Nexus between boardroom independence and firm financial performance: evidence from South Asian emerging market

The study examines whether boardroom independence affects firm financial performance in Pakistan, an emerging market characterized by concentrated ownership, family-controlled businesses, and a one-tier Anglo-Saxon corporate governance model. Following corporate governance reforms (Codes of 2002, 2012, 2013) that mandated increasing proportions of independent directors, the authors investigate the effectiveness of outside independent directors in this institutional context. The research question centers on the impact of board independence (proportion of non-executive directors) on accounting-based (ROA, ROE) and market-based (MBR, Tobin’s Q) performance. The study addresses endogeneity and heterogeneity using dynamic GMM with panel data (2003–2018), aiming to provide evidence for policymakers and contribute to corporate governance literature in emerging markets.

Theoretical perspectives provide mixed predictions. Agency theory posits that a higher proportion of independent directors enhances monitoring, reduces agency costs, and improves performance. Stewardship theory suggests managers act as faithful stewards, implying less need for independent directors and potentially discouraging board independence. Stakeholder and resource-dependence theories highlight value creation through managerial networks and access to external resources, also acknowledging roles for outside directors. Empirical evidence is mixed across contexts: many studies report positive effects of board independence on firm performance, particularly where information and monitoring are effective or in state-owned firms; others document negative or insignificant effects, especially in environments with family control, weak protection of minority shareholders, part-time outside directors, or passive monitoring. Meta-analytic and country-specific studies also show divergent results (e.g., higher accounting performance but lower market valuation with more independence). Based on this mixed evidence and the Pakistani institutional setting with prevalent family control and close ties among directors, the study proposes the hypothesis: Boardroom independence is negatively linked with financial performance in emerging markets.

Design: Longitudinal panel study of non-financial firms listed on the Pakistan Stock Exchange (PSX), 2003–2018. Sample: 152 firms selected from an initial pool based on (i) minimum 10 consecutive years of data, (ii) availability of corporate governance disclosures (board size, composition, ownership) for at least 10 consecutive years, and (iii) exclusion of firms with missing values. This yields 2280 firm-year observations (reduced to 1976 in GMM estimations due to lags and data requirements). Data sources: Financials from State Bank of Pakistan’s “Analysis of Financial Statements of Non-Financial Companies” (SBP, 2003–2007; 2007–2012; 2013–2018); corporate governance variables manually collected from firms’ annual reports. Variables: Dependent variables (financial performance): ROA = Net Income/Total Assets; ROE = Net Income/Total Equity; Tobin’s Q = (Total Borrowing + Market Capitalization)/Total Assets; Market-to-Book Ratio (MBR) = Market Capitalization on last trading day/Book Value of Equity. Key independent variable: Board independence (BIND) = number of non-executive outside directors/total directors. Controls: Board size (log of total directors), CEO duality (indicator =1 if CEO is also board chair), firm size (log total assets), leverage (total debt/total assets), growth (% annual change in sales), profit margin (net income/total sales), payout ratio (cash dividend/net income), liquidity ratio (current assets/current liabilities). Model and estimation: Dynamic panel GMM (Arellano–Bond/Arellano–Bover type) to address endogeneity and firm-level unobserved heterogeneity. Baseline specification includes lagged dependent variable (Y_{t−1}) and controls, with year and industry effects. Diagnostic tests include AR(1) and AR(2) serial correlation tests and Hansen/J-statistic for over-identifying restrictions. Multicollinearity assessed via VIF (all < 10).

Descriptive statistics: Average board independence is 0.58 (58%), ranging 0.09–1.00; average board size ≈ 8 directors (6–16); CEO duality occurs in ~95% of firm-years. Performance averages: ROA ≈ 6%, ROE ≈ 1.32% (high variance), MBR and TQ exhibit wide dispersion. Main results (Dynamic GMM, Table 4): Board independence is significantly negatively associated with all four performance measures: ROA coefficient −0.498 (p<0.001), ROE −8.04 (p<0.001), MBR −9.630 (p<0.001), TQ −21.734 (p<0.001). Board size negatively relates to ROA, ROE, MBR, TQ (all p<0.001). CEO duality shows no significant effect on ROA (p=0.425) but significant negative effects on ROE, MBR, TQ (all p<0.001). Firm size positively relates to all performance proxies (all p<0.001). Liquidity and leverage generally relate negatively to ROA, ROE, MBR (all p<0.001), with leverage positively associated with TQ (p<0.001). Growth and payout ratio are positively associated with ROA, ROE, MBR (p<0.01 or better), while growth is negative for TQ and profit margin is positive for ROA but negative for ROE, MBR, TQ (all p<0.001). Lagged performance terms are significant, confirming dynamics. Diagnostics: AR(1) p-values ~0.001–0.002 (expected), AR(2) p-values 0.33–0.92 (no second-order serial correlation), J-statistics p-values ~0.19–0.23 (valid instruments).

Findings support the hypothesis that greater boardroom independence is associated with lower firm financial performance in the Pakistani context. The results are interpreted in light of institutional features: independent directors are often not truly independent due to personal, financial, and social ties with dominant shareholders and management, leading to passive monitoring and limited influence on strategic decisions. High CEO duality and family/group control further entrench management, weakening oversight and potentially prioritizing short-term objectives. Larger boards may impede communication and timely decision-making, especially when populated by family representatives or proxy directors, which can reduce monitoring effectiveness. While agency theory would predict benefits from more independent directors, the observed negative association aligns with stewardship-oriented arguments and prior evidence from similar emerging markets. Policy implications include strengthening criteria and enforcement for appointing truly independent directors and enhancing board monitoring capacity.

The study provides firm-level, dynamic-panel evidence from Pakistan (152 non-financial PSX-listed firms, 2003–2018) that higher boardroom independence correlates with poorer accounting and market performance, contradicting simple agency-theory expectations in this setting. It also documents negative effects of larger boards and CEO duality on performance, while firm size, growth, and payout policies generally relate positively to performance. Contributions include addressing endogeneity via dynamic GMM and offering context-specific insights for emerging markets with concentrated, family-based ownership. Policy recommendations urge clearer criteria and mechanisms for appointing and ensuring the independence of outside directors, alongside strengthening board monitoring. Future research directions suggested include examining outside directors’ characteristics (e.g., gender, qualifications, financial expertise, legitimacy) and extending analysis to the financial sector and other emerging markets.