Corporate Governance and Returns on Investments of Pakistani Listed Companies

Abstract

This paper analyzes the effects of corporate governance institutions on investment returns of Pakistani listed companies. A marginal q is used to estimate returns on investments from cash flows, debt, and equity. Return on total investment is 31% lower than the cost of capital, which suggests that largest shareholders or managers invest beyond the optimal investment level that maximizes the wealth of shareholders. Return on reinvested cash flow is 30% lower than the cost of capital. There is evidence of our hypothesis that largest shareholders or managers exercise discretion while reinvesting cash flows. Return on investment financed from debt is lower than the cost of capital as financial institutions are faced with asymmetric information while analyzing creditworthiness of investments. The analysis provides evidence of market discipline on investments financed from debt by companies whose ultimate shareholders are foreign entities. Corporate governance institutions are unable to control managers of foreign-owned companies from issuing equity to finance investments with returns lower than the costs of capital. Financial market development is retarded because outside shareholders are reluctant to invest in equities and financial institutions are wary of financing borrowers. The weak corporate governance system is unable to properly protect financial institutions from loan delinquencies.