Abstract:
This paper examines how corporate governance mechanisms impact financial
distress of listed non-financial companies in Sri Lanka, which is an emerging
market typified by a concentrated ownership structure, a dynamic regulatory
framework, and a relatively weak institutional enforcement. The study adopts a
quantitative research design and utilizes panel data collected from the annual
reports of 74 non-financial companies listed on the Colombo Stock Exchange
(CSE) over the period from 2019 to 2023. The companies were selected using a
simple random sampling method to make sure that the sample of the population
was not biased in terms of sector. Financial distress was measured using the
popular Altman Z-score model, and corporate governance was assessed based
on four board-specific variables: board size, number of board meetings, board
independence, and CEO duality. A panel regression model of fixed effects was to
be used to test the hypothesized relationships with the control of unobservable
characteristics of the firms. The results suggest that the financial distress is
negatively affected by board size and board meeting frequency in a significant
negative way, which implies that the bigger the boards and the more frequent the
board meetings, the greater the ability of the companies to sustain themselves
in case of financial difficulties. These findings confirm the resource
dependence theory, which argues the relevance of board diversification and
proactive participation in enhancing organizational resilience. Contrastingly,
CEO duality shows that the agency theory that the concentration of managerial
and supervisory power undermines board oversight and leads to an increase in
governance risks is supported by a strong positive correlation with financial
distress. However, board independence was statistically negligible, which means
that formal independence is not necessarily an effective measure of monitoring
in the Sri Lankan corporate setting. The study adds to the literature on
corporate governance with empirical evidence in Sri Lanka in the period of
2019-2023 that has encompassed the devastating economic crisis of 2022 in the
country. The study contributes to a fresh understanding of the operations of
governance systems to prevent corporate financial weaknesses in emerging
economies through the application of financial distress instead of firm
performance.
