Related parties transactions

and rms market value:

the French case
Mehdi Nekhili
Rouen Business School, University of Reims Champagne-Ardenne,
Reims, France, and
Moez Cherif
University of Jendouba, Jendouba, Tunisia
Abstract
Purpose The purpose of this article is to study the impact of the related parties transactions
(RPTs) on rm value, and to identify the ownership and governance characteristics of companies that
engage in this type of transactions.
Design/methodology/approach The paper uses 3SLS simultaneous model carried out on a
sample of 85 companies listed on the Paris Stock Exchange during the period 2002-2005.
Findings The results show that RPTs are mainly inuenced by the voting rights held by the main
shareholder, the size of the board of directors, the degree of independence enjoyed by the audit
committee and the board of directors, the choice of external auditor, the debt ratio and the fact of being
listed in the USA. Mainly the transactions carried out directly with the main shareholders, directors
and/or managers that have a negative inuence on rm value.
Research limitations/implications In future studies, it will be interesting to test the impact of
the level of expertise as well as the level of qualication in the eld of accounting and nance of the
members of the French audit committees on the frequency of RPTs.
Originality/value The current research complements prior studies on the RPT by showing that
the frequency of RPTs can be damaging to companies and can destroy their market value.
Keywords Related party transactions, Minority expropriation, Ownership structure, Governance,
Firm value, France
Paper type Research paper
1. Introduction
Apart from their declared motives, related parties transactions (RPTs) can mask stakes
related to the enrichment of one party at the expense of other parties that are not
involved in the transaction. They may, thus, lead to the expropriation of minority
shareholders, to the benet of controlling shareholders, directors or administrators.
These groups can make prots by selling to the rm (or buying from it), assets, goods
or services, at prices higher (lower) than the market price. They can also obtain loans
on favorable terms (La Porta et al., 2003), use the rms assets as security for their
personal loans, and even dilute the interest of minority shareholders by acquiring
additional shares at preferential prices ( Johnson et al., 2000a, b). Both prots and assets
can be transferred via transactions between rms belonging to the same group. The
transfer of wealth goes from rms located at the bottom of the pyramid towards those
located at the top, where the ownership rights of the principal shareholders are higher
(Bebchuk et al., 2000). The empirical bases of the opportunism of these transactions
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Review of Accounting and Finance
Vol. 10 No. 3, 2011
pp. 291-315
qEmerald Group Publishing Limited
1475-7702
DOI 10.1108/14757701111155806
extend from the emerging economies, known for the weakness of their systems of
governance (Chang, 2003; Jian and Wong, 2004), to countries in Europe (Faccio and
Lang, 2002; Johnson et al., 2000a, b; Marco and Mengoli, 2004) or America (Shastri and
Kahle, 2004; Gordon et al., 2006). Thus, it has been shown, in accordance with the idea
of diversion of resources by related parties that, as a reaction to these transactions,
minority shareholders carry out a reduction in the value of securities, which in turn
leads to a signicant decrease in the value of the rm. This has been the case for rms
from America (Kohlbeck and Mayhew, 2010; Gordon et al., 2006), China ( Jian and
Wong, 2004), Hong Kong (Cheung et al., 2006) and Taiwan (Lin et al., 2010).
France holds a certain interest for the study of RPTs. This choice of eld of study
can be justied for at least two reasons. First, the degree of protection afforded to
investors if relatively low in France. Indeed, La Porta et al. (2000) characterize France
as a country that offers a low level of protection to minority shareholders. With regard
to the protection of minorities and corporate governance, the institutional differences
between the various countries concerned constitute, for us, an additional stimulus, the
more so because our research is close to that of Gordon et al. (2006), which was carried
out in a different context, namely, the USA. In our study, the distinguishing feature is
the integration of certain governance mechanisms (such as audit committees). These
mechanisms are all the more regulated in the USA, in that there is no longer any
difference in practice between American rms. The choice still offered to French rms,
regarding the adoption of certain governance practices makes a study of them
interesting, in relation to RPTs. Second, the Paris Stock Exchange is dominated by
closely held corporations (Claessens et al., 2000; Bloch and Kremp, 2001; Faccio and
Lang, 2002; Broye and Schatt, 2003). This ownership structure favors the expropriation
of minority shareholders. In this respect, our study differs from that of Gordon et al.
(2006) by emphasizing more the conicts between majority and minority shareholders.
In fact, when ownership is concentrated, conicts between directors and shareholders
are transformed into conicts between majority and minority shareholders.
The aim of our article is to study the impact of the use of RPTs on a companys
value. The frequency of RPTs is an endogenous variable explained by ownership and
governance characteristics. The results of the regression analyses carried out on a
sample of 85 French companies quoted on the Paris Stock Exchange during the
2002-2005 period show that RPTs are mainly inuenced by the concentration of voting
rights, the presence of an audit committee and the degree of independence exercised by
the audit committee and the board of directors, and by the choice of external auditor.
After a certain amount of segmentation within our sample, our results show that it is
principally those transactions directly carried out with the main shareholders, board
members and directors that have a negative impact on the companys value. Among
the governance mechanisms we adopted for our study, only joint-auditing by two of
the Big Four audit rms proved to be effective in reducing the frequency of RPTs.
The paper is organized as follows. Section 2 introduces the theoretical and
conceptual framework of our study. We begin with the identication of the relevant
parties, and an examination of the relationship between the risk of fraud and RPTs.
If this relationship is conrmed, it should manifest itself through a negative impact on
the frequency of RPTs on the market value of a rm. In this section also, we cover the
ownership and governance characteristics that are thought to inuence these
transactions. The ownership characteristics adopted for our study are the separation
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of ownership and control, the percentage of voting rights held by the main
shareholders and the fact of belonging to a group or not. As governance characteristics,
we adopt the size of the board of directors, the presence or not of external directors on
the board and in the audit committee, the fact of being listed in the USA or not, the
quality of the audit and the debt ratio. Section 3 concerns the methodological approach.
We introduce, successively, the sample, the period under analysis, the variables and
the descriptive statistics. In Section 4, we introduce the model and we discuss the
empirical results. Our study concerns a period following the promulgation of the 2001
law known as NRE, on new economic regulations, and the law known as Financial
Security Law (LSF), on nancial security, which today regulate RPT transactions in
France. Finally, Section 5 summarizes and concludes the paper.
2. Theoretical and conceptual framework
2.1 RPT: denition and risk of expropriation of minority shareholdings
2.1.1 Denition of related parties and of RPTs. A transaction with a related party
involves a company and another entity to which it is related, such as, for example,
a controlling shareholder, a director, a manager, etc. or also companies under their
control, or with which they are afliated, together with other companies controlled by
the company itself. Agreements between two companies with the same directors are
also subject to the provisions for regulated agreements. To this should also be added
agreements concluded between two companies when one of the corporate
representatives of one company (director, chairman of the board or CEO) is also the
owner of, a partner in or a director of the other company. RPTs involve all transactions
of this nature, whether major or marginal. In practice, the denitions, for legal
purposes, of related party and related party transaction, as also the rules for listing
and accounting standards, vary from country to country. In France, RPTs are
governed by Article L. 225-38 of the new commercial code, adopted in September 2000,
which concerns regulated party agreements. A regulated party agreement is:
Any agreement entered into, either directly or through an intermediary, between the
company and its general manager, one of its assistant general managers, one of its directors,
one of its shareholders holding a fraction of the voting rights greater than 5% or, in the case
of a corporate shareholder, the company which controls it within the meaning of Article L.
233-3[1], must be subject to the prior consent of the board of directors. The same applies to
agreements in which a person referred to in the previous paragraph has an indirect interest.
In France, such transactions are subject to a special report drawn up by the auditor, who
is asked to match the information provided with the original documents it arises from, in
order to draw up a report on agreements made and intended for the general meeting of
the shareholders, who decide whether to approve the RPT or not[2]. The auditor,
therefore, has a mission to provide information, and must in no case give an opinion
on the utility, the merit or the advisability of the agreements. Agreements with no prior
authorization are more difcult to identify, but the auditor is not expected to conduct any
thoroughgoing search for them. Vigilance must simply be exercised during the usual
checks.
In France, in the last fewyears, the regulatory provisions concerning these questions
have been modied considerably. The new economic regulations (NRE) law of 2001
enlarged the scope of the list of people who are required to respect the regulated
agreements procedure when carrying out a transaction with the company beyond
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the group of managers and directors, in particular so as to include certain shareholders
holding a fraction of the voting rights greater than 5 percent. The LSF no. 2003-706 of
1 August 2003, represented a retreat with regard to transparency, by exempting
transactions concerning current operations that are concluded in normal circumstances.
In addition, the threshold for the compulsory submission for approval of agreements
made with a shareholder was raised from a 5 percent holding of voting rights to
10 percent. Finally, this law makes no judgment on transactions and their probable
effects on the wealth of minority holdings. It should also be noted that, since the LSF
law, auditors no longer classify operations with related parties known as current, and
which were concluded, under normal circumstances, in the category of regulated
agreements, and do not therefore signal them in their special report on regulated
agreements. In general, current operations are carried out with the company within the
context of its activity, and in so-called normal conditions.
2.1.2 RPT and the risk of fraud. At this time, there is no formal procedure companies
can follow in order to inform the market whether they check their activities with related
parties, and if so, how this is done. Where RPTs are concerned, internal checking
systems are inadequate (Gordon et al., 2006). National and international standards, stock
market authorities and legislation supplement, duplicate and sometimes contradict each
other, but all aim to improve the quality of the information supplied to the users of
nancial statements, and to make it compulsory to publicize these transactions where
they are likely to affect the companys results and, consequently, its nancial situation.
Moreover, expropriation is more likely to happen when it is difcult to detect
(Mitton, 2002). Although studies on results management and creative accounting have
proliferated in the last 15 years, the links between results management and RPT have
received very little attention. In this eld, the studies by Gordon et al. (2006) and
Henry et al. (2007) represent an advance in the understanding of the challenges RPTs
within companies present, with regard to the management of results and the production
of fraudulent nancial documents. RPTs, then, may be considered to represent a tool
for managing results with a view to presenting them to third parties with acceptable or
favorable nancial statements, or for transferring a companys results to other parties,
thereby removing prots, or losses, fromthe nancial statements. RPTs may, indeed, be
used to enable companies to present results that comply with the demands of the
managers, who are themselves obliged to meet the expectations of investors or creditors.
Although the fact that RPTs have taken place does not in itself constitute a proof of
fraud, it remains the case that some RPTs can be used to produce fraudulent documents
(Henry et al., 2007). For Moyes et al. (2005), the existence of RPTs is, in the eyes of internal
auditors, an indication of the risk of fraud or opportunism. Among the large number of
risk factors identied in standard SAS 99, the 77 internal auditors interviewed by the
authors classied the existence of RPTs as the second most important with regard to
opportunism, and the fth most important with regard to fraud.
2.1.3 RPT and the companys value. While the shareholders who control the capital
may divert the resources of a quoted company via RPTs, it would seem that minority
shareholders, as a reaction to these transactions, may effect a depreciation of the
companys share value, thereby entailing a signicant decrease in the companys value.
Cheung et al. (2006) examined a sample of 375 transactions between rms quoted on
the Hong Kong exchange and their main shareholders and directors in the period
1998-2000. The authors distinguished three categories of RPT:
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(1) transactions that a priori result in the expropriation of the rms minority
shareholders (acquisition/sale of assets, commercial relations, etc.);
(2) transactions that may be to the advantage of the minority shareholders of the
quoted company (cashing of liquid assets and relations with subsidiaries); and
(3) transactions that are carried out for strategic reasons and which therefore have
no purpose of expropriation (takeover bids and alliances with equity
investment, acquisitions and sales of shareholdings in shared subsidiaries).
Over a period of 12 months following the announcement of these transactions,
Cheung et al. (2006) found that returns were negative, and signicant. Compared with
similar transactions with unrelated parties over the same period, RPTs are associated
withlower returns. JianandWong(2004) concur andshow, onthe basis of 137 companies
quoted in China between 1997 and 2000, that loans grated to related parties have a
signicant negative effect on the value of the rm, measured by the market-to-book
ratio (the ratio between the market value and the book value of the shareholders equity).
Gordon et al. (2006) examined the relationship between RPTs and the value of
112 companies quoted in the USA over the period 2000-2001 (the period before the
promulgation of the Sarbanes-Oxley Act in 2002). They also found that abnormal stock
market yields are negatively associated with RPTs. This result was obtained for
transactions carried out with both executive and non-executive directors. Furthermore,
there is a negative relationship between industry-adjusted yields and loans granted
to executive and non-executive directors. Kohlbeck and Mayhew (2010) also nd, in a
sample of 1,261 American rms, that transactions with the companys directors,
managers and main shareholders result in negative yields. In addition, annual yields on
shares associated with the sales of goods and services to relatedparties are lower than on
those associated with sales to unrelated parties. At the international level, Dahya et al.
(2008) examined 782 companies from countries where investor protection is low, and
which had one controlling shareholder above the 10 percent threshold. The authors
found that, in general, the companies that do not use RPTs have a higher value than
those having recourse to such transactions:
H1. RPTs negatively affect the companys market value.
2.2 Ownership and control characteristics and RPT
2.2.1 Separation between ownership-control and RPT. RPTs are more likely to occur in
companies where the main shareholders have both the incentive and the power to
expropriate minority shareholders. When the voting rights of the main shareholders
increase, they can indulge in transactions that are favorable to them, to the detriment of
minority shareholdings (Claessens et al., 2000). Cheung et al. (2006) showed that rms
in Hong Kong that engage in RPTs are liable to lead to the expropriation of minority
shareholdings, and to have a high level of concentration of equity ownership in the
hands of the rms main shareholder. In France, Le Maux (2004) found that the fact
that the controlling coalition was at the same time the majority in terms of equity
holding (with a threshold of 40 percent) and in terms of representation on the board of
directors, led to a signicantly increased use of RPTs. According to Le Maux (2004),
this result shows that the controlling coalition, secure in the knowledge that it will not
have to deal with any potential takeover bid, uses all the powers available to it in order
to extract as much wealth for itself, to the detriment of minority shareholders.
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In France, few companies have dispersed capital (Faccio and Lang, 2002;
La Porta et al., 1999). In their study of 402 companies oated on the stock exchange
between 1986 and 2000, Broye and Schatt (2003) found that the main shareholder held,
on average, 48.83 percent of the shares (median value 50.64 percent), as against
14.02 percent (median 12.13 percent) for the second biggest shareholder, often a member
of the same family, or the co-founder of the company. In addition, they reported that
64.82 percent of companies are controlled by families, against only 14 percent with
dispersed shareholdings. These results conrm those that Bloch and Kremp (2001)
obtained with a sample of CAC 40 quoted companies, which showed that the average
holdings of banks, insurance companies and other institutions were particularly large.
Further to this, Faccio and Lang (2002) showed that, in half of all cases, the main
shareholder alone held the majority of voting rights in French companies, whereas the
average for cash-ow rights was 46.68 percent. For these authors, the degree of
separation between the ownership and control of equity corresponds to the degree to
which minority shareholders are vulnerable to expropriation by the main shareholder:
H2a. Separation of ownership and control of the main shareholder favors RPTs.
H2b. The main shareholders voting rights favor RPTs.
2.2.2 Afliation to a group and RPTs. Shareholders that control the capital can increase
their voting rights relative to their cash-ow rights, by the formation of groups with a
pyramid structure (Faccio and Lang, 2002). Claessens et al. (2006) highlight the fact
that RPTs are more numerous in companies that are afliated with a group. Groups are
characterized by the development of an internal capital market, which is essential for
the nancing of transactions between member companies. Scharfstein and Stein (2000)
speak of the dark side of the internal capital market, to emphasize its role in the
development of RPTs at the group level. Several authors, in fact, have shown that
transactions between companies in the same group are used as a way to manage
results ( Johnson et al., 2000a, b; Jian and Wong, 2004; Khanna and Yafeh, 2005;
Thomas et al., 2004), or to divert substantial free cash ow, by transferring the
investment capital of divisions with strong growth potential to divisions with weak
potential (Chang, 2003; Friedman et al., 2003; Jian and Wong, 2004; Marco and Mengoli,
2004; Liu and Lu, 2007). When certain rms generate large amounts of free cash ow,
they can divert these resources by offering loans to other members of the group on
favorable terms. Bianchi et al. (2002), based on a sample of 728 rms quoted in Italy in
1996, showed that the debt incurred by one of a groups subsidiaries can be used to
nance another. Internal loans, on favorable terms, are used to the advantage of the
rms held by the dominant shareholder. This operation is carried out with the sole
purpose of increasing the volume of assets controlled by the dominant shareholder. In
these conditions, the minority shareholders of the subsidiary dominated by the
controlling shareholder assume, without proting from, a signicant amount of the
debt servicing. The study by Marco and Mengoli (2004) showed that, in the 1989-1996
period, the sale of shares within Italian groups with pyramid structures was a means
for transferring the wealth of the minority shareholders to the advantage of those
controlling the capital. Thus, when acquisition and sale operations between
the different elements in the group are carried out, the price is set in such a way as
to move wealth up to the companies located in the higher levels of the pyramid, where
ownership by majority shareholders is least diluted:
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H3. Afliation to a group favors RPTs.
2.3 Governance structure and RPT
The weight of the agency costs associated with RPTs seems to indicate an even more
signicant role for governance mechanisms in the control of rms (Kohlbeck and
Mayhew, 2010). Good quality corporate governance reduces the frequency of use of
RPTs and, as a consequence, the risk of the expropriation of minority shareholdings
(Gordon et al., 2006).
2.3.1 Characteristics of the board of directors. The literature concerning corporate
governance considers that small boards of directors perform the role of control better
than larger ones (Fama and Jensen, 1983; Klein, 2002; Yermack, 1996). A large number
of directors on the board can, indeed, lead to collusion and conicts of interest. It could
then become a favorable terrain for the establishment of a climate of conict and
uncertainty. Beasley (1996), based on a sample of 150 American companies, found that
fraud increases in relation to the size of the board of directors. The appointment of a
new director tends to increase the board of directors ability to exercise control, but this
effect is counterbalanced by the marginal cost in terms of communication, coordination
and decision making. According to Gordon et al. (2006), an increase in the number of
directors (an indicator of weak governance) is associated with a higher occurrence of
RPTs, particularly transactions involving executive directors:
H4. A large board of directors favors RPTs.
Apart fromits size, the composition of the board of directors is also an element that may
employ its effectiveness to exercise control. The presence of independent, non-executive
directors implies the presence of deciders who have no economic interest inthe company,
and who do not take any part in its running (Fama and Jensen, 1983). A low number of
independent directors casts doubt onthe ability of the board of directors to ensure its role
of oversight, and to protect the interests of minority shareholders. As a consequence, the
appointment of independent directors can limit the number of RPTs (Gordon et al., 2006;
Cheung et al., 2006). For Dahya et al. (2008) and Kohlbeck and Mayhew (2010),
the independence of the board of directors reduces the propensity to engage in RPTs:
H5. The presence of independent directors on the board of directors limits the
number of RPTs.
2.3.2 The presence of an independent audit committee. Audit committees have an
important role to play with regard to RPTs, insofar as they are responsible for
overseeing the transparency of information and the implementation of control
procedures. Another of their missions is to ensure that the legal auditor carries out all the
necessary investigations to ensure that the mission is achieved in compliance with
professional standards. American legislation requires not only the presence of a legal
auditor, but also their total independence, and the presence of at least one member with
the necessary experience in the eld of nance. Some American studies, such as Abbott
and Parker (2000) and Abbott et al. (2003), demonstrate a positive connection between
the characteristics of the audit committee (independence, nancial expertise and number
of meetings) and the quality of the audit. Based on these observations, we might expect
that companies with an independent audit committee would be stricter with regard to
RPTs. However, despite the diversity of research on the relationship between
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the independence of the audit committee and the risk of the manipulation of accounts, to
our knowledge there are no studies concerning RPTs and their relationship to the
characteristics of the audit committee. According to Gordon et al. (2006), only a few
companies submit RPTs to an independent audit committee for approval.
In France, the implementation of audit committees is a recent occurrence, coming
mainly after the publication of the Vienot reports (1995 and 1999). The NRE law of
2001, and the LSF (nancial security) law of 2003 have not changed the situation.
This is why a certain number of French companies have chosen not to have such a
committee. Where it exists, it is considered as having more of an advisory capacity
than a role of control. Companies therefore are given the possibility of choosing the
audit committees eld of activity in accordance with their needs:
H6. The presence of an independent audit committee has a limiting effect on RPTs.
2.3.3 Choice of an external auditor. One of the main problems today, in the eld of
auditing nancial statements, is the identication and exposure of related parties and
RPTs (Gordon et al., 2007). Expropriation seems more probable when it is difcult to
detect (Mitton, 2002). The shareholders who control the capital can, then, allay the fears
of expropriationexpressedbyminorityshareholders, byhaving recourse to high-quality
external auditors. Companies that are audited by one of the big audit houses are
presumed to have a higher quality of information disclosure. Fan and Wong (2005) use a
sample of companies in eight Asian countries to show that the companies that are
most exposed to agency problems call on the services of the Big Five audit rms. The
Big Five auditors charge high fees and establish a low threshold of modication,
compared to other auditors. It is difcult for them to ignore problems in nancial
statements, since their reputation is at stake. These auditors are perceived as being the
best information producers, simply because foreign investors associate a familiar name
with higher quality information. The results obtained by Mitton (2002) using a sample of
399 companies listedin South Korea, Indonesia, Malaysia, Thailand andThe Philippines
during the 1997-1998 nancial crisis, show that companies audited by these big audit
rms provided better disclosure of information for minority shareholders. These results
concur withthose of Cheunget al. (2006), whichshowthat companies that are not audited
by one of the Big Five register negative yields following the announcement of RPTs.
An auditor belonging to the Big Five family is, apparently, more demanding with
regard to respect for the interests of minority shareholders, and more attentive to RPTs.
However, RPTs are very difcult to audit, both by the Big Five and by the
Non-big-Five, because the external auditor has to rely on the good faith of the
managers, in revealing the identity of related parties and the nature of the RPTs
(Gordon et al., 2007). In this respect, Louwers et al. (2008) accuse certain auditors of what
they call lack of professionalism, where it is mainly a question of RPTs. For these
auditors, failure with regard to auditing RPTs is not due to any shortcoming in auditing
standards, but rather to a lack of diligence on the part of the external auditors, who have
sometimes proved to be less than discerning in their identication, examination and
disclosure of RPTs. Often, external auditors do not apply the recommended auditing
procedures correctly. They are satised with the evidence with which they are provided,
trust inthe managers andrelyonthe effectiveness of the internal auditingprocess. It also
happens, occasionally, that external auditors conceal evidence that could furnish
proof of fraud. This is the case with auditors who maintain a special relationship
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with the managements of companies, and who depart fromthe principle of independence
if sizeable audit, or non-audit, fees are at stake (Humphrey, 2008). Finally, even when it
has been divulged or detected, the fact of concluding a transaction with one or more
related parties does not always mean that there has been an attempt to defraud, and thus
does not necessarily increase the vigilance of auditors in evaluating the object of the
transaction (Gordon et al., 2007).
Aquestion which should be asked at this point is, in what way are the Big auditors
more competent and independent than the others, as far as auditing RPTs is concerned?
To answer this question, Louwers et al. (2008) carryout ananalysis of shortcomings with
regard to the auditing of RPTs according to the prole of the audit rm. A shortcoming
may be registered when the auditor does not respect the standards recommended by the
SEC for the auditing of RPTs. In spite of the formal structure these standards bring to
the practice of American auditors, the auditing of RPTs is an exercise that raises a large
number of problems for the auditor, at all stages of the audit process. Between 1983 and
2006, the authors noted 43 cases of external auditors not respecting the regulations. The
auditing standards specify a process that can be dened as a sequence of three steps.
The rst consists of identifying the related parties through certain events that are
evidence of an RPT. The second step consists of examining and detecting RPTs. The last
step is the disclosure of the RPT. Second, the authors classied the errors according
to whether they were committed by one of the Big Four audit rms, by one of the
Non-Big Four or by independent auditors. The authors noted that ve auditing errors
were committed by the Big Four audit rms, or 12 percent of the overall total (43). The
greatest number of errors, 29 (67 percent), of which 22 occurred during the examining
the RPT step, involved the Non-Big Four audit rms, and, nally, nine errors were
committed by independent auditors. In addition, it can be noted that the Big Four
auditors committed ve errors, of which four occurred in the disclosure step, or the same
as for the Non-Big Four auditors. Although the Big Four auditors might show their
competence compared with other auditors thanks to their greater ability to detect RPTs,
the quality of disclosure, and therefore of independence, seems to be rather lacking.
French regulations oblige companies submitting consolidated accounts to be audited by
at least two audit rms. This joint-auditing offers the possibility of the reciprocal
verication of the diligence exercised by the auditors and, as a consequence, strengthens
the independence of the auditors (Piot and Janin, 2005). Competence and independence
are the two principal components of the quality of an audit (De Angelo, 1981), and the
question we ask ourselves in this respect is whether the competence of the Big Four
auditors is, in itself, sufcient to lead companies to renounce all doubtful transactions,
and thus their proliferation, and also whether an audit carried out by two of the
Big Four is more effective than one carried out by a single member of the Big Four.
In order to determine this, we test the following hypothesis:
H7. The joint audit by two Big Four limits the number of RPTs.
2.3.4 Listing in markets where minority shareholders have strong protection. Being
listed in stock markets where minority shareholders enjoy strong protection enables
companies to raise capital more easily. However, it also means they are subject to strict
obligations regarding disclosure of information, which can limit the expropriation of
minority shareholders. According to Mitton (2002), when a company issues an American
Depositary Receipt, the quality of information disclosure can be affected in two ways.
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First, the company is subject to additional obligations regarding disclosure of
information, over and above whatever is required in its home country. Second, once it is
listed in another country, the company can target a larger pool of investors and analysts
who may have higher requirements concerning better accounting information
disclosure. Klapper and Love (2004) showed that companies that have part of their
capital quoted in the USA have a better classication, not only in terms of information
disclosure, but also in terms of respect for the rules of good governance, such as those
concerning the composition and operations of the board of directors. For Reese and
Weisbach (2001), the protection of minority shareholders is the prime motivation for
non-American companies to list in the USA. According to these authors, the
shareholders who control the equity of companies listed in the USA cannot extract so
much uncontrolled prot as the majority shareholders of companies listed outside the
USA. The motivation for being listed in the USA depends on the ownership and
control characteristics of the company. Doidge et al. (2004) use data on more than
4,000 companies from 31 countries, and nd that the shareholders rights of control,
together with the difference between voting rights and cash-ow rights, are negatively,
and signicantly, affected by the fact of being listed in the USA. The authors conclude
that when uncontrolled prots are high, the controlling shareholders do not seek to have
their shares listed in the USA.
However, not all authors agree on the advantages arising from the listing of foreign
companies in the USA. For Coffee (2002) and Licht (2003), American nancial markets
are far from being a hub that offers the best protection to minority shareholders in
foreign companies. They agree that access to American markets does not systematically
entail a substantial change in the governance practice of foreign companies, and then in
the behavior of their managers and main shareholders[3]. Siegel (2009), after carrying
out a survey of the legal measures taken by the SEC in America against foreign
companies in the period from1993 to 2003, remarkedthat the American courts have been
ineffective in establishing a systemof sanctions for foreign companies that engage in the
expropriation of minority shareholdings. It is the investors, rather than the courts, that
sanction the doubtful practices of foreign companies, by devaluing their shares on the
market:
H8. Listing in the USA limits RPTs.
2.3.5 Debt nancing. Considered as a useful tool for resolving conicts between
managers and shareholders (particularly those concerning free cash ow), debt can
also be used to expropriate minority shareholdings. This is the hidden aspect of debt,
which is revealed in closely held companies, and particularly in groups (McConnell and
Servaes, 1995). Faccio et al. (2004) speak about the case in which debt is contracted by
controlled parties on behalf of, and to the benet of, the companys main shareholder.
This situation is frequent in South East Asia, where the ultimate controller of the
equity of 60 percent of listed companies is also the controller of a bank. Faccio et al.
(2004) studied the relationship between debt as a mechanism for governing a company
and the risk of expropriation, in a sample composed of companies from the ve most
developed European countries (France, Germany, Italy, Spain and the UK), nine Far
Eastern countries (Hong Kong, Indonesia, Japan, Malaysia, The Philippines, Singapore,
South Korea, Taiwan and Thailand). The authors found that debt is positively linked
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300
to the risk of expropriation, measured by the degree of separation between the
ownership and control of equity.
Debt can also be diverted via non-equitable transactions between companies that are
members of the same group. This situation applies when the debt is contracted from
banks controlled by the companys main owner. According to La Porta et al. (2003),
banks lend to companies that are controlled by the banks owners, on more
advantageous terms than those imposed on loans to non-related parties. The authors
found that annual interest rates are 4 percent lower than the rates applied to non-related
parties. An increase of the external debt, via companies where the cash-owrights of the
main shareholder are low, may represent a potential source of expropriation of external
shareholders, by making external shareholders carry a large share of the debt burden.
In this way, it is possible for certain subsidiaries to incur debts, and for the cash ow to
be circulated within the group, to the benet of certain entities. The expropriation of the
minority shareholders in the debt-burdened subsidiaries thus results from the cost of
the nancial distress borne by them, instead of by the main shareholder:
H9. Debt favors the use of RPTs.
3. Research methodology
In this section, we introduce the sample, the data collection method, the variables and
the descriptive statistics.
3.1 Sample
Our study concerns French companies listed on the Paris Stock Exchange that were
included in the SBF 120 index during the period 2002-2005. Financial institutions and
insurance companies, six in all, were eliminated from the initial sample. After the
elimination of those companies for whichwe were unable to collect all necessarydata, the
nal sample comprised85 companies, representing340 observations. For data collection,
we read through the annual reports and other reference documents of each company in
the sample. The data concerning RPTs are found in the section headed Auditors special
report on regulated agreements. This report includes the names of the people
responsible for the agreements, and a description of the terms of the agreement. All other
data were collected through reading the relevant sections in the annual reports.
3.2 Measurement of variables and descriptive statistics
3.2.1 Measurement of RPTs. In our study, we explore several forms of RPT that may
result in a potential change of wealth. The aim of dividing RPTs according to
the category of related party is to be able to identify those that most frequently entail the
expropriation of minority shareholdings. In fact, the transfer of wealth may be made
directly to the main shareholders, directors and/or managers, or indirectly, to companies
in which the shareholders, directors and/or managers hold substantial interests, or to
subsidiaries or afliated companies. Our sample was divided in two ways.
The rst cut enabled us to separate the transactions into two major categories. The
rst of these includes subsidiaries and associated companies (TSAC). The subsidiaries
are rms in which the company holds more than half the voting rights. The associated
companies are those, other than subsidiaries, in which the company holds between
10 and 50 percent of the voting rights. In the literature, these transactions are not
always made to the detriment of minority shareholdings. The second category includes
Related parties
transactions
301
transactions between the main shareholders, directors or managers, and the companies
with which they are afliated. These are transactions that may result in the potential
expropriation of minority shareholders (TEXP). Transactions involving directors may
concern exceptional remuneration, a modication of the employment contract, a golden
handshake, extra attendance fees, an extraordinary bonus, etc. Transactions involving
the main shareholders consist of administrative and operational expenses,
consultancy, acquisitions and sales of goods and services, acquisition and sale of
shares, fees, etc. Finally, transactions involving subsidiaries include service provision,
guarantees, cash management, rentals for goods, opening a credit line, etc. The second
cut enables us to distinguish between, on the one hand, transactions concluded directly
with the main shareholders, directors and/or managers (TMSDM) and, on the other
hand, those indirectly carried out with these related parties via their own subsidiaries
and/or companies with which they are afliated (TSSDM). In this latter case, it is a
question of transactions involving companies held substantially by the main
shareholders, and companies in which the directors and/or directors are associated,
and/or in which they hold substantial interests.
RPTs can be apprehended by their number, by their amount in currency units
(Gordon et al., 2006) or by a binary variable that designates the use or otherwise of the
transaction in question (Cheung et al., 2006; Kohlbeck and Mayhew, 2010). For our
study, we adopted the number of RPTs. In fact, a reading of the report drawn up by the
auditors does not make it possible for us to determine the amount involved for each
category of RPT[4]. The nature of the relationship between the listed company and the
related party is not always clearly explained in annual reports. In general, the auditors
report mentions only the name if it is a question of a natural person, or the business
name if it is a corporate body. In this case, and in order to reveal the identity of the
related party, we examine the organization chart of the company, the breakdown of its
capital and voting rights and the composition of its board of directors. If the related
party is a company, we try to establish whether it is a subsidiary, a company controlled
by one of the main shareholders, directors and/or managers, or in which the directors
or the managers hold substantial interests or perform the function of director, CEO or
manager. If the related party is a natural person, we check to nd out if he/she is one of
the main shareholders, or a director or manager. For the estimation of our model, and
because of the signicant disparity of numbers in each category of RPT, we use natural
logarithms to measure the frequency of each category of RPT.
The degree to which minority shareholders are expropriated is measured via the
effect of each category of transaction on the companys value. As a way of measuring
the value of the company, we adopt Tobins Q ratio. Tobins Q ratio is an indicator that
expresses the ex ante performance of the company, which in principle constitutes a
measure of all anticipated income up to a dened future date. Tobins Q is the ratio
between the market value of the company (shareholders equity nancial debt) and
the replacement cost of assets. In a large number of empirical studies, the book value
represents an approximate but satisfactory measurement of the replacement cost of
assets. In our study, we calculate Tobins Q on the basis of the total stock market
capitalization of the company (at the end of the scal year), and the book value of its
liabilities as a ratio of total assets. This is used by a large number of researchers
as a way of measuring the value of a company, and any reduction is considered
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10,3
302
as indicating the expropriation of minority shareholders (McConnel and Servaes, 1995;
Claessens et al., 2000; Jian and Wong, 2004).
Table I summarizes the denitions of the different variables used in our study, and
what they measure.
3.2.2 Descriptive statistics. Table II gives the distribution of the numbers of each
category of RPT. It shows overall that the companies in our sample made a total of 1,186
transactions during the period 2002-2005, and that they conducted more transactions
with subsidiaries and afliated companies (TSAC 815) than with main shareholders,
directors and/or managers (TEXP 371). In the latter category of transaction, we may
note a greater number made directly with main shareholders, directors and managers
(TMSDM 261) than indirectly via afliated companies (TSSDM 110).
Table III is constructed in the same way as that presented in Gordon et al. (2006).
It gives the numbers of transactions, from 0 to more than ten, per category of related
party, over the period 2002-2005. It should be noted that 70.83 percent of the companies
in our sample (80 percent for Gordon et al. (2006)) disclosed at least one RPT, as against
29.17 percent that declared ten or more transactions (20 percent for Gordon et al. (2006)).
This table shows that 84.37 percent of the companies made at least one transaction with
the main shareholders, directors and/or managers (against 15.63 percent of the
companies that made ten or more) and that 64.66 percent of themconcluded transactions
with their subsidiaries and/or afliated companies (against 35.34 percent that concluded
ten or more transactions). It can also be noted that, in 85.82 percent of cases, the
shareholders, directors and/or managers make at least one transaction directly with the
listed company (against 14.18 percent of cases with ten or more transactions) and in
80.91 percent of cases indirectly via their own subsidiaries or the companies with which
they are afliated.
Table IV shows the distribution of the models continuous explanatory variables
(part A) and dichotomous variables (part B). Part A shows that, in the companies in our
sample, 33.52 percent of voting rights were held by the main shareholder, and the ratio
between the main shareholders cash-ow rights and voting rights was 0.859.
In addition, the companies have a board of directors with around 11 members, of whom
45.66 percent are independent. The degree of independence of their audit committees is
relatively low, with only 54.53 percent of the members being independent on average.
On average also, they have a low economic rate of return (3.14 percent), and turnover
growth rate (5.13 percent), and a Tobins Q greater than 1 (1.495). Their dividends
average 1.95 times the share price. We also note, nally, that their R&D intensity is on
average 2.8 percent, and that they have a high debt ratio, with debts standing at
63.89 percent of total assets.
In part B, it can be seen that 26.28 percent of the companies in our sample belong to
a group, and that about a third of them are listed in the USA. Finally, we can see that
46.47 percent use the services of one of the Big auditing rms, and that 39.12 percent
are audited by two of the Big rms.
4. Model and results
4.1 Model
For all transactions, as well as for each segmentation cut carried out, we use a system
of type 3SLS simultaneous equations, insofar as the transactions that can determine
the value of the company are themselves affected by the companys ownership
Related parties
transactions
303
Variable Denition Measurement
Company value
QT Tobins Q Stock market capitalization plus book value of
liabilities as a ratio of total assets
Related party transactions
RPT Transactions with all related parties Natural logarithm of the total number of related
party transactions
TEXP Related party transaction likely to lead
to expropriation
Natural logarithm of the number of transactions
with main shareholders, directors and managers
TSAC Transactions with subsidiaries and
afliated companies
Natural logarithm of the number of transactions
with subsidiaries and afliated companies
TMSDM Transactions with main shareholders,
directors and/or managers
Natural logarithm of the number of transactions
with main shareholders, directors and/or
managers
TSSDM Transactions with subsidiaries and
companies afliated to main
shareholders, directors and/or
managers
Natural logarithm of the number of transactions
with subsidiaries and companies afliated to
main shareholders, directors and/or managers
Ownership and control characteristics
VOTE Control rights of the main shareholder Percentage of voting rights held by the main
shareholder
SEP Separation between ownership and
control
Ratio between voting rights and cash-ow
rights of main shareholder
GROUP Afliation to a group 1, if the company is part of a group, 0 otherwise
Governance characteristics
NDIR Size of the board of directors Number of directors the company has
DIRIND Degree of independence of the board of
directors
Ratio between the number of independent,
non-executive directors and the total number of
directors
AUDC Presence or not of an audit committee Binary variable: value 1 if the company has an
audit committee, 0 otherwise
INDAUDC Degree of independence of the audit
committee
Ratio between the number of independent
directors and the total number of directors
BIG Audit by one of the big audit rms Trichotomic variable: value 2 if the company is
audited by two of the Big Four, 1 if the rm is
audited by only one of the Big Four,
0 otherwise
CROSS Listing in nancial markets where
investor protection is strong
1, if the company is listed in a country other
than France, 0 otherwise
DEBT Debt ratio Ratio between nancial liabilities and total
assets
Control variables
ROA Economic rate of return Ratio between EBITDA and total assets
VARTUR Variation in turnover percentage Ratio between the variation in turnover between
t and T 2 1 and the turnover in T 2 1
R&D R&D intensity Ratio between the volume of R&D and the
turnover
DIV Dividend yield Ratio between the distributed dividend and the
share price
SIZE Size of the company Natural logarithm of total assets
Table I.
Denition of variables
and what they measure
RAF
10,3
304
characteristics and governance mechanisms. Our model thus checks, in the rst
equation, the effect of eachcategoryof equationonthe value of the company, as measured
byTobins Q. As control variables, we introduce the size of the company, measuredbythe
natural logarithm of the total assets, the economic rate of return, measured by the ROA,
the sales performance, measured by the variation in the turnover (VARTUR) and the
R&D intensity. Very large companies have better exposure to, and good coverage in,
the nancial press (Cheung et al., 2006). In the second equation, we will try to see the
extent to which ownership characteristics and governance mechanisms may affect
RPTs. In addition to the explanatory variables, we include the dividend yield, measured
by the ratio of the dividend per share to the share price, and nally the size of the
company, as control variables. The sustained distribution of dividends is the sign of a
certain level of protection for minority shareholdings, and it should also mean a reduced
use of RPTs. It is in the very large companies that the frequency of RPTs may be greater.
Our model, therefore, can be expressed as follows:
TQ
it
a
0
a
1
RPT
it
a
2
SEP
it
a
3
VOTE
it
a
4
GROUP
it
a
5
NDIR
it
a
6
DIRIND
it
a
7
INDAUDC
it
a
8
BIG
it
a
9
CROSS
it
a
10
DEBT
it
a
11
VARTUR
it
a
12
ROA
it
a
13
R&D
it
a
14
SIZE
it
1
1
First segment Second segment
RPT TEXP TSAC TMSDM TSSDM
Number noted 340 340 340 340 340
Number of RPTs 1,186 371 815 261 110
Average 3.49 1.09 2.40 0.77 0.32
SD 0.222 0.087 0.197 0.068 0.045
Median 2.00 0.00 1.00 0.00 0.00
Minimum 0 0 0 0 0
Maximum 25 9 25 8 7
Table II.
Descriptive statistics of
related party transactions
First segment Second segment
No. of observations RPT TEXP TSAC TMSDM TSSDM Number of
transactions Freq. % Freq. % Freq. % Freq. % Freq. % Freq. %
0 66 19.41 0 0 0 0 0 0 0 0 0 0
1 74 21.76 74 6.24 44 11.86 30 3.68 31 11.88 13 11.82
2 38 11.18 76 6.41 26 7.01 50 6.13 21 8.04 5 4.54
3 50 14.71 150 12.65 45 12.13 105 12.88 25 9.58 20 18.18
4 20 5.88 80 6.75 25 6.74 55 6.75 17 6.51 8 7.27
5 21 6.18 105 8.85 42 11.32 63 7.73 39 14.94 3 2.73
6 14 4.12 84 7.08 34 9.16 50 6.13 28 10.73 6 5.45
7 10 2.94 70 5.09 18 4.85 52 6.38 15 5.75 3 2.73
8 15 4.41 120 10.12 52 14.02 68 8.34 35 13.41 17 15.45
9 9 2.65 81 6.83 27 7.28 54 6.63 13 4.98 14 12.73
$ 10 23 6.76 346 29.17 58 15.63 288 35.34 37 14.18 21 19.09
Total 340 100 1,186 100 371 100 815 100 261 100 110 100
Table III.
Number of transactions
made with each category
of related party
Related parties
transactions
305
RPT
it
b
0
b
1
SEP
it
b
2
VOTE
it
b
3
GROUP
it
b
4
NDIR
it
b
5
DIRIND
it
b
6
INDAUDC
it
b
7
BIG
it
b
8
CROSS
it
b
9
DEBT
it
b
10
DIV
it
b
11
SIZE
it
1
2
The correlation matrix (Table V) does not show any major collinearity. All the
explanatory variables are therefore retained in the estimation of our model.
4.2 Results
Arst reading of Table VI shows that, overall, RPTs have a negative effect on the value
of the company, as measured by Tobins Q. This effect is 22.165 and is signicant to a
threshold of 5 percent. In other words, the market does not give a favorable welcome to
the making of these transactions which, in the long term, may represent an opportunity
cost for the company in comparison with what might have been achieved with
non-related parties. In the rst segmentation, the results show that transactions with
shareholders, directors and managers, as well as transactions with subsidiaries and
afliated companies, have a negative impact on the value of the company, signicant to
a threshold of 10 percent. This result, analogous to that found by Jian and Wong (2004)
using Chinese data, and by Gordon et al. (2006) using US data, conrms our H1. These
transactions are considered as a way of transferring the wealth of minority shareholders
towards those who control the company, the board of directors and/or the companies
afliated with them. The results of the second segmentation show that it is more
the transactions made directly with the main shareholders, directors and/or
Panel A: continuous variables
Minimum Maximum Mean SD
SEP 0.395 2.877 0.859 0.011
VOTE 0% 100% 33.52% 0.139
NDIR 3 21 10.79 0.212
DIRIND 0% 100% 45.66% 0.012
INDAUDC 0% 100% 54.53% 0.583
DEBTE 3.28% 92.79% 63.89% 0.008
ROA 242.40% 21.30% 3.14% 0.003
R&D 0 28.60% 0.028 0.050
DIV 0 20 1.95 0.001
SIZE (total assets in millions of euros) 166 109,350 13,680.69 1,129.07
Tobins Q 0.730 4.870 1.495 0.035
VARTUR 267.23% 115.88% 5.13% 0.009
Panel B: binary variables
Frequency Percentage
GROUP 0 251 73.82
1 89 26.28
Total 340 100
CROSS 0 226 66.47
1 114 33.53
Total 340 100
BIG 0 49 14.41
1 158 46.47
2 133 39.12
Total 340 100
Table IV.
Descriptive statistics for
the explanatory variables
RAF
10,3
306
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2
0
.
0
4
9
(
0
.
3
6
7
)
2
0
.
0
8
6
(
0
.
1
1
2
)
0
.
2
2
7
*
*
1
.
0
0
0
R
&
D
2
0
.
1
2
3
*
(
0
.
0
2
4
)
0
.
0
2
1
(
0
.
6
9
5
)
0
.
0
3
9
(
0
.
4
7
6
)
2
0
.
0
6
2
(
0
.
2
5
4
)
0
.
0
8
0
(
0
.
1
4
2
)
0
.
1
9
1
*
*
(
0
.
0
0
0
)
0
.
1
7
3
*
*
(
0
.
0
0
1
)
0
.
2
5
0
*
*
(
0
.
0
0
0
)
2
0
.
3
2
5
*
*
(
0
.
0
0
0
)
2
0
.
0
0
8
(
0
.
8
8
2
)
0
.
1
0
0
(
0
.
0
6
6
)
1
.
0
0
0
D
I
V
0
.
0
3
1
(
0
.
5
6
6
)
0
.
0
7
9
(
0
.
1
4
6
)
0
.
0
4
5
(
0
.
4
1
1
)
0
.
2
4
7
*
*
(
0
.
0
0
0
)
0
.
0
0
6
(
0
.
9
0
7
)
0
.
0
1
5
(
0
.
7
9
0
)
2
0
.
0
2
7
(
0
.
6
2
1
)
2
0
.
0
4
9
(
0
.
3
7
2
)
0
.
0
3
1
(
0
.
5
6
3
)
0
.
1
3
9
*
(
0
.
0
1
0
)
2
0
.
0
5
1
(
0
.
3
5
3
)
2
0
.
2
0
5
*
(
0
.
0
0
0
)
1
.
0
0
0
S
I
Z
E
2
0
.
1
6
3
*
*
(
0
.
0
0
3
)
0
.
3
0
5
*
*
(
0
.
0
0
0
)
2
0
.
0
6
5
(
0
.
2
3
5
)
0
.
6
6
0
*
*
(
0
.
0
0
0
)
0
.
2
2
3
*
*
(
0
.
0
0
0
)
0
.
2
4
1
*
*
(
0
.
0
0
0
)
0
.
2
6
5
*
*
(
0
.
0
0
0
)
0
.
3
5
5
*
*
(
0
.
0
0
0
)
0
.
3
6
3
*
*
(
0
.
0
0
0
)
2
0
.
1
4
6
*
*
(
0
.
0
0
7
)
2
0
.
1
2
4
*
(
0
.
0
2
2
)
2
0
.
0
6
5
(
0
.
2
3
4
)
0
.
2
1
7
*
*
(
0
.
0
0
0
)
1
.
0
0
0
N
o
t
e
:
S
i
g
n
i

c
a
n
t
a
t
:
*
5
a
n
d
*
*
1
p
e
r
c
e
n
t
Table V.
Correlation matrix
Related parties
transactions
307
T
o
t
a
l
s
a
m
p
l
e
F
i
r
s
t
s
e
g
m
e
n
t
a
t
i
o
n
S
e
c
o
n
d
s
e
g
m
e
n
t
a
t
i
o
n
V
a
r
i
a
b
l
e
T
Q
R
P
T
T
Q
T
E
X
P
T
Q
T
S
A
C
T
Q
T
M
S
D
M
T
Q
T
S
S
D
M
R
P
T
2
2
.
1
6
5
*
*
(
2
2
.
0
8
)
2
3
.
6
0
5
*
(
2
1
.
7
1
)
2
1
.
6
7
3
*
(
2
1
.
8
5
)
2
2
.
9
4
2
*
*
(
2
2
.
1
2
)
0
.
0
5
6
(
0
.
8
5
)
S
E
P
2
0
.
1
0
1
(
2
0
.
4
1
)
0
.
0
3
0
(
0
.
2
1
)
2
0
.
4
8
9
(
2
1
.
6
4
)
2
0
.
1
0
0
(
2
0
.
8
9
)
2
0
.
1
0
1
(
2
0
.
4
4
)
0
.
0
6
3
(
0
.
4
4
)
2
0
.
6
4
8
*
*
(
2
2
.
3
3
)
2
0
.
1
6
4
(
2
1
.
6
2
)
2
0
.
1
9
4
*
*
(
2
2
.
1
7
)
0
.
0
3
0
(
0
.
4
1
)
V
O
T
E
0
.
9
6
1
(
1
.
6
0
)
0
.
4
0
5
*
*
(
2
.
1
0
)
1
.
2
5
2
(
1
.
4
2
)
0
.
3
2
3
*
*
(
2
.
1
3
)
0
.
4
1
7
(
1
.
0
7
)
0
.
2
2
5
(
1
.
1
6
)
1
.
0
7
9
*
(
1
.
7
2
)
0
.
3
4
1
*
*
*
(
2
.
5
7
)
0
.
0
3
0
(
0
.
2
5
)
2
0
.
0
1
9
(
2
0
.
2
0
)
G
R
O
U
P
0
.
1
2
9
(
0
.
8
0
)
0
.
0
2
4
(
0
.
2
4
)
2
0
.
0
1
8
(
2
0
.
0
9
)
2
0
.
0
3
1
(
2
0
.
4
0
)
0
.
1
7
3
(
1
.
1
1
)
0
.
0
5
7
(
0
.
5
8
)
0
.
1
1
9
(
0
.
7
7
)
0
.
0
1
2
(
0
.
1
7
)
0
.
0
8
3
(
1
.
3
5
)
2
0
.
0
5
2
(
2
1
.
0
3
)
N
D
I
R
0
.
0
7
1
*
(
1
.
7
6
)
0
.
0
2
6
*
(
1
.
8
5
)
0
.
1
2
3
(
1
.
6
3
)
0
.
0
3
1
*
*
*
(
2
.
7
3
)
0
.
0
1
8
(
0
.
7
7
)
0
.
0
0
3
(
0
.
2
1
)
0
.
0
7
7
*
(
1
.
8
8
)
0
.
0
2
2
*
*
(
2
.
2
2
)
0
.
0
0
7
(
0
.
8
1
)
0
.
0
1
2
*
(
1
.
7
2
)
D
I
R
I
N
D
2
0
.
4
7
0
(
2
1
.
2
4
)
2
0
.
0
0
7
(
2
0
.
0
3
)
1
.
6
9
4
(
1
.
2
2
)
0
.
5
9
9
*
*
*
(
3
.
2
8
)
2
1
.
1
5
1
*
*
(
2
2
.
3
7
)
2
0
.
4
0
0
*
(
2
1
.
7
1
)
0
.
9
5
4
(
1
.
2
0
)
0
.
4
8
3
*
*
*
(
3
.
0
1
)
2
0
.
4
8
5
*
*
*
(
2
3
.
3
6
)
0
.
1
2
8
(
1
.
0
8
)
I
N
D
A
U
D
C
0
.
1
8
0
(
0
.
8
5
)
2
0
.
0
3
7
(
2
0
.
3
1
)
0
.
6
3
3
*
*
(
2
.
3
8
)
0
.
1
1
1
(
1
.
2
0
)
0
.
0
5
6
(
0
.
2
4
)
2
0
.
1
4
2
(
2
1
.
2
1
)
0
.
9
4
5
*
*
*
(
2
.
9
3
)
0
.
2
3
3
*
*
*
(
2
.
8
8
)
0
.
2
9
6
*
*
*
(
4
.
0
1
)
2
0
.
1
1
7
*
(
2
1
.
9
5
)
B
I
G
2
1
.
0
7
9
*
*
(
2
1
.
9
4
)
2
0
.
4
8
7
*
*
*
(
2
7
.
2
0
)
2
0
.
4
8
5
(
2
1
.
4
2
)
2
0
.
1
2
8
*
*
(
2
2
.
4
0
)
2
0
.
8
1
5
*
(
2
1
.
7
4
)
2
0
.
4
8
3
*
*
*
(
2
7
.
1
0
)
2
0
.
4
0
6
*
(
2
1
.
7
0
)
2
0
.
1
3
1
*
*
*
(
2
2
.
8
0
)
0
.
0
0
3
(
0
.
0
6
)
2
0
.
0
2
4
(
2
0
.
7
0
)
C
R
O
S
S
0
.
6
8
2
*
*
*
(
3
.
0
8
)
0
.
2
2
6
*
*
(
2
.
2
8
)
0
.
0
9
9
(
0
.
4
0
)
2
0
.
0
2
7
(
2
0
.
3
4
)
0
.
6
4
8
*
*
*
(
2
.
7
5
)
0
.
2
5
3
*
*
*
(
2
.
5
3
)
0
.
0
8
8
(
0
.
4
5
)
2
0
.
0
3
7
(
2
0
.
5
3
)
0
.
2
4
8
*
*
*
(
3
.
9
5
)
0
.
0
2
1
(
0
.
4
1
)
D
E
B
T
2
0
.
1
9
4
(
2
0
.
3
9
)
2
0
.
0
5
1
(
2
0
.
1
7
)
0
.
8
3
5
(
1
.
2
7
)
0
.
3
0
2
(
1
.
3
1
)
2
0
.
5
2
5
(
2
1
.
0
1
)
2
0
.
2
7
9
(
2
0
.
9
5
)
1
.
1
4
1
(
1
.
6
2
)
0
.
4
1
5
*
*
(
2
.
0
4
)
2
0
.
0
0
2
(
2
0
.
0
1
)
2
0
.
0
8
8
(
2
0
.
5
8
)
R
O
A
4
.
1
0
5
*
*
(
2
.
4
3
)
3
.
2
7
1
(
0
.
9
9
)
5
.
0
3
7
*
*
*
(
7
.
3
2
)
4
.
2
6
9
*
*
*
(
2
.
9
1
)
5
.
0
1
2
*
*
*
(
1
0
.
9
8
)
V
A
R
T
U
R
2
0
.
0
8
6
(
2
0
.
2
9
)
2
0
.
3
5
8
(
2
0
.
4
7
)
0
.
0
7
8
(
0
.
4
9
)
2
0
.
2
3
0
(
2
0
.
4
6
)
0
.
1
0
1
(
0
.
6
3
)
R
&
D
4
.
7
9
7
*
*
(
2
.
2
5
)
4
.
4
5
0
*
*
(
2
.
3
9
)
3
.
7
4
3
*
*
*
(
3
.
1
2
)
4
.
7
1
1
*
*
(
2
.
3
3
)
3
.
8
1
5
*
*
*
(
6
.
7
1
)
D
I
V
2
.
1
3
3
(
0
.
8
5
)
1
.
2
2
4
(
0
.
6
2
)
3
.
3
4
1
(
1
.
3
3
)
1
.
6
1
8
(
0
.
9
4
)
2
0
.
1
7
6
(
2
0
.
1
4
)
S
I
Z
E
2
0
.
0
5
8
(
2
0
.
8
0
)
0
.
0
2
7
(
0
.
7
0
)
2
0
.
1
6
7
*
*
(
2
2
.
0
7
)
2
0
.
0
1
3
(
2
0
.
4
3
)
0
.
0
0
5
(
0
.
0
6
)
0
.
0
7
3
*
(
1
.
8
5
)
2
0
.
1
9
6
*
*
*
(
2
2
.
9
1
)
2
0
.
0
2
7
(
2
1
.
0
0
)
2
0
.
1
2
8
*
*
*
(
2
5
.
3
7
)
0
.
0
2
4
(
1
.
2
1
)
C
O
N
S
4
.
6
1
6
*
*
*
(
4
.
0
3
)
1
.
0
2
1
*
*
*
(
3
.
0
0
)
2
.
3
6
7
*
*
*
(
3
.
4
3
)
2
0
.
0
5
2
(
2
0
.
1
9
)
3
.
9
7
4
*
*
*
(
4
.
2
8
)
0
.
9
2
3
*
*
*
(
2
.
7
0
)
2
.
4
3
5
*
*
*
(
4
.
5
6
)
0
.
0
0
4
(
0
.
0
2
)
2
.
4
0
2
*
*
*
(
1
0
.
7
4
)
2
0
.
0
8
7
(
2
0
.
5
0
)
R
2
(
%
)
4
9
.
0
5
1
6
.
5
6
4
9
.
0
7
8
.
1
2
4
9
.
0
8
1
8
.
3
0
4
9
.
0
4
1
0
.
2
7
4
9
.
1
5
4
.
7
0
N
o
t
e
:
S
i
g
n
i

c
a
n
t
a
t
t
h
r
e
s
h
o
l
d
o
f
:
*
1
0
,
*
*
5
a
n
d
*
*
*
1
p
e
r
c
e
n
t
Table VI.
Results obtained: entire
sample and each
segmentation
RAF
10,3
308
managers (TMSDM), not those made with subsidiaries and afliated companies
(TSSDM), that have a greater effect in depreciating the companys value. With regard to
the other variables in the rst equation, the fact of being listed in the USA, along with the
ROA and the R&D intensity, has a positive effect on the value of the company. The
results of the second segmentation showthat the degree of separation between ownership
and control, as a measurement of the risk of the expropriation of minority shareholders by
the main shareholder, has a negative effect on the value of the company. Being audited by
one of the Big audit rms does not work to the advantage of value. Its impact is negative
and signicant. The results obtained for the other variables are mixed.
In the case where ownership and control are separate, the main shareholders can
extract personal prots at lower cost (Claessens et al., 2000; Faccio et al., 2002). When the
main shareholders voting rights are greater than his cash-ow rights, he can use this
voting power to indulge in creating the means, in this case RPTs, to enable him to
increase the volume of the ow in his favor. However, as pointed out by Cronqvist and
Nilsson (2005), it is the percentage of voting rights, rather than the separation between
ownership and control, which leads to the expropriation of minority shareholdings. The
results obtained for the second segmentation show that the voting rights held by the
main shareholder (VOTE) favor the expropriation of minority shareholdings, through
the proliferation of transactions made directly with the main shareholders and the board
of directors (TMSDM), whereas the impact of the degree of separation between
ownership and control (SEP) is not signicant. Claessens et al. (2000) found that the
voting rights of the main shareholder, as a measurement of the risk of expropriation of
minority shareholdings by the main shareholder, have a negative effect on the value of
the company. Our study shows that this relationship may be direct, but also indirect,
through the proliferation of transactions with the main shareholders, directors and
managers. No signicant result was observed, moreover, withregardto the impact of the
GROUP variable on RPTs as a whole, or on the transactions obtained regarding each
segmentation. In view of our results, we can conrm H2b, and reject H2a and H3.
With regard to governance mechanisms, our results coincide with Kohlbeck and
Mayhew (2010) and Gordon et al. (2006), who consider that a large board of directors is
a favorable environment for the making of RPTs. In our case, the effect observed
is positive and signicant on transactions made directly with shareholders, managers
and directors (TMSDM), and indirectly through afliated companies (TSSDM). These
results enable us to retain H4.
The independence of the board of directors does not seem to play an active role in
reducing the numbers of RPTs. Independent directors favor transactions that
potentially entail expropriation (TEXP), particularly those made directly with the main
shareholders, directors and managers (TMSDM). This result is contrary to that of
Gordon et al. (2006) and Kohlbeck and Mayhew (2010), and it does not authorize us to
conrm H5. The independent directors are appointed by the board of directors, and
mainly by the managers and main shareholders. When it is a question of protable
transactions, they can enter into collusion with the latter in order to make personal
prot. The limit of ve directorships held, simultaneously imposed by the NRE law
of 2001, does not seem to have prevented the tacit agreements that may exist between
independent directors and the main shareholders, directors and/or managers. In view
of the results we found, we can only underline a feeling of doubt as to the reality of the
independence of directors in France.
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The problems associated with the question of the independence of directors seem
also to concern the independence of the audit committee. Our results show that the
degree of independence of the audit committee has a positive effect on transactions that
potentially entail the expropriation of minority shareholdings, particularly those made
directly with shareholders, managers and directors (TMSDM). This effect is 0.233, and
it is signicant to a threshold of 1 percent. The audit committee is more effective,
however, in reducing transactions made indirectly with the shareholders, managers
and directors through companies with which they are afliated (TSSDM). The effect
identied is negative (20.117) and signicant to a threshold of 10 percent. In other
words, the members of the audit committee seem to limit all transactions to a company
in which they have no personal interest. H6 cannot therefore be retained.
The audit committee can however play another role, no less important, with regard to
reducing the number of RPTs, if this contributes effectively to the appointment of an
external auditor. In fact, the results show that the appointment of an external auditor
from among the Big rms is the most important mechanism with regard to reducing
the number of RPTs. Its effect is, as suggested in H7, negative (20.487) and signicant
to a threshold of 1 percent. In spite of the limits mentioned above, concerning the ability
of auditors to followup and supervise RPTs, the Big auditors seem, fromour results, to
be more effective than other audit rms in limiting the number of RPTs. The results
found for the BIGvariable remain unchanged in relation to what we were able to observe
throughout the sample. The Big auditors do not, apparently, employ the difference
between the various categories of transactions obtained via our segmentation. An audit
carried out by an internationally renowned rmreduces the number of transactions with
the main shareholders, directors and/or managers (TEXP) to the same extent with
subsidiaries and/or afliated companies (TSAC). We should note, however, that the
effect observed is noticeably lower with transactions, and potentially entails the
expropriation of minority shareholders rather than transactions with subsidiaries
and/or afliated companies. In the second segmentation, our results show that, when a
company is audited by one of the Big rms, the number of transactions made directly
with the main shareholders, directors and managers (TMSDM) is reduced. The effects
found are negative and signicant to a threshold of 5 percent. However, this does not
have any signicant impact on the transactions made indirectly with these related
parties via the companies afliated to them (TSSDM). Overall, an audit by a big auditor
may be considered as an effective governance mechanism, by limiting the expropriation
of minority shareholders through RPTs. This result supports the idea that, at least
where RPTs are concerned, there is a positive relationship between the size of the auditor
and the quality of the audit. In view of these results, H7 is conrmed.
The fact of being listed in the USA, which is considered one of the nancial markets
where the protection of minority shareholders is strongest, has the effect of increasing
the frequency of transactions with subsidiaries and afliated companies (TSAC).
It should further be noted that no signicant effect is observed on the other categories
of RPT. This result coincides with those of Coffee (2002), Licht (2003) and Siegel (2009),
for whom multi-listing is not an effective mechanism for reducing the expropriation of
minority shareholders. Therefore, H8 cannot be retained.
Contrary to the results obtained by Gordon et al. (2006), the use of debt cannot be
considered as having any disciplinary effect on managers, in the sense that it can lead
to a reduction of transactions that might prove damaging for minority shareholders.
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From our results, it would appear to be an extra resource that is liable to be
expropriated by the main shareholders, directors and managers. As Faccio et al. (2004)
found, debt favors transactions that potentially entail the expropriation of minority
shareholdings. The impact of the DEBT variable on the TMSDM variable is 0.415, and
it is signicant to a threshold of 5 percent. H9 is therefore rejected.
The policy regarding distribution of dividends has no effect at all on the frequency of
related party transactions. In all categories, no signicant effect of dividend yield on the
number of transactions is thus noted. Regarding the size of the company, the only
signicant impact observed is on transactions made with subsidiaries and afliated
companies (TSAC). However, it should be noted that in this case it is low, and signicant
to 10 percent. The size of the company does not then represent fertile ground for the
proliferation of transactions with shareholders and the board of directors.
5. Summary and conclusions
A large number of managers, directors and main shareholders have been accused of
having played a signicant role in the various scandals that led to the collapse of certain
very large companies or groups of companies. More particularly, they have been
reproached with carrying out doubtful transactions with the company, with the objective
of expropriating minority shareholders and furthering their own interests. Based on a
sample of 85 companies listed on the Paris Stock Exchange during the period 2002-2005,
we have shown that it is the transactions directly made with the main shareholders, and
also those made indirectlyvia companies withwhichtheyare afliated, that depreciate the
value of the company. These transactions are the most damaging to small shareholders,
and they are determined mainly by the voting rights held by the main shareholders.
The size of the board of directors increases the frequency of RPTs. In addition, the
presence on the board of independent directors and an audit committee calls out for
review. Although they make a marked contribution to reducing transactions with
subsidiaries and afliated companies, independent directors, paradoxically, seem to
foster transactions made with the main shareholders, directors and/or managers.
Furthermore, the presence of an audit committee seems to be effective only in reducing
transactions made with subsidiaries and afliated companies. Its degree of
independence serves only to strengthen its impact on this category of transaction,
but has no effect at all on transactions potentially entailing expropriation.
In the USA, the Sarbanes-Oxley Act prohibits certain RPTs that are considered
damaging to small shareholders. In France, although it represents an advance with
regard to the governance of French companies, the law on NRE of the 15 May 2001 and
the LSF of the 1 August 2003 say nothing about the damage certain RPTs can cause
to minority shareholders. In view of our results, these two laws do not seem to offer
minority shareholders any real protection, faced with possible coalitions between
managers, main shareholders and directors. Our study does not conrm the role of
audit committees in reducing the number of related party transactions. In addition,
it should be noted that it is only since December 2008 that a European directive has
made these committees compulsory, and subject to strict rules concerning
independence and competence. The complexity of these transactions requires a
certain level of expertise in the members of the audit committee. US Stock Exchange
regulations require the presence of at least one member having sufcient expertise in
the eld of accounting and nance. A more comprehensive study, covering, apart from
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the question of independence, the level of expertise as well as the level of qualication
in the eld of accounting and nance of the members of such committees, would enable
us to measure the impact of these characteristics with regard to the supervision of
RPTs in French companies.
Notes
1. According to Article L 233-3 of the Commercial Code: I. a company is deemed to control
another company: (1) when it directly or indirectly holds a fraction of the capital that gives it
a majority of the voting rights at that companys general meetings; (2) when it alone holds a
majority of the voting rights in that company by virtue of an agreement entered into with
other partners or shareholders and this is not contrary to the companys interests; and (3)
when it effectively determines the decisions taken at that companys general meetings
through the voting rights it holds; II. it is presumed to exercise such control when it
directly or indirectly holds a fraction of the voting rights above 40 percent and no other
partner or shareholder directly or indirectly holds a fraction larger than its own. III. [. . .]
two or more companies acting jointly are deemed to jointly control another company when
they effectively determine the decisions taken at its general meetings.
2. According to Le Maux (2004), these agreements are approved in the majority of cases
(98 percent).
3. According to Licht (2003), companies which register their shares in American stock
exchanges or which issue takeover bids in the USA are subject to disclosure requirements
and share registration obligations which differ from those to which American companies are
subject. For example, foreign issuers are required to give the names of people holding more
than 10 percent of the voting rights, whereas American companies must announce the names
of people holding more than 5 percent of the voting rights.
4. Several other reasons could be put forward to justify the choice of the number (not the value)
of RPTs as a relevant measurement in a study of the degree to which minority shareholdings
are protected. The value of the RPTs may be low, and the fact that they have taken place
may sufce to reect the divergence between the interests of small shareholders and more
powerful groups (majority shareholders or directors). The second reason is that certain
transactions represent expenses for the company (purchases of goods and services), while
others involve revenue (sales of products and services); grouping them together, then, would
make no sense. The third is that the information concerning the values of the transactions
differs from company to company. Some publish the amount for the transactions in the scal
year, while others report only the balance of these transactions. The fourth reason is related
to the fact that, particularly in the case of transactions involving directors, it is a question of
transactions that have been agreed, but have not been implemented during the scal year
(severance pay). Finally, the last reason is related to the fact that the amounts reported for
certain transactions are annual expenses, which are neither cumulated nor discounted,
whereas the amounts involved in loans are principal amounts, presented in stock.
Consequently, the sum of the amounts related to services and of loans cannot represent a
signicant aggregate of RPTs.
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About the authors
Mehdi Nekhili holds a MPhil degree in Finance (1990) and a PhD degree (1994) from the
University of Burgundy in France. He is now an Associate Professor of Finance at University of
Reims Champagne-Ardenne (France) and an Adjacent Professor at Rouen Business School
(France). His main research interests include accounting, auditing, banking and corporate
governance. He has published several papers in various refereed journals and many chapters in
books. He has also edited a book entitled International Banking Strategies. Mehdi Nekhili is the
corresponding author and can be contacted at: mehdu.nekhili@univ-reims.fr
Moez Cherif is an Assistant Professor of Finance at the University of Jendouba (Tunisia).
He gained his PhD degree (2007) from the University of Reims Champagne-Ardenne in France.
His main research interests include corporate nance and corporate governance.
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