An interaction between financial practices and firm performance with moderating effect of agency cost in Pakistani corporate sector

Abstract

This study investigates the application of firms’ financial practices and its impact on firms’ performance in economic conditions of an emerging market of Pakistan. Firm’s financial practices include capital structure decisions, dividend policy decisions, investment appraisal techniques, working capital policy, methods of measuring cost of capital and financial assessment using financial ratios. This study analyzes the primary data of both financial and non-financial firms listed at Karachi Stock Exchange (KSE) of Pakistan. Data from 141 firms were analyzed using descriptive and factor analyses along with linear and multiple regression techniques to investigate the relationships between financial practices and firms' performance. The magnitude and significance of the moderating effect of agency cost was examined using multiple regression analysis on the relationship between capital structure decisions and dividend policy decisions with firms’ performance. The descriptive findings of the study demonstrate that financial practices are followed in Pakistani corporate sector and are considered very important for a firm’s performance. Results show that capital structure decisions and dividend policy decisions have a significant positive impact on firms’ performance. In a similar vein, investment appraisal techniques, working capital policy, methods of measuring cost of capital and performance assessment using financial ratios are found to be significantly related to firms’ performance. Furthermore, agency cost does not only exert a significant impact on firms’ performance, but also moderates the relationship between dividend policy decisions and firms’ performance. However, agency cost does not moderate the relationship between capital structure decisions and firms’ performance. The study has both theoretical and practical implications for managers and practitioners about the magnitude of each financial practice in relation to agency costs and their contribution in the firms’ performance.