THE IMPACT OF EARNING MANAGEMENT AND CORPORATE GOVERNANCE ON CORPORATE INVESTMENT EFFICIENCY: EVIDENCE FROM PAKISTAN STOCK EXCHANGE

Abstract

Purpose: This study examines the association between earnings management, corporate governance mechanisms, and investment efficiency in the context of industrial firms listed on the Pakistan Stock Exchange (PSX). Design/Methodology: Using a panel dataset of 1,086 firm-year observations from 171 companies spanning 2012–2019, the study applies FGLS regression to examine both direct and combined effects of CG features with earnings management on investment efficiency. Key CG attributes analyzed include CEO duality, gender diversity, board meeting frequency, audit committee size, and audit committee independence. Findings: The results revealed that earnings management alone does not significantly affect investment efficiency. Gender diversity in the board is the strong corporate governance mechanism that significantly improves investment efficiency. Board meetings highlighted governance or operational issues rather than efficient investment decisions, while its interaction with earning management contributed to reducing managerial opportunism, strengthening corporate governance and improving efficient investment decisions. More independence of the audit committee and its interaction with earning management contribute to less efficient investment as more independence of the audit committees fail in effective monitoring of the firms due to some institutional factors. Other governance features and their interactions show no significant effects. Control variables indicate that firm size is positively associated with investment efficiency, while leverage has a negative impact. Overall, non-financial firms in Pakistan focus more on corporate governance factors rather than earning management in determining investment efficiency. Originality: The findings offer valuable insights for stakeholders, regulators, and policymakers, particularly the Federal Board of Revenue, SECP, and non-financial firms, in shaping investment and governance policies. For effective governance in Pakistan’s industrial sector, emphasis should be placed on female inclusion and strengthening corporate governance. Future research should further explore the full corporate governance code’s role in moderating earnings management’s impact on investment efficiency.