Regulation Of Related Party Transactions Research Articles

Minorities' Representativeness on the Board and their Effect on the Level of Compliance with the Italian RPTs Regulation

The definition and regulation of related-party transactions (RPTs) depend mainly on the conceptual framework underlying the interpretation of such a phenomenon. While the conflict of interests hypothesis focuses on opportunistic behaviours, the efficient transaction hypothesis suggests that RPTs lead to more efficient. In such a scenario, instead of providing opposite interpretations, the contingency hypothesis considers the potential risks and benefits associated with specific RPTs, i.e. other contex- tual factors and corporate governance mechanisms. Among the latter, independent di- rectors, empowered by the majority of national legislations worldwide, should play a crucial role in spotlighting opportunistic behaviours to the detriment of minorities. However, in light of the many corporate scandals that have stressed the RPTs' issues, practitioners and academics have questioned their effectiveness, especially in contexts characterized by high ownership concentration, while leaving room for the so-called minority directors, i.e. independent directors appointed by minority shareholders. On this matter, aiming to analyse the potential impact of minority directors on the level of procedural compliance for the RPTs' implementation, this empirical study, based on a data set, shows that they represent a more effective tool for the full and strict adoption of the current RPTs regulation, while independent directors fail in their monitoring role and are ineffective in bolstering corporate transparency with regard to RPTs.

Corporate Law and Governance Pluralism

AbstractFor the past several decades, jurists have invested significant efforts in developing the law in general—and private law in particular—in terms of pluralism. However, the conceptualization of corporate law and governance according to pluralist principles rarely exists. This Essay is the first in the legal literature to address this deficiency by providing a unique pluralist theory of corporate governance regimes. It distinguishes between the plurality of corporate law’s sources, values, and principles, and discusses the implications for governance. Moreover, based on the social systems’ thinking and the framework of complexity, this Essay provides theoretical grounds for skepticism about any policies or structures applicable to all times and contexts. Therefore, rather than perceiving corporate governance as being identically applicable to all corporations, the law must meet the challenge of complexity by designing governance arrangements following a firm-specific perspective. Furthermore, I argue that in conditions of complexity, corporate governance eco-systems should be designed with a firm-specific view that incorporates the effect of the corporation participants’ heterogeneity, the heterogeneity of its internal power relations, and the heterogeneity of industries and markets. These novel arguments have profound implications for redesigning fundamental legal doctrines—such as fiduciary duties of controlling shareholders, regulation of related party transactions, the officers’ duty of care, and the company purpose.

Related party transactions, agency problem, and exclusive effects

This paper examines the incentives for, and economic impact of related-party transactions (RPTs) by controlling shareholders (CSHs) of corporate groups. We analyze a theory model of RPTs transacted on ‘market terms’ by two affiliate firms in a group, one of which belongs to an upstream and the other to a downstream market. We show that RPTs of this kind, although non-advantageous to the CSH of the group in terms of transfer price, may be abusive in that they serve the interests of the CSH by sacrificing minority shareholders. This is due to the exclusive effects of such RPTs. We show that a CSH has a strong incentive to exclude upstream rivals for his/her own sake rather than the group’s when he/she is allowed to implement such RPTs. The results shed light on regulation of RPTs: distortions of RPTs arise not only from unfair transfer-pricing but also from large transaction volume. This further implies that competition policies regarding the leverage of market power and anti-competitive vertical mergers may be applied to regulate harmful RPTs.

From the Law of Corporations to the Law of Corporate

For several decades, jurists have invested significant efforts in developing the law in general and private law, in particular, in terms of pluralist conception. However, the conceptualization of corporate law and governance in terms of pluralist notions rarely exists. The lack of a comprehensive pluralist theory of corporate law appears puzzling. This Essay intends to fill this void by providing a novel pluralist theory of corporate governance regimes. This account is based on social systems theory and the framework of complexity that is rooted in the natural sciences and was since spread to social science disciplines. I argue that under conditions of complexity, the ecosystem of corporate governance regimes has to incorporate the influence of participants’ heterogeneity and firm-specific power relations on outcomes and performance. This argument has profound implications for redesigning several legal doctrines, such as fiduciary duties of controlling shareholders, regulation of related party transactions, the company objective, and officers’ duty of care. Our study rejects the “one size fits all” regulation approach and supports the view that good governance design is not universal but rather depends on firm-specific characteristics. Accordingly, this Essay calls for establishing internal and external corporate governance regimes following firm-specific views.

The Political Economy of the Related Party Transactions Regulation in the Shareholders’ Rights Directive II

Abstract This study tracks the legislative process of the Shareholders’ Rights Directive II as regards the regulation of related party transactions (RPT) and identifies important factors that have led to the current regime of RPT regulation in the EU. While the European Commission’s Proposal subjected material RPTs to approval by the majority of (minority) shareholders (MOM approval) and a number of other requirements, the requirements have been greatly watered down in the legislative process. The analysis suggests that the ambition of the European policy makers to strengthen European capital markets and attract/facilitate more foreign/cross-border investment led the European Commission to propose MOM approval for RPTs based on the feedback/demand from the institutional investors. This proposal, however, faced a backlash from the business community and some Member States. Relatedly, as a result of the pressure of the interest groups that represent the European companies and some reluctant Member States, during the legislative process, numerous compromises have been made, giving wide discretion to Member States in devising a regime of RPT regulation and effectively spelling the death of the European Commission’s ambitions. The study then concludes by connecting this process to accounts of how corporate law develops in the literature.

The Pluralist Foundations of Corporate Law and Governance

For the past several decades, jurists have invested significant efforts in developing the law in general, and private law, in particular, in terms of pluralism. However, the conceptualization of corporate law and governance according to pluralist principles rarely exists. This Article is the first in the legal literature to address this deficiency by providing a unique pluralist theory of corporate governance regimes, based on social systems thinking and the framework of complexity that is rooted in the natural sciences and has since spread to social disciplines, as well. The complexity framework perceives organizations as a subset of social systems that represent a sophisticated web of interconnectivity between human beings and their environment. Organizations are made of interactive, adaptive agents, groups, and departments, that communicate with one another through feedback mechanisms. The features of such exchanges, and their normative implications, may significantly differ between numerous companies that operate in various industries. Accordingly, the complexity framework provides theoretical grounds for skepticism about any policies or structures that are applicable to all times and all contexts. Therefore, rather than perceiving corporate governance as being identically applicable to all corporations, the law must meet the challenge of complexity by designing contextual governance arrangements, following a firm-specific perspective. I believe that the versatility of companies’ characteristics indicates that a “one-size-fits-all” approach should be avoided, and a contextual approach should be embraced when crafting tailor-made law. Furthermore, I argue that in conditions of complexity, corporate governance eco-systems should be designed with a firm-specific perspective that incorporates the effect of the corporation participants’ heterogeneity, the heterogeneity of its internal power relations, and the heterogeneity of industries on their performance. These novel arguments have profound implications for redesigning fundamental legal doctrines—such as fiduciary duties of controlling shareholders; regulation of related party transactions; the company objective; and officers’ duty of care in different legal systems.

Related Party Transactions in Commonwealth Asia: Complicating the Comparative Paradigm

The World Bank’s influential Doing Business Report (DBR) has been a key platform for the American-driven dissemination of global norms of good corporate governance. A prominent part of the DBR is the related party transactions (RPT) index, which ranks 190 jurisdictions from around the world on the quality of their laws regulating RPTs. According to the RPT Index, the regulation of RPTs in Commonwealth Asia’s most important economies is stellar. In the 2018 RPT Index, Singapore ranked 1st, Hong Kong and Malaysia tied for 3rd, and India came in at 20th. However, despite the uniformly high RPT Index scores in all of Commonwealth Asia’s most important economies, empirical, case-study, and anecdotal evidence overwhelmingly suggests that there are in practice significant inter-jurisdictional and intra-jurisdictional differences in the actual function and regulation of RPTs in Commonwealth Asia. In this article, we assert that the conspicuous gap between what the RPT Index suggests should be occurring and what is actually occurring in Commonwealth Asia exists because it fails to capture the complexity of RPTs in three respects, which we term: (1) regulatory complexity; (2) shareholder complexity; and, (3) normative complexity. First, it appears that the RPT Index overly emphasizes the role played by a jurisdiction’s formal corporate and securities laws in determining the effectiveness of its RPT regulation, and it fails to pay due regard to its corporate culture and rule of law norms in determining the efficiency of its RPT regulation. Second, the RPT Index erroneously assumes that controlling shareholders are a homogeneous group driven by similar incentives. Third, the general assumption that RPTs per se are evidence of defective corporate governance and that stricter regulation of RPTs consequently equates to “good law” is erroneous. Demonstrating the frailties of the RPT Index is important in practice because jurisdictions – especially developing ones – commonly look to the DBR and its indices when reforming their laws. In addition, the RPT Index is built on some of the most influential research in the field of comparative corporate law, which makes our challenge to the validity of the RPT Index academically significant.

Related Party Transactions in France - A Critical Assessment

In France, the regulation of related party transactions (RPTs) involves three steps following the notification to the board of an RPT. First, the board gives its prior authorisation to the transaction. Those who are self-interested do not take part in the vote. Secondly, auditors prepare a report on RPTs. Thirdly, a general meeting of shareholders approves or rejects it. If the shareholders do not endorse the transaction, any adverse consequences will be borne by the interested insiders. The RPT can only be avoided if it was not approved by the board and is harmful to the company. This longstanding procedure has been designed to prevent company officers and substantial shareholders from using their power to influence a contract with the company on terms less advantageous than those that the company would have obtained from a third party in a fair and balanced negotiation. This rather burdensome procedure often proved artificial and ineffective. Anti-tunnelling laws may have been unproductive because demand for them and shareholder protection more generally had traditionally been low in a culture where top management was a closed club. However, the addition of AMF recommendations in 2012 and legislative modifications in 2014 have increased the quality and quantity of information passed on to auditors and shareholders. The implementation of the 2017 Directive on Shareholders’ Rights may be the occasion to introduce further useful adjustments, such as a legislative clarification of the scope of French RPT law.

The Law and (Some) Finance of Related Party Transactions: An Introduction

This paper is the introductory chapter of Luca Enriques and Tobias Troger (eds.), The Law and Finance of Related Party Transactions (Cambridge University Press: forthcoming). Its goal is to sketch out the individual chapters’ contributions to the scholarly and policy debates on the adequate regulation of related party transactions (RPTs). For that purpose, we scope the issue by highlighting the principal costs and benefits of shareholder control, which allows both the implementation of entrepreneurial vision and various forms of rent-seeking. We next proceed by putting the challenges of regulating RPTs into the broader context of conflicts of interest and tunneling techniques. Against this background, we then turn to the main regulatory options available for legislators (independent/disinterested director approval, majority of the minority approval, ex post fairness review, and involvement of supervisory agencies), highlighting some of the key insights on each of them from individual chapters. Finally, we show how the chapters in the book can also inform European legislators who are currently in the process of implementing the revised Shareholder Rights Directive rules on RPTs.

Related Party Transactions in Insolvency

Transaction avoidance rules are widely considered to be an important tool for the regulation of related party transactions in insolvency. Existing ‘best practice’ guidance on the design of insolvency laws assumes that such avoidance rules are best operationalised within collective insolvency procedures. But in many jurisdictions the commencement of collective insolvency proceedings is value destructive; so much so that creditors may prefer to see firms fail outside such proceedings, even if this means foregoing opportunities to use the avoidance tools available within them. This suggests that avoidance tools may be most powerful when available outside insolvency proceedings as well as within them. Many jurisdictions do have some such form of avoidance action, often described as the ‘actio Pauliana outside bankruptcy’, on their statute books. But these forms of action have been neglected in the literature on the control of related party transactions in insolvency, and, perhaps as a consequence, have not benefited from international initiatives to improve the operation of domestic insolvency rules in cross-border cases in the same way that transaction avoidance actions brought in connection with collective insolvency proceedings have benefited. The chapter begins by evaluating the case for approaching transaction avoidance within insolvency proceedings, before turning to consider aspects of the design of the ‘actio Pauliana outside bankruptcy’, including measures to improve its efficacy in cross-border cases.

Related Party Transactions in Commonwealth Asia: Complexity Revealed

The World Bank’s influential Doing Business Report (DBR) has been a key platform for the American-driven dissemination of global norms of good corporate governance. A prominent part of the DBR is the related party transactions (RPT) index, which ranks 190 jurisdictions from around the world on the quality of their laws regulating RPTs. According to the RPT Index, the regulation of RPTs in Commonwealth Asia’s most important economies is stellar. In the 2018 RPT Index, Singapore ranked 1st, Hong Kong and Malaysia tied for 3rd, and India came in at 20th. However, despite the uniformly high RPT Index scores in all of Commonwealth Asia’s most important economies, empirical, case-study, and anecdotal evidence overwhelmingly suggests that there are in practice significant inter-jurisdictional and intra-jurisdictional differences in the actual function and regulation of RPTs in Commonwealth Asia. In this article, we assert that the conspicuous gap between what the RPT Index suggests should be occurring and what is actually occurring in Commonwealth Asia exists because it fails to capture the complexity of RPTs in three respects, which we term: (1) regulatory complexity; (2) shareholder complexity; and, (3) normative complexity. First, it appears that the RPT Index overly emphasizes the role played by a jurisdiction’s formal corporate and securities laws in determining the effectiveness of its RPT regulation, and it fails to pay due regard to its corporate culture and rule of law norms in determining the efficiency of its RPT regulation. Second, the RPT Index erroneously assumes that controlling shareholders are a homogeneous group driven by similar incentives. Third, the general assumption that RPTs per se are evidence of defective corporate governance and that stricter regulation of RPTs consequently equates to “good law” is erroneous. Demonstrating the frailties of the RPT Index is important in practice because jurisdictions – especially developing ones – commonly look to the DBR and its indices when reforming their laws. In addition, the RPT Index is built on some of the most influential research in the field of comparative corporate law, which makes our challenge to the validity of the RPT Index academically significant.

Related Party Transactions: UK Model

This paper analyses the regulation of related party transactions in the UK through two comparative lenses, one external, the other internal. The external comparison is between English law and the law on RPTs in the United States, especially in Delaware. The internal comparison is between the English corporate law applying to all companies and the additional rules applicable to companies quoted on the London Stock Exchange, both those with a premium listing on the Main Market and those traded on the Alternative Investment Market. The first external comparison highlights two features of the general regulation of RPTs in the UK. The first is the adherence of English law to the classical concept of a fiduciary and the second is reluctance to use assessment of the substantive fairness of the transaction as a test for the legality of the RPT and, in consequence, its reliance on wholly procedural controls. The first feature made it difficult for the general law to handle RPTs with shareholders, including directors in their capacity as shareholders. The second came into prominence when the private-ordering model which underlies UK company law led to the shift of the procedural controls from the shareholders to the board. For both problems, UK statute law developed some work-arounds, but without comprehensive revision of these underlying characteristics of the general law. The comparison with the rules for publicly traded companies shows how rules might develop when the starting point is a functional one. Substantial shareholders are as much subject to the constraints as directors and fairness opinions are routinely utilised. However, exchanges have become subject to much sharper regulatory competition than national legal systems. Rule-makers are cautious in their use of exchange rules to promote corporate governance objectives which go beyond what is internationally acceptable. As early as 1993 the London Stock Exchange seems to have pulled back from a widespread application of majority-of-the-minority shareholder approval for RPTs and this century it has wavered in its policies towards subjecting controlling shareholders to effective constraints on RPTs.

Be Careful What You Wish for: How Progress Engendered Regression in Related Party Transaction Regulation in Israel

The regulation of related party transactions (RPTs) is today the single most important yardstick for the quality of corporate governance systems. It is also one of the thorniest issues because RPTs are a well-documented cause of abuse by corporate insiders, yet they could be valuable and sometimes simply inevitable. This paper analyzes reform measures adopted in Israel with a view to improving corporate governance in general and RPT regulation in particular. Whereas one set of measures revolved around procedural safeguards based on disinterested informed approval (a property-like rule), another set purported to establish a Delaware-like business court that would implement an “entire fairness” review (a liability-like rule). The latter trend came to dominate the former notwithstanding applicable statutory and case law, thus engendering regression instead of progress in RPT regulation. This case suggests lessons for law makers, be they judges or legislators, who contemplate mimicking the “corporate capital of the world”.

Enforcing Rules on Related Party Transactions in Italy: One Securities Regulator's Challenge

In the wake of the corporate scandals of the early 2000s, Italian policymakers tackled tunnelling via related party transactions (RPTs) by enacting a three-layer regime: a statute setting the goals of a regulation (transparency, and substantial and procedural fairness of RPTs); a regulation enacted by the financial markets authority (Consob), which defines the “principles” for achieving those goals; and individual companies’ internal codes which implement those principles. As a consequence of that approach, Consob was entrusted with two challenging functions: first, to spell out those principles and, second, to enforce the new regime. Consob designed a flexible regulatory framework where, in addition to a set of mandatory provisions, various default ones and some opt-in rules were made available. The core provisions, on the one hand, require immediate disclosure on material transactions to improve market scrutiny, and, on the other, bolster internal governance mechanisms, by granting independent directors veto power on material RPTs. As for Consob’s role in enforcement, which is the focus of this chapter, we first describe the formal and informal powers that Consob can use to prevent tunnelling via RPTs and how, in the first years after the RPT Regulation came into force, Consob prioritized such goals both in its strategic plans and its internal organization choices. Then, we report two cases to illustrate how the regulator’s timely action, particularly requests for additional disclosure, can encourage companies to adopt better practices and improve RPT terms. At the same time, the analysis of substantial issues (e.g. if the RPT is substantially fair) has made actual enforcement trickier, leading Consob to prefer soft rather than formal powers. Our tale, though, has no happy ending. We show how, after a few years of zealous enforcement of the RPT rules, Consob has become less aggressive in its (somewhat isolated) fight against tunnelling.

The SEC and the Courts’ Cooperative Policing of Related Party Transactions

A transaction between a corporation and its director or officer (a “related party transaction”) presents conflicts of interest that could harm, or alternatively, could also benefit the corporation. To sort beneficial related party transactions from detrimental ones, the current legal regime relies on both ex ante screening and ex post litigation. Disclosure plays an essential role in both stages. Based on a set of hand-collected data on actual disclosures from Fortune top fifty companies, this Article casts doubt on the effectiveness of the current regulation of related party transactions. The ambiguity of the federal securities regulations leaves too much room for manipulation. An approving committee of each company exercises considerable discretion not only over which proposed transactions to approve, but also over which transactions to disclose to its shareholders and what information to include in the disclosures. In the context of state corporate law, uncertainty exists in fiduciary duty of loyalty litigation regarding when and whether a court should bypass the fairness test and apply the business judgment rule to a related party transaction that satisfies certain safe harbor conditions, such as approval by disinterested directors. This Article proposes a fix by linking the strategic disclosure problem to the question of the applicable standard of review in fiduciary duty of loyalty litigation. To that end, the court should consider a disclosure under federal securities law as a strong signal of fairness of the disclosed transaction and be more willing to apply the business judgment rule rather than the fairness test in state duty of loyalty litigation. Potential benefits of the proposal include creating better incentives to disclose related party transactions, giving litigants more predictable rules, and allowing for richer accumulation of disclosure data over time, thus providing better guidance to companies and market participants in distinguishing between beneficial and harmful related party transactions.

The SEC and the Courtss Cooperative Policing of Related Party Transactions

A transaction between a corporation and its director or officer (a “related party transaction”) presents conflicts of interest that could harm, or alternatively, could also benefit the corporation. To sort beneficial related party transactions from detrimental ones, the current legal regime relies on both ex ante screening and ex post litigation. Disclosure plays an essential role in both stages. Based on a set of hand-collected data on actual disclosures from Fortune top fifty companies, this Article casts doubt on the effectiveness of the current regulation of related party transactions. The ambiguity of the federal securities regulations leaves too much room for manipulation. An approving committee of each company exercises considerable discretion not only over which proposed transactions to approve, but also over which transactions to disclose to its shareholders and what information to include in the disclosures. In the context of state corporate law, uncertainty exists in fiduciary duty of loyalty litigation regarding when and whether a court should bypass the fairness test and apply the business judgment rule to a related party transaction that satisfies certain safe harbor conditions, such as approval by disinterested directors. This Article proposes a fix by linking the strategic disclosure problem to the question of the applicable standard of review in fiduciary duty of loyalty litigation. To that end, the court should consider a disclosure under federal securities law as a strong signal of fairness of the disclosed transaction and be more willing to apply the business judgment rule rather than the fairness test in state duty of loyalty litigation. Potential benefits of the proposal include creating better incentives to disclose related party transactions, giving litigants more predictable rules, and allowing for richer accumulation of disclosure data over time, thus providing better guidance to companies and market participants in distinguishing between beneficial and harmful related party transactions.

The Effect of the IFRS on Intercompany Transactions. The Case of the Greek Food-beverage Sector

The present study examines the value relevance of disclosed related party transactions (RPTs) in group of companies at the Greek food-beverage sector. We are based on two types of transactions, exchange of goods- products and exchange of assets, using a value relevance approach. We apply the model of Ohlson for the period 2003-2012 and we observe that the reported earnings of firms selling goods or assets to related parties exhibit a lower valuation coefficient than those of firms in Greece without such transactions. This result is not observed after 2005, when a new fair value measurement rule for related party transactions came into effect. Our evidence suggests that the new RPT regulation in Greece is perceived to be effective at reducing the potential misuse of RPTs for earnings management purposes. Since RPTs have been the subject of numerous scandals, our evidence from the Greek stock markets suggests that new RPT accounting standards could prove an effective solution to this issue.

Related party transactions in continental European countries: Evidence from Italy

Related party transactions (RPTs) are potentially either efficient arrangements or tools for self-dealing. Unlike previous empirical studies using data from the United States or developing countries, this article focuses on RPTs in Italy. First, the article compares Italian RPT regulation and disclosure requirements with those of two major Continental European countries (France and Germany). This comparison highlights the burdensome character of the Italian discipline compared with the French and German regulations. Second, it presents data on RPTs disclosed by Italian listed companies. The data indicate that ordinary intra-group commercial and borrowing activities are the most common types of RPTs. Third, the article examines the relationship between RPTs and financial/governance variables used as proxies for costs of, and incentives for, tunnelling. Only a weak association emerges between those variables and RPTs, providing very limited indication of potentially opportunistic behaviour.

The Effect of the International Accounting Standards on the Related Party Transactions Disclosure

Problem statement: Several recent North American corporate scandals have brought attention to the potential for accounting manipulations associated with Related Party Transactions (RPTs), which have lead to a decline in perceived earnings quality. We examine the value relevance of disclosed RPTs in Greek corporations. Approach: We focus on two types of RPTs: sales of goods and sales of assets, using a value relevance approach. Results: From 2002-2007, we find that the reported earnings of firms selling goods or assets to related parties exhibit a lower valuation coefficient than those of firms in Greece without such transactions. This result is not observed during 2005-2007 after a new fair value measurement rule for RPTs came into effect. Conclusion: Our evidence suggests that the new RPT regulation in Greece is perceived to be effective at reducing the potential misuse of RPTs for earnings management purposes. Since RPTs have been the subject of numerous scandals in North America, our evidence from the Greek stock markets suggests that new RPT accounting standards could prove an efficient solution to this issue.

Value relevance of disclosed related party transactions

Abstract Several recent North American corporate scandals have brought attention to the potential for accounting manipulations associated with related party transactions (RPTs), which have lead to a decline in perceived earnings quality. We examine the value relevance of disclosed RPTs in Chinese corporations. We focus on two types of RPTs: sales of goods and sales of assets. From 1997 to 2000, we find that the reported earnings of firms selling goods or assets to related parties exhibit a lower valuation coefficient than those of firms in China without such transactions. This result is not observed during 2001–2003 after a new fair value measurement rule for RPTs came into effect. Our evidence suggests that the new RPT regulation in China is perceived to be effective at reducing the potential misuse of RPTs for earnings management purposes. Since RPTs have been the subject of numerous scandals in North America, our evidence from the Chinese stock markets suggests that new RPT accounting standards could prove an efficient solution to this issue.