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Related parties transactionsand firms market value:

the French caseMehdi Nekhili

Rouen Business School, University of Reims Champagne-Ardenne,Reims, France, and

Moez CherifUniversity of Jendouba, Jendouba, Tunisia

Abstract

Purpose The purpose of this article is to study the impact of the related parties transactions

(RPTs) on firm value, and to identify the ownership and governance characteristics of companies thatengage in this type of transactions.

Design/methodology/approach The paper uses 3SLS simultaneous model carried out on asample of 85 companies listed on the Paris Stock Exchange during the period 2002-2005.

Findings The results show that RPTs are mainly influenced by the voting rights held by the mainshareholder, the size of the board of directors, the degree of independence enjoyed by the auditcommittee and the board of directors, the choice of external auditor, the debt ratio and the fact of beinglisted in the USA. Mainly the transactions carried out directly with the main shareholders, directorsand/or managers that have a negative influence on firm value.

Research limitations/implications In future studies, it will be interesting to test the impact ofthe level of expertise as well as the level of qualification in the field of accounting and finance of themembers of the French audit committees on the frequency of RPTs.

Originality/value The current research complements prior studies on the RPT by showing that

the frequency of RPTs can be damaging to companies and can destroy their market value.

KeywordsRelated party transactions, Minority expropriation, Ownership structure, Governance,Firm value, France

Paper typeResearch paper

1. IntroductionApart from their declared motives, related parties transactions (RPTs) can mask stakesrelated to the enrichment of one party at the expense of other parties that are notinvolved in the transaction. They may, thus, lead to the expropriation of minorityshareholders, to the benefit of controlling shareholders, directors or administrators.These groups can make profits by selling to the firm (or buying from it), assets, goodsor services, at prices higher (lower) than the market price. They can also obtain loanson favorable terms (La Porta et al., 2003), use the firms assets as security for theirpersonal loans, and even dilute the interest of minority shareholders by acquiringadditional shares at preferential prices (Johnsonet al., 2000a, b). Both profits and assetscan be transferred via transactions between firms belonging to the same group. Thetransfer of wealth goes from firms located at the bottom of the pyramid towards thoselocated at the top, where the ownership rights of the principal shareholders are higher(Bebchuk et al., 2000). The empirical bases of the opportunism of these transactions

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Related partiestransactions

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pp. 291-315q Emerald Group Publishing Limited

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extend from the emerging economies, known for the weakness of their systems ofgovernance (Chang, 2003; Jian and Wong, 2004), to countries in Europe (Faccio andLang, 2002; Johnsonet al., 2000a, b; Marco and Mengoli, 2004) or America (Shastri andKahle, 2004; Gordonet al., 2006). Thus, it has been shown, in accordance with the idea

of diversion of resources by related parties that, as a reaction to these transactions,minority shareholders carry out a reduction in the value of securities, which in turnleads to a significant decrease in the value of the firm. This has been the case for firmsfrom America (Kohlbeck and Mayhew, 2010; Gordon et al., 2006), China (Jian andWong, 2004), Hong Kong (Cheunget al., 2006) and Taiwan (Lin et al., 2010).

France holds a certain interest for the study of RPTs. This choice of field of studycan be justified for at least two reasons. First, the degree of protection afforded toinvestors if relatively low in France. Indeed, La Portaet al. (2000) characterize Franceas a country that offers a low level of protection to minority shareholders. With regardto the protection of minorities and corporate governance, the institutional differencesbetween the various countries concerned constitute, for us, an additional stimulus, themore so because our research is close to that of Gordon et al.(2006), which was carriedout in a different context, namely, the USA. In our study, the distinguishing feature isthe integration of certain governance mechanisms (such as audit committees). Thesemechanisms are all the more regulated in the USA, in that there is no longer anydifference in practice between American firms. The choice still offered to French firms,regarding the adoption of certain governance practices makes a study of theminteresting, in relation to RPTs. Second, the Paris Stock Exchange is dominated byclosely held corporations (Claessenset al., 2000; Bloch and Kremp, 2001; Faccio andLang, 2002; Broye and Schatt, 2003). This ownership structure favors the expropriationof minority shareholders. In this respect, our study differs from that of Gordon et al.(2006) by emphasizing more the conflicts between majority and minority shareholders.In fact, when ownership is concentrated, conflicts between directors and shareholders

are transformed into conflicts between majority and minority shareholders.The aim of our article is to study the impact of the use of RPTs on a companys

value. The frequency of RPTs is an endogenous variable explained by ownership andgovernance characteristics. The results of the regression analyses carried out on asample of 85 French companies quoted on the Paris Stock Exchange during the2002-2005 period show that RPTs are mainly influenced by the concentration of votingrights, the presence of an audit committee and the degree of independence exercised bythe audit committee and the board of directors, and by the choice of external auditor.After a certain amount of segmentation within our sample, our results show that it isprincipally those transactions directly carried out with the main shareholders, boardmembers and directors that have a negative impact on the companys value. Amongthe governance mechanisms we adopted for our study, only joint-auditing by two of

the Big Four audit firms proved to be effective in reducing the frequency of RPTs.The paper is organized as follows. Section 2 introduces the theoretical and

conceptual framework of our study. We begin with the identification of the relevantparties, and an examination of the relationship between the risk of fraud and RPTs.If this relationship is confirmed, it should manifest itself through a negative impact onthe frequency of RPTs on the market value of a firm. In this section also, we cover theownership and governance characteristics that are thought to influence thesetransactions. The ownership characteristics adopted for our study are the separation

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of ownership and control, the percentage of voting rights held by the mainshareholders and the fact of belonging to a group or not. As governance characteristics,we adopt the size of the board of directors, the presence or not of external directors onthe board and in the audit committee, the fact of being listed in the USA or not, the

quality of the audit and the debt ratio. Section 3 concerns the methodological approach.We introduce, successively, the sample, the period under analysis, the variables andthe descriptive statistics. In Section 4, we introduce the model and we discuss theempirical results. Our study concerns a period following the promulgation of the 2001law known as NRE, on new economic regulations, and the law known as FinancialSecurity Law (LSF), on financial security, which today regulate RPT transactions inFrance. Finally, Section 5 summarizes and concludes the paper.

2. Theoretical and conceptual framework2.1 RPT: definition and risk of expropriation of minority shareholdings2.1.1 Definition of related parties and of RPTs. A transaction with a related partyinvolves a company and another entity to which it is related, such as, for example,a controlling shareholder, a director, a manager, etc. or also companies under theircontrol, or with which they are affiliated, together with other companies controlled bythe company itself. Agreements between two companies with the same directors arealso subject to the provisions for regulated agreements. To this should also be addedagreements concluded between two companies when one of the corporaterepresentatives of one company (director, chairman of the board or CEO) is also theowner of, a partner in or a director of the other company. RPTs involve all transactionsof this nature, whether major or marginal. In practice, the definitions, for legalpurposes, of related party and related party transaction, as also the rules for listingand accounting standards, vary from country to country. In France, RPTs aregoverned by Article L. 225-38 of the new commercial code, adopted in September 2000,

which concerns regulated party agreements. A regulated party agreement is:Any agreement entered into, either directly or through an intermediary, between thecompany and its general manager, one of its assistant general managers, one of its directors,one of its shareholders holding a fraction of the voting rights greater than 5% or, in the caseof a corporate shareholder, the company which controls it within the meaning of Article L.233-3[1], must be subject to the prior consent of the board of directors. The same applies toagreements in which a person referred to in the previous paragraph has an indirect interest.

In France, such transactions are subject to a special report drawn up by the auditor, whois asked to match the information provided with the original documents it arises from, inorder to draw up a report on agreements made and intended for the general meeting ofthe shareholders, who decide whether to approve the RPT or not[2]. The auditor,therefore, has a mission to provide information, and must in no case give an opinionon the utility, the merit or the advisability of the agreements. Agreements with no priorauthorization are more difficult to identify, but the auditor is not expected to conduct anythoroughgoing search for them. Vigilance must simply be exercised during the usualchecks.

In France, in the last few years, the regulatory provisions concerning these questionshave been modified considerably. The new economic regulations (NRE) law of 2001enlarged the scope of the list of people who are required to respect the regulatedagreements procedure when carrying out a transaction with the company beyond


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the group of managers and directors, in particular so as to include certain shareholdersholding a fraction of the voting rights greater than 5 percent. The LSF no. 2003-706 of1 August 2003, represented a retreat with regard to transparency, by exemptingtransactions concerning current operations that are concluded in normal circumstances.

In addition, the threshold for the compulsory submission for approval of agreementsmade with a shareholder was raised from a 5 percent holding of voting rights to10 percent. Finally, this law makes no judgment on transactions and their probableeffects on the wealth of minority holdings. It should also be noted that, since the LSFlaw, auditors no longer classify operations with related parties known as current, andwhich were concluded, under normal circumstances, in the category of regulatedagreements, and do not therefore signal them in their special report on regulatedagreements. In general, current operations are carried out with the company within thecontext of its activity, and in so-called normal conditions.

2.1.2 RPT and the risk of fraud. At this time, there is no formal procedure companiescan follow in order to inform the market whether they check their activities with relatedparties, and if so, how this is done. Where RPTs are concerned, internal checkingsystems are inadequate (Gordon et al., 2006). National and international standards, stockmarket authorities and legislation supplement, duplicate and sometimes contradict eachother, but all aim to improve the quality of the information supplied to the users offinancial statements, and to make it compulsory to publicize these transactions wherethey are likely to affect the companys results and, consequently, its financial situation.Moreover, expropriation is more likely to happen when it is difficult to detect(Mitton, 2002). Although studies on results management and creative accounting haveproliferated in the last 15 years, the links between results management and RPT havereceived very little attention. In this field, the studies by Gordon et al. (2006) andHenryet al.(2007) represent an advance in the understanding of the challenges RPTswithin companies present, with regard to the management of results and the production

of fraudulent financial documents. RPTs, then, may be considered to represent a toolfor managing results with a view to presenting them to third parties with acceptable orfavorable financial statements, or for transferring a companys results to other parties,thereby removing profits, or losses, from the financial statements. RPTs may, indeed, beused to enable companies to present results that comply with the demands of themanagers, who are themselves obliged to meet the expectations of investors or creditors.Although the fact that RPTs have taken place does not in itself constitute a proof offraud, it remains the case that some RPTs can be used to produce fraudulent documents(Henry et al., 2007). For Moyes et al. (2005), the existence of RPTs is, in the eyes of internalauditors, an indication of the risk of fraud or opportunism. Among the large number ofrisk factors identified in standard SAS 99, the 77 internal auditors interviewed by theauthors classified the existence of RPTs as the second most important with regard to

opportunism, and the fifth most important with regard to fraud.2.1.3 RPT and the companys value . While the shareholders who control the capital

may divert the resources of a quoted company via RPTs, it would seem that minorityshareholders, as a reaction to these transactions, may effect a depreciation of thecompanys share value, thereby entailing a significant decrease in the companys value.Cheunget al. (2006) examined a sample of 375 transactions between firms quoted onthe Hong Kong exchange and their main shareholders and directors in the period1998-2000. The authors distinguished three categories of RPT:

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(1) transactions that a priori result in the expropriation of the firms minorityshareholders (acquisition/sale of assets, commercial relations, etc.);

(2) transactions that may be to the advantage of the minority shareholders of thequoted company (cashing of liquid assets and relations with subsidiaries); and

(3) transactions that are carried out for strategic reasons and which therefore haveno purpose of expropriation (takeover bids and alliances with equityinvestment, acquisitions and sales of shareholdings in shared subsidiaries).

Over a period of 12 months following the announcement of these transactions,Cheunget al.(2006) found that returns were negative, and significant. Compared withsimilar transactions with unrelated parties over the same period, RPTs are associatedwith lower returns. Jian and Wong (2004) concur and show, on the basis of 137 companiesquoted in China between 1997 and 2000, that loans grated to related parties have asignificant negative effect on the value of the firm, measured by the market-to-bookratio (the ratio between the market value and the book value of the shareholders equity).

Gordon et al. (2006) examined the relationship between RPTs and the value of112 companies quoted in the USA over the period 2000-2001 (the period before thepromulgation of the Sarbanes-Oxley Act in 2002). They also found that abnormal stockmarket yields are negatively associated with RPTs. This result was obtained fortransactions carried out with both executive and non-executive directors. Furthermore,there is a negative relationship between industry-adjusted yields and loans grantedto executive and non-executive directors. Kohlbeck and Mayhew (2010) also find, in asample of 1,261 American firms, that transactions with the companys directors,managers and main shareholders result in negative yields. In addition, annual yields onshares associated with the sales of goods and services to related parties are lower than onthose associated with sales to unrelated parties. At the international level, Dahya et al.(2008) examined 782 companies from countries where investor protection is low, and

which had one controlling shareholder above the 10 percent threshold. The authorsfound that, in general, the companies that do not use RPTs have a higher value thanthose having recourse to such transactions:

H1. RPTs negatively affect the companys market value.

2.2 Ownership and control characteristics and RPT2.2.1 Separation between ownership-control and RPT. RPTs are more likely to occur incompanies where the main shareholders have both the incentive and the power toexpropriate minority shareholders. When the voting rights of the main shareholdersincrease, they can indulge in transactions that are favorable to them, to the detriment ofminority shareholdings (Claessenset al., 2000). Cheunget al.(2006) showed that firmsin Hong Kong that engage in RPTs are liable to lead to the expropriation of minorityshareholdings, and to have a high level of concentration of equity ownership in thehands of the firms main shareholder. In France, Le Maux (2004) found that the factthat the controlling coalition was at the same time the majority in terms of equityholding (with a threshold of 40 percent) and in terms of representation on the board ofdirectors, led to a significantly increased use of RPTs. According to Le Maux (2004),this result shows that the controlling coalition, secure in the knowledge that it will nothave to deal with any potential takeover bid, uses all the powers available to it in orderto extract as much wealth for itself, to the detriment of minority shareholders.


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In France, few companies have dispersed capital (Faccio and Lang, 2002;La Porta et al., 1999). In their study of 402 companies floated on the stock exchangebetween 1986 and 2000, Broye and Schatt (2003) found that the main shareholder held,on average, 48.83 percent of the shares (median value 50.64 percent), as against

14.02 percent (median 12.13 percent) for the second biggest shareholder, often a memberof the same family, or the co-founder of the company. In addition, they reported that64.82 percent of companies are controlled by families, against only 14 percent withdispersed shareholdings. These results confirm those that Bloch and Kremp (2001)obtained with a sample of CAC 40 quoted companies, which showed that the averageholdings of banks, insurance companies and other institutions were particularly large.Further to this, Faccio and Lang (2002) showed that, in half of all cases, the mainshareholder alone held the majority of voting rights in French companies, whereas theaverage for cash-flow rights was 46.68 percent. For these authors, the degree ofseparation between the ownership and control of equity corresponds to the degree towhich minority shareholders are vulnerable to expropriation by the main shareholder:

H2a. Separation of ownership and control of the main shareholder favors RPTs.H2b. The main shareholders voting rights favor RPTs.

2.2.2 Affiliation to a group and RPTs. Shareholders that control the capital can increasetheir voting rights relative to their cash-flow rights, by the formation of groups with apyramid structure (Faccio and Lang, 2002). Claessens et al. (2006) highlight the factthat RPTs are more numerous in companies that are affiliated with a group. Groups arecharacterized by the development of an internal capital market, which is essential forthe financing of transactions between member companies. Scharfstein and Stein (2000)speak of the dark side of the internal capital market, to emphasize its role in thedevelopment of RPTs at the group level. Several authors, in fact, have shown thattransactions between companies in the same group are used as a way to manage

results (Johnson et al., 2000a, b; Jian and Wong, 2004; Khanna and Yafeh, 2005;Thomas et al., 2004), or to divert substantial free cash flow, by transferring theinvestment capital of divisions with strong growth potential to divisions with weakpotential (Chang, 2003; Friedmanet al., 2003; Jian and Wong, 2004; Marco and Mengoli,2004; Liu and Lu, 2007). When certain firms generate large amounts of free cash flow,they can divert these resources by offering loans to other members of the group onfavorable terms. Bianchiet al.(2002), based on a sample of 728 firms quoted in Italy in1996, showed that the debt incurred by one of a groups subsidiaries can be used tofinance another. Internal loans, on favorable terms, are used to the advantage of thefirms held by the dominant shareholder. This operation is carried out with the solepurpose of increasing the volume of assets controlled by the dominant shareholder. Inthese conditions, the minority shareholders of the subsidiary dominated by thecontrolling shareholder assume, without profiting from, a significant amount of thedebt servicing. The study by Marco and Mengoli (2004) showed that, in the 1989-1996period, the sale of shares within Italian groups with pyramid structures was a meansfor transferring the wealth of the minority shareholders to the advantage of thosecontrolling the capital. Thus, when acquisition and sale operations betweenthe different elements in the group are carried out, the price is set in such a way asto move wealth up to the companies located in the higher levels of the pyramid, whereownership by majority shareholders is least diluted:

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H3. Affiliation to a group favors RPTs.

2.3 Governance structure and RPTThe weight of the agency costs associated with RPTs seems to indicate an even moresignificant role for governance mechanisms in the control of firms (Kohlbeck andMayhew, 2010). Good quality corporate governance reduces the frequency of use ofRPTs and, as a consequence, the risk of the expropriation of minority shareholdings(Gordonet al., 2006).

2.3.1 Characteristics of the board of directors. The literature concerning corporategovernance considers that small boards of directors perform the role of control betterthan larger ones (Fama and Jensen, 1983; Klein, 2002; Yermack, 1996). A large numberof directors on the board can, indeed, lead to collusion and conflicts of interest. It couldthen become a favorable terrain for the establishment of a climate of conflict anduncertainty. Beasley (1996), based on a sample of 150 American companies, found thatfraud increases in relation to the size of the board of directors. The appointment of a

new director tends to increase the board of directors ability to exercise control, but thiseffect is counterbalanced by the marginal cost in terms of communication, coordinationand decision making. According to Gordonet al. (2006), an increase in the number ofdirectors (an indicator of weak governance) is associated with a higher occurrence ofRPTs, particularly transactions involving executive directors:

H4. A large board of directors favors RPTs.

Apart from its size, the composition of the board of directors is also an element that mayemploy its effectiveness to exercise control. The presence of independent, non-executivedirectors implies the presence of deciders whohave no economic interest in the company,and who do not take any part in its running (Fama and Jensen, 1983). A low number ofindependent directors casts doubt on the ability of the board of directors to ensure its role

of oversight, and to protect the interests of minority shareholders. As a consequence, theappointment of independent directors can limit the number of RPTs (Gordon et al., 2006;Cheung et al., 2006). For Dahya et al. (2008) and Kohlbeck and Mayhew (2010),the independence of the board of directors reduces the propensity to engage in RPTs:

H5. The presence of independent directors on the board of directors limits thenumber of RPTs.

2.3.2 The presence of an independent audit committee. Audit committees have animportant role to play with regard to RPTs, insofar as they are responsible foroverseeing the transparency of information and the implementation of controlprocedures. Another of their missions is to ensure that the legal auditor carries out all thenecessary investigations to ensure that the mission is achieved in compliance with

professional standards. American legislation requires not only the presence of a legalauditor, but also their total independence, and the presence of at least one member withthe necessary experience in the field of finance. Some American studies, such as Abbottand Parker (2000) and Abbott et al.(2003), demonstrate a positive connection betweenthe characteristics of the audit committee (independence, financial expertise and numberof meetings) and the quality of the audit. Based on these observations, we might expectthat companies with an independent audit committee would be stricter with regard toRPTs. However, despite the diversity of research on the relationship between


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the independence of the audit committee and the risk of the manipulation of accounts, toour knowledge there are no studies concerning RPTs and their relationship to thecharacteristics of the audit committee. According to Gordon et al. (2006), only a fewcompanies submit RPTs to an independent audit committee for approval.

In France, the implementation of audit committees is a recent occurrence, comingmainly after the publication of the Vienot reports (1995 and 1999). The NRE law of2001, and the LSF (financial security) law of 2003 have not changed the situation.This is why a certain number of French companies have chosen not to have such acommittee. Where it exists, it is considered as having more of an advisory capacitythan a role of control. Companies therefore are given the possibility of choosing theaudit committees field of activity in accordance with their needs:

H6. The presence of an independent audit committee has a limiting effect on RPTs.

2.3.3 Choice of an external auditor. One of the main problems today, in the field ofauditing financial statements, is the identification and exposure of related parties and

RPTs (Gordonet al., 2007). Expropriation seems more probable when it is difficult todetect (Mitton, 2002). The shareholders who control the capital can, then, allay the fearsof expropriation expressed by minority shareholders, by having recourse to high-qualityexternal auditors. Companies that are audited by one of the big audit houses arepresumed to have a higher quality of information disclosure. Fan and Wong (2005) use asample of companies in eight Asian countries to show that the companies that aremost exposed to agency problems call on the services of the Big Five audit firms. TheBig Five auditors charge high fees and establish a low threshold of modification,compared to other auditors. It is difficult for them to ignore problems in financialstatements, since their reputation is at stake. These auditors are perceived as being thebest information producers, simply because foreign investors associate a familiar namewith higher quality information. The results obtained by Mitton (2002) using a sample of

399companies listed in South Korea, Indonesia, Malaysia,Thailand and The Philippinesduring the 1997-1998 financial crisis, show that companies audited by these big auditfirms provided better disclosure of information for minority shareholders. These resultsconcur with those of Cheung etal. (2006), which show that companies thatare not auditedby one of the Big Five register negative yields following the announcement of RPTs.An auditor belonging to the Big Five family is, apparently, more demanding withregard to respect for the interests of minority shareholders, and more attentive to RPTs.

However, RPTs are very difficult to audit, both by the Big Five and by theNon-big-Five, because the external auditor has to rely on the good faith of themanagers, in revealing the identity of related parties and the nature of the RPTs(Gordon et al., 2007). In this respect, Louwers et al. (2008) accuse certain auditors of whatthey call lack of professionalism, where it is mainly a question of RPTs. For these

auditors, failure with regard to auditing RPTs is not due to any shortcoming in auditingstandards, but rather to a lack of diligence on the part of the external auditors, who havesometimes proved to be less than discerning in their identification, examination anddisclosure of RPTs. Often, external auditors do not apply the recommended auditingprocedures correctly. They are satisfied with the evidence with which they are provided,trust in the managers and rely on the effectiveness of the internal auditing process. It alsohappens, occasionally, that external auditors conceal evidence that could furnishproof of fraud. This is the case with auditors who maintain a special relationship

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with the managements of companies, and whodepart from the principle of independenceif sizeable audit, or non-audit, fees are at stake (Humphrey, 2008). Finally, even when ithas been divulged or detected, the fact of concluding a transaction with one or morerelated parties does not always mean that there has been an attempt to defraud, and thus

does not necessarily increase the vigilance of auditors in evaluating the object of thetransaction (Gordonet al., 2007).

A question which should be asked at this point is, in what way are the Big auditorsmore competent and independent than the others, as far as auditing RPTs is concerned?To answer this question, Louwers et al. (2008) carry out an analysis of shortcomings withregard to the auditing of RPTs according to the profile of the audit firm. A shortcomingmay be registered when the auditor does not respect the standards recommended by theSEC for the auditing of RPTs. In spite of the formal structure these standards bring tothe practice of American auditors, the auditing of RPTs is an exercise that raises a largenumber of problems for the auditor, at all stages of the audit process. Between 1983 and2006, the authors noted 43 cases of external auditors not respecting the regulations. Theauditing standards specify a process that can be defined as a sequence of three steps.The first consists of identifying the related parties through certain events that areevidence of an RPT. The second step consists of examining and detecting RPTs. The laststep is the disclosure of the RPT. Second, the authors classified the errors accordingto whether they were committed by one of the Big Four audit firms, by one of theNon-Big Four or by independent auditors. The authors noted that five auditing errorswere committed by the Big Four audit firms, or 12 percent of the overall total (43). Thegreatest number of errors, 29 (67 percent), of which 22 occurred during the examiningthe RPT step, involved the Non-Big Four audit firms, and, finally, nine errors werecommitted by independent auditors. In addition, it can be noted that the Big Fourauditors committed five errors, of which four occurred in the disclosure step, or the sameas for the Non-Big Four auditors. Although the Big Four auditors might show their

competence compared with other auditors thanks to their greater ability to detect RPTs,the quality of disclosure, and therefore of independence, seems to be rather lacking.French regulations oblige companies submitting consolidated accounts to be audited byat least two audit firms. This joint-auditing offers the possibility of the reciprocalverification of the diligence exercised by the auditors and, as a consequence, strengthensthe independence of the auditors (Piot and Janin, 2005). Competence and independenceare the two principal components of the quality of an audit (De Angelo, 1981), and thequestion we ask ourselves in this respect is whether the competence of the Big Fourauditors is, in itself, sufficient to lead companies to renounce all doubtful transactions,and thus their proliferation, and also whether an audit carried out by two of theBig Four is more effective than one carried out by a single member of the Big Four.In order to determine this, we test the following hypothesis:

H7. The joint audit by two Big Four limits the number of RPTs.

2.3.4 Listing in markets where minority shareholders have strong protection. Beinglisted in stock markets where minority shareholders enjoy strong protection enablescompanies to raise capital more easily. However, it also means they are subject to strictobligations regarding disclosure of information, which can limit the expropriation ofminority shareholders.According to Mitton (2002), when a company issues an AmericanDepositary Receipt, the quality of information disclosure can be affected in two ways.


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First, the company is subject to additional obligations regarding disclosure ofinformation, over and above whatever is required in its home country. Second, once it islisted in another country, the company can target a larger pool of investors and analystswho may have higher requirements concerning better accounting information

disclosure. Klapper and Love (2004) showed that companies that have part of theircapital quoted in the USA have a better classification, not only in terms of informationdisclosure, but also in terms of respect for the rules of good governance, such as thoseconcerning the composition and operations of the board of directors. For Reese andWeisbach (2001), the protection of minority shareholders is the prime motivation fornon-American companies to list in the USA. According to these authors, theshareholders who control the equity of companies listed in the USA cannot extract somuch uncontrolled profit as the majority shareholders of companies listed outside theUSA. The motivation for being listed in the USA depends on the ownership andcontrol characteristics of the company. Doidge et al. (2004) use data on more than4,000 companies from 31 countries, and find that the shareholders rights of control,

together with the difference between voting rights and cash-flow rights, are negatively,and significantly, affected by the fact of being listed in the USA. The authors concludethat when uncontrolled profits are high, the controlling shareholders do not seek to havetheir shares listed in the USA.

However, not all authors agree on the advantages arising from the listing of foreigncompanies in the USA. For Coffee (2002) and Licht (2003), American financial marketsare far from being a hub that offers the best protection to minority shareholders inforeign companies. They agree that access to American markets does not systematicallyentail a substantial change in the governance practice of foreign companies, and then inthe behavior of their managers and main shareholders[3]. Siegel (2009), after carryingout a survey of the legal measures taken by the SEC in America against foreigncompanies in the period from 1993 to 2003, remarked that the American courts have beenineffective in establishing a system of sanctions for foreign companies that engage in theexpropriation of minority shareholdings. It is the investors, rather than the courts, thatsanction the doubtful practices of foreign companies, by devaluing their shares on themarket:

H8. Listing in the USA limits RPTs.

2.3.5 Debt financing. Considered as a useful tool for resolving conflicts betweenmanagers and shareholders (particularly those concerning free cash flow), debt canalso be used to expropriate minority shareholdings. This is the hidden aspect of debt,which is revealed in closely held companies, and particularly in groups (McConnell andServaes, 1995). Faccioet al.(2004) speak about the case in which debt is contracted by

controlled parties on behalf of, and to the benefit of, the companys main shareholder.This situation is frequent in South East Asia, where the ultimate controller of theequity of 60 percent of listed companies is also the controller of a bank. Faccio et al.(2004) studied the relationship between debt as a mechanism for governing a companyand the risk of expropriation, in a sample composed of companies from the five mostdeveloped European countries (France, Germany, Italy, Spain and the UK), nine FarEastern countries (Hong Kong, Indonesia, Japan, Malaysia, The Philippines, Singapore,South Korea, Taiwan and Thailand). The authors found that debt is positively linked

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to the risk of expropriation, measured by the degree of separation between theownership and control of equity.

Debt can also be diverted via non-equitable transactions between companies that aremembers of the same group. This situation applies when the debt is contracted from

banks controlled by the companys main owner. According to La Porta et al. (2003),banks lend to companies that are controlled by the banks owners, on moreadvantageous terms than those imposed on loans to non-related parties. The authorsfound that annual interest rates are 4 percent lower than the rates applied to non-relatedparties. An increase of the external debt, via companies where the cash-flow rights of themain shareholder are low, may represent a potential source of expropriation of externalshareholders, by making external shareholders carry a large share of the debt burden.In this way, it is possible for certain subsidiaries to incur debts, and for the cash flow tobe circulated within the group, to the benefit of certain entities. The expropriation of theminority shareholders in the debt-burdened subsidiaries thus results from the cost ofthe financial distress borne by them, instead of by the main shareholder:

H9. Debt favors the use of RPTs.

3. Research methodologyIn this section, we introduce the sample, the data collection method, the variables andthe descriptive statistics.

3.1 SampleOur study concerns French companies listed on the Paris Stock Exchange that wereincluded in the SBF 120 index during the period 2002-2005. Financial institutions andinsurance companies, six in all, were eliminated from the initial sample. After theelimination of those companies for which we were unableto collect all necessarydata, thefinal sample comprised 85 companies, representing 340 observations. For data collection,

we read through the annual reports and other reference documents of each company inthe sample. The data concerning RPTs are found in the section headed Auditors specialreport on regulated agreements. This report includes the names of the peopleresponsible for the agreements, and a description of the terms of the agreement. All otherdata were collected through reading the relevant sections in the annual reports.

3.2 Measurement of variables and descriptive statistics3.2.1 Measurement of RPTs. In our study, we explore several forms of RPT that mayresult in a potential change of wealth. The aim of dividing RPTs according tothe category of related party is to be able to identify those that most frequently entail theexpropriation of minority shareholdings. In fact, the transfer of wealth may be madedirectly to the main shareholders, directors and/or managers, or indirectly, to companiesin which the shareholders, directors and/or managers hold substantial interests, or tosubsidiaries or affiliated companies. Our sample was divided in two ways.

The first cut enabled us to separate the transactions into two major categories. Thefirst of these includes subsidiaries and associated companies (TSAC). The subsidiariesare firms in which the company holds more than half the voting rights. The associatedcompanies are those, other than subsidiaries, in which the company holds between10 and 50 percent of the voting rights. In the literature, these transactions are notalways made to the detriment of minority shareholdings. The second category includes


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transactions between the main shareholders, directors or managers, and the companieswith which they are affiliated. These are transactions that may result in the potentialexpropriation of minority shareholders (TEXP). Transactions involving directors mayconcern exceptional remuneration, a modification of the employment contract, a golden

handshake, extra attendance fees, an extraordinary bonus, etc. Transactions involvingthe main shareholders consist of administrative and operational expenses,consultancy, acquisitions and sales of goods and services, acquisition and sale ofshares, fees, etc. Finally, transactions involving subsidiaries include service provision,guarantees, cash management, rentals for goods, opening a credit line, etc. The secondcut enables us to distinguish between, on the one hand, transactions concluded directlywith the main shareholders, directors and/or managers (TMSDM) and, on the otherhand, those indirectly carried out with these related parties via their own subsidiariesand/or companies with which they are affiliated (TSSDM). In this latter case, it is aquestion of transactions involving companies held substantially by the mainshareholders, and companies in which the directors and/or directors are associated,

and/or in which they hold substantial interests.RPTs can be apprehended by their number, by their amount in currency units

(Gordonet al., 2006) or by a binary variable that designates the use or otherwise of thetransaction in question (Cheung et al., 2006; Kohlbeck and Mayhew, 2010). For ourstudy, we adopted the number of RPTs. In fact, a reading of the report drawn up by theauditors does not make it possible for us to determine the amount involved for eachcategory of RPT[4]. The nature of the relationship between the listed company and therelated party is not always clearly explained in annual reports. In general, the auditorsreport mentions only the name if it is a question of a natural person, or the businessname if it is a corporate body. In this case, and in order to reveal the identity of therelated party, we examine the organization chart of the company, the breakdown of itscapital and voting rights and the composition of its board of directors. If the relatedparty is a company, we try to establish whether it is a subsidiary, a company controlledby one of the main shareholders, directors and/or managers, or in which the directorsor the managers hold substantial interests or perform the function of director, CEO ormanager. If the related party is a natural person, we check to find out if he/she is one ofthe main shareholders, or a director or manager. For the estimation of our model, andbecause of the significant disparity of numbers in each category of RPT, we use naturallogarithms to measure the frequency of each category of RPT.

The degree to which minority shareholders are expropriated is measured via theeffect of each category of transaction on the companys value. As a way of measuringthe value of the company, we adopt Tobins Q ratio. Tobins Q ratio is an indicator thatexpresses the ex ante performance of the company, which in principle constitutes a

measure of all anticipated income up to a defined future date. Tobins Q is the ratiobetween the market value of the company (shareholders equity financial debt) andthe replacement cost of assets. In a large number of empirical studies, the book valuerepresents an approximate but satisfactory measurement of the replacement cost ofassets. In our study, we calculate Tobins Q on the basis of the total stock marketcapitalization of the company (at the end of the fiscal year), and the book value of itsliabilities as a ratio of total assets. This is used by a large number of researchersas a way of measuring the value of a company, and any reduction is considered

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as indicating the expropriation of minority shareholders (McConnel and Servaes, 1995;Claessenset al., 2000; Jian and Wong, 2004).

Table I summarizes the definitions of the different variables used in our study, andwhat they measure.

3.2.2 Descriptive statistics. Table II gives the distribution of the numbers of eachcategory of RPT. It shows overall that the companies in our sample made a total of 1,186transactions during the period 2002-2005, and that they conducted more transactionswith subsidiaries and affiliated companies (TSAC 815) than with main shareholders,directors and/or managers (TEXP 371). In the latter category of transaction, we maynote a greater number made directly with main shareholders, directors and managers(TMSDM 261) than indirectly via affiliated companies (TSSDM 110).

Table III is constructed in the same way as that presented in Gordon et al. (2006).It gives the numbers of transactions, from 0 to more than ten, per category of relatedparty, over the period 2002-2005. It should be noted that 70.83 percent of the companiesin our sample (80 percent for Gordonet al.(2006)) disclosed at least one RPT, as against29.17 percent that declared ten or more transactions (20 percent for Gordon et al. (2006)).This table shows that 84.37 percent of the companies made at least one transaction withthe main shareholders, directors and/or managers (against 15.63 percent of thecompanies that made ten or more)and that 64.66 percent of them concluded transactionswith their subsidiaries and/or affiliated companies (against 35.34 percent that concludedten or more transactions). It can also be noted that, in 85.82 percent of cases, theshareholders, directors and/or managers make at least one transaction directly with thelisted company (against 14.18 percent of cases with ten or more transactions) and in80.91 percent of cases indirectly via their own subsidiaries or the companies with whichthey are affiliated.

Table IV shows the distribution of the models continuous explanatory variables(part A) and dichotomous variables (part B). Part A shows that, in the companies in our

sample, 33.52 percent of voting rights were held by the main shareholder, and the ratiobetween the main shareholders cash-flow rights and voting rights was 0.859.In addition, the companies have a board of directors with around 11 members, of whom45.66 percent are independent. The degree of independence of their audit committees isrelatively low, with only 54.53 percent of the members being independent on average.On average also, they have a low economic rate of return (3.14 percent), and turnovergrowth rate (5.13 percent), and a Tobins Q greater than 1 (1.495). Their dividendsaverage 1.95 times the share price. We also note, finally, that their R&D intensity is onaverage 2.8 percent, and that they have a high debt ratio, with debts standing at63.89 percent of total assets.

In part B, it can be seen that 26.28 percent of the companies in our sample belong toa group, and that about a third of them are listed in the USA. Finally, we can see that

46.47 percent use the services of one of the Big auditing firms, and that 39.12 percentare audited by two of the Big firms.

4. Model and results4.1 ModelFor all transactions, as well as for each segmentation cut carried out, we use a systemof type 3SLS simultaneous equations, insofar as the transactions that can determinethe value of the company are themselves affected by the companys ownership


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Variable Definition Measurement

Company value

QT Tobins Q Stock market capitalization plus book value of liabilities as a ratio of total assets

Related party transactions

RPT Transactions with all related parties Natural logarithm of the total number of relatedparty transactions

TEXP Related party transaction likely to leadto expropriation

Natural logarithm of the number of transactionswith main shareholders, directors and managers

TSAC Transactions with subsidiaries andaffiliated companies

Natural logarithm of the number of transactionswith subsidiaries and affiliated companies

TMSDM Transactions with main shareholders,directors and/or managers

Natural logarithm of the number of transactionswith main shareholders, directors and/ormanagers

TSSDM Transactions with subsidiaries andcompanies affiliated to main

shareholders, directors and/ormanagers

Natural logarithm of the number of transactionswith subsidiaries and companies affiliated to

main shareholders, directors and/or managers

Ownership and control characteristics

VOTE Control rights of the main shareholder Percentage of voting rights held by the mainshareholder

SEP Separation between ownership andcontrol

Ratio between voting rights and cash-flowrights of main shareholder

GROUP Affiliation to a group 1, if the company is part of a group, 0 otherwise

Governance characteristics

NDIR Size of the board of directors Number of directors the company has

DIRIND Degree of independence of the board ofdirectors

Ratio between the number of independent,non-executive directors and the total number ofdirectors

AUDC Presence or not of an audit committee Binary variable: value 1 if the company has anaudit committee, 0 otherwise

INDAUDC Degree of independence of the auditcommittee

Ratio between the number of independentdirectors and the total number of directors

BIG Audit by one of the big audit firms Trichotomic variable: value 2 if the company isaudited by two of the Big Four, 1 if the firm isaudited by only one of the Big Four,0 otherwise

CROSS Listing in financial markets whereinvestor protection is strong

1, if the company is listed in a country otherthan France, 0 otherwise

DEBT Debt ratio Ratio between financial liabilities and totalassets

Control variables

ROA Economic rate of return Ratio between EBITDA and total assetsVARTUR Variation in turnover percentage Ratio between the variation in turnover between

t and T 2 1 and the turnover in T 2 1

R&D R&D intensity Ratio between the volume of R&D and theturnover

DIV Dividend yield Ratio between the distributed dividend and theshare price

SIZE Size of the company Natural logarithm of total assets

Table I.Definition of variablesand what they measure

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characteristics and governance mechanisms. Our model thus checks, in the firstequation,the effectof each category of equation on the value of the company, as measuredby Tobins Q. As control variables, we introducethesize of the company, measured by thenatural logarithm of the total assets, the economic rate of return, measured by the ROA,

the sales performance, measured by the variation in the turnover (VARTUR) and theR&D intensity. Very large companies have better exposure to, and good coverage in,the financial press (Cheunget al., 2006). In the second equation, we will try to see theextent to which ownership characteristics and governance mechanisms may affectRPTs. In addition to the explanatory variables, we include the dividend yield, measuredby the ratio of the dividend per share to the share price, and finally the size of thecompany, as control variables. The sustained distribution of dividends is the sign of acertain level of protection for minority shareholdings, and it should also mean a reduceduse of RPTs. It is in the very large companies that the frequency of RPTs may be greater.

Our model, therefore, can be expressed as follows:

TQit a0 a1RPTit a2SEPit a3VOTEit a4GROUPit a5NDIRit a6DIRINDit a7INDAUDCit a8BIGit a9CROSSit a10DEBTit a11VARTURit a12ROAit a13R&Dit a14SIZEit 11

First segment Second segmentRPT TEXP TSAC TMSDM TSSDM

Number noted 340 340 340 340 340Number of RPTs 1,186 371 815 261 110Average 3.49 1.09 2.40 0.77 0.32SD 0.222 0.087 0.197 0.068 0.045Median 2.00 0.00 1.00 0.00 0.00Minimum 0 0 0 0 0Maximum 25 9 25 8 7

Table II.Descriptive statistics of

related party transactions

First segment Second segmentNo. of observations RPT TEXP TSAC TMSDM TSSDMNumber of

transactions Freq. % Freq. % Freq. % Freq. % Freq. % Freq. %

0 66 19.41 0 0 0 0 0 0 0 0 0 01 74 21.76 74 6.24 44 11.86 30 3.68 31 11.88 13 11.822 38 11.18 76 6.41 26 7.01 50 6.13 21 8.04 5 4.54

3 50 14.71 150 12.65 45 12.13 105 12.88 25 9.58 20 18.184 20 5.88 80 6.75 25 6.74 55 6.75 17 6.51 8 7.275 21 6.18 105 8.85 42 11.32 63 7.73 39 14.94 3 2.736 14 4.12 84 7.08 34 9.16 50 6.13 28 10.73 6 5.457 10 2.94 70 5.09 18 4.85 52 6.38 15 5.75 3 2.738 15 4.41 120 10.12 52 14.02 68 8.34 35 13.41 17 15.459 9 2.65 81 6.83 27 7.28 54 6.63 13 4.98 14 12.73$ 10 23 6.76 346 29.17 58 15.63 288 35.34 37 14.18 21 19.09Total 340 100 1,186 100 371 100 815 100 261 100 110 100

Table III.Number of transactions

made with each categoryof related party


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RPTit b0 b1SEPit b2VOTEit b3GROUPit b4NDIRit b5DIRINDit b6INDAUDCit b7BIGit b8CROSSit b9DEBTit b10DIVit b11SIZEit 12

The correlation matrix (Table V) does not show any major collinearity. All theexplanatory variables are therefore retained in the estimation of our model.

4.2 ResultsA first reading of Table VI shows that, overall, RPTs have a negative effect on the valueof the company, as measured by Tobins Q. This effect is 22.165 and is significant to athreshold of 5 percent. In other words, the market does not give a favorable welcome tothe making of these transactions which, in the long term, may represent an opportunitycost for the company in comparison with what might have been achieved withnon-related parties. In the first segmentation, the results show that transactions withshareholders, directors and managers, as well as transactions with subsidiaries andaffiliated companies, have a negative impact on the value of the company, significant toa threshold of 10 percent. This result, analogous to that found by Jian and Wong (2004)using Chinese data, and by Gordonet al.(2006) using US data, confirms ourH1. Thesetransactions are considered as a way of transferring the wealth of minority shareholderstowards those who control the company, the board of directors and/or the companiesaffiliated with them. The results of the second segmentation show that it is morethe transactions made directly with the main shareholders, directors and/or

Panel A: continuous variablesMinimum Maximum Mean SD

SEP 0.395 2.877 0.859 0.011VOTE 0% 100% 33.52% 0.139NDIR 3 21 10.79 0.212DIRIND 0% 100% 45.66% 0.012INDAUDC 0% 100% 54.53% 0.583DEBTE 3.28% 92.79% 63.89% 0.008ROA 242.40% 21.30% 3.14% 0.003R&D 0 28.60% 0.028 0.050DIV 0 20 1.95 0.001SIZE (total assets in millions of euros) 166 109,350 13,680.69 1,129.07Tobins Q 0.730 4.870 1.495 0.035VARTUR 267.23% 115.88% 5.13% 0.009

Panel B: binary variablesFrequency Percentage

GROUP 0 251 73.82

1 89 26.28Total 340 100CROSS 0 226 66.47

1 114 33.53Total 340 100

BIG 0 49 14.411 158 46.472 133 39.12

Total 340 100

Table IV.Descriptive statistics forthe explanatory variables

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VOTE

GROUP

SEP

NDIR

DIRINDIND

AUDC

BIG

CROSS

DEBT

ROA

VARTUR

R&D

DIV

SIZE

GROUP

0.039

(0.469)

1.000

SEP

2

0.026

(0.629)

20

.041

(0.447)

1.000

NDIR

2

0.119*

(0.028)

0.26

2**

(0.000)

2

0.069

(0.205)

1.000

DIRIND

2

0.516**

(0.000)

0.032

(0.554)

0.070

(0.196)

0.099

(0.068)

1.000

INDAUDC2

0.130*

(0.016)

0.050

(0.361)

2

0.026

(0.638)

0.101

(0.063)

0.311**

(0.000)

1

.000

BIG

0.033

(0.539)

0.005

(0.920)

0.004

(0.935)

0.216**

(0.000)

0.072

(0.183)

0.2

25**

(0

.000)

1.000

CROSS

2

0.293**

(0.000)

0.073

(0.179)

0.064

(0.240)

0.255**

(0.000)

0.262**

(0.000)

0.3

50**

(0

.000)

0.259**

(0.000)

1.000

DEBT

2

0.065

(0.235)

0.1

07*

(0.048)

0.091

(0.094)

0.238**

(0.000)

2

0.082

(0.129)

2

0.105

(0

.054)

2

0.047

(0.386)

0.100

(0.064)

1.000

ROA

0.120*

(0.027)

0.011

(0.844)

2

0.171**

(0.002)

2

0.035

(0.525)

0.048

(0.378)

20.141**

(0

.009)

2

0.042

(0.439)

2

0.181**

(0.001)

2

0.337**

(0.000)

1.000

VARTUR

0.022

(0.689)

0.059

(0.276)

2

0.113*

(0.038)

2

0.128*

(0.018)

2

0.089

(0.101)

2

0.086

(0

.112)

2

0.024

(0.659)

2

0.049

(0.367)

2

0.086

(0.112)

0.227**

1.000

R&D

2

0.123*

(0.024)

0.021

(0.695)

0.039

(0.476)

2

0.062

(0.254)

0.080

(0.142)

0.1

91**

(0

.000)

0.173**

(0.001)

0.250**

(0.000)

2

0.325**

(0.000)

2

0.008

(0.882)

0.100

(0.066)

1.000

DIV

0.031

(0.566)

0.079

(0.146)

0.045

(0.411)

0.247**

(0.000)

0.006

(0.907)

0

.015

(0

.790)

2

0.027

(0.621)

2

0.049

(0.372)

0.031

(0.563)

0.139*

(0.010)

2

0.051

(0.353)

2

0.205*

(0.000)

1.0

00

SIZE

2

0.163**

(0.003)

0.30

5**

(0.000)

2

0.065

(0.235)

0.660**

(0.000)

0.223**

(0.000)

0.2

41**

(0

.000)

0.265**

(0.000)

0.355**

(0.000)

0.363**

(0.000)

2

0.146**

(0.007)

2

0.124*

(0.022)

2

0.065

(0.234)

0.217**

(0.0

00)

1.000

Note:Significantat:*5and**1percent

Table V.Correlation matrix


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Totalsample

Firstsegmentation

Secondsegmentation

Variable

TQ

RPT

TQ

TEXP

TQ

TSAC

TQ

TMSDM

TQ

TSSDM

RPT

2

2.165**(22.08)

2

3.605*(21.71)

2

1.673*(21.85)

2

2.94

2**(22.12)

0.056(0.85)

SEP

2

0.101(20.41)

0.030(0.21)

2

0.489(21.64)

2

0.100(20.89)

2

0.101(20.44)

0.063(0.44)

2

0.64

8**(22.33)

2

0.164(21.62)

2

0.194**(22.17)

0.030(0.41)

VOTE

0.961(1.60)

0.405**(2.10)

1.252(1.42)

0.323**(2.13)

0.417(1.07)

0.225(1.16)

1.07

9*(1.72)

0.341***(2.57)

0.030(0.25)

2

0.019(20.20)

GROUP

0.129(0.80)

0.024(0.24)

2

0.018(20.09)

2

0.031(20.40)

0.173(1.11)

0.057(0.58)

0.11

9(0.77)

0.012(0.17)

0.083(1.35)

2

0.052(21.03)

NDIR

0.071*(1.76)

0.026*(1.85)

0.123(1.63)

0.031***(2.7

3)

0.018(0.77)

0.003(0.21)

0.07

7*(1.88)

0.022**(2.22)

0.007(0.81)

0.012*(1.72)

DIRIND

2

0.470(21.24)

2

0.007(20.03)

1.694(1.22)

0.599***(3.2

8)

2

1.151**(22.37)2

0.400*(21.71)

0.95

4(1.20)

0.483***(3.01)

2

0.485***(23.36)

0.128(1.08)

INDAUDC

0.180(0.85)

2

0.037(20.31)

0.633**(2.38)

0.111(1.20)

0.056(0.24)

2

0.142(21.21)

0.94

5***(2.93)

0.233***(2.88)

0.296***(4.01)

2

0.117*(21.95)

BIG

2

1.079**(21.94)2

0.487***(27.20)

2

0.485(21.42)

2

0.128**(22.40)

2

0.815*(21.74)

2

0.483***(27.10)2

0.40

6*(21.70)

2

0.131***(22.80)

0.003(0.06)

2

0.024(20.70)

CROSS

0.682***(3.08)

0.226**(2.28)

0.099(0.40)

2

0.027(20.34)

0.648***(2.75)

0.253***(2.53)

0.08

8(0.45)

2

0.037(20.53)

0.248***(3.95)

0.021(0.41)

DEBT

2

0.194(20.39)

2

0.051(20.17)

0.835(1.27)

0.302(1.31)

2

0.525(21.01)

2

0.279(20.95)

1.14

1(1.62)

0.415**(2.04)

2

0.002(20.01)

2

0.088(20.58)

ROA

4.105**(2.43)

3.271(0.99)

5.037***(7.32)

4.26

9***(2.91)

5.012***(10.98)

VARTUR

2

0.086(20.29)

2

0.358(20.47)

0.078(0.49)

2

0.23

0(20.46)

0.101(0.63)

R&D

4.797**(2.25)

4.450**(2.39)

3.743***(3.12)

4.71

1**(2.33)

3.815***(6.71)

DIV

2.133(0.85)

1.224(0.62)

3.341(1.33)

1.618(0.94)

2

0.176(20.14)

SIZE

2

0.058(20.80)

0.027(0.70)

2

0.167**(22.07)2

0.013(20.43)

0.005(0.06)

0.073*(1.85)

2

0.19

6***(22.91)2

0.027(21.00)

2

0.128***(25.37)

0.024(1.21)

CONS

4.616***(4.03)

1.021***(3.00)

2.367***(3.43)2

0.052(20.19)

3.974***(4.28)

0.923***(2.70)

2.43

5***(4.56)

0.004(0.02)

2.402***(10.74)

2

0.087(20.50)

R2

(%)

49.05

16.56

49.07

8.12

49.08

18.30

49.04

10.27

49.15

4.70

Note:Significantatthresholdof:*10,

**5and

***1percent

Table VI.Results obtained: entiresample and eachsegmentation

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managers (TMSDM), not those made with subsidiaries and affiliated companies(TSSDM), that have a greater effect in depreciating the companys value. With regard tothe other variables in the first equation, the fact of being listed in the USA, along with theROA and the R&D intensity, has a positive effect on the value of the company. The

results of the second segmentation show that the degree of separation between ownershipand control, as a measurement of the risk of the expropriation of minority shareholders bythe main shareholder, has a negative effect on the value of the company. Being audited byone of the Big audit firms does not work to the advantage of value. Its impact is negativeand significant. The results obtained for the other variables are mixed.

In the case where ownership and control are separate, the main shareholders canextract personal profits at lower cost (Claessens et al., 2000; Faccio et al., 2002). When themain shareholders voting rights are greater than his cash-flow rights, he can use thisvoting power to indulge in creating the means, in this case RPTs, to enable him toincrease the volume of the flow in his favor. However, as pointed out by Cronqvist andNilsson (2005), it is the percentage of voting rights, rather than the separation betweenownership and control, which leads to the expropriation of minority shareholdings. Theresults obtained for the second segmentation show that the voting rights held by themain shareholder (VOTE) favor the expropriation of minority shareholdings, throughthe proliferation of transactions made directly with the main shareholders and the boardof directors (TMSDM), whereas the impact of the degree of separation betweenownership and control (SEP) is not significant. Claessens et al. (2000) found that thevoting rights of the main shareholder, as a measurement of the risk of expropriation ofminority shareholdings by the main shareholder, have a negative effect on the value ofthe company. Our study shows that this relationship may be direct, but also indirect,through the proliferation of transactions with the main shareholders, directors andmanagers. No significant result wasobserved, moreover, with regard to the impactof theGROUP variable on RPTs as a whole, or on the transactions obtained regarding each

segmentation. In view of our results, we can confirmH2b, and rejectH2a andH3.With regard to governance mechanisms, our results coincide with Kohlbeck and

Mayhew (2010) and Gordonet al.(2006), who consider that a large board of directors isa favorable environment for the making of RPTs. In our case, the effect observedis positive and significant on transactions made directly with shareholders, managersand directors (TMSDM), and indirectly through affiliated companies (TSSDM). Theseresults enable us to retain H4.

The independence of the board of directors does not seem to play an active role inreducing the numbers of RPTs. Independent directors favor transactions thatpotentially entail expropriation (TEXP), particularly those made directly with the mainshareholders, directors and managers (TMSDM). This result is contrary to that ofGordonet al.(2006) and Kohlbeck and Mayhew (2010), and it does not authorize us to

confirm H5. The independent directors are appointed by the board of directors, andmainly by the managers and main shareholders. When it is a question of profitabletransactions, they can enter into collusion with the latter in order to make personalprofit. The limit of five directorships held, simultaneously imposed by the NRE lawof 2001, does not seem to have prevented the tacit agreements that may exist betweenindependent directors and the main shareholders, directors and/or managers. In viewof the results we found, we can only underline a feeling of doubt as to the reality of theindependence of directors in France.


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The problems associated with the question of the independence of directors seemalso to concern the independence of the audit committee. Our results show that thedegree of independence of the audit committee has a positive effect on transactions thatpotentially entail the expropriation of minority shareholdings, particularly those made

directly with shareholders, managers and directors (TMSDM). This effect is 0.233, andit is significant to a threshold of 1 percent. The audit committee is more effective,however, in reducing transactions made indirectly with the shareholders, managersand directors through companies with which they are affiliated (TSSDM). The effectidentified is negative (20.117) and significant to a threshold of 10 percent. In otherwords, the members of the audit committee seem to limit all transactions to a companyin which they have no personal interest. H6cannot therefore be retained.

The audit committee can however play another role, no less important, with regard toreducing the number of RPTs, if this contributes effectively to the appointment of anexternal auditor. In fact, the results show that the appointment of an external auditorfrom among the Big firms is the most important mechanism with regard to reducingthe number of RPTs. Its effect is, as suggested inH7, negative (20.487) and significantto a threshold of 1 percent. In spite of the limits mentioned above, concerning the abilityof auditors to follow up and superviseRPTs, the Big auditors seem, from our results, tobe more effective than other audit firms in limiting the number of RPTs. The resultsfound for the BIG variable remain unchanged in relation to what we were able to observethroughout the sample. The Big auditors do not, apparently, employ the differencebetween the various categories of transactions obtained via our segmentation. An auditcarried out by an internationally renowned firm reduces the number of transactions withthe main shareholders, directors and/or managers (TEXP) to the same extent withsubsidiaries and/or affiliated companies (TSAC). We should note, however, that theeffect observed is noticeably lower with transactions, and potentially entails theexpropriation of minority shareholders rather than transactions with subsidiaries

and/or affiliated companies. In the second segmentation, our results show that, when acompany is audited by one of the Big firms, the number of transactions made directlywith the main shareholders, directors and managers (TMSDM) is reduced. The effectsfound are negative and significant to a threshold of 5 percent. However, this does nothave any significant impact on the transactions made indirectly with these relatedparties via the companies affiliated to them (TSSDM). Overall, an audit by a big auditormay be considered as an effective governance mechanism, by limiting the expropriationof minority shareholders through RPTs. This result supports the idea that, at leastwhere RPTs are concerned, there is a positive relationship between the size of the auditorand the quality of the audit. In view of these results,H7is confirmed.

The fact of being listed in the USA, which is considered one of the financial marketswhere the protection of minority shareholders is strongest, has the effect of increasing

the frequency of transactions with subsidiaries and affiliated companies (TSAC).It should further be noted that no significant effect is observed on the other categoriesof RPT. This result coincides with those of Coffee (2002), Licht (2003) and Siegel (2009),for whom multi-listing is not an effective mechanism for reducing the expropriation ofminority shareholders. Therefore, H8cannot be retained.

Contrary to the results obtained by Gordon et al. (2006), the use of debt cannot beconsidered as having any disciplinary effect on managers, in the sense that it can leadto a reduction of transactions that might prove damaging for minority shareholders.

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From our results, it would appear to be an extra resource that is liable to beexpropriated by the main shareholders, directors and managers. As Faccio et al.(2004)found, debt favors transactions that potentially entail the expropriation of minorityshareholdings. The impact of the DEBT variable on the TMSDM variable is 0.415, and

it is significant to a threshold of 5 percent. H9 is therefore rejected.The policy regarding distribution of dividends has no effect at all on the frequency of

related party transactions. In all categories, no significant effect of dividend yield on thenumber of transactions is thus noted. Regarding the size of the company, the onlysignificant impact observed is on transactions made with subsidiaries and affiliatedcompanies (TSAC). However, it should be noted that in this case it is low, and significantto 10 percent. The size of the company does not then represent fertile ground for theproliferation of transactions with shareholders and the board of directors.

5. Summary and conclusionsA large number of managers, directors and main shareholders have been accused of

having played a significant role in the various scandals that led to the collapse of certainvery large companies or groups of companies. More particularly, they have beenreproached with carrying out doubtful transactions with the company, with the objectiveof expropriating minority shareholders and furthering their own interests. Based on asample of 85 companies listed on the Paris Stock Exchange during the period 2002-2005,we have shown that it is the transactions directly made with the main shareholders, andalso those madeindirectly via companies with which they areaffiliated,thatdepreciate thevalue of the company. These transactions are the most damaging to small shareholders,and they are determined mainly by the voting rights held by the main shareholders.

The size of the board of directors increases the frequency of RPTs. In addition, thepresence on the board of independent directors and an audit committee calls out forreview. Although they make a marked contribution to reducing transactions with

subsidiaries and affiliated companies, independent directors, paradoxically, seem tofoster transactions made with the main shareholders, directors and/or managers.Furthermore, the presence of an audit committee seems to be effective only in reducingtransactions made with subsidiaries and affiliated companies. Its degree ofindependence serves only to strengthen its impact on this category of transaction,but has no effect at all on transactions potentially entailing expropriation.

In the USA, the Sarbanes-Oxley Act prohibits certain RPTs that are considereddamaging to small shareholders. In France, although it represents an advance withregard to the governance of French companies, the law on NRE of the 15 May 2001 andthe LSF of the 1 August 2003 say nothing about the damage certain RPTs can causeto minority shareholders. In view of our results, these two laws do not seem to offerminority shareholders any real protection, faced with possible coalitions between

managers, main shareholders and directors. Our study does not confirm the role ofaudit committees in reducing the number of related party transactions. In addition,it should be noted that it is only since December 2008 that a European directive hasmade these committees compulsory, and subject to strict rules concerningindependence and competence. The complexity of these transactions requires acertain level of expertise in the members of the audit committee. US Stock Exchangeregulations require the presence of at least one member having sufficient expertise inthe field of accounting and finance. A more comprehensive study, covering, apart from


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the question of independence, the level of expertise as well as the level of qualificationin the field of accounting and finance of the members of such committees, would enableus to measure the impact of these characteristics with regard to the supervision ofRPTs in French companies.

Notes

1. According to Article L 233-3 of the Commercial Code: I. a company is deemed to controlanother company: (1) when it directly or indirectly holds a fraction of the capital that gives ita majority of the voting rights at that companys general meetings; (2) when it alone holds amajority of the voting rights in that company by virtue of an agreement entered into withother partners or shareholders and this is not contrary to the companys interests; and (3)when it effectively determines the decisions taken at that companys general meetingsthrough the voting rights it holds; II. it is presumed to exercise such control when itdirectly or indirectly holds a fraction of the voting rights above 40 percent and no otherpartner or shareholder directly or indirectly holds a fraction larger than its own. III. [. . .]two or more companies acting jointly are deemed to jointly control another company when

they effectively determine the decisions taken at its general meetings.2. According to Le Maux (2004), these agreements are approved in the majority of cases

(98 percent).

3. According to Licht (2003), companies which register their shares in American stockexchanges or which issue takeover bids in the USA are subject to disclosure requirementsand share registration obligations which differ from those to which American companies aresubject. For example, foreign issuers are required to give the names of people holding morethan 10 percent of the voting rights, whereas American companies must announce the namesof people holding more than 5 percent of the voting rights.

4. Several other reasons could be put forward to justify the choice of the number (not the value)of RPTs as a relevant measurement in a study of the degree to which minority shareholdingsare protected. The value of the RPTs may be low, and the fact that they have taken place

may suffice to reflect the divergence between the interests of small shareholders and morepowerful groups (majority shareholders or directors). The second reason is that certaintransactions represent expenses for the company (purchases of goods and services), whileothers involve revenue (sales of products and services); grouping them together, then, wouldmake no sense. The third is that the information concerning the values of the transactionsdiffers from company to company. Some publish the amount for the transactions in the fiscalyear, while others report only the balance of these transactions. The fourth reason is relatedto the fact that, particularly in the case of transactions involving directors, it is a question oftransactions that have been agreed, but have not been implemented during the fiscal year(severance pay). Finally, the last reason is related to the fact that the amounts reported forcertain transactions are annual expenses, which are neither cumulated nor discounted,whereas the amounts involved in loans are principal amounts, presented in stock.Consequently, the sum of the amounts related to services and of loans cannot represent a

significant aggregate of RPTs.

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La Porta, R., Lopez-de-Silanes, F., Shleifer, A. and Vish

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