The Impact of Related-Party Transactions on the Value Relevance of Earnings in Determining the Stock Market Value of Companies Listed in Tehran Stock Exchange

Document Type : پژوهشی

Authors

• MohamadReza Lotfalipour ¹
• Somayeh Galdipour ²
• Omid Arian ³

¹ Ferdowsi university of Mashhad

² Hakiman University of Bojnourd

³ Supreme audit court

https://doi.org/10.22067/pm.v23i12.35443

Abstract

Related-party transactions are one of the major concerns in financial market scandals. So that the intended use of these transactions and the non-disclosure or insufficient disclosure has been a deteriorating factor for the enterprises. Recent scandals in the United States, such as Adelphia and the Riga family's corporate group, and Hollinger and Conrad Black's corporate group, have brought related-party transactions under the spotlight (Ge, Drury, Fortin, Liu & Tsang, 2010). It is alsoa great concern in Iran, since accounting standard No.12 is dedicated to related-party transactions. Related-party transactions can be used within these corporate groups in order to optimize internal resource allocation, reduce transaction costs, and improve return-on-assets. On the other hand, these transactions, if used opportunistically by management or other stakeholders, can produce misleading operating results and adversely affect minority shareholders' wealth.
The FASB’s concerns about the non-arms-length nature of RP transactions raise concern about management and insider opportunism. FASB argues that potential wealth transfers can occur between the firm and the related parties, and RP transactions enable the firm to manipulate its financial statements (FASB, 1982). FASB’s concern about RP transactions clearly focuses on the lack of an arms-length transaction which makes RP transactions inherently susceptible to manipulation by management for their own gain. Furthermore, financial statement manipulation can interfere with accounting-based contracting and monitoring. The management opportunism view suggests the market will view RP transactions negatively (Kohlbeck & Mayhew, 2009).
Management opportunism was a key driver in the misappropriation of assets and misleading financial reporting in the recent frauds at Enron, Healthsouth and other firms. In many of these frauds, management allegedly used RP transactions both to enrich themselves and to generate misleading financial statements. For example, Enron engaged in a number of large purchases and sales with related entities producing earnings that would not have otherwise been recognized (Swartz & Watkins, 2003). At the same time, the transactions significantly increased the CFO and other officers’ wealth. Kalyta and Magnan (2008) document that powerful CEOs extract rents using executive pensions where the disclosures are of lower quality. Erickson et al. (2000) also describe in detail how RP transactions enabled Lincoln Savings and Loan to meet important regulatory capital constraints, but later led to its collapse. While RP transactions can be opportunistic, they can also potentially fulfill the underlying needs of the company. For instance, some companies make strategic investments in joint ventures to obtain and secure access to supplies or markets (e.g. vertical integration) and to manage risk. Transactions between RP and firms also generally involve less information asymmetry between the two parties, than is typically the case when the transaction occurs between the firm and a third-party.
Prior research documents that financial statements contain value relevant information. For example, Bao and Chow (1999) show that reported earnings and book values are significantly associated with share prices for sample firms issuing shares to foreigners. They also show that the combined explanatory power of earnings and book values has increased over time. Haw, Qi, and Wu (1999) document a significant association between stock returns and changes in earnings in both long-window and short-window studies. By using both return specifications and price specifications. Chen, Chen, and Su (2001) provide evidence that accounting information, including earnings and book value, is value relevant in the Chinese markets. Overall, the empirical evidence from prior research suggests that earnings and book values are value relevant to investors. We examine the value relevance of disclosed RPTs in corporations and focus on two types of RPTs: sales of goods and sales of assets.
Methodology
The present study in terms of objective is categorized as an applied research, and in terms of the methodology is a descriptive research. And, among the descriptive studies, this is a correlational research. The analysis and test of the hypotheses were done according to the proposed hypotheses and functional definition of the dependent and independent variables based on the Pierson correlation coefficients and by using multi-variable regression
analyze at the 5% Significance Level. Also, by defining the R2 coefficient, the changes of the dependent variables versus independent variables were analyzed. In the present study, the Student statistics (t) was used in order to investigate the accuracy of the research hypotheses and the Fischer statistics (f) was used in order to investigate the adequacy (efficiency) of the proposed model. Moreover, in order to investigate the normality of the data which is prerequisite of the accuracy test of the hypotheses, Kolmogorov-Smirnov test was used, and finally in order to analyze the hypotheses and supplementary tests in order to validate the regression model, Eviews software was applied. In order to achieve the above mentioned objectives, the following hypotheses are proposed:
Hypothesis1: Sales of goods to related parties affects the earning relevance in determining the market value of shares.
Hypothesis2: Sales of assets to related parties affects the earning relevance in determining the market value of shares.
The following models were designed on the basis of Ge et al.’s 2010 model :
Price it = β0 + β1 BV it + β2 EPS it + β3 EPS it*S goods it +ε it
Price it = β0 + β1 BV it + β2 EPS it + β3 EPS it*S assets it +ε it
where:
Price: Stock price in end of year;
BV: book value of equity per share;
EPS: annual earnings per share;
Sgoods : dummy variable, coded 1 for firms selling goods to related parties and 0 otherwise;
Sassets : dummy variable, coded 1 for firms selling fixed assets to related parties and 0 otherwise.
Results and Discussion
Hypothesis1
According to the obtained EPS correlation coefficients (sig = 1.5463), it can be concluded that there is a positive and significant relationship between the EPS and the stock price of the companies, and it decreases to 0.0078 after including the interaction term EPS*S goods. This represents a reduction of profits in companies that are related party transactions of sales of goods. As the valuation parameter of EPS in our valuation model is a function of earnings persistence, macro-economic and time-specific factors, this difference may not be caused by the standard adoption. Our interaction terms distinguish the coefficient of EPS between firms with and without related-party sales during the same time-period, and we draw our inferences about the impacts of the standard adoption from the coefficient estimates of the interaction terms. Prior research documents that financial statements contain value relevant information. For example, Bao and Chow (1999) show that reported earnings and book values are significantly associated with share prices for sample firms issuing shares to foreigners. They also show that the combined explanatory power of earnings and book values have increased over time. Haw, Qi, and Wu (1999) document a significant association between stock returns and changes in earnings in both long-window and short-window studies. By using both return specifications and price specifications. Chen, Chen, and Su (2001) provide evidence that accounting information, including earnings and book value, is value relevant in the Chinese markets. Overall, the empirical evidence from prior research suggests that earnings and book values are value relevant to investors.












































Hypothesis2
According to the obtained EPS correlation coefficients (sig = 2.2131), it can be concluded that there is a positive and significant relation between the EPS and the stock price of the companies, and it decreases to 0.0033 after including the interaction term EPS*Sassets. This represents a reduction of profits in companies that have related party transactions of sales of assets, but it is not significant, because the p-value of interaction term EPS*Sassets(0.413) is more than .005. As the valuation parameter of EPS in our valuation model is a function of earnings persistence, macro-economic and time-specific factors, this difference may not be caused by the standard. Our interaction terms distinguish the coefficient of EPS between firms with and without related-party sales during the same time-period, and we draw our inferences about the impact of the standard adoption from the coefficient estimates of the interaction terms. Prior research documents that financial statements contain value relevant information. For example, Bao and Chow (1999) show that reported earnings and book values are significantly associated with share prices for sample firms issuing shares to foreigners. They also show that the combined explanatory power of earnings and book values have increased over time. Haw, Qi, and Wu (1999) document a significant association between stock returns and changes in earnings in both long-window and short-window studies. By using both return specifications and price specifications. Chen, Chen, and Su (2001) provide evidence that accounting information, including earnings and book value, is value relevant in the Chinese markets. Overall, the empirical evidence from prior research suggests that earnings and book values are value relevant to investors.











































Conclusions
The purpose of this study was to investigate the effect of related-party transactions on the value relevance of earnings in determining the market value of the shares of the companies listed in the Tehran Stock Exchange. This study focuses on two types of related-party transactions includingsales of goods and materials, and sales of fixed assets to related-parties. For achieving this purpose, 164 companies listed in Tehran Stock Exchange were analyzed during the years 2009 to 2015. Research hypotheses were tested using multiple regression and panel data methods with fixed effects Estimation method used for the analysis of survey data in multiple regression.
The results indicated that value relevance of earnings in determining the market value has been reduced in the companies that have related-party transactions using sales of goods and materials. Also, related-party transactions using sale of fixed assets did not have significant effects on value relevance of earnings in determining the market value of firm.

Keywords

• related-party transactions
• value relevance of earnings
• stock market value
• goods and material sales
• fixed asset sales

References

[1] Accounting Standards Committee (2007). Iran accounting standards. Tehran, Audit organization publication. (In Persian).

[2] Aghyi, M. A., Vafayi, H. R. (2015). Analysis of the effects of inflation, firm size and profit stability on the relevance of net income. Knowledge of financial accounting, 1(1): 29-48. (In Persian)

[3] Amir, E., & Lev, B. (1996). Value-relevance of nonfinancial information: The wireless communications industry. jornal of Accounting and Economics, 22 (1-3): 3-30.

[4] Bao, B. H., & Chow, L. (1999). The usefulness of earnings and book value for equity valuation in emerging capital markets: Evidence from listed companies in the People's Republic of China. Journal of International Financial Management and Accounting, 10(2): 85−104.

[5] Chen, C. J. P., Chen, S., & Su, X. (2001). Is accounting information value-relevant in the emerging Chinese stock market? Journal of International Accounting, Auditing & Taxation, 10: 1−22.

[6] Copeland, R. M., & Licastro, J.F. (1968). Income manipulation and the purchase-pooling choice. Journal of Accounting Research (Autumn): 188-195.

[7] Faghani, M. K. (2015). Investigate the relevance of book value, earnings and cash flow with stock prices. Acounting management, 2 (24): 43-59. (In Persian).

[8] Financial Accounting Standard Board. (1980). Statement of Financial Accounting Concepts, No. 2, "Qualitative Characteristics of Accounting Information".

[9] Ge, W., Drury, D., Fortin, S., Liu, F., & Tsang, D. (6494). Value Relevance of Disclosed Related Party Transaction. Advaces in Accounting, Incorporating Advances in International Accounting, 61: 90- 91.

[10] George, S. Y. (2015). Value relevance, earnings management and corporate governance in China. Emerging Markets Review, 23 : 186–207.

[11] Ghaemi, M. H., Livani, A. J., & Deh Bozorgi, S. (2008). Earnings Quality and stock returns. Accounting and Auditing Reviews, 15(52): 71-72. (In Persian).

[12] Gordon, E. A. & Henry, E. (2005). Related Party Transactions and Earnings Management. Retrieved from http://papers.ssrn.com/sol3/ papers. Cfm? abstract_id=612234&rec=1&srcabs=993532&alg =1& pos = 1.

[13] Jian, M., & Wong, T. (2010). Propping Through Related Party Transactions. Review of Accounting Studies, 15(1): 70-105.

[14] Kakyabi, Y., Buzhmehrani, E., & Naderi, F. (2015). Profit forecast error, related party transactions and the proportion of outside board members. Experimental Studies Quarterly Financial Accounting, 43: 135-151. (In Persian).

[15] Karami, G. (2008). The relationship between institutional ownership and profit information content. Accounting and Auditing Reviews, 15(54), 81-83. (In Persian)

[16] Kohlbeck, M., & Mayhew, B. (2009). Valuation of firms that disclose related party transactions. Jornal of Public Policy, 29: 115-137.

[17] Kuan, L., Tower, G., Rusmin, R., & Mitchell, J-L.W. (2010). Related Party Transactions and Earnings Management. Jurnal Akuntansi & Auditing Indonesia, 14 (2): 93–115.

[18] Lashkari, Z., Shirzadi, N. (2008). Investigating the relationship between exposure and return on equity of listed companies on Tehran Stock Exchange. Journal of Financial Accounting and Auditing, 30: 75-91. (In Persian).

[19] Liew, C. Y., Alfan, E., & Devi, S. (2015). Independent Directors’ Tenure, Related Party Transactions, Expropriation and Firm Value: Evidence from Malaysian Firms. Paper presented at the 5th International Conference on Corporate Governance in Emerging Markets, Leipzig, Germany.

[20] Miliano, D. C. (2014). Related party transactions and separation between control and direction in business groups: The Italian case. Corporate Governance, 14 (1): 58 – 85.

[21] Monaligod, M., & Del Rosario, V. (2012). Related Party transactions. American International. Journal of contemporary Research, 2(5): 79-102.

[22] Moscariello, N. (2010). Related Party Transaction: Opportunistic or Efficient Behavior? Evidence from the Italian Listed Company. Working Paper, Second University of Naples.

[23] Qu, X., Zhang, G. (2015). Value-relevance of Earnings and Book Value Over the Institutional Transition in China: The Suitability of Fair Value Accounting in This Emerging Market. The International Journal of Accounting, 50 (2): 195–223.

[24] Raffournier, B., & Pascal, D. (2002). Accounting and Capital Markets: A Survey of the European Evidence. The European Accounting Review, 11(1): 60-75.

[25] Saeedi, A., & Gahderi, E. (2007). Investigate the relevance of accounting earnings, book value and operating cash flow and investment in price-based valuation models. Accounting and Auditing Reviews,14(50): 47-64. (In Persian).

[26] Sarlak, N., & Akbari, M. (2014). Relationship between related party transactions and earnings management. Accounting and Auditing Reviews, 20(4): 77-92. (In Persian).

[27] Sheri, S., & Hamidi, E. (2012). Identify incentives of related party transactions. Accounting empirical research, 6: 49-64. (In Persian).

[28] Sheri, S., & Hamidi, E. (2013). The adequacy of the disclosure of related party transactions. Experimental Studies Quarterly Financial Accounting, 37: 39-57. (In Persian).

[29] Ullah, H., & Shah, A. (2015). Related Party Transactions and Corporate Governance Mechanisms: Evidence from Firms Listed on the Karachi Stock Exchange. Pakistan Business Review, 17(3): 663-680.

[30] Yezhen, W., Leon, W. (2015). Ownership, related party transactions and performance in China. Accounting Research Journal, 28 (2):143 – 159.