Corporate governance is the procedure or the way entities are managed and governed. Good governance creates goodwill and enhance company financial performance but if the companies are governed poorly then they lose confidence of each stakeholder due to weak financial performance. The objective of this research study is to empirically examine the relationship between corporate governance and firm profitability of a multinational and national pharmaceutical industries of Pakistan. For accomplishment of this research objective 40 pharmaceutical sector of firms both multinational and national are taken. This study gives attention to measure corporate governance dimensions in terms of insider fraction of board size, independent director, board committees, board remuneration, and firm size. Whereas, profitability of the pharmaceutical firms are measured using correlation and regression analysis in terms of return on assets (ROA), return on equity (ROE) and return on sales (ROS). Positive relationship between corporate governance and firm profitability has been observed. Thus, the study has concluded that corporate governance has a strong significant impact on the profitability of the pharmaceutical firms in Pakistan.
Index terms—- Corporate governance, Firm profitability, ROA, ROE, ROS, Pharmaceutical firm.
In the last few decades, there has been a growing attention and interest in Corporate Governance (CG). Corporate Governance has been extensively debatable and arguable issue for researchers, corporate managers, financial analyst, academicians, and strategists. Therefore, in the last decade, a number of renowned organizations unexpectedly collapsed due to poor corporate governance such as bank of credit and commerce international 1991; Polly Peck in 1990; Nordbanken in 1991; Bre-X in 1997; Equitable Life Assurance Society in 2000; HIH Insurance in 2001; WorldCom in 2001; Enron in 2001; Refco in 2005; Lehman Brothers in 2008; and Banco Espirito Santo in 2014.
Corporate governance is the system by which companies are directed and controlled .More briefly we can say that it is the framework by which the interests of various stakeholders arebalanced It shows a set of relationships between a company’s management, its board of directors, its shareholders and other stakeholders. Corporate governance provide the mechanism by which the problems of corporation stakeholders, which include the shareholders, creditors, management, employees, consumers and the public at large are framed and resolved. Corporate governance also includes the relationships among the many stakeholders involving external stakeholders and internal stakeholders. In contemporary business corporations, the main external stakeholders are shareholders, debt holders, trade creditors, suppliers, and customers. Internal stakeholders are the board of directors, executives, and other employees. Good and proper corporate governance is considered imperative for the establishment of a Competitive market. Corporate governance practices stabilize and strengthen good capital markets and protect investors. They help companies to improve their performance and attract investment. Corporate governance enables corporations to attain their corporate objectives and to protect the rights of shareholders.
Good corporate governance (GCG) practices are essential in attracting investors; reduce risk, by defending shareholders concern and improving efficiency of the company. A good practice of Corporate Governance leads to better performance and enhance decision-making procedure, real time flow of information in the company. Hence, efficient governance means the slight expropriation of company funds by managers, which lead to better utilization of assets and improved financial and operational performance of the firm.
Corporate Governance is indispensable for emergent economies like Pakistan. The code of Corporate Governance has established by Securities and Exchange Commission of Pakistan. These codes are finalized in March 2002, and then it updates in 2012. The fundamental goal of corporate governance is to protect all stakeholders of the firm. In advance countries, the relationship between governance and corporate performance has been examined therefore, fewer studies carrying out.
1.1. Pharmaceutical industries of Pakistan
Pakistan has vibrant and forward looking pharmaceutical industry. Total 800 pharmaceutical manufacturing units are working in the country including 25 multinationals. The Pakistan pharmaceutical Industry meets around 70% of the country’s demand of finished medicines.
The national pharmaceutical industry has shown a progressive growth over the years, particularly over the last one decade. The industry has invested substantially in upgrading itself in the last few years, and today the majority industry is following good manufacturing practices, in accordance with the domestic, as well as international, guidance. Currently the industry has the capacity to manufacture a variety of product ranging from simple pills to sophisticated biotech, oncology and value -added Generic compounds.
The Pakistan pharma industry is relatively young in the international markets with an export turnover of over $212 million as of 2014 to 2015. Pakistan pharma industry boasts of quality producers and many units are approved by regulatory authorities all over the world. Like domestic market the sales in international market have gone almost double during last five years. In the meantime, exports are also likely to be boosted by new regional and global opportunities.
2. OBJECTIVES OF THE RESEARCH STUDY
I. To empirically examine the relationship between corporate governance and firm profitability of pharmaceutical industries of Pakistan.
II. To measure the dimensions of Corporate Governance in terms of board size, independent directors, board committees, board remuneration and firm size.
III. To measure the profitability of firm using correlation and regression analysis in terms of return on assets (ROA), return on equity (ROE) and return on sales (ROS).
3. LITERATURE REVIEW
3.1. Board size
By doing literature review it has found that the board size and firm performance are inversely related to each other. However results shows that board size increases inclination in the organization. Moreover the flow of information is difficult when size of board is more. Also the study reveals that the firm with lesser board members tends to have better operating productivity. Eisenberg, Sundgren and Wells (1998), have reported negative association between size of board and profitability of the firms. Vafeas (1999), shows that frequency of board meeting is negatively associated with value of the firm. Thus, the board has the responsibility to monitor, discipline, and hold ineffective management.
3.2. Board committees
Many organizations around the world has been denigrated due to bad governance. Therefore, various companies have established remuneration committee, audit committee, and nominating committee. Significance of these committees has recognized in the modern business world (Petra 2007). Cadbury Committee report in 1992, is suggested that boards should make sub-committees to deal with the following three tasks:
• To supervise and monitor the accounting measures and outdoor audits;
• To make a decision about the remuneration of corporate managers;
• To appoint officers and directors
These committees should be autonomous, have access to information, and members of the committees are financially literate, otherwise these committees will be just like a window dressing (Peters and Bagshaw 2014). These committees could be included independent non-executive directors to strengthen the internal control systems of firms (Davis 2002; Laing & Weir 1999).
3.3. Board remuneration
Lewellen and Huntsman (1970) had found strong evidence between corporate managers and board compensation. Their study reveals that board remuneration is dependent on profits generation. Main et al. (1996) analyzed the impact of compensation on firm performance by utilize panel data from 1981 to 1989. They concluded that there is a significant association between board compensation and corporate performance. Kato (1997) investigates the relationship between executive compensation and corporate performance by using panel data from 1986 to 1995. The study shows that compensation is sensitive to the performance of the firm. Aduda, (2011) examines the relationship between compensation and performance of the commercial banks by using a regression model. The study exhibits negative correlation between compensation and firm performance.
3.4. Independent directors
It has concluded that boards with more autonomous directors have higher possibilities to remove poorly presented CEOs. Chen et al. (2006), have revealed that organization with higher proportion of autonomous directors on board are chances of financial fraud. Uzun et al. (2004), have documented that more numbers of autonomous directors on the compensation and auditing committee leads to reduce in the frequency of financial fraud and therefore, profit increases.
3.5. Firm size
The literature and survey shows that large firms producing goods in less cost which increases the profit and revenue. Yang & Chen (2009) has found that large size firms has more number of employees that are professional in their work which make good quality products in less cost.
4. RESEARCH METHODOLOGY
4.1. Graphical model
Figure 4.1 (graphical model of methodology)
Determinants Variables Description Notation
Return on assets
Net profit before tax/Total assets
Return on equity
Profit Before Tax/(Paid-up Equity capital+Reserve and funds
Return on sale
Net Profit/Total Sales
Total number of directors on board
Dummy Variable: “0” if the Firm have less than three Committees otherwise “1”
Total number of independent director on the board
Average salary of the board
Log of total assets
Table 4.1 (variables)