Value Relevance of Disclosed Information about Related Party Transactions

Abstract

Several recent North American corporate scandals have brought to attention the potential for accounting manipulations associated with related parties and related party transactions. Related parties potentially create the concerns that transactions are designed to manage earnings, thereby leading to a decline in perceived earnings quality. We examine the value relevance of disclosed information about related party transactions to investors in China. We focus on two types of related party transactions: sales of goods and sales of assets. We find that, during 1997-2000, the reported earnings of firms selling goods or assets to related parties have a lower valuation coefficient than that of firms without such transactions. This result is not observed during 2001-2003 after a new measurement rule for related party transactions became effective. Our evidence suggests that the new related party transactions measurement regulation adopted in China is perceived effective at reducing the potential for earnings management through related party transactions. Since related party transactions have been the subject of numerous scandals recently in North America, the evidence suggests that new accounting standards could potentially offer more reliable information to investors.