Supply Chain Structure, Corporate Governance, and Market Competition in Related Party Transactions

Abstract

This paper examines how supply chain coordination between the two related parties — a parent firm and its subsidiary firms — is affected by its supply chain structure, corporate governance, and market competition. We hypothesize that, under the supply chain structure of upstream subsidiary-downstream parent, the parent's CEO is more willing to deviate from the coordinated decisions, i.e., operational diversion, compared to that of the opposite structure of upstream parent-downstream subsidiary. To test our hypothesis, we analyze a unique dataset on related party transactions of 541 Korean multinational firms in manufacturing, wholesale, and retail industries from 2006 to 2013. We use the adoption of IFRS (International Financial Reporting Standards) in 2011 as a quasi-natural experiment on the effect of operational diversion in related party transactions and support our hypothesis using difference-in-differences analysis. This study provides evidence that the supply chain structure can serve as a useful corporate governance mechanism for improving supply chain coordination and that governance quality becomes more critical when a parent firm is in downstream rather than upstream. In addition, we show that the supply chain structure of upstream parent-downstream subsidiary acts as a self-regulating mechanism that can restrain the operational diversion even under weak governance quality and weak market competition.