Impact Of Corporate Governance Practices On Financial Distress: Evidence From Listed Commercial Banks In Sri Lanka

Abstract

The study investigates the influence of corporate governance (CG) practices on financial distress among listed commercial banks in Sri Lanka from 2019 to 2024. The research addresses a critical gap in emerging market contexts, where regulatory frameworks are evolving and economic challenges, such as the COVID-19 pandemic, have heightened risks of financial instability. The study employs board size, board independence, board activity, audit committee size, and audit committee independence as CG indicators, and Altman Z-score as a proxy for financial distress. Using data from listed commercial banks and conducting regression and correlation analyses, the study reveals that board independence and board activity significantly reduce financial distress, while larger board size increases it. The findings affirm that governance mechanisms related to board composition and engagement are pivotal in mitigating financial distress in Sri Lankan banks. Specifically, smaller, more independent, and actively meeting boards promote better oversight and risk management, reducing insolvency risk. These results support agency theory predictions that independent directors enhance the effectiveness of monitoring and reduce agency conflicts. The lack of significant influence from audit committee size and independence contrasts with some international studies, indicating potential contextual constraints such as inadequate enforcement, political interference, or lack of expertise within Sri Lankan audit committees. This gap highlights the need to strengthen audit functions beyond formal compliance. Acknowledging limitations such as sample size and data constraints, this study proposes a roadmap for strengthening CG practices in the Sri Lankan banking sector