Cash‐based related party transactions in new economy firms

Abstract

This paper investigates associations between related party transactions (RPTs) and governance and performance factors of new economy firms. Previous research has examined the related party transactions of large U.S. firms. In contrast, we focus on smaller, newly listed Australian firms. Referred to as 'commitments test entities' (CTE), these firms are distinguished by the unique Australian Securities Exchange listing requirements applying to them, and associated additional (quarterly cash flow) reporting requirements. While strong corporate governance characteristics may be expected to constrain the amounts of payments and loans to related parties, we find only weak evidence to support that proposition. The results show that financial condition dominates the decision to engage in RPTs and suggest that external monitoring (associated both with larger firm size and the quarterly reporting phase) are a more effective restraint on the magnitude of RPTs for these high-risk CTE firms. The findings are generally consistent with the 'conflict of interest view' proposed by Gordon et al. (2004a, 2004b), suggesting related party transactions do not serve shareholders' interests. The findings suggest that external monitoring may be a more effective control over RPTs than internal corporate governance mechanisms in this institutional context of small 'cashbox' firms. Since RPTs may not be in the best interests of shareholders, extending mandatory RPT disclosures to all periodic cash flow reports warrants further consideration by regulators. This study contributes to the limited research on the effects and implications of related party transactions.