The Impact of Corporate Governance on the Default Risk of the Banking Industry in Pakistan

Abstract

The several financial crises and other reforms in banking sector of Pakistan have made it compulsory to explore the default risk and governance characteristic of banks in Pakistan. So this thesis has focused on the relationship between corporate governance and the default risk of Commercial Banks in Pakistan. The study has used the sample of 21 Pakistani commercial banks listed on the Karachi stock exchange (KSE-100) over the 10 year period 2005-2014.The agency theory is about the view point that corporate governance characteristics can be the reason of default risk in an organization. This study has captured the default risk for banks through three measures Merton default risk measure that is the probability of default, cumulative first passage probability of default and Z-score of the firm. The corporate governance (CG) is measured through board size, board composition, insider ownership, institutional ownership and board meeting. This study has also taken total assets of the firms as a control variable. The result of the study shows that increase in board composition and institutional ownership helps in reducing the default risk for the full sample, whereas in large banks sample the board structure variables (board size and board composition) have significant relation and the ownership variable's relationship (institutional ownership and insider ownership) is still unclear. In contrast the results for the sample of medium size banks shows that insider ownership and meeting frequency have a positive relationship where as the institutional ownership have a negative relationship with default risk.