Decoding Financial Performance: The Influence of Corporate Governance through the Lens of Earnings Management

Corporate governance has gained prominence as one of the subjects of scholarly and policy debate over the past few decades in both developed and developing countries. This rising interest can be traced to the increased incidence of financial and non-financial scandals and to the well-publicized corporate failures that erupted in different parts of the world. Such incidents have led to erosion of public trust in corporations and emphasize putting in place strong governance frameworks. Likewise, it is now accepted that good corporate governance enhances firm performance and makes certain compliance with regulation. The structure and practice of corporate governance varies from country to country, shaped by each country's law, market, social, political, and cultural contexts. Every country crafts its governance laws to fit its own system of corporate management. The study dives into the interplay between corporate governance practices and the financial performance of firms in a developing economy—Pakistan in particular. In this study, 327 companies for 29 non-financial sectors are being analyzed from the secondary data listed on the Pakistan Stock Exchange (PSX) from 2016 to 2023 to see the relationship. Applying different panel data techniques including fixed and random effect models for the purpose of analysis, in addition, the study applied the two-step System GMM for the purpose of further strengthening the robustness of the findings. The results suggest that effective corporate governance is an important variable enhancing the financial performance of an organization, both in the short run and long run. The study identifies the adverse influence of earnings management, which negates long-term financial performance. Importantly, the findings suggest that earnings management acts as a negative mediator in the interaction between corporate governance and performance, effectively draining the power of governance mechanisms and amplifying undesirable financial results. These findings carry substantial implications for corporate managers, investors, policymakers, and regulators.