Does capital structure mediate the relationship between corporate governance compliance and firm performance? Empirical evidence from Pakistan

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PurposeThe purpose of this study is to examine how capital structure mediates the effects of corporate governance (CG) compliance on firm performance (FP) in the context of a developing market experiencing significant reforms to its governance landscape.Design/methodology/approachAn index was built to measure firm-level compliance with Pakistan’s code of CG. Several robustness checks were performed, including alternate proxies of dependent and independent variables, using additional control variables and considering the Global Financial Crisis period. To address dynamic effects and endogeneity, several identification strategies were used: a leading dependent variable, fixed effects model, generalised method of moments model and propensity score matching.FindingsCG compliance leads to higher FP. However, higher leverage partially and negatively mediates this association. The results of this study are robust against alternate proxies of dependent and independent variables and possible endogeneity issues.Originality/valueThis study constructs a summative measure of CG compliance that captures not only firm-level compliance to the prescribed codes but also the benefits of incremental improvements and reforms in the governance of the Pakistan market. This study offers insights into an emerging market, contributing further empirical evidence to support greater market transparency through mechanisms such as CG compliance and the monitoring effects of debt. However, this study cautions that greater compliance raises costs, especially when associated with higher leverage, and can undermine FP.