Ownership Structure and Leverage Deviation: Evidence from Pakistan

Introduction
The global financial landscape is a complex web of interactions, influenced by various
components that shape the strategic decisions of companies and the economic dynamics of
nations. Among these factors, deviation in leverage and ownership structure play essential role in
driving financial strategies and risk management practices of businesses worldwide. Over the
years, corporate governance has gained increasing attention because it plays a crucial role in
safeguarding organizations from crises. While much research has focused on developed
countries, there's been limited exploration in emerging economies like Pakistan, which also
required research attention (Magdi and Nadareh, 2002; V. Bairathi, 2009). According to V.
Bairathi (2009), corporate governance encompasses more than just overseeing a company; it
involves striving to achieve strategic objectives.

Corporate governance is a prominent and distinctive area of research which places a

significant emphasis in the realm of finance. Corporate governance pertains to the regulations
and methodologies employed to guide and oversee a firm's management, with the overarching
goal of optimizing returns for its shareholders while duly considering the interests of various
stakeholders (Berle & Means, 1932; Shleifer & Vishny, 1997). Within both business and
academic discourse, there is an extensive discussion regarding the identification of mechanism
related to corporate governance that enhance processes for making decisions and contribute to
the maximization of a company’s value. Among these mechanisms, ownership structure stands
out as a pivotal element influencing a company's efficiency and performance.

Ownership structure also mitigating conflicts of interest in firms, which encompasses an

internal corporate governance mechanism that serves as a crucial function in between managers
and shareholders. Ownership structure pertains to how a company's shares are distributed among
its shareholders. According to Ezeoha and Okafor in 2010, the composition of ownership
structure encompasses several components, including institutional ownership (held by block
holders), government ownership (owned by state), managerial ownership (owned by insiders),
and ownership held by foreigners. Intertwined with governance mechanisms, ownership structure
plays a pivotal role in shaping the preferences of capital structure in companies. According to
Laeven & Levine (2009), decisions regarding capital structure is an important part of financial
strategy, and the practice of these decisions are significantly influenced by corporate governance,
as they determine the allocation of control and decision-making authority. Understanding how
governance practices impact capital structure choices is essential for assessing financial risk and
performance. Leverage, as a critical financial tool, influences a profitability, firm's risk profile,
and valuation (Modigliani & Miller, 1958). Deviations from an optimal leverage ratio can have
significant implications for financial stability.

Turning our attention to the Pakistani context, the literature on ownership and leverage is
relatively sparse but rapidly growing. Pakistan, like many emerging economies, has witnessed a
transition from state-controlled enterprises to a mixed ownership landscape. Numerous scholarly
investigations have delved into the intricacies of corporate governance within the context of
Pakistan. Ownership structure in Pakistan is shaped by unique factors that have been explored in
different studies like Khan et al., in 2017 and Qadir et al., in 2020. As in the Pakistani equity
market, the capital structure of firms is also influenced by corporate governance and ownership
structure decisions (Ali Shah et al., 2009). The empirical findings revealed an inverse correlation
among leverage ratio and the managerial ownership. In Pakistani context, where firms operate in
a unique blend of ownership structures, investigating the factors driving leverage deviations is
essential for understanding risk management practices. However, the link between these
ownership patterns and leverage decisions remains an open question. Ownership structure serves
as a vital component of corporate governance, focusing on enhancing productivity and
safeguarding shareholders' interests to achieve organizational objectives. This research holds
significance for investors seeking insights into the factors influencing ownership structure and is
equally valuable for organizations aiming to mitigate agency-related issues. The primary
objectives of this research revolve around uncovering potential relationships between ownership
structure and leverage deviation.

Purpose of study
Ownership structure pertains to how ownership shares are distributed among firm's
shareholders; therefore, it is essential in providing the ability and incentives to oversee
management effectively, thereby minimizing agency conflicts. Ownership structure, in turn, has
implications for various decision-making processes within a company, including decisions
related to leverage. In essence, this implies that leverage deviation and ownership structure have
a connection in a particular way. Therefore, the key objective of our research is to determine how
different types of ownership structures affect leverage deviation.

Problem Statement and Gap Area

In organizations, agency problems between shareholders and management develop when
there is an ineffective corporate governance. The central focus of ownership structure revolves
around addressing these agency problems, as highlighted by Asadi and Pahlevan in 2016. A
fundamental concept in governance and corporate finance is agency theory, and the research that
examines the connection between ownership structure and financial decisions like leverage can
provide valuable insights in this context. Firstly; there may be conflict of interest arises in
organizations due to various stakeholders which includes managers and shareholders, according
to agency theory. It suggests that ownership by management has a potential to bring shareholders
and managers interests into alignment. This research paper will investigate how managerial
ownership influences leverage deviation in Pakistan, and can empirically validate or challenge
this aspect of agency theory. The theory’s prediction would be supported if the findings show a
correlation between leverage and managerial ownership.

Secondly; agency theory also acknowledges the influence of government and institutional
ownership on managerial behavior. This paper also investigates these ownership structures and
their impact on leverage can shed light on how institutional investors and government ownership
may act as monitoring mechanisms or exacerbate agency conflicts. Overall, this research paper
has the potential to provide empirical support for agency theory by investigating how different
ownership structures affect leverage deviation in Pakistan. It can contribute to the border
understanding of corporate governance and financial decision-making as well as help to validate
or refine agency theory’s prediction in the specific context of an emerging market. This study
aims to bridge existing gaps in our understanding through analyzing the complex interactions
between leverage deviation and ownership structure within the Pakistani corporate sector.
Through empirical analysis, we endeavor/aim to uncover patterns, trends, and anomalies that
shed light on how ownership structures and governance mechanisms influence firms' capital
structure decisions and subsequent leverage outcomes.
Research Objectives
This study’s main objective is to investigate the impact of different types of ownership
structure on leverage deviation across the Pakistani corporate landscape. The sub-objectives of
this research paper are:

a. To examine the impact of managerial ownership on leverage deviation in Pakistan.

b. To examine the impact of institutional ownership on leverage deviation in Pakistan.
c. To examine the impact of state ownership on leverage deviation in Pakistan.
d. To examine the impact of foreign ownership on leverage deviation in Pakistan.

Research Questions
a. How does managerial ownership influence leverage deviation in Pakistani firms?
b. How does institutional ownership influence leverage deviation in Pakistani firms?
c. How does state ownership influence leverage deviation in Pakistani firms?
d. How does foreign ownership influence leverage deviation in Pakistani firms?

Significance of Study
This study aimed to assess how ownership structure influence leverage deviation. Ownership
structure focuses on evaluating the effectiveness of a company’s operations to ensure the welfare
of shareholders and the attainment of organizational objectives. Firstly, this research makes a
positive contribution in the academic field of governance and corporate finance in Pakistani
context, by providing information and analysis within the correlation between leverage deviation
and ownership structure. This expands the academic understanding of the subject matter,
potentially leading to the refinement or expansion of existing theories. However, this study
provides useful information to corporations that are operating in Pakistan. Understanding how
different ownership structures influence leverage can help firms make informed decisions
regarding their capital structure, potentially leading to improved financial performance and risk
management. Secondly, the outcomes of this study have the potential to assist investors in
making informed investment decisions. However, Investors, both domestic and foreign, can
benefit from the study's findings. It provides insights into how ownership structures may impact
investment decisions and risk assessments, aiding investors in making informed choices.
Additionally, the findings of this study may provide guidance for enhancing corporate
governance practices in Pakistani firms. It can make recommendations for how to balance the
desires of managers and shareholders, promoting better governance and preventing conflicts
between agencies by examining how financial decisions are affected by ownership structures.

LITERATURE REVIEW
Corporate Governance of Firms
The rules and regulations that govern interactions between businesses executives, investors
and other stakeholders such as creditors and employees contribute to effective corporate
governance. In 2004 as stated by OECD, by enhancing efficiency in the economy, maintaining
the reliability of financial markets, and strengthening market trust, corporate governance plays a
crucial role in promoting financial stability and growth. According to Cadbury (1992), within
organizations effective leadership and accountability are based on good corporate governance. It
includes all methods and procedures used to direct and manage businesses. It is extremely
important to have strong corporate governance policies in emerging economies like Pakistan.
According to Rehman et al. (2020), strong corporate governance serves an important role in
organizing the interests of external stakeholders, shareholders and managers by providing a wide
range of ownership structures that are common in the country.

According to a report by the Co-operation and Development in 2004, the world witnessed a
series of major scandals involving companies like WorldCom and Enron. These incidents drew
significant attention to corporate governance concerns. The subsequent collapses of Enron and
MCI due to fraudulent accounting practices acted as a catalyst for new regulatory measures in
the U.S., leading to the Sarbanes-Oxley Act of 2002. According to B. Nanette et al., (2003), in
the past seven decades, this act was considered one of the most comprehensive governance
reforms. In Pakistan, the regulation of corporate governance in the financial sector falls under the
purview of the State Bank of Pakistan (SBP), while the securities and exchange commission of
Pakistan oversees the non-financial sector (M. A. Naseem et al., 2017). In comparison to recent
years, SBP has improved its monitoring ability in financial sector and provides guidelines.
According to a survey conducted by the OECD in 2014, Pakistan updated its corporate
governance code and principles. Many experts have argued that controlling a company’s
operations requires careful consideration of corporate governance (B. Mashayekhi and M. S.
Bazazb, 2008, Q. R. Yasser et al., 2011).
 Prior research has indicated that effective corporate governance is a fundamental key to
enhance the value of businesses. Good corporate governance constitutes a systematic approach to
business management with the primary goal of enhancing long-term shareholder value as
keeping the desires of stakeholders in mind, as observed by Sugosha and Artini (2020). As a
result, adopting good corporate governance in organizations can enhance the business
environment and strengthen stakeholder confidence, particularly among investors. Particularly
the ownership structure and composition of board have become important factors in determining
the value of a company within the context of corporate governance mechanisms. As stated by
Fama and Jensen in 1983, the task of boards directors is to minimize and monitor managerial
opportunism because they serve as the company’s internal control mechanism. According to
Sugosha and Artini, (2020), another important component of corporate governance is ownership
structure that can be used to mitigate conflicts of interest within an organization, particularly
when it comes to the payment of dividends to investors. Conflict of interest typically arises
among companies’ managers and shareholders or within minority stakeholders and major
shareholders, often resulting in a diminishment of firm value. Therefore, as observed by
Abdullah et al., (2017), the main purpose ownership structure is to increase firm value and
reduce agency conflicts, while managerial interests must be aligned with those of shareholders.

Ownership Structure of Firms

The most important aspect of corporate governance is ownership structure, which influences
the firm's decision-making processes and strategic choices. Ownership structure refers to how
ownership is distributed among the shareholders of an entity (Jiang, 2004). In Pakistan,
ownership structures range from family-owned enterprises to state-controlled corporations and
multinational conglomerates (Khan et al., 2017). The ownership structure of an organization
shows that how managerial responsibilities are transferred from its shareholders to those who are
in charge of managing it daily affairs. According to Rusyda, (2018), Ownership structure’s
components and factors significantly influence how an organization successfully achieve its
goals and eventually enhance the value and wealth of investors.

Butt & Hasan, (2009) stated in his study that financial decisions made by the company are
significantly influenced by the ownership structure and corporate governance. In the presence of
agency issue in between management and stockholders, managers put less efforts in overseeing
the company’s operations. Furthermore, these issues can potentially result in managers using
company assets for personal gain. Increased managerial shareholding can serve as a means to
mitigate the misuse of assets for personal purposes. Foreign ownership, government ownership
(state ownership), managerial ownership and institutional ownership are the components of
ownership structure, based on the concepts of Ezeoha and Okafor (2010).

Managerial Ownership
The proportion of company’s shares held by directors and managers at the end of a specific
period is known as managerial ownership. This variable serves the purpose of understanding the
advantages of ownership in mitigating agency conflicts, with the assumption that if a manager is
also an owner, the agency problem tends to diminish. If the large portion of shares held by
management in organization, managers will be less inclined to maximize the use of resources
while minimizing agency costs due to conflict of interest. Consequently, managers who are
shareholders in the company are more likely to formulate strategies that enhance the firm's
performance, especially over the long term (Martsila & Meiranto, 2013). Managerial ownership
exerts an influence on the corporation, impacting its performance in the pursuit of goals such as
maximizing corporate value and averting financial distress that could lead to bankruptcy
(Mappadang, 2021). As, ownership shared by company executives will encourage careful
management in employing debt to reduce or prevent financial distress that might result in
bankruptcy, so company’s debt will be less as its managerial ownership increases. The extent of
managerial ownership is instrumental in reducing agency costs, and bringing shareholders and
management interests into alignment. Companies with substantial managerial ownership tend to
experience lower agency costs, as there is greater potential within managers and stakeholders for
alignment who play dual roles as both principals and agents, as articulated by Jensen and
Meckling (1976),

Institutional Ownership
According to Sihombing et al., (2007), and Sirojuzilam and Muda, (2017), the proportion of
company’s shares held by businesses like banks, insurance agencies, as well as other
organizations at the end of a specific period is referred to as institutional ownership. These
institutions typically encompass entities like mutual funds, life insurance companies, investment
firms, pension funds, and similar organizations. It signifies ownership of voting rights and
underscores how the presence of institutional ownership can enhance oversight of company
management with the aim of generating profits for shareholders. Enterprises with substantial
institutional ownership, often exceeding 5%, demonstrate their capacity to monitor and examine
managerial decisions. Institutions possess the resources and capabilities required to effectively
oversee management practices, thereby promoting the company's long-term sustainability. The
principles of agency theory will be aligned with the increase in institutional ownership, which
suggests that implementation of a robust monitoring mechanism can help to reduce conflicts
between managers, as highlighted by Khafid (2017). Institutional investors can significantly
bolster the company's overall performance by accumulation shares and may also influence
external investors, assuring them of the advantages and security associated with their investment

State Ownership
The outstanding shares that are owned by governments or entities associated with the
government is known as “state ownership”. It is characterized by distinctive attributes, a position
of influence, and a significant impact on the companies under its control. This means that the
state, through various agencies or state-owned enterprises, becomes a major shareholder in the
firm, often with the objective of exerting influence or control over the company's operations and
strategic decisions. The government may provide financial support to businesses that are owned
by state, which can impact their leverage decisions. Because of government support, they could
potentially willing to acquire more debt financing quickly or with better condition which could
leads to higher leverage levels. According to Su et al., (2008), state oversight can enhance
corporate performance through direct engagement and reduced risk exposure. Furthermore, as
observed by Chen et al., in 2009, state-controlled companies may experience improved
mechanisms for sharing both risks and benefits.

Foreign Ownership
The term “foreign ownership” describes as individuals, companies, or entities from one
country own a significant portion of the equity or assets of a business located in another country.
It implies that the ownership of these assets or entities is in the hands of foreign individuals,
companies, or governments. It involves foreign entities having a stake or controlling interest in a
domestic business, often in the form of equity ownership, investments, or ownership of assets.
Corporate Governance and Capital Structure of Firms
The company’s financial strategy depends extensively on decisions regarding its capital
structure, which includes the proportion of equity and debt financing. These decisions are
significantly influenced by corporate governance practices, as they determine the allocation of
control and decision-making authority (Laeven & Levine, 2009). Understanding how governance
practices impact capital structure choices is essential for assessing financial risk and
performance. Corporate governance and capital structure have garnered/collected significant
public attention due to their roles in fostering economic and social growth. Sound and efficient
business management is promoted by well-structured capital practices and effective corporate
governance. This, in turn, contributes to a reduction in instances of corporate failures, weak
internal control systems, suboptimal corporate structures, and lapses in discipline among both
management and employees. It's crucial to note that poorly governed corporations not only
endanger themselves but also pose risks to others, potentially undermining the stability of the
capital market.

According to previous research projects like; Abor (2007), Wen et al. (2002), Friend and
Lang (1988), and Berger et al. (1997), all authors emphasized in their studies that how important
corporate governance is in determining a company’s capital structure, particularly those that are
large and publicly listed. The pursuit of an optimal capital structure is a paramount objective for
a firm's Chief Financial Officer in order to achieve the fundamental goal of maximizing
shareholders wealth (Ajibola et al., 2018; Do et al., 2020; Rahman et al., 2019) and enhanced its
share prices (Purwanti, 2020; Hirdinis, 2019), as it holds immense importance for profitability
(Mujiatun et al., 2021; Shubita and Alsawalhah, 2012; Singh and Bagga, 2019).

Ownership Structure and Capital Structure of Firms

According to Wang et al. (2014), and Baba and Baba (2021) opinions, the capital structure of
companies is significantly influenced by ownership structure, interlaced with governance
mechanisms which reflects how ownership is distributed within a corporation across different
characteristics and the connections between these attributes. Saona et al (2018) stated that the
importance of capital structure choices has increased in the modern corporate finance. According
to A. Shah & Khan, (2007), and Ahmad et al., (2018) study, the capital structure of a business
describes the various funding sources it uses to raise capital for its general operations and
growth. Nomran et al (2018) investigate that the overall cost of capital is decreased while
simultaneously combining equity and debt financing. As mentioned by Ahmad et al. (2018),
equity may be represented as retained earnings, preferred stock or common stock, whereas debt
can manifest itself in many ways, such as notes payable and the issuance of bonds. As indicated
by Bajagai et al. (2019), the choices that an organization makes regarding its financial structure
is also addressed by capital structure. These choices regarding a firm's capital structure are
importance because they directly impact the company's ability to satisfy its stakeholders.

Aligning manager’s interests with the needs of stockholders through managerial ownership is
beneficial, according to Boubaker et al. (2012). Managerial ownership not only not only
increases shareholders interest but also improves management’s skills, which consequently
decreases issues related to agency, as investigated by Chen and Chen (2012). Conversely,
managerial ownership has an inverse effect on the capital structure of an organization, and
suggest in that the dependence on debt financing tends to decline under managerial ownership, as
explained by Joher et al. (2006). The debt ratio and managerial ownership of Jordanian
companies are negatively correlated, based on Al-Fayoumi and Abuzayed (2009) study.
Furthermore, there is also a non-linear correlation between capital structure and managerial
ownership, as demonstrated by Brailsford et al. (2002).

Institutional investors exert the ability to influence a company's capital structure

significantly. Their role in managing corporate affairs because they have substantial stakes in the
company as well as their oversight capabilities. The beneficial effects of such ownership by
institutions on the capital structure of an organization’s are highlighted by Crutchley et al.
(1999). Institutional ownership tends to lead to increased debt financing for firms, it is also
justified by the findings of Butt and Hasan (2009). As suggested by Hunjra et al. (2020b), this
benefit of institutional ownership on capital structure improves the efficiency of monitoring
while simultaneously reducing managerial opportunism and agency costs.

Leverage Deviation of Firms

Leverage is a financial metric used to measure how much a business depends on borrowing
money from outside sources or financing from external sources to fund its operational activities.
According to Dwiantari et al. (2020), it measures the percentage of a company's business
operations funded through borrowed funds in contrast to its own capital. A lower level of
leverage signifies that the company is prudent in its use of debt for financing its operations. This
approach reduces the risk of potential financial difficulties in meeting debt obligations in the
future, particularly due to the associated high interest costs, it may harm the business’s
procedures for operation and put it in financial hazard.

A company chooses to enhance its leverage as a means of financing its business operations
without necessitating an increase in its equity. It's important to note that leverage is not
inherently harmful; in fact, it can enhance the returns realized by shareholders and often carries
tax advantages associated with borrowing. Existing research has demonstrated that a firm’s
investment and financing decisions can be significantly impacted by how far it deviates from its
optimal leverage level. Elevated leverage may result in reduced cash generation for the company,
potentially impacting its financial performance. Firms with substantial debt or high leverage
often exhibit a tendency to retain their earnings and prioritize meeting debt obligations.
Furthermore, companies that have higher leverage are more likely to use lower dividends as a
strategy to decrease dependency on external sources of capital.

Leverage, as a critical financial tool, influences a profitability, firm's risk profile, and
valuation (Modigliani & Miller, 1958) and deviations from an optimal leverage ratio can have
significant implications for financial stability. Leverage deviations can occur in both positive
(overleveraging) and negative (underleveraging) directions. The costs of overleveraging are
often larger than the costs of underleveraging, according to a significant portion of the empirical
literature that is already present. This phenomenon may be explained by a finding that investors
frequently have less concerns about the cost of forgoing tax benefits linked to underleveraging
than they do about the costs of potential bankruptcy resulting from overleveraging. The findings
of studies by Uysal in 2011, Harford et al. in 2009, Kayhan and Titman in 2007, and Hovakimian
et al. in 2001, all support the idea that the overleveraging, rather than underleveraging, tends to
be associated with limitations on investment and financing opportunities.

Hypothesis Development
According to Jensen and Meckling-proposed Agency Theory in 1976, when managers act in
their own interests rather than considering the benefits to the company then composition of
capital structure may be problematic. The ownership structure within a company is often
characterized as the primary concern of agency theory (Zaid et al., 2020). According to this
theory, in situations where agency conflicts exist, managers may favor a particular capital
structure to enhance their own financial gains, which can impact the firm's financing and
dividend decisions. Additionally, the theory posits that an optimal ownership structure and
capital structure can help minimize these agency-related costs. An optimal capital structure and
ownership structure can reduce these agency-related costs as posited by agency theory. As
highlighted by Fama in 1980 and Jensen in 1986, research also shows that managers interest
tends to be more in line with those of shareholders when they own a sizable portion of the
business.

As proposed by Jensen in 1986, a regulation of interest and principal payment encourage

responsible financial management by increasing debt financing might work as an approach for
minimizing conflicts between agencies. When managers fail to act in the shareholders' best
interests, they may be less inclined to provide voluntary disclosure, as observed by Nekhili et al.
in 2012. The issues related to the capital structure of a company could be resolved by including
more debt or by changing the proportion of stock held by managers, as noted by Jensen in 1986.
This change in ownership or increased debt can encourage managers to exercise caution when
utilizing surplus cash. Furthermore, as emphasized by Berger et al. (1997) in his study, managers
with substantial ownership in the company have greater incentives to allocate surplus funds
wisely. Therefore, effective managerial control allows managers to avoid excessive reliance on
debt.

In the literature of finance, the relation among leverage deviation and ownership structure
have become an important concept. As highlighted by La Porta et al. in 1999, different
ownership configurations, such as family-owned businesses, widely-held corporations, and state-
controlled enterprises, have been studied extensively about their impact on the company’s
choices regarding capital structure, across the globe. As discussed earlier by Jensen and
Meckling (1976), financial decisions made by organizations are significantly influenced by
managerial incentives. A positive correlation between managerial ownership and leverage
deviation has been found by in empirical research based on American companies, including
studies by Berger et al. in 1997 and Mehran in 1992. This suggest that the value of firm will be
enhanced by those managers whose monetary interest ties with external investors, so they will
look for a higher financial leverage in order to increase shareholders wealth.
 Research by Harris and Raviv (1988) and Stulz (1988) in an entrenchment perspective
reveals that leverage might be boost/raise above then the target level due to entrenched CEOs,
for the purpose of lowering their chance of takeover and increase their own power of vote. Also,
the research by Hewa and Locke's (2012), supports this idea that managerial ownership
influences leverage decisions in a positive way. However, there are counterarguments to this
perspective. An inverse correlation between shares held by management and level of debt was
found by Friend and Lang in 1988. This study suggests that managers might prefer lower
leverage, mainly because as large portion of their financial resources belongs to the business
capital. Similarly, leverage and ownership by management are negatively correlated in Pakistan,
as noticed by Sheikh and Wang (2011). This similar relation was also observed in 2009 by Al-
Fayoumi and Abuzayed in Jordanian manufacturing companies. In UK and Australian
companies, leverage and managerial ownership follow the U-shape pattern as introduced by
Florackis and Ozkan (2009) and Brailsford et al. (2002). Drawing from the literature reviewed
above, the following hypothesis has been eatablished:

H1: There is a significant relationship between managerial ownership and leverage deviation

In financial markets a crucial role was played by institutional investors, particularly in

develping countries like Egypt where privatization policies have underscored their impact on
corporate governance. According to Chidambaran and John (2010), Jensen (1986), and Jensen
and Meckling (1976), institutional investors possess substantial expertise in collecting and
analyzing information regarding a firm's performance, which can effectively mitigate cost of
agency. But a variety of outcomes have been generated in different investigations. Institutional
shareholding and debt ratio have a strong negative correlation, which indicates that institutional
investors exert significant influence on company managers and thereby reducing problems
related to agency, as observed by Al-Najjar and Taylor (2008). However, the debt-to-equity ratio
is negatively correlated with institutional ownership, as discovered by Hussainey and Aljifri in
2012. In this study, pecking order theory is supported by data showing that companies with a
substantial institutional shareholder happen to use lower level of debt funding. Conversely, the
financial leverage is positively correlated to institutional ownership, according to research done
in Tehran by Abdoli et al. (2012). According to this finding, businesses with significant
ownership held by institution may find it less difficult to get bonds or loans or other types of
financing.

Institutional ownership is an essential monitoring tool which help in reducing issues related
to agency, as there is a strong correlation between institutional ownership and leverage ratio that
was also discovered by Joher Huson et al. in 2006. In Iran, there is no relation exist in between
them, as studied by Bodaghi and Ahmadpour in 2010, and Hassan and Ali in 2009. Institutional
investors have been promoted as a potential substitute for individual investors, as an approach of
dealing with the issues related to overinvestment, as highlighted by Pound (1988) and Shleifer
and Vishny (1986). Given their expertise in information gathering and interpretation, along with
heightened incentives tied to their equity ownership, institutional investors are positioned to
closely oversee managerial activities. This suggest that managerial self-interest was also
controlled by ownership held by institutions. In different studies like Crutchley and Jensen
(1996), Bathala, Moon, and Rao in 1994, and Grier and Zychowicz (1994), it is observed that
leverage and institutional ownership are negatively correlated to each other. We establish the
subsequent hypothesis from the literature review mentioned above:

H2: There is a significant relationship between institutional ownership and leverage

deviatiom

Stake owned by government in businesses, increase their accessibility to various monetary

assets and their chances of borrowing money at affordable rates, was studied by both Ezeoha and
Okafor (2009) and Deesomsak et al. (2004). However, mixed results were observed by empirical
findings. In China, it is observed that as compared to non-state-owned enterprises, enterprises
owned by government tend to utilize more debt and resulting in greater ratios of leverage, as
observed by Liu et al. (2011). According to Kato and Long in 2011 & 2006, due to lack of strong
managerial incentives, risk-averse managers in businesses owned by government may lean
toward lower leverage levels. A significant and positive correlation was identified by Aljifri and
Moustafa (2007), which suggest that executives may opt for higher debt levels to mitigate risks
related to employment. Government ownership strongly prefer financing through equity which
means low assets-to-debt ratios was observed in businesses owned by government, as founded by
Zuoping in 2009. In UAE and China, there is no significant relationship was found in the studies
by Hussainey and Aljifri (2012) and Huang and Song (2006). Subsequent hypothesis has been
drawing from the above literature reviewed above:

H3: There is a significant relationship between state ownership and leverage deviation

The relationship between ownership held by foreign and leverage deviation is not uniform
and can vary depending on the country, the type of foreign investors (institutional vs. individual),
and the specific characteristics of the firms under study. While some studies have found that
greater deviation in leverage has been linked with foreign ownership, others have reported the
opposite. In the context of American businesses, Lang and Stulz (1994) examined that how
foreign ownership affected variation in leverage. They discovered a correlation between lower
levels of leverage and foreign ownership. It suggests the fact that foreign investors tended to
favor firms with more conservative capital structures. Kang and Kim's (2016) study focused on
South Korean firms and their foreign ownership structure. They found that leverage deviation
was positively influenced by foreign ownership. It also suggests that shares held by foreign in
South Korea were associated with firms deviating from their optimal capital structure by taking
on more debt. In a global context, impact of institutional ownership by foreign entities on
leverage deviation are examined by Anderson et al. in 2010. Their findings revealed a positive
correlation between leverage deviation and ownership by foreigners. Hovakimian et al. (2012)
investigated U.S. organizations, in which a negative correlation exists in between variation in
leverage and foreign ownership. Conversely, ownership by foreign doesn't exert a noteworthy
influence on leverage, as observed by Zou and Xiao (2006). We develop the following
hypotheses from the literature review mentioned above:

H4: There is a significant relationship between foreign ownership and leverage deviation

Research Methodology
Data Sources and Sample Selection
This study’s primary objective was to explore how various ownership structures affected the
variation in leverage among the Karachi Stock Exchange 100th Index’s listed companies. Our
main focus is on non-financial companies while excluding financial institutions from the KSE
100th Index. Because firstly, non-financial firms and financial institutions exhibit distinctive
ownership structures, and their governance provisions differ significantly. Secondly, both non-
financial and financial companies employ leverage as a financial tool, but their methodologies
and calculations differ significantly due to regulatory requirements, risk management practices,
and their unique business models. Consequently, we chose to exclude financial institutions from
our analysis due to their distinct capital structures and accounting practices.

All non-financial listed companies on the KSE 100th Index between the years 2018 - 2022
provides information over a five-year period for our dataset. The year 2018 was purposefully
selection for our study/analysis because it marks the period immediately following Pakistan
Code of Corporate Governance adoption. However, by selecting 2022, we can be sure that our
research will be done with the most recent data available, giving us a comprehensive and current
understanding of the relation among leverage deviation and ownership structures. As a result, our
dataset has a total sample size of 395 firm-year observations, which includes 79 firms over a
five-year period, so that it will takes the shape of panel data set. It is significant to note that the
data used in this study is secondary in nature and has been gather from a number of sources,
which includes a report by the State Bank of Pakistan titled “Financial Statement Analysis of
non-financial listed firms on PSX” and reports of each year that can be accessed through official
websites of their companies. Our data collection process focused on variables relevant to our
study, relying on their availability.

Measurement of Dependent Variable

Leverage is a financial metric that helps us evaluate how a company finances its operational
activities, whether through borrowing or external sources. Building on earlier research by
academics/scholars like Uysal (2011) and Kayhan and Titman (2007), the disparity between its
target leverage and actual leverage of firm is known as "leverage deviation". In simpler terms,
negative deviations indicate that a company is underleveraged, while deviations positively
suggest that it is overleveraged. As by using financial data which is available publicly, we can
easily calculate the actual leverage ratio, determining the ratio of target leverage is a bit more
complex as it cannot be directly observed and necessitates estimation. Firstly, we will compute
the actual leverage using the following formula as employed by Dwiantari et al., (2021):

Actual Leverage = Total Liabilities / Total Equity ………. (1)

The next step involves estimating the target leverage for each industry by employing a regression
model, where the actual leverage serves as the dependent variable. This regression incorporates
various company-specific characteristics that are recognized as factors influencing the ideal level
of leverage. It's important to note that we construct a separate target leverage equation for each
industry, acknowledging that the leverage behavior varies across different sectors. In this study,
the target leverage is estimated by using four independent variables: the market-to-book ratio,
asset tangibility, firms’ profitability, and firms’ size. Previous studies have shown that these four
factors are strongly relate to leverage (Frank & Goyal, 2009) and have a significant impact on it
(Rajan & Zingales, 1995).

To estimate the target leverage, Equation 2 is applied using an unbalanced panel data model:

Li,t = β0 + β1Sizei,t-1 + β2Tangi,t-1 + β3Profiti,t-1 + β4Growthi,t-1 + µi,t ………(2)

Here, the company’s target leverage is represented by Li,t at time 't', at time 't-1' its size is
denoted by Sizei,t-1, at time 't-1' the firms tangibility is denoted by Tang i,t-1, at time 't-1' its
profitability is denoted by Profit i,t-1, at time 't-1' the company growth opportunity is represented
by Growthi,t-1, and µi,t represents the error terms. Equation 1 and 2 was used to determine the
leverage deviation for each company after estimated the target leverage for respective industry.

Deviationi,t (LDi,t) = Target/Optimal Leveragei,t - Actual Leveragei,t-1 ……. (3)

In this equation, Deviationi,t stands for the deviation of ‘i’ company at ‘t’ time, actual leverage of
‘i’ company at ‘t’ time is denoted by actual leveragei,t-1, and optimal/target leverage of ‘i’
company at ‘t’ time is denoted by Target/Optimal Leveragei,t.

Measurement of Independent Variable

A crucial and widely acknowledged component of corporate governance is ownership
structure. We examine four distinct categories of ownership structure in this study that are
managerial ownership (MO), foreign ownership (FO), institutional ownership (IO), and
government/state ownership (GO). In organizations, the proportion of equity share owned by the
executives, managers and directors are known as managerial ownership (MO i,t). The percentage
of equity share held by foreign institutions, businesses and foreign individuals is known as
foreign ownership (FOi,t). The proportion of equity shares owned by government-affiliated
entities and financial institutions is known as institutional ownership (IO i,t). Lastly, the
proportion of equity share hold by government-related agencies or government is known as
government/state ownership (GOi,t). Annual reports of chosen companies are used to collect data
on these various ownership structure for examination purposes.

Measurement of Control variable

Leverage deviation of companies will be either negative or positive, which is also
potentially influenced by the several firm control variables. This study focuses on investigating
the debt utilization choices made by publicly listed companies in Pakistan, which also includes
the five specific factors related to firm that are; firm growth rate, profitability, non-debt tax
shields, asset tangibility, and firm size. Firm growth rate is determined by the change in total
assets (current year assets minus previous year assets) divided by previous year overall asset.
Profitability is described by EBIT, which is adjusted as sales of 'k' value, while the ratio in which
net fixed assets is divided by total capital is used to measure tangibility. Non-debt tax shields are
measured by the total annual depreciation divided by the overall capital. Natural log of total
capital is used to measure the size of the company.

Specification of Model
The study formulates the following empirical model, in order to investigate how ownership
structure affects leverage deviation:

LDi,t = α0 + α1 OWNSi,t + α2 CVi,t + εi,t ………….. (4)

Here, LDi,t is the leverage deviation which was measured by using equation (3), OWNS i,t
represents firm ownership structure that encompassing institutional ownership (IO i,t), managerial
ownership (MOi,t), government/state ownership (GOi,t), and foreign ownership (FOi,t). CVi,t
comprises of the group of control variables, including factors like firm size (S i,t), growth (Gi,t),
profitability (Pi,t), volatility (Vi,t) , free cash flow (FCFi,t) , non-debt tax shield (NDTSi,t) , and
tangibility (Ti,t), however, εi,t is the error term, 't' represents the time, represented as (t = 1,2,3, ...,
T), and 'i' represent firms, denoted as (i = 1,2,3, ..., n).

Methodology
As this research basically comprises of 79 companies mainly in the manufacturing sector that
utilizes panel data from 2018 to 2022. According to Demsetz and Villalonga (2001), it's worth
noting that empirical investigations in the realm of corporate governance often grapple with
endogeneity issues, primarily because ownership is considered an endogenous variable. We
employ a dynamic panel GMM (Generalized Method of Moments) estimator to address this
endogeneity concern related to ownership. In previous research, this strategy has been applied
variously, which includes; Flannery and Hankins in 2013, Demsetz and Villalonga in 2001,
Nguyen et al. in 2014, Nakano and Nguyen in 2012, Antoniou et al., in 2008, Wintoki et al. in
2012, and Din, S.U., et al. in 2022. We include the dependent variable’s one-year lag (LD it−1) as
an independent variable in the dynamic GMM model. This addition serves two purposes: it helps
capture the adjustment dynamics and aids in mitigating the endogeneity issue, following the
methodology highlighted by Udin et al. in 2017. Equation (4) is consequently modified as
follows:

LDi,t = α0 + γ LDit−1 + α1 OWNSi,t + α2 CVi,t + εi,t ………….. (5)

where, LDit−1 represents the leverage deviation at time (t-1) of company (i). By putting the
control variables and different types of ownership, restated equation (5) will be given below:

LDi,t = α0 + γLDit−1 + α1MOi,t + α2IOi,t + α3GOi,t + α4FOi,t + α5Si,t + α6Gi,t + α7Pi,t + α8Vi,t + α9Ti,t
+ α10FCFi,t + α11NDTS + εi,t ……………(6)