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Relationship of Cost of Governance and Firm’s Profitability

Corporate Governance is considered as the basic pillar for the long term existence and stability of the firms. Recent falls of one of the biggest corporations in world like Enron and World Call sparked the debate on the importance and practical application of better governance mechanisms in the corporations. The literature has been comprehensively added with the experiences of different industrial countries and the recent collapse of subprime mortgage and subsequent bankruptcies of numerous banks and corporations including Lehman Brothers and mortgage giants like Fannie Mae in USA. In Pakistan, Code of Corporate Governance 2002 was a major milestone and different studies have been conducted. This research covers 9 industries and 22 firms including banks, insurance, engineering, cement, fertilizers and chemicals. The focus on the research is to establish a significant relationship between the compensation paid for the mechanisms of Corporate Governance i.e. Directors, CEO and Senior Executives. The compensation data is tested for 6significant relationship with company’s' performance variables including Sales, Assets, Pre Tax Profit, Operating Cash Flows, Selling and Administrative Expenses, Profit as percentage of Sales and Return on Assets. The relationships signify the fact that companies pay the governance bodies in the firm based upon the firms' performance. Different variables are used as indicator of performance in different companies and industries and differences also exists within industries. This study is statistically significant for the time period of 2003-2007. These results can be used to improve the corporate governance compensation paid and profitability generated by the firms. The research confirms the significant relationships between different stakeholders compensation in the organization and performance indicators. Different industries pay according to their own business cycles and also different companies compensate respectively in the same industry as well. Thus compensation management is the solution to Principle Agent Problem in the Corporate Governance framework and understanding it will help companies solve it.