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The IUP Journal of Applied Finance

Do Board Characteristics and Ownership Structure Influence Related Party Transactions? Evidence from India

Article Details

Pub. Date	: Oct, 2021
Product Name	: The IUP Journal of Applied Finance
Product Type	: Article
Product Code	: IJAF11021
Author Name	: Aleksandar Vasilev
Availability	: YES
Subject/Domain	: Finance
Download Format	: PDF Format
No. of Pages	: 22

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Abstract

Many corporate scandals, including Satyam scam, raised considerable concern about Related Party Transactions (RPTs). The hypotheses associated with RPTs say that RPTs have dual effect, transaction efficiency and conflicts of interests. RPTs increase transaction efficiency by reducing the transaction cost, but the conflicts of interest hypothesis says that the controlling shareholders may use RPTs to transfer firm resources for their private benefit. The literature says that both the internal and external governance mechanism of firms and ownership characteristics have a significant impact on the decision to enter RPTs. The best governance practices can transform abusive RPTs into efficient transactions. This paper examines the impact of governance mechanism and ownership structure on the size of RPTs. The empirical findings of the study prove that both the governance and ownership characteristics have a significant impact on the size of RPTs.

Description

A related-party transaction is a transfer of resources, services, or obligations between related parties, regardless of whether a price is charged (Ind-AS 24). A firm's transaction towards its managers, subsidiaries, directors, and affiliates is always a reason for concern because they may violate the principle of arm's length pricing to divert firm resources for their benefit (Gordon et al., 2004; Cheung et al., 2009; Chen et al., 2011; and Elkelish, 2017) which makes these types of transactions more complex and diverse. On the other hand, Related Party Transactions (RPTs) are considered efficient business transactions because they reduce transaction cost and create an internal market within corporate groups (El-Helaly, 2016). Hwang and Kim (2016), Downs et al. (2016) and Yaron et al. (2016) claim that RPTs are not harmful and these are ordinary business transactions conducted for business purposes which help to improve firm performance. The corporate failures-Satyam (India), Enron (USA) and Tyco (Ireland)-show that RPTs are one of the ways used by the controlling owners to expropriate firms' resources for their private benefit. RPTs are harmful to the firm only when they are the result of the conflict of interest between controlling and minority shareholders. The dual effects of RPTs increase the role of regulators and auditors to control the abusive RPTs and facilitate RPTs which improve firms' operating efficiency. A sound governance mechanism is essential for monitoring RPTs. The literature says that RPTs which result from the opportunistic behavior of the controlling shareholders worsen firms' performance and negatively affect the wealth of the firm. The available evidence also shows that the managers