Financial Distress Assessment Using Related Party Transactions

Abstract

In the past few years, several companies in India have filed for bankruptcy, after facing financial distress. Investigations showed that many of these companies, which were from the infrastructure sector, had high values of related party transactions (RPTs) before and during the financial crisis. In this study, RPTs towards sales, loans or payments are analysed for these companies to assess if they have a pattern that can be an indicator of ensuing financial distress. The article develops a model for assessing financial distress with a combination of RPTs and accounting variables. The sample uses financial data from 2010 to 2016 of 18 companies facing financial distress and combines with 15 financially stable companies from the same sector. The study shows that combining RPTs and accounting variables in a model provides higher accuracy in assessing financial distress when compared to a model with accounting variables only. The study recommends that such transactions by financially unstable companies should be monitored closely by lenders and investors, to ensure there is no diversion of funds during the distress period. There are few studies in India or globally on the pattern of RPTs made by financially distressed companies.