Although firms’ annual reports are supposed to provide an unbiased and accurate picture of their financial position, managers may be induced to engage in earnings management in order to circumvent expectations. Such incentives can take the shape of stock prices, management incentives, or debt covenants. The purpose of this study is to investigate the effectiveness of three attributes of corporate governance in constraining earnings management practices. These include board characteristics, audit committee characteristics, and ownership structure. Based on a sample of 120 nonfinancial firms listed on the Karachi Stock Exchange during 2003–12, we find that audit committee independence is negatively associated with earnings management, while CEO duality and institutional shareholding is positively associated with earnings management. Moreover, the effectiveness of governance mechanisms in constraining earnings management practices differs across high- and low-growth firms.
KEYWORDS: Earnings management, financial statements, corporate governance, board characteristics.

JEL: G34.

This study focuses on the revealed comparative advantage analysis for Clothing and Textile sectors of Pakistan, India and Bangladesh. We have applied the Balassa’s (1965) Index for the analysis. The revealed comparative advantage has been analyzed in two different ways: one static on the year 2010 and the other one dynamic based on 1980, 1990, 2000 and 2010. For the dynamic analysis, the average of the three previous years from 2010 were taken and used for revealed comparative advantage. The results show Pakistan’s highest revealed comparative advantage for textiles over both India and Bangladesh. India has revealed a comparative disadvantage in textile in competition of Pakistan and Bangladesh. For clothing, Bangladesh has very dominant revealed comparative advantage when competing with Pakistan and India. Dynamic revealed comparative advantage indicates Pakistan has been gaining a comparative advantage in textiles since 1980 but with a declining percentage of textile export. Bangladesh has significantly gained a comparative advantage in clothing since the 1980s.
KEYWORDS: Revealed Comparative Advantage, Textile, Clothing, Product Positioning, Balassa Index, Pakistan.

JEL: F14, F15, F10, O57.

This study estimates a cost function for fossil fuel-based electricity generating plants operating in Pakistan during 2006–11. It employs a six-year panel dataset for 31 plants to estimate the cost function parameters. In the absence of any current evidence on comparative cost performance, the study’s attempt to document the economic efficiency of power plants in a large electricity sector is an important contribution to the literature. We find that on average, private nonutility plants (IPPs) are about 17 years younger than utility-owned plants and that the average capacity utilization, as measured by load factor, is higher for private IPPs than for public plants. After controlling for observables, the results show that, for a large part of the system, private plants produce electricity at a lower unit fuel cost than utility-owned public plants. The low efficiency of public plants is likely a result of the lack of operational maintenance and routine repairs. We find that the average fuel price (PRs per MMBTU) is lower for public plants and utility-owned private plants compared to nonutility-owned private plants which is mainly due to the composition of the fuel mix used for power generation. We also find that (i) the partial effect of fuel price changes on the average unit cost is higher for private plants than for public plants and (ii) on average, private plants use relatively expensive fuels compared to public plants. On an average fuel cost comparison, the private sector plants may be better base load plants than public sector plants, though the private sector plants may not be being used as base load plants because of the higher tariffs they change.
KEYWORDS: Cost function, utility-owned public plants, load factor, productive efficiency.

JEL: D22, D24, L94.

This study analyzes the impact of corporate governance and ownership structure on earnings management for a sample of 372 firms listed on the Karachi Stock Exchange over the period 2003–10. We estimate discretionary accruals using four well-known models: Jones (1991); Dechow, Sloan, and Sweeney (1995); Kasznik (1999); and Kothari, Leone, and Wasley (2005). The results indicate that discretionary accruals increase monotonically with the ownership percentage of a firm’s directors, their spouses, children, and other family members. This supports the view that managers who are more entrenched in a firm can more easily influence corporate decisions and accounting figures in a way that may serve their interests. This finding is consistent with prior research evidence on the role of dominant directors in expropriating external minority shareholders in Pakistan. Further, our results indicate that institutional investors play a significant role in constraining earnings management practices. We do not find any evidence that CEO duality, the size of the auditing firm, the number of members on the board of directors, and ownership concentration influence discretionary accruals. Among the control variables, we find that firms that are more profitable, are growing, or have higher leverage actively manage their earnings, while earnings management decreases with the age of the firm. The results are robust to several alternative specifications.
KEYWORDS: Corporate governance, earnings management, ownership structure, discretionary accruals, KSE, Pakistan.

JEL: G32, G3, M4.

This study investigates whether exposure to downside risk, as measured by value-at-risk (VaR), explains expected returns in an emerging market, i.e., Pakistan. We find that portfolios with a higher VaR are associated with higher average returns. In order to explore the empirical performance of VaR at the portfolio level, we use a time series approach based on 25 size and book-to-market portfolios. Based on monthly portfolio data for October 1992 to June 2008, the results show that VaR has greater explanatory power than the market, size, and book-to-market factors.
KEYWORDS: Value-at-risk, emerging market, Fama-French factors.

JEL: G32, C32.

This paper uses foreign direct investment (FDI) data from 39 developing countries for the period 2002–11 to explore whether the expected future turmoil risk of a country plays a significant role in determining FDI. It concludes that countries for which the expected future turmoil risk is very high are likely to have lower FDI inflows than countries for which the expected future turmoil risk is low, keeping all other factors constant. The results also illustrate that GDP per capita, democratic accountability, religious tension, and FDI inflows in the previous period are important determinants of FDI in developing countries.
KEYWORDS: Political risk, foreign direct investment, expected future turmoil risk.

JEL: F23, C33, C23, F21.

This study examines the impact of the 2008 global financial crisis on economic growth and employment in Pakistan. We conduct a time series analysis of quarterly data for 1997–2011, applying the autoregressive distributed lag bounds-testing approach and an unrestricted error correction model. Our analysis suggests that the impact of the crisis was transmitted primarily through two channels—the financial sector and trade—with a corresponding negative effect on economic growth and employment. Of the two channels, the magnitude of the trade effect is larger than that of the financial sector.
KEYWORDS: Financial crisis, financial stress, economic growth, cointegration.

JEL: O16, C51, C43, O4.

This study attempts to determine the factors that affect educated women’s decision to participate in the labor force. Based on a field survey conducted in the district of Multan, we find that a number of factors have a positive and significant impact on women’s decision to work. These include women who fall in the age groups 35–44 and 45–54, the coefficients of all levels of education, the presence of an educated husband, marital status, family structure, and family expenditure. The presence of an educated father, being an educated married woman, location, distance from the district headquarters, the husband’s employment status and income, and ownership of assets significantly reduces women’s labor force participation. The results of the earnings equation show that variables such as women who live in an urban area and their level of education and experience are associated with a substantial increase in earnings with each additional year. The number of children has a negative and significant impact on women’s earnings. The hours-of-work model shows that age and the number of completed years of education have a positive effect on working hours, while the number of dependents and the number of hours spent on household activities have a negative effect on working hours.
KEYWORDS: Human capital, labor force participation, earnings function, time allocation, Punjab, Pakistan.

JEL: D00, J21.

Over the last few years, the Pakistani economy has faced a variety of challenges which has led economic managers to focus more on immediate problems at the expense of long term structural issues. The purpose of the Lahore School’s Tenth Annual Conference on the Management of the Pakistan Economy was to help policy makers take a step back and look at some of the critical issues that Pakistan needs to face if it is to achieve growth in the medium to long term. Thus the central theme of the conference was ‘Pakistan in the Global Economy – Opportunities and Challenges’ and a range of key structural issues was discussed by a variety of experts. What made the conference unique was that many of these issues have not been discussed and debated thoroughly before in the Pakistani context. Some of the highlights of the conference were Asma Khalid’s (from the State Bank of Pakistan) extremely insightful analysis of the parallel foreign exchange market in Pakistan (which has not been analyzed in depth before) as well as the call by many of the presenters for a well-formulated industrial policy in Pakistan. Similarly, the conference also focused on some key export sectors (such as garments) as well as strategies for improving Pakistan’s export competitiveness and diversifying exports. Finally, some of the participants noted that in a rush to access new markets, Pakistan must tread carefully when agreeing to trade agreements with potentially large trading partners. As Pakistani policy makers sit and decide on economic strategies, it is absolutely critical that they pay very close attention to these issues.
KEYWORDS: Pakistan, economy, Pakistan, policy.

JEL: N/A.

This paper seeks to describe and analyze the parallel foreign exchange (FX) market in Pakistan. The very nature of this market implies that there is little formal documentation or data to describe it, and so any assessment will be, by definition, subjective. However, parties that transact in the parallel market are familiar with parts of it, on which basis this paper aims to give a comprehensive picture of the structure and evolution of this market in Pakistan. We start with a brief historical perspective, which flags the importance of workers’ remittances to the country and explains how the bulk of this inflow is transacted through the hundi/hawala network (informal moneychangers). We then place this network within the context of the larger FX market and show how it interfaces with the interbank market. We also discuss how many hundi/hawala agents have evolved into formal exchange companies and list the various sources and uses of FX transacted in the kerb market. The conclusion spells out the importance and resilience of the parallel FX market, the need to push toward full amalgamation with the formal FX market, and the key role of workers’ remittances in Pakistan’s macro-economy.
KEYWORDS: Pakistan, foreign exchange, informal economy, hundi/hawala, macro-economy.

JEL: F31, E44.

One of the most pressing issues concerning policymakers today is the choice of an exchange rate regime. Despite the intricacies of this problem, monetary authorities could narrow down their list of options if they were to focus on the following principles: full implementation to ensure credibility and synchronization with domestic realities and economic infrastructure. This paper proposes an optimal exchange rate regime for Pakistan based on a historical study of the outcomes and performance of different monetary stances adopted over the last 40 years.
KEYWORDS: Exchange rate, flexibility, regime, fear of floating, floating, pegging, Pakistan.

JEL: F31, E58, F41, E42, F33.

This paper aims to assess the harmful impacts of exchange rate depreciations on Pakistan’s economy, including impacts on international capital movements, wages, the domestic price level, and development. Devaluation of a currency in terms of foreign currencies or metallic standards was for long considered to be undesirable and, if unavoidable, a sign of failure. Attitudes have since changed and devaluation is thought to bring advantages, especially by making economies more competitive exporters. This paper is intended to show that it has disadvantages that outweigh any supposed advantages, notably its effects on inflation, income distribution, service on foreign debt and incentives. It does so by describing in concrete terms the relations between foreign and domestic prices and the costs of untradeable goods and services that are components of the price of any good in any domestic price index. It also discusses the motives, official and unofficial, that have prompted the monetary authorities of Pakistan to make a practice of regular depreciation of the rupee and to question their justification.
KEYWORDS: Pakistan, exchange rate, depreciation.

JEL: E31, O24.

This paper’s basic premise is that an improvement in Pakistan’s export performance is crucial to raising economic growth. After examining the reasons generally given for Pakistan’s poor export performance, we conclude that the country’s very slow productivity growth was the single most important factor that hurt competitiveness. We argue that a coherent and articulated industrial policy is required to overcome this disadvantage. While the experience of the East Asian economies offers useful lessons, Pakistan’s policy must accord with its own conditions, which are, in many ways, different. The formulation of industrial policy should involve key stakeholders, particularly the private sector. The paper identifies certain factors that should underpin the new industrial policy, notably the changed basis of international specialization and rules governing world trade.
KEYWORDS: East Asia, industrial policy, export performance, productivity.

JEL: F43, L59.

This paper takes a historical perspective to search for the major causes of Pakistan’s stop-go growth cycles and come to the conclusion that, to varying degrees, the foreign exchange constraint provides a major explanation for these cycles of irregular economic growth in the country, particularly since the 1990s.
KEYWORDS: Pakistan, macroeconomic management, foreign exchange, IMF.

JEL: F43.

The textiles industry in Pakistan has failed to fulfill its “historical mission,” whether judged in terms of promoting rapid and sustained economic growth, reducing poverty, or providing employment to young women and so promoting wider social transformation. This paper makes a case for a particular and targeted form of industrial policy that would help the textiles sector learn and upgrade. It argues that those factors commonly seen as constraints to industrial policy—the “China effect,” the global rules of globalization, global value chains, and the problems of energy and education in Pakistan—do need careful consideration, but they are not insurmountable obstacles to industrial upgrading. The key market failure is the risk and uncertainty associated with acquiring and learning to use new technology. The paper explores a number of policy options, reviewing the lessons that cannot be learned from the Republic of Korea and India and one that can from Bangladesh. The latter shows that rapid and sustainable export growth in textiles can be achieved, even in an economy with a weak, corrupt, and unstable form of governance.
KEYWORDS: Pakistan, Korea, Bangladesh, textiles, industrial policy, technological change, upgrading.

JEL: O40, L50.

This paper focuses on a group of Asian countries that have successfully increased exports and found a common industrial strategy. Several key factors emerge from this study. First, countries that have managed to increase their exports focused on doing so in sectors in which they had expertise while slowly developing new export sectors at the same time. Second, high-growth Asian economies have developed their export sectors by making a significant move up the quality ladder and, in particular, moving away from low value-added to higher value-added exports. Third, there is no single economic policy that has worked across Asia; rather, successful exporters have used two or three policies in tandem to boost exports. Fourth, industrial policy has been coordinated with education and training policies to develop both the entrepreneurs and the workforce needed to produce high value-added exports. Finally, the only consistent factor that has an impact on high value-added export growth is domestic credit to the private sector. These results point to the urgent need for a coherent industrial strategy to boost Pakistan’s exports (preferably before future trade agreements are signed, which could otherwise damage potential export sectors).
KEYWORDS: Pakistan, East Asia, industrial policy, quality ladder.

JEL: F10, L50.

A variety of stylized facts about exporters have emerged in the new literature on international trade based on firm-level data. These include low levels of export participation among firms; small shares of export sales in firm revenue; larger firms; and higher levels of productivity, skill, and capital intensity among exporters. In this paper, we seek to examine the extent to which these stylized facts fit the experience of firms in Pakistan, using two cross-sections of firm-level data—the Census of Manufacturing Industries (CMI) 2000/01 for Punjab and the World Bank Enterprise Survey dataset (2006/07) for all Pakistan. We find similar levels of export market participation but very large shares of export sales in firm revenue for those who do, compared to the US sample studied by Bernard, Jensen, Redding, and Schott (2007). We also find, as do many other studies, that exporters exhibit significantly higher total factor productivity (TFP) and are larger in terms of employment than nonexporters. Exporters’ TFP was 150 percent higher than non-exporters before we controlled for firm size. Considering the eight largest sectors (which comprise more than 80 percent of the CMI Punjab), with a few exceptions, exporters had higher labor productivity and offered higher compensation to workers, but used more capital per worker and more imported inputs. The government’s recent emphasis on developing the readymade garments sector is well placed: more than half the apparel producers in the CMI Punjab 2000/01 were exporting—and nearly all of their output (93 percent). The capital-labor ratio and use of imported inputs was modest. Exporters were relatively large employers with 400 workers on average and offered significantly higher compensation than nonexporting firms. A greater understanding of firm dynamics could be gained if the CMI were to resume collecting data on firm-level exports (not collected since 2000/01) and if this data were linked across years so that firm performance could be measured over time.
KEYWORDS: Pakistan, export, firm, sales, revenue, Census of Manufacturing Industries (CMI).

JEL: F10, L60.

This paper describes the level of compliance with quality standards in relation to Pakistan’s top export product categories. With greater competition, innovations in technology, and stricter measures of quality being enforced, Pakistan needs to adopt a holistic, systematic approach to not just meeting, but also exceeding, international quality standards and certifications for its exports. Focusing on rice and textiles, we identify which compliance-related gaps need to be filled to ensure the sustainable growth of high-quality exports to major global markets. The study outlines the key dimensions of international quality standards as well as specific standards and requirements for textiles and rice, examines the quality assurance infrastructure in Pakistan, and presents policy recommendations.
KEYWORDS: Global quality standards, exports, compliance, Pakistan.

JEL: P45, L15, Q18, Q27.

This paper makes the case for a vigorous policy thrust to support investment-led growth. Pakistan’s economy has not maintained a sufficient level of capital formation to sustain growth over the long term. Two thirds of current growth is driven by consumption and not investment: this needs to be turned around. The government needs to put in place an investment regime that motivates and induces industry to invest, innovate, and reinvest. Foreign direct investment can play an important role in strengthening the country’s investment rates. There is also need for deliberate polices to boost technological capabilities in the enterprise sector. In this context, East Asia – which successfully created a dynamic process of capital formation and technological learning that upgraded its productive capacity and underpinned export success – holds important lessons for Pakistan.
KEYWORDS: Investment, technology, industry, Pakistan.

JEL: F21, O38, O53.

The textiles and garments (T&G) sector accounts for almost 50% of Pakistan’s exports and is the largest component of manufacturing. T&G sector, because of recent favorable developments for the industry in Pakistan and the expected future changes in the international trade structure for the sector, has the potential to play an important role in expanding Pakistan’s exports. In addition, garments manufacturing is the least energy and capital intensive industrial activity and thus resonates with Pakistan’s resource endowment to generate economic growth and employment. Garment manufacturers have tried to overcome the constraints arising from the energy shortages and adverse security and country risk perceptions by investing in power generation, upgrading IT, developing design and R&D capability. Punjab Government’s focus on garments as a central plank of its industrial strategy has also helped. However, this paper argues that for the sector to fully realize its potential, government policies that shape the incentive structure faced by the industry need to be re-aligned In this regard, the most important is Pakistan’s import policies and customs procedures that discourage the import of materials such as synthetic yarn and fabric, technical textiles and specialized trimmings and accessories needed by exporters to move up the value chain, and a significant bump up in the growth trajectory will only take place if import policy and custom procedures are substantially reformed. This paper focuses on the following themes: First, structural changes and trends in T&G exports; second, the associated constraints to growth of the garments sector; and third, to highlight some of the steps taken by the industry leaders in terms of policy reforms and by firms, particularly with regards to managing resources to enhance competitiveness.
KEYWORDS: Pakistan, exports, textiles, garments, international trade, growth, global value chain.

JEL: F13, O10, O14, F10, L50, L10, L25, L60, L67.