Ijfs 07 00062 v2

International Journal of
Financial Studies
Article
Corporate Governance, Political Connections, and
Bank Performance
Muhammad Haris 1, * , Hongxing Yao 1 , Gulzara Tariq 1 , Hafiz Mustansar Javaid 2 and
Qurat Ul Ain 3
1 School of Finance and Economics, Jiangsu University, Zhenjiang 212013, China; hxyao@ujs.edu.cn (H.Y.);
gulcute327@gmail.com (G.T.)
2 School of Economics, Sapienza Università di Roma, 00161 Roma, Italy; mustansar022@gmail.com
3 School of Economics and Finance, Xi’an Jiaotong University, Xi’an 710049, China; qurat057@gmail.com
* Correspondence: harmalik@outlook.com

Received: 8 May 2019; Accepted: 8 October 2019; Published: 15 October 2019
Abstract: This study investigates the impact of corporate governance characteristics and political
connections of directors on the profitability of banks in Pakistan. The study uses the data of 26
domestic banks over the latest and large period of 2007–2016. Our findings firstly affirm that bank
profitability is negatively affected by the presence of politically connected directors on the board,
reporting significantly lower return on assets, return on equity, net interest margin, and profit margin.
Secondly, our findings also affirm the negative political influence on the sustainability of the banking
industry, reporting significantly lower return on assets, return on equity, net interest margin, and
profit margin during the government transition of banks having politically connected directors sitting
on their board. Our findings further report an inverted U-shaped relationship between board size
and bank profitability, suggesting that a board size beyond 8–9 members decreases the profitability.
The study further finds a positive impact of board composition, board independence, and director
compensation on bank profitability, while also finding a negative impact of frequent board meetings,
presence of foreign directors, and audit committee independence.
Keywords: Pakistan; banks; profitability; corporate governance; political connections
JEL Classification: G21; G28; G34
1. Introduction
Sustainable profitability is vitally important for the stability of banks (García-Herrero et al. 2009)
and the economic growth of any country (Sinha and Sharma 2016). The banking sector is regarded as the
most vital component of the financial industry, which itself is a key pillar of the economy of a country.
The economic growth is positively related to growth in banks and other financial intermediaries
(Haris et al. 2019a). Thus, the sustainable growth of banks in Pakistan is essential, as it enables them to
continue their supporting role in economic growth.
Many studies from non-financial firms claimed that political connections benefit the firms in
accessing higher loans at a lower cost from political banks. Because firms appoint politically connected
directors (PCDs) to obtain political benefits (Jackowicz et al. 2014), those appointed directors use
their political relations to access easy loans from political banks to finance the electoral campaigns
of ruling parties and/or their associated political parties. Pakistan is a political economy, and many
firms in Pakistan are aligned with political connections. The firms use their political connections
to gain monetary and nonmonetary benefits such as licensing, tax subsidies, contracting, and, most
importantly, easy access to higher loans from political banks (Cheema et al. 2016). The political
Int. J. Financial Stud. 2019, 7, 62; doi:10.3390/ijfs7040062 www.mdpi.com/journal/ijfs

Int. J. Financial Stud. 2019, 7, 62 2 of 37
connections of banks can also be beneficial for them with regard to accessing tax advantages, financial
bailouts, etc. Nevertheless, political connections (PCs) may affect the corporate governance mechanism
of banks; for instance, PCs might affect audit independence and accounting information. PCs may
increase the risk of agency problems, because PCDs prefer achieving political goals that could damage
the interest of shareholders; PCs can also raise conflicts of interest among PCDs and non-PCDs because
of their exclusive interests. On the one hand, politically connected firms face low risk through their
access to higher credit and financial bailouts during times of distress. On the other hand, politically
connected banks face higher risk by injecting higher credit to politically connected firms at a lower
cost with easy terms. Therefore, the advantages of political connections are different for financial
and non-financial firms. Recently, Chen et al. (2018) reported the lower performance of politically
connected banks than non-political banks. They also reported a higher default ratio of those banks
having politically connected chief executive officers (CEOs). They further suggested that politically
connected directors use their political power and influence lending decisions by interfering in lending
standards and, thus, raise their bank’s sensitivity to lower performance and risk, especially during
crises. Theoretically, this indicates that the government is likely to direct state-owned banks to finance
certain projects for political expediency, especially during election years, even if such projects are of
less significance to the public interest. The ruling government parties, specifically in Pakistan, gain
monetary advantages (e.g., preferential loans) by putting pressure on political connected directors
during election years. Thus, it is important to examine the empirical work with regard to the impact
of political connections on bank performance during government transitions. The studies from the
perspective of political connections in banks are still limited and scarce. Therefore, it would be more
interesting to see the role of corporate governance and political connections in the context of Pakistani
financial institutions in relation to their financial performance.
Corporate governance practices aid to build an effective relationship between shareholders
(referred to as principals) and the management (referred to as agents) for the sustainability of
banks (Adams and Mehran 2012). Different corporate governance theories also emphasize the
importance of corporate governance in the improved performance of banks, such as the agency theory
(Jensen and Meckling 1976), transaction cost theory (Williamson 1985), resource-dependent theory
(Pfeffer and Salancik 1978), and stewardship theory (Donaldson and Davis 1991). Corporate governance
provides structure and an effective framework to set and monitor the performance of banks by
establishing a strong principal–agent relationship (Mehran 2003). Given the importance of deregulation,
globalization, increasing risk, and investor protection, as well as the positive role of the banking
sector in economic growth, corporate governance has significant importance for the sustainability of
the banking industry, because corporate governance practices help to build sustainable value for the
banking industry (Yatim and Yusoff 2014). Both the Organization for Economic Co-operation and
Development (OECD 1999) and Basel Committee on Banking Supervision (BCBS 1999; BCBS 2006)
produced and made recommendations regarding the best corporate governance practices for a sound
financial system, which is important for sustained economic growth (de Andres and Vallelado 2008;
Ferdous et al. 2014). Following the OECD and Basel committee recommendations, many countries,
including Pakistan1 , developed their own guidelines for the best corporate governance practices in
order to monitor and enhance the performance of their banking system and to protect shareholder
1 Initially, in 2002, the Security and Exchange Commission of Pakistan (SECP), in collaboration with United Nation
Development Program (UNDP), started a project which involved developing, designing, and implementing the code of
corporate governance in order to improve best corporate governance practices in the country (SECP 2004) for the sustainable
growth of industry. The focus of the project was to develop codes for the banking industry, but mainly for non-banking
sector. Later, based on the OECD principles (OECD 1999) and Basel committee recommendations (BCBS 1999; BCBS 2006),
the State Bank of Pakistan (SBP—the central bank of the country) issued a “Handbook of Corporate Governance” in 2003
particularly for the banking industry, containing guidelines for the board of directors, auditor, audit committee, disclosure,
and management. Furthermore, the Banking Companies Ordinance (1962) and Prudential Regulations for banks issued by
the SBP also direct governance requirements. Additionally, the SECP and SBP as major shareholders initiated a “Pakistan
Institute of Corporate Governance” in order to promote governance education in the country. Apart from that, both the
wealth. Because of the idiosyncratic nature of financial institutions, banks are considered as highly
leveraged and vulnerable to risky exposures, which require prudent lending decisions to avoid the
higher risk of loan losses, which is possible through the developed mechanism of sound corporate
governance practices such as the formation of risk and audit committees. The adoption of sound
corporate governance practices ensures the implementation of all prudential regulations and prevents
the financial institutions from penalties, thus mitigating the regulatory risk and enhancing performance.
Therefore, it is equally important to examine whether these corporate governance practices made a
substantial contribution in achieving the improved performance of banks, which has vital importance
for the sustainability of the whole financial system (Yatim and Yusoff 2014).
Corporate governance studies regarding the financial sector are still limited and scarce. The unique
nature of the banking business and its relevance in the economic system result in problems being very
specific, based on their corporate governance mechanism. The complex nature of banking operations
squeezes the stakeholders’ power to monitor the decisions of bank managers and enhances asymmetric
information. Banks are highly leveraged because of taking deposits, which requires a more intense
regulatory control for reducing payment and systematic risk, as well as safeguarding the deposits,
thereby ensuring a stable payment system and prudent lending mechanism. Therefore, regulations
for the corporate governance of banks are somehow different from non-financial firms. Excessive
regulatory measures, e.g., bank ownership restrictions, credit restrictions, reduced operations, and
deposit insurance, tend to reduce the risk. However, these excessive measures may cause agency
problems because they are not aligned with the profit maximization goal of shareholders. Thus, the
developed mechanism of corporate governance of banks, e.g., bank board, board independence, and
board committees, helps in the framework of higher informational asymmetries and intense regulations,
thereby controlling the behavior of managers. Due to the complexity of banking operations, the
knowledge possessed by board members enables them to monitor the efficiency of business. The board
creates a link with regulators by ensuring regulatory compliances, and reduces the conflict between
regulators and banks, thus raising the performance. Therefore, examining the role of corporate
governance in the improved performance of banks is an important research area for academics
and policy-makers.
Our study contributes to the existing literature in several ways. The issue of political connections
of bank directors gained much attention during recent years. Pakistan is a political country, where the
performance of the banking industry is always influenced by high political interference. Previously,
Khwaja and Mian (2005) found that the performance of Pakistani banks is influenced by higher
preferential bank loans. They argued that these loans are injected by banks into politically connected
firms during election years because of political influence in the banking industry. Liang et al. (2013)
also argued that politically connected boards have structure-oriented incentive behaviors toward
government objectives and allow political interference in internal decisions, which harms bank
performance through pursuing political concerns at the expense of banks. Political connections make
banks more open to risk-taking by lowering interest rates and leveraging lending terms, which damages
the performance. Thus, politically connected firms access easy loans more frequently from government
banks. Therefore, for the first time, we intend to study the political connections of directors and
examine their impact on bank profitability in Pakistan. Moreover, Yao et al. (2018) found a lower
profitability of the Pakistani banking industry during government transitions and argued that the
lower profitability could be because of political connections. Haris et al. (2019a) also reported a lower
profitability of Pakistani government banks during the period of government elections. They argued
that this negative growth was due to the high political influence. Therefore, we also contribute to
analyzing the profitability of banks having the presence of politically connected directors (PCDs)
SECP and SBP revise and update the corporate governance guidelines from time to time through circulars (for further
details, visit https://www.secp.gov.pk and http://www.sbp.org.pk/).
during the period of government transitions2 . Because, in Pakistan, nine out of 29 domestic banks are
government-owned and politically dominant, some privately owned banks also suffer from political
influence. Both government- and private-owned banks disburse a higher amount of lending to
government projects, departments, and personnel because of political connections, which leads to
lower profitability due to loan defaulting upon government change (Yao et al. 2018). Consequently,
government change negatively affects the sustainable growth in the profitability of Pakistani banks
(Yao et al. 2018). Furthermore, our study, for the first time, intends to examine the impact of internal
corporate governance characteristics (board size, board composition, board independence, director
compensation, presence of foreign directors, board meetings, audit committee meetings, and audit
committee independence) on the profitability of Pakistani banks by considering four accounting
measures of profitability, i.e., return on assets (ROA), return on equity (ROE), net interest margin (NIM),
and profit margin (PM), taken from Haris et al. (2019b), Yao et al. (2018), and Tan (2016). Our study
further extends the evidence to support the findings of Yeung (2018), Yulia (2016), Grove et al. (2011),
and de Andres and Vallelado (2008), by examining the nonlinear (inverted U-shaped) relationship
between board size and profitability. Furthermore, the endogeneity issue also remains unaddressed
in the few available studies of corporate governance in the Pakistani banking industry. Our baseline
methodology is the generalized method of moments (GMM), which draws more robust and consistent
findings by eradicating the problem of endogeneity in corporate governance characteristics. Our study
also makes a substantial contribution by examining, for the first time, the corporate governance of the
whole domestic banking industry of Pakistan during the period of 2007–2016, which is the most recent
ten-year period representative of free market operation and the revival of the democratic process in the
country, based on two government transition periods (Yao et al. 2018).
The robust results report the lower profitability of banks having politically connected directors
(PCDs) sitting on their board than those who do not. This affirms the political influence on the
banking industry due to the existence of political connections. In addition, the results also report
the lower profitability, during government transitions, of banks having PCDs sitting on their board.
This suggests that the PCDs sitting on the board adversely affect sustainable profitability during
government transitions. It also indicates the negative political influence on banking decisions,
specifically during the period of government transitions, because of the sustained political connections
of the directors (Hung et al. 2017). The results related to the political connections of the directors
also support the arguments of Yao et al. (2018), stating that the Pakistani banking industry suffers
from political connections. The results also affirm an inverted U-shaped relationship between board
size and bank profitability in Pakistan. This supports the findings of Yeung (2018), Yulia (2016),
Grove et al. (2011), and de Andres and Vallelado (2008); a board size up to 8–9 members is suggested
to improve the profitability, after which a further increase in board members reduces profitability.
Furthermore, the results report that, on the one hand, the profitability of Pakistani banks increases
due to the presence of non-executive directors and independent directors, as well as the higher
compensation paid to the directors. On the other hand, the profitability weakens due to the frequent
board meetings and the audit committee independence. Moreover, the study finds a lower profitability
of banks having foreign directors sitting on their boards than those who do not, indicating the negative
effect of the presence of foreign directors.
The rest of the paper is structured as follows: Section 2 reviews the Pakistani banking system.
Section 3 presents the hypothesis development based on the existing literature. Section 4 discusses
2 In the past, some researchers studied the periods of election years (Jackowicz et al. 2013; Liang et al. 2013; Micco et al. 2007),
but our study considered electoral cycles referred to as government transitions, consistent with Haris et al. (2019b),
Yao et al. (2018), Cole (2009), and Baum et al. (2010). Government elections took place in the country during 2008 and 2013;
therefore, a value of 1 was assigned to 2008–2009 (transition period) and 2013–2014 (transition period); otherwise, a value of
0 was used (Yao et al. 2018).
the data and the methodology used in this study. Section 5 provides the main findings of the study.
Section 6 concludes and discusses the paper.
2. Review of Pakistani Banking System

There is always a requirement for a healthy, sound, and stable financial system to ensure a
functioning economy. However, the Pakistani financial sector (PFS) faces several regimes and daunting
challenges mainly because of an unstable political system. Since its independence in 1947 until
today, Pakistan’s economy experienced almost 25 governments, including elected, interim, and
military governments. If we exclude the military and interim governments, the average life span of a
politically elected government is around 2.5 years. Therefore, the PFS suffered due to the different
economic policies and higher political interference as a response of authoritarian and democratic
regimes. At the time of independence, Pakistan inherited a financial system dominated by foreign
banks (Haris et al. 2019b). However, the State Bank of Pakistan (SBP), i.e., the Central Bank, was
incorporated by the political government in July 1948 to establish a financial system and to regulate the
monetary and credit system of the country. As a result, five banks operated with 97 branches until 1951
(Haris et al. 2019a). However, in February 1953, the first martial law was imposed, and the first military
government assumed full control of the country in 1958. Consequently, during this period, reforms
were implemented vigorously with impressive results in the financial system and economic growth
until 1970 (Yao et al. 2019). Later, in 1971, the military government transited into a civil government,
and the PFS suffered a setback in 1974, when the elected government introduced another set of reforms
to nationalize all banks (Haris et al. 2019a). In the aftermath of the nationalization, the supervisory role
of the SBP was distorted due to the incorporation of the Pakistan Banking Council (PBC). The purpose
of the PBC was to monitor and inspect the banks and to oversee the objectives of nationalization.
However, a second military government again assumed command of the state in 1977, and, once
again, the democratic regime transited into an authoritarian one (Yao et al. 2019). Because of reforms,
realizing the adverse effect of nationalization, in 1980, licenses were issued to private banks allowing
them to operate side by side (Haris et al. 2019a). However, after the end of the authoritarian regime,
as part of the federal government policy of privatization and deregulation of the financial sector, the
PFS was opened to the private sector in 1989. The broader macroeconomic structural adjustment
programs initiated financial sector deregulation and liberalization during the 1990s. The SBP was
awarded partial autonomy in 1994 and declared a completely autonomous body in May 1997, when
the PBC was dissolved during the same year. Since the 1980s, there were a series of reforms initiated to
counter the adverse effects of nationalization and to streamline the financial sector on modern lines
with the intention of making it conducive to economic growth and stability. A number of studies were
conducted to study the aftermath of these reforms, and most of them converged to the same conclusion
that sector performance remains a question mark (Haris et al. 2019a). The lack of human and financial
resources, in addition to political interference and political instability, hindered industry growth in
the past. However, significant improvement was noted in recent years. The financial sector and stock
market development are likely to continue, given the growth of Pakistan’s gross domestic product
(GDP), which hit an average growth of 5.2% over the past decade. The tremendous performance
of the Pakistani financial sector contributed to establishing Pakistan as one of the most renowned
stock markets around the globe (Yao et al. 2018). The contribution of the financial sector to the GDP
of Pakistan was raised to 3.39% by the end of 2018 from 3% (2011), and the sector itself achieved a
growth of 6.13% in 2018, which was negative (−4.22%) by the end of 2011 (Yao et al. 2019). Despite this,
Figure 1 reports a lower profitability (ROA, ROE, NIM, and PM) of Pakistani banks during the periods
of government transition (2008 and 2013), which shows the negative impact of government transitions
on Pakistani bank profitability due to political interference (Yao et al. 2018). Therefore, this study
intends to measure the political influence on the PFS by empirically examining the impact of political
connections on the profitability of banks in Pakistan.
Figure 1. Trend
Figure 1. Trend in
in the
the profitability
profitabilityof
of Pakistani
Pakistani banks
banks (2007–2016).
(2007–2016). PB,
PB, private
private banks;
banks; GB,
GB, government
government
banks; TB, total banks.
banks; TB, total banks.
3. Related Literature and Hypothesis Development
3. Related Literature and Hypothesis Development
Considering the purpose of our study, which was to evaluate the impact of corporate governance
Considering the purpose of our study, which was to evaluate the impact of corporate
characteristics and political connections of directors on the profitability of Pakistani banks, this section
governance characteristics and political connections of directors on the profitability of Pakistani
extends the development of hypotheses based on the related literature.
banks, this section extends the development of hypotheses based on the related literature.
Politically Connected Directors: In a politicized economy, banks tend to lend more money at
Politically Connected Directors: In a politicized economy, banks tend to lend more money at a
a lower cost and offer favorable terms to firms linked to politicians. These preferential bank
lower cost and offer favorable terms to firms linked to politicians. These preferential bank loans fund
loans fund the electoral campaigns of politicians and suppress the management’s ability to achieve
the electoral campaigns of politicians and suppress the management’s ability to achieve sustainable
sustainable business growth. Politically connected directors (PCDs) influence board decisions by
business growth. Politically connected directors (PCDs) influence board decisions by allowing more
allowing more political interference to pursue political objectives at the expense of banks, which
political interference to pursue political objectives at the expense of banks, which adversely affects
adversely affects the performance (Liang et al. 2013). The political connectedness was first found
the performance (Liang et al. 2013). The political connectedness was first found in the influential
in the influential studies conducted by Tullock (1967), Stigler (1971), and Krueger (1974). Later,
studies conducted by Tullock (1967), Stigler (1971), and Krueger (1974). Later, it was extensively
it was extensively studied in the body of literature related to the performance of non-financial
studied in the body of literature related to the performance of non-financial firms (Boubakri et al.
firms (Boubakri et al. 2008; Domadenik et al. 2016; Faccio 2006; Fan et al. 2007; Fonseka et al. 2015;
2008; Domadenik et al. 2016; Faccio 2006; Fan et al. 2007; Fonseka et al. 2015; Hasan et al. 2017; Khwaja
Hasan et al. 2017; Khwaja and Mian 2005; Kroszner and Stratmann 1998; Muttakin et al. 2015;
and Mian 2005; Kroszner and Stratmann 1998; Muttakin et al. 2015; Wu et al. 2012; Xu et al. 2013; Yeh
Wu et al. 2012; Xu et al. 2013; Yeh et al. 2013) and financial institutions (Berger et al. 2009; Charumilind
et al. 2013) and financial institutions (Berger et al. 2009; Charumilind et al. 2006; Chen and Liu 2013;
et al. 2006; Chen and Liu 2013; Dinç 2005; Firth et al. 2009; Hung et al. 2017; Jackowicz et al. 2013;
Dinç 2005; Firth et al. 2009; Hung et al. 2017; Jackowicz et al. 2013; Khwaja and Mian 2005; Liang et
Khwaja and Mian 2005; Liang et al. 2013; Micco et al. 2007). Baum et al. (2010) provided evidence
al. 2013; Micco et al. 2007). Baum et al. (2010) provided evidence and argued that the government
and argued that the government forces politically connected banks (especially state-owned banks) to
forces politically connected banks (especially state-owned banks) to extend funding to government
extend funding to government projects and political cronies at lower interest rates, resulting in the
projects and political cronies at lower interest rates, resulting in the misallocation of resources and
misallocation of resources and lower profitability. They reported that government banks underperform
lower profitability. They reported that government banks underperform during election years. Fan
during election years. Fan et al. (2007) argued that bank lending decisions are affected by the political
et al. (2007) argued that bank lending decisions are affected by the political connections of directors,
connections of directors, which negatively affect bank performance. PCDs tend to lend more to
which negatively affect bank performance. PCDs tend to lend more to those firms linked with
those firms linked with politicians at lower interest rates with easy collateral terms to support the
politicians at lower interest rates with easy collateral terms to support the electoral campaigns of
electoral campaigns of associated politicians (so-called preferential banks loans), which suppress the
associated politicians (so-called preferential banks loans), which suppress the management’s ability
management’s ability to achieve a desired profitability. Previously, Micco et al. (2007) also supported
to achieve a desired profitability. Previously, Micco et al. (2007) also supported the political view that,
the political view that, during the period of government elections, the higher amount of lending by
during the period of government elections, the higher amount of lending by state-owned banks (Dinç
state-owned banks (Dinç 2005) relates to lower interest charges, which reduces the profitability of
2005) relates to lower interest charges, which reduces the profitability of banks. The resource-based
banks. The resource-based theory postulates that firms may have higher competitive advantages
theory postulates that firms may have higher competitive advantages because of accessing many
because of accessing many benefits due to their political connections (Cheema et al. 2016). Thus, PCDs
benefits due to their political connections (Cheema et al. 2016). Thus, PCDs sitting on bank boards
may have political goals to achieve, which lead the bank to perform poorly. The grabbing hand theory
argues that directors appointed by politicians pursue political objectives rather than social welfare.
sitting on bank boards may have political goals to achieve, which lead the bank to perform poorly.
The grabbing hand theory argues that directors appointed by politicians pursue political objectives
rather than social welfare. Similarly, the network theory states that financial resources are directed to
fund unviable government projects with the help of networks between the government and institutions.
This theory can be supported in the context of Pakistan. In Pakistan, the connections between bank
directors and ruling parties were disclosed as a result of a criminal investigation with regard to money
laundering and fake bank accounts3 . Thus, the political connections of the bank directors damaged the
reputation of banks among stakeholders and investors, which affected their performance negatively.
Another main theory of corporate governance also explains the negative effect of political connections
on bank performance via agency problems. Politically connected directors always seek to meet the
needs of associated politicians (e.g., favorable loans, relaxation in loan repayments, and job provisions),
which causes a conflict between the goals of shareholders and managers, thus increasing the agency
cost and reducing performance. Moreover, Khwaja and Mian (2005) also specified, in the context of
Pakistan, that, during elections, state-owned banks lend more to politically connected firms, which
leads to a higher rate of default and, thus, deteriorates bank profitability. They further argued that
politically connected firms access 40% more loans and have a 50% default rate, thereby leading the
banks toward lower profitability.
Additionally, government change affects the economy overall, because elections may influence
the monetary instruments and outcomes through injecting money to support the needs of an expensive
election campaign due to political manipulation. Many studies reported a lower profitability of
financial institutions during election years because of the political connectedness of banks. Cole (2009)
extended the evidence of political interference and found a higher injection of agricultural credit
by state-owned banks during elections years. Jackowicz et al. (2013) stated that state-owned banks
serve as a tool to fund political goals and found a lower profitability of banks in 11 central European
countries during election years due to political connections. Chen and Liu (2013) also found a lower
profitability of state-owned financial institutions than privately owned institutions during election
years. Liang et al. (2013) found a negative relationship between the proportion of PCDs and the
profitability of 52 Chinese banks. Other recent studies by Haris et al. (2019b) and Yao et al. (2018) also
extended the evidence of political interference and found a lower profitability of 28 banks in Pakistan
during periods of government transition. Furthermore, Haris et al. (2019a) also reported a lower
profitability of nine Pakistani government banks during the period of government election (2013). We,
thus, pose our first hypothesis.
Hypothesis 1a (H1a). The profitability of Pakistani banks deteriorates due to the presence of politically
connected directors on the board.
Hypothesis 1b (H1b). Banks in Pakistan earn lower profitability during government transitions because of
the presence of politically connected directors.
3 During the last decade, one former Prime Minister and one former President were sentenced to prison in cases of money
laundering and fake bank accounts. The regulatory authorities also arrested the president of a provincial government-owned
bank in relation to the fake bank accounts. Furthermore, the Supreme Court of Pakistan directed the Federal Investigation
Agency to put the names of the heads of three Pakistani banks on the exit control list, as they were alleged to open fake bank
accounts to launder money. Moreover, the appointment of a president of another state-owned bank was also challenged, as
it was claimed that his appointment was based on nepotism and political interest, which was illegal. In addition, some
private banks were also found guilty with regard to opening fake bank accounts to launder money. Information can be
accessed from http://www.msn.com/en-xl/asia/pakistan/nab-arrests-sindh-bank-chief-in-fake-accounts-case/ar-AAEciNy,
https://en.dailypakistan.com.pk/business/president-nbp-saeed-ahmeds-appointment-challenged/, and https://gulfnews.
com/world/asia/pakistan/former-pakistan-president-asif-ali-zardari-arrested-in-fake-bank-accounts-case-1.64511834; https:
//www.pakistantoday.com.pk/2018/07/08/sc-orders-to-place-heads-of-ubl-sindh-bank-summit-bank-on-ecl/.
Board Size: The board of directors (BODs) protects bank interests and provides strategic directions
to monitor the achievement of the banking system’s strategic objectives. The duties and responsibilities
of BODs are important aspects of corporate governance practices, which lead to achieving sustainable
growth for banks (Yatim and Yusoff 2014). The addition of many directors to the board brings more
knowledge, expertise, and experience, which lead to a sustained competitive advantage, raising
the performance of the banking industry (Barroso et al. 2011). However, in the literature, there
is no single consensus with regard to the relationship between board size and the performance of
banks. On the one hand, some studies suggested that an adequately sized board performs relatively
better than a very small board. Large boards carry a wide range of expertise for decision-making,
effectively monitoring management activities (Isaac 2017) and dealing with the complexity of the
financial system (Adams and Mehran 2003, 2012; Yermack 1996), thereby raising bank performance.
Some previous studies, for instance, Farag et al. (2017), Nawaz (2017), and Isaac (2017), found a
positive relationship between board size and profitability. On the other hand, both Jensen (1993) and
Lipton and Lorsch (1992) stated a certain limit for board size and suggested that a board size beyond 7–8
members functions ineffectively and, thus, deteriorates profitability. Previously, some studies also found
a negative relationship between profitability and boards with a large number of members (Ghosh 2006;
Liang et al. 2013; Masulis et al. 2012; Mollah and Zaman 2015; Pathan et al. 2007; Tanna et al. 2011).
In addition to the above positive and negative relationships, some studies found a nonlinear
relationship (inverted U-shaped) between board size and profitability (de Andres and Vallelado 2008;
Grove et al. 2011; Yeung 2018; Yulia 2016). These studies suggested that the addition of too many
directors decreases the performance due to problems of coordination and communication, thereby
prolonging the process of decision-making, and leading to agency cost outweighing the benefits
(Coles et al. 2008; Janis 1983; Yermack 1996). Therefore, in light of the above findings, we construct a
second hypothesis.
Hypothesis 2 (H2). There is an inverted U-shaped relationship between board size and the profitability of
Pakistani banks.
Board Composition: The OECD principles clearly regulate board composition and suggest that
every company must ensure the presence of non-executive directors (NEDs) on the board in sufficient
number (OECD 1999). A balanced board composed of non-executive and executive directors brings
an objective view, aligns the interests of different parties, and acts to enhance shareholder wealth
(Luo 2016). Previously, Jensen and Meckling (1976) suggested that the agency problem between
shareholders and directors can be minimized through the addition of NEDs, which translates into
sustained performance. Fama and Jensen (1983) also suggested that the presence of more NEDs on
a bank’s board helps minimize conflicts of interest, which increases value for shareholders through
disciplining and monitoring of the managers (Salim et al. 2016). de Andres and Vallelado (2008)
also argued that bank performance can be increased through the advisory and monitoring role of
NEDs. Although, there is a vast body of literature available on board composition, we could not find
conclusive evidence regarding the impact of appointing more NEDs on profitability. Some studies
found a positive impact (Cornett et al. 2009; Dahya et al. 2008; Liang et al. 2013; Pathan et al. 2007;
Tanna et al. 2011) and some found a negative impact (Awadh and Azhar 2015; Erkens et al. 2012;
Isaac 2017; Pathan and Faff 2013) of NEDs on performance. de Andres and Vallelado (2008) found an
inverted U-shaped impact indicating both a positive and negative relationship between a higher ratio
of NEDs and the profitability of 69 banks in six countries. In addition to that, some studies did not
find any association between appointing NEDs and bank performance (Manas and Palanisamy 2017;
Nawaz 2017; Salim et al. 2016). However, considering the above findings, our third hypothesis is
as follows:
Hypothesis 3 (H3). There could be a significant association between board composition and the profitability of
banks in Pakistan.
Board Independence: The boards of banks in Pakistan are composed of a blend of executive,
non-executive, and independent directors (INDs). Therefore, in order to examine the impact of board
independence, we treat the presence of INDs separately from the board composition4 . The presence of
INDs is important for performing a better monitoring role, which helps to achieve a higher profitability,
as suggested by agency theory (Farag and Mallin 2017). Board independence as a vital corporate
governance attribute promotes profitable growth through positively influencing the performance of
banks (Kumari and Pattanayak 2017). Financial performance can be attained with a more independent
board (Dalton et al. 1998), as it performs a better monitoring role (Carter et al. 2010) because independent
directors are alleged to be effective monitors (Adams et al. 2010). Previously, many studies reported a
positive relationship between board independence and profitability. Liang et al. (2013) argued that
board independence is a central theme in corporate governance and found a positive association between
board independence and the profitability of 52 Chinese banks. Furthermore, some studies, such as
Farag and Mallin (2017), Yulia (2016), Cornett et al. (2009), and Pathan et al. (2007), also found a positive
association between board independence and performance. Additionally, Rosenstein and Wyatt (1990)
linked board independence with stock prices and found that the increase in stock prices was due to
the nomination of independent directors. Considering the above evidence, our fourth hypothesis is
as follows:
Hypothesis 4 (H4). There is a positive relationship between board independence and the profitability of
Pakistani banks.
Board Ownership: We use this characteristic in order to observe the ownership effect. We relate
this factor to foreign ownership, which also represents diversity5 . Previous studies suggested that
foreign directors increase innovation, creativity, and collaborations, as well as acquaint experiences and
ideas (Ezat and Ahmed 2008; Samaha et al. 2012). Agency theory also suggests that foreign directors
bring diversity and increase performance to foster sustainability of the financial system. However, the
literature extends different results. On the one hand, some studies found a positive relationship between
performance and the presence of foreign directors on the board (Choi et al. 2007; Estélyi and Nisar 2016;
Oxelheim and Randøy 2003). On the other hand, Masulis et al. (2012) found a lower performance of
firms with the presence of foreign directors. They argued that foreign directors possess less knowledge
of the local market, which makes them ineffective when monitoring management activities because
of a lesser understanding of laws, rules, regulations, and governance standards, thereby lowering
performance. Furthermore, it was also argued that the foreign directors are less likely to attend board
meetings because of their geographical distance and security concerns, which slows the decision
process and creates snags for strengthening their relationship with management (Knyazeva et al. 2011;
Masulis et al. 2012; Miletkov et al. 2014). Previously, Liang et al. (2013) also found a lower ROA and
4 The statement of compliance with the code of corporate governance, published in the annual reports of each bank operating
in Pakistan, categorizes directors into independent, non-executive, and executive directors. As per the SBP circular No. 15
dated 28 December 2016 available at http://www.sbp.org.pk/bprd/2016/C15.htm, the revised definition of an independent
director is given below. The abovementioned circular also states that each bank operating in Pakistan must ensure that
the board is composed of one-third independent directors by 31 March 2018, an increase from the previous proportion
of one-fourth.
“Independent Director means a Director who is not connected or does not have any other relationship, whether pecuniary
or otherwise, with the bank/DFI, its associated companies, subsidiaries, holding company, or Directors. The test of
independence principally emanates from the fact whether such person can reasonably be perceived as being able to exercise
independent business judgment without being subservient to any form of conflict of interest.”
5 Previously, many studies linked diversity with gender and nationality (Adams et al. 2010; Adams and Ferreira 2009;
Anderson et al. 2011; Carter et al. 2003; Estélyi and Nisar 2016; García-Meca et al. 2015; Ionascu et al. 2018). We did not
find the presence of any women on the boards of Pakistani banks except for a few cases. Out of a total of 251 bank–year
observations, we only found 28 (1.12%) observations regarding the presence of women directors on the boards of a few
banks during different years. Here, we confirm that the Pakistani banking industry has less gender diversity on the board.
ROE of Chinese banks due to concentrated foreign ownership. In light of the above evidence, we are
not certain about the specific impact of foreign directors on performance. We, thus, pose the following
fifth hypothesis:
Hypothesis 5 (H5). There could be a significant association between the presence of foreign directors and bank
profitability in Pakistan.
Board Meetings: Meetings of BODs signify the intensity of board activities. The agency theory
suggests that board meetings increase performance through better monitoring and a reduction in
agency cost, which are key areas to promote business sustainability (Yulia 2016). Considering the
complex nature of the banking industry, boards of banks are required to meet more frequently to ensure
sustainability of the financial system (Manas and Palanisamy 2017). The guidelines issued on corporate
governance for the banking industry in Pakistan also emphasize frequent meetings of bank boards in
order to enhance the monitoring and advisory role of directors6 . Frequent meetings enable directors to
exchange ideas, as well as monitor and supervise management activities and bank strategies, which
might be valuable for improving the financial performance of banks. Thus, frequent board meetings are
the sign of a proactive board, which enhance the supervisory and monitoring role of directors and lead
toward higher performance (de Andres and Vallelado 2008; Liang et al. 2013). Previously, on the one
hand, Grove et al. (2011), Haß et al. (2016), and Liang et al. (2013) found a positive association between
the frequency of board meetings and performance. On the other hand, some researchers argued
that frequent board meetings might occur during times of controversial decisions, financial distress,
and poor performance, indicating a reactive board (de Andres and Vallelado 2008; Liang et al. 2013;
Vafeas 1999). Previously, Farag et al. (2017) and Vafeas (1999) found a negative relationship between
board meetings and performance. Therefore, we are not certain about the impact of board meetings on
the performance of Pakistani banks. Thus, we pose our sixth hypothesis.
Hypothesis 6 (H6). There could be a significant relationship between board meetings and the profitability of
Pakistani banks.
Director Compensation: The significant link between director compensation and firm performance
signals an effective corporate governance mechanism, which is of utmost important for the
sustainability of financial system (Hermalin and Weisbach 1998). This suggests that, in order
to establish an effective corporate governance framework, director compensation is essential
(Chang et al. 2015), because investment in human capital is one of the main drivers which helps
to achieve the sustainable growth of banks (Nawaz 2017). Therefore, director compensation
helps to improve the performance of banks (Kumari and Pattanayak 2017). Moreover, director
compensation also helps to minimize agency problems, because directors act as the agents of
shareholders (principals) in order to protect and maximize their wealth. Consequently, efficient
compensation motivates directors to increase shareholder wealth because the pay–performance
issue is linked with the principal–agent theory (Jensen and Murphy 1990; Murphy 1985). Previously,
Matolcsy and Wright (2011) found a lower performance of firms whose CEO compensation was not
linked with their characteristics. Mehran (1995) found a higher return to shareholders, where a
positive relationship between CEO pay and firm performance was revealed. Hall and Liebman (1998)
6 The SBP designed Prudential Regulations (PRs) for the banking industry and periodically compiles amendments. It is stated,
under section G of the PRs for corporate governance, that boards of all banks should meet more frequently, preferably
once a month or at least once a quarter. For further facilitation and to ensure good corporate governance practices, the
SBP also allows boards to hold some meetings abroad or via video conferencing if any bank represents 40% or more
foreign shareholders. Additionally, the SBP also requires boards to submit certified copies of board meetings to the off-site
Supervision and Enforcement Department, including the meeting agenda and all matters decided/resolved. PRs are available
at http://www.sbp.org.pk or http://www.sbp.org.pk/l_frame/index2.asp.
found a positive impact of CEO compensation on firm performance. Ghosh (2006) also extended a
positive relationship between CEO compensation and firm performance. In addition, many studies
related to the financial sector also reported a positive association between director compensation
and performance (Ang et al. 2002; Becher et al. 2005; Chang et al. 2015; Doucouliagos et al. 2007;
Houston and James 1995; John and Qian 2003; Peng and Mansor 2015). In light of the above findings,
we postulate our seventh hypothesis.
Hypothesis 7 (H7). There is a positive association between director compensation and the profitability of banks
in Pakistan.
Audit Meetings: The key purpose of an audit committee is to monitor the financial performance of
a business (Yatim 2009). We use the frequency of audit committee meetings to measure the activities
of an audit committee. Menon and Williams (1994) argued that the activeness of audit committees
is essential for effective monitoring. Because the audit committee ensures compliance and works
to protect the interest of shareholders, more frequent meetings of an audit committee affirm the
transparency and protection of shareholder interest and, thus, increase performance. An effective
audit committee leads to more funds from depositors, which turn into investments, thus translating
into improved performance (Isaac 2017). However, the literature extends a mixed relationship
between audit committee meetings and performance. Recently, Isaac (2017) found a significant
positive relationship between audit committee meetings and the performance of financial institutions.
Previously, Kyereboah-Coleman (2008) also found a positive association between audit committee
meetings and performance. However, Contessotto et al. (2014) suggested that an audit committee only
reduces audit risk through enhancing the integrity of financial reporting; consequently, organizations
comply with statutory requirements to avoid penalties and sanctions to protect business sustainability.
Additionally, Adelopo et al. (2012) argued that more frequent audit committee meetings might be in
response to an undesired situation for loss-making firms. Thus, in this way, such committees have
no contribution to the enhancement of financial performance (Beasley 1996). Considering the above
arguments, we postulate our eighth hypothesis.
Hypothesis 8 (H8). There could be a significant relationship between audit meetings and the profitability of
Pakistani banks.
Audit Independence: An independent audit committee helps to defuse agency conflicts between
owners and managers through the independent and effective monitoring of management activities
(Al-Janadi et al. 2012; Arcay and Vázquez 2005; Bronson et al. 2009; Kelton and Yang 2008).
This leads to the desired business sustainability through improved performance. The banking
regulations7 in Pakistan also emphasize the independence of audit committees in order to monitor
financial performance and ensure the integrity of financial reporting, which is essential for business
stability. In the past, many studies found a positive association between the independence of audit
committees and performance (Carcello et al. 2011; Chan and Li 2008; Klein 1998; Salisu and Mohd 2015;
Woidtke and Yeh 2013; Yeh et al. 2011). Thus, we pose our last hypothesis.
Hypothesis 9 (H9). There is a positive association between audit committee independence and the profitability
of Pakistani banks.
7 Both PRs issued by the SBP and corporate governance regulations issued by the SECP state that each bank board in
Pakistan must establish an audit committee comprising a minimum of three board members and that the committee
must be chaired by an independent director. Furthermore, it is also stated that, among the committee members, one
member must be a financial literate to ensure the expertise of the audit committee. Information was accessed from
http://www.sbp.org.pk/l_frame/index2.asp and https://www.secp.gov.pk/corporate-governance/listed-companies/.
4. Data and Methodology
4.1. Sample and Data

The Pakistani banking system is based on 33 commercial banks (29 fully commercial and four
specialized), six investment banks, and 11 microfinance banks (Yao et al. 2019). The investment and
microfinance banks are not included in this study due to their different nature of operations, because
neither type of banks is involved in commercial lending and deposits. Our main target is commercial
banks that are involved in all types of commercial lending and borrowing activities. The SBP also
treats investment and microfinance banks differently from the banking sector8 . The 33 commercial
banks include four foreign and 29 local banks. We excluded foreign banks from our study due to the
non-availability of required data and the fact that foreign banks hold only a 2.46% share of assets in
the Pakistani banking industry9 . Out of the remaining 29 local banks, the MCB Islamic bank was
established during the year 2015; therefore, it was also excluded from the sample. Furthermore, the
required corporate governance data of Dubai Islamic bank Pakistan limited and Punjab Provincial
Co-operative Bank Ltd. were not available; thus, we also excluded both banks from the sample.
Our final sample for this study comprised 26 local banks operating during the period of 2007–2016; all
26 banks in the sample cover around 96.5% of the Pakistani banking industry in terms of assets.
We hand-collected corporate governance data from the statement of compliance with the code of
corporate governance, director reports to shareholders, and corporate profiles published in annual
reports by each bank and from the database maintained by the Pakistan credit rating agency (PACRA).
The data to measure profitability indicators, as well as bank-specific and industry-specific variables,
were obtained from the audited annual financial statements available in the databases maintained by
each bank and the SBP. The data for country-specific variables were obtained from the database of the
World Bank. We obtain the annual data of each bank over the period of 2007–2016. Sindh banks limited
(SBL) was established during the year 2011; thus, we could only obtain six years (2011–2016) of data.
Some corporate governance data of SME bank limited (SMEBL) were also missing before the year 2011;
thus, we could only obtain five years (2012–2016) of data. Our final sample was based on unbalanced
panel data of 26 banks covering the period of 2007–2016, which provided 251 bank–year observations.
In order to ensure originality, we cross-checked our data twice and found consistency with the source.
4.2. Variables Description
4.2.1. Profitability Indicators

Our study analyzed the impact of different corporate governance factors and political connections
of the directors on the profitability of banks in Pakistan. We obtained four accounting measures of
profitability from Haris et al. (2019b), Yao et al. (2018), and Tan (2016). Their studies used return on
assets (ROA), return on equity (ROE), net interest margin (NIM), and profit margin (PM) as different
measures of profitability (see Table 1). ROA indicates the efficient utilization of assets to maximize
earnings. It is widely used in the literature related to corporate governance, e.g., Hung et al. (2017)
and de Andres and Vallelado (2008). ROE is a measure of profitability earned on equity invested by
shareholders, and it is widely used in the study of corporate governance, e.g., Farag et al. (2017) and
Mollah and Zaman (2015). NIM is a measure of income generated from interest-bearing activities
after compensating for the interest cost. It also shows the investment decision-making ability of the
8 Microfinance banks provide financial services to low-income households who lack access to commercial banking.
The investment banks act as agents or underwriters that assist governments, corporates, and individuals in raising
financial capital. The list of banks can be extracted from www.sbp.org.pk/departments/stats/FSA-2013-17.pdf, where the
SBP treats investment and microfinance banks differently from the banking sector.
9 As on 31 December 2016. The figures were extracted from the Statistics of the Banking System issued by the Financial
Stability Department of the SBP. Available at www.sbp.org.pk.
management relative to the funding cost. NIM was used by Jackowicz et al. (2013). PM is almost
similar to ROA, but PM evades the effect of taxes and measures the actual profitability earned on
a single rupee invested in assets. We did not find the use of this indicator in corporate governance
studies; however, it was also used by Molyneux and Thornton (1992).
Table 1. List of variables.
Variables Notation Description Expected Results

Dependent
Return on assets ROA Profit after tax to average assets
Return on equity ROE Profit after tax to average equity
Net interest margin NIM Interest income—interest expense/average earning assets
Earning assets defined as investment, advances, and lending to
financial institutions
Profit margin PM Profit before tax to average assets
Independent
Corporate Governance
Dummy variable equal to 1 if at least one director appointed by
Politically connected directors PCDs the government of Pakistan sits on the board or if a bank is −
state-owned, and 0 otherwise
Board size BOSIZE Logarithm of total number of board members +
Board composition BCOMP Non-executive directors to total members in a board +/−
Board independence BIND Independent directors to total members in a board +
Dummy variable equal to 1 if board contains at least one foreign
Board ownership BOWN +/−
director, and 0 otherwise
Board meetings BMEETs Logarithm of total board meetings held in a year +/−
Director compensation DCOMP Logarithm of total compensation paid to the board of directors +
Audit meetings AUDMEETs Logarithm of total audit committee meetings held in a year +/−
Dummy variable equal to 1 if at least one independent director is
Audit independence AUDIND +
present in the audit committee, and 0 otherwise
Bank-Specific
Bank size SIZE Logarithm of total assets +/−
Solvency SOLV Total shareholder equity to total assets +
Credit quality CQ Total loan loss provisions to total advances −
Industry-Specific
Ratio between the total assets of largest five banks and total assets
Industry concentration IC5 −
of all domestic banks
Country-Specific
Annual percentage change in the gross domestic product (GDP) of
Economic growth GDPR +
the country
Equal to 1 if there is a government transition (2008–2009 and
Government change (dummy) GOV −
2013–2014), and 0 otherwise
Note: The largest five banks collectively hold a 52.57% share of assets. The top five banks include Habib bank
limited (HBL), National bank of Pakistan (NBP), United bank limited (UBL), Allied bank limited (ABL), and MCB
bank limited (MCBL), as each bank holds a 15.60%, 12.87%, 10.28%, 6.97%, and 6.85% share of assets, respectively.
Elections took place in the country during the years 2008 and 2013; therefore, we considered 2008–2009 and 2013–2014
as transition periods.
4.2.2. Explanatory Variable

Our focus was to evaluate the impact of characteristics related to corporate governance and
political connections of the directors on the profitability of banks in Pakistan. We also controlled the
impact of some other factors categorized into bank-specific, industry-specific, and country-specific
variables. We added an important dummy variable of politically connected directors (PCDs) to see the
impact of political connections of the directors on profitability; for that, we assigned a binary value of 1
if the board of any bank represented at least one director appointed by the government of Pakistan
or if the bank was state-owned, and 0 otherwise. Among corporate governance characteristics, we
used the natural logarithm of board size as a proxy to analyze the impact of board size (BSIZE) on
profitability. Following de Andres and Vallelado (2008), we also used the sum of the square of board
size (BSIZE-SQ) to evaluate the inverted U-shaped relationship between board size and profitability.
The ratio of non-executive directors to total directors was used as a proxy of board composition
(BCOMP), and the ratio of independent directors to total directors was used as a proxy of board
independence (BIND). We used a dummy variable to see the impact of board ownership (BOWN); for
that, we assigned a value of 1 if the board of any bank represented at least one foreign director, and
0 otherwise. The natural logarithm of total compensation paid to the directors and CEO was used
as a proxy of director compensation (DCOMP). In this study, the board compensation was defined
as the annual cash-based compensation paid to the directors including the CEO (CEOs sit on the
board as executive directors). In the past, several studies considered equity-based compensation
(Bugeja et al. 2016; Fernandes et al. 2013; Masulis et al. 2012; Matolcsy and Wright 2011; Yermack 2004);
however, we found that only cash-based compensation is paid to CEOs of banks in Pakistan. Cash-based
compensation includes managerial remuneration, utilities, bonuses, all other allowances and benefits
paid to the CEOs, and fees paid to the directors (except executive directors). The natural logarithm of
board meetings held in a year was used as a proxy of the frequency of board meetings (BMEETs) to
analyze the impact of board activities. We also used two other variables related to the audit committee.
One was the natural logarithm of audit committee meetings held in a year (AUDMEETs), used to
evaluate the impact of audit committee activities, and the other was a binary variable equal to 1
if the audit committee represented at least an independent director, and 0 otherwise, which was
used to analyze the impact of audit committee independence (AUDIND). To control the impact of
bank-specific, industry-specific, and country-specific factors, our study followed Haris et al. (2019b)
and Yao et al. (2018). The bank-specific variables included bank size (BSIZE), measured as the natural
logarithm of total assets, solvency (SOLV), measured as a ratio between shareholder equity and total
assets, and credit quality (CQ), measured as the ratio of loan loss provisions to total advances. The
five-bank concentration ratio (IC5 ) was used as an industry-specific variable. The annual growth of
gross domestic product (GDPR) was a country-specific variable used to control the impact of economic
growth of the country. We also controlled the impact of government transition (GOV) within the
country, which was considered as a country-specific variable. The detailed list of variables used in this
study is given in Table 1.
4.3. Econometric Methodology

Profitability tends to persist over time, and bank profitability is affected by some characteristics of
banks which are not easy to identify or measure in an equation, which then creates the problem of
unobserved heterogeneity. For example, the performance of banks can be affected by the bank manager’s
behavior and the management attitude toward risk and internal policies (Yao et al. 2018). If the
influence of these characteristics and the persistence of profitability are not taken into consideration, the
calculated coefficients can be biased due to the correlation between error term and explanatory variables
(Trujillo-Ponce 2013). Furthermore, some corporate governance characteristics suffer from endogeneity,
such as board size and board composition, which might be determined simultaneously with a dependent
variable. Consequently, due to the existence of an unobserved fixed effect and endogeneity, the use of
ordinary least square (OLS) produces inconsistent and biased results (de Andres and Vallelado 2008;
Baltagi 2001). Therefore, following Haris et al. (2019b) and Yao et al. (2018), this study used the
generalized method of moments (GMM), which was first used by Arellano and Bond (1991) for
dynamic panel data. It allows the use of a lagged dependent variable on the left side and the lag of all
strictly exogenous variables to address the unobserved fixed effect by differencing, called difference
GMM. Later, Blundell and Bond (1998) and Arellano and Bover (1995) built a system of two equations,
i.e., a first-difference equation and level equation, called system GMM, by introducing the use of
more instruments in a system to improve the efficiency of GMM. Our baseline methodology was a
two-step GMM system estimator, which dealt with the problems of serial correlation, endogeneity, and
unobserved heterogeneity. It was considered efficient due to the use of orthogonality conditions and,
thus, produced more consistent and unbiased results (Baum et al. 2003; Roodman 2009).
To deal with endogeneity, following Farag et al. (2017) and de Andres and Vallelado (2008), we
used board size and board composition as endogenous variables and implemented them with different
lag lengths (3–5) along with the lagged profitability measures. Furthermore, we also implemented
strictly exogenous variables in levels. Previously, Hermalin and Weisbach (2003) also suggested that
the board is determined endogenously by firm performance. Although system GMM reduces small
sample bias, Windmeijer (2005) showed using Monte Carlo studies that estimated asymptotic standard
errors can be downward biased in the case of small samples when using an efficient two-step GMM.
Since we did not have a large sample, to avoid any potential bias in the estimation of asymptotic
standard errors, we applied Windmeijer (2005) corrections to the standard errors that produced robust
and corrected inference, consistent with Haris et al. (2019b), Yao et al. (2019, 2018).
Following Haris et al. (2019b), Yao et al. (2019, 2018), since the GMM allows the use of instruments,
the validity of these instruments is crucial for the consistency of the GMM. The GMM calculates
Hansen-J statistics for over-identifying restrictions under the null hypothesis of joint validity of the
instruments. It indicates that the residuals and instruments are not correlated. Furthermore, for the
validity of instrument subsets, GMM also calculates the difference-in-Hansen test (also called C-statistic)
under the null hypothesis of exogeneity of instrument subsets (Roodman 2009). The problems of
Arellano and Bond (1991) with regard to serial correlations, i.e., first-order autocorrelation (AR-1) and
second-order autocorrelation (AR-2), are also addressed by GMM under the null hypothesis of no
serial correlations. However, the absence of AR-2 indicates the validity of GMM even in the presence
of AR-1. Furthermore, our study applied “orthogonal deviation” because, in unbalanced panel data, it
subtracts the average of future available observations of a variable in the transformed data and reduces
the gap, while the use of first-difference transformations magnifies the gap (Arellano and Bover 1995).
4.4. Econometric Specification

Considering the time persistence of profitability, following past studies (for instance,
Haris et al. (2019b), Yao et al. (2018), Farag et al. (2017), Saona (2016), Tan (2016), and
Trujillo-Ponce (2013)), we added a one-year lag of each profitability indicator on the left side
as an independent variable, making our model dynamic. Previously, some studies concluded
that bank-specific, industry-specific, and country-specific variables have a strong influence on
bank profitability (see, for instance, Yao et al. (2018), Zhang et al. (2018), Haris et al. (2019a),
Shahab et al. (2017), Tan (2016), Trujillo-Ponce (2013), and Athanasoglou et al. (2008)). Therefore,
in order to get more consistent and robust results, we controlled the impact of bank-specific,
industry-specific, and country-specific variables, taken from Haris et al. (2019b) and Yao et al. (2018).
Furthermore, Dinç (2005) and Micco et al. (2007) also suggested that government transitions, especially
during election periods, influence bank performance. A recent study by Yao et al. (2018) found a
lower profitability of the Pakistani banking industry during government transitions; therefore, we
also controlled the impact of government transitions in order to offer robust results. To analyze the
impact of political connections and corporate governance characteristics on the profitability of banks
in Pakistan, the first dynamic model of our study is given below.
J K
j
Pit = α0 + δPit−1 + βi PCDsit + β j CGit + βk BSVitk + βl ISVt + βm CSVt
P P
j=1 k =1 (1)
+βn GOVt + ϕo TDt + vit + µit ,
where i represents each bank, and t represents the time considered as years; Pit indicates the profitability
of i bank at time t, which is expressed as return on assets (ROA), return on equity (ROE), net interest
margin (NIM), and profit margin (PM); δPit−1 is the one-year lag of each profitability indicator to deal
with time persistence, and δ refers to the adjustment speed; PCDsit refers to politically connected
j
directors; CGit indicates the corporate governance variables expressed as board size, board composition,
board independence, board meetings, directors compensation, board ownership, audit committee
meetings, and audit committee independence; BSVitk controls the impact of bank-specific variables
expressed as bank size, capitalization, and credit quality; ISVt controls the impact of industry-specific
variables expressed as industry concentration; CSVt controls the impact of country-specific variables
expressed as the annual growth rate of gross domestic product of the country; GOVt is a dummy
variable which controls the impact of government transitions (for details, see Table 1); α is a constant,
and β is a coefficient; TDt represents the time dummies (year effect), vit is the unobserved bank
individual effect, and µit is the residual.
We further interacted politically connected directors (PCDs) with each explanatory indicator
(except for ISV and CSV) and checked the impact on profitability. For that, we applied the following
dynamic panel model:
J K
j
Pit = α0 + δPit−1 + β j CGit × PCDsit + βk BSVitk × PCDsit + βl ISVt + βm CSVt
P P
j=1 k =1 (2)
+βn GOVt × PCDsit + ϕo TDt + vit + µit .
5. Findings
Before using the data, we applied some pre-estimation tests to ensure the validity of our unbalanced
dynamic panel data. For that, firstly, a Fisher-type root test (augmented Dickey–Fuller (ADF)) was
performed to check the stationarity of the data. The ADF unit root results are presented in Table 2.
The significant p-values of each variable rejected the presence of a unit root, making the data stationary.
Secondly, a variance inflation factor (VIF) test was performed to address the multicollinearity problem
among all explanatory variables. The VIF values of each variable along with mean VIF (1.87) are
presented in Table 2, rejecting the existence of multicollinearity among variables at the cut-off value of
10 (Netter et al. 1989).
Table 2. Unit root and multicollinearity results.
Coef p-Value VIF Coef p-Value VIF

Profitability Indicators Control
ROA 206.263 0.000 BSIZE 135.865 0.000 2.60
ROE 169.514 0.000 SOLV 151.657 0.000 1.35
NIM 120.894 0.000 RISK 129.823 0.000 1.37
PM 153.756 0.000 IC5 134.501 0.000 1.16
Corporate Governance GDPR 108.527 0.000 1.25
PCDs 212.040 0.000 1.59 GOV 187.168 0.000 1.05
BOSIZE 143.097 0.000 1.40 Mean VIF 1.87
BCOMP 134.510 0.000 2.55
BINDP 126.862 0.000 3.33
BOWN 115.533 0.000 1.80
BMEETs 174.405 0.000 1.43
DCOMP 226.546 0.000 2.29
AUDMEETs 198.334 0.000 1.79
AUDIND 142.853 0.000 3.10
Note: We applied the augmented Dickey–Fuller (ADF) test to address the unit root and the variance inflation factor
(VIF) to address the multicollinearity problem. Coef—coefficient.
We also performed correlation analysis, as presented in Table 3. The correlation matrix shows
the relationship among independent variables and also addresses the problem of multicollinearity;
however, a correlation coefficient <0.8 rejects the presence of multicollinearity (Kennedy 2008).
Table 3. Correlation matrix.
PCDs BOSIZE BCOMP BINDP BOWN BMEETs DCOMP AUDMEETs AUDIND BSIZE SOLV RISK IC5 GDPR GOV
PCDs 1.000
BOSIZE −0.191 1.000
BCOMP 0.079 0.084 1.000
BINDP 0.079 −0.202 −0.638 1.000
BOWN −0.495 0.076 0.119 −0.187 1.000
BMEETs 0.368 −0.166 −0.085 0.292 −0.338 1.000
DCOMP −0.248 0.241 −0.223 0.143 0.342 −0.020 1.000
AUDMEETs 0.267 −0.099 0.053 0.375 −0.247 0.353 0.072 1.000
AUDIND −0.035 −0.138 −0.679 0.725 −0.144 0.228 0.298 0.198 1.000
BSIZE −0.057 0.357 −0.004 0.087 0.007 0.139 0.595 0.346 0.169 1.000
SOLV 0.055 −0.077 −0.070 0.210 0.001 −0.024 −0.255 0.004 −0.018 −0.341 1.000
RISK 0.185 −0.351 −0.019 0.022 −0.079 −0.021 −0.202 −0.030 0.075 −0.358 −0.039 1.000
IC5 −0.001 0.013 0.187 −0.168 0.028 −0.054 −0.220 −0.074 −0.275 −0.174 0.066 −0.070 1.000
GDPR 0.007 −0.013 −0.230 0.210 −0.122 −0.012 0.196 0.058 0.347 0.200 −0.052 0.077 −0.219 1.000
GOV 0.045 −0.047 −0.014 0.012 0.019 −0.045 −0.063 0.019 −0.070 −0.076 0.071 −0.003 0.147 −0.121 1.000
5.1. Descriptive Statistics

The results of descriptive statistics are presented in Table 4, showing a total of 251 bank–year
observations. Some variables had lower observations due to missing values; however, out of a total
of 4769 values of 19 variables (251 × 19), our data reported only 60 missing values for six variables
(1.26%). Therefore, orthogonal deviation was used for the unbalanced dynamic panel data to generate
consistent results (Arellano and Bover 1995).
Table 4 shows that the average ROA of banks in Pakistan was 0.5%, the average ROE was 4.8%,
the average NIM was 4.3%, and the average PM was 0.9%. A mean value of 0.378 PCDs indicates that,
on average, 38% banks in Pakistan had PCDs represented on their boards. The value ranged from 0 to
1 as it was a dummy variable indicating the presence (1) or absence (0) of a political director on the
board. Turning to the corporate governance variables, Table 4 shows that the average board size of
Pakistani banks comprised approximately 8–9 (average 8.45) members, which is almost equivalent to
the average board size of Islamic banks (8.88) of 13 countries including 11 Asian countries (Farag et al.
2017) and less than the average board size (10.97) of United States (US) commercial banks (Yulia 2016).
The board size of banks in Pakistan ranged from four to 13 members, where SME bank limited (SMEBL)
had the smallest board size at the end of 2016 and MCB bank limited (MCBL) had the largest board
size. The 0.586 mean value of board composition (BCOMP) indicates that boards of Pakistani banks
constituted on average 58.6% non-executive directors, which shows that bank boards were highly
dominated by outside directors. The BCOMP ranged from 11.1% to 92.3% for different banks during
different years. The board independence (BIND) ratio was 26.9%, which shows that banks in Pakistan,
on average, had at least two independent directors on their board. The average BIND ratio was higher
than the minimum required ratio of 25% by the SBP10 . It ranged from 0% to 87.5%, where 0 indicates
that banks had no representation of independent directors on their boards during some years. The
average frequency of board meetings (BMEETs) was 6.466, which shows that the boards of Pakistani
banks met, on average, six times a year, which is higher than the regulatory requirement of a minimum
of four meetings a year11 . This frequency of board meetings was less than the average of eight board
meetings a year in 13 countries (Farag et al. 2017) and the average of 11.67 board meetings a year for
US commercial banks (Yulia 2016), but higher than the average of 3.47 board meetings for non-banking
financial institutions in Ghana (Isaac 2017). The frequency of BMEETs ranged from two to 17 meetings
a year, where the boards of SME bank limited (SMEBL) and Zarai Tarakiati Bank limited (ZTBL) met
only twice in 2009, and the board of the Bank of Punjab (BOP) met 17 times in 2013. The provincial
government of the country owns the BOP; therefore, the 2013 government elections in the country
could explain the frequent meetings to support the political campaigns of associated politicians.
10 As per the prudential regulations by the SBP, every bank operating in Pakistan must constitute 25% independent directors
(available at www.sbp.org.pk).
11 As per prudential regulations issued by the SECP and SBP, both the boards and audit committees of banks are directed to
meet at least once every quarter (available at http://www.secp.org.gov.pk and http://www.sbp.org.pk).
Table 4. Descriptive statistics. Obs—observed; Min—minimum; Max—maximum.
Obs. Mean SD Min Max Obs. Mean SD Min Max

Profitability Indicators Control Variables
ROA 251 0.005 0.019 −0.092 0.044 BSIZE 251 19.023 1.306 15.483 21.596
ROE 251 0.048 0.248 −2.030 0.334 CAP 251 0.111 0.079 0.002 0.762
NIM 251 0.043 0.019 −0.020 0.100 RISK 247 0.137 0.259 0.000 2.005
PM 251 0.009 0.025 −0.095 0.060 IC5 251 0.540 0.012 0.525 0.562
Corporate Governance GDPR 251 3.709 1.335 1.607 5.741
PCDs 251 0.378 0.486 0 1 GOV 251 0.398 0.491 0 1
BOSIZE 242 8.446 1.662 4 13
BCOMP 236 0.586 0.214 0.111 0.923
BINDP 239 0.269 0.213 0.000 0.875
BOWN 251 0.434 0.497 0 1
BMEETs 236 6.466 2.264 2 17
DCOMP 247 10.807 0.832 8.045 12.840
AUDMEETs 250 5.156 2.855 3 28
AUDIND 251 0.681 0.467 0 1
Turning to the audit committee meetings (AUDMEETs), on average, the frequency of AUDMEETs
was 5.16, which is higher than the minimum regulatory requirement of four meetings a year.
This frequency of AUDMEETs is less than the 7.88 average audit committee meetings of US banks
(Yulia 2016), which shows the strict board control of US banks in the auditing role. The frequency of
AUDMEETs ranged from three to 28 meetings a year, where ZTBL and BOP had the lowest frequency
and the National Bank of Pakistan had the highest frequency of AUDMEETs in 2009, following the
2008 period of sub-prime crises and government elections in the country. Finally, a 0.434 mean value
of board ownership (BOWN) indicates that almost 43% of banks in Pakistan had a representation of
foreign directors on their board. This value ranged from 0 to 1, as it was a dummy variable indicating
the presence (1) or absence (0) of a foreign director on the board.
5.2. Empirical Findings

Our study used a generalized method of moments (GMM) two-step system estimator to examine
the relationship among corporate governance characteristics, political connections of directors, and
bank profitability. Our results are robust to Windmeijer (2005) estimated asymptotic standard errors
and also robust to the four profitability indicators and sets of control variables categorized into
bank-specific, industry-specific, and country-specific variables. The results are reported in Tables 5–7.
The results of the impact of political connections of directors on profitability are reported in Table 5.
Table 6 reports the interaction effect of political connections of directors and their impact on profitability
during government transitions. Table 7 reports the relationship between corporate governance and
bank profitability expressed as return on assets (ROA), return on equity (ROE), net interest margin
(NIM), and profit margin (PM).
In Tables 5–7, the significant coefficients of lagged profitability prove the dynamic nature of
the models. The 1% p-values of the F-statistics indicate the joint significance of our models. The
results report the problem of AR-1 in some models, but the insignificant p-values of AR-2 in all
estimated models indicate the absence of AR-2 and lead to acceptance of the null hypothesis of no serial
correlation. The insignificant p-values of Hansen-J and C-statistics in all models also prove the validity
of the instruments and the exogeneity of instrument subsets utilized to address the endogeneity.
5.2.1. Political Connections of Directors and Bank Profitability

In Table 5, there are four models; each model examines one profitability indicator, i.e., ROA, ROE,
NIM, and PM. We found significant negative coefficients of PCDs in each model, indicating the lower
ROA, ROE, NIM, and PM of banks having PCDs sitting on their board than those who do not. This is
consistent with the findings of Chen and Liu (2013), Jackowicz et al. (2013), and Liang et al. (2013).
It indicates the significant negative impact of PCDs on the board, thus leading our hypothesis being
accepted. This is because of the fact that Pakistani commercial banks with the presence of PCDs tend
to lend more to those firms linked with politicians, resulting in lower interest rates and leveraging in
collateral to support their electoral campaigns (so-called preferential banks loans), which reduces their
profitability (Dinç 2005; Micco et al. 2007). We argued that the loan quality of politically connected
banks in Pakistan is lower because of sustained political connections, resulting in lower profitability.
Moreover, the performance of politically connected banks in Pakistan is also affected by conflicts of
interest between PCDs and non-political directors and even among PCDs associated with different
political parties. PCDs sitting on the boards of Pakistani commercial banks are more likely to pursue
political interests to gain political advantages. Furthermore, our findings are also supported by the
view that a bank’s board having politically connected directors may act in favor of politicians instead
of maximizing shareholder value, thus leading to a deterioration in the performance of Pakistani banks
due to policy loans injected for political purposes (Berger et al. 2009; Hung et al. 2017).
Table 5. Politically connected directors (PCDs) and bank profitability.
ROA ROE NIM PM

0.684 ** 0.405 *** 0.420 ** 0.243 **
DEPt−1
(0.303) (0.108) (0.202) (0.114)
−0.007 ** −0.075 * −0.009 ** −0.010 *
PCDs
(0.004) (0.041) (0.004) (0.005)
−0.017 −0.201 −0.007 −0.024
BOSIZE
(0.030) (0.204) (0.032) (0.027)
0.035 0.779 ** 0.047 ** 0.069 *
BCOMP
(0.033) (0.360) (0.020) (0.041)
−0.004 0.232 0.009 0.019
BINDP
(0.027) (0.304) (0.026) (0.028)
−0.030 * −0.425 ** −0.034 ** −0.048 **
BOWN
(0.017) (0.196) (0.015) (0.023)
−0.010 * −0.148 * −0.009 −0.027 ***
BMEETs
(0.006) (0.081) (0.006) (0.007)
0.010 0.160 ** 0.009 ** 0.009 **
DCOMP
(0.007) (0.066) (0.004) (0.005)
−0.000 −0.302 * −0.013 −0.019
AUDMEETs
(0.011) (0.172) (0.019) (0.020)
0.013 0.209 0.006 0.014
AUDIND
(0.014) (0.258) (0.016) (0.024)
Control Variables
−0.000 0.018 0.002 0.009 ***
BSIZE
(0.004) (0.020) (0.002) (0.003)
0.027 0.387 0.082 ** 0.070 **
SOLV
(0.025) (0.264) (0.040) (0.031)
−0.010 −0.256 *** 0.004 −0.020 *
RISK
(0.012) (0.084) (0.008) (0.010)
−0.330 −1.055 −0.332 0.238
IC5
(0.236) (1.176) (0.276) (0.319)
−0.005 *** −0.040 ** −0.006 * −0.001
GDPR
(0.001) (0.018) (0.003) (0.003)
0.005 0.029 0.011 0.000
GOV
(0.008) (0.043) (0.010) (0.009)
0.126 −0.635 0.102 −0.283 *
Constant
(0.130) (0.919) (0.246) (0.167)
Obs. 210 210 210 210
Banks 26 26 26 26
Instrument 26 26 26 25
F-statistics 24.43 *** 141.17 *** 26.89 *** 140.73 ***
AR-1 (p-value) −1.37 (0.171) −2.83 (0.005) −2.01 (0.045) −2.36 (0.018)
AR-2 (p-value) 1.05 (0.296) −0.19 (0.851) −0.13 (0.893) 0.60 (0.546)
Hansen-J (p-value) 9.60 (0.384) 3.49 (0.942) 7.38 (0.598) 3.37 (0.909)
C-statistics (p-value) 6.13 (0.105) 0.98 (0.805) 1.12 (0.773) 1.34 (0.719)
Notes: This study applied a generalized method of moments (GMM) two-step system estimator with orthogonal
deviation. The Windmeijer (2005) robust standard errors are in parentheses. ***, **, and * represent the significance
level at 1%, 5%, and 10%, respectively. Following Farag et al. (2017) and de Andres and Vallelado (2008), BOSIZE
and BCOMP were treated as endogenous variables and implemented with a lag level (3–5). The significant p-values
of F-statistics indicate the joint significance of the model. AR-1 denotes the results of the Arellano–Bond first-order
autocorrelation, while AR-2 denotes the second-order autocorrelation. The insignificant p-values of AR-2 led to
acceptance of the null hypothesis of no autocorrelation. The insignificant p-values of Hansen-J statistics address the
over-identifying restrictions under the null hypothesis of joint validity of exogenous instruments. The insignificant
p-values of the difference-in-Hansen test (C-statistics) led to acceptance of the null hypothesis of exogeneity of the
full instrument subset.
Table 6. Interaction effect of politically connected directors (PCDs).
ROA ROE NIM PM

0.887 *** 0.622 *** 0.471 *** 0.957 ***
DEPt−1
(0.132) (0.091) (0.161) (0.143)
−0.097 *** −1.281 *** −0.058 *** −0.175 ***
BOSIZE × PCDs
(0.030) (0.485) (0.020) (0.064)
−0.015 0.101 0.058 * 0.005
BCOMP × PCDs
(0.031) (0.438) (0.031) (0.042)
−0.001 0.449 0.045 * 0.030
BINDP × PCDs
(0.015) (0.284) (0.027) (0.039)
−0.012 0.047 0.021 −0.025
BOWN × PCDs
(0.011) (0.376) (0.027) (0.020)
−0.010 * −0.035 −0.002 −0.010
BMEETs × PCDs
(0.005) (0.148) (0.008) (0.010)
0.000 −0.093 −0.006 −0.008
DCOMP × PCDs
(0.004) (0.088) (0.006) (0.010)
−0.004 −0.327 * −0.027 ** −0.026
AUDMEETs × PCDs
(0.013) (0.185) (0.013) (0.041)
−0.015 −0.339 * −0.001 −0.024
AUDIND × PCDs
(0.011) (0.176) (0.016) (0.013)
Control Variables
0.013 *** 0.027 *** 0.009 *** 0.028 ***
BSIZE × PCDs
(0.005) (0.062) (0.003) (0.008)
0.017 −0.047 0.084 *** 0.029
SOLV × PCDs
(0.018) (0.258) (0.028) (0.041)
0.001 −0.151 * −0.002 0.003
RISK × PCDs
(0.007) (0.84) (0.005) (0.014)
−0.135 −2.220 −0.250 *** −0.203
IC5
(0.110) (0.854) (0.064) (0.219)
−0.002 * −0.003 −0.002 *** −0.003
GDPR
(0.001) (0.006) (0.001) (0.002)
−0.009 *** −0.100 ** −0.002 −0.017 **
GOV × PCDs
(0.003) (0.048) (0.004) (0.007)
0.079 1.351 0.164 *** 0.120
Constant
(0.061) (0.463) (0.034) (0.122)
Obs. 211 211 211 211
Banks 26 26 26 26
Instrument 26 26 26 26
F-statistics 170.67 *** 184.66 *** 135.76 *** 369.21 ***
AR-1 (p-value) −1.59 (0.112) −1.82 (0.069) −2.51 (0.012) −1.57 (0.117)
AR-2 (p-value) 0.22 (0.825) −1.57 (0.116) −0.49 (0.625) −0.63 (0.527)
Hansen-J (p-value) 4.42 (0.926) 3.11 (0.979) 4.93 (0.896) 3.82 (0.955)
C-statistics (p-value) 1.27 (0.736) 0.18 (0.980) 1.03 (0.793) 2.17 (0.538)
Notes: The study applied a GMM two-step system estimator with orthogonal deviation. The Windmeijer (2005)
robust standard errors are in parentheses. ***, **, and * represent the significance level at 1%, 5%, and 10%,
respectively. Following Farag et al. (2017) and de Andres and Vallelado (2008), BOSIZE and BCOMP were treated as
endogenous variables and implemented with a lag level (3–5). The significant p-values of F-statistics indicate the
joint significance of the model. AR-1 denotes the results of the Arellano–Bond first-order autocorrelation, while AR-2
denotes the second-order autocorrelation. The insignificant p-values of AR-2 led to acceptance of the null hypothesis
of no autocorrelation. The insignificant p-values of Hansen-J statistics address the over-identifying restrictions under
the null hypothesis of joint validity of exogenous instruments. The insignificant p-values of the difference-in-Hansen
test (C-statistics) led to acceptance of the null hypothesis of exogeneity of the full instrument subset.
Table 7. Corporate governance characteristics and banks profitability.
ROA ROE NIM PM

1 2 1 2 1 2 1 2
0.464 *** 0.958 *** 0.332 *** 0.550 *** 0.724 *** 0.701 *** 0.368 ** 0.791 ***
DEPt−1
(0.153) (0.312) (0.086) (0.137) (0.102) (0.158) (0.141) (0.175)
0.354 *** 0.907 * 6.663 *** 20.903 *** 0.329 *** 0.275 *** 0.453 ** 0.617 ***
BOSIZE
(0.099) (0.456) (1.944) (7.094) (0.057) (0.081) (0.192) (0.208)
−0.080 *** −0.232 ** −1.511 *** −5.232 *** −0.082 *** −0.073 *** −0.099 ** −0.166 ***
BOSIZE-SQ
(0.025) (0.112) (0.480) (1.759) (0.014) (0.020) (0.047) (0.055)
−0.005 0.009 0.586 ** 1.277 *** −0.001 0.014 0.069 ** 0.002
BCOMP
(0.020) (0.016) (0.229) (0.456) (0.013) (0.016) (0.033) (0.019)
−0.001 −0.009 0.195 −0.207 0.027 ** 0.001 0.024 0.029 **
BINDP
(0.011) (0.013) (0.346) (0.193) (0.011) (0.012) (0.023) (0.014)
−0.019 *** −0.011 * −0.165 ** −0.465 * −0.006 *** −0.001 −0.021 * −0.022 **
BOWN
(0.007) (0.006) (0.079) (0.260) (0.002) (0.004) (0.011) (0.011)
−0.012 *** −0.028 *** −0.169 ** −0.352 *** −0.005 ** 0.011 −0.022 ** −0.022 **
BMEETs
(0.003) (0.009) (0.069) (0.123) (0.003) (0.014) (0.008) (0.010)
0.007 *** 0.010 * 0.087 *** 0.001 0.007 *** 0.004 ** 0.008 *** −0.007
DCOMP
(0.002) (0.006) (0.023) (0.145) (0.003) (0.002) (0.003) (0.013)
0.005 0.007 0.012 −0.223 * −0.002 −0.008 0.009 −0.040 **
AUDMEETs
(0.004) (0.015) (0.071) (0.132) (0.005) (0.007) (0.015) (0.015)
−0.009 −0.001 0.074 0.452 −0.023 *** 0.002 0.008 −0.017 ***
AUDIND
(0.007) (0.005) (0.116) (0.243) (0.003) (0.006) (0.007) (0.006)
Control Variables
−0.002 0.124 ** 0.001 0.014 **
BSIZE
(0.004) (0.059) (0.002) (0.007)
−0.004 0.837 0.054 *** 0.054 *
SOLV
(0.019) (0.746) (0.016) (0.030)
0.020 0.181 −0.002 0.009
RISK
(0.023) (0.239) (0.014) (0.014)
−0.288 ** −3.680 ** −0.312 * 0.308
IC5
(0.121) (1.634) (0.176) (0.251)
−0.002 −0.027 −0.003 ** 0.001
GDPR
(0.001) (0.020) (0.001) (0.002)
0.004 0.037 0.002 −0.013 ***
GOV
(0.007) (0.073) (0.002) (0.004)
−0.425 *** −0.722 * −8.262 ** −20.856 ** −0.369 *** −0.142 −0.613 *** −0.813 ***
Constant
(0.102) (0.426) (1.959) (7.661) (0.084) (0.100) (0.218) (0.263)
Table 7. Cont.
ROA ROE NIM PM

1 2 1 2 1 2 1 2
0.464 *** 0.958 *** 0.332 *** 0.550 *** 0.724 *** 0.701 *** 0.368 ** 0.791 ***
DEPt−1
(0.153) (0.312) (0.086) (0.137) (0.102) (0.158) (0.141) (0.175)
Obs. 210 210 210 210 210 210 211 210
Banks 26 26 26 26 26 26 26 26
Instrument 26 26 26 26 26 26 26 26
F-statistics 16.98 *** 29.91 *** 17.66 *** 152.28 *** 51.98 *** 59.66 *** 20.31 *** 195.45 ***
AR-1 (p-value) −1.62 (0.105) −1.70 (0.089) −2.50 (0.012) −2.39 (0.017) −3.25 (0.001) −2.26 (0.024) −1.95 (0.051) −2.08 (0.037)
AR-2 (p-value) 0.81 (0.420) 0.75 (0.452) −0.91 (0.363) −0.38 (0.707) −1.15 (0.251) 0.05 (0.961) −0.12 (0.906) 0.52 (0.605)
Hansen-J (p-value) 7.81 (0.931) 3.33 (0.950) 8.85 (0.885) 2.81 (0.971) 12.66 (0.628) 4.55 (0.872) 14.58 (0.482) 4.64 (0.865)
C-statistics (p-value) 0.26 (0.967) 1.26 (0.739) 1.53 (0.674) 0.85 (0.838) 4.21 (0.240) 0.56 (0.905) 0.98 (0.806) 0.02 (0.999)
Notes: The study applied a GMM two-step system estimator with orthogonal deviation. The Windmeijer (2005) robust standard errors are in parentheses. ***, **, and * represent the
significance level at 1%, 5%, and 10%, respectively. Following Farag et al. (2017) and de Andres and Vallelado (2008), BOSIZE and BCOMP were treated as endogenous variables and
implemented with a lag level (3–5). The significant p-values of F-statistics indicate the joint significance of the model. AR-1 denotes the results of the Arellano–Bond first-order autocorrelation,
while AR-2 denotes the second-order autocorrelation. The insignificant p-values of AR-2 led to acceptance of the null hypothesis of no autocorrelation. The insignificant p-values of
Hansen-J statistics address the over-identifying restrictions under the null hypothesis of joint validity of exogenous instruments. The insignificant p-values of the difference-in-Hansen test
(C-statistics) led to acceptance of the null hypothesis of exogeneity of the full instrument subset.
5.2.2. Interaction Effect of Politically Connected Directors

Table 6 also presents four models; each model examines one profitability indicator, i.e., ROA,
ROE, NIM, and PM. As per the findings of Table 6, the significant negative coefficients of interaction
between board size and PCDs (BSIZE × PCDs) indicate the negative impact of increasing the board
size on the ROA, ROE, NIM, and PM of banks having PCDs sitting on their board. This can be because
of the fact that increases in the board size of politically connected banks in Pakistan may increase
conflicts among PCDs and non-political directors or among PCDs of different political parties, which
would slow the strategic decisions, resulting in lower profitability of Pakistani banks. However, we
did not find any significant impact of PCDs on the other variables used in this study. The significant
relationships between profitability and BCOMP, BIND, BMEETs, AUDMEETs, AUDIND, BSIZE, SOLV,
and RISK held even after interacting them with PCDs.
The study reported interesting results when we interacted politically connected directors with
government transitions (GOV × PCDs). We found significant and negative coefficients of GOV ×
PCDs, suggesting the lower ROA, ROE, and PM, during government transitions, of banks having
PCDs sitting on their board. These findings led to acceptance of our hypothesis and support the
theory that politically connected banks support political benefits, especially during election years.
Politicians in Pakistan use politically connected banks through directors to support their electoral
campaigns, thus resulting in lower profitability. This is in contrast with Jackowicz et al. (2013), who
found a lower profitability of state-owned banks during election years resulting from charging lower
interest rates. Previously, in the context of Pakistan, Khwaja and Mian (2005) specified that state-owned
banks lend more during government elections to politically connected firms, which leads to a higher
rate of default and, thus, lower profitability. Recently, Yao et al. (2018) also argued that politically
connected banks in Pakistan inject a higher amount of lending to the government projects, departments,
and politically connected firms because of political connections and found the lower profitability of
28 Pakistani commercial banks during government transitions. Haris et al. (2019a) measured the
performance of Pakistani government banks during the period of 2010–2016 and reported a negative
profit before tax, as well as a lower ROA, ROE, and net operating margin during the election year
(2013). Their study also reported a higher loan-to-deposit ratio and higher loan loss provisioning
during election years, indicating that higher lending by government banks causes higher loan losses
during government elections. They argued that the overall industry variations and negative growth
in the Pakistani banking industry during the year 2013 were because of government banks, which
are highly influenced by government policies and political instability. The years 2008 and 2013 were
turbulent years for the Pakistani banking industry with respect to political matters, because these
were the years of elections and government change. Moreover, in order to support the findings,
we examined the lending of politically connected banks in Pakistan and found a major increase in
advances extended to the government segment. In the first period of government transition, the total
amount of advances injected to the government segment increased to 323 billion rupees (2009) from
127 billion rupees (2007), and, in the second period of transition, the amount increased to 807 billion
rupees (2014) from 589 billion rupees (2012). This clearly indicates the injection of a higher amount of
lending to government segments during electoral cycles. This lending signals the poor loan quality
of Pakistani commercial banks, associated with easy terms and lower interest rates due to political
influence, resulting in a higher default rate and a subsequent reduction in profitability, especially
during government transitions. Hence, our results confirm the negative political influence on the
stability of the Pakistani banking industry during government transitions because of the presence
of PCDs.
5.2.3. Board Findings

The results of corporate governance are reported in Table 7. Table 7 presents four models, where
each model examines the following two equations:
J
X
j
Pit = α0 + δPit−1 + β j CGit + ϕk TDt + vit + µit , (3)
j=1
J K
j
Pit = α0 + δPit−1 + β j CGit + βk BSVitk + βl ISVt + βm CSVt + βn GOVt + ϕo TDt
P P
j=1 k =1 (4)
+vit + µit .
Equation (3) measures the impact of corporate governance on profitability, while Equation (4)
measures the joint impact of corporate governance and control variables on each profitability indicator,
i.e., ROA, ROE, NIM, and PM.
Turning to the corporate governance results, in Table 7, the coefficients of board size (BOSIZE)
were significant and positive, indicating that there is a positive impact of an increase in board size on the
ROA, ROE, NIM, and PM of Pakistani banks. This is consistent with Farag et al. (2017), Nawaz (2017),
and Adams and Mehran (2005), as their studies reported that an increase in board size is positively
related to profitability. However, this relationship is positive up to a certain point because of decreasing
marginal utility. Therefore, the coefficients of BOSIZE-SQ were significant and negative, indicating an
inverted U-shaped relationship between board size and profitability, i.e., the ROA, ROE, NIM, and PM
of Pakistani banks. This suggests that there is a certain point at which adding a new director on the
board diminishes bank profitability. After regressing the control variables, this inverted U-shaped
relationship held.
An increase in board size positively influences profitability because a large board carries a wide
range of expertise for decision-making, helping directors effectively monitor management activities
(Isaac 2017), deal with complexity (Adams and Mehran 2003, 2012; Yermack 1996), and limit the CEO’s
discretionary power, thus raising profitability. Considering the idiosyncratic nature of the banking
industry, shareholders require a larger board to deal with the complexity of banking operations and
regulations, alleviating governance problems; thus, a larger board enhances value. However, an increase
in board size has a certain limit, after which the further addition of a new director to a bank’s board
destroys the sustained profitability. The ideal board limit in our case is 8–9 (8.45 on average) members.
Previously, Jensen (1993) and Lipton and Lorsch (1992) also suggested that a board size beyond 7–8
members functions ineffectively. This is because of the fact that the addition of too many directors on
the board increases problems of coordination and communication (Janis 1983; Pathan and Faff 2013;
Pathan et al. 2007), leads to a trade-off between monitoring/advising benefits and control/coordination
problems (de Andres and Vallelado 2008), prolongs the decision process (Yermack 1996), and leads
to the costs outweighing the benefits (Coles et al. 2008), thus lowering performance. The inverted
U-shaped relationship is consistent with the findings of 69 commercial banks in six countries including
Canada, France, Italy, Spain, United Kingdom (UK), and US (de Andres and Vallelado 2008), 236
commercial banks in US (Grove et al. 2011), financial institutions in US (Yulia 2016), and 246 companies
listed in the Hong Kong Stock Exchange (Yeung 2018).
Our study found that board composition (BCOMP) does have a significant and positive
impact on ROE and PM, but does not affect the ROA and NIM of Pakistani banks (see Table 7).
However, after regressing the control variables, the BCOMP only affected ROE positively. Previously,
Tanna et al. (2011), Pathan et al. (2007), and de Andres and Vallelado (2008) found the same positive
impact of BCOMP on profitability. This suggests that the addition of NEDs to the board helps
minimize conflicts of interest through an advisory and monitoring role (de Andres and Vallelado 2008;
Salim et al. 2016) and, thus, increases the value for shareholders. The agency theory also predicts that
the addition of NEDs minimizes conflicts and enhances performance (Jensen and Meckling 1976).
In Pakistan, the board structure comprises non-executive, independent, and executive directors.
Therefore, we added the ratio of independent directors to total board members as a proxy of board
independence (BIND). We found that board independence does have a significant and positive impact
on NIM, but does not affect the ROA and ROE of Pakistani banks. However, after regressing the
control variables, BIND was found to affect the PM positively (see Table 7). Although the board
structure of Pakistani banks is highly dominated by NEDs, our study suggests for policy-makers, in
the context of Pakistan, that the advisory and monitoring role of INDs is as important as the role of
NEDs. Previously, Yeung (2018), Liang et al. (2013), Esman and Kebede (2013), Cornett et al. (2009),
and Pathan et al. (2007) also found a positive impact of board independence on performance.
In Table 7, the coefficients of BOWN were significant and negative, indicating the lower ROA,
ROE, NIM, and PM of Pakistani banks having foreign directors sitting on their boards than those who
do not. However, after regressing the control variables, our results of BOWN held. This indicates the
negative association between the presence of foreign directors on the board and the profitability of
Pakistani banks. Although foreign directors bring more diversity of skills and enhance performance,
our study does not support the agency theory. Previously, Masulis et al. (2012), Liang et al. (2013),
and García-Meca et al. (2015) also found the same negative association between performance and the
presence of foreign directors on the board. This can be because of the fact that foreign directors may
not be able to better control the management due to a lack of adequate information on management
methods, standards, laws, and regulations of the local country, which may lead to misunderstandings
and conflicts among directors that slow the strategic decision process and, thus, lower the performance.
The foreign directors may not be well informed about the current performance of banks because of
their absence from board meetings due to geographical distance and security issues, which inhibits
the board’s effectiveness in monitoring and controlling the bank’s performance and enhancing the
information cost (Knyazeva et al. 2011; Masulis et al. 2012). Since, after 11 September 2001, Pakistan
was affected by several terrorist attacks; thus, the security issues in the country might be the reason for
the absence of foreign directors from board meetings, which delays decision processes and creates a
communication gap, thus lowering performance.
The results reported in Table 7 show the significant and negative coefficients of board meetings
(BMEETs), indicating the negative relationship between BMEETs and the profitability of Pakistani
banks. This suggests that an increase in board meetings significantly reduces the ROA, ROE, NIM,
and PM. However, even after regressing the control variables, the relationship between BMEETs and
profitability held (see Table 7). This is consistent with the findings of Vafeas (1999), Farag et al. (2017),
and Isaac (2017). This also indicates that more frequent board meetings lead to a reduction in the
profitability of Pakistani banks. The board structure of Pakistani banks is dominated by outside
directors, including foreign directors. Thus, with the presence of too many outside directors, as a result
of limited time and absence, frequent meetings are not useful for the exchange of information among
directors so as to control performance (Bryne 1996; Jensen 1993). Recently, Masulis et al. (2012) also
suggested that a lower attendance record due to foreign directors reduces performance. Furthermore,
we also observed a sudden increase in board meetings of state-owned banks in Pakistan during the
periods of government elections (2008 and 2013); thus, in this scenario, we may suggest that increased
board meetings are arranged to discuss policy loans to support the election campaigns of associated
politicians, which later lead to worse performance. Moreover, we also observed a drastic increase
in board meetings of all sample banks during the crisis period (2008), leading to the argument that
frequent board meetings are set in response to undesirable outcomes. This is the indication of a
reactive board, whereby such meetings translate into a negative relationship with performance. This
is supported by the view of Jensen (1993), who stated that board meetings are set to confer existing
problems rather than as a proactive approach to improve corporate governance.
The monitoring role and efforts exerted by directors to enhance performance require higher
compensation (Brick et al. 2006). Our study affirmed the positive link between compensation paid
to directors and the profitability of Pakistani banks. The results reported in Table 7 show that the
coefficients of board compensation (DCOMP) were significant and positive, indicating a positive
impact of an increase in board compensation on the ROA, ROE, NIM, and PM of Pakistani banks.
After regressing the control variables, the positive impact of DCOMP held. This is consistent with the
findings of Peng and Mansor (2015), Doucouliagos et al. (2007), Brian et al. (1996), Jaafar et al. (2011),
and Ghosh (2006), as well as the agency theory (Fama 1980). Our study further suggests that the
compensation paid to directors in Pakistan is consistent with past bank performance; therefore, it has a
positive impact on profitability12 . This also shows the higher satisfaction level of directors of Pakistani
banks with their compensation package, which motivates them to sustain the desired profitability.
5.2.4. Audit Committee Findings

Turning to the audit committee, we did not find any significant impact of audit committee meetings
(AUDMEETs) on profitability. This can be supported by the view of Contessotto et al. (2014), who
suggested that audit committees only reduce audit risk through enhancing the integrity of financial
reporting, leading to organizations complying with statutory requirements to avoid penalties and
sanctions. Thus, in this context, such committees have no contribution to enhancing performance
(Beasley 1996). However, after regressing the control variable, we found a significant and negative
impact of AUTMEETs on the NIM and PM of Pakistani banks (see Table 7). This suggests that the
impact of audit meetings is not directly linked to profitability; rather, the impact of audit meetings is
driven by other factors controlled in the study.
Significant and negative coefficients of audit committee independence (AUDIND) were reported
in Table 7, suggesting the lower NIM and PM of the Pakistani banks having at least one independent
director present in their audit committees than those who do not. This led to a rejection of our
hypothesis. However, the significant negative association between audit committee independence
and profitability indicates that Pakistani banks with independent directors on their audit committees
perform poorer than those who do not. This is in contrast with the findings of Isaac (2017) and
Kyereboah-Coleman (2008), as well as the stewardship theory, which suggests that the majority of
independent directors on committees are less likely to perform better because insider directors possess
more knowledge related to banks and the industry due to their experience and technical expertise
(Mamun et al. 2013; Salisu and Mohd 2015).
5.3. Additional Robustness Check

The results of our study were robust to the four profitability indicators, i.e., ROA, ROE, NIM,
and PM, as well as a comprehensive set of control variables and Windmeijer (2005) robust standard
errors. However, we performed several additional robustness checks for the study. The results of these
robust tests are not reported; however, the results are available upon request. Firstly, we changed the
definitions of all dependent variables by replacing the denominator. We calculated the ROA as the profit
after tax to total assets instead of average assets, the ROE as the profit after tax to total equity instead of
average equity, the NIM as the net interest income to total earning assets, and the PM as the profit before
tax to total assets instead of average assets. We re-estimated Equations (1), (3), and (4); our main results
remain unchanged. Secondly, we re-estimated Equation (1) by interacting PCDs with government
transitions (GOV). We still found a significantly lower profitability as measured by the ROA, NIM,
and PM during government transitions for banks with PCDs on their board than those without.
12 To determine the consistency of the relationship between director compensation and past bank performance, we followed
Peng and Mansor (2015) and applied the Granger causality test. We found a significant positive impact of lagged bank
profitability, when measured by ROA, ROE, and PM, on director compensation and an insignificant positive impact of
lagged director compensation on profitability, indicating that, in Pakistan, director compensation is explained by past bank
performance. Our findings contradict Bugeja et al. (2016) and Peng and Mansor (2015), who both found an inconsistent
relationship between past performance and director compensation. The results of the Granger causality are not reported,
but are available upon request.
Thus, our main results still held. Thirdly, following the previous literature (Jackowicz et al. 2013;
Liang et al. 2013; Micco et al. 2007), we replaced the periods of government transition with periods of
government elections, and assigned a value of 1 to election periods (2008 and 2013), and 0 otherwise.
We interacted the government elections with PCDs in Equation (2) and found a significantly lower
profitability as measured by the ROA and PM during election periods for Pakistani banks with PCDs
on their board than those without. Fourthly, consistent with de Andres and Vallelado (2008), we
examined the nonlinear relationship between board composition and profitability, by including the
quadratic term of BCOMP, and we found an inverted U-shaped relationship between BCOMP and
the profitability of Pakistani banks. This can be because the Pakistani banking industry is already
dominated by NEDs; consequently, a further increase in NEDs destroys the profitability. However, the
signs of other corporate governance characteristics remained unchanged. Fifthly, we also examined
the nonlinear relationship between BIND and profitability. We added a quadratic term of BIND and
did not find any nonlinear relationship between BIND and profitability, which is consistent with
Liang et al. (2013). However, the signs of the significant coefficients of the main variables remained
unchanged. Lastly, bank size and performance are likely to be endogenously determined, e.g., assets
can be higher for the most profitable banks due to retaining more reserves, which leads to a future
increase in assets and profitability. Therefore, in order to offer a more robust and corrected inference,
we re-estimated Equations (1) and (4) and treated bank size (BSIZE) as an endogenous variable with a
lag length of 3–5. The magnitude of the significant coefficients changed; however; all maintained their
relationship, consistent with prior findings. Thus, our results still held.
6. Conclusions
This study addressed the two important ongoing issues: (1) how the performance of Pakistani
banks is affected by the presence of politically connected directors on the board, and (2) how the political
connections of directors influence bank profitability during government transitions. Furthermore, in
the context of the ongoing debate on the importance of corporate governance, this paper adds value to
the existing literature by examining the role of corporate governance in the improved performance of
Pakistani banks. A two-step GMM system estimator was applied to the unbalanced panel data of 26
Pakistani banks over the period of 2007–2016.
During recent years, the political connections of directors drew the attention of some researchers.
Here, we confirm that political connections harm the sustainable performance of banks in Pakistan.
Our study contributes to the literature by reporting the lower profitability of banks in Pakistan having
PCDs sitting on their board than those who do not. It affirms that the presence of PCDs on the
board has a negative impact on the profitability of Pakistani commercial banks, suggesting the easy
lending to politically connected firms at lower interest rates and conflicts of interest between politically
connected and non-political directors. Previously, Chen and Liu (2013), Jackowicz et al. (2013), and
Liang et al. (2013) also found a negative relationship between bank performance and the political
connections of directors. Our study also contributes to the literature by extending new evidence
of lower profitability during government transitions for Pakistani banks with PCDs sitting on their
board than those without. We affirm that PCDs sitting on the boards of Pakistani commercial banks
work against the interest of shareholders by favoring politicians, especially during government
transitions, supporting their electoral campaigns at the cost of the banks. This is consistent with
Jackowicz et al. (2013). Previously, Yao et al. (2018) also found a lower profitability of banks in Pakistan
during government transitions.
Consistent with de Andres and Vallelado (2008) and Yeung (2018), among others, this study
confirms the inverted U-shaped relationship between board size and the profitability of Pakistani
commercial banks. This indicates that the addition of new directors to the board, up to a certain limit,
benefits the profitability. In our case, this limit was found to be 8–9 board members, after which further
addition negates the monitoring and advising benefits due to control and coordination problems.
Furthermore, our study, on the one hand, reports a positive relationship among board composition,
board independence, director compensation, and profitability. On the other hand, it reports a negative
relationship among board meetings, audit committee independence, and the profitability of Pakistani
banks. Our study, by reporting the lower profitability of Pakistani banks with foreign directors sitting
on their boards than those without, suggests that the presence of foreign directors on the board
deteriorates the profitability of Pakistani banks.
6.1. Implications of the Study

The results of this study are useful for academics, regulators, investors, policy-makers, and other
stakeholders of the banking industry. The findings of the study have interesting policy implications.
Based on the analysis, we suggest for policy-makers and regulators to monitor and oversee the
decisions/strategies of PCDs in order to strengthen the business and achieve profitable growth.
Furthermore, we also suggest strict monitoring to supervise the lending activities during electoral
cycles in order to obstruct preferential loans at lower interest with easy terms, which later turn into
nonperforming loans, resulting in profitability deterioration. The study suggests and recommends that
a board size beyond 8–9 members harms sustainable profitability. Consequently, we recommend that
the ideal board size should consist of 8–9 members in order to avoid conflicts and ineffective control
of directors. Our study further suggests that both independent and non-executive directors have
significant importance in enhancing profitability, especially in the case of Pakistan. Based on this study,
we encourage the appointment of more INDs and NEDs to achieve desired profitability. Moreover, we
found that the presence of foreign directors is not helpful for Pakistani banks, translating to a negative
impact on profitability. Thus, in order to strengthen profitability, we discourage the appointment of
more foreign directors on the board. Lastly, profitability increases following higher compensation
paid to directors. We recommend investing more in human capital to enhance the monitoring and
controlling efforts of directors in order to increase performance.
6.2. Limitations and Future Research Directions

Although this study was based on a large fraction of banks operating in Pakistan, considering the
important corporate governance characteristics and political connections of the directors, it had certain
limitations. Our study was based on the Pakistani banking industry; however, these findings may
be applicable to other developing economies that are politically dominant with similar institutional
characteristics and that follow the same structure of corporate governance. Future studies may
examine other corporate governance characteristics such as disclosures, the role of different committees,
committee size, attendance of the board and committee members, executive compensation, etc. to
examine their impact on profitability. Moreover, the same set of variables used in this study can be
replicated in future studies to examine their impact on other performance indicators such as risk,
capitalization, and market returns. Future studies may shed light on the correlation between corporate
governance in banks in Pakistan and other countries. Furthermore, other future research may examine
the effect of the existence of politically connected directors on financial reporting and disclosure
activities, which are important aspects of sound corporate governance practices.
Author Contributions: M.H. conceptualized the paper and carried out literature, data curation, empirical analysis,
and complied the original and revised draft. H.Y. supervised and improved the draft. G.T., H.M.J., and Q.U.A.
helped with data curation, writing and editing.
Funding: This work was supported by the National Natural Science Foundation of China no. 71701082
and 71271103.
Conflicts of Interest: The authors declare no conflict of interest.
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Keywords: Pakistan; banks; profitability; corporate governance; political connections

JEL Classification: G21; G28; G34

Int. J. Financial Stud. 2019, 7, 62; doi:10.3390/ijfs7040062 www.mdpi.com/journal/ijfs

2. Review of Pakistani Banking System

4. Data and Methodology

4.1. Sample and Data

4.2. Variables Description

4.2.1. Profitability Indicators

Table 1. List of variables.

Variables Notation Description Expected Results

4.2.2. Explanatory Variable

4.3. Econometric Methodology

4.4. Econometric Specification

Table 2. Unit root and multicollinearity results.

Coef p-Value VIF Coef p-Value VIF

Table 3. Correlation matrix.

5.1. Descriptive Statistics

Table 4. Descriptive statistics. Obs—observed; Min—minimum; Max—maximum.

Obs. Mean SD Min Max Obs. Mean SD Min Max

5.2. Empirical Findings

5.2.1. Political Connections of Directors and Bank Profitability

Table 5. Politically connected directors (PCDs) and bank profitability.

ROA ROE NIM PM

Table 6. Interaction effect of politically connected directors (PCDs).

ROA ROE NIM PM

Table 7. Corporate governance characteristics and banks profitability.

ROA ROE NIM PM

ROA ROE NIM PM

5.2.2. Interaction Effect of Politically Connected Directors

5.2.3. Board Findings

5.2.4. Audit Committee Findings

5.3. Additional Robustness Check

6.1. Implications of the Study

6.2. Limitations and Future Research Directions

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