**H1.** *Agency costs have a negative e*ff*ect on the firm performance*.

#### 3.2.2. Corporate Governance, Agency Cost, and Firm Performance

Managers' opportunistic behavior increases their wealth, which leads to a decrease in firm performance. This opportunistic behavior of managers can be curtailed through a good set of internal and external corporate governance principles. Leverage is considered to be an agency mitigating mechanism, as outsiders monitor the actions of managers with respect to efficient contracting (Jensen 1986; Lang et al. 1995; Malmquist 1990). Debt covenants are considered an essential part of efficient contracting that, in addition to active monitoring, prevents specific risk-taking activities by management. All these efforts reduce the agency cost on one hand, while the value of the firm is increased on the other.

Dividend policy is also considered to be an agency mitigating variable, as elaborated by Ghosh et al. (2000). Two ways in which shareholder wealth can be maximized, either by increasing the share price by investing in value-enhancing projects or by distributing the excess cash in the form of dividends if managers fail to identify value-maximizing projects. Managers try to gain hold of the firm's resources when they have no positive NPV projects; hence, the agency cost of free cash flow occurs. In this case, dividends play an essential role in alleviating the agency problem (Jensen 1986). Porta et al. (2000) claimed that with the country having low investor protection, dividend policy becomes a robust governance mechanism for alleviating agency cost.

Studies have shown the effects of different board characteristics on firm performance in emerging economies (Borlea et al. 2017). A strong and independent board structure aligns the interest of managers and shareholders. Jackling and Johl (2009), in their study, concluded that from the perspective of agency theory, having independent directors on the Board enhances firm performance. Independent directors not only the have experience and the knowledge required to scrutinize the opportunistic behavior of the managers, but can also dissent from the other board members if they find any irregularities (Marchetti et al. 2017). The literature has shown mixed results regarding the size of the board, e.g., Mappadang et al. (2018) found that larger board size led to tax avoidance. Some studies have suggested that the optimal board size is either very small or very large (U-shaped), when assessed with respect to performance (Coles et al. 2008). However, a study conducted by Beiner et al. (2004) shows that the choice of the board size is dependent on environmental factors. Pearce and Zahra (1992) suggested that large boards were characterized by efficient monitoring and had a larger impact on corporate performance than small boards. Similarly, in advanced economies, studies have shown a positive association between board size and firm performance (Guest 2009). In the context of the Chinese market, board size has a negative impact on risk taking (Huang and Wang 2015; Haider and Fang 2016). Since board size leads to less risk taking in Chinese listed firms, we can propose that managerial appropriations can be curtailed through having a larger board size, thus boosting firm performance. CEO duality is taken as an important component of board characteristics, and generally, empirical research has shown that the separation of the CEO and the chairman results in an alleviation of the agency cost (Goyal and Park 2002; Kula 2005; Lei et al. 2013). Board diversity is also considered an important element of corporate governance. Research has shown that the representation of females on the board reduces the agency cost and enhance the firm value. For example, the relationship between gender diversity and firm performance in Chinese listed firms was investigated by Sial et al. (2018a). They concluded that board diversity influences firm performance, and that corporate social responsibility mediates the relationship. Similarly, research conducted by Sial et al. (2019) highlighted the importance of gender diversity in moderating the relationship between corporate social responsibility and earnings management. Board activity has a significant negative effect on agency costs. Frequent meetings of the Board of directors mean that they are actively involved in the matters of the company, and managers refrain from self-empire building (Ma and Tian 2009; Sahu and Manna 2013).

Some other corporate governance variables, in addition to board structure, also help in mitigating agency cost. The presence of an audit committee with independent members can proactively identify misappropriations in the financial records and can play a significant role in mitigating the agency problem. The agency cost is reduced when an independent committee is devised voluntarily (Collier and Gregory 1999). Additionally, it enhances firm value (Chan and Li 2008). A well-reputed and experienced external auditor can carefully scrutinize the financial statements. They have the required expertise, as well as having market knowledge of harmful financial practices. A Big Four auditor can mitigate the agency cost, as well as help in enhancing the firm value (Eshleman and Guo 2014; Hope et al. 2012). Some researchers have shown a profound effect of corporate social responsibility (CSR) on firm performance. The study conducted by Sial et al. (2018b) suggested CSR to be an important determinant of corporate governance in enhancing the firm performance. However, the earnings management had the negative impact on the relationship between CSR and firm performance.

The encouraging approach to agency cost states that managers can be motivated to carry out specific desirable behavior. Jensen and Meckling (1976) proposed the convergence of interest hypothesis, in which managers who were given stock ownership have a better effect on firm performance. Brander and Poitevin (1992) explained that the terms offered in the compensation contract reduced the agency cost. In China, the same results were established by Zhang et al. (2016), who concluded that the perks of senior executives were negatively related to the agency cost. Managerial ownership is one of the ways to align the interest of the shareholders and managers. By having an ownership stake in the company, the managers would now take ownership of the company and would do their best to increase its value. However, in the literature, this relationship has not been not found to be linear. Still, there is a monotonic relationship, which suggests that at a lower level of managerial ownership, the agency cost is reduced, but the agency cost increases when a certain level of managerial ownership is reached (Jensen and Meckling 1976; McConnell and Servaes 1990).

Many recent studies have examined a combination of agency mitigating governance variables instead of focusing on the effect of an individual variable. Agrawal and Knoeber (1996) suggested a different agency mitigating mechanism and concluded that a single measure could be misleading. Shan (2015) prepared a corporate governance index for eight various corporate governance measures and explored their effect on earnings management and value relevance. Achim et al. (2016) investigated the effect of overall corporate governance quality in the performance of Romanian firms. They found a positive association between the governance quality and business performance in the emerging economy. This study focuses on the design of the corporate governance index comprising agency mitigating variables, and examines the impact of corporate governance in moderating the relationship between agency cost and firm performance. Dey (2008) used seven different proxies of agency conflict and generated seven principal factors from 22 individual governance variables. She concluded that the existence and role of governance mechanism is a function of the level of agency conflict in the firm. The link between corporate governance, agency cost and the firm performance is elaborated in Table A1, Appendix A.

From the literature above, we establish the link between corporate governance variables, agency cost and firm performance. The corporate governance quality mitigates the corporate expropriation through efficient monitoring. The corporate governance is also linked with better performance specifically in emerging markets (Klapper and Love 2004). With effective corporate governance mechanisms, the agency cost can be curtailed, while higher firm performance can simultaneously be achieved. Based on the link between corporate governance attributes and agency cost reduction, as well as the positive association between the corporate governance dimensions and firm performance, we can devise our hypothesis:
