AGENCY COSTS AND FINANCIAL DISTRESS: THE MODERATING ROLE OF DEBT CAPACITY IN PAKISTAN’S TEXTILE SECTOR"

Abstract

This study explores how agency costs affect financial distress in Pakistan’s textile industry and whether a company’s ability to manage debt— its debt capacity— can help ease that impact. Agency costs arise when managers act in their own interest rather than the shareholders’, which can lead to poor financial decisions and increase the risk of financial trouble. Using data from 60 textile firms between 2017 and 2021, the research applies the emerging market Z-score model to measure financial ratios to capture agency costs and debt capacity, the results show that higher agency costs are linked to greater financial distress, but companies with stronger debt-handling capacity are better able to cushion this effect. In simple terms, firms that can responsibly handle debt are less likely to fall intro distress – even when agency issues exist. These findings highlight the importance of good financial management and governance, especially in developing economies like Pakistan, where business failures can ripple through the entire economy.