Related Party Transactions in India and Their Impact on Reported Earnings

Abstract

A review of published financial reports of listed companies in India shows a large presence of related party transactions (RPTs). These transactions can be useful to the company through long-term sales or purchase contracts with these related parties. However, such transactions are often misused by company management to alter and influence reported earnings. This study focuses on the relationship of related party transactions (RPTs) with earnings using a sample of 66 non-financial listed companies, for the period 2009 to 2015. The companies selected are those listed on the Bombay Stock Exchange (BSE) and belong to the BSE 100 index. The study is conducted with two types of listed companies: Group and Non-Group companies. The data on related party transactions for sales, advances, loans to related parties and receivables outstanding has been obtained from the CMIE-Prowess database. The study reviews the impact of sales and loans/advances made to related parties on the earnings reported by the company. It further evaluates the influence of outstanding amounts due from related parties on bad debts/write-offs reported in the following year. Panel data regression is used to test the models. The study confirms that sales made to related parties impact earnings positively for both types of companies, whereas loans and advances to related parties have a mixed impact on earnings depending on the type of the company, Group or non-Group Company. Bad debts reported in the current period, have a positive relationship with amounts due from related parties in the previous period, an indication of diversion of funds. The results show that RPTs are being used extensively by companies for different reasons and there is a need to have regulations to control these transactions and enforce enhanced disclosure requirements. Companies should disclose what percentage of the total transactions related to sales, purchase, loans, and advances are made to related parties and publish them with prior years data. In their financial reports, companies should inform stakeholders if these transactions have increased or decreased in the financial year with explanatory notes.