Abstract

This study investigates the impact of financial inclusion on firm financial performance for a panel of 304 non-financial firms listed on the  Pakistan Stock Exchange  (PSX) over the period 2010–2022, yielding 3,952 firm-year observations.  The study  employs Fixed  Effects (FE)  and  Random  Effects (RE)  panel  estimators  with  firm-clustered standard errors  to  address  unobserved  heterogeneity,   serial  correlation,  and  cross- sectional  dependence.    The  Hausman  test  guides model selection;  diagnostic  tests including the Wooldridge test,  modified Wald test,  and Pesaran  CD test  confirm the need for clustered  standard errors throughout.

The key findings are fourfold. First, financial inclusion exerts a significant negative effect on Return  on Assets (β = −0.005, p < 0.01), suggesting that  deeper financial markets  compress incumbent firm margins  through  competitive  entry.   Second, the Debt-to-Equity ratio consistently and strongly reduces Return on Equity (β = −0.055, p < 0.01) across all specifications, supporting financial distress cost theory over the tax shield hypothesis  in the  Pakistani corporate  context.   Third,  sales growth  positively and significantly affects both ROA and ROE, emerging as a robust performance driver following outlier control through  winsorization.  Fourth, sectoral analysis reveals that the financial inclusion effect is concentrated in competitive, low-margin sectors (Tex- tile,  Sugar,  Chemicals)  while oligopolistic sectors (Fertilizer,  Tobacco,  Cement)  are structurally protected  — a finding confirmed by Chow tests  (F  = 14.90, p < 0.001). Mediation  analysis  following Baron  and  Kenny  (1986) confirms that   the  Debt-to- Equity  ratio  does not mediate  the financial inclusion–profitability relationship;  both operate  as independent, non-overlapping  determinants of firm performance.

The findings contribute to the literature on financial development,  capital  struc- ture,  and firm performance in emerging markets,  and carry direct policy implications for Pakistan’s  National  Financial  Inclusion Strategy  (NFIS 2024–2028).