Related party transactions and corporate governance
01 Dec 2004-Vol. 9, pp 1-27
TL;DR: In this paper, the authors explore two alternative perspectives of related party transactions: the view that such transactions are conflicts of interest which compromise management's agency responsibility to shareholders as well as directors' monitoring functions; and a view that these transactions are efficient transactions that fulfill rational economic demands of a firm such as the need for service providers with in-depth firm-specific knowledge.
Abstract: Transactions between a firm and its own managers, directors, principal owners or affiliates are known as related party transactions. Such transactions, which are diverse and often complex, represent a corporate governance challenge. This paper initiates research in finance on related party transactions, which have implications for agency literature. We first explore two alternative perspectives of related party transactions: the view that such transactions are conflicts of interest which compromise management’s agency responsibility to shareholders as well as directors’ monitoring functions; and the view that such transactions are efficient transactions that fulfill rational economic demands of a firm such as the need for service providers with in-depth firm-specific knowledge. We describe related party transactions for a sample of 112 publicly-traded companies, including the types of transactions and parties involved. This paper provides a starting point in related party transactions research.
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TL;DR: In this paper, the authors examined 43 SEC enforcement actions against auditors related to the examination of related-party transactions and concluded that the audit failures in these fraud cases were more the result of a lack of auditor professional skepticism and due professional care than any deficiency in current auditing standards.
Abstract: SUMMARY: After several high-profile frauds involving related-party transactions, regulators have raised questions as to whether current auditing standards remain appropriate. In this study, we examine 43 SEC enforcement actions against auditors related to the examination of related-party transactions. We conclude that the audit failures in these fraud cases were more the result of a lack of auditor professional skepticism and due professional care than any deficiency in current auditing standards. In other words, revised auditing standards would likely not have prevented these auditing failures, raising questions about the need for auditing standard revision for related-party transactions at this time. Despite this finding, we conclude with some suggestions to improve the auditing of related-party transactions, such as including the discussion of related-party transaction abuse during SAS No. 99 mandated fraud awareness “brainstorming” sessions.
43 citations
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TL;DR: In this paper, the authors consider three types of tunneling: cash flow tunneling, where insiders extract some of the firm's current cash flows, asset tunneling and equity tunneling where insiders acquire equity at below market price, either from the firm through an equity issuance or from other shareholders, often in a freezeout.
Abstract: I. INTRODUCTION Managers and controlling shareholders (insiders) can extract (tunnel) wealth from firms using a variety of methods. Tunneling occurs across both developed1 and developing2 markets, and impacts both trading prices and premia paid for corporate control.3 This Article studies how effectively United States' rules limit tunneling by insiders of public companies. We consider three broad types of tunneling: cash flow tunneling, in which insiders extract some of the firm's current cash flows; asset tunneling, in which insiders buy (sell) assets from (to) the firm at below (above) market prices; and equity tunneling, in which insiders acquire equity at below market price, either from the firm through an equity issuance or from other shareholders, often in a freezeout. We also examine how a broad set of rules, including corporate, securities, accounting, tax, and creditor protection rules, impact each type of tunneling. Prior law and finance literature discuss the potential anti-tunneling role of these sources, but not how they affect particular types of tunneling. Also, creditor protection rules have been seen as important only to protect creditors. However, as we develop below, they also have an important role in indirectly protecting minority shareholders.4 Prior research on the strengths of anti-tunneling protections in the United States is usually limited to a single type of tunneling. For example, one literature discusses freezeouts,5 another discusses executive compensation,6 and a third discusses the weak protections for minority shareholders in private companies.7 Ronald Gilson and Jeffrey Gordon discuss generally how to limit the power of controlling shareholders, but focus on freezeouts and sales of control.8 Most studies also consider only corporate and securities law.9 In contrast, this Article studies how a broad set of rules affects a broad range of tunneling transactions. This breadth comes at a cost as we delve less into the details of specific regulations or types of transactions. But this breadth lets us develop a theme that has not been expressly recognized: U.S. rules do not effectively limit the full range of tunneling transactions. We use case studies to illustrate where current rules permit tunneling. In cash flow tunneling, for example, entire fairness review under corporate law has some bite. Corporate tax law limits pyramid structures, and thus incentives and opportunities for cash-flow tunneling within business groups, but is less effective in limiting cross-border transfers through creative transfer pricing. Securities law and accounting rules ensure some disclosure of related party transactions, but the disclosure can often be generic and leave investors in the dark about transaction fairness. For asset tunneling, disclosure is often limited, and corporate law leaves substantial room for transactions at off-market prices. The principal protection against mispriced transactions is review by independent directors, but if shareholders can do little, the insiders can fool or co-opt them. Bankruptcy law provides some protection against asset tunneling for failing firms. Equity tunneling through freezeouts is relatively well-controlled, but creative insiders can extract value through recapitalizations, and can extract a surprising amount of value over time through equity-based executive compensation. Written broadly, current U.S. rules block some brute-force schemes that might succeed in less developed markets, but often permit more complex schemes to succeed. We propose rule changes to address the principal gaps that emerge from our analysis. We limit the scope of this project to public companies and U.S. rules. We do not study special rules for particular industries. We do not consider tunneling by equity holders from debt holders, or vice-versa.10 However, our taxonomy of tunneling is not limited to the United States. Our analysis is whether a broad set of rules, taken together, can control particular forms of tunneling and whether the rules are adaptable to other countries. …
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TL;DR: In this article, the authors investigate the relationship between tax avoidance and tunneling from a principal-principal agency perspective and find that corporate tax avoidance is positively associated with tunneling after controlling for firm characteristics, corporate governance, and institutional factors that affect tunneling.
Abstract: Taking advantage of the agency conflicts between controlling shareholders and minority shareholders and the weak corporate governance in a transition economy, we investigate the relationship between tax avoidance (proxied by effective tax rates) and tunneling (proxied by related-party lending) from a principal-principal agency perspective. We find that corporate tax avoidance is positively associated with tunneling after controlling for firm characteristics, corporate governance, and institutional factors that affect tunneling. This relationship is more pronounced for firms with cash shortages and in periods with relatively weak investor protection. In addition, the value-enhancing implications of tax avoidance are reduced for firms in which tax avoidance is highly correlated with tunneling. By demonstrating the existence of tunneling-related tax avoidance and its economic consequences, this study sheds light on the emerging agency perspective on tax avoidance. JEL Classifications: G18; H20; M41.
39 citations
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TL;DR: In this paper, the authors analyze the incentives of large shareholders to implement the corporate governance system that favors their interests within a framework of highly concentrated ownership and poor legal protection for investors.
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TL;DR: In this article, a new scoring framework designed by the Asia Pacific Real Estate Association (APREA) was employed to examine the link between corporate performance and quality of corporate governance among externally managed REITs listed on the Singapore Stock Exchange (S-REIT).
Abstract: This paper employs a new scoring framework designed by the Asia Pacific Real Estate Association (APREA) to examine the link between corporate performance and quality of corporate governance among externally managed REITs listed on the Singapore Stock Exchange (S-REITs). The empirical tests provide evidence supporting a positive correlation between corporate governance practices and stock performances. However, we find no positive correlation with operating performance proxied by accounting measures. In other words, S-REITs with higher corporate governance tend to register better risk-adjusted returns but do not outperform operationally. To test for market efficiency, the study shows that S-REITs with the best corporate governance practices also have less information asymmetry.
37 citations
References
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TL;DR: In this article, the authors draw on recent progress in the theory of property rights, agency, and finance to develop a theory of ownership structure for the firm, which casts new light on and has implications for a variety of issues in the professional and popular literature.
49,666 citations
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TL;DR: The authors argue that the separation of decision and risk-bearing functions observed in large corporations is common to other organizations such as large professional partnerships, financial mutuals, and nonprofits. But they do not consider the role of decision agents in these organizations.
Abstract: ABSENT fiat, the form of organization that survives in an activity is the one that delivers the product demanded by customers at the lowest price while covering costs.1 Our goal is to explain the survival of organizations characterized by separation of "ownership" and "control"-a problem that has bothered students of corporations from Adam Smith to Berle and Means and Jensen and Meckling.2 In more precise language, we are concerned with the survival of organizations in which important decision agents do not bear a substantial share of the wealth effects of their decisions. We argue that the separation of decision and risk-bearing functions observed in large corporations is common to other organizations such as large professional partnerships, financial mutuals, and nonprofits. We contend that separation of decision and risk-bearing functions survives in these organizations in part because of the benefits of specialization of
14,045 citations
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01 Jan 1932TL;DR: Weidenbaum and Jensen as mentioned in this paper reviewed the impact of developments not fully anticipated by Berle and Means, such as the rise of the service sector, and the significant role played by institutional investors in the owner/manager equation.
Abstract: This monumental work on the corporation is one of those enduring classics that many cite but few have read. Graced with a new introduction by Weidenbaum and Jensen, this new edition makes this classic available to a new generation. Written in the early 1930s, The Modern Corporation and Private Property remains the fundamental introduction to the internal organization of the corporation in modern society. Combining the analytical skills of an attorney with those of an economist, Berle and Means raise the central questions, even when their answers have been superseded by changing circumstances. The book's most enduring theme is the separation of ownership from control of the modern corporation and its consequences. Berle and Means display keen awareness of the divergent interests of directors and managers, and of each from owners of the firm. Among their predictions are the characteristic increase in size of the modem corporation and concentration of the economy. The authors view stock exchanges and stock markets as essential by-products of the rise of the modem corporation, and explore how these function. They address the difficult questions of whether corporations operate for the benefit of owners or managers, and explore what motivates managers to make effective use of corporate assets. Finally, they examine the role of the corporation as the prevailing form of organizing the production and distribution of goods and services. In their new introduction, Weidenbaum and Jensen, co-directors of the Center for the Study of American Business at Washington University, critically assess the impact of developments not fully anticipated by Berle and Means, such as the rise of the service sector, and the significant role played by institutional investors in the owner/manager equation. They note the authors' prescient observations, including the complex role of and motivating influences on professional managers, and the significance of inside information on stock markets. As they note, The Modern Corporation and Private Property remains of central value to all those concerned with the evolution of this major social institution of the twentieth century. Scholar and practitioner alike will find it of enduring significance.
10,159 citations
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TL;DR: In this article, the authors explain how the separation of security ownership and control, typical of large corporations, can be an efficient form of economic organization, and set aside the presumption that a corporation has owners in any meaningful sense.
Abstract: This paper attempts to explain how the separation of security ownership and control, typical of large corporations, can be an efficient form of economic organization. We first set aside the presumption that a corporation has owners in any meaningful sense. The entrepreneur is also laid to rest, at least for the purposes of the large modern corporation. The two functions usually attributed to the entrepreneur--management and risk bearing--are treated as naturally separate factors within the set of contracts called a firm. The firm is disciplined by competition from other firms, which forces the evolution of devides for efficiently monitoring the performance of the entire team and of its individual members. Individual participants in the firm, and in particular its managers, face both the discipline and opportunities provided by the markets for their services, both within and outside the firm.
8,222 citations
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TL;DR: In this paper, the authors show that standard errors of more than 3.0% per year are typical for both the CAPM and the three-factor model of Fama and French (1993), and these large standard errors are the result of uncertainty about true factor risk premiums and imprecise estimates of the loadings of industries on the risk factors.
6,064 citations
"Related party transactions and corp..." refers methods in this paper
...We define industries following Fama and French (1997)....
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