectively. It shows
that financial firm maximum leverage of total noncurrent liabilities to owner’s equity
and long term liabilities is 0.387 and a financial firm’s minimum as 0.0023 ratio of
total noncurrent liabilities. Leverage shows mean value is 0.100883 and standard
deviation is 0.068642.

30
 Table 4.3.1 Correlation

CEO_

ACI B_I BOARD_SIZE DUALITY FIRM_SIZE FRQ INST ISO LEVERAGE

ACI 1

B_I 0.07113 1

BOARD_SIZE -0.58968 -0.00908 1

CEO_DUALITY 0.117312 0.079301 -0.0716 1

FIRM_SIZE -0.06595 0.177721 0.335733 0.047737 1

FRQ 0.004619 0.199311 -0.04488 -0.10247 -0.00966 1

INST -0.01395 0.196033 -0.09473 -0.09196 -0.23349 0.145008 1

ISO 0.083185 0.061215 -0.10376 0.039956 -0.05468 0.187551 0.205992 1

LEVERAGE 0.137978 -0.07056 0.015346 0.392635 -0.0627 -0.07135 -0.1683 0.015877 1

31
The correlation matrix is used to test the existence of multicollinearity
was by checking the Pearson correlation between the variables. In the
above table all correlation results are below 0.75, which indicates that
multicollinearity is not a potential problem for this study.

Table 4.3.1 Common Effect Model

Variable Coefficient Std. Error t-Statistic Prob.

C -0.00021 0.000367 -0.56616 0.5719

ACI -0.00015 0.000321 -0.47561 0.6348

B_I 0.000398 0.000141 2.8235 0.0052

BOARD_SIZE -1.26E-05 2.09E-05 -0.60231 0.5476

CEO_DUALITY -0.00013 7.51E-05 -1.69526 0.0914

FIRM_SIZE -7.41E-08 1.94E-05 -0.00381 0.997

INST 3.84E-05 4.68E-05 0.820897 0.4126

ISO 0.001009 0.000395 2.555418 0.0113

LEVERAGE 9.94E-06 0.000395 0.025179 0.9799

R-squared 0.091583 F-statistic 2.848055

Prob(F-

Durbin-Watson stat 1.284268 statistic) 0.00493

32
Table 4.3.2 Fixed Effect Model

Variable Coefficient Std. Error t-Statistic Prob.

C 0.000192 0.000491 0.390744 0.6964

ACI 0.000309 0.000365 0.84438 0.3995

B_I 0.000441 0.00018 2.45564 0.0149

BOARD_SIZE -8.15E-06 2.52E-05 -0.32347 0.7467

CEO_DUALITY -0.00011 0.00027 -0.40918 0.6828

FIRM_SIZE -2.70E-05 2.59E-05 -1.04176 0.2988

INST -0.00016 5.86E-05 -2.71326 0.0072

ISO 0.000525 0.000477 1.100215 0.2726

LEVERAGE -3.23E-05 0.00039 -0.08269 0.9342

R-squared 0.40007 F-statistic 4.061793

Prob(F-

Durbin-Watson stat 1.746745 statistic) 0

33
Table 4.3.3 Likelihood test

Effects Test Statistic d.f. Prob.

Cross-section F 4.13421 -25,201 0

Cross-section Chi-square 97.49932 25 0

This study used the likelihood test to select that either common effect model better or
fixed effect model is better. The selection criterion is P-value. If the P-value is
significant then common effect model is rejected. The result shows that the P-value is
significant 0.00 so, this study reject the common effect model.

Table 4.3.4 Random Effect model

Variable Coefficient Std. Error t-Statistic Prob.

C 5.01E-05 0.000418 0.119784 0.9048

ACI 0.000145 0.000335 0.433274 0.6652
B_I 0.000431 0.000158 2.731702 0.0068
BOARD_SIZE -6.60E-06 2.20E-05 -0.30038 0.7642
CEO_DUALITY -0.00013 0.000115 -1.16288 0.2461
FIRM_SIZE -1.96E-05 2.21E-05 -0.88752 0.3757
INST -7.45E-05 5.13E-05 -1.45381 0.1474
ISO 0.000809 0.000425 1.902848 0.0583
LEVERAGE -5.83E-05 0.000371 -0.15681 0.8755

R-squared 0.061066 F-statistic 1.837299

Adjusted R-squared 0.027829 Prob(F-statistic) 0.07128
Durbin-Watson stat 1.58744

34
Table 4.3.5 Hausman Test

Chi-Sq.

Test Summary Statistic Chi-Sq. d.f. Prob.

Cross-section random 12.21913 8 0.1417

Here this study checks all the data by different empirical test like common, fixed,
random effect models and hausman and likelihood test. The hausman test prob value
is 0.008.Which is less than the 5%, it mean fixed effect model is used in this study.

35
 Table 4.3.6 Fixed Effect Model

Variable Coefficient Std. Error t-Statistic Prob.

C 0.000192 0.000491 0.390744 0.6964

ACI 0.000309 0.000365 0.84438 0.3995

B_I 0.000441 0.00018 2.45564 0.0149

BOARD_SIZE -8.15E-06 2.52E-05 -0.32347 0.7467

CEO_DUALITY -0.00011 0.00027 -0.40918 0.6828

FIRM_SIZE -2.70E-05 2.59E-05 -1.04176 0.2988

INST -0.00016 5.86E-05 -2.71326 0.0072

ISO 0.000525 0.000477 1.100215 0.2726

LEVERAGE -3.23E-05 0.00039 -0.08269 0.9342

R-squared 0.40007 F-statistic 4.061793

Durbin-Watson stat 1.746745 Prob(F-statistic) 0.00

The Fixed effect panel regression model is selected in this study. The R_squareis
40%. It shows that independent variables of this study could explain variation in the
dependent variable about 40%. F-probability prob. is 0.000, which indicates that the
model is and the variables are mutually significant. As shown in the table 4.3.6
leverage, Iso, ACI, CEO duality and Firm size have no statistically significance on
FRQ at 5% level. Whereas board independence has positive and significant and INST
has negative and significant relationship at 5%.

According to these results four hypotheses are showed the impact on financial
reporting quality. Board independence shows the (prop=0.01) positive and significant
impact on FRQ. It means that a more independent board shows the better FRQ.INST
shows the (prop=0.008) negative and significant impact on FRQ. It means that a
lessnumber of Institutional shareholders show the better FRQ.The other variables of

36
this study rejects the hypothesis that board size, firm size, INST and leverage has no
significant impact on FRQ.

37
 Chapter 05

Conclusion

5.1 Conclusion

Financial reporting quality (FRQ) is consider as backbone of economic activities and

now the studies are increasing on financial reporting quality. But the determinants or
characteristics of FRQ is not clearly understandable in finance literature, because it’s
meaning is different in different fields. So here is a question can FRQ is measured
and its determinants are identified. Past studies attempted to find out these factors and
provide different evidence about the impact of these factors on FRQ. But these
researches are conducted on developed countries where institutions have similarities
and advanced monitoring framework.

This study explores the impact of CG mechanisms and FRQ in Pakistan. It is

observed that financial reporting quality gained interest by users and investors in
investment decisions. And it is best way to check the FRQ by corporate governance.
The corporate governance factors are board independence, board size, institutional
shareholder ownership, leverage, INST, firm size, CEO duality and audit committee’s
independence.
The finding of this study discovered, there are significant and positive association
between the some factors of corporate governance on FRQ in financial firms of
Pakistan.
This study suggests that it is helpful for the government of Pakistan and other
financial institutions that how can they make better financial reporting quality and
avoid the risk. It is also helpful for the investors who want to invest they must
carefully observe that corporate governance factors which has impact on financial
reporting quality.

Future Research:
Although this study supports the argument that the corporate governance affects the
financial reporting quality in the context of Pakistan. However, further research is

38
necessary to provide additional insight into the role of corporate governance and the
reporting quality. First, it would be appropriate to verify these findings by including
the non-financial companies. Then, it would be worthwhile to incorporate other
governance variables (such as the gender discrimination) or other measures of
information quality (such as the voluntary disclosure). It would be also very
interesting to determine if the governance mechanisms and the reporting quality
influence the cost of capital of the Pakistan’s firms. Finally, it suggest investigating
the link between corporate governance and financial reporting quality in other
emerging markets.

39
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45
 Bank names

S.no Banks
1 BAHL
2 FBL
3 FINCA
4 FWBL
5 HBL
6 HMB
7 JSBL
8 KASB
9 KBL
10 MCB
11 MBL
12 NBP
13 NIB
14 NRSP
15 PBIC Ltd
16 PIC Ltd
17 PKIC Ltd
PLHC
18 Ltd
PO Bank

19 Ltd

20 POIC Ltd

21 SAMBA

22 SILK

23 SINDH

46
24 SBL

SPIAIC

25 Ltd

26 SCB

27 SUMMIT

28 TFMB

29 BOK

30 BOP

TM B

31 Ltd

32 UMB Ltd

33 UBL

34 ZTBL

47
 Appendix

Descriptive statistics

Sum
Maximu Minimu Std. Skewne Kurtosi Jarque- Probabili Sq. Observati
m m Dev. ss s Bera ty Sum Dev. ons
-
0.00169 0.0015 0.0003 1.3361 11.523 781.31 -9.81E- 3.34E-
1 6 78 12 66 26 0 05 05 235
1 1 0 NA NA NA NA 235 0 235
0.57142 0.1428 0.0959 0.8456 2.7837 28.464 0.00000 71.005 2.1556
9 57 8 1 91 09 1 39 62 235
-
0.92307 0.1818 0.1802 0.7470 2.3338 26.205 0.00000 165.18 7.6027
7 18 51 9 44 87 2 81 91 235
1.5497 0.3850 3.2434 6.3879 0.04100 561.97
13 4 1 67 72 36 9 1964 45 235
0.3525 2.0201 5.0809 202.23 29.080
1 0 3 28 19 61 0 34 85 235
-
21.5623 15.207 1.4125 0.5354 2.6216 12.632 0.00180 4409.0 466.88
1 95 34 8 24 35 7 77 87 235
3.04609 0.5641 3.0005 11.659 1086.8 69.030 74.465
7 -0.2008 18 29 42 58 0 14 66 235
0.0623 2.4733 13.728 1366.6 20.254 0.9102
0.5105 0.0103 68 95 77 95 0 55 14 235
0.0686 1.6947 5.4380 170.69 23.707 1.1025
0.387 0.0023 42 29 83 49 0 5 35 235

48
 Correlation

ACI B_I BOARD_SIZE CEO_DUALITY FIRM_SIZE FRQ INST ISO LEVERAGE

1 0.07113 -0.58968 0.117312 -0.06595 0.004619 -0.01395 0.083185 0.137978

0.07113 1 -0.00908 0.079301 0.177721 0.199311 0.196033 0.061215 -0.07056

-0.58968 -0.00908 1 -0.0716 0.335733 -0.04488 -0.09473 -0.10376 0.015346

0.117312 0.079301 -0.0716 1 0.047737 -0.10247 -0.09196 0.039956 0.392635

-0.06595 0.177721 0.335733 0.047737 1 -0.00966 -0.23349 -0.05468 -0.0627

0.004619 0.199311 -0.04488 -0.10247 -0.00966 1 0.145008 0.187551 -0.07135

-0.01395 0.196033 -0.09473 -0.09196 -0.23349 0.145008 1 0.205992 -0.1683

0.083185 0.061215 -0.10376 0.039956 -0.05468 0.187551 0.205992 1 0.015877

0.137978 -0.07056 0.015346 0.392635 -0.0627 -0.07135 -0.1683 0.015877 1

49
Common Effect model

Dependent Variable: FRQ

Method: Panel Least Squares
Date: 11/05/17 Time: 20:42
Sample: 2005 2014
Periods included: 10
Cross-sections included: 26
Total panel (unbalanced) observations: 235

Variable Coefficient Std. Error t-Statistic Prob.

C -0.00021 0.000367 -0.56616 0.5719

ACI -0.00015 0.000321 -0.47561 0.6348
B_I 0.000398 0.000141 2.8235 0.0052
BOARD_SIZE -1.26E-05 2.09E-05 -0.60231 0.5476
CEO_DUALITY -0.00013 7.51E-05 -1.69526 0.0914
FIRM_SIZE -7.41E-08 1.94E-05 -0.00381 0.997
INST 3.84E-05 4.68E-05 0.820897 0.4126
ISO 0.001009 0.000395 2.555418 0.0113
LEVERAGE 9.94E-06 0.000395 0.025179 0.9799

R-squared 0.091583 Mean dependent var -4.18E-07

Adjusted R-squared 0.059427 S.D. dependent var 0.000378
S.E. of regression 0.000366 Akaike info criterion -12.9487
Sum squared resid 3.03E-05 Schwarz criterion -12.8162
Log likelihood 1530.469 Hannan-Quinn criter. -12.8953
F-statistic 2.848055 Durbin-Watson stat 1.284268
Prob(F-statistic) 0.00493

50
Fixed Effect model

Dependent Variable: FRQ

Method: Panel Least Squares
Date: 11/05/17 Time: 20:43
Sample: 2005 2014
Periods included: 10
Cross-sections included: 26
Total panel (unbalanced) observations: 235

Std.
Variable Coefficient Error t-Statistic Prob.

C 0.000192 0.000491 0.390744 0.6964

ACI 0.000309 0.000365 0.84438 0.3995
B_I 0.000441 0.00018 2.45564 0.0149
BOARD_SIZE -8.15E-06 2.52E-05 -0.32347 0.7467
CEO_DUALITY -0.00011 0.00027 -0.40918 0.6828
FIRM_SIZE -2.70E-05 2.59E-05 -1.04176 0.2988
INST -0.00016 5.86E-05 -2.71326 0.0072
ISO 0.000525 0.000477 1.100215 0.2726
LEVERAGE -3.23E-05 0.00039 -0.08269 0.9342

Effects Specification

Cross-section fixed (dummy variables)

Mean dependent -4.18E-

R-squared 0.40007 var 07
Adjusted R-
squared 0.301574 S.D. dependent var 0.000378
S.E. of regression 0.000316 Akaike info criterion -13.1508
Sum squared
resid 2.00E-05 Schwarz criterion -12.6503
Log likelihood 1579.219 Hannan-Quinn criter. -12.949
Durbin-Watson
F-statistic 4.061793 stat 1.746745
Prob(F-statistic) 0

51
Randoms effect model

Dependent Variable: FRQ

Method: Panel EGLS (Cross-section random effects)
Date: 11/05/17 Time: 20:44
Sample: 2005 2014
Periods included: 10
Cross-sections included: 26
Total panel (unbalanced) observations: 235
Swamy and Arora estimator of component variances

Std.
Variable Coefficient Error t-Statistic Prob.

C 5.01E-05 0.000418 0.119784 0.9048

ACI 0.000145 0.000335 0.433274 0.6652
B_I 0.000431 0.000158 2.731702 0.0068
BOARD_SIZE -6.60E-06 2.20E-05 -0.30038 0.7642
CEO_DUALITY -0.00013 0.000115 -1.16288 0.2461
FIRM_SIZE -1.96E-05 2.21E-05 -0.88752 0.3757
INST -7.45E-05 5.13E-05 -1.45381 0.1474
ISO 0.000809 0.000425 1.902848 0.0583
LEVERAGE -5.83E-05 0.000371 -0.15681 0.8755

Effects Specification
S.D. Rho

Cross-section random 0.000187 0.2594

Idiosyncratic random 0.000316 0.7406

Weighted Statistics

Mean dependent -9.15E-

R-squared 0.061066 var 07
Adjusted R-
squared 0.027829 S.D. dependent var 0.000323
S.E. of regression 0.000318 Sum squared resid 2.29E-05
Durbin-Watson
F-statistic 1.837299 stat 1.58744
Prob(F-statistic) 0.07128

Unweighted Statistics

R-squared 0.057966 Mean dependent -4.18E-

52
 var 07
Sum squared Durbin-Watson
resid 3.14E-05 stat 1.154239

53