Development Financing and Economic Governance: Analysis of the Liquidity Crisis and Circularity Debts in Pakistan

Abstract

‘Corporate Governance’ is a term which has been used in the literature of management, finance and economics. It is unfortunate that misunderstanding and use of the terms in misleading manners has created several gaps in academic conclusions and its practical implications. This study is an attempt to fill these gaps. This study is based on the models derived by the researchers to explain the patterns of corporate governance, firms’ financial policies and liquidity position, so extensive use of references and financial literature is obvious. A deductive approach has been adopted in the study to reconcile and examine the different models of corporate governance and firms’ financial policies. The study showed that corporate savings is a good predictor of the macro level investment in the country. The magnitude of national investment will increase by improvement in corporate savings. In fact the corporate savings indicate the expansion in business activities which may be an indicator of the trust and confidence of private sector. On the other hand it explains the financial health of corporate sector, which may provide the significant portion of tax revenue to the government for developing projects in public sector. Government is responsible to create a business environment where transparent management of public finance becomes possible at the national level. In case the government regulation is not efficient, rules of conduct for the private sector are desired. Particularly, improving the corporate social responsibility and relevance of corporate governance is needed. The direction of causality has been tested before estimation of this model. Not only may the return on investment but circularity of debt and liquidity position also affect the corporate savings. 6 The study has concluded that corporate governance is a significant variable in determining the liquidity and circularity debts. In this way corporate governance becomes a crucial determinant of the national investment. The bad corporate governance may deteriorate the investment activities at national level, which may damage the economy for a longer term. This study also indicates that capital structure and the patterns of ownership play important role in the determination of corporate governance of an institution. The conclusions of the study have been reconciled with previous findings and the extensive use of references and discussion on theoretical advancement in the literature of corporate governance was natural requirement for this purpose. The study has been arrived at the conclusion through a deductive approach however; the results have been confirmed through empirical evidences. To analyses the data and empirical evidences, econometric modeling has been followed. The present research is a blend of economic governance and development financing. It develops a theorem, identifying antecedent variables which can better expound the given phenomenon. It has now come into the fact that investment position in a country can be improved if corporate sector plays its rigorous role to convert its earnings into investment. This earning must be converted into fixed investment in plant and machinery in order to grow in future. Investment in current assets will allow CEOs to enjoy freedom of uing this money in their own favor. Agency costs must be minimized which exists in the form of personal expenses of CEOs of corporations. This is possible when compensation policy is designed in a manner that it is based on firms’ performance. This will lead a CEO to take decisions which are in the best interest of shareholders. 7 It was deduced from the theorem which states that the state of corporate governance must be improved in order to minimize the circularity debt problem which is really a governance issue. Resolution of this issue will lead the corporate sector to raise their liquidity and profitability as well. Government must focus on the issue of circularity debt from the governance point of view rather from the perspective of finance. There were multiple objectives of the dissertation. First, it attempts to investigate the corporate governance practices being followed in the public listed firms in Pakistan. This is translated as whether the remunerations of CEOs of corporations are set in accordance with the good corporate governance practices? Some big families in Pakistan have more than one business. Transfer of one CEO to another company is a common practice which hinders the corporate governance practices. Similarly, compensation of CEOs is also biased due to relationship based corporate governance structure. Salaries and other requisites are not performance based, rather determined either on political or relation grounds. Secondly, the study aims to examine the issue of circularity debt exists in the energy sector of Pakistan in relation to corporate governance. In other words, whether circularity debt issue arises because of bad corporate governance practices in Pakistan? It is an attempt to explain not only the factors contributing good corporate governance but also to seek an understanding of its relationship with circularity debt with respect to liquidity crisis. CEOs of corporate sector are not aligned with the objective of shareholders and they raise their salaries and other perquisites in the form of salary and other personal expenses. This constitutes a bad governance state which further enhances the issue of circularity 8 debt. Therefore, attention must be diverted towards improving the governance state of the corporate sector in order to match the objectives of shareholders with the agents. The dissertation has a fundamental premise that bad corporate governance is responsible for circularity debt and liquidity crisis. Pakistan has been facing this phenomenon for almost one decade. There were several solutions given but no one was long run. This study is an endeavor to recommend a long lasting as well as beneficial solution for both the government as well as all stakeholders. It also intended to explore the causes based on which firms decide to retain their earnings and increase the equity. It is assumed that retained earnings depend on liquidity and after tax earnings of the company. Finally, the dissertation recommends a path way to a developing country to progress by increasing the corporate savings as macro level investment in the country depends on corporate savings. Although, dividend is good in the yes of an investor, emphasize must be made towards increasing the corporate savings in order to enjoy better earnings in times to come. Economic governance is the key to improve the economic situation of a country and must be readdressed with respect to the corporate governance, especially in government owned firms. There are three integrated theoretical models which have been tested in this study. Corporate governance which is endogenous variable in first model becomes exogenous in the second model. Similarly, liquidity which is endogenous variable in the second model becomes exogenous in the third model. Because of the nature of the models, 3-stage least square regression is appropriate to explain the phenomenon. The model is non-recursive as there are 9 some reciprocal paths between models. In such cases, single equation estimation technique like 2SLS may not provide an efficient estimate as 3SLS. Consequently, 3SLS was employed for the data analysis as it takes into account the information present within and across the hypothesized equations.