The Impact of Related Party Transactions on Performance and Valuation of Malaysian Listed Firms: Testing the Influence of
Corporate Governance
Victor Gan
A Thesis Submitted for the Degree of
Master of Commerce
Faculty of Business and Design
Swinburne University of Technology
April 2017
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Abstract
This study examines the impact of related party (RP) transactions on the performance and
valuation of Malaysian listed firms. It also investigates the influence that corporate governance
has on this relationship. This study uses a sample of 187 firms listed in Malaysia over the period
of 2012 to 2014 for 531 firm-year observations. This study measures RP transactions using
magnitude, number of transactions, and ratios. RP transactions are further broken down into
tunnelling and propping type transactions for further testing. Performance and valuation are
proxied by return on assets (ROA) and Tobin’s Q respectively. Corporate governance is measured
by indicators of both internal mechanisms (board of directors) and external mechanisms
(ownership concentration, audit quality).
This study finds empirical evidence that tunnelling RP transactions have a significant negative
association with firm valuation. At the same time, propping RP transactions have a significant
positive impact on firm valuation. This finding suggests that tunnelling RP transactions represent
expropriation of shareholder wealth and are discounted by investors accordingly, whereas
propping RP transactions are efficient transactions that benefit the firm. This finding is robust
after controlling for leverage, firm size, and stock exchange index membership.
Consistent with prior studies, this evidence confirms that investors in Malaysian firms perceive
tunnelling RP transactions negatively as self-dealing resulting. This supports the conflict of
interest view that tunnelling RP transactions are a front for extraction of private benefits from the
firm resulting in a valuation discount. At the same time, evidence is presented in support of RP
transactions as efficient transactions that can benefit firms operating in imperfect markets.
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Declaration
This thesis contains no material which has been accepted for the award to me of any other degree
or diploma, except where due reference is made in the text of the thesis. To the best of my
knowledge this thesis contains no material previously published or written by another person
except where due reference is made in the text of the thesis.
Victor Gan
Faculty of Business and Design
Swinburne University of Technology
6 April 2017
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Acknowledgment
It has been through the counsel of many that this thesis is complete. I wish to record my thanks
to my supervisors for their guidance and advice, to my parents and sister for their patience and
understanding, and most of all to the LORD God from whom all knowledge and wisdom flows.
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List of Tables
Table 1 Summary of Tunnelling and Propping Definitions ........................................................ 22
Table 2 Malaysian Corporate Governance Research .................................................................. 38
Table 3 RP Transactions and Risks to Firm Valuation ............................................................... 44
Table 4 Definitions of Shareholder Identity ............................................................................... 47
Table 5 Definition of Tobin's Q Equation Variables .................................................................. 53
Table 6 Further Definitions of Tobin's Q Equation Variables .................................................... 53
Table 7 Definition of RP Transaction Variables ......................................................................... 54
Table 8 Further Definitions of RP Transaction Variables .......................................................... 55
Table 9 Examples of Tunnelling and Propping RP Transactions ............................................... 57
Table 10 Definition of Corporate Governance and Ownership Concentration Variables .......... 58
Table 11 Definition of Return on Assets .................................................................................... 59
Table 12 Defintion of Control Variables .................................................................................... 60
Table 13 Summary of Companies Selected for Data .................................................................. 62
Table 14 Descriptive Statistics for All Variables ........................................................................ 65
Table 15 Descriptive Statistics for RP transactions .................................................................... 68
Table 16 Descriptive Statistics on RP Transaction Disclosure ................................................... 68
Table 17 Descriptive Statistics on Value of RP Transactions ..................................................... 69
Table 18 Example of Variations in RP Transaction Disclosure ................................................. 71
Table 19 Pearson's Correlation Matrix ....................................................................................... 72
Table 20 Effect of Related Party Transactions on Firm Valuation ............................................. 80
Table 21 Effect of Tunnelling and Propping Related Party Transactions................................... 81
Table 22 Impact of Corporate Governance and Ownership Concentration ................................ 82
Table 23 Impact of Corporate Governance and Ownership Concentration on Tunnelling and
Propping RP Transactions ........................................................................................................... 84
Table 24 Effect of Related Party Transactions on Firm Performance ........................................ 89
Table 25 Effect of Tunnelling and Propping Related Party Transactions on Firm Performance 90
Table 26 Impact of Ownership Concentration and Corporate Governance ................................ 91
Table 27Impact of Ownership Concentration and Corporate Governance on Tunnelling and
Propping RP Transactions ........................................................................................................... 93
Table 28 Factors Associated with RP Transactions .................................................................... 99
Table 29 Summary of Results for Effect of Related Party Transactions on Firm Valuation and
Performance .............................................................................................................................. 103
Table 30 Summary of Results for Effect of Tunnelling and Propping Related Party Transactions
.................................................................................................................................................. 104
Table 31 Summary of Results for Firm Valuation .................................................................... 110
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Table 32 Summary of Results for Firm Performance ............................................................... 111
Table 33 Summary of Results for Factors Associated with RP Transactions ........................... 114
Table 34 Summary of Duality Trend ........................................................................................ 132
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Table of Contents 1 Introduction ............................................................................................. 1
1.1 Research Motivations .................................................................................................... 1
1.2 Problem Statement ........................................................................................................ 1
1.3 Research Question ........................................................................................................ 2
1.4 Research Objectives ...................................................................................................... 2
1.5 Significance of Contributions to Topic ......................................................................... 3
1.6 Assumptions and Limitations........................................................................................ 3
1.7 Structure of the Thesis .................................................................................................. 4
1.8 Summary ....................................................................................................................... 5
2 Literature Review ................................................................................... 6
2.1 Introduction ................................................................................................................... 6
2.2 The Role of Corporate Governance .............................................................................. 6
2.2.1 Introduction ........................................................................................................... 6
2.2.2 Development of Corporate Governance................................................................ 7
2.2.3 Related Party Transactions and Corporate Governance ........................................ 8
2.2.4 Internal and External Mechanisms of Corporate Governance .............................. 9
2.3 Related Party Transactions and Theoretical Framework ............................................ 13
2.3.1 RP Transactions: Efficient Transactions or Conflict of Interest? ....................... 13
2.3.2 Agency Theory and Conflict of Interest .............................................................. 13
2.3.3 Transaction Cost Economics and Efficient Transactions .................................... 17
2.3.4 RP Transactions as Source of Tunnelling or Propping ....................................... 19
2.3.5 Related Party Transactions and Earnings Management ...................................... 23
2.3.6 Factors Associated With Related Party Transactions ......................................... 24
2.4 Regulatory Background and Disclosure of Related Party Transactions ..................... 26
2.4.1 Accounting Standards and Market Listing Rules ................................................ 27
2.4.2 Companies Act 1965 and 2007 Amendment ...................................................... 28
2.4.3 Related Party Transactions and Disclosure ......................................................... 28
2.4.4 The Malaysian Political Economy ...................................................................... 29
2.4.5 Corporate Governance in Malaysia ..................................................................... 31
2.5 Review of Existing Empirical Evidence ..................................................................... 32
2.5.1 Review of Studies on Firm Valuation ................................................................. 32
2.5.2 Review of Malaysian Corporate Governance Studies......................................... 33
2.5.3 RP Transactions and the Risks to Firm Valuation .............................................. 43
2.5.4 Impact of Ownership Concentration on RP transactions and Firm Valuation .... 43
2.6 Development of Hypotheses ....................................................................................... 45
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2.6.1 Related Party Transactions and Association with Firm Performance and Valuation ............................................................................................................................. 45
2.6.2 Effects of Different Types of Related Party Transactions .................................. 46
2.6.3 The Impact of Ownership Concentration and Corporate Governance ................ 48
2.6.4 Factors Associated with Related Party Transactions .......................................... 48
2.7 Summary ..................................................................................................................... 49
3 Research Design ................................................................................... 50
3.1 Introduction ................................................................................................................. 50
3.2 Research Philosophy ................................................................................................... 50
3.3 Theoretical Framework ............................................................................................... 50
3.4 Model Specification and Operationalization of Variables .......................................... 52
3.4.1 Tobin’s Q ............................................................................................................ 52
3.4.2 Related Party Transactions .................................................................................. 53
3.4.3 RP Transactions and Firm Valuation .................................................................. 57
3.4.4 Corporate Governance, Ownership Concentration and RP Transactions ........... 57
3.4.5 RP transactions and Firm Performance ............................................................... 59
3.4.6 Factors Associated with RP Transactions ........................................................... 59
3.4.7 Control Variables ................................................................................................ 60
3.5 Secondary Data and Quantitative Methods ................................................................. 61
3.6 Sample Selection ......................................................................................................... 61
3.7 Data Source ................................................................................................................. 63
3.8 Summary ..................................................................................................................... 64
4 Descriptive Statistics ............................................................................ 65
4.1 Introduction ................................................................................................................. 65
4.2 Variable Means, Medians, Standard deviation ........................................................... 65
4.3 Issue Encountered During Data Collection ................................................................. 69
4.4 Correlation and Multicollinearity ................................................................................ 71
5 Empirical Results .................................................................................. 74
5.1 Introduction ................................................................................................................. 74
5.2 RP Transactions and Firm Valuation .......................................................................... 75
5.2.1 Effect of Related Party Transactions on Firm Valuation .................................... 75
5.2.2 Effect of Tunnelling and Propping Related Party Transactions .......................... 76
5.2.3 Impact of Corporate Governance and Ownership Concentration ....................... 77
5.3 RP Transactions and Firm Performance ..................................................................... 86
5.3.1 Effect of Related Party Transactions on Firm Performance ............................... 86
5.3.2 Effect of Tunnelling and Propping Related Party Transactions .......................... 86
5.3.3 Impact of Ownership Concentration and Corporate Governance ....................... 87
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5.4 Factors Associated with RP Transactions ................................................................... 95
5.4.1 RP Indicator Variables ........................................................................................ 95
5.4.2 Ratio of Number of RP Transactions to Board Size ........................................... 96
5.4.3 Ratio to Total Value of RP Transactions to Firm Size ........................................ 97
5.4.4 Total Dollar Value of RP Transactions ............................................................... 98
5.5 Discussion of Results ................................................................................................ 103
5.5.1 Effect of Related Party Transactions on Firm Valuation and Performance ...... 103
5.5.2 Effect of Tunnelling and Propping Related Party Transactions ........................ 104
5.5.3 Impact of Corporate Governance and Ownership Concentration ..................... 106
5.5.4 Factors Associated with RP Transactions ......................................................... 112
6 Conclusion .......................................................................................... 116
6.1 Summary of Thesis ................................................................................................... 116
6.2 Summary of Results .................................................................................................. 117
6.3 Implications of Study ................................................................................................ 118
6.3.1 Extending Existing Theory ............................................................................... 118
6.3.2 Extending Existing Malaysian Corporate Governance Research ..................... 122
6.3.3 Investors and Public Stakeholders .................................................................... 128
6.3.4 Regulators and Standard-setters ........................................................................ 128
6.4 Limitation of Study ................................................................................................... 130
6.5 Future Research Direction ........................................................................................ 131
6.6 Conclusion ................................................................................................................ 132
7 References ........................................................................................... 133
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1 Introduction
1.1 Research Motivations Malaysia is a leading capital market in the region. According to the Securities Commission
Malaysia’s annual report, in 2014, the Malaysian capital markets’ size was RM2.76 trillion. Initial
public offerings and other debt instruments raised RM91.9 billion during the year, and Malaysia
also has the largest unit trust industry in Southeast Asia with RM343 billion in assets under
management (Securities Commission Malaysia 2015). In line with the government’s vision to
build a strong capital market and attract investors, there is a need for continual study to understand
how to build a strong regulatory and governance system. At the same time, the close ties between
businesses and politics Malaysia represents a unique institutional and governance setting to be
studied. This is characterized by the involvement of the government and political parties via
policies to redistribute wealth along ethnic lines, which has influenced the development of
business structures and governance in Malaysia (Munir & Gul 2010).
Related party (RP) transactions are a key area of study in corporate governance and related topics
such as accounting disclosure, investor protection and fraud. In one study comprising 448 firms
over the period from 2005 to 2007, there were 4,044 RP transactions valued at RM65.2 billion by
listed companies in Malaysia (Wahab et al. 2011, p.146). Such volumes and magnitude of RP
transactions reflects its acceptance but also highlights the problems it can bring. RP transactions
in Malaysia in the past have been singled out as abusive and as mechanisms for expropriation of
wealth (Wahab et al. 2011, p.132). At the same time, RP transactions may actually have economic
benefits to the firm and its stakeholders. In addition, while regulation, restrictions and guidelines
are being formulated to constrain RP transactions, it must be noted that no country has totally
banned RP transactions (Djankov et al. 2008, p.431).
Within the current literature on RP transactions in other countries, there is no conclusive
knowledge on the nature of the relationship between RP transactions and firm valuation and
performance. There is also a distinct lack of studies on RP transactions in Malaysia. The majority
of studies on RP transactions in this region focus on companies listed in China (Chen et al. 2011;
Chen et al. 2012; Ge et al. 2012; Hu & Li 2010; Lo et al. 2010).
1.2 Problem Statement The need for research into RP transactions is important as Malaysia is a rapidly emerging
economy. Each country has its own unique national character, and each corporation has its own
unique background, environment and business objectives. The variances in corporate governance
practice across the world make it almost impossible to define the term (Aguilera & Jackson 2003).
Thus what is desirable from a corporate governance perspective in one scenario may not be so in
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another (Haniffa & Hudaib 2006, p.1035). Differences in each country’s legal system will afford
varying levels of investor protection (Demirgüç-Kunt & Maksimovic 2002). Corporate
governance or other alternative governance mechanisms such as ownership concentration may
evolve to cope with legal gaps in investor protection (La Porta et al. 1996). Corporate governance
can also develop based on previous governance and ownership structures, in a path dependent
fashion (Bebchuk & Roe 1999; Licht et al. 2001). Malaysia’s policy of ethnic based wealth
redistribution over the last 40 years via the New Economic Policy (NEP) is a key source of path
dependence in determining current governance practices. At the same time, these governance
practices need to be considered within the social context in which they occur, in that they develop
embedded within an existing social context (Gomez-Mejia & Wiseman 2005; Huse 2005).
Although Malaysia is a leader in the region in the development of a comprehensive system of
corporate governance, significant issues still remain in the areas of expropriation of minority
shareholders (Tam & Tan 2007, p.220). Firstly, without a proper understanding of RP transactions
and its impact on firm valuation and performance, it will be difficult to build a framework for
further development of the Malaysian capital market. This could risk the Malaysian capital
markets losing out regionally to more dynamic centres. Secondly, this is an opportunity for
Malaysia to develop even further as a regional capital market of choice with the right regulatory
stance, armed with a better understanding of the impact of RP transactions.
1.3 Research Question The complex interplay between RP transactions, firm valuation and performance, and corporate
governance gives rise to specific research questions in a Malaysian context:
Research Question 1: What is the relationship between RP transactions and firm valuation and
performance of Malaysian listed firms?
Research Question 2: What is the relationship between RP transactions, corporate governance and
ownership concentration on firm valuation and performance?
Research Question 3 What is the relationship between corporate governance and ownership
concentration and RP transactions?
1.4 Research Objectives More specifically, the research objectives of this study can be expressed as follows:
Research Objective 1 (RO1): To determine the effects of RP transactions on firm valuation and
performance of Malaysian listed companies.
Research Objective 2 (RO2): To determine the effects of RP transactions, corporate governance
and ownership concentration on firm valuation and performance.
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Research Objective 3 (RO3): To determine the association between corporate governance and
ownership concentration on RP transactions.
1.5 Significance of Contributions to Topic Firstly, the majority of studies on RP transactions in this region focus on companies listed in
China (Chen et al 2011; Chen et al. 2012; Ge et al. 2012; Hu & Li 2010; Lo et al. 2010). Although
current research into the area of RP transactions is limited, its effects can be widely felt.
Secondly this study extends the usefulness of agency theory and efficient transactions in
understanding the underlying nature of RP transactions. This investigation into the relationship
between ownership concentration, governance structure and RP transactions can establish
principles and characteristics of a strong governance system. Additionally, corporate governance
and ownership concentration is seen to be a moderating factor in the effect of RP transactions.
The effect of corporate governance to constrain RP transactions has been documented by previous
researchers (Gordon et al. 2004b, p.36; Wahab et al. 2011, p.158), but no prior study has
investigated the effect of ownership concentration on this relationship. This study is also unique
in the use of multiple indicators of RP transactions that have been previously developed by
researchers. Briefly, four (4) categories of variables representing RP transactions are identified.
They are namely indicator variables, ratio of number of transactions to board size, ratio of total
amount by firm size, and by total dollar value. Within these four categories, twelve (12) variables
are defined, consistent with existing research into RP transactions and prior work by various
researchers (Gordon et al. 2004a, p.11; Gordon et al. 2004b, p.24; Kohlbeck & Mayhew 2004,
p.10; Ryngaert & Thomas 2007, p.11; Gallery et al. 2008, p.155; Kohlbeck & Mayhew 2010,
p.121; Ge et al. 2010, p.137; Munir & Gul 2010, p.13; Wahab et al. 2011, p.140; Hu et al. 2012,
p.63). Specific details of each variable are presented in later chapters on the operationalization of
variables.
Thirdly this study present empirical evidence that confirms prior studies but in a Malaysian
context. By shedding light on this area, it is hoped that governance standards can be raised and
help the capital market attract both foreign and local investors. It will also serve to inform the
perspectives of all stakeholders, in particular investors and regulators, to give a clearer and more
accurate picture on RP transactions. By doing so, Malaysia is one step nearer to becoming a
developed nation and a leading capital market in the region.
1.6 Assumptions and Limitations Firstly the research is limited to the effects of RP transactions on Malaysian listed firms in the
Trading sector. The Trading sector of Bursa Malaysia was selected over other sectors as it has the
largest market capitalization by far when compared to any other sector. The selection of the
Trading sector as the sample represents the best balance between achieving significant coverage
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of the total market and limiting the costs of data collection. Within the Trading sector itself, a
wide variety of businesses are represented. The diverse range of businesses undertaken by firms
within the Trading sector allows for this study to take a good cross-section of related party
transactions performed by various companies. Additionally, firms within the Trading sector are
not separately regulated. This is unlike financial firms such as banks or insurers, which have
additional oversight from the central bank. The central bank, Bank Negara Malaysia imposes
additional regulations and prohibitions on related party transactions (Bank Negara Malaysia
2014). Such regulations may artificially distort the level of related party transaction undertaken
by an entity.
The limiting of the sample to only the Trading sector is a restrictive factor in that the results may
not be extrapolated to be representative of Malaysian listed firms, or Malaysian firms as a whole,
which are beyond the scope of this study. However, the findings may of this study are empirical
evidence that may lead to informed perspectives on RP transactions and their effects.
Secondly, the study assumes that all publicly available information is accurate. This is a limitation
as many times there are specific mechanisms and schemes to conceal information for various
reasons. In particular, due to the nature of RP transactions, concealment of such transactions in
the context of its usage as a tool for expropriation should be expected. This study assumes RP
transactions are the reported and disclosed RP transactions. Yet it is not unlikely that there are
unreported RP transactions amongst the various transactions carried out by firms. Similarly,
information about corporate governance is taken at face value, but this does not negate the fact
that there are hidden directors or undisclosed levels of ownership (Juliarto 2012, p.69). However
the study is not able to take this into account and it is assumed that publicly available information
is representative of the variables being measured.
Thirdly, although it is expected that RP transactions, and in particular tunnelling RP transactions,
will have a negative relationship with firm valuation, there is a possibility that the entire
Malaysian market as a whole is discounted due to RP transactions (Cheung et al. 2006, p.384).
Despite the limitations and assumptions outlined above, this study presents empirical evidence
that can give further insight into RP transactions and corporate governance.
1.7 Structure of the Thesis The remainder of the thesis is divided as follows. Chapter 2 lays out the theoretical framework,
current regulatory requirements, review of existing studies, and development of hypotheses. In
Chapter 3, based on the hypotheses, the research design is explained and operationalization of
variables is listed. Chapter 4 has the descriptive statistics based on the sample data collected.
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Chapter 5 discusses the results of the empirical testing. Chapter 6 concludes this thesis as well as
outlining potential direction of any future research.
1.8 Summary This section introduces the problem statement and motivations for this study, as well as the
research questions and research objectives. The significance of the contributions of this study to
the topic are also outlined. Finally major assumptions and limitations of this study are explained.
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2 Literature Review
2.1 Introduction The purpose of this chapter is to review existing literature on RP transactions, reasons for this
study, and to develop the hypotheses for testing. This chapter contains 5 sections. In the first
section, the role and significance of corporate governance is examined. The concept of corporate
governance itself, and traditional theories such as agency theory and transaction cost economics
are considered. Both internal and external corporate governance mechanisms are also looked at.
The second section examines the nature of RP transactions within the theoretical framework
developed by other researchers. In particular, agency theory and transaction cost economics are
used in building up the case for this study. In the following section, a detailed elaboration of the
Malaysian context of RP transactions from the viewpoint of legislation and regulator-issued
guidance is dealt with. Key aspects of the Malaysian political economy are also covered. The
fourth section reviews existing studies and their results regarding RP transactions, corporate
governance and firm valuation and performance. Finally, based on the arguments of the preceding
chapters, and underpinned by the theoretical framework in place, the necessary hypotheses are
developed and outlined.
2.2 The Role of Corporate Governance
2.2.1 Introduction The issue of asymmetric information is the primary driver that necessitates the existence of
corporate governance in the structure of a firm (Gordon 2004b, p.1). Corporate governance can
be defined in many ways. The Organisation for Economic Co-operation and Development
(OECD) gives a broad definition (OECD 2004, p.11):
Corporate governance involves a set of relationships between a company’s management,
its board, its shareholders and other stakeholders. Corporate governance also provides
the structure through which the objectives of the company are set, and the means of
attaining those objectives and monitoring performance are determined.
This view is representative of the state and understanding of corporate governance in the large
majority of developed countries, in particular in those under the Anglo-American legal and
economic environment (Shleifer & Vishny 1997, p.737). The definition given by the OECD is
reflective of the external and internal structures and mechanisms, by which a company may attain
its objectives and monitor its performance (Mallin 2013, p.15). The need for these structures and
mechanisms would not exists if external providers of finance and other stakeholders had perfect
information on the management of a firm. The external parties would be able to monitor, reward,
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and penalize the behaviour of the managers, thereby preventing any self-dealing or expropriation
of the firm (Gordon 2004b).
A much narrower definition of corporate governance is given by Shleifer and Vishny (1997,
p.737):
Corporate governance deals with the ways in which suppliers of finance to corporations
assure themselves of getting a return on their investment. How do the suppliers of finance
get managers to return some of the profits to them? How do they make sure that managers
do not steal the capital they supply or invest it in bad projects? How do suppliers of
finance control managers?
This view is a very practical one, and deals exclusively with the potential for management to
expropriate from the company, at the expense of the shareholders. It is only concerned with how
investors will obtain a return from managers on the capital they have sunk in to a firm. This
interpretation of corporate governance assumes separation of ownership and control and frames
the governance structure from an agency problem perspective. However, it fails to bring up the
potential conflicts of interest that may exist if the management is also a principal shareholder.
This type of conflict is typically referred to principal-principal conflict (Shleifer & Vishny 1997,
p.737; La Porta et al. 1999, p.471; Cheung et al. 2006, p.343). It involves the expropriation by the
major shareholder against the minority shareholders. Additionally, other parties such as
debtholders would not be covered by this definition.
2.2.2 Development of Corporate Governance Agency theory and the separation of ownership and control underpinned the early development
of corporate governance (Smith 1904, Berle & Means 1932, Jensen & Meckling 1976, Fama &
Jensen 1983). Management could not be expected to utilise capital within the company provided
by external investors as diligently as if that same capital had been provided by themselves (Smith
1904). Early corporation law development was largely done with the intent on preventing outright
expropriation by the management of a firm. This was evident in the 18th to 19th centuries in
Britain as well as Europe (Shleifer & Vishny 1997, p.741). Consequently, courts and corporation
law have in the past set the tone and laid down the rules by which the duties, rights and
responsibilities of management were defined (La Porta et al. 1996).
A key feature of the agency problem espoused by the separation of ownership and management
model of Berle & Means (1932), Jensen & Meckling (1976), and Fama & Jensen (1983) is the
that the conflict is between management and a wide shareholding base. In recent years this view
of the agency theory that assumes diffused shareholding to be a given has increasingly been
viewed as a Western and Anglo-American take on corporate governance (Juliarto 2013, p.2). A
wide shareholding base is primarily a feature of major Western capital markets and is not
8
representative of the shareholding structures in other parts of the world, for example in Africa,
Asia, the Middle East and South America. In these markets researchers have found that ownership
is more concentrated, and controlling shareholders have higher stakes in the companies they own
(La Porta et al. 1999, p.471; Claessens et al. 2000, p.81; Faccio et al. 2001, p.54; Claessens et al.
2002, p.2741; Young et al. 2008, p.196).
In emerging and developing markets, the focus of corporate governance shifts from mitigating
principal-agent conflicts to restraining principal-principal conflicts (La Porta et al. 1999, p.471).
This becomes an issue that is more pressing in view of the fact that many emerging markets do
not have adequate corporate governance systems and the necessary legal recourse in place for the
protection of minority shareholders (La Porta et al. 1999, p.471; Liu & Lu 2007, p.881). This
problem is further exacerbated by the high ownership concentration that is a feature of listed
companies in many of these markets (Claessens et al. 2000, p.81). In Asia, much research has
been conducted, particularly in China. The issues faced are exemplary of the complexity of
managing the different interests in a country with a developing capital market, high ownership
concentration, and relatively weak corporate governance (Jian & Wong 2003; Chen et al. 2009,
p.285; Hu et al. 2009, p.190; Hwang et al. 2013, p.292). Listed firms in such an environment
typically have a large controlling shareholder. This shareholder would have the ability to select,
monitor and control management. This give power to the controlling shareholder to expropriate
funds that should be used for the benefit of all investors (Huyghebaert & Wang 2012, p.308).
2.2.3 Related Party Transactions and Corporate Governance
Gordon (2004b, p.35) finds that corporate governance and external monitors such as lenders are
associated with a reduced dollar amount of RP transactions in the United States. In Malaysia
Wahab et al. (2011, p. 158) found that RP transactions are linked to a reduction in firm return on
assets. In the same study the authors find that external monitoring such as a big-four auditor and
the level of board independence have a moderating effect on the performance-reducing impact of
RP transactions. The study however did not differentiate between different types of RP
transactions, and only concentrated on the effect on asset return rather than firm valuation. This
is consistent with the Kohlbeck and Mayhew’s (2004, p. 20) study which also found that higher
levels of board independence were associated with less RP transactions. Other governance
mechanisms such as the presence of audit committees were also found to affect the level of RP
transactions disclosed by a company (Cheung et al. 2009, p. 924).
Studies on internal and external governance measures to protect minority investors from the
majority have also been conducted. As the gap between the major shareholders’ control rights and
cash flow rights increases, so does the level of RP transactions that a firm engages in
(Huyghebaert & Wang 2012, p.308). In this particular study, it was also found that state-owned
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firms were associated with more RP transactions, possibly to subsidise other financially weak
state-owned firms. Corporate governance mechanisms such as the board of directors and
independent directors were unable to limit this relationship.
The concept of ex ante and ex post RP transactions has also been examined. Ex ante refers to RP
transactions entered into when the counterparty is already a related party. Ex post refers to RP
transactions initiated before the counterparty becomes a related party and the effects on firm
valuation and performance. An examination of small to medium-sized American firms finds no
relationship between RP transactions and firm performance or valuation in general. However
when RP transactions are differentiated between ex ante and ex post, there is a significant
difference (Ryngaert & Thomas 2012, p.845). In particular, ex post transactions have a negative
relationship with firm performance and value, and in fact are associated with future financial
distress in firms. Ex ante transactions show no such relationship.
An examination of the key issues regarding regulation of RP transactions is the focus of a paper
by Trivun et al. (2012, p.15). They conclude that approval and disclosure of such transactions, as
well as holding board members and the controlling shareholder responsible if the firm suffers
economic losses due to the RP transactions, are key issues. This is further enhanced by having a
clear definition of RP transactions and an effective enforcement regime.
2.2.4 Internal and External Mechanisms of Corporate Governance The established view of research into corporate governance generally divides governance
mechanisms into two broad categories, namely internal and external mechanisms. Internal
mechanisms comprise primarily the board of directors, as well as ownership structure (e.g.
ownership concentration and large blockholders) (Shleifer & Vishny 1997, p.737; Boubakri et al.
2005, p.369; Jiang & Peng 2011, p.15; Huyghebaert & Wang 2012, p.308). External mechanisms
would include the regulatory and legal environmental, institutional development, leverage and
the takeover markets (Shleifer & Vishny 1997, p.737; Claessens & Fan 2002, p.71; Boubakri et
al. 2005, p.369; Wahab et al. 2011, p.131; Huyghebaert & Wang 2012, p.308).
The primary pillar of modern corporate governance in the firm is the board of directors. The board
is the pinnacle of the systems put in place to monitor, reward and penalize management of the
company (Fama & Jensen 1983, Jensen 1993, p.831). The board also serves as the first line of
defence against issues that may escalate into the crisis stage. Unfortunately few boards have
served this internal control mechanism effectively over the past few decades (Jensen 1993, p.831).
There is some evidence that research is progressing in understanding the complexities behind
board effectiveness. It is presumed that if the board is effective, the value of the firm will increase
(Amran 2004, p.48).
10
Board size is a factor that can contribute to elevating the board’s effectiveness (Jensen 1993,
p.865). It is argued that the larger the board, the less effective it becomes. Coordination between
members and going through processes with a large number of members outweighs the benefits
from having more individuals to draw on (Jensen 1993, p.865). This also makes it easier for
management to influence or manipulate. Empirical findings in the United States (Yermack 1996,
p.185), Europe (Eisenberg et al. 1998, p.35), Singapore and Malaysia (Mak & Kusnadi 2005,
p.301) support this view. In each of the previous studies, the researchers found that larger board
sizes were negatively related to firm value. This is consistent with prior research in organizational
behaviour that finds small groups being more effective than larger groups in decision making
(Mak & Kusnadi 2005, p.391). Additionally the risk of a large board being captured and
controlled by the CEO or management is higher than that of a small board (Jensen 1993, p.831).
From a practical stand, a large board consumes more in terms of remuneration, which is a direct
usage and drain on firm resources (Mak & Kusnadi 2005, p.391). Finally, a large board may be a
symptom of a predisposition of the existing board to add directors rather than replace them. This
causes an expansion in board size over time. The issue that arises is that the underlying reason for
such addition rather than replacement could be the board culture which avoids conflict and is
content to merely rubber-stamp decisions (Jensen 1993, p.831; Mak & Kusnadi 2005, p.391). At
the same time, larger boards may contribute to an increased access to resources, as well as a wider
range of experience which reduces risk to the firm (Haniffa & Hudaib 2006, p.1038). This
enhances corporate governance, as a variety of skills, experiences, knowledge and expertise can
be had with a larger board (Ghazali 2010, p. 112). A larger board also may have increased
capability to monitor management as the number of directors increases (Sulong & Noor 2008, p.
62). Board size is therefore an important corporate governance variable that must be taken into
account.
In the latest iteration of the Malaysian Code on Corporate Governance (MCCG), the code
recommends having a board composed of a majority of independent directors if the chairman is
not an independent director (Securities Commission Malaysia 2013). Board independence is
important in ensuring an effective control environment for management (Fama & Jensen 1983).
Independent directors have incentive to develop their reputation as experts on decision making,
and to be seen as watchdogs, with the main purpose of taking care of shareholder interests (Fama
1980, Fama & Jensen 1983). It is argued then that a larger proportion of independent directors on
the board ensures better monitoring and alignment of shareholder interest as the independent
directors wish to maintain their reputation as experts in decision control (Fama & Jensen 1983).
They have no economic interest in the firm and do not participate in day to day operations, and
are therefore able to provide objective assessments of the decision making process at the board
level (Rahmat 2013, p. 73). At the same time, arguments have been put forth on opposing
11
perspectives on board independence. Independent directors, by virtue of their lack of day to day
involvement, have limited time commitment to the company (Amran 2004, p.51) Additionally
they normally will not have shares in the firm, thus contributing to a lack of incentive to perform
a monitoring function (Amran 2004, p.51). Generally, the evidence supports higher board
independence as having a positive impact on firm valuation and performance, and this is reflected
in policy makers’ choices in mandating board independence via codes such as the MCCG.
Duality refers to the practice whereby the CEO and Chairman of the board are one and the same
person (Rahmat 2013, p.67). It is a widely accepted practice that is prone to be subject to conflicts
of interest if performed by the same individual (Jensen 1993, p.866). The function of the chairman
is to monitor and evaluate the CEO. Therefore if the CEO were to assume the position of chairman
also, it would be difficult in practice to achieve the function of chairman performed in an
independent manner (Jensen 1993, p.866). This also creates an atmosphere at the board level that
lacks independence and is characterized by conflict of interest (Amran 2004, p.52). Such an
environment can reduce the role of independent directors to mere rubber stampers, and not able
to protect the interests of shareholders (Amran 2004, p. 53). In the context of a market with
concentrated ownership, a controlling shareholder can dominate management by ensuring that the
chairman and CEO are both the same appointed individual. This can contribute to principal-
principal conflict that results in expropriation of minority shareholders (Jensen 1993, p.866).
Duality reduces the check and balance that should exist between the two positions of chairman
and CEO, and enable self-dealing behaviour to be unchecked (Rahmat 2013, p.67).
Ownership structure can act as both an internal corporate governance mechanism and also a
source of agency conflict (Shleifer & Vishny 1997, p.737; Gordon et al. 2004b, p.36; Boubakri et
al. 2005, p.377). Ownership concentration refers to the ownership of large blocks of shares by
investors, as opposed to diffused shareholding where many investors own many small blocks of
shares (Shleifer & Vishny 1997, p.754). It is easier for a single shareholder or a small number of
shareholders to act together to maintain their interests by monitoring, rewarding and penalizing
management as they have the necessary incentive to protect their investments (Shleifer & Vishny
1997, p.754). The large shareholder has the most to gain from any effort expended in watching
over management (Gordon et al. 2004b, p.36). This can be contrasted to the scenario of diffused
ownership, whereby no single small shareholder will want to act, as this will lead to a marginal
benefit for that individual while benefitting the remaining shareholders for free (free rider
problem) (Shleifer & Vishny 1997, p.756). At the same time, ownership concentration can have
its own costs to the remaining shareholders. A large controlling shareholder can also more easily
control management by appointing key posts and engage expropriation of minority shareholders
(Shleifer & Vishny 1997, p.758; Claessens et al. 2000, p.81).
12
Two major aspects of ownership structure have been researched. They are the level of ownership
concentration, and the identity of the owners (Boubakri et al. 2005, p.376; Juliarto 2012, p.29).
The identity of owners may be generally categorized as follows: government, local institutions,
foreign investors, employees and individuals (Boubakri et al. 2005, p. 375). This study groups
these into 2 even broader categories, namely institutions (government, local institutions, and
foreign investors) and families (employees and individuals). The identity of the shareholder in a
concentrated ownership situation can have very different impacts. For example having an
institution as a controlling owner may lead to better monitoring and oversight of management,
whereas having a family as a large shareholder tends to lead to higher rates of expropriation of
minority shareholders (Ismail & Sinnadurai 2012, p.255; Juliarto 2012, p.30). These issues arise
as large shareholders represent their own interests, which may or may not be the same as the
interests of the minority shareholders (Shleifer & Vishny 1997, p.758).
Family ownership in particular is an aspect that is common among Asian firms (Claessens & Fan
2002, p.71). Typically the family will have a controlling stake in the firm, or the firm will be part
of a larger group controlled by the family (Juliarto 2012, p.31). On one hand family ownership
may assist to align the interests of the shareholders with management (Jensen & Meckling 1976,
p.305; Fama & Jensen 1983). On the other hand, the risk of expropriation of minority shareholders
is also increased (Faccio et al. 2001, p.54).
Audit quality can serve as an effective external governance measure. The role of the independent
auditor is increasing users’ confidence in financial statements by expressing an opinion as to their
fairness of presentation and reliability of reported figures (Rahmat 2013, p.75). The Companies
Act 1965 requires auditors to be independent and have the right to address the shareholders in a
general meeting, thus fulfilling the public role of a public accountant (Wahab et al. 2011, p.198).
Although there is a general requirement for financial statements to be audited, the quality of the
auditor may vary. A more reputable auditor is likely to be more effective in preventing financial
statement misreporting and self-dealing activities as they have more of reputation to protect
(Wahab et al. 2007, p.108). At the same time, a more credible auditor might be appointed by a
company that has a propensity for more self-dealing to enhance the legitimacy of their
transactions and to play a certification role (Wahab et al. 2011, p.198; Gordon et al. 2007, p.83;
Fan & Wong 2005, p.35). The auditor in each of these situations would play the role of an external
corporate governance mechanism. In a large number of studies, audit quality is proxied by the
usage of Big 4 or Tier 1 public accounting firms (Rahmat 2013, p.75; Wahab et al. 2011, p.198;
Chien & Hsu 2010; Gordon et al. 2007, p.81). A criticism of using this metric is the obvious
involvement of the former top tier public accounting firm, Arthur Andersen & Co.’s implication
in the Enron scandal of 2001 (Rahmat 2013, p.76). This reinforces the notion that a firm with
shady RP transactions might seek to legitimise those same transactions by having them signed off
13
by a reputable auditing firm (Gordon et al. 2007, p.93; Wahab et al. 2011, p.143). At the same
time, having a strong and independent external monitor, outside of the board of directors, can be
an effective mechanism in countering the negative effects of RP transactions (Rahmat 2013, p.76;
Gordon et al. 2007, p.93).
Leverage can also act as a corporate governance mechanism (Jensen & Meckling 1976, p.40).
External creditors are concerned with the ability of the firm to repay borrowings, and will
therefore ensure management or controlling shareholders do not expropriate firm resources. They
have the necessary incentives to monitor firms and their management to ensure sufficient funds
for debt repayment (Gordon et al. 2004b, p.36).
2.3 Related Party Transactions and Theoretical Framework
2.3.1 RP Transactions: Efficient Transactions or Conflict of Interest? Related party transactions are transactions between the firm and a party that is related either as a
subsidiary, associate, principal owners, officers or directors (Gordon et al. 2007, p.83). There are
two primary views on RP transactions in the extant literature which result in either positive or
negative effects on investors and minority shareholders. Gordon et al. (2004a, 2004b) and
Kohlbeck and Mayhew (2004) were among the earliest to identify these two opposing
perspectives on RP transactions. Prior to this it had been perceived that RP transactions would
only constitute conflicts of interest that were detrimental to shareholders. However, based on
rational economic arguments, it was hypothesized that it was possible to view RP transactions in
two contrasting ways. One view is that RP transactions are conflicts of interest and are negative
for firm performance and valuation, and the other view is that RP transactions are efficient
transactions that benefit firm performance and valuation. These two views are also known as the
conflict of interest hypothesis, and the efficient transactions hypothesis.
Under the conflict of interest hypothesis, RP transactions were a breach of the agent’s
responsibility. This responsibility could take the form of management’s duties to shareholders, or
the monitoring function of the board of directors (Gordon et al. 2004a, p.4, 2004b, p.11). The
alternative efficient transactions hypothesis states that RP transactions are the most economically
efficient method for the company to carry out certain dealings. In the next section, we examine
the detailed theoretical frameworks underpinning these two contrasting views on RP transactions.
2.3.2 Agency Theory and Conflict of Interest
Related party transactions have emerged as a form of self-dealing with the potential for a
multitude of negative consequences. The basis of determining the negative impact of RP
transactions has its roots in agency theory (Gordon et al. 2004a, p.4; Kohlbeck & Mayhew 2004,
p.3; Cheung et al. 2006, p.346).
14
The modern firm is characterized by separation of ownership and management. Agency theory
explains the nature of the separation of ownership and management in a firm. This has been
developed by Berle and Means (1932), and further refined for the modern corporation by Jensen
& Meckling (1976). Subsequent work in this area led to development of contracting theories of
the firm (Fama 1980; Fama & Jensen 1983). However much of this development was done in
Western or Anglo-American economies where there is a high dispersion of ownership. In
emerging economies such as Malaysia, concentrated ownership is the norm. Research in a
Malaysian context, with concentrated ownership, is limited.
The majority of research in corporate governance is based on agency theory. Principal-agent
conflict arises between shareholders (principal) and management (agents). Management is
assumed to have different objectives from shareholders, many of which are to benefit themselves.
Mechanisms such as the board of directors are governance measures put in place to ensure that
management acts in the interest of shareholders. These measures represent agency contracting
costs, which are put into place at the expense of the shareholders, to align management’s
objectives to that of shareholders.
The Great Depression-era book ‘The Modern Corporation and Private Property’ was among the
earliest works on the basis of agency theory and modern corporate governance. Published in 1932,
it examined the evolution of the corporation that had resulted in the separation of ownership and
management. It also looked at the implications for the corporation and its shareholders. Written
by Adolf Berle and Gardiner Means, the key idea was this: once an investment had been made in
a corporation by shareholders, they were distanced legally from the property (investment) they
had put into the corporation. Legal title now rested with the corporation. It is noted that the
shareholders own the corporation; in fact in many instances now and in the past, they were also
the management. However, through the changing roles and delegation of power in a corporation,
management in a modern corporation is often surrendered to a controlling group other than the
shareholders (Berle & Means 1932, p. 334).
Berle and Means (1932 p. 336) state that “All powers granted to management and control are
powers in trust”, but the question arises as to how to ensure that those powers are not abused.
Courts and corporation law have in the past laid down the rules by which the statement above is
enforced (La Porta et al. 1996, p. 12). In the working paper entitled ‘Law and Finance’, the authors
study the legal rights attached to shares (La Porta et al. 1996). These legal rights are the means
by which shareholders ensure their investment is protected and a return can be obtained from it.
Shareholder rights such as voting rights, calling for general meetings, obtaining relevant
information and protection of minority shareholders are all meant to protect the investments of
shareholders. As seen in the previous section on the Malaysian Companies Act, there has been an
15
effort to regulate RP transactions in Malaysia through various amendments to the Act. This is an
overall theme of whether there is sufficient legislation and regulation to protect shareholders,
investors and the general public from fraud in RP transactions in Malaysia.
Another issue to consider is the type of abuse that may occur. The most obvious is outright
expropriation. As Adam Smith (1904 p. 439) writes in his book entitled ‘The Wealth of Nations’,
managers of companies in which the capital is not their own will not have the same ‘anxious
vigilance’ of a company managed by the capital providers. Consequently, a significant amount of
early corporation law development was focused on preventing outright theft by the controlling
group of management. This was evident in the 18th to 19th centuries in Britain as well as Europe
(Shleifer & Vishny 1997, p. 742).
However, mere legal protection for investors is insufficient. Rigid rules do not put the interests of
the investors, the management or the corporation in good stead. Due to the endless variety in the
nature of business that could be carried out by a corporation, it is not practical for the courts to
determine the commercial merits of transactions carried out by a corporation. Take for example
the United States, which is the most litigious society in the world (Rubin 2010). Even in this
country, courts refuse to engage in meddling with the day-to-day affairs of a corporation, quoting
the now universal ‘business judgement rule’ (Shleifer & Vishny 1997, p. 741). It is also not in
commercial interests to have shareholders running the corporation through voting on every
transaction (OECD 1999, p.12). In Malaysia, the development of regulation is an ongoing process
to bring it in line with global best practices (Chan 2010, p.3). This needs to be balanced with
effective enforcement, which has been lacking in the past (La Porta et al. 1996, p.6). A study on
the impact of RP transactions and factors associated with it will aid both the development of
regulation and effectiveness of enforcement in Malaysia.
Jensen and Meckling (1976, p.58), in their paper on the theory of the firm, developed the
formalized view of the agency problem using financial economics. Contracting within the agency
relationship is between the shareholders (principal) and management (agent). Due to the
separation of ownership and control, the problem of ensuring that funds or capital are not wasted,
and that a return is assured, arises as a concern for shareholders.
Related party transactions can be seen as a conflict of interest between the agents and principals
in the agency relationship within a corporation. The incentive to expropriate varies with cash flow
rights (Jensen & Meckling 1976, p.64). Cash flow rights refer to ownership via shareholding. In
a widely held corporation, this indicates that management’s self-dealing is a maximization of their
own utility at the expense of the other shareholders. Jensen & Meckling (1976, p.58) further
expound that there will be differences in the decisions made by the agent relative to the best
interests of the principal. The key assumption here is that both the principal and agent are utility
16
maximizers. It would then be expected that the agent may not act in a manner that is optimal from
the perspective of the principal. The opportunism of the agent may variously result in misuse of
power, overconsumption of perquisites, adverse risk-taking, and information asymmetry (Mallin
2013, p.15).
This has led to the view of the firm as a nexus of contracts, with each contract interconnected to
the other, balancing out the various incentives and costs to the principal and agent. The sets of
contracts act together to discipline the individual members of in a firm and the firm as a whole to
be aligned to the interests of the principal. The monitoring function of a board of directors that
brings independence and oversight to the firm is also theorized (Fama 1980, p.293; Fama &
Jensen 1983, p.14).
A more common issue in emerging markets is the problem of principal-principal conflict. High
ownership concentration is a common feature of firms in this region, including Malaysia. La Porta
et al. (1999, p.471) concluded that higher ownership concentration increases the power that major
shareholders have to expropriate the minority. In a closely held corporation (i.e. concentration of
ownership) this would indicate maximization of the principal shareholders’ utility ahead of the
other minority shareholders. Principal-principal conflict arises when there is concentrated
shareholding. Here there is conflict between two principals – the major shareholder and the
minority one. The effect of this conflict is the major shareholder expropriating the minority one.
Management may act to benefit the major shareholder, but at the expense of the minority
shareholders. Governance mechanisms such as the board of directors may be overridden by the
major shareholder. This is because the major shareholder has the ability to appoint the board.
Research on both principal-agent and principal-principal conflict is categorized as self-dealing.
Earlier studies have focused on issues such as managements spending on perquisites (Djankov et
al. 2008, p.430). This has progressed to studies on the private benefits of control by which insiders
enrich themselves. Several researchers have variously examined excessive compensation, transfer
pricing, appropriation of corporate opportunities, self-serving financial transactions, preferential
placement of equity, personal loans to directors or management and outright expropriation of the
firm’s assets (Shleifer & Vishny 1997, p.737). The common link and the emerging focus of self-
dealing is however on related party transaction, and their impact on the firm and implication in
self-dealing. Related party transactions, more than any other method, represent a key enabler of
management opportunism and an avenue for both principal-agent and principal-principal conflict.
Gordon et al. (2004a, p.4, 2004b, p.11) explores the idea of RP transactions as being a conflict of
interest by the agent through the lens of agency theory. The related party transaction would reflect
neglect of the agent’s responsibility to the principal, and subversion of the monitoring function of
the board of directors. The researchers also highlight the role that RP transactions played in the
17
multitude of corporate scandals that had emerged in the wake of Enron in 2001. As a result, the
view of RP transactions was a fulfilment of the very concerns raised of an agent not acting in the
interests of the principal. The researchers put forth this view of RP transactions to be known as
the conflict of interest hypothesis.
Kohlbeck & Mayhew (2004, p.6) further build on the prior work by Gordon et al. (2004a, 2004b)
using agency theory to differentiate between various classes of RP transactions. In particular they
conclude that simple RP transactions might be the results of self-dealing by management, whereas
more complex RP transactions are consistent with efficient contracting to align interests of the
principal and agent.
Delving into the specific mechanics of self-dealing and RP transactions, Cheung et al. (2006)
examined actual transactions of listed firms in Hong Kong. Their work shows clear demarcation
in terms of the impact of different types of RP transactions on firm valuation by the market. Of
particular note is the consistency of the result with predictions by agency theory as to which
transactions would be value-destroying. Cheung et al. (2009) continue further to compare RP
transactions versus their arm’s length equivalents to show clearly the mechanisms used by agents
(majority shareholders, in an environment of concentrated ownership) to expropriate from the
minority shareholders.
2.3.3 Transaction Cost Economics and Efficient Transactions An alternative view of RP transactions as efficient transactions was proposed by Gordon et al.
(2004a, p.4, 2004b, p.11) and is known as the efficient transactions hypothesis. This is based off
the work of Coase (1937) and Williamson (1988) on the topic of transaction cost economics.
Transaction cost economics takes the position that the firm is a governance structure for the
efficient conduct of economic affairs. This can be contrasted to the agency theory view that sees
a firm as a nexus of contracts (Mallin 2013, p.16). In the efficient transactions hypothesis, RP
transactions actually help the corporation. The transactions are not viewed as detrimental to the
interests of shareholders, but rather serve to efficiently deliver economic benefits to a firm
(Ryngaert & Thomas 2007, p.6). The RP transactions are posited as an efficient contracting
mechanism.
The firm derives economic benefits from performing certain transactions internally rather than
with external parties (Mallin 2013, p.16). This is consistent with the theory of transaction cost
economics. In the context of this study on RP transactions, conducting transactions internally
would refer to contracting with related parties, as they would be considered internal by virtue of
not being at arm’s length. Williamson (1984, p.28) builds the case for an internal capital market
within the firm. The outcome of such a market would be for the firm to undertake internal
transactions (or, in the case of this study, RP transactions) up to the point where it is more efficient
18
for external transactions to be performed. Another way to phrase this is that a firm should engage
in RP transactions so long as the benefits continue to outweigh its costs. This view of RP
transactions being a form of internal dealings that offer advantages over arm’s length or external
dealings is in line with the theory of transaction cost economics (Pizzo 2013, p.309). The firm
must derive certain benefits from RP transactions to justify the transaction being entered into by
the firm.
Various benefits of RP transactions as efficient transactions have been theorized and would
include lower transaction costs, improving capital allocation, obtaining better returns on assets,
and providing to solutions to overcoming problems impairing production (Pizzo 2013, p.317;
Wahab et al. 2011, p.133; Jian & Wong 2010, p.74). By engaging a related party, information
asymmetry is reduced. For example confidential information does not need to be shared with an
external party (Gordon et al. 2004a, p.4, 2004b, p.17). There would be greater co-ordination of
actions, faster feedback loops, and better insights (Ryngaert & Thomas 2007, p.6). Related party
transaction between related parties assumes that both parties would have sufficient information
on each other. This depth of information might then enable transaction which would not be
otherwise possible at arm’s length. (Pizzo 2013, p.309).
It is also possible that RP transactions could be a substitute or complement to management
compensation (Pizzo 2013, p.309; Kohlbeck & Mayhew 2004, p.6). Related party transactions
may form part of a formal or informal agreement on compensation. The transactions with the
related party could serve as an alternative to cash-based compensation for management. The RP
transactions could also be a more liquid form of compensation for management when they are
remunerated largely in stock options, which tend to be less liquid (Kohlbeck & Mayhew 2004,
p.6).
The related party may also have certain skills or abilities which are not easy to find in the market,
and by engaging them the corporation has saved time and search costs (Kohlbeck & Mayhew
2010, p.119). This could be exemplified by a service provider with comprehensive knowledge of
the firm. Obtaining the services from a related party who already possesses this knowledge will
be more efficient than hiring an external party that is not privy to this information. There is less
information asymmetry and therefore a lower transactional cost. Moreover, the relationship with
the related party providing the service will also be enhanced (Gordon et al. 2004b, p.11). It is also
conceivable that management may prefer working with a known and trusted party, for example
family members, which in turn may enhance the performance of both management and the
contracting party. This benefits the shareholders through better effectiveness and efficiency
(Gordon et al. 2004a, p.4).
19
Another argument in favour of the efficient transactions hypothesis is the inefficient state of
markets in developing economies (Khanna & Palepu 1997). From an institutional context,
markets that are less developed will have imperfect financial, labour and product markets. These
inefficiencies increase the business risk for a firm. It would then make sense for a firm in such a
setting to deal with related parties to be assured of better access to capital, financing, business
development opportunities and economies of scale (Pizzo 2013, p.309; Khanna & Palepu 1997).
Dealing with members of the same group, or at least with parties which are known to the firm,
may mitigate the problems such as enforcement of contracts and property rights, which are critical
to the corporation (Cheung et al. 2009, p.915; Khanna & Palepu 1997). This occurs more
frequently in firms found in East Asia due to the high level of ownership concentration. The
shareholders may hold blocks either through individuals, families, or governments. Typically,
controlling shareholders will install their own family members, or trusted representatives, into
management, which tends to increase the probability of RP transactions happening (Claessens,
Djankov & Lang 2000, p.2741).
It has also been argued that the amount and quantum of RP transactions is small and immaterial
to the firm. The RP transactions may be large in relation to the related party but sufficiently small
so as to be immaterial to the firm. For example, a director may influence a contract worth RM10
million to be awarded to a related party. The sum of RM10 million may very significant from the
view of the personal net worth of the director. However, if the firm has billions of dollars in sales,
this sum of RM10 million will be almost inconsequential. This argument is consistent with the
view that RP transactions do not negatively impact the firm (Gordon et al. 2004a, p.19; Wahab et
al 2011, p.133).
Furthermore, although there are varying levels of restrictions on RP transactions around the world,
no nation has completely outlawed them (Djankov et al. 2008, p.430). This lends credence to the
efficient transactions hypothesis of RP transactions that they can be in some ways beneficial to
the firm. An efficient transaction yields benefits to the firm and its shareholders, and does not act
against their interests.
2.3.4 RP Transactions as Source of Tunnelling or Propping This study considers the two alternative views of RP transactions, which are the conflict of interest
view and efficient transactions hypothesis. These two alternative views suggest that there are
variations in the in different types of RP transactions undertaken by the company (Kohlbeck &
Mayhew 2004, p.6). In examining whether the RP transactions has a positive or negative impact
on the company, the actual nature of the transactions should be looked at.
Gordon et al. (2004a, p.4) was an early study looking into the various types of RP transactions in
the United States. The authors merely classified the transactions examined, offered descriptive
20
statistics and suggested possible implications of the various types of transactions. Agreements
related to employment and indemnification agreements were left out in the study as these were
deemed to be clearly compensation for executives. Gordon et al. (2004a, p.8) also established a
measure of the complexity of a company’s RP transactions. This is achieved by looking at the
number of parties and the number of types of transactions, with a higher number for either
indicating increased complexity. Increased complexity in RP transactions would be a sign of
potential conflicts of interest and bypass of monitoring mechanisms in the firm.
Gordon et al. (2004b, p.32) continue from their earlier work to investigate the effect of corporate
governance on RP transactions, as well as the effect of RP transactions on firm value. They find
evidence generally of conflict of interest, and a restraining effect of strong corporate governance
on RP transactions. In particular, the identity of the related party involved in the transactions
impacted the effect on firm value.
Kohlbeck & Mayhew (2004, p.14) apply a categorization system to RP transactions. The two
categories they defined were simple and complex. Simple transactions are typically very clear in
purpose and involve few financial statement items. Complex transactions involve multiple parties
and impact the financial statements in more subtle ways. The study found that stronger board
independence lowered the probability of RP transactions. Moreover the study suggested that both
the conflict of interest perspective and efficient transactions hypothesis could be supported
depending on the type of RP transaction. There was evidence that complex RP transaction would
lead to better future investor returns, consistent with the efficient transactions hypothesis. At the
same time, simple RP transactions were negatively associated with future returns, in line with the
conflict of interest view.
Cheung et al. (2006) examined the various types of RP transactions which could result in
expropriation. The study on Hong Kong based listed companies presents an early look at direct
evidence of RP transactions being used in conflict of interest situations. From nine different RP
transactions types, the authors classify the transactions into three broad categories. The categories
are RP transactions likely to result in expropriation (asset acquisition, asset sales, equity sales,
trading relationships, cash payments), RP transactions likely to benefit the listed firm (cash
receipts and subsidiary relationships), and RP transactions driven by strategic purposes (takeovers
and joint-ventures) (Cheung et al. 2006, p.345). Like many East Asian stock markets, the authors
note that Hong Kong firms have high ownership concentration. The RP transaction in a conflict
of interest situation is therefore primarily a principal-principal conflict. This involves the
expropriation of minority shareholders by the controlling or majority shareholder. The
phenomenon is known as tunnelling, and the first category used by Cheung et al. (2006, p.355) in
their study may be classified as such. Propping on the other hand would refer to transactions
21
between the firm and related parties that are likely to benefit the firm (Friedman, Johnson &
Mitton 2003, p.732). The study by Cheung et al. (2006) performed direct examination of the
mechanisms of RP transactions and found that tunnelling RP transactions resulted in lower firm
valuation. Higher levels of ownership concentration magnified the negative effect. Propping RP
transaction had a positive effect on returns on valuation, although not at a significant level. These
results build on previous studies to affirm the view of tunnelling and propping as two alternative
views of RP transactions.
Henry et al. (2007) examined a sample of RP transactions in the United States that were subject
to enforcement action by the Securities Exchange Commission (SEC). It was found that lending
to related parties, payments to officers of the firm, and sales of goods and services, were the three
most common types of RP transactions subject to action by the SEC for fraud. The authors note
that fraud could have occurred without the RP transaction, and concluded that RP transactions
were not essential in fraud. However the study also concluded that differentiating between RP
transactions is necessary in light of the broader governance structure of the firm (Henry et al.
2007, p.28).
Cheung et al. (2009, p.914) performed a comparison of assets disposals and acquisitions involving
related parties in Hong Kong. Their results clearly indicate that firms receive disadvantageous
terms when dealing with related parties for either asset disposal or acquisition. Assets bought
from related parties were at prices higher than comparable arm’s length transactions, whereas
assets sold to related parties were at lower prices than similar arm’s length deals (Cheung et al.
2009, p.914).
Kohlbeck & Mayhew (2010) continue from their previous work in 2004 to examine the
association of different types of RP transactions with firm valuation. Of note is their findings that
both simple RP transactions as well as loan transactions with director, officers or shareholders
drive a negative association with firm valuation. The study also found that complex RP transaction
with a firm’s investments or joint-ventures did not appear to be negatively valued (Kohlbeck &
Mayhew 2010, p.134).
Liew et al. (2011) investigate the impact of RP transactions on firm valuation in Malaysia, as well
as the strength of the effect if a firm is a family firm. The study uses only the RP transactions
categorized as likely to result in expropriation (conflict of interest view) as defined by Cheung et
al. (2006). The findings affirm the view that RP transaction likely to result in expropriation are
negatively associated with lower firm valuation (Liew et al 2011, p.150), which is consistent with
the conflict of interest perspective. The idea that local banks were a tool for expropriation was
also explored. Williams & Taylor (2013, p.28) investigate propping by controlling shareholders
in China. The paper affirmed the view that propping can be beneficial for minority shareholders,
22
albeit for the near future only. Ying and Wang (2013, p. 133) take this idea further and posit that
controlling shareholders are willing to prop up a firm to avoid costly short-term penalties (e.g.
loss of listing status, inability to refinance), only to engage in tunnelling subsequently once the
risk of short-term penalties has passed.
Table 1 Summary of Tunnelling and Propping Definitions
Study Tunnelling Propping
Gordon et al. (2004a)
No clear attempt to differentiate categories into conflict of interest vs efficient transaction Number of RP transactions (complexity) Type of RP transaction Amount of RP transactions Party to transaction (Executive, Non-executive, Principal Owner,
Subsidiary, Other) Gordon et al. (2004b)
Board members, principal owners Number of RP transactions
scaled by board members (pervasiveness)
Type of RP transaction Amount of RP transactions
(importance to party)
Subsidiaries, others Number of RP transactions
scaled by board members (pervasiveness)
Type of RP transaction Amount of RP transactions
(importance to party)
Kohlbeck & Mayhew (2004, p.18)
Indicator variable if RP transaction is with Director, Officer or Major Shareholder Simple Loans, Guarantees, Borrowings,
Consulting, Legal services, Leases etc
Few related parties Involve few financial statement
items
Complex Related and unrelated business,
overheads, stock transactions Multiple related parties Numerous conditions Involve multiple financial
statement items
Indicator variable if RP transaction is with Investment or Joint Venture or Affiliate Simple Loans, Guarantees, Borrowings,
Consulting, Legal services, Leases etc
Few related parties Involve few financial statement
items
Complex Related and unrelated business,
overheads, stock transactions Multiple related parties Numerous conditions Involve multiple financial
statement items Cheung et al. (2006, p.356)
Dollar amount of Transactions that are a priori likely to result in expropriation of the listed firm’s minority shareholders Assets acquisitions Assets sales Equity sales Trading relationships Cash payments
Dollar amount of Transactions likely to benefit the listed firm’s minority shareholders Cash receipts Subsidiary relationships Dollar amount of Transactions that could have strategic rationales and perhaps are not expropriation Takeovers
23
Joint ventures Henry et al. (2007, p.26)
Borrowing to related parties Payments to officers of the firm Sales of goods and services
Not covered in study
Cheung et al. (2009, p.914)
Asset disposal to related party Asset acquisition from related
party
Not covered in study
Kohlbeck & Mayhew (2010, p.135)
Indicator variable if RP transaction is with Director, Officer or Major Shareholder Simple Loans, Guarantees, Borrowings,
Consulting, Legal services, Leases etc
Complex Related and unrelated business,
overheads, stock transactions
Indicator variable if RP transaction is with Investment or Joint Venture or Affiliate Simple Loans, Guarantees, Borrowings,
Consulting, Legal services, Leases etc
Complex Related and unrelated business,
overheads, stock transactions
Liew et al. (2011, p.144)
Amount of RP transactions that are likely to result in expropriation (based on Cheung et al. 2006), at year t divided by total RP transactions value at year t.
Not covered in study
Williams & Taylor (2013, p.35)
Not covered in study Sales to related party (controlling owner)
Ying & Wang (2013, p.133)
Indicator variable based on Ordinary Least Squares regression of purchase of goods or assets, guarantees, mortgages, projects and other transactions that generate income for the related party, as a proportion of total assets
Indicator variable based on Ordinary Least Squares regression of funding, guarantees, mortgages and other transactions that generate income for the company, as a proportion of total assets
2.3.5 Related Party Transactions and Earnings Management The use of RP transactions by management to manipulate earnings is not a new phenomenon.
Many of the studies in this area have been conducted on Chinese companies. Early research has
focused on establishing RP transactions as a tool for earnings management (Jian & Wong 2003).
Research has now focused on its use during the initial public offering (IPO) of a company. Chen,
Cheng, and Xiao (2011, p.165) studied Chinese companies which tend to have a concentrated
ownership structure. This type of ownership structure tends to lend itself to RP transactions being
agency conflicts of interest. The empirical results of Chen, Cheng, and Xiao (2011, p.165) showed
24
that RP transactions were used to inflate pre-IPO results, and this resulted in a poor firm
performance post-IPO.
Research has also looked at the use of RP transactions in propping a firm. This can be used when
the firm wishes to avoid reporting losses (Jian & Wong 2010, p.73). Extensive losses can invite
regulator’s attention and even result in delisting from a stock exchange. Existing research has
shown that the tool of choice for management in this situation has been related party sales
(Williams & Taylor 2013, p.28). As would be expected, these RP transactions are found in
companies that had poor results and declining returns.
Research has also been done using multiple criteria decision-making algorithms to detect earnings
management in RP transactions (Lin, Chang, & Wu 2009, p.337). This method uses pattern
detection of certain numbers to identify manipulated earnings. The empirical results were
promising for future usage by regulators and auditors.
Another area of research is the impact of RP transactions on operational performance. Previous
studies on earnings management tend to focus more on the statutory reporting of the firm. Chen,
Chen, and Chen (2009, p.285) focused on the impacts of different RP transactions such as sales
and purchases on operational performance of a firm. This narrows down the effect of RP
transactions and aids in identifying which RP transactions have a positive effect and which have
a negative effect on a firm’s performance.
2.3.6 Factors Associated With Related Party Transactions
In the search for factors associated with RP transactions, many studies have first attempted to
classify RP transactions into two general categories, namely good and bad RP transactions. A key
study by Gordon et al. (2004a, p.4) takes the view of RP transactions as either an agency conflict
of interest or an efficient transaction. Good RP transactions can constitute propping by the related
party, or can be a decrease in the company’s transaction costs. On the other hand, bad RP
transactions consist of tunnelling, expropriation of minority shareholders and a general increase
in the company’s transaction costs. An issue that has been explored is whether there are factors
that can influence RP transactions to shift from one category to another, which is good to bad or
vice versa (Chen, Wang, & Li 2012, p.293). Other than factors that can influence RP transactions,
are there are other moderating roles of other factors in RP transactions? A key question to be
answered is the relationship between RP transactions and firm performance, which has been
examined by Chien and Hsu (2010). A negative relationship was found between RP transactions
and firm performance. The same study also found that corporate governance had a positive
moderating effect on the negative relationship. A similar study by Daie and Hasnan (2012, p.233)
reported a negative relationship between RP transactions and earnings quality, but corporate
governance had a positive moderating effect on the negative relationship. Both these studies
25
affirm the view of RP transactions as a conflict of interest. Furthermore, it is important to
distinguish between internal governance measures and external governance measures. Taking a
similar conflict of interest view, internal measures may not be as effective as external measures
in constraining RP transactions and their negative effect on firm performance (Gallery et al. 2008,
p.147). A later study by Hu and Li (2010, p.3) of Chinese firms found that certain internal
governance mechanisms such as percentage of independent directors were associated with lower
magnitude of RP transactions. However, other mechanisms such as equity compensation had no
effect. The study by Hu, Shen, and Xu (2009, p.190) found that ownership concentration was
associated with larger magnitude of RP transactions, but this relationship weakened with the
existence of stronger second and third largest shareholders. The study also found duality (or
pluralism, whereby the same person holds the position of Chairperson and CEO) increased the
size of RP transactions. Recent studies have continued to reaffirm the positive association
between ownership concentration, duality and the size of RP transactions (Hu et al. 2012, p.58).
In the same vein, the percentage of independent directors was also found to have a negative
association with RP transactions. These studies were conducted mainly on Chinese companies.
Other studies have investigated the effect of the business environment and ownership factors on
the level of RP transactions (Juliarto 2012, p.4).
Kohlbeck and Mayhew (2004, p.134) found that RP transactions were positively associated with
lower levels of board independence and CEO stock-options compensation. They also found RP
transactions had a negative association with CEO cash compensation. Their study found
differences in firm performance based on the RP transactions ex-post the transaction. In particular,
RP transactions with investments of the firm were associated with positive firm performance,
whereas RP transactions with directors, officers and shareholders were inversely related to
shareholder returns.
Many other studies have been done on factors associated with RP transactions, in particular with
a focus on factors that can restrain opportunism in RP transactions. Board independence, having
financial experts on board committees and separating the position of CEO and chairman have
been found to be effective in reducing the negative effects of RP transactions in the context of
transfer pricing (Lo, Wong, & Firth 2010, p.225).
Further modification of the above models has been done by other researchers. An example would
be an investigation of the moderating effect of corporate governance on the relationship between
RP transactions and firm performance (Wahab et al. 2011, p.159), which found that higher board
independence, higher executive remuneration, and the presence of a “Big 4” auditor reduced the
negative effect of RP transactions on firm performance. This study did not distinguish between
26
the different types of RP transactions but looked at the number of transactions and total value of
the transactions.
By breaking down RP transactions into different categories, it is also possible to classify the
motives of management in using the various types of RP transactions. Does the management use
the RP transactions to extract private benefits, or is the RP transaction an efficient transaction that
benefits the firm? Corporate governance is then found to have a moderating effect on the RP
transactions used depending on the situation the firm is in (Yeh, Shu, & Su 2012, p.755). Gordon,
et al. (2004a) in a key study on the association between corporate governance, RP transactions
and firm value established the foundation that weaker corporate governance was associated with
higher values of RP transactions. At the same time, weaker firm performance was found to be
associated with RP transactions. Specific studies on factors associated with RP transactions have
been conducted as well. In one study on the relationship between RP transactions and ownership
concentration, an inverted U curve was found (Amzaleg & Barak 2013, p.239).
2.4 Regulatory Background and Disclosure of Related Party Transactions Related party transactions are subject to numerous pieces of regulation and guidance including
corporation law, accounting standards, stock exchange listing rules, and codes of corporate
governance. Fields (2000) examines the issue of how tax authorities view transfer pricing in RP
transactions. In particular, the author highlights the concept of RP transactions as a tool for tax
avoidance. It is interesting to note that the points raised by tax authorities are in many ways similar
to concerns that stakeholders might have about RP transactions. All the concerns revolve around
one central problem, that is, RP transactions are not conducted at arm’s length and/or do not serve
a valid business purpose. Taking a closer look at these concerns about RP transactions, the key
issue that arises is whether RP transactions are a mechanism for fraud. The presence of RP
transactions can indicate fraudulent financial reporting and is a red flag to both investors and
professionals such as auditors alike (Henry et al. 2007, p.25). In the field of forensic accounting,
identifying which RP transactions are fraudulent and which are harmless poses a challenge even
to the experts. It is hard to pick out transactions that have been carefully and cleverly concealed.
In a separate study on audit failure in fraud-related RP transactions, Louwers et al. (2008)
identified a lack of professional scepticism as the culprit, rather than insufficient auditing
standards. This is an overall theme of whether there is sufficient legislation and regulation to
protect shareholders, investors and the general public from fraud in RP transactions. Moreover,
RP transactions should be considered in the context of the governance structure of a company as
a whole, and although their mere presence may not indicate fraud, they are often present when
fraud is detected (Gordon et al. 2007, p.82).
27
2.4.1 Accounting Standards and Market Listing Rules As this study is limited to listed companies in Malaysia due to focus of the study to enhance
knowledge in a local context, the relevant accounting standards to be considered are the Malaysian
Financial Reporting Standards (MFRS) issued by the Malaysian Accounting Standards Board
(MASB), as well as the Bursa Malaysia Listing Rules. Listed companies in Malaysia disclosed
RP transactions under Financial Reporting Standard 124 Related Party Disclosures (FRS124) up
to 1 January 2012, and subsequently under the Malaysian accounting standard Malaysian
Financial Reporting Standard Related Party Disclosures (MFRS124). They are also required to
disclose details of RP transactions under Chapter 10 of the Bursa Malaysia Main Market Listing
Rules. The Listing Rules define a related party as a director, major shareholder or person
connected with such director or major shareholder of a listed company (Bursa Malaysia 2013).
Related party transactions are dealt with in Part E of the Listing Rules, paragraph 10.08. The
Listing Rules utilize percentage ratios as a threshold for disclosure and shareholder approval.
There are 8 types of percentage ratios, which each give relative values of a transaction to the total
value of the company, whether from balance sheet or income statement perspective. Disclosure
for any type of RP transactions is mandatory unless the amount is less than the higher of 0.25%
percentage ratio or RM250,000. If RP transactions percentage ratio is 5% or more, shareholder
approval and an independent advisor is needed. If the percentage ratios exceed 25%, a main
advisor is to be appointed prior to finalizing the terms of transaction.
The Malaysian accounting standard MFRS124 covers business transactions and executive
compensation. In the statement on the purpose of the standard, MFRS124 acknowledges that RP
transactions are normal, but also that related parties may sometimes transact on terms that
unrelated parties might not, i.e. not at arm’s length. This in turn would affect the financial
statements of the company. Therefore appropriate disclosure is necessary to highlight this to users
of the financial statements (MASB 2012).
The definition of a related party in the accounting standards differs slightly from that of the listing
rules. MFRS124 specifies that a person or a close member of that person’s family is related to a
reporting entity if that person:
has control or joint control over the reporting entity;
has significant influence over the reporting entity; or
is a member of the key management personnel of the reporting entity or of a parent of the
reporting entity.
Close members of the family of a person are those family members who may be expected to
influence, or be influenced by, that person in their dealings with the entity and include:
28
that person’s children and spouse or domestic partner;
children of that person’s spouse or domestic partner; and
dependants of that person or that person’s spouse or domestic partner.
MFRS124 requires an entity to disclose all relationships, as well as information on any
transactions performed. For RP transactions, the amount of transactions, the balance outstanding,
provisions for doubtful debts, and RP transactions bad debts expense must all be disclosed.
Additionally, the standard requires disclosure by way of a statement on whether the transaction
was at arms’ length terms.
2.4.2 Companies Act 1965 and 2007 Amendment
In 2007, an amendment to the Malaysian Companies Act 1965 extended a ban on loan transactions
with related parties. This prohibition was not dissimilar to a ban on RP loans to officers and
directors under the Sarbanes-Oxley Act (SOX) in the United States in 2002 (Rahmat 2013, p.5).
The 2007 amendment to the Malaysian Companies Act 1965 was born out of recommendations
of the High Level Finance Committee. This Committee itself was set up as a result of the Asian
Financial Crisis in 1998 to further advance the development of corporate law reform and corporate
governance in Malaysia. The Asian Financial Crisis brought to the fore a great number of
corporate expropriations and abuses, in particular those that were enabled by RP transactions.
This subsequently damaged investor confidence in the Malaysian capital markets. The
recommendations of the Committee, some of which were adopted in the 2007 amendment to the
Companies Act, strengthened the clauses relevant to RP transaction for the protection of
shareholders (Chan 2010, p.3).
More specifically, the Companies Act 1965 deals with RP transactions in sections 131, 132E, 133
and 133A. The 2007 amendment saw the amendments of section 131 and 132E. Even with these
amendments, work is still on-going to tighten the regime around RP transactions. In 2007 itself,
after the amendment to the Companies Act 1965, the Corporate Law Reform Committee (CLRC)
was established to continue the work of updating the Companies Act and best practices with
regards to corporate governance. Ultimately the goal is to bring the legislation and guidance in
Malaysia in line with best practices globally (Chan 2010, p.3).
2.4.3 Related Party Transactions and Disclosure Disclosure in published annual accounts is the primary information source for investors and other
stakeholders to observe RP transactions. More importantly, this information forms the basis of
their decision-making process (Cottingham & Hussey 1995, p.351). Disclosure has also emerged
as a key area of research in RP transactions. Research has found varying levels of disclosure for
different types of RP transactions (Ariff & Hashim 2013). This has implications for determining
29
the nature of RP transactions: whether they are positive or negative for firm performance and
shareholder value. Going beyond mandatory compliance for disclosure, it is suggested that a
voluntary disclosure index can better reflect the underlying nature of these RP transactions.
Another emerging area of research is the perception of experts on the relationship between
corporate governance and disclosure of RP transactions (Fooladi & Shukor 2011).
However, the act of disclosure itself can be a deterrent to the use of RP transactions in agency
conflict of interest situations. Hwang, Chiou, and Wang (2013, p.293) demonstrate that having to
report back to shareholders and stakeholders on the existence of RP transactions can reduce the
use of RP transactions in their study of Taiwanese firms conducting cross-border transactions
with related parties in China.
Outside mainstream thought on RP transactions, there are studies that take an alternative view of
RP transactions other than classifying them as either conflict of interest situations or efficient
transactions. There has been some work in developing a middle ground, for example a
contingency perspective which takes into account organisational and institutional settings whilst
also incorporating other business factors (Pizzo 2013, p.310). Early research in the ASEAN region
regarding RP transactions involved questions like the type of RP transactions that local joint
venture companies engage in with their holding companies (Tang 1990, p.59). Apart from
engaging in descriptive studies on disclosure of RP transactions, and their implications in transfer
pricing, early studies such as this did not examine the further effects of the transactions. This
study builds on earlier work on RP transaction disclosure and extends it by testing for its impact
on firm performance and valuation, in particular within a Malaysian context.
2.4.4 The Malaysian Political Economy The intricate links between business and politics in Malaysia are well documented. Gomez and
Jomo (1999) detail many case studies of the patronage relationship between the government and
politically-linked businesses.
Malaysia is a multiracial society. In Malaya, as it was known prior to independence, the ethnic
composition was a majority of Malays, followed by significant numbers of Chinese, and a
minority of Indians. Malaysia’s economy after independence from the British in 1957 was very
much split along racial lines. The economy and enterprise was dominated by the Chinese, who
were more entrepreneurial (Gomez & Jomo 1999). This led to Malay resentment, and was a factor
triggering serious racial riots in 1969. In response, the government set about restructuring the
economy through the New Economic Policy (NEP). The NEP was aimed at removing race based
economic functions, and increasing the Malay share of the economy.
The NEP was implemented in 1971. This policy has entrenched the government’s participation
and involvement in the business sector (Lim et al. 2013, pg 356). It introduced a policy of positive
30
discrimination in favour of the Malays, to build a Malay business sector. Although the NEP
increased the share of corporate equity held by Malays from 1.5% to 20.3% from 1969 to 1990,
it is questionable if the NEP achieved its goal of producing a Malay business class (Gomez &
Jomo 1999). Rather, the NEP enabled crony capitalism, where a select group of favoured
businessmen benefitted from their close relationships with the government. These businessmen,
who had close ties to Malay politicians from the ruling United Malay National Organization
political party, engaged in various rent-seeking activities and privatization of national assets
(Gomez & Jomo 1999). Explicably, the redistribution of control of major economic enterprises
was done in the name of rebalancing the ethnic composition of the economy, with an eye towards
increasing Malay ownership. In reality the NEP was mired in secrecy and corruption, with the
redistributed assets going to a small, select group of cronies (Gomez & Jomo 1999).
The NEP and subsequent developments in the Malaysian political economy created a culture of
rent seeking (Searle 1999; Ng 2012). Gomez and Jomo (1999) posit that the new class of Malay
capitalists who benefitted from the economic redistribution did not have the expertise in building
or maintaining competitive enterprises, and were instead constantly reliant on government
support. The NEP was also co-opted by Chinese businessmen, who found that close ties with
prominent Malay politicians were beneficial in gaining access to government patronage, which
contributed to a culture of rent-seeking (Ng 2012). The politicians themselves also stood to benefit
from this system of patronage, as it enabled access to financial resources for election campaigns
at the party and national level (Ng 2012). Gomez and Jomo (1999) use the term ‘money politics’
to describe the issues surrounding the system of political patronage and political party
involvement in business. Money politics also enabled the rise of new class of tycoon in the mid-
1980s comprising select Malay and Chinese businessmen, who were well connected with the
ruling political party (Ng 2012). This group held a high concentration of corporate wealth, often
through the redistribution of state assets, and were often embroiled in business scandals, conflicts
of public interest, insider trading, stock price manipulation and corruption (Jomo & Gomez 1999;
Ng 2012).
As a result of the complexity of the political economy environment in Malaysia, political
interference in the corporate regulatory process remains a constant challenge. The nature of
money politics poses difficulties for regulators in enforcing good governance due to businessmen
having close ties with the government, and political interference in the enforcement process (Ng
2012). This resulted in the resources and incentives for expropriation via RP transactions, as
politically connected businessmen have the protection that their political ties affords them (Liew
et al. 2011, pg 141; Ng 2012).
31
2.4.5 Corporate Governance in Malaysia The Asian Financial Crisis was instrumental in unearthing poor corporate governance not only in
Malaysia but also in the region (Munir & Gul 2010). Among the issues that came to the fore were
the high levels of leverage, lack of transparency by management, a lack of minority shareholder
protection, expropriation by corporate insiders, and cronyism (Wahab et al. 2007, p.106; Munir
& Gul 2010). Following the Asian Financial Crisis of 1998, many major steps have been taken to
improve corporate governance in Malaysia (Wahab et al. 2011, p.131).
The Malaysian Code of Corporate Governance (MCCG) was first introduced in 2000, and was
later incorporated into the Bursa Malaysia Listing requirement in 2001. A major revision was
done in 2007, to mandate the inclusion of a requirement for the majority to audit committee
members to be independent (Wahab et al. 2011, p.139). The latest revision to the MCCG was
done in 2012. Among the salient features of the latest MCCG are a focus on sustainability,
capping the tenure of independent directors, mandating that the role of CEO and Chairman be
separated, and putting resolutions to a poll rather than a show of hands at the general meetings of
the company (Securities Commission Malaysia 2013).
Compliance with the best practices in the code is voluntary. Companies listed on Bursa Malaysia
must however state in their annual report the level of their compliance, and also include any
explanation for any departure from the best practices. The MCCG was first developed from the
base framework for corporate governance codes laid down by the Cadbury Report (Cadbury et al.
1992) from the United Kingdom (Wahab et al. 2007, p.139). The latest version contains eight
main principles which are:
Establish clear roles and responsibilities;
Strengthen composition;
Reinforce independence;
Foster commitment;
Uphold integrity in financial reporting;
Recognise and manage risks;
Ensure timely and high quality disclosure; and
Strengthen relationship between company and shareholder (Securities Commission
Malaysia 2013).
Each principle then has several recommendations with practical steps to be taken by the board
and management of the company. The MCCG also has detailed commentary on each
recommendation to guide directors on how best to comply for effective implementation
(Securities Commission Malaysia 2013).
32
The code outlines best practices that are aimed at improving the performance of the board of
directors with regards to independence, transparency and accountability to stakeholders. This in
turn will help the board serve its role of monitoring management more effectively (Wahab et al.
2007, p.139). Subsequent to the implementation of the MCCG, it was found that shareholder value
was increased by 4.8% (Wahab et al. 2007, p.158).
Another issue which arose after the Asian Financial Crisis was the lack of shareholder activism
by local institutions (Claessens & Fan 2002, p.71). In 1999, the Ministry of Finance, acting on
the recommendations of High Level Finance Committee, mooted the setup of the Minority
Shareholders Watchdog Group (MSWG). In the Committee’s Report on Corporate Governance
to the Ministry of Finance, it was noted that the protection of minority shareholders was critical
given that Malaysian listed companies had high levels of ownership concentration (Wahab et al.
2011, p.131). The MSWG was established in 2001 and was funded by five local institutional
investors, namely the Employees Provident Fund, the National Equities Corporation (Permodalan
Nasional), the Armed Forces Pension Fund (Lembaga Tabung Angkatan Tentera), the Pilgrims
Fund Board (Tabung Haji) and the Social Security Organization (SOCSO). The MSWG serves
as a platform for shareholder activism, and monitors public listed companies for breaches and
non-compliance, as well promoting and educating the public on shareholder rights and the role of
good corporate governance in the capital markets (Wahab et al. 2011, p.131).
2.5 Review of Existing Empirical Evidence
2.5.1 Review of Studies on Firm Valuation Corporate governance is deemed to have a restraining effect on negative RP transactions. A clear
example is in China where extensive share structure reform was carried out, and studies have been
done on the effect of this change (Zhu & Zhu 2012, p.73). The reform presents a clear before and
after improvement in corporate governance; this change was found to reduce the negative effects
of RP transactions. Utama and Utama (2014, p. 361) also document a restraining effect of
corporate governance on abusive RP transactions in Indonesia.
Antonios, Ioannis, and Panagiotis (2011, p.156) in their study of Greek companies have observed
that new accounting standards requiring fair value disclosure of RP transactions resulted in less
market discounting of firms engaging in RP transactions. This has implications for new
regulation, as it shows how legislation and accounting standards can act as a constraint on the
negative effects of RP transactions.
Similar research was conducted on Chinese companies, and a consistent result was obtained. Prior
to the implementation of fair value accounting in RP transactions, firms that had RP transactions
faced an investor discount (Ge et al. 2010, p.134). Subsequent to implementation of new
accounting rules, this discount of earnings to valuation disappeared.
33
Kohlbeck and Mayhew (2010, p.115) in a study of North American companies found a valuation
discount for firms engaging in RP transactions. The research refined the value relevance of
different classes of RP transactions; simple RP transactions such as loans had a negative effect on
firm valuation, whilst complex RP transactions with firm’s investments did not have any effect.
A more detailed study on the link between RP transactions and firm valuation was done by Nekhili
and Cherif (2011, p.291) on French companies, focusing on the identity of the counterparty in the
RP transactions. Their findings concluded that RP transactions with the major shareholder or
companies affiliated with the main shareholder as determined by voting rights were the most
damaging for firm valuation. The presence of an audit committee and independent directors was
not found to have any effect on limiting the value relevance of RP transactions.
2.5.2 Review of Malaysian Corporate Governance Studies
Abdullah (2004, p.47) found that board independence, proxied by percentage of outside directors
and role duality had no effect on company performance as measured by ROA. A possible
explanation was that the financial ratios (ROA) may only measure short-term performance, and
perhaps a market-driven measure (e.g. valuation) may have been better, which was adopted by
this study in the testing of Tobin’s Q. Additionally Abdullah (2004) only examined 2 aspects of
corporate governance, namely board independence and duality, which has been expanded by this
study to cover a broader spectrum of other corporate governance mechanisms.
Haniffa and Hudaib (2006, p.1034) found that large boards had a significant negative relationship
with Tobin’s Q. Neither board independence nor duality were found to be significant in their
relationship with Tobin’s Q. It was also found that concentrated shareholding had a significant
negative relationship with Tobin’s Q. When the study tested the effects on accounting
performance measures, a positive association between board size was found. Board independence
was not significant, but duality was negatively associated with firm performance. Although this
study tests various corporate governance mechanisms, there was no examination of RP
transactions or their impact.
Tam and Tan (2007, p.208) found that concentration of ownership is highest in state-owned
corporations whereas it was lowest in firms owned by a single individual. Individual-owned firms
outperformed state and trust fund owned firms in valuation, and state firms in ROA, but lagged
behind foreign-owned firms in both measures. Ownership concentration was negatively
associated with ROA, signalling expropriation by owners. Their study concludes that more
research needs to be done into effective governance mechanisms, particularly in scrutinising large
shareholders to prevent expropriation of minority shareholders. Tam and Tan (2007) do not go
into the actual mechanics of such measures, for example examining the role RP transactions could
play.
34
Wahab et al. (2007, p. 106) observed that corporate governance improved after the MCCG was
incorporated into Bursa Listing Rules in 2001. Firms with high corporate governance index scores
had better returns. Firms with improved corporate governance index scores also had better returns.
These results underscored the need for continuous improvement to the system of governance in
place.
Mohamad Ariff et al. (2007, p.562) found that only the size of the firm (total sales) has a
significant positive relationship with position in the ranking in Corporate Governance Reporting
Initiative 2004. Other factors, such as Tobin’s Q, net profit margin, leverage, sales growth, market
capitalization, firm age, ownership concentration and foreign operations did not have an impact.
Studies such as this by Mohamad Ariff et al. (2007) present indirect evidence of the inconclusive
nature of the relationship between firm characteristics and corporate governance. There is a need
for more study to address these by examining specific relationships, for example between RP
transactions and firm performance and valuation, to extend the understanding of such
relationships.
Sulong and Noor (2008, p.55) found that dividend yield had a significant positive relationship
with firm value. At the same time, ownership concentration has no significant effect on firm value
but good board governance played a role in improving monitoring role of other mechanisms such
as dividend yield and ownership structure. Amran and Ahmad (2009, p.53) found no difference
in value between family and non-family firms. Family firms had a lower proportion of
independent boards and those with no duality outperformed those with role duality.
Ghazali (2010, p.109) observed that none of the corporate governance variables (board size,
percentage of independent directors, role duality) had statistically significant relationships with
firm value. Government and foreign owners were significantly positively related to performance.
The lack of evidence for improvement in firm valuation subsequent to adoption of corporate
governance practices was explained by the time of sampling. Ghazali (2010) utilised data for
2001, which was also the same year many of the practices were adopted. Other reason cited were
the lack of tailoring of corporate governance mechanisms to a local context, and differing legal
environment affecting incentives to implement corporate governance practices (Ghazali 2010,
p.117).
Ibrahim and Samad (2011, p.105) found that family firms have higher ROE but lower ROA and
Tobin’s Q compared to non-family firms. Family firms have lower percentage of independent
directors, and there was a significant negative relationship between percentage of independent
directors and ROA and ROE for family firms. Role duality in family firms was significantly
negatively related to all measures of performance. There was no significant relationship found
between board independence and performance of the firm. Ibrahim and Samad (2011, p.109)
35
explained that this infers that outside directors do not lead directly to improved performance but
merely improve decision making.
Amran and Ahmad (2011, p.15) observed that the percentage of independent non-executive
directors is significantly negatively related to operating cash flow. At the same time role duality
is positively related to Tobin’s Q. These findings were broadly inconsistent with prior literature.
This may be due to the sample which was limited exclusively to family firms. Larger boards were
found to have a positive impact; this may be due to the practice in Malaysia of appointing
prominent board members (e.g. retired civil servants, army members) which enhances the prestige
and reputation of the board (Amran & Ahmad 2011, p.23).
Wahab et al. (2011, p.131) was an early investigation into the effects of RP transaction. The study
utilised two measure of RP transactions which were total number of RPT scaled by directors and
total amount RPT scaled by assets respectively. Both internal and external corporate governance
were tested and a negative relationship between RPT (both measures) and performance was
found. Executive remuneration, board independence and audit quality were also found to mitigate
negative impact of RP transactions. A key limitation was that various types of RPT and the
identity of parties transacted with was ignored.
Juliarto (2012, p.15) conducted a cross-country survey on tunnelling RP transactions. The
research highlighted the issue of the perception of the agency problem as mainly being an Anglo-
American problem. It was not representative of international focus or markets with concentrated
ownership as large blockholders are common in non-Western markets. Tunnelling is a serious
problem in emerging economies. Juliarto found a strong association between family ownership
and tunnelling RP transactions (2012, p.144). The results showed that expropriation is a real threat
for minority shareholders in the ASEAN region. Juliarto (2012, p.158) concluded by emphasizing
the need for additional disclosure and codes of governance to be strengthened by strong
legislation. Another solution, the practicality of which is debatable, is to have multiple
blockholders, who each hold significant shareholding percentages. The idea behind this is that
they will balance each other out and constrain any act of expropriation (Juliarto 2012, p. 158).
Liew et al. (2011, p.139) found that related party transactions that are likely to result in
expropriation reduce firm value (Tobin’s Q). Average independent directors’ tenure is not linked
to expropriation by controlling shareholders of these firms. There is also no conclusive and
significant evidence that ownership concentration by family firms’ controlling shareholders has
significant relationships with both market-based and accounting-based firm performance
measures. The power to control a corporation might provide the majority family shareholder
(family controlling shareholder) the opportunity and incentives to expropriate the firm’s resources
for his or her own interests while other shareholders as well as other stakeholders of the firm bear
36
the costs. Such expropriation generally reduce the observed market value of the firm and is
empirically proven. Expropriation activities undertaken by family controlling shareholders to
maximize their personal utility lead to suboptimal firm policies resulting in poor firm
performance. Malaysian family firms are also situated in a unique government and institutional
setting. They embrace the culture of rent-seeking which is encouraged by the Government’s
affirmative action policy. Liew et al. (2011) classify a firm as a family firm if a person is the
controlling shareholder; that is a person (rather than a state, corporation, management trust or
mutual fund) can obtain enough shares to assure at least 20% of the voting rights and the highest
percentage of voting rights in comparison to other shareholders.
Azizan and Ameer (2012, p.774) studied family firms targeted for intervention by the Minority
Shareholder Watchdog Group (MSWG). Family company was defined as a family having equity
shareholding equal to at least 20% of total shareholding of the firm. The study found abnormal
market returns for family firms targeted for MSWG intervention, in particular for firms in which
family control is less than 33%. MSWG activism was also significantly related to higher operating
cash flow in family firms. MSWG intervention is significantly negatively related to dividends per
share in family companies. Shareholder activism is lacking in Malaysia, and should be encouraged
by the authorities as an alternative corporate governance mechanism.
Mohd Hasan Abdullah et al. (2012, p.71) found that dividends were significantly positively
correlated with concentration of ownership. Managerial ownership had a negative but
insignificant relationship with dividends. Both institutional and foreign ownership had no
significant effect on dividends.
Ibrahimy and Ahmad (2012) examined the relationship between firm performance and ownership
structure. It was argued that at least in part by weaknesses in legal systems, the ownership
structure can play the dominant role to counter managerial agency problems, and hence, increase
the firm value. The Malaysian economy has a high ownership concentrated economy among East-
Asian countries (Claessens et al. 2000). This concentrated ownership, coupled with weak
corporate governance and regulatory framework in Asian countries and weak protections of
minority rights of Asian countries lead to expropriation of minority shareholders (Claessens &
Fan 2002). Blockholders, defined as shareholders who own 5% of shares and above, was
positively insignificant with firm performance when considering the market based performance
measurement (Tobin’s Q). However, it shows significant positive relationship with low
magnitude of beta coefficients against accounting based performance measure, when industry
effects are taking into consideration. The negative relationship of blockholder ownership with
firm performance by univariate analysis indicated the probability of expropriation of minority
shareholders’ wealth by blockholders (Ibrahimy & Ahmad 2012).
37
Ng (2012) examined the performance of family firms. The proportion of family equity ownership
positively influences corporate performance. Family-affiliated firms generally underperform non-
family affiliated firms. The heterogeneity of business groups results in considerable differences
in performance (Ng 2012, p.69). Specifically, the size of business group has a negative
moderating effect on the firm diversification-performance relationship. Profit redistribution
occurs in firms that have a high level of family ownership and that are affiliated to large business
groups. Board independence in general lacked effectiveness in moderating the influence of firm
strategies or activities on firm performance. Even when a professional managers are hired from
outside the family to manage a family-controlled firm, the impact is limited by the influence of
the controlling families (Ng 2012, p.7). Essentially, concentrated ownership in the relatively weak
enforcement environment of Malaysia enables owner-managers to implement policy or strategy
related corporate activities or practices that generate for them private benefits of control at the
expense of minority shareholders, firm efficiency and performance. As an example, the practice
of forming business groups or strategies to diversify a firm can be used by controlling families to
facilitate their expropriation of minority shareholders. A possible reasons for relatively weak law
enforcement is the Malaysian environment that practices political patronage in business. Rules
and regulations and may be selectively enforced against firms which are closely associated with
influential political figures or the ruling political party (Ng 2012, p.64).
Lim et al. (2013, p.355) examined the impact of corporate governance and ownership structures
on firm performance of 293 Bursa Malaysia companies six years before and after the
implementation of Malaysian Code of Corporate Governance (MCCG) in 2001. Descriptive
statistics show significant differences in corporate governance practices before and after MCCG
2001, despite minimal legislation. Institutional and foreign shareholdings were found to be
significantly associated with both market (Tobin’s Q) and accounting performance (ROA)
measures before and after implementation of MCCG, implying their positive roles on
performance. Contrary to the recommendation by MCCG, role duality (positions of Chairman
and CEO were the same person) was observed to be negatively related to accounting performance
measures but in the opposite direction for market performance measures. The key limitation of
the study is that the ownership identities of large shareholders are not explored. They may have
different investment objectives and culture, and this may result in different corporate governance
mechanisms employed. Secondly, the issue of causality has not been explored, for example, the
causal relationship between corporate governance and ownership structure and firm performance
should be studied further so as to predict the cause and effect relationship more accurately. Noor
and Fadzil (2013, p.191) examined the direct relationship between board characteristics with
firms’ ROA. Board independence, experience and meeting frequency had significant impacts on
ROA.
38
Table 2 Malaysian Corporate Governance Research
Work Title Dependent Independent Control Key Findings Abdullah 2004
Board composition, CEO duality and performance among Malaysian listed companies
ROA Return on equity Earnings per share Net profit margin
Percentage of outside directors
Role duality
N/A 313 companies from 1994 to 1996 Board independence proxied by percentage of outside directors and
role duality have no effect on company performance as measured by ROA
The financial ratios (ROA) may only measure short-term performance, and perhaps a market-driven measure (e.g. valuation) may be better
However role duality is negatively associated with board independence Haniffa and Hudaib 2006
Corporate governance structure and performance of Malaysian listed companies.
Tobin’s Q ROA
Board size Percentage of non-
executive directors Role duality Ownership
concentration Multiple directorships
Sales (proxy for size) Capital expenditure
(proxy for growth) Industry type
347 companies from 1996 to 2000 Large boards have a significant negative relationship with Tobin’s Q Concentrated shareholding has a significant negative relationship with
Tobin’s Q
Tan and Tam 2007
Ownership, governance and firm performance in Malaysia
Tobin’s Q ROA
Ownership concentration
Ownership types Role duality Firm age Industry Market capitalization Debt structure
N/A 150 companies from 1994 to 2000 Concentration of ownership is highest in state-owned corporations
(5523%) Concentration of ownership is lowest in firms owned by a single
individual (3845%) Individual-owned firms outperform state and trust fund owned firms
in valuation, and state firms in ROA, but lag behind foreign-owned firms
Ownership concentration is negatively associated with ROA, signalling expropriation by owners
Wahab et al. 2007
The impact of the Malaysian code on corporate governance: compliance, institutional investors and stock performance
Annual share returns Corporate governance index based on 2001 Malaysian code on corporate governance
Audit quality Intangible assets Institutional ownership ROA Market risk Managerial ownership Firm size (assets)
440 companies from 1999 to 2002 Dependent variable used was continuously compounded annual
market-adjusted share returns based on December share prices and Bursa Malaysia’s Composite Index
Corporate governance has improved after the MCCG was incorporated into Bursa Listing Rules in 2001
Firms with high corporate governance index scores have better returns Firms with improved corporate governance index scores have better
returns Mohamad Ariff et al. 2007
Determinants of firm level governance: Malaysian evidence.
Ranking in Corporate Governance Reporting
Tobin’s Q Net profit margin Leverage
N/A 95 companies from 1999 to 2003 Only the size of the firm (total sales) has a significant positive
relationship with position in the CGRI 2004 rankings
39
Initiative 2004 (CGRI 2004)
Sales growth Market capitalization Firm age Firm size Ownership
concentration Foreign operations
Sulong and Nor 2008
Dividends, ownership structure and board governance on firm value: empirical evidence from Malaysian listed firms
Tobin’s Q Dividend yield Ownership
concentration Ownership types Role duality Percentage of
independent non-executive directors
Board size
Market capitalization Firm age Leverage EPS Industry type
406 companies from 2002 and 2005 Dividend yield has a significant positive relationship with firm value Ownership concentration has no significant effect on firm value Overall good board governance played a role in improving monitoring
role of other mechanisms such as dividend yield and ownership structure
Amran and Ahmad 2009
Family business, board dynamics and firm value: evidence from Malaysia
Tobin’s Q Percentage of independent non-executive directors
Board size Role duality CEO tenure
Firm size (total assets) Firm age Sales growth Leverage
896 companies from 2000 to 2003 Family company defined as family equity at least 10% No difference in value between family and non-family firms Family firms have lower proportion of independent boards Family firms with separate roles outperform those with role duality
Ghazali 2010
Ownership structure, corporate governance and corporate performance in Malaysia.
Tobin’s Q Board size Percentage of
independent directors Role duality Director ownership Ownership type
Firm size (assets) Competitiveness (ratio
of sales to industry total)
87 companies in 2001 None of the corporate governance variables (board size, percentage of
independent directors, role duality) statistically significant Government and foreign owner significantly positively related to
performance
Ibrahim and Samad 2011
Corporate governance mechanisms and performance of public-listed family-ownership in Malaysia
Tobin’s Q ROA Return on equity
Board size Percentage of
independent directors Role duality
Firm size (assets) Firm risk Firm age
290 companies from 1999 to 2005 Family company defined as family equity at least 20% Family firms have higher ROE but lower ROA and Tobin’s Q
compared to non-family firms Family firms have lower percentage of independent directors, There is a significant negative relationship between percentage of
independent directors and ROA and ROE for family firms Role duality in family firms is significantly negatively related to all
measures of performance Amran and Ahmad 2011
Board mechanisms and Malaysian family companies' performance
Tobin’s Q Earnings per share Operating cash flow
Board size Leverage Firm age Firm size
189 companies from 2003 to 2007 Family company defined as family equity at least 20%
40
Percentage of independent non-executive directors
Percentage of directors with degree
Percentage of directors with professional qualifications
Role duality
Percentage of independent non-executive directors is significantly negatively related to operating cash flow
Role duality is positively related to Tobin’s Q
Amran 2011
Corporate governance mechanisms and company performance: evidence from Malaysian companies
Tobin’s Q Board size Percentage of
independent non-executive directors
Percentage of directors with degree
Percentage of directors with professional qualifications
Role duality
Leverage Firm age Firm size
424 companies from 2003 to 2007 Family company defined as family equity at least 20% Family firms with role duality outperform those with role separation Smaller boards have a significant positive relationship with
performance in family firms
Wahab et al. 2011
Does corporate governance matter? Evidence from related party transactions in Malaysia
ROA RP transactions Duality Board independence Board size Executive
remuneration Institution ownership Audit quality
Natural log of total assets
Debt-asset ratio Management
ownership Bumiputera ownership Interlocking directors Family ownership Political links
448 firm year observations, from 2005-2007 RPT measured by A total number of RPT scaled by directors; and B
total amount RPT scaled by assets Both internal and external corporate governance tested Negative relationship between RPT (both measures) and performance Executive remuneration, board independence and audit quality
mitigate negative impact of RPT Limitations: ignores various types of RPT, identity of parties
Juliarto 2012
Tunneling: related party transactions of ASEAN listed firms
Tunnelling RP transactions
Regulatory business environment
Competitive business environment
Family ownership Managerial ownership Foreign ownership
Board independence Legal system Size Leverage
Perception of agency problem mainly Anglo-American, not representative of international focus or markets with concentrated ownership
Large blockholders common in non-Western markets Tunnelling is a serious problem in emerging economies Strong association between family ownership and tunnelling RP
transactions Liew et al. 2011
Expropriation-related variables & firm performance: evidence
Tobin’s Q Market to book value Return on equity
RP transactions likely to result in expropriation
Firm size Firm risk Leverage
Found that related party transactions that are likely to result in expropriation reduce firm value (Tobin’s Q)
41
from Malaysian family firms
ROA Ownership concentration
Board independence Firm age Non-affiliated
blockholders Firm growth Family or non-family
firm
Average independent directors’ tenure is not linked to expropriation by controlling shareholders of these firms
There is also no conclusive & significant evidence that ownership concentration by family firms’ controlling shareholders has no significant relationships with both market-based and accounting-based firm performance measures
The power to control a corporation might provide the majority family shareholder (family controlling shareholder) the opportunity and incentives to expropriate the firm’s resources for his or her own interests while other shareholders as well as other stakeholders of the firm bear the costs
Such expropriation generally reduce the observed market value of the firm and is empirically proven
Expropriation activities undertaken by family controlling shareholders to maximize their personal utility lead to suboptimal firm policies resulting in poor firm performance
Azizan and Ameer 2012
Shareholder activism in family-controlled firms in Malaysia
Market adjusted returns Buy and hold returns EBITDA Operating cash flow Total debt Dividends per share
Family firms targeted for intervention by the Minority Shareholder Watchdog Group (MSWG)
N/A 321 companies from 2005 to 2009 Family firms targeted for intervention by the Minority Shareholder
Watchdog Group (MSWG) Family company defined as family equity at least 20% Abnormal market returns for family firms targeted for MSWG
intervention, in particular for firms in which family control is less than 33%
MSWG activism is also significantly related to higher operating cash flow in family firms
MSWG intervention is significantly negatively related to dividends per share in family companies
Mohd Hasan Abdullah et al. 2012
The influence of ownership structure on the firms dividend policy based lintner model
Change in dividends paid
Ownership concentration
Ownership dispersion Foreign ownership Institutional ownership Managerial ownership
N/A 100 companies in the year 2010 Dividends are significantly positively correlated with concentration of
ownership Managerial ownership has a negative but insignificant relationship
with dividends Both institutional and foreign ownership have no significant effect on
dividends Ibrahimy and Ahmad 2012
Blockholders, corporate governance and the value of the firm: a panel data analysis of Malaysian non-financial companies
Tobin’s Q Return on equity
Blockholder ownership (form of ownership concentration)
Profit volatility Leverage Firm growth
N/A 201 companies from 2002 to 2008 Ownership concentration has limited effect as a corporate governance
mechanism No significant relationship found between ownership concentration
and firm valuation, although negative coefficient indicates expropriation by blockholders
42
Firm size Industry
Small positive association between ownership concentration and return on equity
Overall monitoring effect of blockholders may be negated by their expropriation of firm resources and subsequent adverse impact on firm performance
Ng 2012 The influence of ownership, control, governance and diversification on the performance of family-controlled firms in Malaysia
Tobin’s Q ROA
Ownership concentration
Ownership identity Business group
affiliation Firm diversification
Firm age Firm size Leverage Industry classification
314 companies from 2007 and 2008 Ownership concentration had a positive association with ROA The presence of foreign institutional investors and state blockholders
in family firms positively impacts firm performance Board independence has no effect on the relationship between
ownership concentration and firm performance In general family firms underperformed non-family firms in terms of
ROA Lim et al. 2013
Corporate governance and financial performance of public listed companies: pre and post implementation of the Malaysian code of corporate governance
Tobin’s Q ROA
Board size Board independence Duality Audit committee Nominating committee Remuneration
committee Ownership
concentration Ownership identity
Firm size Leverage
293 companies from 1995 to 2006 Analyse effects of the implementation of the Malaysian code of
corporate governance (MCCG) Larger board size was less effective prior to MCCG implementation
but more effective after Board independence was significantly positively associated with firm
performance and valuation Duality had a negative impact on firm performance Foreign and institutional shareholders had a positive impact on firm
performance and firm valuation Noor and Fadzil 2013
Board characteristics and performance from perspective of governance code in Malaysia
ROA Board education Board experience Board size Board independence Board meeting
frequency
N/A 162 companies from 2006 and 2008 Direct relationship between board characteristics with firms’ ROA Board independence, experience and meeting frequency had
significant impacts on ROA
43
2.5.3 RP Transactions and the Risks to Firm Valuation RP transactions presents multiple risks to firm valuation. Firms that engage in RP transactions are
likely to experience discounting by the market and investors (Zhu & Zhu 2012, p.73; Antonios,
Ioannis, & Panagiotis 2011, p.156; Ge et al. 2010, p.134; Kohlbeck & Mayhew 2010, p.119;
Nekhili & Cherif 2011, p.291). This valuation discount is present as RP transactions is associated
with fraud (Henry et al. 2007, p.3), expropriation (Cheung et al. 2009, p.915; Liew et al. 2011,
p.150), weak firm performance (Gordon et al. 2004b, p.36) and earnings management (Jian &
Wong 2003; Chen, Cheng & Xiao 2011, p.165). In particular, RP transactions is associated with
self-dealing by management to maximize their own utility at the expense of shareholders, which
is expropriation and a conflict of interest (Jensen & Meckling 1976, p.870).
At the same time, reforms to share structure (Zhu & Zhu 2012, p.73) and accounting standards
(Antonios, Ioannis, & Panagiotis 2011, p.156; Ge et al. 2010, p.134) have shown some results in
reducing the discount to firm valuation caused by RP transactions.
A study of North American companies by Kohlbeck and Mayhew (2010, p.134) found a valuation
discount for firms engaging in RP transactions. The research broke down the value relevance of
different classes of RP transactions into different categories with different effects observed on
firm valuation; simple RP transactions such as loans had a negative effect on firm valuation,
whilst complex RP transactions with firm’s investments did not have any effect. The proposed
study will be similar to this analysis but taking it in a Malaysian context for Malaysian listed
firms.
Nekhili and Cherif (2011) conducted a further detailed study on the link between RP transactions
and firm valuation in in listed companies in France. This study was focussed on the identity of
the counterparty in the RP transactions. Their findings concluded that RP transactions with the
major shareholder or companies affiliated with the main shareholder as determined by voting
rights were the most damaging for firm valuation. The presence of an audit committee and
independent directors was not found to have any effect on limiting the value relevance of RP
transactions. We do not at this stage propose to conduct such detailed analysis in a Malaysian
context, without first establishing the value relevance of different classes of RP transactions as
per Kohlbeck and Mayhew (2010, p.119).
2.5.4 Impact of Ownership Concentration on RP transactions and Firm Valuation Previous studies have suggested that the relationship between RP transactions and firm valuation
is influenced by ownership concentration and corporate governance structure (Gordon et al.
2004a, p.11; Amzaleg & Barak 2013, p.239; Chien & Hsu 2010). A study by Hu, Shen, and Xu
(2009, p.190) found that ownership concentration was associated with larger magnitude of RP
transactions. More recent studies have continued to reaffirm the positive association between
44
ownership concentration, duality and the size of RP transactions (Hu et al. 2012, p.58). Research
has also focused on ownership concentration and RP transactions during the initial public offering
(IPO) of a company. Chen, Cheng, and Xiao (2011, p.165) in their study of Chinese companies,
which tend to have a concentrated ownership structure, found that this structure tends to lend itself
to RP transactions resulting in agency conflicts of interest. The empirical results of Chen, Cheng,
and Xiao (2011, p.165) showed that RP transactions were used to inflate pre-IPO results, and this
resulted in a poor firm performance post-IPO and lower firm valuation.
All these studies were conducted on Chinese listed firms, which is largely representative of
research on RP transactions in this region being led by studies in China. Furthermore, there is a
distinct lack of research in the context of Malaysian listed firms. Previous studies have produced
mixed findings. Therefore further study is necessary to consider what impact RP transactions has
on firm valuation, and how RP transactions impacts firm valuation.
Table 3 RP Transactions and Risks to Firm Valuation
Author & Title Statistics Definition
Claessens, S., Djankov, S.,
Lang, L.H.., 2000. The
separation of ownership and
control in East Asian
Corporations. Journal of
Financial Economics 58, 81–
112.
2,980 corporations in nine East Asian countries in 1996, 238 from Malaysia
14.9% of Malaysian firms have some form of crossholding
67.2% are controlled by families, 13.4% by the state
Top 15 families control 28.3% of total listed corporate assets.
Analysis of cash-flow and control rights of companies done by studying all shareholders who control over 5% of the votes.
Definition of ownership relies on cash-flow rights.
Control is defined as 20% voting rights
Tam, O.K., Tan, M.G.-S.,
2007. Ownership,
Governance and Firm
Performance in Malaysia.
Corporate Governance: An
International Review 15,
208–222.
In firms where the state was the ultimate shareholder, the average shareholding was 55.23%
Where the ultimate shareholder was a family it was 38.45%
Ultimate ownership is
defined as the sum of shares
owned, directly or indirectly,
by a single owner through
cross-shareholdings and/or
pyramids.
Ghazali, N.A.M., 2010.
Ownership structure,
corporate governance and
corporate performance in
Malaysia. International
Journal of Commerce &
Management 20, 109–119.
87 companies from 2001 64% of the companies have
the government as a substantial shareholder
Definition of substantial
shareholder not stated
45
2.6 Development of Hypotheses This section builds on the theoretical framework developed over the preceding chapters to develop
testable hypotheses for: (a) the association of RP transactions on firm valuation and performance;
(b) the variations in impact between different types of RP transactions; (c) the effect that
ownership concentration and corporate governance together with RP transactions on firm
valuation and performance; and (d) the association between ownership concentration and
corporate governance with RP transactions.
2.6.1 Related Party Transactions and Association with Firm Performance and
Valuation
Various studies have shown that RP transactions are likely to result in the market and investors
giving a valuation discount to firms that engage in such transactions (Zhu & Zhu 2012, p.73;
Antonios, Ioannis, & Panagiotis 2011, p.156; Ge et al. 2010, p.134; Kohlbeck & Mayhew 2010,
p.119; Nekhili & Cherif 2011, p.219). RP transactions present multiple risks to the firm and its
investors. Research has associated RP transactions with fraud (Henry et al. 2007, p.3),
expropriation of minority investors (Cheung et al. 2009, p.914; Liew et al. 2011, p.141), weak
firm performance (Gordon et al. 2004b, p.36) and earnings management (Jian & Wong 2003,
p.74; Chen, Cheng & Xiao 2011, p.165). In particular, RP transactions are linked with self-dealing
by management to maximize their own utility at the expense of shareholders, which is
expropriation and a conflict of interest (Jensen & Meckling 1976, p.305).
An alternative view of RP transactions is that the firm derives economic advantages from
performing certain transactions internally rather than with external parties (Gordon et al. 2004b,
p.6; p Mallin 2013, p.15). This understanding of RP transactions sees them being a form of
internal dealings that offer benefits over arm’s length or external dealings (Pizzo 2013, p.309).
The firm must derive certain benefits from RP transactions to justify the transaction being entered
into by the firm. Various benefits of RP transactions as efficient transactions have been theorized,
and would include lower transaction costs, improving capital allocation, obtaining better returns
on assets, and providing solutions to overcoming problems impairing production (Pizzo 2013,
p.309; Wahab et al. 2011, p.131; Jian & Wong 2010, p.70).
RP transactions are required to be disclosed, and this gives parties that have an interest in such
transactions, for example investors, an avenue to monitor, reward or penalise the firm engaging
in them (Kohlbeck & Mayhew 2010, p.151). The act of disclosure itself, of having to report back
to shareholders and stakeholders on the existence of RP transactions, can be a deterrent to the use
of RP transactions in agency conflict of interest situations, as argued by Hwang, Chiou, and Wang
(2013, p.292). At the same time, the mere disclosure of RP transactions alone does not prevent
the transaction taking place. It then becomes possible for an equilibrium condition to exist
46
whereby investors price protect against the potential effects of RP transactions (Jensen &
Meckling 1976, p.305). This means that investors would assign a lower market valuation to a firm
engaging in RP transactions in anticipation of the costs to the firm of the said transactions
(Kohlbeck & Mayhew 2010, p.134). The valuation discount would persists so long as the potential
negative effects of the RP transactions did not become so prohibitive as to trigger other
mechanisms such as corporate takeovers (Kohlbeck & Mayhew 2010, p.134).
This leads to the argument that the market and investors will value firms with RP transactions
differently from those firms that do not. Kohlbeck and Mayhew (2010, p. 120) formulated a null
hypothesis to test this argument initially. Similarly, to formally test this proposition the following
null hypothesis is formed:
H1: Related party transactions do not have a significant effect on the firm’s
valuation and performance.
2.6.2 Effects of Different Types of Related Party Transactions
It has also been suggested that the type of RP transactions matters when examining the potential
positive or negative effects on the firm (Kohlbeck & Mayhew 2004, p.13). Cheung et al.’s (2006)
investigation of actual transactions of listed firms in Hong Kong shows clear differences in the
impact of different types of RP transactions on firm valuation by the market. The consistency of
the results they obtained with predictions by agency theory as to which transactions would be
value-destroying is significant.
The RP transaction in a conflict of interest situation is primarily a principal-principal conflict.
This involves the expropriation of minority shareholders by the controlling or majority
shareholder. The phenomenon is known as tunnelling, and the first category used by Cheung et
al. (2006) in their study may be classified as such. Propping on the other hand would refer to
transactions between the firm and related parties that are likely to benefit the firm (Friedman,
Johnson & Mitton 2003, p.732).
This study adopts a classification of RP transactions consistent with the literature (Gordon et al.
2004b, p.36; Kohlbeck & Mayhew 2004, p.10; Cheung et al. 2006, p.384; Kohlbeck & Mayhew
2010, p.121). The RP transactions are divided into two categories, namely tunnelling RP
transactions and propping RP transactions. The classification of transactions is determined by the
identity of the related party. The identity of the owners in RP transactions is a key variable to be
considered (Boubakri et al. 2005, p.375; Juliarto 2012, p.29). The identity of the related party
varies with the ownership structure, and may be generally categorized as follows: government,
local institutions, foreign investors, employees and individuals (Boubakri et al. 2005, p. 375).
This study groups these into 2 even broader categories, namely institutions (government, local
institutions, and foreign investors) and families (employees and individuals) and also adds new
47
categories consistent with a Malaysian context (widely held, tycoons, and political parties). The
categories of tycoons and political parties are products of the Malaysian political economy.
Tycoon here is defined as a politically well-connected businessman, or one who is key member
of the dominant political party. The tycoon is characterized by sprawling business empires with
multiple public-listed companies, typically built on the foundation of some form of wealth
redistribution or political patronage. Although the argument has been put forth that politically
connected businessmen may take advantage of the protection their political ties afford them (Ng
2012), dealing with members of the same group, or at least with parties which are known to the
firm, may mitigate the problems such as enforcement of contracts and property rights, which are
critical to the corporation (Cheung et al. 2009). For political parties, ownership motivation is often
driven by the party’s need for financial resources for election campaigns at the party and national
level (Ng 2012). The identities of the largest shareholder is a mandatory disclosure under the
Bursa Malaysia listing rules.
Table 4 Definitions of Shareholder Identity
Institution owned Government, local institutions, and foreign investors (Boubakri
et al. 2005, p. 375)
Widely held by public (no shareholder holding more than 5%)
Political parties Family owned Employees and individuals (Boubakri et al. 2005, p. 375)
Owner-managed (Sulong & Noor 2008, p.59)
Directors of the company
Tycoons (individual owner with large corporate group)
RP transactions with related parties in a family owned firm are classified as tunnelling
transactions. With sufficiently high ownership concentration, there is an incentive to assert control
to protect the interests of the controlling shareholders (Sulong & Noor 2008, p.59). Controlling
shareholders that are families will install their own family members, or trusted representatives,
into management, which tends to increase the probability of RP transactions happening that
results in expropriation of minority shareholders (Claessens, Djankov & Lang 2000, p.81). This
is an economic cost to the firm, and lowers its valuation and returns. To formally test this
proposition the following hypothesis is formed:
H2: Tunnelling related party transactions have a significant negative effect on the
firm’s valuation and performance.
RP transactions with related parties in an institution owned firm are classified as propping
transactions. Dealing with members of the same group, or at least with parties which are known
48
to the firm, may mitigate the problems such as enforcement of contracts and property rights, which
are critical to the corporation (Cheung et al. 2009, p.914; Khanna & Palepu 1997). This confers
economic benefits on the firm and should either have a neutral or positive effect on the firm’s
valuation and performance. To formally test this proposition the following hypotheses are formed:
H3: Propping related party transactions have either a neutral or significant positive
effect on the firm’s valuation and performance.
2.6.3 The Impact of Ownership Concentration and Corporate Governance Ownership structure can act as both an internal corporate governance mechanism and also a
source of agency conflict (Shleifer & Vishny 1997, p.742; Gordon et al. 2004b, p.24; Boubakri et
al. 2005, p.369). High ownership concentration is a common feature of firms in this region,
including Malaysia. A large controlling shareholder has the necessary incentive to protect their
investments (Shleifer & Vishny 1997, p.742) and it could be argued that the interests of
management and investors are more aligned. On the other hand, La Porta et al. (1999, p.471)
posits that higher ownership concentration increases the power that major shareholders have to
expropriate the minority. In a closely held corporation (i.e. high concentration of ownership) this
would indicate maximization of the principal shareholders’ utility ahead of the other minority
shareholders.
Corporate governance is deemed to have a restraining effect on negative RP transactions
(Kohlbeck & Mayhew 2010, p.119; Utama & Utama, p.361; Zhu & Zhu 2012, p.73). Better
corporate governance ensures better monitoring and alignment of shareholder interest (Fama &
Jensen 1983, p.14). A more independent board, separation of the role of chairman and CEO,
quality external audit and monitoring of creditors all work together to discipline management and
reduce the negatives impact of RP transactions (Kohlbeck & Mayhew 2010, p.119). To formally
test this proposition discussed above, the following hypothesis is formed:
H4: Ownership concentration and corporate governance has a significant effect on
the relationship between related party transactions and firm valuation and
performance.
2.6.4 Factors Associated with Related Party Transactions
It is also possible that any relationship between RP transactions in their various forms and the
firm’s valuation and return are a symptom rather than a cause (Kohlbeck & Mayhew 2010, p 130).
The decision to engage in RP transactions may actually be associated with other factors that
themselves lead to lower valuations or returns resulting in an endogeneity bias in this study
(Kohlbeck & Mayhew 2010, p.130). To formally test this proposition the following hypothesis is
formed:
49
H5: Corporate governance and ownership concentration are associated with related
party transactions.
2.7 Summary This chapter reviews existing literature on RP transactions, reasons for this study, and develops
the hypotheses for testing. The background to RP transactions from the viewpoint of legislation
and regulator-issued guidance in Malaysia is examined. The key pieces of legislation are the
Malaysian Financial Reporting Standards, the Bursa Malaysia Listing Rules and the Companies
Act 1965 and 2007 Amendment. The second section examines RP transactions within the
theoretical framework developed by other researchers. In particular, agency theory and
transaction cost economics are used in building up the case for this study. The opposing views of
RP transactions as efficient transactions or conflicts of interest are detailed. Variations in the type
of RP transactions in the form of propping or tunnelling transactions are also explained. In the
following section, the role and significance of corporate governance is examined. Both internal
and external corporate governance mechanisms are considered, and a review of studies done in a
Malaysian context are summarised. The fourth section reviews existing studies and their results
regarding RP transactions, corporate governance and firm valuation and performance. Finally,
based on the arguments of the preceding chapters, and underpinned by the theoretical framework
in place, the necessary hypotheses are developed and outlined to be tested in the following
chapter.
50
3 Research Design
3.1 Introduction This chapter will outline the conceptual framework used by this study as well as the general
formulae that will be used to test the hypotheses developed in the previous chapter. This is
followed by the detailed specification of each model, as well as the definition and
operationalization of each variable. In the course of this study, it was noted that a large number
of prior work on RP transactions do not explain the practical aspects of data collection and
variable definition with relation to RP transactions. To this end this study has clearly defined the
exact data parameters used for each variable, traceable to the secondary data utilised.
The remaining sections deal with the usage of secondary data and the reasons for doing so. This
chapter then concludes with the process of the sample selection for this study.
3.2 Research Philosophy This study adopts a positivist approach, similar to prior corporate governance studies (Ng 2012;
Williams 2014). In this research philosophy, empirical testing of stated hypotheses is undertaken
to determine true causes of social scientific outcomes (Johnson & Onwuegbuzie 2004). This study
has developed hypotheses, based on existing theoretical frameworks, regarding the relationships
between RP transactions, corporate governance, ownership concentration, and firm valuation and
performance. In applying a positivist approach, data is collected and empirically tested using the
tools of regression analysis to achieve observations that are free from personal bias and are
emotional detached from the researcher (Johnson & Onwuegbuzie 2004).
3.3 Theoretical Framework The previous chapter developed the hypotheses to be tested by this study. The relationship
between the key variables can be summarized by the conceptual diagram below. Related party
transactions impact firm valuation and performance. Different RP transactions have different
effects on firm valuation and performance. Corporate governance and ownership concentration
have an effect on the relationship between RP transactions and firm valuation and performance.
At the same time, corporate governance and ownership concentration can themselves be a factor
associated with RP transactions.
51
The conceptual framework above can be distilled into six models that can be put into three distinct
sets that explain firm valuation and performance. In the first set, the association between any and
all RP transactions is examined. The RP transactions are then broken down into either propping
or tunnelling RP transactions to determine the impact of the different types of RP transactions.
Firm valuation and performance = f(RP transactions, Control variables) + Ɛ
… Model 1
Firm valuation and performance = f(Tunnelling RP transactions, Propping RP
transactions, Control variables) + Ɛ
… Model 2
In the second set, the same models are reused from the first set, but this time with the addition of
corporate governance and ownership concentration to modify the models. This allows for the
impact of these additional factors to be seen and tested.
Firm valuation and performance = f(RP transactions, Corporate governance, Ownership
concentration, Control variables) + Ɛ
… Model 3
Firm valuation and performance = f(Tunnelling RP transactions, Propping RP
transactions, Corporate governance, Ownership concentration, Control variables) + Ɛ
… Model 4
In the third set, corporate governance and ownership concentration are factors that may be
associated with RP transactions. The model is further refined to explain differences in the various
types of RP transactions.
Related party transactions (H1, H2, H3)
Corporate governance (H4, H5)
Firm valuation & performance
Ownership concentration (H4, H5)
52
RP transactions = f(Corporate governance, Ownership concentration, Control variables)
+ Ɛ
… Model 5
Tunnelling RP transactions, Propping RP transactions = f(Corporate governance,
Ownership concentration, Control variables) + Ɛ
… Model 6
These models allow for exploration of the extent of the impact of RP transactions on firm
valuation and performance, the subsequent effect of corporate governance and ownership
concentration, and also factors which might affect the extent of RP transactions themselves.
3.4 Model Specification and Operationalization of Variables From the hypotheses developed the conceptual framework and models above were established.
To enable testing of the conceptual framework and models above, it is necessary to define and
specify the variables and formula for testing. The various variables and their definitions are
outlined. These variables are then put together in various equations that reflect the theoretical
framework built up, to allow for testing this study’s hypotheses.
3.4.1 Tobin’s Q
Tobin’s Q is defined as the ratio of market value of the firm to the replacement cost of its assets
(Chung & Pruitt 1994, p. 70). In its original iteration, the formula requires complex and costly
calculations involving valuation of debt and adjustments for inflation. Various researchers have
devoted effort to finding alternative approximations of Tobin’s Q to overcome its complexities
and high computational costs (Perfect & Wiles 1994, p313.). Chung and Pruitt (1994) estimate
Tobin’s Q using a formula which is less intense in its requirements and therefore is more practical
in collection of data. Their simplified formula calculates the ratio of market value of the firm
against its book value which is assumed to proxy replacement cost (Chung & Pruitt 1994). This
formula was then tested and was found to significantly approximate the theoretically correct
formula (Chung & Pruitt 1994).
This study measures Tobin’s Q using this simplified measure, consistent with the definition laid
out by Chung & Pruitt (1994). The usage of this formula in corporate governance research is
consistent with prior research in relating specifically to RP transactions (Chen & Ho 2000; Chu
& Cheah 2004; Ryngaert & Thomas 2007; Kohlbeck & Mayhew 2010; Munir & Gul 2010; Liew
et al. 2011). Generally the usage of Tobin’s Q in corporate governance research in Malaysia is
well established by many prior works (Haniffa & Hudaib 2006; Mohamad Ariff 2007; Sulong &
Nor 2008; Amran & Ahmad 2009; Ghazali 2010; Ibrahim & Samad 2011; Amran & Ahmad
2011).
53
TOBINS_Qi,t = (Di,t + MVEi,t) ÷ Ai,t …(Equation 1)
Where D is total book value of debt, MVE is market value of equity and A is total book value of
assets.
Table 5 Definition of Tobin's Q Equation Variables
Variable Definition
D CURRENT_LIABILITIES_THOUSANDS + NON_CURRENT_LIABILITIES_THOUSANDS
MVE NUMBER_OF_SHARES x SHAREPRICE_CLOSE
A CURRENT_ASSETS_THOUSANDS + NON_CURRENT_ASSETS_THOUSANDS
This is further operationalized and calculated using the following definitions:
Table 6 Further Definitions of Tobin's Q Equation Variables
Variable Definition
CURRENT_ASSETS_THOUSANDS Audited current assets in RM thousands
CURRENT_LIABILITIES_THOUSANDS Audited current liabilities in RM thousands
NON_CURRENT_ASSETS_THOUSANDS Audited non-current assets in RM thousands
NON_CURRENT_LIABILITIES_THOUSANDS Audited non-current liabilities in RM thousands
NET_PROFIT_LOSS_TO_SHAREHOLDERS_THOUSANDS
Audited net profit to shareholders in RM thousands
NUMBER_OF_SHARES Number of shares as at financial year end
SHAREPRICE_CLOSE Share price (unadjusted) as at financial year end. Where not available the calendar year end price is taken.
3.4.2 Related Party Transactions This study tests multiple measures of RP transactions in line with various literature and prior
studies. Broadly, four (4) categories of metrics or proxies for RP transactions are outlined,
namely indicator variables, by ratio of number of transactions to board size, by ratio of total
amount by firm size, and by total dollar value. Within these four categories, twelve (12)
54
variables are defined, consistent with existing research into RP transactions and identified in the
prior chapter.
Table 7 Definition of RP Transaction Variables
Indicator Variables 1 RPT_INDICATOR Value is 1 if a firm discloses one or more RPT of any
type. Value is 0 if otherwise.
2 RP_INDICATOR_TUNNELING
Value is 1 if a firm discloses one or more RPT of Tunnelling type. Value is 0 if otherwise.
3 RP_INDICATOR_PROPPING
Value is 1 if a firm discloses one or more RPT of Propping type. Value is 0 if otherwise.
Ratio Of Number Of Transactions To Board Size 4 RP_TOTAL_COUNT_SC
ALED_BOARD Number of RPT scaled by board size. Calculated as: RPT_TOTAL_COUNT ÷ BOARD_SIZE
5 RPT_TUNNELLING_COUNT_SCALED_BOARD
Number of tunnelling transactions disclosed scaled by board size. Calculated as: RPT_TUNNELLING_COUNT ÷ BOARD_SIZE
6 RPT_PROPPING_COUNT_SCALED_BOARD
Number of propping transactions disclosed scaled by board size. Calculated as: RPT_PROPPING_COUNT ÷ BOARD_SIZE
Ratio Of Total Amount By Firm Size 7 RPT_TOTAL_SCALED_
ASSETS RPT Value Scaled by Assets. Calculated as: RPT_TOTAL_THOUSANDS ÷ (CURRENT_ASSETS_THOUSANDS + NON_CURRENT_ASSETS_THOUSANDS)
8 RPT_TUNNELLING_THOUSANDS_SCALED_ ASSETS
RPT Tunnelling Value only Scaled by Assets. Calculated as: RPT_TUNNELLING_THOUSANDS ÷ (CURRENT_ASSETS_THOUSANDS + NON_CURRENT_ASSETS_THOUSANDS)
9 RPT_PROPPING_THOUSANDS_SCALED_ ASSETS
RPT Propping Value only Scaled by Assets. Calculated as:
55
RPT_PROPPING_THOUSANDS ÷ (CURRENT_ASSETS_THOUSANDS + NON_CURRENT_ASSETS_THOUSANDS)
Total Dollar Value 10 RPT_LN_TOTAL Natural log of value of total RPT.
Calculated as: ln (RPT_TOTAL_THOUSANDS)
11 RPT_LN_TUNNELLING Natural log of value of tunnelling RPT. Calculated as: ln (RPT_TUNNELLING_THOUSANDS)
12 RPT_LN_PROPPING Natural log of value of propping RPT. Calculated as: ln (RPT_PROPPING_THOUSANDS)
The variables used in the calculations above are further defined and operationalized below:
Table 8 Further Definitions of RP Transaction Variables
RPT_TUNNELLING_THOUSANDS
Value of significant related party transactions and recurrent related party transactions as disclosed in RM thousands.
Any transaction with related party of director.
Any transaction with related party of individual largest shareholder where firm is family owned.
RPT_TUNNELLING_COUNT Number of tunnelling transactions disclosed, where tunnelling transactions are:
Any transaction with related party of director.
Any transaction with related party of individual largest shareholder where firm is family owned.
RPT_PROPPING_THOUSANDS Value of significant related party transactions and recurrent related party transactions as disclosed in RM thousands.
Any transaction with related party where largest shareholder is institution owned.
Any transaction with associates, joint ventures, jointly-controlled entities, as long as not related to a director.
RPT_PROPPING_COUNT Number of propping transactions disclosed, where propping transactions are:
Any transaction with related party where largest shareholder is institution owned.
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Any transaction with associates, joint ventures, jointly-controlled entities, as long as not related to director.
RPT_TOTAL_THOUSANDS Total RPT_TUNNELLING_THOUSANDS + RPT_PROPPING_THOUSANDS
RPT_TOTAL_COUNT Total count RPT_TUNNELLING_COUNT + RPT_PROPPING_COUNT
Three indicator variables for RP transactions are tested. The indicator variables take a value of 1
if a firm discloses RP transactions, and 0 if otherwise. Prior research has used indicator variables
to mark the mere presence of RP transactions (Kohlbeck & Mayhew 2004; Kohlbeck & Mayhew
2010, p.115), which is reflected in this study’s Total RP transactions indicator variable. Separate
indicator variables for tunnelling RP transactions (Kohlbeck & Mayhew 2004; Kohlbeck &
Mayhew 2010, p.115; Ge et al. 2010, p.134) and propping RP transactions (Kohlbeck & Mayhew
2004; Kohlbeck & Mayhew 2010, p.115; Ge et al. 2010, p.134) are also defined.
Three variables representing the ratio of number of RP transactions to board size are tested.
Scaling the total number of RP transactions by the number of directors gives an indication of the
pervasiveness of RP transactions. Prior studies have tested total RP transactions scaled by board
size (Gordon et al. 2004a, p.11; Gordon et al. 2004b, p.36; Wahab et al. 2011, p.132), as well as
differentiating different RP transactions. Total tunnelling RP transactions scaled by board size
(Gordon et al. 2004a, p.11; Gordon et al. 2004b, p.36; Wahab et al. 2011, p.132), Total propping
RP transactions scaled by board size (Gordon et al. 2004a, p.11; Gordon et al. 2004b, p.36; Wahab
et al. 2011, p.132).
Three variables for the ratio of total RP transaction amount scaled by firm size are tested. Extant
literature has evidence for using this measure in determining the relative importance of RP
transactions, as tested by total RP transactions scaled by assets (Gallery et al. 2008, p.155; Munir
& Gul 2010, p.2; Wahab et al. 2011, p.131). Variables for testing the different total tunnelling RP
transactions scaled by assets (Gallery et al. 2008, p.155; Wahab et al. 2011, p.131) and total
propping RP transactions scaled by assets (Wahab et al. 2011, p.131) are also in line with the
literature.
Finally three variables for the total dollar value are tested. Prior studies have utilized the natural
log of total RP transactions (Gordon et al. 2004b, p.36; Ryngaert & Thomas 2007, p.6; Hu et al.
2012, p.63), as well as the natural log of tunnelling RP transactions (Gordon et al. 2004b, p.36;
Ryngaert & Thomas 2007, p.6; Hu et al. 2012, p.63) and natural log of propping RP transactions
(Gordon et al. 2004b, p.36; Ryngaert & Thomas 2007, p.6; Hu et al. 2012, p.63).
57
To clearly illustrate the specification of the classification of Tunnelling and propping RP
transactions, a variety of common scenarios observed in this study are detailed here.
Table 9 Examples of Tunnelling and Propping RP Transactions
Tunnelling Propping
Largest shareholder is family
RP transaction is with director (regardless
related or unrelated to largest shareholder)
Largest shareholder is family
RP transaction is with associates, joint
ventures, jointly-controlled entities, not
related to a director
Largest shareholder is institution
RP transaction is with director (regardless
related or unrelated to largest shareholder)
Largest shareholder is institution
RP transaction is with associates, joint
ventures, jointly-controlled entities, not
related to a director
Largest shareholder is family
RP transaction is with shareholder
Largest shareholder is institution
RP transaction is with shareholder
It should be noted that these measures are assumed to be approximations of the economic loss or
gain via RP transactions. The actual economic loss or gains are very difficult to quantify. For
example, if a company purchases goods from a related party for RM1 million, that value is not
the actual economic loss or gain. The company may have overpaid for it by 10%, which is
RM100,000. This RM100,000 would then be the actual economic loss to the company. However,
it is not feasible to measure this, and such information would not be readily available.
3.4.3 RP Transactions and Firm Valuation In testing for firm performance and valuation we use the following formula:
TOBINS_Qi,t = β0 + β1RPT + β2DEBT_ASSET_RATIO + β3LNASSETS + β4FBMKLCI +
Ɛi,t …(Equation 2)
The variable RPT is a vector that defined as twelve (12) separate variables, as outlined in the
previous section. The variables for total RP transactions are each tested separately, whereas the
variables for tunnelling and propping RP transactions are tested together. This study controls for
the firm’s financial risk as defined by the debt to asset ratio (DEBT_ASSET_RATIO), the size of
the company, represented by the assets of the company (LNASSETS), and whether the company
was selected to be a component member of the stock exchange’s indicator index (FBMKLCI).
The details of the control variables are addressed in a subsequent section of this study.
3.4.4 Corporate Governance, Ownership Concentration and RP Transactions
This study then tests the firm performance and valuation after controlling for ownership
concentration and corporate governance:
58
TOBINS_Qi,t = β0 + β1RPT + β2DEBT_ASSET_RATIO + β3LNASSETS + β4FBMKLCI + β5PERCNTG_HELD_BY_LARGEST_SHAREHOLDER + β6IND_SHAREHOLDER_DIRECTOR + β7BOARD_SIZE + β8BOARD_INDEPENDENCE + β9DUALITY + β10BIG4_AUDITOR + Ɛi,t …(Equation 3)
Table 10 Definition of Corporate Governance and Ownership Concentration Variables
PERCNTG_HELD_BY_LARGEST_SHAREHOLDER
Percentage of shares held by the largest shareholder including both direct and indirect interests.
IND_SHAREHOLDER_DIRECTOR
Value is 1 if the largest shareholder is an individual that sits on the board of directors.
Value is 0 if otherwise.
BOARD_SIZE Number of directors at date of annual report for the financial year end.
Alternate directors are not counted, as they are deemed to be replacements in the absence of the nominated director.
BOARD_INDEPENDENCE Number of independent directors divided by BOARD_SIZE
DUALITY Value is 1 if Chairman and CEO is same person.
Value is 0 if otherwise.
Where no Chairman disclosed, the assumption is that it is not the same person.
BIG4_AUDITOR Value is 1 if auditor for financial year end is “Big 4” auditor; PwC, EY, Deloitte, KPMG.
Value is 0 if otherwise.
PERCNTG_HELD_BY_LARGEST_SHAREHOLDER and
IND_SHAREHOLDER_DIRECTOR are variables used in prior studies as proxies of ownership
concentration and family ownership (Kohlbeck & Mayhew 2004; Kohlbeck & Mayhew 2010;
Wahab et al. 2011). Such studies have been carried out in Malaysia by researchers (Haniffa &
Hudaib 2006; Tam & Tan 2007; Sulong & Nor 2008; Ghazali 2010).
BOARD_SIZE has been an important corporate governance variable examined in international
studies (Gordon et al. 2004b; Kohlbeck & Mayhew 2004; Kohlbeck & Mayhew 2010; Wahab et
al. 2011) and also by Malaysian researchers (Haniffa & Hudaib 2006; Sulong & Nor 2008; Amran
& Ahmad 2009; Ghazali 2010; Ibrahim & Samad 2011; Amran & Ahmad 2011).
59
BOARD_INDEPENDENCE is also another critical corporate governance variable studies
extensively by international studies (Gordon et al. 2004b, Kohlbeck & Mayhew 2004, Gallery et
al. 2008, Kohlbeck & Mayhew 2010, Munir & Gul 2010, Wahab et al. 2011, Hu et al. 2012) as
well as in the extant local literature on corporate governance (Abdullah 2004, Haniffa & Hudaib
2006, Sulong & Nor 2008, Amran & Ahmad 2009, Ghazali 2010, Ibrahim & Samad 2011, Amran
& Ahmad 2011).
DUALITY has been researched internationally (Gordon et al. 2004b; Kohlbeck & Mayhew 2004;
Munir & Gul 2010; Kohlbeck & Mayhew 2010; Wahab et al. 2011) and has also been covered
in Malaysian research into corporate governance (Abdullah 2004; Haniffa & Hudaib 2006; Tam
& Tan 2007; Sulong & Nor 2008; Amran & Ahmad 2009; Ghazali 2010; Ibrahim & Samad 2011;
Amran & Ahmad 2011).
BIG4_AUDITOR as a proxy for audit quality being an external corporate governance mechanism
has been studied by various researchers (Gallery et al. 2008; Munir & Gul 2010; Wahab et al.
2011).
3.4.5 RP transactions and Firm Performance
This study also tests for the effects of RP transaction on firm performance. To achieve this, the
models presented in Equation 2 and 3 are replicated, but the dependent variable is replaced with
returns on assets (ROA) rather than Tobin’s Q. ROA is a proxy of firm performance and has been
tested extensively by other researchers (Haniffa & Hudaib 2006; Gallery et al. 2008; Munir &
Gul 2010; Wahab et al. 2011).
ROAi,t = β0 + β1RPT + β2DEBT_ASSET_RATIO + β3LNASSETS + β4FBMKLCI + Ɛi,t
…(Equation 4)
ROAi,t = β0 + β1RPT + β2DEBT_ASSET_RATIO + β3LNASSETS + β4FBMKLCI + β5PERCNTG_HELD_BY_LARGEST_SHAREHOLDER + β6IND_SHAREHOLDER_DIRECTOR + β7BOARD_SIZE + β8BOARD_INDEPENDENCE + β9DUALITY + β10BIG4_AUDITOR + Ɛi,t …(Equation 5)
Table 11 Definition of Return on Assets
ROA
NET_PROFIT_LOSS_TO_SHAREHOLDERS_THOUSANDS ÷ (CURRENT_ASSETS_THOUSANDS + NON_CURRENT_ASSETS_THOUSANDS)
3.4.6 Factors Associated with RP Transactions It is also possible that any relationship between RP transactions in their various forms and the
firm’s valuation and return are a symptom rather than a cause (Kohlbeck & Mayhew 2010, p 130).
The decision to engage in RP transactions may actually be associated with other factors that
60
themselves lead to lower valuations or returns resulting in an endogeneity bias in this study
(Kohlbeck & Mayhew 2010). To test this the following model incorporating corporate
governance factors and ownership concentration is tested to see the impact such factors have on
the presence of RP transaction in totality and in Tunnelling and propping RP transactions.
RPTi,t= β1DEBT_ASSET_RATIO + β2LNASSETS + β3FBMKLCI + β4PERCNTG_HELD_BY_LARGEST_SHAREHOLDER + β5IND_SHAREHOLDER_DIRECTOR + β6BOARD_SIZE + β7BOARD_INDEPENDENCE + β8DUALITY + β9BIG4_AUDITOR + Ɛi,t …(Equation 6)
3.4.7 Control Variables In all models we control for the following variables.
Table 12 Defintion of Control Variables
DEBT_ASSET_RATIO Total non-current liabilities divided by total assets.
Calculated as:
NON_CURRENT_ASSETS_THOUSANDS÷ (CURRENT_ASSETS_THOUSANDS + NON_CURRENT_ASSETS_THOUSANDS)
LNASSETS Natural logarithm of company’s total assets.
Calculated as:
ln (CURRENT_ASSETS_THOUSANDS + NON_CURRENT_ASSETS_THOUSANDS)
FBMKLCI Indicator variable. If Company was a component stock of the FBMKLCI Index as at 12 October 2015, the date of sample selection, value is 1. Value is 0 if otherwise.
http://www.ftse.com/products/indices/bursa-malaysia
DEBT_ASSET_RATIO represents leverage and is controlled for in prior RP transactions research
(Gordon et al. 2004b; Haniffa & Hudaib 2006; Kohlbeck & Mayhew 2010; Munir & Gul 2010;
Wahab et al. 2011; Juliarto 2012; Hu et al. 2012; Tam & Tan 2007; Amran & Ahmad 2009).
LNASSETS proxies for firm size and is tested extensively as a control variable in the extant
literature on RP transactions internationally (Gordon et al. 2004b; Kohlbeck & Mayhew 2004;
Ryngaert & Thomas 2007; Gallery et al. 2008; Munir & Gul 2010; Kohlbeck & Mayhew 2010;
Juliarto 2012; Hu et al. 2012) and also in Malaysia (Amran & Ahmad 2009; Ibrahim & Samad
2011).
61
FBMKLCI as a proxy for a firm’s inclusion in a market index is controlled for. In prior studies
(Gallery et al. 2008; Kohlbeck & Mayhew 2010) the membership of a firm in an index such as
the S&P500 (United States) or ASX500 (Australia) was controlled for. This was based on earlier
work by Gompers et al. (2003), who found that index membership had predictive association with
firm value. Bringing this to a Malaysian context, this study has chosen membership of the FTSE
Bursa Malaysia KLCI index as a proxy for index membership. The FTSE Bursa Malaysia KLCI
index was selected as it is the “the headline index of the FTSE Bursa Malaysia Index series”
(FTSE Russel 2009), thus making it the closest local equivalent to other representative indexes
such as the S&P500 or the ASX500.
3.5 Secondary Data and Quantitative Methods This study utilises quantitative methods based on multiple regression of secondary data. The
quantitative analyses is involved to test the hypotheses outlined and developed in the previous
chapter. Usage of secondary data is justified and is a widely accepted practice in the field of RP
transactions research and corporate governance in general (Gordon et al. 2004a; Gordon et al.
2004b; Kohlbeck & Mayhew 2004; Cheung et al. 2006; Kohlbeck & Mayhew 2010 ; Munir &
Gul 2010; Wahab et al. 2011; Juliarto 2012; Hu et al. 2012; Tam & Tan 2007; Amran & Ahmad
2009).
The usage of primary data by way of expert interviews, case studies or observations is not possible
for this study. The confidential nature of a company’s transactions, in particular RP transactions,
as well as the commercial consideration of any such transaction precludes such an approach
(Williams 2014). Even if such primary data could be collected, it would likely be restricted in
nature and subject to a high degree of biasness (Williams 2014).
3.6 Sample Selection This study starts with all securities listed as at 12 October 2015 under the Trading sector of the
Bursa Malaysia stock market, as extracted from the published list by Bursa Malaysia. As large
segments of data for this study are collected by hand, the cost to collect data for more years or
over a more sectors would have been excessive, a view adopted by Kohlbeck & Mayhew (2010)
also.
The Trading sector of Bursa Malaysia was selected over other sectors (e.g. Property, Finance) by
this study for the following reasons. Firstly, this sector has the largest market capitalization by far
when compared to any other sector. For example, for the samples from the year 2014, the market
capitalization of the Trading sector was approximately RM647 billion at year end. This accounts
for almost 40% of the total market capitalization of Bursa Malaysia, which was approximately
RM1,651 billion at the end of 2014 (Securities Commission Malaysia 2016). The selection of the
62
Trading sector as the sample represents the best balance between achieving significant coverage
of the total market and limiting the costs of data collection.
Secondly, within the Trading sector itself, a wide variety of businesses are represented. These
include trading houses, education, retail, food and beverage, logistics, engineering firms,
professional services, oil and gas, media, automotive firms, shipping, gaming, and
telecommunications. The diverse range of businesses undertaken by firms within the Trading
sector allows for this study to take a good cross-section of related party transactions performed
by various companies.
Thirdly, these firms are not separately regulated. This is unlike financial firms such as banks or
insurers, which have additional oversight from the central bank. The central bank, Bank Negara
Malaysia imposes additional regulations and prohibitions on related party transactions (Bank
Negara Malaysia 2014). Such regulations may artificially distort the level of related party
transaction undertaken by an entity.
The Trading sector of Bursa Malaysia had 231 securities as at 12 October 2015. Of these, this
study eliminates 44 securities which are actually traded call or put warrants. These securities are
options or derivatives and do not represent underlying equity interest in the firm.
This study then observes three (3) years of data from the remaining sample of 187 companies.
There was no requirement that firms be listed continuously within these 3 years, similar to Cheung
et al. (2006). Out of these observations, 30 observations are further excluded due to unavailability
of data. The reasons for unavailability of data include lack of financial reports due to suspension
and corporate restructuring and newly listed companies in 2015 and 2014 which do not have
previously published annual reports. Although financial statements are available for newly listed
companies through prospectus information, this study has chosen to eliminate these from the
sample. The reason is that prior to listing on the stock exchange, there is no market valuation and
also scant corporate governance information.
Table 13 Summary of Companies Selected for Data
Total number of listed securities under Trading Sector @ 12 October 2015
231
Less: Call warrants other non-ordinary equity securities (44) 187 Three (3) years of observations 561 Less: No data due to being newly listed/corporate exercise/de-listed (30) Final sample of total observations 531
63
3.7 Data Source Both financial and non-financial data was required to test the hypotheses. Data for each of the
531 observations was drawn from two sources. For financial information such as accounting book
values the data is published in either the firm’s annual audited accounts or its annual report. The
accounting figures that this study used are the audited figures, and not the unaudited results
published by the management of the company. To expedite collation of the accounting
information, a commercial financial investment database, EquitiesTracker, was used. The
database is an investment portfolio system that requires a subscription. Within this database, the
necessary audited accounting information for each of the observations is summarized in table
form and was duly extracted. For the RP transactions, corporate governance, and ownership
concentration data, the respective annual reports of the individual companies were downloaded
from the Bursa Malaysia repository. The requisite information was then extracted by hand and
populated into a spreadsheet. The RP transactions within each annual report was discovered using
a textual search of each report. Typically the disclosure was under the notes to the accounts, and
would contain information as to the number of transactions, quantum of transactions, and
contracting related party. All financial information was disclosed in Ringgit Malaysia (RM). In
the rare cases where the financial information was not presented in RM, for example Media
Chinese International Ltd has its presentation currency in United States Dollars, the numbers were
converted into RM at the prevailing Bank Negara Malaysia exchange rates.
Corporate governance information was extracted from the front portion of each annual report,
which would normally contain a summary of corporate information. This would summarize the
names of directors, i.e. the size of the board, and also their respective positions, which would be
independent, executive, and/or chairman. It would also list the name of the auditor, which was
then used to determine if the auditor was a “Big 4” auditor.
The number of shares was also extracted from the individual firms’ annual reports under the
shareholding section. This would give the number of shares issued as at the date of the annual
report. Information on ownership concentration would also be available in this section. The names
of the top 20 largest shareholders is disclosed in the same section and is used to determine the
identity of the largest owner, as well as the level of ownership concentration. If the company is
owned by the directors, this is disclosed as director’s shareholding also.
Finally the share price at the financial year end of each observation is extracted from the
EquitiesTracker database, which has historical prices of all the securities in this study’s sample.
We use the unadjusted share price. The unadjusted share price represents the actual share price
64
being traded, and incorporates market driven adjustments due to share splits, share consolidations,
bonus issues and rights issues.
3.8 Summary This chapter has outlined the theoretical framework used by this study as well as the general
formulae used to test the hypotheses developed in the previous chapter. This is followed by the
detailed specification of each model, as well as the definition and operationalization of each
variable. References to prior studies utilizing all such variables are explained for each individual
variable. To assist future researchers, the practical aspects of data collection and variable
definition with relation to RP transactions is documented. This includes detailed documentation
on data extraction, and handling errors and non-standard observations. To this end this study has
clearly defined the exact data parameters used for each variable, traceable to the secondary data
utilised. The remaining sections deal with the usage of secondary data and the reasons for doing
so. This chapter then concludes with the process of the sample selection for this study.
65
4 Descriptive Statistics
4.1 Introduction This chapter contains descriptive analysis of the variables being tested. The numbers are
compared to prior studies from Malaysia. An in-depth look at RP transaction is also performed,
contributing to the body of knowledge on RP transactions in Malaysia and providing descriptive
statistics for such transactions. The following section then outlines some issues encountered
during data collection and analysis. This serves to document such issues and their resolution for
future researchers looking into this area. The practical aspects of data collection are explained in
details as this was a feature missing from much of prior research, especially in Malaysia. Finally
the chapter ends with tests for multicollinearity via a Pearson’s coefficient matrix.
4.2 Variable Means, Medians, Standard deviation
Table 14 Descriptive Statistics for All Variables
n= Mean Median
Std.
Deviati
on
Minim
um
Maxim
um
TOBINS_Q 531 1.3552 0.9688 1.3994 0.2216 15.733
9
ROA 531 0.0357 0.0431 0.3859 -5.5438 6.4949
RP_INDICATOR 531 0.8399 1.0000 0.3670 0.0000 1.0000
RP_INDICATOR_TUNNELIN
G 531 0.6648 1.0000 0.4725 0.0000 1.0000
RP_INDICATOR_PROPPING 531 0.4670 0.0000 0.4994 0.0000 1.0000
RPT_TOTAL_COUNT_SCAL
ED_BOARD 531 1.3254 0.6250 2.4773 0.0000
28.333
3
RPT_TUNNELLING_COUNT
_SCALED_BOARD 531 0.9531 0.2857 2.2378 0.0000
22.111
1
RPT_PROPPING_COUNT_SC
ALED_BOARD 531 0.3723 0.0000 0.7212 0.0000 6.2222
RPT_TOTAL_SCALED_ASSE
TS 531 0.1021 0.0137 0.3528 0.0000 3.9776
RPT_TUNNELLING_THOUS
ANDS_SCALED_ASSETS 531 0.0329 0.0031 0.1082 0.0000 1.1614
66
(contd.) n= Mean Median
Std.
Deviati
on
Minim
um
Maxim
um
RPT_PROPPING_THOUSAN
DS_SCALED_ASSETS 531 0.0691 0.0000 0.3294 0.0000 3.9776
RPT_LN_TUNNELLING 353 8.7352 8.8622 2.2937 0.6931 14.277
4
RPT_LN_PROPPING 248 9.9297 10.342
9 3.2340 0.0000
17.451
7
RPT_LN_TOTAL 446 9.7098 9.5898 2.8025 0.0000 17.451
7
PERCNTG_HELD_BY_LARG
EST_SHAREHOLDER 531 0.3935 0.3756 0.1670 0.0368 0.7880
IND_SHAREHOLDER_DIRE
CTOR 531 0.6290 1.0000 0.4835 0.0000 1.0000
BOARD_SIZE 531 7.6930 7.0000 2.0963 4.0000 15.000
0
BOARD_INDEPENDENCE 531 0.4770 0.4545 0.1226 0.2500 0.8333
DUALITY 531 0.1111 0.0000 0.3146 0.0000 1.0000
BIG4_AUDITOR 531 0.5556 1.0000 0.4974 0.0000 1.0000
DEBT_ASSET_RATIO 531 0.1333 0.0958 0.1401 0.0000 0.8097
LNASSETS 531 13.332
9
13.007
0 1.7761 8.9077
18.522
0
FBMKLCI 531 0.0716 0.0000 0.2580 0.0000 1.0000 Variables are defined as follows: Tobin's Q = an approximation of Tobin’s Q from Equation 1; RP_INDICATOR = value is 1 if a firm discloses one or more RPT of any type, value is 0 if otherwise; RP_INDICATOR_TUNNELING = value is 1 if a firm discloses one or more RPT of tunnelling type, value is 0 if otherwise; RP_INDICATOR_PROPPING = value is 1 if a firm discloses one or more RPT of propping type, value is 0 if otherwise; RP_TOTAL_COUNT_SCALED_BOARD = number of RPT scaled by board size; RPT_TUNNELLING_COUNT_SCALED_BOARD = number of tunnelling transactions disclosed scaled by board size; RPT_PROPPING_COUNT_SCALED_BOARD = number of propping transactions disclosed scaled by board size; RPT_TOTAL_SCALED_ASSETS = RPT value scaled by assets; RPT_TUNNELLING_THOUSANDS_SCALED_ ASSETS = RPT tunnelling value only scaled by assets; RPT_PROPPING_THOUSANDS_SCALED_ ASSETS = RPT propping value only scaled by assets; RPT_LN_TOTAL = natural log of value of total RPT; RPT_LN_TUNNELLING = natural log of value of tunnelling RPT; RPT_LN_PROPPING = natural log of value of propping RPT; PERCNTG_HELD_BY_LARGEST_SHAREHOLDER = percentage of shares held by the largest shareholder including both direct and indirect interests; IND_SHAREHOLDER_DIRECTOR = value is 1 if the largest shareholder is an individual that sits on the board of directors, value is 0 if otherwise; BOARD_SIZE = number of directors at date of annual report for the financial year end; BOARD_INDEPENDENCE = Number of independent directors divided by total directors; DUALITY = value is 1 if Chairman and CEO is same person, value is 0 if otherwise; BIG4_AUDITOR = value is 1 if auditor for financial year end is “Big 4” auditor, Value is 0 if otherwise; DEBT_ASSET_RATIO = Total non-current liabilities divided by total assets; LNASSETS = natural logarithm of company’s total assets; FBMKLCI = value is 1 if company was a component stock of the FBMKLCI Index, value is 0 if otherwise.
67
The table above details the descriptive statistics of all variables being tested by this study. Of note
were the following. In terms of the dependant variable, the mean Tobin’s Q was 1.36, indicating
an overall premium of market value to book value. Sulong and Noor (2008, p.80) report a mean
Tobin’s Q of 1.46 and 1.66 in 2002 and 2005 respectively. Tam and Tan (2007) report a mean
Tobin’s Q value of 0.98 based on a sample of 150 companies from Malaysia over the year 2000
and 2001 period. Return on assets (ROA) had a mean of 3.57%. This compares to a mean of 6.4%-
6.8% over the 1994 to 1996 period (Amran 2004, p.55), 15.0% over the 1994 to 2000 period (Tam
& Tan (2007, p.214) and 3.2% over the 1999 to 2005 period (Ibrahim & Samad 2011, p.113).
For internal governance variables, the observations were fairly consistent with prior Malaysian
research. The mean board of directors had 7.693 directors, with the smallest board having 4
directors, and the largest having 15. The median number of directors was 7.000. Wahab et al.
(2011, p.149) with n=448 over the year 2005 to 2007 period reported an average board size of
5.975 with a median of 6.000. It is also in line with Amran (2004, p.55), who reported an average
of 7.66 to 7.78 board members over the 1994 to 1996 period. The mean percentage of board
members who were independent was 47.70%. This is an increase from Wahab et al.’s (2011,
p.149) observation of 33.7%, and Amran and Ahmad’s (2001, p.21) reported mean of 36%,
indicating higher independence in the overall sample within the board. For duality, 11.11% of
firms reported having both the position of chairman and CEO being held by the same individual.
This is in line with a general decreasing trend over the years. This is a marked decrease from
Wahab et al.’s (2011, p.149) observation of 57.8% for duality in 2005 to 2007, Sulong and Noor
(2008) who report duality at 68% and 69% for 2002 and 2005 respectively, and Amran (2004,
p.55) which reported figures of between 77.6% to 79.8% from 1994 to 1996. This study believes
this can be attributed to clauses within the Malaysian Code if Corporate Governance which
identifies duality as not being a best practice. It may also be evidence of a general improvement
in corporate governance practices in Malaysia.
External governance measures are the audit quality and also ownership concentration. 55.56% of
firms used a Big 4 auditor. This is also largely the same as Wahab et al.’s (2011, p.149) report of
55.80% over the year 2005 to 2007 period. In terms of ownership concentration, the mean
percentage held by the single largest shareholders in the sample was 39.35%, with a median of
37.56%. This is lower than the figure reported by Tam and Tan (2007) which had a median
ownership concentration of 43.00%.
68
Table 15 Descriptive Statistics for RP transactions
n= Mean Median
Std.
Deviation Minimum Maximum
RPT_TOTAL_THO
USANDS 446
467,096.1
3 14,614.50
3,023,666
.13 1.00
37,948,32
8.00
RPT_TUNNELLIN
G_THOUSANDS 353 50,998.30 7,060.00
153,225.3
5 2.00
1,587,002
.00
RPT_PROPPING_T
HOUSANDS 248
767,429.3
4 31,065.50
4,026,522
.11 1.00
37,948,32
8.00
RPT_TOTAL_COU
NT 446 12.2915 6.0000 22.3894 1.0000 255.0000
RPT_TUNNELLIN
G_COUNT 353 11.0283 4.0000 22.3579 1.0000 199.0000
RPT_PROPPING_C
OUNT 248 6.4073 4.0000 6.8901 1.0000 56.0000
Within the sample, in 446 out of 531 observations firms disclosed RP transactions. Tunnelling
RP transactions were found in 353 instances, and propping RP transactions in 248 instances.
Tunnelling and propping RP transactions are not mutually exclusive, and it is possible for a firm
to have either one or both in the observation. The high count number of RP transactions in total
indicates the pervasiveness of RP transactions among listed firms in Malaysia.
Table 16 Descriptive Statistics on RP Transaction Disclosure
Percentage of firms
disclosing one or
more RP transaction
RPT_TOTAL_COUNT 83.99%
RPT_TUNNELLING_COUNT 66.48%
RPT_PROPPING_COUNT 46.70%
Among firms that disclosed RP transactions, the mean number of transactions was 12.29, with a
median of 6.00. The minimum number of RP transactions was 1, and the highest observed was
255. For tunnelling RP transactions, the mean number of transactions was 11.03, with a median
of 4.00. The minimum was 1, and the maximum was 199. For propping transactions, the mean
69
number of transactions was lower at 6.41, with the same median of 4.00. The minimum was 1,
and the maximum was 56.
In terms of the dollar value of RP transactions disclosed, the average RP transactions was
RM467,096,130. The median transaction was RM14,614,500. The smallest transactions was
RM1,000 and the largest transaction was RM37,948,328,000. This maximum figure of over thirty
seven billion ringgit is attributed to RP transactions between government owned companies and
the government. When the different types of RP transactions are examined, tunnelling RP
transactions had a mean of RM50,998,300, with a median of RM7,060,000. The smallest
transaction was RM2,000 and the largest was RM1,587,002,000. For propping RP transactions,
the mean was RM767,429,340, with a higher median of RM31,065,500. The minimum was
RM1,000, and the maximum was RM37,948,328,000.
Table 17 Descriptive Statistics on Value of RP Transactions
Total Value of Transactions
2012
(RM ‘000)
2013
(RM ‘000)
2014
(RM ‘000)
Total
(RM ‘000)
RPT_TOTAL_THOUSANDS 71,016,998 65,328,757 71,979,120 208,324,875
RPT_TUNNELLING_THOUS
ANDS 5,875,589 5,718,277 6,408,532 18,002,398
RPT_PROPPING_THOUSAND
S 65,141,409 59,610,480 65,570,588 190,322,477
In terms of total value of transactions, this study observer that although there were fewer propping
RP transactions, the value of these transactions far exceeded the value of tunnelling RP
transactions. The total value of RP transactions over the 3 years from 2012 to 2014 was
approximately RM208.32 billion, and this from only the Trading sector of firms listed on Bursa
Malaysia. This is contrasted with a value of RM65.2 billion observed over the 2005 to 2007 period
by Wahab et al. (2011) in the Malaysian market.
4.3 Issue Encountered During Data Collection In the course of the collection of the data and observations from the various annual reports, several
issues were encountered and were resolved satisfactorily.
The identity of the largest shareholder is a key differentiator of the various types of RP
transactions in this study. Therefore having correct disclosure of the largest shareholder is
paramount. This study observed the use of trustees and foundations to obscure directors’
shareholding. An example of this would be the Genting Bhd and Genting Malaysia Bhd whereby
70
a trustee foundation is the ultimate largest shareholder. The result of this is that although the
family members of the founding family are directors on the board, they are not disclosed as having
an interest in the company as they are not deemed interested in the foundation. This obscures the
true nature of the shareholding, and where this scenario was observed this study treated such
observations as family owned, based on other publicly available documents regarding the nature
and beneficiaries of the trust.
Another scenario encountered was where the largest shareholder was an individual with a large
corporate group or in common parlance, a tycoon. Such an individual would have multiple listed
companies and firms. Examples of this are Tan Sri Syed Mokhtar Al-Bukhary and Tan Sri Dato’
Sri Vincent Tan, who each personally control multiple listed entities. How should RP transactions
with each listed entity be treated? These individuals may not on a day-to-day basis be involved in
the RP transactions, and in fact due to the sheer size of the businesses they oversee, it is quite
likely that strong internal controls and policies are in place to prevent expropriation. This study
takes the view that although this may very well be the case, nonetheless these individuals are the
beneficiaries ahead of minority shareholders of the various entities they control by virtue of their
high ownership concentration level. Therefore these firms are treated as family owned, and any
RP transaction with related parties that are under related ownership are classified as tunnelling.
Consistent with our earlier classification, transactions that are with associates, joint ventures,
jointly-controlled entities, as long as not related to a director, are classified as propping.
In a similar example, the owners of Shin Yang Shipping obtained an exemption from the
Companies Commission of Malaysia for the disclosure of direct shareholdings in the firm. The
reason and purpose of such an exemption was not disclosed. The effect of this exemption was to
obscure the ultimate shareholding of directors. Based on publicly available information, this study
thus treats the firm as family owned.
Continuing on the issue of ownership identity, several political parties in Malaysia wield
significant business influence. In particular, media firms such as The Star and Utusan Malaysia
are owned by established political parties. Such political parties are controlled by their members,
rather than a single dominant owner. In view of the nature of such ownership, this study treats
such owners as institutions, and RP transaction are classified accordingly based on this.
In several other cases, there were various discrepancies encountered with regard to shareholding
percentages, and differences in RP transactions disclosed from one year to the next. For example,
each annual report requires two years, the current year and the prior year’s financial information,
to be disclosed. However, there were instances in which the previous year’s disclosure did not
agree to the current year’s disclosure. These discrepancies may be due to reclassification of
figures or corrections of material misstatements in the prior year’s financial statements.
71
Table 18 Example of Variations in RP Transaction Disclosure
2015 Annual Report
Related party disclosure 2015: RM240,000 2014: RM300,000
2014 Annual Report
Related party disclosure 2014: RM276,000 2013: RM120,000
As illustrated in the example above the 2014 disclosure in the 2015 Annual Report is RM300,000.
However in the 2014 Annual Report, the amount disclosed for 2014 was only RM276,000. Where
this scenario was encountered, the disclosure from the newest report was used, i.e. RM300,000
for 2014.
4.4 Correlation and Multicollinearity A Pearson’s correlation matrix is computed for all independent variables to test for
multicollinearity. A general guide and rule-of-thumb adopted by Rahmat (2013) and Williams
(2014) based on work by Farrar and Glauber (1967) and Pallant (2007) is that multicollinearity
does not become an issue until the correlation co-efficient reaches approximately 0.7 to 0.8. Based
on the Pearson’s correlation matrix, there were several coefficients of correlation that exceeded
this rule. The highest correlation was between
RPT_TUNNELLING_COUNT_SCALED_BOARD and
RPT_TOTAL_COUNT_SCALED_BOARD with a coefficient of 0.958. This was followed by
the correlation between RPT_PROPPING_THOUSANDS_SCALED_ASSETS and
RPT_TOTAL_SCALED_ASSETS (coefficient 0.952) and RPT_LN_TOTAL and
RPT_LN_PROPPING (coefficient 0.896) and finally RPT_LN_TOTAL and
RPT_LN_TUNNELLING (coefficient 0.822). The high correlation between these variables is
expected as they are all representative of RP transactions. A high correlation is therefore expected
as they are each based on the same raw data, which is the disclosure of RP transactions.
Additionally, although these variables correlate with each other, it should be noted that they are
each tested separately in each of the models that are utilized in the multiple regression. If the
correlations between independent variables associated with RP transactions are excluded, there
were no other high correlations to be found among the independent variables. All other
correlations were less than 0.7, and this can be interpreted to indicate that multicollinearity is not
a problem in subsequent regression analysis.
72
Table 19 Pearson's Correlation Matrix
RP_
IND
ICA
TOR
RP_
IND
ICA
TOR_
TUN
NE
LIN
G
RP_
IND
ICA
TOR_
PRO
PPI
NG
R
PT_T
OTA
L_C
OU
NT_
SC
ALE
D_B
OA
RD
R
PT_T
UN
NEL
LIN
G_C
OU
NT_
SCA
LED
_BO
AR
D
RPT
_PR
OPP
ING
_CO
UN
T_
SCA
LED
_BO
AR
D
RPT
_TO
TAL_
SCA
LED
_A
SSET
S R
PT_T
UN
NEL
LIN
G_T
HO
USA
ND
S_SC
ALE
D_A
SSE
TS
RPT
_PR
OPP
ING
_TH
OU
S
AN
DS_
SCA
LED
_ASS
ETS
RPT
_LN
_TU
NN
ELLI
NG
RPT
_LN
_PR
OPP
ING
RPT
_LN
_TO
TAL
DEB
T_A
SSET
_RA
TIO
LNA
SSET
S
FBM
KLC
I
PER
CN
TG_H
ELD
_BY
_LA
RG
EST_
SHA
REH
OLD
ER
IND
_SH
AR
EHO
LDER
_DI
REC
TOR
B
OA
RD
_SIZ
E
BO
AR
D_I
ND
EPEN
DEN
CE
DU
ALI
TY
BIG
4_A
UD
ITO
R
RP_INDICATOR 1.00
RP_INDICATOR_TUNNELING .615** 1.00
RP_INDICATOR_PROPPING .409** -.079 1.00
RPT_TOTAL_COUNT_SCALED_BOARD .234** .259** .167** 1.00
RPT_TUNNELLING_COUNT_SCALED_BOARD .186** .303** .007 .958** 1.00
RPT_PROPPING_COUNT_SCALED_BOARD .226** -.048 .552** .462** .189** 1.00
RPT_TOTAL_SCALED_ASSETS .126** -.084 .178** .071 .029 .153** 1.00
RPT_TUNNELLING_THOUSANDS_SCALED_ASSETS .133** .216** -.103* .217** .263** -.069 .362** 1.00
RPT_PROPPING_THOUSANDS_SCALED_ASSETS .092* -.160** .224** .004 -.055 .186** .952** .059 1.00
RPT_LN_TUNNELLING .c .c .163** .355** .349** .151** .330** .413** .142** 1.00
RPT_LN_PROPPING .c -.220** .c .099 -.046 .470** .419** -.035 .441** .290** 1.00
RPT_LN_TOTAL .c -.209** .417** .272** .147** .470** .430** .200** .394** .822** .896** 1.00
DEBT_ASSET_RATIO .157** .054 .166** .060 .031 .110* -.121** -.118** -.091* .352** .242** .322** 1.00
LNASSETS .325** .046 .463** .215** .094* .445** .120** -.075 .153** .517** .644** .675** .581** 1.00
FBMKLCI .121** .011 .150** .047 -.005 .175** .169** -.070 .205** .306** .388** .384** .318** .563** 1.00
PERCNTG_HELD_BY_LARGEST_SHAREHOLDER .258** .150** .164** .273** .214** .275** .224** .198** .175** .282** .215** .278** .005 .219** .129** 1.00
IND_SHAREHOLDER_DIRECTOR .005 .322** -.312** -.029 .076 -.335** -.175** .090* -.217** -.189** -.417** -.372** -.132** -.352** -.135** -.131** 1.00
BOARD_SIZE .147** -.091* .218** .025 .000 .085* .002 -.063 .023 .183** .207** .233** .353** .423** .281** -.005 -.254** 1.00
BOARD_INDEPENDENCE -.177** -.123** -.137** -.160** -.165** -.036 -.060 .018 -.070 -.102 .140* -.001 -.033 -.032 .019 -.110* -.045 -.268** 1.00
DUALITY -.025 .073 -.043 .020 .036 -.044 -.060 .006 -.067 .054 -.056 -.018 -.048 -.048 .041 .071 .210** -.209** .095* 1.00
BIG4_AUDITOR .188** -.049 .298** .243** .164** .326** .160** .051 .154** .327** .414** .433** .222** .465** .190** .207** -.373** .234** -.048 -.058 1.00
**. Correlation is significant at the 0.01 level (2-tailed).
*. Correlation is significant at the 0.05 level (2-tailed).
c. Cannot be computed because at least one of the variables is constant.
73
*p-Value indicates significance at the 0.10 level using two-tailed significance tests. **p-Value indicates significance at the 0.05 level using two-tailed significance tests. ***p-Value indicates significance at the 0.01 level using two-tailed significance tests.
Variables are defined as follows: RP_INDICATOR = value is 1 if a firm discloses one or more RPT of any type, value is 0 if otherwise; RP_INDICATOR_TUNNELING = value is 1 if a firm discloses one or more RPT of tunnelling type, value is 0 if otherwise; RP_INDICATOR_PROPPING = value is 1 if a firm discloses one or more RPT of propping type, value is 0 if otherwise; RP_TOTAL_COUNT_SCALED_BOARD = number of RPT scaled by board size; RPT_TUNNELLING_COUNT_SCALED_BOARD = number of tunnelling transactions disclosed scaled by board size; RPT_PROPPING_COUNT_SCALED_BOARD = number of propping transactions disclosed scaled by board size; RPT_TOTAL_SCALED_ASSETS = RPT value scaled by assets; RPT_TUNNELLING_THOUSANDS_SCALED_ ASSETS = RPT tunnelling value only scaled by assets; RPT_PROPPING_THOUSANDS_SCALED_ ASSETS = RPT propping value only scaled by assets; RPT_LN_TOTAL = natural log of value of total RPT; RPT_LN_TUNNELLING = natural log of value of tunnelling RPT; RPT_LN_PROPPING = natural log of value of propping RPT; DEBT_ASSET_RATIO = Total non-current liabilities divided by total assets; LNASSETS = natural logarithm of company’s total assets; FBMKLCI = value is 1 if company was a component stock of the FBMKLCI Index, value is 0 if otherwise; PERCNTG_HELD_BY_LARGEST_SHAREHOLDER = percentage of shares held by the largest shareholder including both direct and indirect interests; IND_SHAREHOLDER_DIRECTOR = value is 1 if the largest shareholder is an individual that sits on the board of directors, value is 0 if otherwise; BOARD_SIZE = number of directors at date of annual report for the financial year end; BOARD_INDEPENDENCE = Number of independent directors divided by total directors; DUALITY = value is 1 if Chairman and CEO is same person, value is 0 if otherwise; BIG4_AUDITOR = value is 1 if auditor for financial year end is “Big 4” auditor, Value is 0 if otherwise.
74
5 Empirical Results 5.1 Introduction This chapter presents the results of the multiple regression analysis performed on the sample of
variables for firm valuation and performance, RP transactions, and their determinants. The
primary purpose of the data analysis is to test the hypotheses outlined in Chapter 2. This is
presented in order of the hypotheses developed and is divided into three sections.
The first and second sections deal with the effects of RP transaction, as well as corporate
governance and ownership concentration, on firm valuation (Section 5.2 RP Transactions and
Firm Valuation) and firm performance (Section 5.3 RP Transactions and Firm Performance)
respectively. For each hypotheses a separate model is utilised. These models were developed
previously in Section 3.1 Theoretical Framework. The analysis starts with a base model that tests
the effects of RP transactions in totality on firm valuation or performance:
Firm valuation and performance = f(RP transactions, Control variables) + Ɛ
… Model 1
This model is then modified to differentiate between tunnelling and propping RP transactions to
determine their effect on firm valuation and performance:
Firm valuation and performance = f(Tunnelling RP transactions, Propping RP
transactions, Control variables) + Ɛ
… Model 2
The final model adds variables for corporate governance and ownership concentration to the first
two models. This is done to distinguish the effects of corporate governance and ownership
concentration on RP transactions in totality, as well as RP transactions when divided into
tunnelling and propping, against the dependant variables of firm valuation and performance:
Firm valuation and performance = f(RP transactions, Corporate governance, Ownership
concentration, Control variables) + Ɛ
… Model 3
Firm valuation and performance = f(Tunnelling RP transactions, Propping RP
transactions, Corporate governance, Ownership concentration, Control variables) + Ɛ
… Model 4
.
75
The third section examines factors associated with RP transactions.
RP transactions = f(Corporate governance, Ownership concentration, Control variables)
+ Ɛ
Tunnelling RP transactions, Propping RP transactions = f(Corporate governance,
Ownership concentration, Control variables) + Ɛ
… Model 5
Within each model for the hypotheses, four (4) categories of different variables representing RP
transactions are tested. These four categories are indicator variables, ratio of number of
transactions to board size, ratio of total amount by firm size, and total dollar value. The results
are then summarized for each category.
The fourth and final section contains the discussion of the results.
5.2 RP Transactions and Firm Valuation This section presents the results of the multiple regression where the dependent variable is Tobin’s
Q, being representative of firm valuation.
5.2.1 Effect of Related Party Transactions on Firm Valuation Multiple regression was carried out to investigate the effect of RP transactions in totality on firm
valuation. The model utilised controls for leverage, firm size, and membership of a stock market
index.
TOBINS_Qi,t = β0 + β1RPT + β2DEBT_ASSET_RATIO + β3LNASSETS + β4FBMKLCI +
Ɛi,t …(Equation 2)
The variable RPT was tested using four separate measures. Of the four RP transactions variables
tested for impact on firm valuation, only RPT_TOTAL_SCALED_ASSETS and
RPT_LN_TOTAL are significant at the 1% and 5% significance level respectively. Both variables
had positive standardized coefficients. RPT_INDICATOR and
RP_TOTAL_COUNT_SCALED_BOARD were not statistically significant, and had opposing
signs of positive and negative values. The inference is that the mere presence of RP transactions
(proxied by RPT_INDICATOR) and the pervasiveness of RP transactions (proxied by
RP_TOTAL_COUNT_SCALED_BOARD) do not have an impact on firm valuation. On the
other hand, the relative importance of RP transactions (as proxied by
RPT_TOTAL_SCALED_ASSETS and RPT_LN_TOTAL) has a significant impact on firm
valuation. This impact is positive in nature. The null hypothesis H1 that RP transactions do not
have a significant effect on the firm’s valuation is therefore not supported. This is consistent with
a situation where an equilibrium condition exists whereby investors price protect against the
76
potential effects of RP transactions (Jensen & Meckling 1976, p.305). RP transactions, when
measured by relative importance to the firm and related party, do have a significant impact on
firm valuation. The positive coefficients for both RPT_TOTAL_SCALED_ASSETS and
RPT_LN_TOTAL may on the surface be due to larger amounts of beneficial RP transactions
contained within the totals. Both these variables are totals of both tunnelling and propping RP
transactions. A cursory examination of the descriptive statistics is in line with this reasoning. For
example, RPT_TOTAL_SCALED_ASSETS is the total of
RPT_TUNNELLING_THOUSANDS_SCALED_ASSETS and
RPT_PROPPING_THOUSANDS_SCALED_ASSETS, which each have a mean of 0.0329 and
0.0691 respectively. It is clear from these means that the propping RP transactions have a mean
(0.0691) that is more than twice that of the tunnelling RP transactions (0.0329). To further
examine the relationship between RP transactions and firm valuation, the next section divides the
RP transactions into both tunnelling and propping RP transactions to analyse the effect each
different type has on firm valuation.
5.2.2 Effect of Tunnelling and Propping Related Party Transactions Multiple regression was carried out to investigate the effect of RP transactions when categorized
into tunnelling and propping transactions on firm valuation. The model utilised controls for
leverage, firm size, and membership of a stock market index.
TOBINS_Qi,t = β0 + β1RPT + β2DEBT_ASSET_RATIO + β3LNASSETS + β4FBMKLCI +
Ɛi,t …(Equation 2)
The variable RPT was replaced by two variables, with one representing tunnelling RP
transactions, and another representing propping RP transactions. When RP transactions were
divided by type of transaction, it was clear that the different types of RP transactions had varying
impacts on firm valuation. This result is consistent with the work of Cheung et al. (2006) which
showed clear demarcation in terms of the impact of different types of RP transactions on firm
valuation by the market in Hong Kong. Based on the observed results of the regression analysis,
in 3 out of the 4 tunnelling RP transaction variables tested, the coefficient had a negative sign.
This is consisted with the tunnelling hypothesis that states that such RP transactions are conflicts
of interest that results in expropriation of the minority shareholders that reduces firm value.
RPT_LN_TUNNELLING was statistically significant, and this at the 5% level. The hypothesis
H2 that tunnelling RP transactions have a significant negative effect on the firm’s valuation and
performance is therefore supported. For RP_INDICATOR_TUNNELING and
RPT_TUNNELLING_COUNT_SCALED_BOARD, the variables tested had negative
coefficients but were not statistically significant. The inference is that investors do not price
protect or give a valuation discount to a firm merely due to the presence of tunnelling RP
77
transactions (proxied by RP_INDICATOR_TUNNELING), or due to the pervasiveness of such
transactions (proxied by RPT_TUNNELLING_COUNT_SCALED_BOARD). The primary
motivator for the valuation discount by the market is relative importance of the RP transaction to
the related party (as proxied by RPT_LN_TUNNELLING). The level of tunnelling RP
transactions relative to the size of the company was not relevant (proxied by
RPT_TUNNELLING_THOUSANDS_SCALED_ ASSETS). This is in line with the view that it
is possible for the quantum of RP transactions to be large in relation to the related party but
sufficiently small so as to be immaterial to the firm. This argument is consistent with the view
that RP transactions do not negatively impact the firm (Gordon et al. 2004a, p.11; Wahab et al.
2011, p.131).
In all 4 different RP transaction variables representing propping, a positive coefficient was found,
consistent with the expectation of the theoretical framework. All 4 propping RP transaction
variables were also significant, at varying degrees. RP_INDICATOR_PROPPING and
RPT_PROPPING_THOUSANDS_SCALED_ ASSETS were significant at the 1% level,
RPT_LN_PROPPING was significant at the 5% level, and
RPT_PROPPING_COUNT_SCALED_BOARD was significant at the 10% level. The inference
can be drawn that propping RP transactions were efficient transactions that were positively
associated with firm valuation. The mere presence of propping RP transactions (indicated by
RP_INDICATOR_PROPPING), as well as the relative importance of propping RP transactions
(indicated by RPT_PROPPING_THOUSANDS_SCALED_ ASSETS and
RPT_LN_PROPPING) were key drivers of this positive impact. ). The firm must derive certain
benefits from propping RP transactions that justify the transaction being entered into by the firm.
Dealing with members of the same group, or at least with parties which are known to the firm,
may mitigate the problems such as enforcement of contracts and property rights, which are critical
to the corporation (Cheung et al. 2009; Khanna & Palepu 1997). Other benefits of propping
include the reduction of information asymmetry. For example confidential information does not
need to be shared with an external party (Gordon et al. 2004a, p.11; 2004b, p.36). It is inferred
that these benefits confer an advantage on the firm undertaking propping RP transactions,
resulting in better market valuation.
The hypothesis H3 that propping RP transactions have a neutral or significant positive effect on
the firm’s valuation is therefore supported.
5.2.3 Impact of Corporate Governance and Ownership Concentration
Multiple regression was carried out to investigate the effect of corporate governance and
ownership concentration on the relationship of RP transactions and firm valuation. The model
utilised controls for leverage, firm size, and membership of a stock market index.
78
TOBINS_Qi,t = β0 + β1RPT + β2DEBT_ASSET_RATIO + β3LNASSETS + β4FBMKLCI + β5PERCNTG_HELD_BY_LARGEST_SHAREHOLDER + β6IND_SHAREHOLDER_DIRECTOR + β7BOARD_SIZE + β8BOARD_INDEPENDENCE + β9DUALITY + β10BIG4_AUDITOR + Ɛi,t …(Equation 3)
This study utilised 8 models grouped into 2 sets to examine the impact of ownership concentration
and corporate governance on RP transactions. The first set utilised RP transaction variables
without classifying the transactions into different categories, whereas the second set utilised RP
transaction variables that had divided the transactions into either propping or tunnelling category.
The first set of results show limited impact of ownership concentration and corporate governance
on RP transactions effect on firm valuation. Both RPT_TOTAL_SCALED_ASSETS and
RPT_LN_TOTAL, which were statistically significant when tested without including corporate
governance and ownership concentration variables remain so. Both were significant at the 5%
level. At the same time, RPT_INDICATOR and RP_TOTAL_COUNT_SCALED_BOARD
which were not statistically significant when tested without including corporate governance and
ownership concentration variables also remained so. It was observed that the coefficients retained
their direction as well, but with reduced magnitude. The inference is that RP transactions affect
firm valuation, regardless of the level of ownership concentration and extent of corporate
governance. Without discriminating between various types of RP transactions, the hypothesis H4
that ownership concentration and corporate governance has a significant effect on the relationship
between RP transactions and firm valuation and performance is not supported.
In the first set of results, ownership concentration, as measured by the percentage shareholding
held by the largest shareholder (PERCNTG_HELD_BY_LARGEST_SHAREHOLDER) was
significantly positively associated with the relationship between RP transactions and firm
valuation. The identity of the shareholder as family-owned, as expected, had a negative
relationship with firm valuation. Board size and audit quality were positively related to firm
valuation. However, board independence and duality had no significant impact on the relationship
between RP transactions and firm valuation.
The second set of results displayed the impact that ownership concentration and corporate
governance had on varying types of RP transactions and firm valuation. . In only 2 out of the 4
tunnelling RP transaction variables tested did the coefficient have a negative direction
(RPT_TUNNELLING_COUNT_SCALED_BOARD and RPT_LN_TUNNELLING).
Additionally only RPT_LN_TUNNELLING was significant, and this was at the 10% level. This
is a reduction from the when this variables was tested without including corporate governance
and ownership concentration variables, as it was significant at the 5% level previously. This gives
credence to the inference that ownership concentration acts as an external corporate governance
79
mechanism, and together with other internal and external corporate governance mechanisms can
limit the negative impact of tunnelling RP transactions on firm valuation.
In the second set of results, ownership concentration, as measured by the percentage shareholding
held by the largest shareholder (PERCNTG_HELD_BY_LARGEST_SHAREHOLDER) was
significantly positively associated with the relationship between the different types of RP
transactions and firm valuation. The identity of the shareholder as family-owned did not have any
significant impact. Board size, board independence and audit quality were positively related to
firm valuation. However, duality had no significant impact on the relationship between RP
transactions and firm valuation.
In all 4 different RP transaction variables representing propping, a positive coefficient was found,
consistent with when these variables were tested without including corporate governance and
ownership concentration variables. The level of significance was reduced, with only 3 out of 4
variables tested being significant. RP_INDICATOR_PROPPING and
RPT_PROPPING_THOUSANDS_SCALED_ ASSETS were significant at the 5% level, whereas
they were both significant at the 1% level when tested without including corporate governance
and ownership concentration variables. RPT_LN_PROPPING was significant at the 5% level
previously and remained so in this model. RPT_PROPPING_COUNT_SCALED_BOARD was
significant at the 10% level previously but was not significant in this model. The inference is that
the level of corporate governance and ownership concentration can reduce the positive impact of
propping transactions. The hypothesis H4 that ownership concentration and corporate governance
has a significant effect on the relationship between RP transactions and firm valuation and
performance is supported when RP transactions are examined based on the tunnelling and
propping categories.
80
Table 20 Effect of Related Party Transactions on Firm Valuation
Dependent Variable
Tobi
n's Q
Sig.
Tobi
n's Q
Sig.
Tobi
n's Q
Sig.
Tobi
n's Q
Sig.
Independent Variables
RPT
RPT_INDICATOR 0.036 0.431
RP_TOTAL_COUNT_SCALED_BOARD -0.007 0.868
RPT_TOTAL_SCALED_ASSETS 0.179 0 ***
RPT_LN_TOTAL 0.21 0.001 **
FIRM CHARACTERISTICS
DEBT_ASSET_RATIO 0.064 0.225
0.062 0.245
0.114 0.035 ** 0.076 0.189
LNASSETS -0.157 0.014 ** -0.14 0.026 ** -0.179 0.003 ** -0.3 0 ***
FBMKLCI 0.156 0.003 ** 0.152 0.004 ** 0.127 0.015 ** 0.166 0.004 **
R2
0.02
0.011
0.041
0.035
Sig.
0.031
0.04
0
0.001
*p-Value indicates significance at the 0.10 level using two-tailed significance tests. **p-Value indicates significance at the 0.05 level using two-tailed significance tests. ***p-Value indicates significance at the 0.01 level using two-tailed significance tests.
Variables are defined as follows: Tobin's Q = an approximation of Tobin’s Q from Equation 1; RP_INDICATOR = value is 1 if a firm discloses one or more RPT of any type, value is 0 if otherwise; RP_TOTAL_COUNT_SCALED_BOARD = number of RPT scaled by board size; RPT_TOTAL_SCALED_ASSETS = RPT value scaled by assets; RPT_LN_TOTAL = natural log of value of total RPT; DEBT_ASSET_RATIO = Total non-current liabilities divided by total assets; LNASSETS = natural logarithm of company’s total assets; FBMKLCI = value is 1 if company was a component stock of the FBMKLCI Index, value is 0 if otherwise.
81
Table 21 Effect of Tunnelling and Propping Related Party Transactions
*p-Value indicates significance at the 0.10 level using two-tailed significance tests. **p-Value indicates significance at the 0.05 level using two-tailed significance tests. ***p-Value indicates significance at the 0.01 level using two-tailed significance tests.
Variables are defined as follows: Tobin's Q = an approximation of Tobin’s Q from Equation 1; RP_INDICATOR_TUNNELING = value is 1 if a firm discloses one or more RPT of tunnelling type, value is 0 if otherwise; RP_INDICATOR_PROPPING = value is 1 if a firm discloses one or more RPT of propping type, value is 0 if otherwise; RPT_TUNNELLING_COUNT_SCALED_BOARD = number of tunnelling transactions disclosed scaled by board size; RPT_PROPPING_COUNT_SCALED_BOARD = number of propping transactions disclosed scaled by board size; RPT_TUNNELLING_THOUSANDS_SCALED_ ASSETS = RPT tunnelling value only scaled by assets; RPT_PROPPING_THOUSANDS_SCALED_ ASSETS = RPT propping value only scaled by assets; RPT_LN_TUNNELLING = natural log of value of tunnelling RPT; RPT_LN_PROPPING = natural log of value of propping RPT; DEBT_ASSET_RATIO = Total non-current liabilities divided by total assets; LNASSETS = natural logarithm of company’s total assets; FBMKLCI = value is 1 if company was a component stock of the FBMKLCI Index, value is 0 if otherwise.
Dependent Variable
Tobi
n's Q
Sig.
Tobi
n's Q
Sig.
Tobi
n's Q
Sig.
Tobi
n's Q
Sig.
Independent Variables
RPT
RP_INDICATOR_TUNNELING -0.022 0.601 RP_INDICATOR_PROPPING 0.191 0 *** RPT_TUNNELLING_COUNT_SCALED_BOARD -0.038 0.386 RPT_PROPPING_COUNT_SCALED_BOARD 0.083 0.098 * RPT_TUNNELLING_THOUSANDS_SCALED_
ASSETS
0.034 0.434 RPT_PROPPING_THOUSANDS_SCALED_ ASSETS 0.175 0 *** RPT_LN_TUNNELLING -0.197 0.031 ** RPT_LN_PROPPING 0.269 0.013 ** FIRM CHARACTERISTICS
DEBT_ASSET_RATIO 0.094 0.077 * 0.08 0.14
0.114 0.035 ** 0.138 0.174
LNASSETS -0.265 0 *** -0.189 0.006 ** -0.18 0.003 ** -0.373 0.02 ** FBMKLCI 0.183 0 *** 0.159 0.003 ** 0.124 0.017 ** 0.111 0.274
R2
0.038
0.015
0.039
0.069
Sig.
0
0.022
0
0.008
82
Table 22 Impact of Corporate Governance and Ownership Concentration
Dependent Variable
Tobi
n's Q
Sig.
Tobi
n's Q
Sig.
Tobi
n's Q
Sig.
Tobi
n's Q
Sig.
Independent Variables
RPT
RPT_INDICATOR 0.036 0.446
RP_TOTAL_COUNT_SCALED_BOARD -0.023 0.621
RPT_TOTAL_SCALED_ASSETS 0.151 0.001 **
RPT_LN_TOTAL 0.176 0.007 **
FIRM CHARACTERISTICS
DEBT_ASSET_RATIO 0.076 0.154
0.074 0.167
0.11 0.042 ** 0.092 0.116
LNASSETS -0.321 0 *** -0.302 0 *** -0.318 0 *** -0.43 0 ***
FBMKLCI 0.172 0.001 ** 0.166 0.002 ** 0.141 0.007 ** 0.197 0.001 **
OWNERSHIP CONCENTRATION
PERCNTG_HELD_BY_LARGEST_SHAREHOLDE
R
0.076 0.099 * 0.087 0.059 * 0.06 0.187
-0.013 0.798
IND_SHAREHOLDER_DIRECTOR -0.094 0.056 * -0.086 0.079
-0.071 0.145
-0.139 0.014
CORPORATE GOVERNANCE
BOARD_SIZE 0.117 0.023 ** 0.116 0.025 ** 0.129 0.011 ** 0.055 0.326
BOARD_INDEPENDENCE 0.041 0.365
0.034 0.463
0.047 0.295
0.019 0.691
DUALITY -0.061 0.169
-0.062 0.161
-0.052 0.235
-0.062 0.201
BIG4_AUDITOR 0.103 0.04 ** 0.108 0.033 ** 0.092 0.064 * 0.098 0.08 *
R2
0.049
0.049
0.068
0.066
Sig.
0
0
0
0
83
*p-Value indicates significance at the 0.10 level using two-tailed significance tests. **p-Value indicates significance at the 0.05 level using two-tailed significance tests. ***p-Value indicates significance at the 0.01 level using two-tailed significance tests.
Variables are defined as follows: Tobin's Q = an approximation of Tobin’s Q from Equation 1; ; RP_INDICATOR = value is 1 if a firm discloses one or more RPT of any type, value is 0 if otherwise; RP_TOTAL_COUNT_SCALED_BOARD = number of RPT scaled by board size; RPT_TOTAL_SCALED_ASSETS = RPT value scaled by assets; RPT_LN_TOTAL = natural log of value of total RPT; PERCNTG_HELD_BY_LARGEST_SHAREHOLDER = percentage of shares held by the largest shareholder including both direct and indirect interests; IND_SHAREHOLDER_DIRECTOR = value is 1 if the largest shareholder is an individual that sits on the board of directors, value is 0 if otherwise; BOARD_SIZE = number of directors at date of annual report for the financial year end; BOARD_INDEPENDENCE = Number of independent directors divided by total directors; DUALITY = value is 1 if Chairman and CEO is same person, value is 0 if otherwise; BIG4_AUDITOR = value is 1 if auditor for financial year end is “Big 4” auditor, Value is 0 if otherwise; DEBT_ASSET_RATIO = Total non-current liabilities divided by total assets; LNASSETS = natural logarithm of company’s total assets; FBMKLCI = value is 1 if company was a component stock of the FBMKLCI Index, value is 0 if otherwise.
84
Table 23 Impact of Corporate Governance and Ownership Concentration on Tunnelling and Propping RP Transactions
Dependent Variable
Tobi
n's Q
Sig.
Tobi
n's Q
Sig.
Tobi
n's Q
Sig.
Tobi
n's Q
Sig.
Independent Variables
RPT
RP_INDICATOR_TUNNELING 0.021 0.644 RP_INDICATOR_PROPPING 0.173 0.001 ** RPT_TUNNELLING_COUNT_SCALED_BOARD -0.041 0.368 RPT_PROPPING_COUNT_SCALED_BOARD 0.049 0.338 RPT_TUNNELLING_THOUSANDS_SCALED_
ASSETS
0.021 0.63 RPT_PROPPING_THOUSANDS_SCALED_
ASSETS
0.151 0.001 ** RPT_LN_TUNNELLING -0.185 0.051 * RPT_LN_PROPPING 0.251 0.023 ** FIRM CHARACTERISTICS
DEBT_ASSET_RATIO 0.098 0.068 * 0.083 0.127
0.11 0.042 ** 0.193 0.083 * LNASSETS -0.406 0 *** -0.329 0 *** -0.32 0 *** -0.501 0.007 ** FBMKLCI 0.194 0 *** 0.169 0.001 ** 0.138 0.009 ** 0.146 0.197
OWNERSHIP CONCENTRATION
PERCNTG_HELD_BY_LARGEST_SHAREHOLDE
R
0.076 0.094 * 0.083 0.072 * 0.064 0.161
0.099 0.2793
7
IND_SHAREHOLDER_DIRECTOR -0.07 0.178
-0.073 0.147
-0.066 0.184
-0.017 0.8676
5
CORPORATE GOVERNANCE BOARD_SIZE 0.12 0.019 ** 0.122 0.019 ** 0.131 0.011 ** 0.129 0.1869
6
BOARD_INDEPENDENCE 0.061 0.18
0.033 0.466
0.049 0.272
0.188 0.0333
6
** DUALITY -0.067 0.129
-0.061 0.168
-0.053 0.232
-0.105 0.2317
8
BIG4_AUDITOR 0.099 0.047 ** 0.108 0.034 ** 0.094 0.058 * 0.021 0.8242
6
R2
0.068
0.049
0.067
0.081
Sig.
0
0
0
0.016
85
*p-Value indicates significance at the 0.10 level using two-tailed significance tests. **p-Value indicates significance at the 0.05 level using two-tailed significance tests. ***p-Value indicates significance at the 0.01 level using two-tailed significance tests.
Variables are defined as follows: Tobin's Q = an approximation of Tobin’s Q from Equation 1; RP_INDICATOR_TUNNELING = value is 1 if a firm discloses one or more RPT of tunnelling type, value is 0 if otherwise; RP_INDICATOR_PROPPING = value is 1 if a firm discloses one or more RPT of propping type, value is 0 if otherwise; RPT_TUNNELLING_COUNT_SCALED_BOARD = number of tunnelling transactions disclosed scaled by board size; RPT_PROPPING_COUNT_SCALED_BOARD = number of propping transactions disclosed scaled by board size; RPT_TUNNELLING_THOUSANDS_SCALED_ ASSETS = RPT tunnelling value only scaled by assets; RPT_PROPPING_THOUSANDS_SCALED_ ASSETS = RPT propping value only scaled by assets; RPT_LN_TUNNELLING = natural log of value of tunnelling RPT; RPT_LN_PROPPING = natural log of value of propping RPT; PERCNTG_HELD_BY_LARGEST_SHAREHOLDER = percentage of shares held by the largest shareholder including both direct and indirect interests; IND_SHAREHOLDER_DIRECTOR = value is 1 if the largest shareholder is an individual that sits on the board of directors, value is 0 if otherwise; BOARD_SIZE = number of directors at date of annual report for the financial year end; BOARD_INDEPENDENCE = Number of independent directors divided by total directors; DUALITY = value is 1 if Chairman and CEO is same person, value is 0 if otherwise; BIG4_AUDITOR = value is 1 if auditor for financial year end is “Big 4” auditor, Value is 0 if otherwise; DEBT_ASSET_RATIO = Total non-current liabilities divided by total assets; LNASSETS = natural logarithm of company’s total assets; FBMKLCI = value is 1 if company was a component stock of the FBMKLCI Index, value is 0 if otherwise.
86
5.3 RP Transactions and Firm Performance This section presents the results of the multiple regression analysis performed on the sample of
RP transactions and their determinants. The models tested in this section are identical as the
models used in the previous section with the exception of the dependant variable being return on
assets (ROA) rather than Tobin’s Q. The dependent variable, ROA, is representative of firm
performance. The data used in this section is also identical to the previous section which tested
firm valuation.
5.3.1 Effect of Related Party Transactions on Firm Performance Multiple regression was carried out to investigate the effect of RP transactions in totality on firm
performance. The model utilised controls for leverage, firm size, and membership of a stock
market index.
ROAi,t = β0 + β1RPT + β2DEBT_ASSET_RATIO + β3LNASSETS + β4FBMKLCI + Ɛi,t
…(Equation 4)
None of the four RP transaction variables tested were statistically significant in their impact on
firm performance at either the 1%, 5% or 10% level. Therefore hypothesis H1 that RP transactions
do not have a significant effect on the firm’s performance is supported. This clearly shows that
the mere presence of RP transactions cannot be linked to any increase or decrease in the firm’s
performance. It is possible that the lack of impact on firm performance is due to firm performance
being represented by ROA, which is an accounting based measure. The reported effects of RP
transactions may have been concealed in statutory reporting, as RP transactions themselves are
noted as a tool for earnings management (Jian & Wong 2003).
The results initially seem to conflict with findings from Wahab et al. (2011, p.153), who found a
significant negative relationship between RP transactions and firm performance. However upon
closer examination, the significance of the relationship found in previous research was very
minimal. When translated into economic terms, the negative relationship with RP transactions
resulted in a mere -1.014% decrease to ROA (Wahab et al., 2011, p.153). It is also plausible that
the effects of tunnelling and propping RP transactions cancel out each other. Wahab et al. (2011)
utilizes an RP transaction measure which does not discriminate between tunnelling and propping,
as is similar to the RP transactions variables tested in this section. Further testing in hypotheses
H2 and H3 to examine the impact of RP transactions when broken down into tunnelling and
propping components attempts to find more insight into the relationship and is dealt with next.
5.3.2 Effect of Tunnelling and Propping Related Party Transactions
Multiple regression was carried out to investigate the effect of RP transactions when categorized
into tunnelling and propping transactions on firm performance. The model utilised controls for
leverage, firm size, and membership of a stock market index.
87
ROAi,t = β0 + β1RPT + β2DEBT_ASSET_RATIO + β3LNASSETS + β4FBMKLCI + Ɛi,t
…(Equation 4)
When RP transactions are divided into tunnelling and propping RP types, the direction of the sign
is consistent with the theoretical framework. In all 4 of the RP tunnelling transaction variables
tested, the coefficient had a negative sign. Similarly in 3 out of the 4 RP propping transaction
variables tested, the coefficient had a positive sign. The inference from these results is that
tunnelling can negatively impact firm performance, and propping can positively impact firm
performance. However, out of all the variable tested in these models, only RPT_LN_PROPPING
was significant. This was recorded at the 5% significance level. For tunnelling RP transactions,
no variable was significant at the 1%, 5% or 10% level. Therefore, even though the general
direction of the sign is consistent with the hypothesis, H2 that tunnelling RP transactions have a
significant negative effect on the firm’s performance is not supported. For propping RP
transactions, there is evidence that H3 is supported. For H3, that states that propping RP
transactions have a either a neutral or significant positive effect on the firm’s performance, this is
supported by the statistically significant results of the model utilising RPT_LN_PROPPING
which shows a positive effect on firm performance. At the same time, propping RP transactions
are also shown to have a neutral effect on firm’s performance in view of the lack of significant
results for RP_INDICATOR_PROPPING, RPT_PROPPING_COUNT_SCALED_BOARD and
RPT_PROPPING_THOUSANDS_SCALED_ ASSETS. The hypothesis is therefore supported.
These results also illustrate that the insignificance of RP transactions in totality on firm
performance may possibly be due to the effects of tunnelling and propping cancelling out each
other, as stated in 5.3.1, as both tunnelling and propping RP transactions had negative and positive
coefficients respectively.
5.3.3 Impact of Ownership Concentration and Corporate Governance
Multiple regression was carried out to investigate the effect of corporate governance and
ownership concentration on the relationship of RP transactions and firm performance. The model
utilised controls for leverage, firm size, and membership of a stock market index.
ROAi,t = β0 + β1RPT + β2DEBT_ASSET_RATIO + β3LNASSETS + β4FBMKLCI + β5PERCNTG_HELD_BY_LARGEST_SHAREHOLDER + β6IND_SHAREHOLDER_DIRECTOR + β7BOARD_SIZE + β8BOARD_INDEPENDENCE + β9DUALITY + β10BIG4_AUDITOR + Ɛi,t …(Equation 5)
This study utilised 8 models grouped into 2 sets to examine the impact of ownership concentration
and corporate governance on RP transactions and firm performance. The first set utilised RP
transaction variables without classifying the transactions into different categories, whereas the
second set utilised RP transaction variables that had divided the transactions into either propping
or tunnelling category.
88
The first set of results show no significant impact of ownership concentration and corporate
governance on RP transactions effect on firm valuation. All 4 RP transaction variables, namely
RPT_INDICATOR, RP_TOTAL_COUNT_SCALED_BOARD,
RPT_TOTAL_SCALED_ASSETS and RPT_LN_TOTAL, were not statistically significant
when tested without including corporate governance and ownership concentration variables,
remained so even with the inclusion of corporate governance and ownership concentration into
the model. It was also observed that the coefficients retained their direction as well. The inference
is that RP transactions do not affect firm valuation, regardless of the level of ownership
concentration and extent of corporate governance. Without discriminating between various types
of RP transactions, the hypothesis H4 that ownership concentration and corporate governance has
a significant effect on the relationship between RP transactions and firm performance is not
supported.
The second set of results displayed the impact that ownership concentration and corporate
governance had on varying types of RP transactions and firm performance. In all 4 of the RP
tunnelling transaction variables tested, the coefficient had a negative sign. Similarly in 3 out of
the 4 RP propping transaction variables tested, the coefficient had a positive sign. This was
consistent with testing in the previous model without corporate governance and ownership
concentration. Additionally only RPT_LN_PROPPING was significant, and this was at the 10%
level. This is a reduction from the when this variables was tested without including corporate
governance and ownership concentration variables, as it was significant at the 5% level
previously. Overall it can be inferred that ownership concentration and corporate governance did
not have any significant impact on the relationship between RP transactions and firm
performance. The hypothesis H4 that ownership concentration and corporate governance has a
significant effect on the relationship between RP transactions and firm performance is therefore
not supported when RP transactions are examined based on the tunnelling and propping
categories.
89
Table 24 Effect of Related Party Transactions on Firm Performance
Dependent Variable ROA Sig.
ROA Sig.
ROA Sig.
ROA Sig.
Independent Variables
RPT
RPT_INDICATOR 0.075 0.102
RP_TOTAL_COUNT_SCALED_BOARD -0.016 0.72
RPT_TOTAL_SCALED_ASSETS -0.008 0.855
RPT_LN_TOTAL -0.076 0.238
FIRM CHARACTERISTICS
DEBT_ASSET_RATIO -0.085 0.11
-0.09 0.091 * -0.091 0.097 * -0.099 0.094 *
LNASSETS 0.145 0.023 ** 0.181 0.004 ** 0.177 0.004 ** 0.135 0.107
FBMKLCI -0.048 0.364
-0.056 0.286
-0.053 0.313
-0.011 0.849
R2
0.021
0.016
0.016
0
Sig.
0.025
0.072
0.119
0.415
*p-Value indicates significance at the 0.10 level using two-tailed significance tests. **p-Value indicates significance at the 0.05 level using two-tailed significance tests. ***p-Value indicates significance at the 0.01 level using two-tailed significance tests.
Variables are defined as follows: ROA = return on assets, net profit/loss to shareholders divided by total assets; RP_INDICATOR = value is 1 if a firm discloses one or more RPT of any type, value is 0 if otherwise; RP_TOTAL_COUNT_SCALED_BOARD = number of RPT scaled by board size; RPT_TOTAL_SCALED_ASSETS = RPT value scaled by assets; RPT_LN_TOTAL = natural log of value of total RPT; DEBT_ASSET_RATIO = Total non-current liabilities divided by total assets; LNASSETS = natural logarithm of company’s total assets; FBMKLCI = value is 1 if company was a component stock of the FBMKLCI Index, value is 0 if otherwise.
90
Table 25 Effect of Tunnelling and Propping Related Party Transactions on Firm Performance
Dependent Variable ROA Sig.
ROA Sig.
ROA Sig.
ROA Sig.
Independent Variables
RPT
RP_INDICATOR_TUNNELING -0.004 0.927 RP_INDICATOR_PROPPING 0.053 0.29 RPT_TUNNELLING_COUNT_SCALED_BOARD -0.007 0.877 RPT_PROPPING_COUNT_SCALED_BOARD -0.025 0.616 RPT_TUNNELLING_THOUSANDS_SCALED_
ASSETS
-0.043 0.328 RPT_PROPPING_THOUSANDS_SCALED_
ASSETS
0.009 0.848 RPT_LN_TUNNELLING -0.071 0.443 RPT_LN_PROPPING 0.241 0.03 ** FIRM CHARACTERISTICS
DEBT_ASSET_RATIO -0.08 0.137
-0.095 0.083 * -0.091 0.097 * -0.068 0.515
LNASSETS 0.142 0.041 ** 0.193 0.005 ** 0.175 0.005 ** -0.172 0.294
FBMKLCI -0.046 0.388
-0.058 0.273
-0.058 0.276
0.051 0.625
R2
0.018
0.007
0.008
0.053
Sig.
0.087
0.119
0.093
0.148
*p-Value indicates significance at the 0.10 level using two-tailed significance tests. **p-Value indicates significance at the 0.05 level using two-tailed significance tests. ***p-Value indicates significance at the 0.01 level using two-tailed significance tests.
Variables are defined as follows: ROA = return on assets, net profit/loss to shareholders divided by total assets; RP_INDICATOR_TUNNELING = value is 1 if a firm discloses one or more RPT of tunnelling type, value is 0 if otherwise; RP_INDICATOR_PROPPING = value is 1 if a firm discloses one or more RPT of propping type, value is 0 if otherwise; RPT_TUNNELLING_COUNT_SCALED_BOARD = number of tunnelling transactions disclosed scaled by board size; RPT_PROPPING_COUNT_SCALED_BOARD = number of propping transactions disclosed scaled by board size; RPT_TUNNELLING_THOUSANDS_SCALED_ ASSETS = RPT tunnelling value only scaled by assets; RPT_PROPPING_THOUSANDS_SCALED_ ASSETS = RPT propping value only scaled by assets; RPT_LN_TUNNELLING = natural log of value of tunnelling RPT; RPT_LN_PROPPING = natural log of value of propping RPT; DEBT_ASSET_RATIO = Total non-current liabilities divided by total assets; LNASSETS = natural logarithm of company’s total assets; FBMKLCI = value is 1 if company was a component stock of the FBMKLCI Index, value is 0 if otherwise.
91
Table 26 Impact of Ownership Concentration and Corporate Governance
Dependent Variable ROA Sig.
ROA Sig.
ROA Sig.
ROA Sig.
Independent Variables
RPT
RPT_INDICATOR 0.072 0.135
RP_TOTAL_COUNT_SCALED_BOARD -0.016 0.732
RPT_TOTAL_SCALED_ASSETS -0.01 0.837
RPT_LN_TOTAL -0.096 0.154
FIRM CHARACTERISTICS
DEBT_ASSET_RATIO -0.093 0.088 * -0.096 0.078 * -0.098 0.079 * -0.085 0.161
LNASSETS 0.194 0.008 ** 0.225 0.002 ** 0.222 0.002 ** 0.123 0.174
FBMKLCI -0.041 0.437
-0.049 0.353
-0.046 0.389
0.021 0.726
OWNERSHIP CONCENTRATION
PERCNTG_HELD_BY_LARGEST_SHAREHOLDE
R
-0.02 0.672
-0.003 0.944
-0.005 0.915
-0.071 0.168
IND_SHAREHOLDER_DIRECTOR 0.023 0.652
0.036 0.465
0.034 0.499
-0.112 0.053 *
CORPORATE GOVERNANCE
BOARD_SIZE -0.036 0.49
-0.036 0.49
-0.036 0.497
-0.112 0.053 *
BOARD_INDEPENDENCE -0.033 0.483
-0.044 0.346
-0.042 0.36
-0.08 0.112
DUALITY -0.102 0.025 ** -0.104 0.022 ** -0.105 0.021 ** -0.004 0.935
BIG4_AUDITOR -0.053 0.298
-0.047 0.365
-0.049 0.341
0.034 0.56
R2
0.035
0.031
0.031
0.007
Sig.
0.046
0.088
0.123
0.229
*p-Value indicates significance at the 0.10 level using two-tailed significance tests. **p-Value indicates significance at the 0.05 level using two-tailed significance tests. ***p-Value indicates significance at the 0.01 level using two-tailed significance tests.
92
Variables are defined as follows: ROA = return on assets, net profit/loss to shareholders divided by total assets; RP_INDICATOR = value is 1 if a firm discloses one or more RPT of any type, value is 0 if otherwise; RP_TOTAL_COUNT_SCALED_BOARD = number of RPT scaled by board size; RPT_TOTAL_SCALED_ASSETS = RPT value scaled by assets; RPT_LN_TOTAL = natural log of value of total RPT; PERCNTG_HELD_BY_LARGEST_SHAREHOLDER = percentage of shares held by the largest shareholder including both direct and indirect interests; IND_SHAREHOLDER_DIRECTOR = value is 1 if the largest shareholder is an individual that sits on the board of directors, value is 0 if otherwise; BOARD_SIZE = number of directors at date of annual report for the financial year end; BOARD_INDEPENDENCE = Number of independent directors divided by total directors; DUALITY = value is 1 if Chairman and CEO is same person, value is 0 if otherwise; BIG4_AUDITOR = value is 1 if auditor for financial year end is “Big 4” auditor, Value is 0 if otherwise; DEBT_ASSET_RATIO = Total non-current liabilities divided by total assets; LNASSETS = natural logarithm of company’s total assets; FBMKLCI = value is 1 if company was a component stock of the FBMKLCI Index, value is 0 if otherwise.
93
Table 27Impact of Ownership Concentration and Corporate Governance on Tunnelling and Propping RP Transactions
Dependent Variable ROA Sig.
ROA Sig.
ROA Sig.
ROA Sig.
Independent Variables
RPT
RP_INDICATOR_TUNNELING -0.025 0.602
RP_INDICATOR_PROPPING 0.059 0.252
RPT_TUNNELLING_COUNT_SCALED_BOARD -0.009 0.84
RPT_PROPPING_COUNT_SCALED_BOARD -0.019 0.715
RPT_TUNNELLING_THOUSANDS_SCALED_
ASSETS
-0.042 0.348
RPT_PROPPING_THOUSANDS_SCALED_
ASSETS
0.007 0.884
RPT_LN_TUNNELLING -0.083 0.387
RPT_LN_PROPPING 0.197 0.079 *
FIRM CHARACTERISTICS
DEBT_ASSET_RATIO -0.086 0.116
-0.099 0.075 * -0.098 0.08 * 0.059 0.6
LNASSETS 0.194 0.012 ** 0.232 0.002 ** 0.218 0.002 ** -0.415 0.028 **
FBMKLCI -0.041 0.447
-0.05 0.347
-0.051 0.341
0.168 0.142
OWNERSHIP CONCENTRATION
PERCNTG_HELD_BY_LARGEST_SHAREHOLDE
R
-0.004 0.936
-0.002 0.961
0.002 0.96
0.117 0.208
IND_SHAREHOLDER_DIRECTOR 0.053 0.316
0.033 0.519
0.042 0.41
-0.253 0.014 **
CORPORATE GOVERNANCE
BOARD_SIZE -0.038 0.474
-0.038 0.474
-0.033 0.527
0.09 0.361
BOARD_INDEPENDENCE -0.037 0.432
-0.044 0.347
-0.038 0.407
0.104 0.245
DUALITY -0.106 0.019 ** -0.105 0.022 ** -0.106 0.021 ** -0.056 0.525
BIG4_AUDITOR -0.052 0.309
-0.047 0.368
-0.045 0.377
-0.043 0.651
94
R2
0.034
0.01
0.012
0.123
Sig.
0.081
0.123
0.102
0.056
*p-Value indicates significance at the 0.10 level using two-tailed significance tests. **p-Value indicates significance at the 0.05 level using two-tailed significance tests. ***p-Value indicates significance at the 0.01 level using two-tailed significance tests.
Variables are defined as follows: ROA = return on assets, net profit/loss to shareholders divided by total assets; RP_INDICATOR_TUNNELING = value is 1 if a firm discloses one or more RPT of tunnelling type, value is 0 if otherwise; RP_INDICATOR_PROPPING = value is 1 if a firm discloses one or more RPT of propping type, value is 0 if otherwise; RPT_TUNNELLING_COUNT_SCALED_BOARD = number of tunnelling transactions disclosed scaled by board size; RPT_PROPPING_COUNT_SCALED_BOARD = number of propping transactions disclosed scaled by board size; RPT_TUNNELLING_THOUSANDS_SCALED_ ASSETS = RPT tunnelling value only scaled by assets; RPT_PROPPING_THOUSANDS_SCALED_ ASSETS = RPT propping value only scaled by assets; RPT_LN_TUNNELLING = natural log of value of tunnelling RPT; RPT_LN_PROPPING = natural log of value of propping RPT; PERCNTG_HELD_BY_LARGEST_SHAREHOLDER = percentage of shares held by the largest shareholder including both direct and indirect interests; IND_SHAREHOLDER_DIRECTOR = value is 1 if the largest shareholder is an individual that sits on the board of directors, value is 0 if otherwise; BOARD_SIZE = number of directors at date of annual report for the financial year end; BOARD_INDEPENDENCE = Number of independent directors divided by total directors; DUALITY = value is 1 if Chairman and CEO is same person, value is 0 if otherwise; BIG4_AUDITOR = value is 1 if auditor for financial year end is “Big 4” auditor, Value is 0 if otherwise; DEBT_ASSET_RATIO = Total non-current liabilities divided by total assets; LNASSETS = natural logarithm of company’s total assets; FBMKLCI = value is 1 if company was a component stock of the FBMKLCI Index, value is 0 if otherwise.
95
5.4 Factors Associated with RP Transactions Multiple regression was carried out to investigate the association between RP transactions and
corporate governance and ownership concentration. The model utilised controls for leverage, firm
size, and membership of a stock market index.
RPTi,t= β1DEBT_ASSET_RATIO + β2LNASSETS + β3FBMKLCI + β4PERCNTG_HELD_BY_LARGEST_SHAREHOLDER + β5IND_SHAREHOLDER_DIRECTOR + β6BOARD_SIZE + β7BOARD_INDEPENDENCE + β8DUALITY + β9BIG4_AUDITOR + Ɛi,t …(Equation 6)
5.4.1 RP Indicator Variables
The presence of RPT in a firm was significantly positively associated with firm size (0.382),
ownership concentration (0.187) and family ownership (0.171). There was significant negative
association with membership of a stock index (-0.094) and board independence (-0.126). This
clearly demonstrates the effect that ownership concentration and corporate governance has on the
presence of RPT as proxied by the variable RPT_INDICATOR. Hypothesis H5 is therefore
supported by this model.
The model then alternates between testing the indicators of RP transactions when classified into
indicator variables for tunnelling and propping transactions. RP_INDICATOR_TUNNELING
which represents the presence of tunnelling RP transactions is significantly positively associated
with firm size (0.191), ownership concentration (0.154) and family ownership (0.376). This is
consistent with the theoretical framework and existing literature that points to higher propensity
for a larger owner, in particular a family owner, to expropriate from minority shareholders. At the
same time, RP_INDICATOR_TUNNELING was significantly negatively related to board size (-
0.107) and board independence (-0.108). Both of these were significant at the 5% level. In this
we can see the constraining effect of corporate governance to limit tunnelling RP transactions.
RP_INDICATOR_PROPPING, which is a proxy for the presence of propping RP transactions
was significantly positively associated with firm size (0.543) at the 1% significance level. There
were significant negative associations with leverage (-0.136), membership of stock exchange
index (-0.142), family ownership (-0.154), and board independence (-0.127). These results are
also consistent with extant literature. Family ownership is less associated with propping RP
transactions, as such owners would only be concerned with extraction of private benefits for
themselves. A larger firm, with less family ownership, would indicate an institution owned
corporate group. Such a group would have member firms which could transact within the group
to mitigate the problems such as enforcement of contracts and property rights, which are critical
to the corporation (Cheung et al. 2009, p.915; Khanna & Palepu 1997). At the same time the
inverse relationship with board independence is consistent with earlier results for
96
RPT_INDICATOR and RP_INDICATOR_TUNNELING. It is possible that lower board
independence contributes to higher levels of RP transactions of all types, regardless if they are
tunnelling or propping.
In all three models duality and auditor quality were not significant. For
RP_INDICATOR_TUNNELING, both duality and audit quality had negative associations,
whereas for propping RP transactions the direction of the sign was reversed and was positive.
These results are mixed and inconclusive. Hypothesis H5 that corporate governance and
ownership concentration are associated with RP transactions is therefore supported by these
models.
5.4.2 Ratio of Number of RP Transactions to Board Size
The pervasiveness of RP transactions was significantly positively related to ownership
concentration (0.194), and family ownership (0.095). It was negatively related to the corporate
governance mechanisms of board size (-0.084) and board independence (-0.142), but positively
related to audit quality (0.169). It was inferred that ownership concentration, and in particular
family ownership, contributes to higher prevalence of RP transactions. It was also inferred that
corporate governance mechanisms such as a more independent board can lessen the prevalence
of RP transactions. The link between RP transactions and audit quality can be seen as a way of
legitimizing or signalling to the market by hiring Big 4 auditors to audit firms with higher
pervasiveness of RP transactions (Gordon et al. 2007, p.93; Wahab et al. 2011, p.143). At the
same time, having a strong and independent external monitor, outside of the board of directors,
can be an effective mechanism in countering the negative effects of RP transactions (Rahmat
2013, p.76; Gordon et al. 2007, p.93).
Hypothesis H5 that corporate governance and ownership concentration are associated with RP
transactions is therefore supported by this model.
The model then alternates between testing the indicators of RP transactions when classified into
indicator variables for tunnelling and propping transactions.
RPT_TUNNELLING_COUNT_SCALED_BOARD which represents the pervasiveness of
tunnelling RP transactions was significantly directly related to ownership concentration (0.173)
and family ownership (0.162). Board independence had a significant negative association (-0.142)
with RP tunnelling transactions, but audit quality had a significant positive association (0.163).
This is consistent with the conflict of interest view of RP tunnelling transactions, in that higher
ownership concentration increases the likelihood of expropriation of minority shareholders. At
the same time, corporate governance, through board independence, can negate the pervasiveness
of RP tunnelling transactions. Increased audit quality can be seen as a way of legitimizing or
97
signalling to the market by hiring Big 4 auditors to audit firms with higher pervasiveness of
tunnelling RP transactions.
RPT_PROPPING_COUNT_SCALED_BOARD has significant positive relationships with
ownership concentration (0.132), but negative association with family ownership (-0.175), and
board size (-0.129). This is consistent with the view that RP transactions can be efficient
transactions. A higher level of ownership gives more incentive to the major shareholder to protect
the investment in the firm via propping. This in particular would apply to non-family firms that
do not have a personal interest in the extraction of private benefits from the firm. Audit quality
again is positively associated (0.073), acting as a sign of legitimacy and signalling to the market
that the RP propping transactions are above board.
In all three models duality was not significant. Hypothesis H5that corporate governance and
ownership concentration are associated with RP transactions is therefore supported by these
models.
5.4.3 Ratio to Total Value of RP Transactions to Firm Size
It was observed that RPT_TOTAL_SCALED_ASSETS, being representative of the level of RP
transactions in the firm, had a significant positive association with ownership concentration
(0.152). There was also a significant inverse association with family ownership (-0.116). Audit
quality was positively associated (0.082), acting as a sign of legitimacy and signalling to the
market that the RP transactions are above board.
When the level of RP transactions are classified into tunnelling and propping, the results were as
follows. RPT_TUNNELLING_THOUSANDS_SCALED_ ASSETS was significantly positively
associated with ownership concentration (0.222) and family ownership (0.137). This is consistent
with the conflict of interest view of RP tunnelling transactions, in that higher ownership
concentration increases the likelihood of expropriation of minority shareholders. Additionally
family ownership increases the level of tunnelling RP transactions in a firm as the controlling
shareholders can use this to extract private benefits. Audit quality was positively associated
(0.107), acting as a sign of legitimacy and signalling to the market that the RP transactions are
above board. RPT_PROPPING_THOUSANDS_SCALED_ ASSETS on the other hand was
significantly related to ownership concentration (0.09) but inversely related to family ownership
(-0.169). This is consistent with existing literature that the higher level of ownership gives more
incentive to the major shareholder to protect the investment in the firm via propping. This in
particular would apply to non-family firms that do not have a personal interest in the extraction
of private benefits from the firm. There was also significant negative association between
propping and board size (-0.089) and board independence (-0.092). It can be inferred that the
98
propping RP transactions were efficient transactions, thus reducing the level of corporate
governance oversight needed.
In all three models duality was not significant. Hypothesis H5that corporate governance and
ownership concentration are associated with RP transactions is therefore supported by these
models.
5.4.4 Total Dollar Value of RP Transactions The total value of a firm’s RP transactions was found to be positively related to ownership
concentration (0.135), but inversely related to family ownership (-0.072). Audit quality was
observed to have a significant positive association with the total value of RP transactions. None
of the other corporate governance variables were associated significantly with total value of RP
transactions. This infers that the relative importance of the RP transactions is associated with
higher levels on non-family ownership.
When the RP transactions are classified into tunnelling and propping transactions, the following
was observed. RPT_LN_TUNNELLING representing total value of RP tunnelling transactions
was positively associated with ownership concentration (0.201). There was a negative association
with the corporate governance variable of board independence (-0.088), but a positive association
with audit quality (0.109) This inferred that consistent with the conflict of interest view, tunnelling
RP transactions were commonly found in firms with high levels of ownership concentration as
the owner stood to benefit from the transaction the most. Board independence constrains the
negative effects, and higher levels of audit quality were to signal to the market that the RP
transactions were above board. RPT_LN_PROPPING was found to be significantly negatively
associated with family ownership (-0.135). This is in line with the view that family owners were
more likely to expropriate minority shareholders due to benefit maximization. Audit quality again
is positively associated (0.101), acting as a sign of legitimacy and signalling to the market that
the propping RP transactions are above board.
In all three models duality and board size were not significant. Hypothesis H5 that corporate
governance and ownership concentration are associated with RP transactions is therefore
supported by these models.
99
Table 28 Factors Associated with RP Transactions
RPT
_IN
DIC
ATO
R
Sig.
RP_
IND
ICA
TOR
_TU
NN
ELIN
G
Sig.
RP_
IND
ICA
TOR
_PR
OP
PIN
G
Sig.
FIRM CHARACTERISTICS
DEBT_ASSET_RATIO -0.036 0.472
0.042 0.407
-0.136 0.004 **
LNASSETS 0.382 0 *** 0.191 0.003 ** 0.543 0 ***
FBMKLCI -0.094 0.054 * -0.044 0.373
-0.142 0.002 **
OWNERSHIP CONCENTRATION
PERCNTG_HELD_BY_LARGEST_SHAREHOLDER 0.187 0 *** 0.154 0 *** 0.02 0.606
IND_SHAREHOLDER_DIRECTOR 0.171 0 *** 0.376 0 *** -0.154 0 ***
CORPORATE GOVERNANCE
BOARD_SIZE 0.016 0.738
-0.107 0.026 ** 0.001 0.981
BOARD_INDEPENDENCE -0.126 0.003 ** -0.108 0.011 ** -0.127 0.001 **
DUALITY -0.036 0.386
-0.016 0.7
0.028 0.478
BIG4_AUDITOR 0.049 0.29
-0.012 0.803
0.036 0.413
*p-Value indicates significance at the 0.10 level using two-tailed significance tests. **p-Value indicates significance at the 0.05 level using two-tailed significance tests. ***p-Value indicates significance at the 0.01 level using two-tailed significance tests.
Variables are defined as follows: RP_INDICATOR = value is 1 if a firm discloses one or more RPT of any type, value is 0 if otherwise; RP_INDICATOR_TUNNELING = value is 1 if a firm discloses one or more RPT of tunnelling type, value is 0 if otherwise; RP_INDICATOR_PROPPING = value is 1 if a firm discloses one or more RPT of propping type, value is 0 if otherwise; DEBT_ASSET_RATIO = Total non-current liabilities divided by total assets; LNASSETS = natural logarithm of company’s total assets; FBMKLCI = value is 1 if company was a component stock of the FBMKLCI Index, value is 0 if otherwise; PERCNTG_HELD_BY_LARGEST_SHAREHOLDER = percentage of shares held by the largest shareholder including both direct and indirect interests; IND_SHAREHOLDER_DIRECTOR = value is 1 if the largest shareholder is an individual that sits on the board of directors, value is 0 if otherwise; BOARD_SIZE = number of directors at date of annual report for the financial year end; BOARD_INDEPENDENCE = Number of independent directors divided by total directors; DUALITY = value is 1 if Chairman and CEO is same person, value is 0 if otherwise; BIG4_AUDITOR = value is 1 if auditor for financial year end is “Big 4” auditor, Value is 0 if otherwise.
100
RP_
TOTA
L
_CO
UN
T_S
CA
LED
_BO
AR
D
Sig.
RPT
_TU
NN
ELLI
NG
_C
OU
NT_
SCA
LED
_BO
AR
D
Sig.
RPT
_PR
OPP
ING
_CO
UN
T_SC
ALE
D
_BO
AR
D
Sig.
FIRM CHARACTERISTICS
DEBT_ASSET_RATIO -0.05 0.329
-0.004 0.933
-0.157 0.001 **
LNASSETS 0.237 0 *** 0.099 0.143
0.508 0 ***
FBMKLCI -0.089 0.072 * -0.074 0.148
-0.077 0.085 *
OWNERSHIP CONCENTRATION
PERCNTG_HELD_BY_LARGEST_SHAREHOLDER 0.194 0 *** 0.173 0 *** 0.132 0.001 **
IND_SHAREHOLDER_DIRECTOR 0.095 0.04 ** 0.162 0.001 ** -0.175 0 ***
CORPORATE GOVERNANCE
BOARD_SIZE -0.084 0.083 * -0.052 0.299
-0.129 0.004 **
BOARD_INDEPENDENCE -0.142 0.001 ** -0.142 0.001 ** -0.047 0.232
DUALITY 0.004 0.919
0.01 0.824
-0.015 0.692
BIG4_AUDITOR 0.169 0 *** 0.163 0.001 ** 0.073 0.09 *
*p-Value indicates significance at the 0.10 level using two-tailed significance tests. **p-Value indicates significance at the 0.05 level using two-tailed significance tests. ***p-Value indicates significance at the 0.01 level using two-tailed significance tests.
Variables are defined as follows: RP_TOTAL_COUNT_SCALED_BOARD = number of RPT scaled by board size; RPT_TUNNELLING_COUNT_SCALED_BOARD = number of tunnelling transactions disclosed scaled by board size; RPT_PROPPING_COUNT_SCALED_BOARD = number of propping transactions disclosed scaled by board size; DEBT_ASSET_RATIO = Total non-current liabilities divided by total assets; LNASSETS = natural logarithm of company’s total assets; FBMKLCI = value is 1 if company was a component stock of the FBMKLCI Index, value is 0 if otherwise; PERCNTG_HELD_BY_LARGEST_SHAREHOLDER = percentage of shares held by the largest shareholder including both direct and indirect interests; IND_SHAREHOLDER_DIRECTOR = value is 1 if the largest shareholder is an individual that sits on the board of directors, value is 0 if otherwise; BOARD_SIZE = number of directors at date of annual report for the financial year end; BOARD_INDEPENDENCE = Number of independent directors divided by total directors; DUALITY = value is 1 if Chairman and CEO is same person, value is 0 if otherwise; BIG4_AUDITOR = value is 1 if auditor for financial year end is “Big 4” auditor, Value is 0 if otherwise.
101
RPT
_TO
TA
L_SC
ALE
D
_ASS
ETS
Sig.
RPT
_TU
NN
ELLI
NG
_T
HO
USA
ND
S_SC
ALE
D
_ A
SSET
S
Sig.
RPT
_PR
OPP
ING
_TH
OU
SAN
DS_
SC
ALE
D_
ASS
ETS
Sig.
FIRM CHARACTERISTICS
DEBT_ASSET_RATIO -0.23 0 *** -0.083 0.121
-0.219 0 ***
LNASSETS 0.067 0.314
-0.062 0.37
0.092 0.166
FBMKLCI 0.179 0 *** -0.046 0.369
0.207 0 ***
OWNERSHIP CONCENTRATION
PERCNTG_HELD_BY_LARGEST_SHAREHOLDER 0.152 0 *** 0.222 0 *** 0.09 0.037 **
IND_SHAREHOLDER_DIRECTOR -0.116 0.013 ** 0.137 0.005 ** -0.169 0 ***
CORPORATE GOVERNANCE
BOARD_SIZE -0.075 0.125
0.024 0.634
-0.089 0.071 *
BOARD_INDEPENDENCE -0.068 0.119
0.06 0.181
-0.092 0.033 **
DUALITY -0.067 0.118
-0.037 0.398
-0.059 0.165
BIG4_AUDITOR 0.082 0.089 * 0.107 0.031 ** 0.052 0.276
*p-Value indicates significance at the 0.10 level using two-tailed significance tests. **p-Value indicates significance at the 0.05 level using two-tailed significance tests. ***p-Value indicates significance at the 0.01 level using two-tailed significance tests.
Variables are defined as follows: RPT_TOTAL_SCALED_ASSETS = RPT value scaled by assets; RPT_TUNNELLING_THOUSANDS_SCALED_ ASSETS = RPT tunnelling value only scaled by assets; RPT_PROPPING_THOUSANDS_SCALED_ ASSETS = RPT propping value only scaled by assets; DEBT_ASSET_RATIO = Total non-current liabilities divided by total assets; LNASSETS = natural logarithm of company’s total assets; FBMKLCI = value is 1 if company was a component stock of the FBMKLCI Index, value is 0 if otherwise; PERCNTG_HELD_BY_LARGEST_SHAREHOLDER = percentage of shares held by the largest shareholder including both direct and indirect interests; IND_SHAREHOLDER_DIRECTOR = value is 1 if the largest shareholder is an individual that sits on the board of directors, value is 0 if otherwise; BOARD_SIZE = number of directors at date of annual report for the financial year end; BOARD_INDEPENDENCE = Number of independent directors divided by total directors; DUALITY = value is 1 if Chairman and CEO is same person, value is 0 if otherwise; BIG4_AUDITOR = value is 1 if auditor for financial year end is “Big 4” auditor, Value is 0 if otherwise.
102
RPT
_LN
_TO
T
AL
Sig.
RPT
_LN
_TU
N
NEL
LIN
G
Sig.
RPT
_LN
_PR
O
PPIN
G
Sig.
FIRM CHARACTERISTICS
DEBT_ASSET_RATIO -0.06 0.163
0.11 0.046 ** -0.163 0.013 **
LNASSETS 0.628 0 *** 0.369 0 *** 0.669 0 ***
FBMKLCI 0.015 0.722
0.015 0.794
0.025 0.694
OWNERSHIP CONCENTRATION
PERCNTG_HELD_BY_LARGEST_SHAREHOLDER 0.135 0 *** 0.201 0 *** -0.025 0.63
IND_SHAREHOLDER_DIRECTOR -0.072 0.081 * 0.012 0.81
-0.135 0.025 **
CORPORATE GOVERNANCE
BOARD_SIZE -0.054 0.185
0 0.995
-0.078 0.156
BOARD_INDEPENDENCE -0.057 0.113
-0.088 0.069 * 0.022 0.663
DUALITY 0.013 0.712
0.052 0.269
-0.07 0.172
BIG4_AUDITOR 0.106 0.01 ** 0.109 0.037 ** 0.101 0.075 *
*p-Value indicates significance at the 0.10 level using two-tailed significance tests. **p-Value indicates significance at the 0.05 level using two-tailed significance tests. ***p-Value indicates significance at the 0.01 level using two-tailed significance tests.
Variables are defined as follows: RPT_LN_TOTAL = natural log of value of total RPT; RPT_LN_TUNNELLING = natural log of value of tunnelling RPT; RPT_LN_PROPPING = natural log of value of propping RPT; DEBT_ASSET_RATIO = Total non-current liabilities divided by total assets; LNASSETS = natural logarithm of company’s total assets; FBMKLCI = value is 1 if company was a component stock of the FBMKLCI Index, value is 0 if otherwise; PERCNTG_HELD_BY_LARGEST_SHAREHOLDER = percentage of shares held by the largest shareholder including both direct and indirect interests; IND_SHAREHOLDER_DIRECTOR = value is 1 if the largest shareholder is an individual that sits on the board of directors, value is 0 if otherwise; BOARD_SIZE = number of directors at date of annual report for the financial year end; BOARD_INDEPENDENCE = Number of independent directors divided by total directors; DUALITY = value is 1 if Chairman and CEO is same person, value is 0 if otherwise; BIG4_AUDITOR = value is 1 if auditor for financial year end is “Big 4” auditor, Value is 0 if otherwise.
103
5.5 Discussion of Results This section discusses the results of the data analysis performed, and the interpretation of the results.
5.5.1 Effect of Related Party Transactions on Firm Valuation and Performance H1: Related party transactions do not have a significant effect on the firm’s valuation and
performance.
Table 29 Summary of Results for Effect of Related Party Transactions on Firm Valuation and Performance
Prediction Firm Valuation Firm Performance
RPT_INDICATOR ?
RP_TOTAL_COUNT_SCALED_BOA
RD
?
RPT_TOTAL_SCALED_ASSETS ? Not supported, 0.179,
p<0.01
RPT_LN_TOTAL ? Not supported, 0.210,
p<0.05
Variables are defined as follows: RP_INDICATOR = value is 1 if a firm discloses one or more RPT of any type, value
is 0 if otherwise; RP_TOTAL_COUNT_SCALED_BOARD = number of RPT scaled by board size;
RPT_TOTAL_SCALED_ASSETS = RPT value scaled by assets; RPT_LN_TOTAL = natural log of value of total
RPT.
Hypothesis H1 is a null hypothesis. Total RP transactions, when measured by relative importance
to the firm and related party (RPT_TOTAL_SCALED_ASSETS, RPT_LN_TOTAL), do have a
significant impact on firm valuation. This is consistent with a situation where an equilibrium
condition exists whereby investors price protect against the potential effects of RP transactions
(Jensen & Meckling 1976, p.305). The positive coefficients for both
RPT_TOTAL_SCALED_ASSETS and RPT_LN_TOTAL may on the surface be due to larger
amounts of beneficial RP transactions contained within the totals. Both these variables are totals
of both tunnelling and propping RP transactions. A cursory examination of the descriptive
statistics is in line with this reasoning. For example, RPT_TOTAL_SCALED_ASSETS is the
total of RPT_TUNNELLING_THOUSANDS_SCALED_ASSETS and
RPT_PROPPING_THOUSANDS_SCALED_ASSETS, which each have a mean of 0.0329 and
0.0691 respectively. It is clear from these means that the propping RP transactions have a mean
(0.0691) that is more than twice that of the tunnelling RP transactions (0.0329). The following
hypotheses H2, and H3 further examine the impact of RP transactions when broken down into
tunnelling and propping components.
On the other hand, no impact is observed on firm performance. The lack of impact on firm
performance can be explained by the way firm performance is measured. As firm performance is
represented by ROA, which is an accounting based measure, it is possible that the reported effects
104
are concealed. RP transactions themselves are noted as a tool for earnings management (Jian &
Wong 2003). These results initially seem to be at odds with findings from Wahab et al. (2011,
p.153). In that study a significant negative relationship between RP transactions and firm
performance was found. Upon a detailed reading of the empirical findings, the significance of the
relationship found in this prior study was of little economic impact. When translated into
economic terms, the negative relationship with RP transactions resulted in a mere -1.014%
decrease to ROA (Wahab et al. 2011, p.153). Further testing in hypotheses H2 and H3 to examine
the impact of RP transactions when broken down into tunnelling and propping components
attempts to find more insight into the relationship.
Based on the observations, hypothesis H1 is supported, but only for firm valuation. Therefore RP
transactions, when considered in totality, have a significant impact on firm valuation, but not on
firm performance.
5.5.2 Effect of Tunnelling and Propping Related Party Transactions H2: Tunnelling related party transactions have a significant negative effect on the firm’s
valuation and performance.
H3: Propping related party transactions have a neutral or significant positive effect on the
firm’s valuation and performance.
Table 30 Summary of Results for Effect of Tunnelling and Propping Related Party Transactions
Prediction Firm Valuation Firm Performance
RP_INDICATOR_TUNNELING -
RP_INDICATOR_PROPPING +/? Supported, 0.191,
p<0.01
RPT_TUNNELLING_COUNT_SCALED_BOARD -
RPT_PROPPING_COUNT_SCALED_BOARD +/? Supported, 0.083,
p<0.10
RPT_TUNNELLING_THOUSANDS_SCALED_
ASSETS
-
RPT_PROPPING_THOUSANDS_SCALED_ ASSETS +/? Supported, 0.175,
p<0.01
RPT_LN_TUNNELLING - Supported, -0.197,
p<0.05
RPT_LN_PROPPING +/? Supported, 0.269,
p<0.05
Supported, -0.241,
p<0.05 Variables are defined as follows: RP_INDICATOR_TUNNELING = value is 1 if a firm discloses one or more RPT of
tunnelling type, value is 0 if otherwise; RP_INDICATOR_PROPPING = value is 1 if a firm discloses one or more RPT
of propping type, value is 0 if otherwise; RPT_TUNNELLING_COUNT_SCALED_BOARD = number of tunnelling
transactions disclosed scaled by board size; RPT_PROPPING_COUNT_SCALED_BOARD = number of propping
105
transactions disclosed scaled by board size; RPT_TUNNELLING_THOUSANDS_SCALED_ ASSETS = RPT
tunnelling value only scaled by assets; RPT_PROPPING_THOUSANDS_SCALED_ ASSETS = RPT propping value
only scaled by assets; RPT_LN_TUNNELLING = natural log of value of tunnelling RPT; RPT_LN_PROPPING =
natural log of value of propping RPT.
Hypotheses H2 and H3 deal with the impact of RP transactions when they are classified into either
tunnelling or propping transactions. When RP transactions were classified into different types of
RP transactions, it was clear that there were varying impacts on firm valuation. Consistent with
the observations of Cheung et al. (2006, p.384) on the relationship of RP transactions on firm
valuation in Hong Kong, an obvious demarcation in terms of the impact of different types of RP
transactions is seen in this study.
Propping RP transaction show a clear positive association firm valuation in all variable tested.
The coefficients range from 0.083 to 0.269, with an average of 0.1795. Based on a mean Tobin’s
Q of 1.3552, the average impact of propping RP transaction is 0.1795/1.3552 = 13.24%. Propping
transactions on average result in a 13.24% valuation premium. The firm must derive certain
benefits from propping RP transactions that justify the transaction being entered into by the firm.
Dealing with members of the same group, or at least with parties which are known to the firm,
may mitigate the problems such as enforcement of contracts and property rights, which are critical
to the corporation (Cheung et al. 2009, p.915; Khanna & Palepu 1997). Other benefits of propping
include the reduction of information asymmetry. For example confidential information does not
need to be shared with an external party (Gordon et al. 2004a, p.11; 2004b, p.36). It is inferred
that these benefits confer an advantage on the firm undertaking propping RP transactions,
resulting in better market valuation.
Tunnelling RP transactions had a clear negative impact on firm valuation. In 3 out of the 4
tunnelling RP transaction variables tested, the coefficient had a negative sign. This is consistent
with the tunnelling hypothesis that states that such RP transactions are conflicts of interest that
results in expropriation of the minority shareholders that reduces firm value (Liew et al. 2011,
p.139). However only the variable which measured relative importance
(RPT_LN_TUNNELLING) was statistically significant. Based on the coefficient of -0.197, and
a mean Tobin’s Q of 1.3552, the average impact was -0.197/1.3552 = -14.54%. This means that
RP transactions resulted in a valuation discount of 14.54%. This compares with an 8% discount
as measured in the North American market study done by Kohlbeck and Mayhew (2010, p.121).
For the variables tested that had negative coefficients but were not statistically significant, it is
inferred that investors do not price protect or give a valuation discount to a firm merely due to the
presence of tunnelling RP transactions (proxied by RP_INDICATOR_TUNNELING), or due to
the pervasiveness of such transactions (proxied by
RPT_TUNNELLING_COUNT_SCALED_BOARD). The primary cause for the valuation
106
discount by the market is relative importance of the RP transaction to the related party (as proxied
by RPT_LN_TUNNELLING). This is in line with the view that it is possible for the quantum of
RP transactions to be large in relation to the related party but sufficiently small so as to be
immaterial to the firm. This argument is consistent with the view that RP transactions do not
negatively impact the firm (Gordon et al. 2004a, p.11; Wahab et al. 2011, p.146). Another
explanation for the lack of significance in the relationship between tunnelling RP transactions and
firm valuation could be that the value of the RP transaction does not fully represent the economic
loss suffered by the firm (Ryngaert & Thomas 2007, p.16). For example, the firm may contract
with a related party to purchase RM1,000,000 worth of goods. The firm may have overpaid for
the goods by say RM200,000, thus leaving the true economic value of the goods at RM800,000.
In this case the economic loss suffered due to the tunnelling RP transactions is the overpayment
of RM200,000. However this study captures the whole value of RM1,000,000 as being a
tunnelling RP transaction, which may over-represent the actual economic loss suffered due to the
tunnelling RP transaction. This leads to the possibility that the loss suffered due to tunnelling RP
transactions is immaterial and does not affect firm valuation. In turn this leads to the lack of any
significant relationship between tunnelling RP transactions and firm valuation as observed above.
None of the variables except for RPT_LN_PROPPING were significantly associated with firm
performance. The lack of impact on firm performance can be explained by the way firm
performance is measured. As firm performance is represented by ROA, which is an accounting
based measure, it is possible that the reported effects are concealed. RP transactions themselves
are noted as a tool for earnings management (Jian & Wong 2003). For RPT_LN_PROPPING, the
coefficient was found to be negative, which was contrary to the expectation that propping would
have a positive to neutral effect on firm performance. It may be inferred that firms that needed
propping were in fact performing poorly financially, thus necessitating the propping transactions
in the first place (Cheung et al. 2006; Ying & Wang 2013). The negative association between
propping RP transactions and firm performance may therefore be one of reverse causality. The
poor firm performance thus creating the need for a propping transaction (Jian & Wong 2010, p.74;
Ying & Wang 2013, p.134). This may be an area for future research into factors surrounding
propping RP transactions.
Based on the observations, hypothesis H2 is supported, but only for firm valuation. Tunnelling
RP transactions, have a significant negative impact on firm valuation, but not on firm
performance. Hypothesis H3 is also supported, again only for firm valuation. Propping RP
transactions have a significant positive impact on firm valuation.
5.5.3 Impact of Corporate Governance and Ownership Concentration H4: Ownership concentration and corporate governance has a significant effect on the
relationship between related party transactions and firm valuation and performance.
107
Hypothesis H4 examines the effects that ownership concentration and corporate governance can
have on the relationship between RP transactions and firm valuation and performance. Ownership
concentration, as measured by the percentage shareholding held by the largest shareholder
(PERCNTG_HELD_BY_LARGEST_SHAREHOLDER) was significantly positively associated
with the relationship between RP transactions and firm valuation. This reaffirms the role of
ownership concentration as an internal corporate governance mechanism (Shleifer & Vishny
1997, p.742; Gordon et al. 2004b, p.24; Boubakri et al. 2005, p.369). The higher the concentration
of ownership, the more incentive a shareholder or a small number of shareholders have to monitor,
reward and penalize management, leading to better firm valuation (Shleifer & Vishny 1997,
p.742).
Similarly, board size was found to have a significant positive association with the relationship
between RP transactions and firm valuation. This is at odds with prior research by Haniffa and
Hudaib (2006, p.1034) that found a negative association between board size and valuation. The
broader literature by Yermack (1996, p.185), Eisenberg et al. (1998, p.35), and Mak & Kusnadi
(2005, p.301) support this view that larger board sizes were negatively related to firm value. The
results in this study may be explained in terms of increased access. Larger boards may increase
the firm’s access to resources, as well expand the range of experience of board members, which
reduces risk to the firm (Haniffa & Hudaib 2006, p. 1038). This enhances corporate governance
as a variety of skills, experiences, knowledge and expertise can be had with a larger board
(Ghazali 2010, p. 112). A larger board also may have increased capability to monitor management
as the number of directors increases (Sulong & Noor 2008, p. 62; Amran & Ahmad 2011, p.23).
This higher level of oversight may contribute to the positive effect of a larger board on firm
valuation. At the same time, as with any corporate governance mechanism, it must be remembered
that each country has its own unique national character, and each corporation has its own unique
background, environment and business objectives. Thus what is desirable from a corporate
governance perspective in one scenario may not be so in another (Haniffa & Hudaib 2006,
p.1035). For example, larger boards in Malaysia may be to accommodate prominent board
members who were retired civil servants or other dignitaries (Amran & Ahmad 2011, p.23).
A significant positive association was also found between audit quality (BIG4_AUDITOR) and
RP transactions and firm valuation. This is consistent with prior studies that posit that a firm with
RP transactions will want a more credible auditor appointed to enhance the legitimacy of their
transactions and to play a certification role (Wahab et al. 2011, p.131; Gordon et al. 2007, p.82;
Fan & Wong 2005, p.35). The auditor plays the role of an external corporate governance
mechanism. Duality was not found to have any significant impact on RP transactions and firm
valuation at all.
108
A key finding was a lack of any significant impact of board independence on the relationship
between RP transactions and firm valuation. This is relevant for when analysis was done for RP
transactions in totality, and also when divided into different types of RP transactions. No
meaningful result was observed. This result is not consistent with prior research done in other
countries, but is consistent with Malaysian research. The monitoring function of a board of
directors brings independence and oversight to the firm (Fama 1980, p.293; Fama & Jensen 1983,
p.14). Kohlbeck and Mayhew (2004, p.6) found that stronger board independence lowered the
probability of RP transactions. Board independence has been found to be effective in reducing
the negative effects of RP transactions in the context of transfer pricing (Lo, Wong, & Firth 2010,
p.225). This is inconsistent with the findings in this study, in which board independence had no
impact on the relationship between RP transactions and firm valuation, except in only one of the
models tested (RPT_LN_TUNNELLING + RPT_LN_PROPPING). The difference in the
findings of this study and other prior international research may be due to prior studies not being
done in a Malaysian context. As with other corporate governance mechanism, each country has
its own unique national character, and each corporation has its own unique background,
environment and business objectives. Thus what is desirable from a corporate governance
perspective in one scenario may not be so in another (Haniffa & Hudaib 2006, p.1035). Studies
from a Malaysian perspective confirm this, as board independence was found not to have any
significant effect on Tobin’s Q (Haniffa & Hudaib 2006, p.1035). It is also possible that politically
connected businessmen, having protection that their political ties afford them, engage in RP
transactions regardless of corporate governance measures in place (Liew et al. 2011, pg 141; Ng
2012).
Corporate governance and ownership concentration had limited impact on RP transactions and
firm performance. This lack of impact is consistent with prior corporate governance research in a
Malaysian context (Noor & Fadzli 2013, p.202; Liew et al. 2011, p.139). The level of ownership
concentration was not significantly associated with the relationship between RP transactions and
firm performance. Although family ownership and board size had significant positive
associations, these were limited to two and one variable tested respectively. Similarly audit quality
was not significantly associated in any of the variables tested. Duality on the other hand was
significantly associated with the relationship between RP transactions and firm performance. This
infers that the check and balance that should exist between the two positions of chairman and
CEO, is reduced and as a result enables self-dealing behaviour to be unchecked (Rahmat 2013,
p.67). This is also consistent with prior research that found negative associations between duality
and firm performance in Malaysia (Haniffa & Hudaib 2006, p.1054). This is also in line with
studies that have reaffirmed the positive association between ownership concentration, duality
and the size of RP transactions (Hu et al. 2012, p.58).
109
Based on the observations, hypothesis H4 is supported for firm valuation but not firm
performance. Corporate governance and ownership concentration have a significant effect on the
relationship between RP transactions and firm valuation.
110
Firm Valuation (Tobin’s Q)
Table 31 Summary of Results for Firm Valuation
Prediction
RPT_INDICATOR
RP_TOTAL_COUNT_SCALED_BOARD
RPT_TOTAL_SCALED_ASSETS
RPT_LN_TOTAL
RP_INDICATOR_TUNNELING + RP_INDICATOR_PROPPING
RPT_TUNNELLING_COUNT_SCALED_BOARD +RPT_PROPPING_COUNT_SCALED_BOARD
RPT_TUNNELLING_THOUSANDS_SCALED_ ASSETS + RPT_PROPPING_THOUSANDS_SCALED_ ASSETS
RPT_LN_TUNNELLING + RPT_LN_PROPPING
PERCNTG_HELD_BY_LARGEST_SHAREHOLDER
+/- Supported, 0.076, p<0.10
Supported, 0.087, p<0.10
Supported, 0.076, p<0.10
Supported, 0.076, p<0.10
IND_SHAREHOLDER_DIRECTOR
- Supported, -0.094, p<0.10
BOARD_SIZE +/- Supported, 0.117, p<0.05
Supported, 0.116, p<0.05
Supported, 0.129, p<0.05
Supported, 0.120, p<0.05
Supported, 0.120, p<0.05
Supported, 0.131, p<0.05
BOARD_INDEPENDENCE
+
Supported, 0.188, p<0.05
DUALITY -
BIG4_AUDITOR + Supported, 0.103, p<0.05
Supported, 0.108, p<0.05
Supported, 0.092, p<0.10
Supported, 0.080, p<0.10
Supported, 0.099, p<0.05
Supported, 0.099, p<0.05
Supported, 0.094, p<0.10
Variables are defined as follows: RP_INDICATOR = value is 1 if a firm discloses one or more RPT of any type, value is 0 if otherwise; RP_TOTAL_COUNT_SCALED_BOARD =
number of RPT scaled by board size; RPT_TOTAL_SCALED_ASSETS = RPT value scaled by assets; RPT_LN_TOTAL = natural log of value of total RPT;
RP_INDICATOR_TUNNELING = value is 1 if a firm discloses one or more RPT of tunnelling type, value is 0 if otherwise; RP_INDICATOR_PROPPING = value is 1 if a firm discloses
one or more RPT of propping type, value is 0 if otherwise; RPT_TUNNELLING_COUNT_SCALED_BOARD = number of tunnelling transactions disclosed scaled by board size;
RPT_PROPPING_COUNT_SCALED_BOARD = number of propping transactions disclosed scaled by board size; RPT_TUNNELLING_THOUSANDS_SCALED_ ASSETS = RPT
tunnelling value only scaled by assets; RPT_PROPPING_THOUSANDS_SCALED_ ASSETS = RPT propping value only scaled by assets; RPT_LN_TUNNELLING = natural log of
value of tunnelling RPT; RPT_LN_PROPPING = natural log of value of propping RPT; PERCNTG_HELD_BY_LARGEST_SHAREHOLDER = percentage of shares held by the largest
shareholder including both direct and indirect interests; IND_SHAREHOLDER_DIRECTOR = value is 1 if the largest shareholder is an individual that sits on the board of directors, value
is 0 if otherwise; BOARD_SIZE = number of directors at date of annual report for the financial year end; BOARD_INDEPENDENCE = Number of independent directors divided by total
directors; DUALITY = value is 1 if Chairman and CEO is same person, value is 0 if otherwise; BIG4_AUDITOR = value is 1 if auditor for financial year end is “Big 4” auditor, Value is
0 if otherwise.
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Firm Performance (ROA)
Table 32 Summary of Results for Firm Performance
Prediction
RPT_INDICATOR
RP_TOTAL_COUNT_SCALED_BOARD
RPT_TOTAL_SCALED_ASSETS
RPT_LN_TOTAL
RP_INDICATOR_TUNNELING + RP_INDICATOR_PROPPING
RPT_TUNNELLING_COUNT_SCALED_BOARD +RPT_PROPPING_COUNT_SCALED_BOARD
RPT_TUNNELLING_THOUSANDS_SCALED_ ASSETS + RPT_PROPPING_THOUSANDS_SCALED_ ASSETS
RPT_LN_TUNNELLING + RPT_LN_PROPPING
PERCNTG_HELD_BY_LARGEST_SHAREHOLDER
+/-
IND_SHAREHOLDER_DIRECTOR
-
Supported, -0.112, p<0.10
Supported, -0.253, p<0.05
BOARD_SIZE +/-
Supported, -0.112, p<0.10
BOARD_INDEPENDENCE
+
DUALITY - Supported, -0.102, p<0.05
Supported, -0.104, p<0.05
Supported, -0.105, p<0.05
Supported, -0.106, p<0.05
Supported, -0.105, p<0.05
Supported, -0.106, p<0.05
BIG4_AUDITOR +
Variables are defined as follows: RP_INDICATOR = value is 1 if a firm discloses one or more RPT of any type, value is 0 if otherwise; RP_TOTAL_COUNT_SCALED_BOARD =
number of RPT scaled by board size; RPT_TOTAL_SCALED_ASSETS = RPT value scaled by assets; RPT_LN_TOTAL = natural log of value of total RPT;
RP_INDICATOR_TUNNELING = value is 1 if a firm discloses one or more RPT of tunnelling type, value is 0 if otherwise; RP_INDICATOR_PROPPING = value is 1 if a firm discloses
one or more RPT of propping type, value is 0 if otherwise; RPT_TUNNELLING_COUNT_SCALED_BOARD = number of tunnelling transactions disclosed scaled by board size;
RPT_PROPPING_COUNT_SCALED_BOARD = number of propping transactions disclosed scaled by board size; RPT_TUNNELLING_THOUSANDS_SCALED_ ASSETS = RPT
tunnelling value only scaled by assets; RPT_PROPPING_THOUSANDS_SCALED_ ASSETS = RPT propping value only scaled by assets; RPT_LN_TUNNELLING = natural log of
value of tunnelling RPT; RPT_LN_PROPPING = natural log of value of propping RPT; PERCNTG_HELD_BY_LARGEST_SHAREHOLDER = percentage of shares held by the largest
shareholder including both direct and indirect interests; IND_SHAREHOLDER_DIRECTOR = value is 1 if the largest shareholder is an individual that sits on the board of directors, value
is 0 if otherwise; BOARD_SIZE = number of directors at date of annual report for the financial year end; BOARD_INDEPENDENCE = Number of independent directors divided by total
directors; DUALITY = value is 1 if Chairman and CEO is same person, value is 0 if otherwise; BIG4_AUDITOR = value is 1 if auditor for financial year end is “Big 4” auditor, Value is
0 if otherwise.
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5.5.4 Factors Associated with RP Transactions H5: Corporate governance and ownership concentration are associated with related party
transactions.
The associations between corporate governance and ownership concentration with related party
transactions are also explored in hypothesis H5. Ownership concentration has a clear positive
association with RP transactions. Higher ownership concentration results in more RP transactions
in general, and more propping and tunnelling transaction more specifically. This observation was
largely consistent across all RP variables tested. This may be the results of the unique settings of
the Malaysian political economy, where a high concentration of corporate wealth, often through
the redistribution of state assets, were held in the hands of a select few, who then engage in RP
transactions to maintain the system of political patronage (Jomo & Gomez 1999; Ng 2012).
Family ownership was also significantly associated with RP transactions. In particular, family
ownership was significantly positively related to tunnelling RP transactions whilst at the same
time being negatively related to propping RP transactions. Family ownership is less associated
with propping RP transactions, as such owners would only be concerned with extraction of private
benefits for themselves. The large shareholder has the most to gain from any effort expended in
watching over management (Gordon et al. 2004b, p.36). At the same time, ownership
concentration can have its own costs to the remaining shareholders. A large controlling
shareholder can also more easily control management by appointing key posts and engage
expropriation of minority shareholders (Shleifer & Vishny 1997, p.737; Claessens et al. 2000,
p.81). This is clearly illustrated by the results of this study, in which family ownership was
significantly positively related to tunnelling RP transactions whilst at the same time being
negatively related to propping RP transactions.
Board size was negatively associated with RP transactions, consistent with existing corporate
governance literature that posits the lack of effectiveness as boards grow in size (Jensen 1993,
p.865; Yermack 1996, p.185; Mak & Kusnadi 2005, p.301). Another key corporate governance
measure is board independence. The level of board independence has a significant negative
relationship with RP transactions of all types. This is consistent with the Kohlbeck and Mayhew’s
(2004, p. 20) study which also found that higher levels of board independence were associated
with less RP transactions. The monitoring function of a board of directors that brings
independence and oversight to the firm is also theorized (Fama 1980, p.293; Fama & Jensen 1983,
p.14). Audit quality had a positive association with RP transactions. This is consistent with prior
studies that posit that a firm with RP transactions will want a more credible auditor appointed to
enhance the legitimacy of their transactions and to play a certification role (Wahab et al. 2011,
p.131; Gordon et al. 2007, p.83; Fan & Wong 2005, p.35). Duality was found to not have any
significant impact on RP transactions in any of the variables tested. A possible explanation is that
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a large controlling shareholder may already control the board, and would not need to have the
same individual in both the role of CEO and chairman. It is also possible that to give the
semblance of good corporate governance, a firm engaging in RP transactions may intentionally
appoint separate individuals to the role of CEO and chairman.
Hypothesis H5 is thus supported. Corporate governance and ownership concentration have a
significant association with RP transactions.
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Table 33 Summary of Results for Factors Associated with RP Transactions
Prediction
RPT_INDICATOR
RP_INDICATOR_TUNNELING
RP_INDICATOR_PROPPING
RP_TOTAL_COUNT_SCALED_BOARD
RPT_TUNNELLING_COUNT_SCALED_BOARD
RPT_PROPPING_COUNT_SCALED_BOARD
RPT_TOTAL_SCALED_ASSETS
RPT_TUNNELLING_THOUSANDS_SCALED_ ASSETS
RPT_PROPPING_THOUSANDS_SCALED_ ASSETS
RPT_LN_TOTAL
RPT_LN_TUNNELLING
RPT_LN_PROPPING
PERCNTG_HELD_BY_LARGEST_SHAREHOLDER
? Supported, 0.187, p<0.01
Supported, 0.154, p<0.01
Supported, 0.194, p<0.01
Supported, 0.173, p<0.01
Supported, 0.132, p<0.05
Supported, 0.152, p<0.01
Supported, 0.222, p<0.01
Supported, 0.090, p<0.05
Supported, 0.135, p<0.01
Supported, 0.201, p<0.01
IND_SHAREHOLDER_DIRECTOR
? Supported, 0.171, p<0.01
Supported, 0.376, p<0.01
Supported, -0.154, p<0.01
Supported, 0.095, p<0.05
Supported, 0.162, p<0.05
Supported,- 0.175, p<0.01
Supported,- 0.116, p<0.05
Supported, 0.137, p<0.05
Supported, -0.169, p<0.01
Supported, -0.072, p<0.10
Supported, -0.135, p<0.05
BOARD_SIZE ?
Supported, -0.107, p<0.05
Supported, -0.084, p<0.10
Supported, -0.129, p<0.05
Supported, -0.89, p<0.10
BOARD_INDEPENDENCE
? Supported, -0.126, p<0.05
Supported, -0.108, p<0.05
Supported, -0.127, p<0.05
Supported, -0.142, p<0.05
Supported, -0.142, p<0.05
Supported, -0.92, p<0.05
Supported, -0.088, p<0.10
DUALITY ?
BIG4_AUDITOR
?
Supported, 0.169, p<0.01
Supported, 0.163, p<0.05
Supported, 0.09, p<0.10
Supported, 0.082, p<0.10
Supported, 0.107, p<0.05
Supported, 0.106, p<0.05
Supported, 0.109, p<0.05
Supported, 0.101, p<0.10
Variables are defined as follows: RP_INDICATOR = value is 1 if a firm discloses one or more RPT of any type, value is 0 if otherwise; RP_TOTAL_COUNT_SCALED_BOARD =
number of RPT scaled by board size; RPT_TOTAL_SCALED_ASSETS = RPT value scaled by assets; RPT_LN_TOTAL = natural log of value of total RPT;
RP_INDICATOR_TUNNELING = value is 1 if a firm discloses one or more RPT of tunnelling type, value is 0 if otherwise; RP_INDICATOR_PROPPING = value is 1 if a firm discloses
one or more RPT of propping type, value is 0 if otherwise; RPT_TUNNELLING_COUNT_SCALED_BOARD = number of tunnelling transactions disclosed scaled by board size;
RPT_PROPPING_COUNT_SCALED_BOARD = number of propping transactions disclosed scaled by board size; RPT_TUNNELLING_THOUSANDS_SCALED_ ASSETS = RPT
tunnelling value only scaled by assets; RPT_PROPPING_THOUSANDS_SCALED_ ASSETS = RPT propping value only scaled by assets; RPT_LN_TUNNELLING = natural log of
value of tunnelling RPT; RPT_LN_PROPPING = natural log of value of propping RPT; PERCNTG_HELD_BY_LARGEST_SHAREHOLDER = percentage of shares held by the largest
shareholder including both direct and indirect interests; IND_SHAREHOLDER_DIRECTOR = value is 1 if the largest shareholder is an individual that sits on the board of directors, value
is 0 if otherwise; BOARD_SIZE = number of directors at date of annual report for the financial year end; BOARD_INDEPENDENCE = Number of independent directors divided by total
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directors; DUALITY = value is 1 if Chairman and CEO is same person, value is 0 if otherwise; BIG4_AUDITOR = value is 1 if auditor for financial year end is “Big 4” auditor, Value is
0 if otherwise.
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6 Conclusion
6.1 Summary of Thesis Chapter 1 begins with an introduction to this thesis, as well as the research objectives, significance
of this study and key limitations.
Chapter 2 reviews the existing literature on RP transactions, reasons for this study, and develops
the hypotheses for testing. This chapter contains 5 sections. In the first section, the role and
significance of corporate governance is examined. The concept of corporate governance itself,
and traditional theories such as agency theory and transaction cost economics are considered.
Both internal and external corporate governance mechanisms are also looked at. The second
section examines the nature of RP transactions within the theoretical framework developed by
other researchers. In particular, agency theory and transaction cost economics are used in building
up the case for this study. In the following section, a detailed elaboration of the Malaysian context
of RP transactions from the viewpoint of legislation and regulator-issued guidance is dealt with.
Key aspects of the Malaysian political economy are also covered. The fourth section reviews
existing studies and their results regarding RP transactions, corporate governance and firm
valuation and performance. Finally, based on the arguments of the preceding chapters, and
underpinned by the theoretical framework in place, the necessary hypotheses are developed and
outlined.
Chapter 3 outlines the conceptual framework used by this study as well as the general formulae
that was used to test the hypotheses developed in the previous chapter. This is followed by the
detailed specification of each model, as well as the definition and operationalization of each
variable. In the course of this study, it was noted that a large number of prior work on RP
transactions do not explain the practical aspects of data collection and variable definition with
relation to RP transactions. To this end this study has clearly defined the exact data parameters
used for each variable, traceable to the secondary data utilised. The remaining sections deal with
the usage of secondary data and the reasons for doing so. This chapter then concludes with the
process of the sample selection for this study.
Chapter 4 contains descriptive analysis of the variables being tested. The numbers are compared
to prior studies from Malaysia. An in-depth look at RP transaction is also performed, contributing
to the body of knowledge on RP transactions in Malaysia and providing descriptive statistics for
such transactions. The following section then outlines some issues encountered during data
collection and analysis. This serves to document such issues and their resolution for future
researchers looking into this area. The practical aspects of data collection are explained in details
as this was a feature missing from much of prior research, especially in Malaysia. Finally the
chapter ends with tests for multicollinearity via a Pearson’s coefficient matrix.
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Chapter 5 presents the results of the multiple regression analysis performed on the sample of
variables for firm valuation and performance, RP transactions, and their determinants. The
primary purpose of the data analysis is to test the hypotheses outlined in Chapter 2. This is
presented in order of the hypotheses developed and is divided into three sections.
The first and second sections deal with the effects of RP transaction, as well as corporate
governance and ownership concentration, on firm valuation (Section 5.2 RP Transactions and
Firm Valuation) and firm performance (Section 5.3 RP Transactions and Firm Performance)
respectively. For each hypotheses a separate model is utilised. These models were developed
previously in Section 3.1 Theoretical Framework. The analysis starts with a base model that tests
the effects of RP transactions in totality on firm valuation or performance. This model is then
modified to differentiate between tunnelling and propping RP transactions to determine their
effect on firm valuation and performance. The final model adds variables for corporate
governance and ownership concentration to the first two models. This is done to distinguish the
effects of corporate governance and ownership concentration on RP transactions in totality, as
well as RP transactions when divided into tunnelling and propping, against the dependant
variables of firm valuation and performance. The third section examines factors associated with
RP transactions. Within each model for the hypotheses, four (4) categories of different variables
representing RP transactions are tested. These four categories are indicator variables, ratio of
number of transactions to board size, ratio of total amount by firm size, and total dollar value. The
results are then summarized for each category. The fourth and final section contains the discussion
of the results.
6.2 Summary of Results RP transactions, when considered in totality, have a significant impact on firm valuation, but not
on firm performance of Malaysian listed companies. This confirms the importance of RP
transactions for all stakeholders involved. The relationship between RP transactions and firm
valuation is significant and contributes to the body of knowledge on RP transactions in Malaysia.
Tunnelling RP transactions, have a significant negative impact on firm valuation, but not on firm
performance of Malaysian listed firms. Propping RP transactions have a significant positive
impact on firm valuation of Malaysian listed firms. Consistent with prior studies this demonstrates
that RP transactions can be both good and bad for investors and stakeholders, depending on the
type of transactions. This is also empirical evidence of the conflict of interest and efficient
transactions hypothesis put forth for RP transactions. Based on the empirical results, both a market
valuation discount (-14.54%) and valuation premium (13.24%) are found for tunnelling and
propping RP transactions respectively.
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Corporate governance and ownership concentration have a significant effect on the relationship
between RP transactions and firm valuation and performance. In particular, the percentage
shareholding of the largest shareholder, board size and audit quality are found to have significant
impact on the relationship between RP transaction and firm valuation. The impact on firm
performance is more limited, with only duality being a significant factor affecting the relationship.
Corporate governance and ownership concentration have a significant association with RP
transactions. Higher ownership concentration results in more RP transactions in general. Family
ownership was significantly positively related to tunnelling RP transactions whilst at the same
time being negatively related to propping RP transactions. Board size, board independence and
audit quality all had significant associations with the level of RP transactions in a Malaysian firm.
6.3 Implications of Study 6.3.1 Extending Existing Theory This study extends the usefulness of agency theory and efficient transactions in understanding the
underlying nature of RP transactions. The two primary views on RP transactions in the extant
literature which can result in either positive or negative effects on investors and minority
shareholders. Both views, known as the conflict of interest hypothesis and the efficient
transactions hypothesis (Gordon et al. 2004a, p.11; 2004b, p.36; Kohlbeck & Mayhew 2004,
p.10), are confirmed in this study. Additionally, the investigation into the relationship between
ownership concentration, corporate governance and RP transactions can assist in establishing
principles and characteristics of a strong governance system. The results observed in this study
are empirical evidence that encouraging good corporate governance can restrain the negative
effects of RP transactions. This can provide the necessary balance, seeing that this study also
provides empirical evidence of the positive effects of RP transactions.
Total RP transactions have a significant impact on firm valuation. This is consistent with a
situation where an equilibrium condition exists whereby investors price protect against the
potential effects of RP transactions (Jensen & Meckling 1976, p.305). No impact is observed on
firm performance. As firm performance is represented by ROA, which is an accounting based
measure, it is possible that the reported effects are concealed. RP transactions themselves are
noted as a tool for earnings management (Jian & Wong 2003). These results initially seem to be
at odds with findings from Wahab et al. (2011, p.153). In that study a significant negative
relationship between RP transactions and firm performance was found. Upon a detailed reading
of the empirical findings, the significance of the relationship found in this prior study was of little
economic impact. When translated into economic terms, the negative relationship with RP
transactions resulted in a mere -1.014% decrease to ROA (Wahab et al., 2011, p.153).
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When RP transactions were classified into different types of RP transactions, it was clear that
there were varying impacts on firm valuation. Consistent with the observations of Cheung et al.
(2006, p.346) on the relationship of RP transactions on firm valuation in Hong Kong, an obvious
demarcation in terms of the impact of different types of RP transactions is seen in this study.
This study observed that propping RP transactions had a positive impact on firm valuation. This
observations confirms the view of propping RP transactions to be efficient transactions. The
transactions do not adversely impact interests of shareholders, but rather serve to efficiently
deliver economic benefits to a firm (Ryngaert & Thomas 2007, p.11). The RP transactions are
posited as an efficient contracting mechanism. Dealing with members of the same group, or at
least with parties which are known to the firm, may mitigate the problems such as enforcement
of contracts and property rights, which are critical to the corporation (Cheung et al. 2009, p.914;
Khanna & Palepu 1997). This indirectly confirms benefits of propping including the reduction of
information asymmetry. For example confidential information does not need to be shared with an
external party (Gordon et al. 2004a, p.11; 2004b, p.36).
Tunnelling RP transactions had a clear negative impact on firm valuation. This observation is
empirical evidence of principal-principal conflict. High ownership concentration is a common
feature of firms in this region, including Malaysia. Higher ownership concentration increases the
power that major shareholders have to expropriate the minority (La Porta et al. 1999, p.471). In a
closely held corporation (i.e. concentration of ownership) this would indicate maximization of the
principal shareholders’ utility ahead of the other minority shareholders, in this case via tunnelling
RP transactions. The effect of this conflict is the major shareholder expropriating the minority
one. Management may act to benefit the major shareholder, but at the expense of the minority
shareholders. Governance mechanisms such as the board of directors may be overridden by the
major shareholder. This is because the major shareholder has the ability to appoint the board. As
it is difficult to observe if the board of directors is overridden by the major shareholder, this
study’s observations are indirect evidence of this conflict. For the variables tested that had
negative coefficients but were not statistically significant, it is inferred that investors do not price
protect or give a valuation discount to a firm merely due to the presence of tunnelling RP
transactions, or due to the pervasiveness of such transactions. The primary cause for the valuation
discount by the market is relative importance of the RP transaction to the related party. It is
possible for the quantum of RP transactions to be large in relation to the related party but
sufficiently small so as to be immaterial to the firm. This argument is consistent with the view
that RP transactions do not negatively impact the firm (Gordon et al. 2004a, p.11; Wahab et al.
2011, p.132). It is also conceivable that the value of the RP transaction does not fully represent
the economic loss suffered by the firm (Ryngaert & Thomas 2007, p.16).
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None of the variables except for RPT_LN_PROPPING were significantly associated with firm
performance. The lack of impact on firm performance can be explained by the way firm
performance is measured. As firm performance is represented by ROA, which is an accounting
based measure, it is possible that the reported effects are concealed. RP transactions themselves
are noted as a tool for earnings management (Jian & Wong 2003). This observation is also in line
with empirical results of Chen, Cheng, and Xiao (2011, p.165) showed that RP transactions were
used to inflate pre-IPO results, and this resulted in a poor firm performance post-IPO. Similarly
this study observes no impact on firm performance, but significant impacts in the previous section
on firm valuation. For RPT_LN_PROPPING, the coefficient was found to be negative, which
was contrary to the expectation that propping would have a positive to neutral effect on firm
performance. It may be inferred that firms that needed propping were in fact performing poorly
financially, thus necessitating the propping transactions in the first place (Cheung et al. 2006,
p.382). The negative association between propping RP transactions and firm performance may
therefore be one of reverse causality. The poor firm performance thus creating the need for a
propping transaction (Jian & Wong 2010, p.74). This may be an area for future research into
factors surrounding propping RP transactions.
Ownership concentration, as measured by the percentage shareholding held by the largest
shareholder was significantly positively associated with the relationship between RP transactions
and firm valuation. This reaffirms the role of ownership concentration as an internal corporate
governance mechanism (Shleifer & Vishny 1997, p.742; Gordon et al. 2004b, p.24; Boubakri et
al. 2005, p.369). The higher the concentration of ownership, the more incentive a shareholder or
a small number of shareholders have to monitor, reward and penalize management, leading to
better firm valuation (Shleifer & Vishny 1997).
Similarly, board size was found to have a significant positive association with the relationship
between RP transactions and firm valuation. In this scenario, a larger boards enhances the
monitoring role of the board of directors (Haniffa & Hudaib 2006, p. 1038). This augurs for better
corporate governance as a variety of skills, experiences, knowledge and expertise can be had with
a larger board (Ghazali 2010, p. 112). A larger board also may have increased capability to
monitor management as the number of directors increases (Sulong & Noor 2008, p. 62). This
higher level of oversight may contribute to the positive effect of a larger board on firm valuation,
confirming the critical role the board plays in corporate governance and its relationship with RP
transactions.
A significant positive association was also found between audit quality and RP transactions and
firm valuation. This is consistent with prior studies that posit that a firm with RP transactions will
want a more credible auditor appointed to enhance the legitimacy of their transactions and to play
121
a certification role (Wahab et al. 2011, p.131; Gordon et al. 2007, p.82; Fan & Wong 2005, p.35).
The auditor plays the role of an external corporate governance mechanism. Duality was not found
to have any significant impact on RP transactions and firm valuation at all.
A key finding was a lack of any significant impact of board independence on the relationship
between RP transactions and firm valuation. This is relevant for when analysis was done for RP
transactions in totality, and also when divided into different types of RP transactions. The
monitoring function of a board of directors brings independence and oversight to the firm (Fama
1980, p.293; Fama & Jensen 1983, p.14). Kohlbeck and Mayhew (2004, p.6) observed that
stronger board independence lowered the probability of RP transactions. Board independence has
been found to be effective in reducing the negative effects of RP transactions in the context of
transfer pricing (Lo, Wong, & Firth 2010, p.225). This is inconsistent with the findings in this
study, in which board independence had an impact on the relationship between RP transactions
and firm valuation in only one of the models tested
Corporate governance and ownership concentration had limited impact on RP transactions and
firm performance. This lack of impact is not inconsistent with prior corporate governance research
in a Malaysian context (Noor & Fadzli 2013, p.202). The level of ownership concentration was
not significantly associated with the relationship between RP transactions and firm performance.
Although family ownership and board size had significant positive associations, these were
limited to two and one variable tested respectively. Similarly audit quality was not significantly
associated in any of the variables tested. Duality on the other hand was significantly associated
with the relationship between RP transactions and firm performance. This infers that the check
and balance that should exist between the two positions of chairman and CEO, is reduced and as
a result enables self-dealing behaviour to be unchecked (Rahmat 2013, p.67). This is also
consistent with studies that have reaffirmed the positive association between ownership
concentration, duality and the size of RP transactions (Hu et al. 2012, p.58).
Ownership concentration has a clear positive association with RP transactions. Higher ownership
concentration results in more RP transactions in general, and more propping and tunnelling
transaction more specifically. This observation was largely consistent across all RP variables
tested. Family ownership was also significantly associated with RP transactions. In particular,
family ownership was significantly positively related to tunnelling RP transactions whilst at the
same time being negatively related to propping RP transactions. Family ownership is less
associated with propping RP transactions, as such owners would only be concerned with
extraction of private benefits for themselves. The large shareholder has the most to gain from any
effort expended in watching over management (Gordon et al. 2004b, p.36). At the same time,
ownership concentration can have its own costs to the remaining shareholders. A large controlling
122
shareholder can also more easily control management by appointing key posts and engage
expropriation of minority shareholders (Shleifer & Vishny 1997, p.741; Claessens et al. 2000,
p.81). This is clearly illustrated by the results of this study, in which family ownership was
significantly positively related to tunnelling RP transactions whilst at the same time being
negatively related to propping RP transactions.
Board size was negatively associated with RP transactions, consistent with existing corporate
governance literature that posits the lack of effectiveness as boards grow in size (Jensen 1993,
p.865; Yermack 1996, p.185; Mak & Kusnadi 2005, p.301). Another key corporate governance
measure is board independence. The level of board independence has a significant negative
relationship with RP transactions of all types. This is consistent with the Kohlbeck and Mayhew’s
(2004, p. 20) study which also found that higher levels of board independence were associated
with less RP transactions. The monitoring function of a board of directors that brings
independence and oversight to the firm is also theorized (Fama 1980, p.293; Fama & Jensen 1983,
p.14). Audit quality had a positive association with RP transactions. This is consistent with prior
studies that posit that a firm with RP transactions will want a more credible auditor appointed to
enhance the legitimacy of their transactions and to play a certification role (Wahab et al. 2011,
p.131; Gordon et al. 2007, p.82; Fan & Wong 2005, p.35). Duality was found to not have any
significant impact on RP transactions in any of the variables tested.
6.3.2 Extending Existing Malaysian Corporate Governance Research Prior Malaysian research has found that board independence, proxied by percentage of outside
directors, and role duality, had no effect on company performance as measured by ROA
(Abdullah 2004, p.47) and Tobin’s Q (Haniffa and Hudaib 2006, p.1034). Similarly this study
finds little support for the impact of board independence on the relationship between RP
transactions and firm performance and valuation. As an independent board is a key corporate
governance mechanism, the continued lack of impact of seemingly independent boards has
implications for investors and regulators.
Tam and Tan (2007, p.208) found that higher ownership concentration was negatively associated
with ROA, signalling expropriation by owners. Sulong and Noor (2008, p.55) found that
ownership concentration has no significant effect on firm value but good board governance played
a role in improving monitoring role of other mechanisms such as dividend yield and ownership
structure. This study finds no such impact of ownership concentration on RP transactions
relationship with firm performance but does find that ownership concentration having a
significant positive impact on the relationship between RP transactions and firm valuation. Tam
and Tan (2007) concluded that more research needs to be done into effective governance
mechanisms, particularly in scrutinising large shareholders to prevent expropriation of minority
shareholders. This study extends the findings of Tam and Tan (2007) by testing variations of RP
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transactions in the form of tunnelling and propping RP transactions and their impact on both firm
performance and firm valuation. The results demonstrate the interplay between various corporate
governance mechanisms, both internal and external, and their interaction with firm valuation.
Wahab et al. (2007, p. 106) observed that corporate governance improved after the MCCG was
incorporated into Bursa Listing Rules in 2001. Firms with high corporate governance index scores
had better returns. Firms with improved corporate governance index scores also had better returns.
These results underscored the need for continuous improvement to the system of governance in
place. This study extends these observations by testing the impact of corporate governance over
a 3 year period on the relationship between RP transactions and firm valuation and firm
performance. The results in this study are an indirect observation of the improvements (or lack
thereof) to the system of corporate governance and its related mechanisms in Malaysia.
Mohamad Ariff et al. (2007, p.562) found that only the size of the firm (total sales) has a
significant positive relationship with position in the ranking in Corporate Governance Reporting
Initiative 2004. Other factors, such as Tobin’s Q, net profit margin, leverage, sales growth, market
capitalization, firm age, ownership concentration and foreign operations did not have an impact.
Ghazali (2010, p.109) observed that none of the corporate governance variables (board size,
percentage of independent directors, role duality) had statistically significant relationships with
firm value. Studies such as these present indirect evidence of the inconclusive nature of the
relationship between firm characteristics and corporate governance. This study attempts to
address these needs by examining specific relationships, in this case between RP transactions and
firm performance and valuation, to extend the understanding of such relationships.
Prior research has also found no difference in value between family and non-family firms (Amran
and Ahmad 2009, p.53). Family firms had a lower proportion of independent boards and those
with no duality outperformed those with role duality. This study did not test for valuation
differences between firms with different controlling shareholder identities. However, family
owned firms were clearly associated with higher levels of tunnelling RP transactions, and were
negatively associated with propping RP transactions. This is largely in line with the conclusions
of Amran and Ahmad (2009) on the likelihood of expropriation of minority shareholders by
family-based firms. Ibrahim and Samad (2011, p.105) found that family firms have higher return
on equity (ROE) but lower ROA and Tobin’s Q compared to non-family firms. Family firms have
lower percentage of independent directors, and there was a significant negative relationship
between percentage of independent directors and ROA and ROE for family firms. Role duality in
family firms was significantly negatively related to all measures of performance. There was no
significant relationship found between board independence and performance of the firm. Ibrahim
and Samad (2011, p.109) explained that this infers that outside directors do not lead directly to
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improved performance but merely improve decision making. Another possible explanation is that
family firms override or influence the board to the point where the board is no longer independent
but merely rubber stamps decisions. Improvements in corporate governance since then by way of
the mandatory disclosure of compliance with the Malaysian Code of Corporate Governance may
have improved the situation. This study however does not do a specific event study before and
after the implementation of the latest corporate governance code. This study does find a lack of
impact of board independence on the relationship between RP transactions and firm valuation.
Wahab et al. (2011, p.131) was an early investigation into the effects of RP transaction. The study
utilised two measure of RP transactions which were total number of RP transactions scaled by
directors and total amount of RP transactions scaled by assets respectively. This study utilised
these exact variables, and further modifies them to test for different types of RP transactions,
namely tunnelling and propping transactions. Wahab et al. (2011, p.131) found both internal and
external corporate governance tested had a negative relationship between RP transactions (both
measures) and performance. This study finds some similarity in that there was a significant
relationship between RP transactions and firm valuation. Executive remuneration, board
independence and audit quality were also found to mitigate negative impact of RP transactions.
This study extends Wahab et al.’s (2011) findings by testing various types of RP, which was a
limitation of that study.
Juliarto (2012, p.15) conducted a cross-country survey on tunnelling RP transactions. The
research highlighted the issue of the perception of the agency problem as mainly being an Anglo-
American problem. It was not representative of international focus or markets with concentrated
ownership as large blockholders are common in non-Western markets. Tunnelling is a serious
problem in emerging economies. Juliarto found a strong association between family ownership
and tunnelling RP transactions (2012, p.144). The results showed that expropriation is a real threat
for minority shareholders in the ASEAN region. Juliarto (2012, p.158) concluded by emphasizing
the need for additional disclosure and codes of governance to be strengthened by strong
legislation. Another solution, the practicality of which is debatable, is to have multiple
blockholders, who each hold significant shareholding percentages. The idea behind this is that
they will balance each other out and constrain any act of expropriation (Juliarto 2012, p. 158).
This study confirms Juliarto’s (2012) observation of expropriation being a real threat by
presenting empirical evidence of the valuation discount present in firms that engage in tunnelling
RP transactions. This study also confirms the strong association between family firms and the
presence of RP transactions. Unlike Juliarto (2012), this study also tests for propping RP
transactions, and provides evidence that they can be value enhancing. This is relevant in light of
the high level of ownership concentration found in Malaysia and in this region.
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Liew et al. (2011, p.139) found that related party transactions that are likely to result in
expropriation reduce firm value (Tobin’s Q). Average independent directors’ tenure is not linked
to expropriation by controlling shareholders of these firms. There is also no conclusive and
significant evidence that ownership concentration by family firms’ controlling shareholders has
significant relationships with both market-based and accounting-based firm performance
measures. The power to control a corporation might provide the majority family shareholder
(family controlling shareholder) the opportunity and incentives to expropriate the firm’s resources
for his or her own interests while other shareholders as well as other stakeholders of the firm bear
the costs. Such expropriation generally reduce the observed market value of the firm and is
empirically proven. This study confirms this observation of expropriation being value reducing
by presenting empirical evidence of the valuation discount present in firms that engage in
tunnelling RP transactions. This is evidence of the direct mechanisms of expropriation (tunnelling
RP transactions) and the subsequent impact on firm valuation.
Liew et al. (2011, p.139) also observed that expropriation activities undertaken by family
controlling shareholders to maximize their personal utility lead to suboptimal firm policies
resulting in poor firm performance. This was not observed in this study, as RP transactions did
not have much significant impact on firm performance, with the exception of
RPT_LN_PROPPING, which actually had a positive impact on firm performance. As firm
performance is represented by ROA, which is an accounting based measure, it is possible that the
reported effects are concealed. RP transactions themselves are noted as a tool for earnings
management (Jian & Wong 2003). For RPT_LN_PROPPING, the coefficient was found to be
negative, which was contrary to the expectation that propping would have a positive to neutral
effect on firm performance. It may be inferred that firms that needed propping were in fact
performing poorly financially, thus necessitating the propping transactions in the first place
(Cheung et al. 2006).
Liew et al. (2011) found that Malaysian family firms are also situated in a unique government and
institutional setting. They embrace the culture of rent-seeking which is encouraged by the
Government’s affirmative action policy. Liew et al. (2011) classify a firm as a family firm if a
person is the controlling shareholder; that is a person (rather than a state, corporation,
management trust or mutual fund) can obtain enough shares to assure at least 20% of the voting
rights and the highest percentage of voting rights in comparison to other shareholders. This
classification is largely similar to the classification of shareholder identity used in this study.
Azizan and Ameer (2012, p.774) studied family firms targeted for intervention by the Minority
Shareholder Watchdog Group (MSWG). Family company was defined as a family having equity
shareholding equal to at least 20% of total shareholding of the firm. The study found abnormal
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market returns for family firms targeted for MSWG intervention, in particular for firms in which
family control is less than 33%. MSWG activism was also significantly related to higher operating
cash flow in family firms. MSWG intervention is significantly negatively related to dividends per
share in family companies. Shareholder activism is lacking in Malaysia, and should be encouraged
by the authorities as an alternative corporate governance mechanism. This is relevant, in view of
this study’s findings that board independence had little impact on the relationship between RP
transactions and firm valuation and firm performance. The lack of significant results are in
themselves evidence of the effectiveness of the board mechanism as a corporate governance
measure in Malaysia. More disclosure should be mandated to ensure that minority shareholders
can make informed decisions.
Ibrahimy and Ahmad (2012) examined the relationship between firm performance and ownership
structure. It was argued that at least in part by weaknesses in legal systems, the ownership
structure can play the dominant role to counter managerial agency problems, and hence, increase
the firm value. The Malaysian economy has a high ownership concentrated economy among East-
Asian countries (Claessens et al. 2000). This concentrated ownership, coupled with weak
corporate governance and regulatory framework in Asian countries and weak protections of
minority rights of Asian countries lead to expropriation of minority shareholders (Claessens &
Fan 2002). Blockholders, defined as shareholders who own 5% of shares and above, was
positively insignificant with firm performance when considering the market based performance
measurement (Tobin’s Q). However, it shows significant positive relationship with low
magnitude of beta coefficients against accounting based performance measure, when industry
effects are taking into consideration. The negative relationship of blockholder ownership with
firm performance by univariate analysis indicated the probability of expropriation of minority
shareholders’ wealth by blockholders (Ibrahimy & Ahmad 2012). Like previous studies, no
empirical evidence on the mechanisms of expropriation are given by Ibrahimy and Ahamd (2012).
This study attempts to address these needs by examining specific relationships, in this case
between RP transactions and firm performance and valuation, to extend the understanding of such
relationships. In particular this study looks at the propping and tunnelling RP transactions as either
efficient transactions or conflicts of interest.
Ng (2012) examined the performance of family firms. The proportion of family equity ownership
positively influences corporate performance. Family-affiliated firms generally underperform non-
family affiliated firms. The heterogeneity of business groups results in considerable differences
in performance (Ng 2012, p.69). Specifically, the size of business group has a negative
moderating effect on the firm diversification-performance relationship. Profit redistribution
occurs in firms that have a high level of family ownership and that are affiliated to large business
groups. Board independence in general lacked effectiveness in moderating the influence of firm
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strategies or activities on firm performance. Even when a professional managers are hired from
outside the family to manage a family-controlled firm, the impact is limited by the influence of
the controlling families (Ng 2012, p.7). Essentially, concentrated ownership in the relatively weak
enforcement environment of Malaysia enables owner-managers to implement policy or strategy
related corporate activities or practices that generate for them private benefits of control at the
expense of minority shareholders, firm efficiency and performance. As an example, the practice
of forming business groups or strategies to diversify a firm can be used by controlling families to
facilitate their expropriation of minority shareholders. A possible reasons for relatively weak law
enforcement is the Malaysian environment that practices political patronage in business. Rules
and regulations and may be selectively enforced against firms which are closely associated with
influential political figures or the ruling political party (Ng 2012, p.64). This study provides
empirical evidence of tunnelling RP transactions, which can be a mechanism by which minority
shareholders are expropriated. At the same time, this study show evidence of the value enhancing
benefits of propping RP transactions. Thus the practice of forming business group as studied by
Ng (2012) may not be purely to facilitate expropriation of minority shareholders but could be a
response to the imperfect financial, labour and product markets of a less developed economy
(Khanna & Palepu 1997). These inefficiencies increase the business risk for a firm and are
mitigated by the formation of a business group and transacting within the group.
Lim et al. (2013, p.355) examined the impact of corporate governance and ownership structures
on firm performance of 293 Bursa Malaysia companies six years before and after the
implementation of Malaysian Code of Corporate Governance (MCCG) in 2001. Descriptive
statistics show significant differences in corporate governance practices before and after MCCG
2001, despite minimal legislation. Institutional and foreign shareholdings were found to be
significantly associated with both market (Tobin’s Q) and accounting performance (ROA)
measures before and after implementation of MCCG, implying their positive roles on
performance. Contrary to the recommendation by MCCG, role duality (positions of Chairman
and CEO were the same person) was observed to be negatively related to accounting performance
measures but in the opposite direction for market performance measures. The key limitation of
the study is that the ownership identities of large shareholders are not explored. They may have
different investment objectives and culture, and this may result in different corporate governance
mechanisms employed. Secondly, the issue of causality has not been explored, for example, the
causal relationship between corporate governance and ownership structure and firm performance
should be studied further so as to predict the cause and effect relationship more accurately. Noor
and Fadzil (2013, p.191) examined the direct relationship between board characteristics with
firms’ ROA. Board independence, experience and meeting frequency had significant impacts on
ROA.
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6.3.3 Investors and Public Stakeholders RP transactions results in real valuation discounts and premiums to investors. The impact is
significant, and affects all stakeholders. This study gives empirical evidence to the problem of
principal-principal conflict. High ownership concentration is a common feature of firms in this
region, including Malaysia. La Porta et al. (1999, p.471) concluded that higher ownership
concentration increases the power that major shareholders have to expropriate the minority. In a
closely held corporation (i.e. concentration of ownership) this would indicate maximization of the
principal shareholders’ utility ahead of the other minority shareholders. Principal-principal
conflict arises when there is concentrated shareholding. Here there is conflict between two
principals – the major shareholder and the minority one. The effect of this conflict is the major
shareholder expropriating the minority one. Consistent with prior research by Juliarto (2012)
tunnelling is a serious problem in countries in the ASEAN region. Juliarto found a strong
association between family ownership and tunnelling RP transactions (2012, p.144). The results
of this study show that expropriation is a real threat for minority shareholders.
On closer examination, this can be broken down into the negative impact of tunnelling RP
transactions and the positive impact of propping RP transactions. Based on the empirical results,
both a market valuation discount (-14.54%) and valuation premium (13.24%) are found for
tunnelling and propping RP transactions respectively. This figure serves to inform the investing
public, company management and boards of directors on the potential implications of engaging
in RP transactions. These discounts and premiums represent an equilibrium condition to exist
whereby investors price protect against the potential costs or benefits of RP transactions (Jensen
& Meckling 1976, p.305). This means that investors would assign a lower market valuation to a
firm engaging in RP transactions in anticipation of the costs to the firm of the said transactions
(Kohlbeck & Mayhew 2010, p.119). In this study it can be said also that investors would assign
a higher market valuation to a firm engaging in RP transactions in anticipation of the benefits to
the firm of the said transaction, as shown by the valuation premium for propping RP transactions.
The value relevance of RP transactions and the relevant market valuation premiums and discounts
can also serve as a guide for the management of any corporation intending to engage in RP
transactions. That is, the board of directors may utilise empirical evidence such as that presented
in this study to justify or calculate the true cost of RP transaction to incorporate potential upside
or downside to firm valuation as a result of undertaking the said RP transaction.
6.3.4 Regulators and Standard-setters As corporate governance and ownership concentration has a significant impact on the relationship
between RP transactions and firm valuation, future regulation should look into this area. A key
focus this study would suggest is the Malaysian Code of Corporate Governance (MCCG). The
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current MCCG, under Principle 3, emphasizes the need for independence in the board (Securities
Commission Malaysia 2013, p.23). Five recommendations are contained within, namely:
the board should undertake an assessment of its independent directors annually;
the tenure of an independent director should not exceed a cumulative term of nine
years. Upon completion of the nine years, an independent director may continue to
serve on the board subject to the director’s re-designation as a non-independent
director;
the board must justify and seek shareholders’ approval in the event it retains as an
independent director, a person who has served in that capacity for more than nine
years;
the positions of chairman and CEO should be held by different individuals, and the
chairman must be a non-executive member of the board; and
the board must comprise a majority of independent directors where the chairman of
the board is not an independent director (Securities Commission Malaysia 2013, p.
25).
A key finding was a lack of any significant impact of board independence on the relationship
between RP transactions and firm valuation. This is relevant for when analysis was done for RP
transactions in totality, and also when divided into different types of RP transactions. The
monitoring function of a board of directors brings independence and oversight to the firm (Fama
1980, p.293; Fama & Jensen 1983, p.14). Kohlbeck and Mayhew (2004, p.10) found that stronger
board independence lowered the probability of RP transactions. Board independence has been
found to be effective in reducing the negative effects of RP transactions in the context of transfer
pricing (Lo, Wong, & Firth 2010, p.225). This is inconsistent with the findings in this study, in
which board independence had an impact on the relationship between RP transactions and firm
valuation in only one of the models tested. Additionally, the lack of relationship between board
independence and firm performance has been documented before by Ibrahim and Samad (2001,
p.109).
It is perhaps time to revisit the recommendations of the MCCG in light of the observations of this
study. For example the final recommendation encourages that a board should comprise of a
majority of independent directors, if the chairman is not independent. The MCCG commentary
states:
A chairman who is an independent director can provide strong leadership by being able
to marshal the board’s priorities more objectively. If the chairman is not an independent
director, then the board should comprise a majority of independent directors to ensure
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balance of power and authority on the board. (Securities Commission Malaysia
2013, p. 25).
This study suggests that as a first step the requirement to have the majority of board members be
independent should not be conditional on having a non-independent chairman. That is to say, the
principle should be changed to have a majority independent board at all times. This can act in
improving corporate governance, and enhancing the effectiveness of the board in its monitoring
function. This study would recommend exploring this and other amendments to the MCCG in
view of the lack of any significant impact of board independence on the relationship between RP
transactions and firm valuation observed.
In 2007, an amendment to the Malaysian Companies Act 1965 extended a ban on loan transactions
with related parties. This prohibition was not dissimilar to a ban on RP loans to officers and
directors under the Sarbanes-Oxley Act (SOX) in the United States in 2002 (Rahmat 2013, p.5).
This is a step in the right direction but could be enhanced further via amendments to the listing
rules. The current listing rules utilize percentage ratios as a threshold for disclosure and
shareholder approval (Bursa Malaysia 2013). This study observed tunnelling RP transactions
having a negative impact on firm valuation, but not at a significant level. This is in line with the
view that it is possible for the quantum of RP transactions to be large in relation to the related
party but sufficiently small so as to be immaterial to the firm (Gordon et al. 2004a, p.11; Wahab
et al 2011, p.146). However, the act of disclosure itself can be a deterrent to the use of RP
transactions in agency conflict of interest situations. Hwang, Chiou, and Wang (2013, p.293)
demonstrate that having to report back to shareholders and stakeholders on the existence of RP
transactions can reduce the use of RP transactions in their study of Taiwanese firms conducting
cross-border transactions with related parties in China. The regulators may wish to re-examine
the thresholds used for RP transaction disclosure and shareholder approval. When RP transactions
are brought to light, the investing public can then judge the merit of each transaction. For
transactions that are sufficiently large, shareholders will have a chance to vote on them; for those
that are small, shareholders can vote with their feet by selling the shares. The key is sufficient and
timely disclosure.
6.4 Limitation of Study This study is limited to the effects of RP transactions on Malaysian listed firms in the trading
sector. The results may not be extrapolated to be representative of Malaysian listed firms, or
Malaysian firms as a whole, which are beyond the scope of this study. The selection of just the
trading sector was done as a compromise between obtaining a sufficiently large sample and the
costs of obtaining data.
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There is also the possibility of incomplete information in the form of unreported RP transactions,
hidden directors or undisclosed levels of ownership (Juliarto 2012, p.69). However the study is
not able to take this into account and it is assumed that publicly available information is
representative of the variables being measured.
This study also does not take into account the mediating or moderating role of corporate
governance and ownership. Testing of the interaction terms between corporate governance,
ownership and the various RP transaction variables was not conducted as it was beyond the scope
of this study.
6.5 Future Research Direction Future research should be directed at increasing the sample size to cover more sectors, or possibly
the entire market. This would allow extrapolation of the results to be representative of Malaysian
listed firms, or Malaysian firms as a whole. It would also be useful to cover a wider variety of
corporate governance variables, including director tenure and auditor-client tenure. These were
not covered within the scope of this study. However in view of the principles of the MCCG
emphasizing the need for an independent monitoring function, these variables may shed light on
the effectiveness of existing corporate governance structure. Building on a key finding that found
a lack of any significant impact of board independence on the relationship between RP
transactions and firm valuation, more research should be conducted in this area. These
observations were relevant for when analysis was done for RP transactions in totality, and also
when divided into different types of RP transactions. Future research should dig deeper into the
nature and background of the independent directors, perhaps to examine the level of actual
independence. This may be done via examining tenure, background and prior business
relationship, and possibly cross-directorships or shareholdings in other corporate entities.
Research in this area would accelerate the evolution of corporate governance reforms and changes
to the regulation as it would provide empirical evidence for the public and the regulators to act
on.
Another area for potential future research would be a multi-year study covering perhaps 10 years
or more on overall corporate governance trends in Malaysia. For example, this study observed a
decreasing trend in duality. This study found 11.11% of firms reported having both the position
of chairman and CEO being held by the same individual. When compared to other prior Malaysian
research, this is a marked decrease. Wahab et al.’s (2011, p.149) observation was 57.8% in 2005
to 2007, Sulong and Noor (2008) reported duality at 68% and 69% for 2002 and 2005
respectively, and Amran (2004, p.55) which reported figures of 77.6% to 79.8% from 1994 to
1996. This may be evidence of a general improvement in corporate governance practices in
Malaysia and should be looked into by future researchers. Such research could shed light on the
132
effectiveness of the various reforms, legislation and corporate governance codes being undertaken
over the years by the authorities and regulators.
Table 34 Summary of Duality Trend
Study Duality Years covered
This study 11.11% 2012 to 2014
Wahab et al. (2011) 57.80% 2005 to 2007
Sulong and Noor (2008) 68%, 69% 2002 and 2005
Amran (2004) 77.6% - 79.8% 1994 to 1996
An observation of this study was firms that needed propping were in fact performing poorly
financially, thus necessitating the propping transactions in the first place (Cheung et al. 2006,
p.384). The negative association between propping RP transactions and firm performance may
therefore be one of reverse causality. This may be an area for future research into factors
surrounding propping RP transactions. At the same time, propping RP transactions benefit a firm
operating in an inefficient state of markets, typical in developing economies (Khanna & Palepu
1997). From an institutional context, markets that are less developed will have imperfect financial,
labour and product markets. These inefficiencies increase the business risk for a firm. It would
then make sense for a firm in such a setting to deal with related parties to be assured of better
access to capital, financing, business development opportunities and economies of scale (Pizzo
2013; Khanna & Palepu 1997). Future research should look into incorporating the level of
development of the market into the model. Ideally this would be conducted in a rapidly evolving
market such as Myanmar or Cambodia, which are only now undertaking market-based reforms.
6.6 Conclusion This study reaffirms the view that differing types of RP transactions have different impacts on
firm valuation and performance. RP transactions, when classified into tunnelling and propping
RP transactions, will affect the firm’s valuation and performance differently. This study reaffirms
the conflict of interest view, based on agency theory, that tunnelling RP transactions have a
significant negative association with firm valuation. At the same time, this study also confirms
the efficient transactions view, based on transaction cost economics, that propping RP
transactions have a significant positive impact on firm valuation. This finding suggests that
tunnelling RP transactions represent expropriation of shareholder wealth and are discounted by
investors accordingly, whereas propping RP transactions are efficient transactions that benefit the
firm. This finding is robust after controlling for leverage, firm size, and index membership.
This study found ownership concentration to be positively associated with RP transactions. This
has implications not only for minority investors in Malaysia, but also for the public, seeing that
133
the government remains a major shareholder in many listed companies. At the same time,
corporate governance’s effect remains mixed and Malaysia will need to find mechanisms that will
work with the country’s unique national character, institutional environment and business climate.
These findings should continue to inform the perspectives of regulators, investors and other
stakeholders in the pursuit of the development of better corporate governance and the
advancement of the Malaysian capital markets.
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