Board composition and size,firm ownership and performance

Abstract

This research study compares the financially-distressed and financially-healthy companies, on the basis of their board composition and size, ownership and performance, over the 2006–2010 time period. While focusing on manufacturing sectors in Pakistan, the logit-regression results reveal that all variables are significantly different between financially-distressed and financially-healthy companies. The first of its kind, the present study benefits business people as well as financial analysts and investors. Their decision-making processes will be enhanced as they evaluate financially-distressed firms and financially-healthy ones. The study has some limitations also. It has ignored financial sector of Pakistan because of different reporting style of financial firms. The periods before and after the period of financial distress have also been ignored in the study. Despite its limitations, the study contributes a pragmatic insight into the systemic aspects of financial performance, most helpful both to future business research and to policymaking practice.

Keywords

Financial distress board composition ownership distribution board size Pakistan

Muqaddas Khalid is a PhD candidate at COMSATS Institute of Information Technology, Lahore, Pakistan. She has completed her MS in 2013. She is author of several research publication in well reputed journals and has presented her work in several national and international conferences and workshops as well. Her area of interest is corporate governance, earnings management and study of financially distressed firms.

Muhammad Kaleem Khan, got PhD degree in (Finance) from School of Economics and Management, Beijing University of posts and Telecommunications, Beijing, China. He obtained his graduation and post-graduation in business administration from COMSATS Institute of Information Technology, Pakistan. He is currently serving there as lecturer. He is associate member of CPA Australia. He has published numerous papers in internationally reputed journals such as Human Systems Management, China Economic Review, Asia Pacific journal of financial Studies, Asia Pacific Journal of Marketing and Logistics , Sustainability, Journal of Educational Computing Research etc. His areas of interest include corporate finance, crowdfunding, accounting and financial economics.

Sadaf Ehsan is a lecturer and Ph.D. scholar at COMSATS Institute of Information Technology, Lahore, Pakistan. She has completed her MS in Finance in January 2012. She has more than ten years of teaching and research experience. She is the author of several publications and produced more than 10 research publications. She has attended many national and international conferences as well. Her areas of research interest include Corporate Social Responsibility, Corporate Governance, Firm Privatization, Dividend Policy, Earnings Management, Debt maturity and Efficiency Analysis

Umair Akram, He got Ph.D. degree in (Marketing) from School of Economics and Management, Beijing University of Posts and Telecommunications, Beijing, China. Before commencing his Doctoral research, he worked as a Lecturer of marketing management at Institute of Business and Management Sciences, UAF, Pakistan. He holds post-graduation in Business Administration specialized in Marketing. He is the author of several publications and international conference proceedings. He has published numerous papers in journals such as Human Systems Management, China Economic Review, Sustainability, Asia Pacific Journal of Marketing and Logistics, British Food Journal, Asia Pacific Journal of Financial Studies, Chinese Management Studies and International Journal of Conflict Management etc. He is reviewer board member of numerous SSCI journals. He is editorial board member of Business and Management studies. His Current areas of interest includes, Online Impulse Buying Behavior, E-Marketing, E-Commerce, Social Commerce and Consumer Psychology.

Imtiaz Ahmad, is working as a Lecturer in the Department of Commerce, University of Sargodha, Gujranwala, Pakistan. He did his Master of Philosophy in Management Sciences from University of Sargodha, Sargodha, Pakistan. He has three books publications. His areas of interest are Accounting and Finance.

1 Introduction

People and human organizations utilize resources and adopt practices toward the achievement of one common purpose: accounting profitability. To achieve said purpose, firms have to run their business activities successfully and to fulfill external investment needs. In turn, to fulfill such investment needs, firms must bear a financial burden, i.e., leverage, acquired from external stakeholder groups, e.g., creditors, investors etc. This burden can only be carried by profitable firms. However, if firms are not profitable and thereby fail to meet these needs, then they become financially distressed.

This failure signals the inability of a business enterprise to cope with external obligations. And a financially-distressed firm’s lost creditworthiness can harm all of its stakeholder groups by causing major losses to them. Not only the external providers of capital, but also the other stakeholder groups become affected, such as, for example, employees and suppliers. The chances of financial distress are increased with increasing fixed costs, illiquid assets or negative earnings over a long-time period. This problematic situation can lead to bankruptcy or liquidation of a business enterprise or other societal organization.

A change has been observed in the perception of people’s minds about the corporate aspiration. Their minds have been changed from the sole aspiration of the corporate to benefit not only the shareholders and emerged to give benefits to all of its stakeholders [16]. With the passage of time, the implementation of corporate governance has moved from “non-binding notion” to “binding responsibility” of corporations [25]. The strong the execution of CG practices in a firm, the strong the positive impact it exerts on the investors to invest their funds in the firm. It also affects operating activities and market confidence of the firms. Fernando [16] said that not only the stakeholders but all societies and countries around the globe are also interested keenly in assuring the adoption and implementation of CG practices in the companies.

In the “Code of Best Practices”, it has been mentioned that corporate governance is “the system by which companies are directed and controlled” (Cadbury, 1992). One of the most erstwhile non-governmental organizations, “Organization of Economic Cooperation and Development (OECD)”, spelled out the corporate governance principles and practices to achieve long-term value. The OECD has developed these principles in 1999 that became the basic guide to assess the corporate governance arrangements of a country [26]. OECD Report for year 2004 contained recommendations about different aspects of corporate governance, including shareholders rights, equal behavior towards all shareholders, functions of stakeholders, transparency, disclosure, and duties of board [34]. Most of the studies on corporate governance are contrary to the fact that the business and organizational reality shows that most of dysfunctional organizational behavior is caused by the inhumane, top-down imposition of the aye-unnatural and faulty, bureaucratically-hierarchized authority and power sham, a delusion of organization that subjugates and enslaves people, in lieu of a pragmatically ecological decision-making structure of collegial control and responsibility [45].

SECP [41] took an important step in Pakistani corporate governance reforms in March 2002 by issuing ‘Code of Corporate Governance (CCG)’. These reforms have made the regulatory bodies more vigilant and enthusiastic to implement CCG corporate sector. The code admits many suggestions in accordance with the international good practices. According to CCG, all listed companies in stock exchanges of Pakistan are required to publish and circulate a “Statement of compliance with the code of corporate governance” to the authorities. To give safety to the diversified stakeholders’ interest, the code is aspired to develop a system in which the company is guided and commanded in conformity with the best practices of the corporate governance. Receptiveness and transparency in business affairs and decision making procedures have also been punctuated by the code. One of the most prominent features of the code is that it embraced the setting up of an audit committee and internal audit functions carried out by them in all the listed companies. In collaboration with “the UNDP” and “Economic Affairs Division” of Government of Pakistan, SECP, in August 2002, launched a plan on corporate governance. The plan was launched chiefly for the execution of CCG and for the strong regulative structure of corporate sector in Pakistan [26]. Rais and Saeed [39] mentioned that overall business structure and environment has been improved by adopting the CCG as it makes the companies more creditworthy, transparent and accountable in business and financial reporting structure.

With the increasing competition between the companies, some of the companies neglect the management strategies and decision making in doing investments, production and operations of the business, due to which they have to see a declination in their operating performance. Due to this entire scenario, companies may be trapped in the situation of financial distress which may ultimately lead the companies towards their winding up or bankruptcy. The companies have to face this situation of financial distress due to the poor management and also due to the non-compliance with the corporate governance practices. Bundle of studies up till today have proved this fact that the companies face financial distress due to the non-compliance and non-adoption of the corporate governance principles and practices [1 , 33].

This study is the first of its kind that compares the financially distressed and financially healthy companies on the basis of board composition, ownership distribution and board size in Pakistani context. It fills up the literature gap by focalizing on the financially distressed firms that have not yet been bankrupted, thus giving them a chance for restructuring their policies. The present study tends to attain the accompanying aspirations;

To compare the financially distressed companies with the financially healthy companies on account of board composition (independence of board and duality of board chair structure),

To see whether the financially distressed companies differ from financially healthy companies on the basis of board size of Pakistani listed companies.

To find out the discrimination between the two groups (i.e., financially distressed and financially healthy companies) on the basis of outside block-ownership distribution in Pakistani context.

This research article intends to answer the following research questions;

Does the ratio of outside directors in the board of directors of Pakistani listed companies is different in financially distressed and financially healthy companies?

Do the financially distressed firms are more likely to have joint CEO-board chair structure than healthy firms?

Does the role of outside block-holders have a different impact on the financially distressed companies than the financially healthy companies of Pakistan?

Is the board size a useful predictor in differentiating between the financially distressed and financially healthy companies of Pakistan?

The present study is lacking in its generalizability on financial sector of Pakistan because of different reporting style of financial firms. The periods before and after the period of financial distress have also been ignored in the study. The rest of the article is planned as follows. Section two discusses the literature, section three is based on the research methodology used in the study, section four presents a comprehensive discussion on results and section five exhibits the conclusion of the study along with its policy implications and limitations.

2 Literature review

Financial distress is the concept that lacks any single definition. Various researchers have defined it in various aspects. Some consider financial distress to be the state of liquidation, bankruptcy, default on debts and delisting from the relevant stock exchange and others consider that the firms enter the state of financial distress due to bad economic conditions. Seminal definition of financial distress has been given by [6] who has defined financial distress as bankruptcy, non-remittal of preferred dividends and debts. Financial distress is the negative connotation that shows the firm’s inability to meet the financial indebtednesses on time or its inability to the full extent due to liquidity problems and other problems being faced by the business [13, 20]. Few researchers have found East Asian Economic Crisis (that broke out in 1997) to be the main reason of the financial distress of companies as this crisis had a great impact on the Asian corporations [1 , 42]. For the purpose of this study, firms that have earned long run negative EPS (Earnings Per Share) are taken as financially distressed firms as taken by [15, 33].

Research studies on the prediction of financial distress are good in number. But studies developing the connection between corporate governance practices and financial distress are not enough. Some studies have argued that financial distress is linked with different characteristics of corporate governance including the board composition, ownership distribution and board size [1 , 33].

2.1 Board composition

Elloumi and Gueyie [15] have examined the relationship between financial distress and CG characteristics for Canadian firms. The results of logit regression analysis have shown that beside financial indicators, board of directors’ composition explicates financial distress. They also indicated that financially distressed firms have lower incidence of outside directors. The results of the study of Abdullah [1] have shown that there is no association of financial distress status with board independence and CEO duality. Elloumi and Gueyie [15] also found no difference in the financially distressed and healthy companies based on CEO duality. According to another study, higher ratio of independent directors in the board is more effective for avoiding bankruptcy in case distress has been identified [17]. Li [29] asserted a negative relationship between independent directors and financial distress of the firms in the study. Hui and Jing-jing [24] analyzed the relationship between financial distress of companies and corporate governance and found that among corporate governance variables, only proportion of independent directors came out to be significantly negatively linked to financial distress costs. Moreover, they found positive association between CEO/chairman duality and financial distress costs. The results of another study also indicated that the presence of CEO duality explain financial distress of the firm [33]. The literature on the board composition of financially distressed companies shows that the imposition of the bureaucratically-hierarchized authority and power artifice produces a delusion of organization which becomes the cause of financial distress of firms. The only possible form of human and organizational development is self-development. Worldwide, pioneering business enterprises and other societal organizations are transforming themselves into truly ecological decision-making structures of collegial control and responsibility to make the firms financially healthy. From the literature discussed so far, we draw following two hypotheses;

1: The proportion of outside / independent directors in the board of directors is negatively associated with financial distress status.

2: Financially distressed firms prone to have greater incidence of joint CEO-board chair structure than healthy firms.

2.2 Ownership distribution

Lee and Yeh [28] took three proxies for corporate governance risk to find whether weak CG characteristics explain financial distress. The proxies taken were percentage of block-holding directors, the percentage of block-holding shareholders’ shareholding assured against loans of banks (pledge ratio) and divergence in control from cash flow rights. The results have shown positive relationship of all the three variables to the possibility of financial distress in the next year which suggested the vulnerability of corporate governance risk to the financial distress and economic downturns. No association between the presence of block-holders and financial distress status of the firm has been reported by [33]. On the other hand, another researcher has provided strong evidence that large shareholders have strong and beneficial impact on the productivity improvements of the poorly performing companies [27]. Moreover, both the studies of [1, 15] reported a negative association between outside block-holders and financial distress status of the firms. The hypothesis, therefore, will be;

3: Outside block-holder’s interest is negatively related to financial distress status of the Pakistani listed firms.

2.3 Board size

Cheng [9] reported that to reach a unanimous decision, the larger boards have to undergo many compromises when compared with the smaller boards. In a comparative study of Japan and Australia, no association has been reported between size of board and financial health of the company [7]. So, the hypothesis will be

4: There is positive association between the board size and likelihood of financial distress status of Pakistani firms.

2.4 Control variables

The research proposes that the firm’s level of leverage is anticipated to boost its probability of going into distress and bankruptcy (for example, [2 , 38]. Awan [3] indicated that the leverage ratios show prominent differentiation between the failed and non-failed companies. He stated that the non-failed firms are less indebted as compared to the failed firms. Thus, based on the literature discoursed above, we tend to draw the hypothesis that;

5: There is a positive connection between the firm’s leverage level and financial distress status of the Pakistani listed firms.

The univariate analysis revealed that the low liquidity is one of the significant indicators of a firm’s failure [3]. Elloumi and Gueyie [15] have shown lower levels of liquidity for distressed firms as compared to the healthy firms. The results of the study conducted by Abdullah have also shown that the distressed companies have lower liquidity ratios than the non-distressed companies [1]. Thus,

6: Liquidity is negatively associated with financial distress status of Pakistani listed firms.

Yoon and Jang [44] signaled that smaller firms are more risky than the larger ones. The results of the another study have shown that the mean value of log of total assets of distressed firms is less than healthy firms which suggest that the financially distressed firms are mostly smaller in size [8, 33]. Therefore, we hypothesize that

7: There is a negative relationship between the firm size and financial distress status of the Pakistani listed firms.

3 Research methodology

3.1 Sample and data

To compare the board composition, ownership distribution and board size between the financially distressed and financially healthy companies, manufacturing sector has been selected which is the third largest sector after agriculture and mining sector of the economy of Pakistan. To identify the financially distressed firms (firms presenting negative EPS for consecutive five years from 2006 to 2010) for initial screening purpose, “Financial statements analysis of Companies (non-financial) listed at Karachi Stock Exchange (2005–2010)” issued by State Bank of Pakistan was sorted [40].

Only those firms from the manufacturing sector are included in the final sample which fulfills the following criteria.

Manufacturing firms which remain enlist in the Karachi Stock Exchange in the period of our study, i.e., from 2006 to 2010.

Firms in the financial sector are omitted due to their financial reporting particularities.

Firms whose financial and corporate governance information is not available during 2006 to 2010 have also been excluded.

Manufacturing companies not meeting the criteria of this study will also be eliminated, i.e.,

if firms’ EPS is not negative in the consecutive five years (2006–2010),

if firms are earning negative EPS for five years but not in the period of our study (2006–2010).

Financially distressed firms which have no matching healthy firms will also be excluded from the final sample.

On the basis of above discussed criteria, the no. of financially distressed firms finally sorted were 42. Each distressed company is then matched with a healthy firm (firms presenting positive EPS in each of the five years from 2006 to 2010), thus forming choice based sample of financially distressed and financially healthy companies. The firm will be categorized as financially healthy if:

It is earning positive EPS in each of the five years from 2006 to 2010,

It is in the same industry in which the distressed firm lies and

The period in which the EPS is analyzed is same (2006–2010) with available financial statement data and proxies.

Data has been amassed from the annual reports of Karachi Stock Exchange (KSE) and Lahore Stock Exchange (LSE), Financial statements analysis of Companies issued by State Bank of Pakistan (2005–2010), published financial statements, websites of Karachi Stock Exchange (KSE) and Lahore Stock Exchange (LSE), websites of sampled companies etc.

3.2 Variables of the study

The dependent variable chosen for the study is financial distress (FDSTRS). FDSTRS is the dummy variable coded 1 if the firm is financially distressed and 0 otherwise (for healthy companies). For the purpose of this study, following [15, 33] firms that are earning negative EPS over the period of five years (2006 to 2010) are categorized as financially distressed firms.

Among the board composition variables, board independence and duality of CEO & board chair structure have been taken. Board independence (BIND) represents the percentage of board members who are considered outside directors to total members on the board. The definition of independent directors taken for this research work is coherent with some of the prior research studies [1 , 33]. Those directors are treated as independent directors with no stakes in the company. This definition is also aligned with the CCG [41]. It states that independent directors are directors who are not affiliated with listed company, its promoters, its directors or its related parties in terms of family relationship or any other relationship. Duality of CEO and Board Chair structure (DBCS) is a dummy variable with a value of 1 if the CEO is also the chairperson of the board, otherwise 0. The same variable has been investigated by many researchers in the past to find its relationship or impact on the financial distress of the companies [1 , 33]. For ownership distribution, outside block-holders have been taken. Outside Block-holders (OBLK) is the cumulative percentage of the shares held by outside shareholders with ten percent or more of the shareholdings. The impact and relation of this variable with financial distress has been observed by a number of studies, e.g., [1, 15 , 38]. The total number of members in the board represents the board size (BSZ). Miglani [33] have used this variable to find its association with the financial distress.

Among the control variables, the first is leverage (LVG) measured as “the ratio of total debts to total assets”. Liquidity (LQY), the second control variable, is defined as “the ratio of current assets to current liabilities” and firm size (FSZ) is calculated as “natural log of total assets of the firm”.

3.3 Model specification

Logit analysis (also known as logistic regression analysis) is employed to determine the relationship of the dichotomous or ordinal response variable with the independent variables [4 , 36]. Maddala [30] found that logit regression analysis is suitable where disproportionate sampling from two different groups is used. The two different groups in our study are financially distressed firms and the non-distressed (healthy) firms. Logit regression analysis has also been employed by [1 , 35] to find the linkage between the financial distress and different practices of corporate governance. The two groups used in these studies were financially distressed and healthy companies. Therefore, the model for our study will be;

$\begin{matrix} {FDSTRS}_{it} = 1 / 1 + e^{- (α_{0} + α_{1} (Board composition, Ownership distribution, Board size)_{it} + β_{2}} \\ (Control variables)_{it} + ɛ_{it}) \end{matrix}$

Where FDSTRS_it = Distress status of the ith company (1 for financially distressed, 0 otherwise) in time period t;

Board composition, Ownership distribution, Board size are the independent variables used in the study of the ith company in time period t, i.e., BIND, DBCS, OBLK and BSZ;

Control variables = These are the control variables used in the study of the ith company in time period t, i.e., LVG, LQY and FSZ;

ɛ_it= Error term

4 Empirical results

Table 1 depicts descriptive statistics of the sample subdivided into financially distressed and financially healthy companies and Table 2 provides t-statistics for testing the difference of means between financially distressed and financially healthy companies. The mean values of earnings per share (EPS) is negative for the distressed companies (–5.317) and positive for the healthy ones (14.861) and this difference is statistically significant at 1% level. The minimum value of earnings per share (EPS) is –40.22 and maximum value is –0.03 for distressed sampled companies while minimum and maximum values of EPS for healthy sampled companies are 0.14 and 124.16 respectively. These results also justify our criteria of selecting the financially distressed and financially healthy companies. Financially distressed companies are those earning negative EPS throughout the study period, i.e., from 2006–2010 while financially healthy companies are those earning positive EPS in the study period.

Table 1
Descriptive statistics of financially healthy and financially distressed firms variables

Fin. Healthy Firms Fin. Distressed Firms

Mean Std. Dev. Min. Max. Mean Std. Dev. Min. Max.

EPS 14.861 16.428 0.14 124.16 –5.317 6.697 –40.22 –0.03

BIND 0.597 0.145 0.14 0.91 0.349 0.178 0.00 0.89

DBCS 0.252 0.435 0.00 1.00 0.695 0.461 0.00 1.00

OBLK 0.283 0.257 0.00 0.94 0.113 0.158 0.00 0.73

BSZ 8.191 1.828 4.00 15.00 7.776 1.611 6.00 15.00

LVG 0.522 0.211 0.00 1.21 8.537 46.580 0.00 361.35

LQY 1.678 1.484 0.00 12.23 0.527 0.598 0.00 6.25

FSZ 9.503 1.322 1.62 11.36 8.603 1.514 0.00 11.32

	Fin. Healthy Firms	Fin. Distressed Firms
EPS	14.861	16.428	0.14	124.16	–5.317	6.697	–40.22	–0.03
BIND	0.597	0.145	0.14	0.91	0.349	0.178	0.00	0.89
DBCS	0.252	0.435	0.00	1.00	0.695	0.461	0.00	1.00
OBLK	0.283	0.257	0.00	0.94	0.113	0.158	0.00	0.73
BSZ	8.191	1.828	4.00	15.00	7.776	1.611	6.00	15.00
LVG	0.522	0.211	0.00	1.21	8.537	46.580	0.00	361.35
LQY	1.678	1.484	0.00	12.23	0.527	0.598	0.00	6.25
FSZ	9.503	1.322	1.62	11.36	8.603	1.514	0.00	11.32

EPS = Earnings Per Share. BIND = Independence of Board (calculated by taking percentage of outside directors on the board). DBCS = Duality of Board Chair Structure (dummy variable coded 1 if CEO is also the chairperson of the board and 0 otherwise). OBLK = Outside Block-holders (calculated by taking the cumulative percentage of the shares held by outside shareholders with 10% or more of the shareholdings). BSZ = Board size (calculated by taking no. of directors on the board). LVG = Leverage (calculated as Total Debts / Total Assets). LQY = Liquidity (calculated as Current Assets / Current Liabilities). FSZ = Firm size (calculated by taking log of Total Assets).

Table 2

Test of difference in means

	Fin. Healthy firms	Fin. Distressed firms
	Mean	Mean	Mean Difference	T-test
EPS	14.861	–5.317	20.178	0.000*
BIND	0.597	0.349	0.248	0.000*
DBCS	0.252	0.695	–0.443	0.000*
OBLK	0.283	0.113	0.170	0.000*
BSZ	8.191	7.776	0.414	0.014**
LVG	0.522	8.537	–8.015	0.013**
LQY	1.678	0.527	1.150	0.000*
FSZ	9.503	8.603	0.89993	0.000*

^*Statistically significant at less than 1% level based on two-tailed tests. ^**Statistically significant at less than 5% level based on two-tailed tests.

The mean of independence of board (BIND) of financially distressed firms is smaller by 0.248 than the financially healthy firms and statistically significant at less than 1% level. Descriptive shows that on the average, 69.5% of the distressed companies have the duality in the board chair structure (DBCS) as compared to the 25.2% of the healthy companies and this difference in the two sub-samples is statistically significant at less than 1% level. The mean value of outside block-holders (OBLK) of distressed sampled companies is 0.17 less than the mean value of outside block-holders of healthy sampled companies. The results show that the healthy companies show more outside block-holders in their total shareholdings as compared to the distressed firms and this also held statistically significant at less than 1% level. The mean value of board size (BSZ) for distressed firms is 7.776 and 8.191 for healthy firms. It means that on the average, the board size of distressed firms is between 7 to 8 members but inclination is more towards 8 members and board size of healthy firms also show that on the average the inclination is more towards the 8 members on the board of directors. This leads us to conclude that there is no difference between these two groups of companies on account of board size and the t-statistic also does not show any significant difference between these two groups keeping board size in mind. Descriptive also shows that in capital structure, distressed firms use more debt, i.e., 853.7% compared to 52.22% in healthy firms and this was also significant at less than 5% level. The descriptive statistics also show that the healthy firms have more liquidity, i.e., 1.678 than that of distressed firms, i.e., 0.527. The current ratio (taken as a measure of liquidity) of 1.678 shows that current assets of the financially healthy companies are more able to satisfy near-term obligations than the financially distressed firms. This stood also statistically significant at less than 1% level. The mean value of firm size shows that the healthy companies are bigger in size than that of the distressed ones. The mean value of firm size of distressed companies is 0.9 less than the firm size of the healthy companies and this is also significant at less than 1% level.

The correlation analysis is observed between the independent and control variables to validate the data as well as to identify the issue of multicollinearity (Table 4). Multicollinearity can be explained when two or more predictors in the model are perfectly correlated [32]. If the value of the correlation coefficient is abnormally high between two independent variables, it can cause the multicollinearity problem. As a result of this problem, the estimates of the coefficients of the model could remain unresolved and the chances of standard errors of these estimates could become huge enough [32]. The description of the strength of association is presented in the following Table 3.

Table 3

Description of correlation coefficient

Correlation coefficient (r)	Description
0.50 or higher	Substantial association
0.30 to 0.50	Moderate association
0.01 to 0.29	Negligible association

Table 4

Correlation

	BIND	DBCS	OBLK	BSZ	LVG	LQY	FSZ
BIND	1.00
DBCS	–0.191^**	1.00
OBLK	0.275^**	–0.267^**	1.00
BSZ	0.359^**	–0.208^**	0.241^**	1.00
LVG	–0.060	0.009	0.101^*	–0.066	1.00
LQY	0.287^**	–0.250^**	0.184^**	0.012	–0.105^*	1.00
FSZ	0.285^**	–0.109^*	0.088	0.265^**	–0.209^**	0.239^**	1.00

^**Correlation is significant at the 0.01 level (2-tailed). ^*Correlation is significant at the 0.05 level (2-tailed).

The Table 4 of Correlational analysis shows that there is no issue of multicollinearity in the data as there is no value above 0.50 which shows any substantial association between the variables.

Logit analysis is conducted to compare between the financially distressed and financially healthy companies on account of board composition, ownership distribution and board size. These estimates show the amount of increase / decrease in the predicted odds of financial distress status Fin_Distress = 1 by one unit increase / decrease in the predictor while keeping all other predictors constant.

Cox & Snell R Square tells us that 58.3% variance is explained by the model in the dependent variable. In other words, we are 58.3% confident that our model is correct. The ‘Hosmer and Lemeshow Test’ is considered to be the most robust test available in SPSS to check the model’s goodness-of-fit statistic. Unlike most of the p-values, the p-value of this test should be greater than or equal to 0.05 to indicate good fit of the data. In other words, the chi-square value should not be statistically significant if the model is really great. For our model, the significance value is 0.891 which indicates that the model is really great. Classification of performance tells us that 90.5% of the cases have been predicted correctly by the model.

Table 4 tells the impact that predictors have on the dependent variable in our logit model. β represents the log-odds ratio, however, for the logistic regression, the odds ratio ‘Exp (β)’ is used for the interpretation. The odds ratio ‘Exp (β)’ can be interpreted in terms of change in odds of the outcome occurring. Field [18] reported that if the value of Exp (β) is greater than 1, it shows that the odds of outcome occurring increases as a result of increase in the predictor. On the other hand, if the value is less than 1, it signals that the odds of outcome occurring decreases as the predictor increases. From the table, it can be seen that all the variables are statistically significant predictors of financial distress as the p-value is less than 0.05. The test result of the intercept (p < 0.05) suggests that the intercept should be included in the model.

In our logit model, the coefficient of BIND (–8.444) is negative as expected and is also significant at 0.05 level which indicates that each percentage increase of outsiders in the board composition decreases the odds of the companies being in financial distress by 0.0004 times keeping all other predictors constant. These findings are consistent with the previous researches of [15, 24]. This supports the first hypothesis that financially distressed firms have insiders dominated boards. The results for the duality of CEO and board chair structure (DBCS) variable (β coefficient = 1.855, p-value = 0.000) are consistent with the prior research of [33] on financial distress and corporate governance of companies. The Exp (β) shows that if there is duality in the CEO and board chair structure, then the odds of the companies to go into financial distress are increased by 6.395 times by keeping all the other predictors constant. This duality can also lead the firms towards bankruptcy [12, 23]. The code of corporate governance also states to separate the two positions of CEO and board chair person but there is no compulsion implied by the code for the separation of these two positions [41]. The coefficient of outside block-holders (OBLK) is negative (–2.418) as expected and is statistically significant at less than 0.05 level (p-value = 0.012). These results are also supported by some prior research studies of [1 , 29]. From the Exp (β), we can detect that with one percent increase of outside block-holders in a company, the odds of the company being in financial distress is decreased by 0.089 times with all other predictors kept as constant. These outside block-holders also proved to be helpful for the productivity improvements of the poorly performing companies [27].

The findings for the board size (β coefficient = 0.449, p-value = 0.000) are consistent with the fourth hypothesis. It can be seen that with a single member increase in the board size, the odds of the company to go into financial distress is increased by 1.567 times with all other predictors kept as constant. It can also be concluded that the communication and decision making become problematic because the companies have larger boards [21] due to which the companies go into financial distress.

With respect to the control variables, leverage (LVG) is found to have statistically significant (β coefficient = 1.625, p-value = 0.009) impact on the financial distress status of the firms. It means that the high leveraged firms are more likely to be in distress than the low leveraged firms [15, 29]. The odds ratio ‘Exp(β)’ shows that one unit increase in the leverage increases its odds of being in financial distress by 5.080 times while holding all other predictors constant. Therefore, the financially distressed firms are more leveraged than the healthy firms. Liquidity (LQY), on the other hand, is negative and statistically significant (β coefficient = –2.198, p-value = 0.000). This shows that financially distressed firms have lower liquidity as compared to the financially healthy firms which is also consistent with the prior researches of [1 , 15]. The odds ratio ‘Exp(β)’ shows that one unit increase in the liquidity of the firms decreases its odds of being in financial distress by 0.111 times while holding all other predictors constant. Firm size (FSZ) is negative (–0.309) and statistically significant (p-value = 0.018) as was expected. This suggests that the smaller firms are more likely to be in financial distress as compared to the larger ones. It is also consistent with the research studies of [33]. Moreover, Titman and Wessels [43] also suggested that larger firms are less likely to be in financial distress as compared to the smaller firms. The odds ratio ‘Exp (β)’ suggests that one unit increase in the firm size decreases its odds of being in financial distress by 0.734 times with all other predictors constant (see Table 5).

Table 5

Logit regression results

Coefficients	Independent Variables	Predicted relation	Logistic Reg. results (β)	Sig.	Exp. (β)
α ₀	Intercept	?	3.632	0.005	37.805
α ₁	BIND	–	–8.444	0.000	0.0004
α ₂	DBCS	+	1.855	0.000	6.395
α ₃	OBLK	–	–2.418	0.012	0.089
α ₄	BSZ	+	0.449	0.000	1.567
β₁	LVG	+	1.625	0.009	5.080
β₂	LQY	–	–2.198	0.000	0.111
β₃	FSZ	–	–0.309	0.018	0.734
Cox &Snell R square					0.583
Hosmer and Lameshow test of Model’s fit:
Chi-square					2.341
Sig.					0.891
Classification of performance (%)					90.5
Number of observations					420

Notes: The sample of this study is composed of 42 financially distressed and 42 financially healthy firms. The dependent variable (Fin_Distress) is 1 for financially distressed firms and 0 for financially healthy firms. The study covers the period 2006–2010 with 420 total no. of observations. The p-value is 0.05.

5 Conclusion

This study has examined the comparison between financially distressed and financially healthy companies of Pakistan on the basis of board composition, ownership distribution and board size. The study utilized a sample of financially distressed companies (those firms that have earned long-run negative earnings per share (EPS), i.e., from 2006 to 2010) and a parallel sample of financially healthy companies (those that have earned positive earnings per share (EPS) for the same period of time). The period taken for the study is 2006 to 2010 and manufacturing sector has been focalized by employing logit regression technique.

The results reveal that all the variables are significantly different in financially distressed and financially healthy companies. The present study shows that the financially distressed firms have lower chances of independent board as compared to the healthy companies. In other words, the number of outside directors in the board composition of distressed firms is low that have caused the companies to go into financial distress while this composition is high in healthy companies. Also the presence of CEO duality is significantly different between the distressed and healthy companies of Pakistan. There is also evidence that the duality in the firms can lead the firms towards bankruptcy [12, 23]. The code of corporate governance also states to separate the two positions of CEO and board chair person but there is no compulsion implied by the code for the separation of these two positions [41]. The financially healthy companies have more outside directors as their block-holders than the financially distressed companies. Outside block-holders are also necessary to run and monitor the poorly performing companies in a better way because such block-holders are believed to work in the best interest of the companies rather than in their own interests and benefits. It also ensued that the financially distressed firms have larger boards as compared to the financially healthy firms. The reason may be that the larger boards face problems in communicating with one another in the board regarding the decision making which results in their financial distress. On the other hand, leverage, liquidity and firm size are also significantly different in distressed and healthy companies of Pakistan.

The recent study has focused also on the financially distressed companies that have not yet been bankrupted and are still listed in the Karachi Stock Exchange (KSE). By virtue of this study, it is possible to save the distressed companies from going into bankruptcy when board composition, ownership distribution and board size are impacting the financial distress of the firms. It becomes possible for the firms to take preventive measure to take the companies into right direction so as to avoid bankruptcy. This research study is the first study of its kind that has compared the financially distressed with the healthy companies by focusing on the board composition, ownership distribution and board size while controlling for the financial variables in the Pakistani context. The findings of the study indicate that these characteristics are significantly different in financially distressed and financially healthy companies.

The findings of the study will be beneficial for the investors, financial analysts, accounting professionals and practitioners. Their decision process may be enhanced regarding the evaluation of financially distressed and healthy companies. The findings of the study would also be accommodating for the regulatory authorities in making policies on corporate governance reformation. As the study provides the early warning of the bankruptcy of the firms, it forecloses the systematic collapse of the economy. This study shows that the imposition of the bureaucratically-hierarchized authority and power artifice, which produces a delusion of organization, produces financially-distressed firms, while easing away from this artifice, toward an ecologically self-organized and self-governed, societal human structure of collegial control and responsibility, leads to financially-healthy firms. The only possible form to make these organizations healthy is self-development. Business enterprises and other societal organizations can do is facilitate their employee, customer and partner self-development. Worldwide, pioneering business enterprises and other societal organizations are transforming themselves into truly ecological decision-making structures of collegial control and responsibility.

The same research can also be carried on the financial sector of Pakistan. The pre-financial-distress and post-financial-distress period can also be examined by focusing on the same variables.

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