The Impact of Corporate Governance on Financial Reporting Quality in Pakistan

Abstract

In this context, this research paper examines the relationship between financial reporting quality (FRQ) and corporate governance mechanisms in the emerging economy of Pakistan. Understanding this dynamic is crucial in order to protect the rights of investors and promote market growth in Pakistan's unique regulatory context and because family-owned business groups tend to dominate the market. The study follows quantitative research methodology with a panel data set of non-financial firms from Pakistan Stock Exchange (PSX) that span the time horizon 2015 to 2022. The Modified Jones Model is used to estimate FRQ, which is proxied by discretionary accruals, where less size of discretionary accruals means better reporting quality. The independent variables included board size, board independence, audit committee size, audit committee financial expertise and CEO duality, while firm size, leverage, and profitability were included as control variables. The empirical results indicate that board independence is positively and significantly related to financial reporting quality. In contrast, board size and the dual roles of the CEO with the board appear to be inversely related to FRQ, with larger boards potentially being less effective at overseeing functions and with the increased centralisation of authority in the CEO potentially being associated with reduced effectiveness of oversight. The characteristics of audit committees, including financial expertise, are positively correlated with reporting quality. The findings highlight the need to further improve the corporate governance codes in Pakistan, especially by encouraging the appointment of independent directors, and improving financial literacy of audit committee members, to increase transparency and foreign direct investment.

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