The Breadth and Depth of R PT
The Breadth and Depth of R PT
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parties and disclosure for government-related entities. The and make an announcement of the detailed poll results.
definition of related parties was simplified, its intended With the many reforms on RPTs in Malaysia, such as the
meaning was clarified, and inconsistencies were eliminated provision that allows for aggregation of transaction and
from the definition. For government related entities, the shareholder approval using tiered approach, the scope of
amendment involves changes from ‗no disclosure‘ to ‗partial protections available to shareholders to curb abusive RPTs
exemption from disclosure‘ for transactions between can be significantly increased. Comparing shareholder
government-related entities. Effective 2012, firms are approval for RPTs between major jurisdictions, [3] indicate
required to apply MFRS124 which is a standard equivalent to that investors protection from risks of abusive RPTs are
accounting standards for RPTs prescribed by the IASB i.e. greater in certain Asian jurisdictions than in other markets
IAS24. The standard has also gone through several revisions, where RPTs receive less attention. Thus, reforms undertaken
undertaken to respond to concerns that the previous to deal with the issues surrounding substantial and related
disclosure requirements were too complex and difficult to party transactions could potentially lead to better investor
apply in practice, especially in environments where protection and greater financial reporting quality in Malaysia.
government control is pervasive [6]. The revised IAS 24 has
received positive review, especially in terms of the benefits
that it can bring to the financial reporting and disclosure on III. THE IMPORTANCE OF RPTS DISCLOSURES
RPTs. Among things that must be disclosed according to the Appropriate disclosure of RPTs is considered vital for
accounting standards include relationships between parents financial statement users to make decision and understand the
and subsidiaries, management compensation, and related impacts of the transaction on the company [10]. There are
party transactions such as the amount of the transactions, the two conflicting impacts of RPTs. Under the efficient
amount of outstanding balances, including terms and transaction hypothesis [11], RPTs are sound business
conditions and guarantees [7]. Requirement for RPTs exchanges that fulfill the economic needs of the firm. RPTs
disclosure are also detailed in Chapter 20 of the Policies and may be in the best interests of shareholders as they can reduce
Guidelines on Issue/offer of Securities by the Securities transaction costs, optimize internal resource allocation, and
Commission of Malaysia [8]. Beside definition on RPTs and improve return on assets. In this propping view, RPTs are
related parties, the guidelines contain the requirement for considered as value-enhancing mechanisms designed to
firms to: a) make an announcement containing brief details of improve efficiency. In contrast, under the principal-agency
RPTs, b) send circulars to shareholders to provide conflicts theory by Berle and Means in 1932, RPTs are
information such as the nature and types of transactions and economically harmful for the firm. RPTs that are tainted with
related parties and their relationship, which are to be attached conflict of interests can lead to the potential expropriation of
with letters of recommendation from independent directors, the firm‘s resources and are detrimental to the shareholders‘
board of directors, and independent advisers, c) obtain wealth [11]. In this tunneling view, RPTs refer to a form of
approval of its shareholders, and d) ensure that the related private benefits of control, which is used as a mean to transfer
party abstains from voting on the relevant resolutions. funds from a firm‘s resources to the hands of controlling
Chapter 10 of the Bursa Malaysia Listing Requirements shareholder (or managements) at the expense of other
sets out the requirements that must be complied by firms in stakeholders. We review RPTs information used in existing
respect of transactions that they entered into, including those studies on RPTs.
that relate to related parties. The provision in the requirement A line of study focuses on disclosure of RPTs in the annual
follows a tiered approach, where some transactions require report, by looking at the footnote information regarding
retrospective reporting, some require stock exchange RPTs. Among the items typically used to represent RPTs are
disclosure, and others require public disclosure and sales, purchases, and loans with related parties. Reference
shareholder approval. Percentage of relevant ratios is used to [12] finds support for the propping up hypothesis as the level
determine the applicable requirement. For example, firms of related sales is positively correlated with the condition that
need to make an announcement for RPTs that exceeds 0.25 firms plan to issue seasoned equity next period and the
percent of any of the percentage ratios, except in the case of condition of a decrease in the reported earnings. They also
recurring RPTs. There is also a provision for aggregation of find support for the internal capital market hypothesis as the
transactions for which small transactions are treated as one, level of related lending and guarantee is negatively correlated
and shareholder approval is required for such transactions. with the condition of an increase in capital expenditure and
Besides, there is a provision that abstain related parties from an increase in net working capital. Additionally, their
voting on the relevant resolution in respect of the related empirical results indicate that corporate governance
party transaction. moderates the relation between the motives and the level of
More recently, Bursa Malaysia have amended the Listing RPTs. Focusing on firms in Malaysia, [13] rely on the
Requirement by adding a provision for poll voting for RPTs monetary value of related asset acquisition, asset sales, equity
that require shareholder approval. Mandating poll voting for sales, trading relationship and cash payment. They show that
RPTs, which allows voting to be done on the principle of one RPTs carried out by family-owned firms are more likely to be
share one vote, gives a fairer voting ability in Malaysian used opportunistically to expropriate minority investors.
context where bulky shareholders structure is still prevalent Reference [14] finds that receivables and payables from
[9]. The inclusion of this provision is in line with the best RPTs exhibit a significant positive relationship with
practice recommended in the Malaysian Corporate performance, and sales and purchases of goods from RPTs
Governance Blueprint, which takes effect in 2012. The board exhibit a significant negative relationship with performance.
is encouraged to put substantive resolutions to vote by poll They conclude that RPTs affect enterprise value, but cannot
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International Journal of Trade, Economics and Finance, Vol. 4, No. 6, December 2013
be used to estimate the optimal results because there are RPTs, suggesting that the controlling shareholders who
many types of RPTs that typically are conducted through tunnel assets may be manipulating the information disclosure
complicated process. Hence, it becomes quite difficult for for the purpose of concealing expropriation. While majority
outsiders to accurately identify the effect of RPTs on of firms in the sample experience a reduction in value at the
corporate value. Reference [15] relies on payables and announcement of RPTs, the reduction in value is not present
receivables turnover ratio and the proportion of debt in similar arm‘s length transactions. They further find that
guarantees to total assets to represent RPTs. They find that firms that voluntarily provide more information about the
firm performance is positively associated with RPTs, but transactions earn positive excess returns.
negatively associated with RPTs which result in Our final review is on studies that focus on specific types
expropriation of firm‘s minority shareholders. In addition, of RPTs or specific settings surrounding the disclosure of
control mechanisms minimize the negative impact of RPTs. RPTs. Reference [20] only focuses on cases where a related
Their study provides the evidence that RPTs which result in party obtained a guarantee of repayment for a loan to the
expropriation of firm‘s minority shareholders exist in the related party that was unrelated to the business activities of
form of irregular credit terms and excessive loan guarantees. the listed firms. Their focus on related-party loan guarantee is
There is a provision of laws in each country that requires substantiated by the cases of expropriation through loan
firm to issue an immediate report of transactions with related guarantees in China in the period where the guarantees were
party to shareholders. The circulars to shareholders must permissible and issued by many listed companies in China
provide full details of the transaction, which is to be followed (before any issuance of new related-party guarantees is
by approval of the transaction by shareholders in a general prohibited by Chinese regulators in June 2000). They find
meeting. A line of studies refer to these circulars. Reference that Tobin‘s Q, ROA, and dividend yield are significantly
[16] analyzes the cumulative abnormal returns surrounding lower, and that leverage is significantly higher, for firms that
the announcement made by Israeli firms. The RPTs in the
issued related guarantees. Reference [21] refers to the
announcement are classified into three categories; fiscal
manipulation of transfer price in RPTs to make inferences
transaction, financial transaction, and compensation
about earnings management through RPTs, as compared to
transaction. Fiscal transaction refers mainly to buying
other studies that plainly rely on volume of related sales or
(selling) a real asset/service from (to) related parties,
abnormal related sales as a measure of earning management.
financial transaction is transactions that are of a financial
Based on the data from firms listed on Shanghai stock
nature such as loans to (from) related parties, and
compensation transaction is defined as the controlling exchange that disclose gross profit ratios of RPTs, they find
shareholders‘ salaries, bonuses, and benefits. The results that the quality of governance plays a role in determining the
show that there is similar market response (CAR) to fiscal used of manipulated transfer prices in RPTs. Reference [22]
and financial deals but, on average, a lower (negative) market examines the value relevance of RPTs disclosures before and
reaction when RPT is a managerial compensation scheme for after the adoption of IFRS in Greece. Focusing on related
a controlling shareholder. There is some evidence that the sales of goods and sales of assets, they find that the adoption
average CAR seems to be related to the type of transaction, of IFRS is perceived to be effective at reducing the potential
suggesting that RPTs are complex mechanisms. In a misuse of RPTs for earnings management purpose. The lower
study-using sample from publicly listed firms in Malaysia, valuation of RPTs observed in the 2002 – 2007 sample is not
[17] look into RPTs that needed independent advice and observed in the period after the adoption of IFRS. Reference
recurrent RPTs derived from circulars to shareholders. They [10] examines the valuation of firms that disclose RPTs prior
find that RPTs are detrimental to shareholders and thus to the Sarbaney-Oxley Act ban on RP loans. They classify
reducing firm performance, but the negative effect is RPTs into three categories; loans, other simple transactions
mitigated with the presence of good governance. and complex strategic transactions. They also classify RPTs
Another set of studies rely on RPTs in corporate filings, according to whether the transaction is with director, officer,
which refer to the notification submitted to the stock and shareholder, or with unconsolidated investment of the
exchange regarding the RPTs. Reading the filings allow firm. They find that RP firms have significantly lower
researcher to evaluate the extensiveness of RPTSs valuations and marginally lower subsequent return than
information [18]. By deriving data from filings of connected non-RP firms. Additionally, they find that market perceptions
transactions, [18] and [19] are able to classify connected differ based on partitioning firms by RP transaction type and
transactions into three categories: a) transactions that are a parties. Market views firms that disclose RP loans and other
priori to result in expropriation (asset acquisitions, asset simple transaction with a director, officer, and shareholders
sales, equity sales, and trading relationships and cash negatively, but disclosure of complex RPTs and RPTs with
payments), b) transactions that are likely benefit the listed firm investments is not associated with valuations or returns.
firms (cash receipts and subsidiary relationships), and c) In similar vein, [23] compare the value relevance of RPTs
transactions that may have been driven by strategic rationales disclosure before and after the ‗2001 PRT Measurement
(takeover offers and joint ventures, joint venture stake Regulation‘ in China. The findings indicate that the
acquisitions and sales). Reference [19] further categorizes regulation is perceived to effective by investors in controlling
these transactions into tunneling or propping activities. They opportunistic earnings management behaviors by managers.
find that there are more tunneling than propping in their In general, research on RPTs has relied on various sources
sample of filings by Chinese listed companies. They also find of RPTs information. Majority of the research focuses on
that value destroying RPTs are accompanied by significantly RPTs disclosed in the annual reports, although there are more
less information disclosure as compared to the remaining disclosures that can be derived from filings and circulars.
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International Journal of Trade, Economics and Finance, Vol. 4, No. 6, December 2013
IV. ISSUES ON RPTS DISCLOSURE appears to happen because more specific guidance is
The requirements for RPTs disclosure are set to inform provided in SEC regulation as compared to the accounting
shareholders on RPTs, for the purpose of protecting their standards on RPTs. Comparison between footnote firms and
interest. While firms generally comply with the disclosure proxy firms indicate that material considerations drive the
requirement, there are issues surrounding such disclosure. differences in RPTs disclosures. More common and less
The first issue is on the level of compliance with mandatory complex RPTs are more likely to receive proxy statement
information and the practice of providing voluntary disclosures, as compared to less common and more complex
information. While reforms on accounting standards may RPTs.
improve the quality of disclosure on RPTs, there are concerns Thirdly, not all RPTs are of similar nature. For example,
that firms adopt the standards at varying levels. In the case of analysis on RPTs in the proxy statements shows that RPTs
the Philippines, [24] investigates the extent of compliance vary according to transaction type [10]. Different types of
with the disclosure requirement of IAS24. Using data on RPTs require different level of disclosures, especially when
related party relationships, related party transactions, and the disclosure is associated with different underlying
compensation of key management personnel, the average incentives and has differential effect on the firm. As
disclosure for RPTs is 0.70 with the lowest at 0.33 and the discussed above, [19] which categorize RPTs into tunneling
highest at 1. Thus, there is deficiency in the compliance of or propping activities indicate that disclosure of information
disclosure requirements per IAS 24, especially related to differs between those two types of transactions. They
disclosures on doubtful accounts, other long term benefits, suggest that manipulation of information disclosure may be
and termination benefits. Meanwhile, firms may opt to used by controlling shareholders to conceal expropriation.
provide information beyond the mandatory requirement. Reference [10], which classifies RPTs into loans, other
Reference [25] investigates the voluntary disclosures of the simple transactions and complex strategic transactions, find
pricing methods of RPTs, in the setting where the regulations that market perceptions differ according to types of RPTs and
encourage but do not require listed companies to disclose the related parties. They find that market views firms that
pricing policies and related details. They find that earnings disclose RP loans and other simple transaction with a
management and its incentives, board composition, and director, officer, and shareholders negatively, but disclosure
ownership structure significantly influence the voluntary of complex RPTs and RPTs with firm investments is not
disclosure decisions of managers. associated with valuations or returns. Reference [14] finds
In similar vein, the issue of the variation in the level of that receivables and payables from RPTs exhibit a significant
compliance exists in the context of complying with listing positive relationship with performance, and sales and
requirements. Reference [24] compares some relevant purchases of goods from RPTs exhibit a significant negative
Paragraphs of Bursa‘s Listing Requirement to a series of relationship with performance. They conclude that RPTs
announcement of companies and various trails of affect enterprise value, but cannot be used to estimate the
transactions. Based on her analysis, she raised up several optimal results because there are many types of RPTs that
peculiarities. For example, she cited a case where a person is typically are conducted through complicated process. Hence,
a director or chairman on both sides of the transaction but it becomes quite difficult for outsiders to accurately identify
doesn‘t own any shares in either company, such transaction is the effect of RPTs on corporate value. Reference [16], which
not considered RPT. There is a case where firms can simply classifies RPTs into fiscal transaction, financial transaction,
state that they are not unable to disclose an exact date of a and compensation transaction, finds that the average CAR
contract due to confidentiality. The details of the valuations related to the type of transaction. They suggest that RPTs are
are also neglected in the cases where the purchase complex mechanisms.
consideration was ‗negotiated on a willing buyer, willing Overall, there are variations in the level of disclosure of
seller bases. While a higher level of transparency is required RPTs information. Prior research that only relies on the
for transactions involving related parties, the peculiarities monetary value of RPTs neglects the fact that non-monetary
that exist in practice raised the issue regarding the information provides more details about such transaction.
motivations and incentives behind disclosure or This is a concern because non-monetary information may be
non-disclosure of RPTs. required to distinguish whether RPTs are value-enhancing or
Secondly, comparison between RPTs of information from value-destroying activities. We recommend future research
different avenues indicates that the level of disclosure differs. on RPTs to consider non-monetary information, such as the
One of the main reasons would be that while the accounting related parties involved in the transaction, in measuring
standard is very much a principle-based approach, the stock RPTs. Further, the level of RPTs disclosure is influenced by
exchange regulations are rule-based approach. Reference the managerial incentive behind such disclosure. As a higher
[10] indicates that many companies do not report RPTs in the level of transparency is required for transactions involving
financial statement, but choose to disclose RPTs in their related parties, we recommend future research to develop a
annual proxy statements. The differences in the disclosure voluntary disclosure index for the purpose of measuring the
can be explained by materiality based on monetary levels. breadth and depth of RPTs information [26].
Reference [11] reviews RPTs disclosure in the annual reports
and proxy filings of the S&P 1500 firms. They find that a
majority of companies (66 percent) disclose RPTs V. CONCLUSION
information only on their proxy statement, 20 percent Our study reviews existing regulation that surrounds RPTs
disclose all RPTs in their footnotes, and 12 percent reports disclosure practise by looking into the accounting standards
unique RPTs in both the proxy statement and footnotes. This on RPTs, listing requirement, and security commission‘s
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International Journal of Trade, Economics and Finance, Vol. 4, No. 6, December 2013
guidelines. We also examine measures of RPTs being used in Financial Economics), Eds. K. John and A. K. Makhija, Emerald
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empirical research that analyzed the economic consequences [18] Y.-L. Cheung, P. R. Rau, and A. Stouraitis, "Tunneling, propping, and
of RPTs information. We find that the level of RPTs expropriation: evidence from connected party transactions in Hong
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[20] H. Berkman, R. A. Cole, and L. J. Fu, "Expropriation through loan
voluntary disclosure index to understand more about the guarantees to related parties: Evidence from China," Journal of
breadth and depth of the RPTs information. Banking & Finance, vol. 33, no. 1, pp. 141-156, 2009.
[21] A. W. Y. Lo, R. M. K. Wong, and M. Firth, "Can corporate governance
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