Bhuiyan2018 RTP and Finance Company Failure New Zealand Evidence

Pacific Accounting Review
Related party transactions and finance company failure: New Zealand evidence
Md. Borhan Uddin Bhuiyan, Jamal Roudaki,
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Md. Borhan Uddin Bhuiyan, Jamal Roudaki, "Related party transactions and finance company failure: New Zealand
evidence", Pacific Accounting Review, https://doi.org/10.1108/PAR-11-2016-0098
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Related party transactions and finance company failure:
New Zealand evidence
1. Introduction
This research examines the existence of related party transactions (RPTs) in failed
financial companies in New Zealand when firms have interlocking directors on the board. The
study also examines the role of auditors in the practice of RPTs. A related party transaction is
defined as the “transfer of resources, services or obligations between a reporting entity and a
related party” (IASB, 2009). While RPTs are a legitimate business activity, regulators, standard
setters, and market participants consider RPTs to be a major issue in financial markets as they
can be used to expropriate minority shareholders or other stakeholders who are not deemed to be
related parties. Consequently, the existence of RPTs in recent high-profile corporate frauds has
raised concerns about the effectiveness of monitoring mechanisms (Chen, Cheng & Xiao, 2011).
Furthermore, the AICPA (2001) expressed concern that RPTs are difficult to identify for many
reasons. These include identifying related parties and the tracking of transactions by the auditor
who relies on management to provide relevant information, even when in some cases top
managers are a part of or involved in such transactions. In the United States’ post-SOX1 era,
RPTs have become a disclosure issue, rather than one of restricting inappropriate transactions
with related parties. Regulators, professionals, and academic researchers are somewhat skeptical
about the practice and consequences of RPTs (Gordon, Henry, Louwers, & Reed, 2007).
New Zealand Accounting Standard 24 (similar to International Financial Reporting Standard 24)
requires a reporting entity to disclose transactions with its related parties as well as any
relationships between parents and subsidiaries, irrespective of whether there have been
transactions between those related parties. The objective of this standard is to ensure that an
entity’s financial statements contain the disclosure necessary to draw attention to the possibility
that its financial position and performance may have been affected by the existence of related
party transactions. IAS 24 was revised in 2003 (effective from 2005) and now requires disclosure
of compensation to key management employees; it also expanded the definition of ‘related party’
1
Sarbanes Oxley Act 2002
Page 1 of 31
by adding joint ventures, etc. Later on, KPMG (2009, p.5) suggested that the previous
amendments to IAS 24 were not sufficient because the standard remained “too complex, lacked
symmetry and included some inconsistencies”. IASB published an exposure draft in February
2007 proposing amendments to IAS 24 Related Party Disclosure – State-controlled Entities and
the definition of a ‘Related Party’. This was finalized and issued in November 2009. To date, no
systematic academic research has identified the disclosure compliance of RPTs, but following
the collapse of some New Zealand (NZ) finance and property companies, the media have
highlighted how these firms materially masked their financial statements so as not to expose bad
and related party debts (Mace, 2012). Several other media reports have centered around concerns
over RPTs and collapsed finance firms: e.g. South Canterbury Finance (Heather, 2010), Pyne
Gould (Steeman, 2012), and Dominion Finance (Mace, 2013). Moreover, research on auditing,
corporate governance, and RPTs often excludes financial institutions from the sample because of
their distinct regulatory requirements. Therefore, the findings from these studies may not be
generalizable to finance institutions, especially non-banking financial institutions. The lack of
research evidence is one motivation for our study.
As indicated by KPMG (2007), rapid growth has been observed in the New Zealand
property sector in the last few decades. Consequently, a golden opportunity has been provided
for finance companies to aggressively fill the gap in mortgage supply, as banks hesitate to take
on high-risk loan agreements. They lend with the security of a first mortgage and the developer’s
own funding from equity or pre-sales. As the banks open their lending to the property sector, the
finance companies extend their services through an enormous expansion of credit facilities
including financing second-hand cars and other consumer purchases, with little attention to the
capacity of lenders to repay loans. The Reserve Bank of New Zealand reports that from late 2004
to mid-2007, household deposits invested in finance companies rocketed from $5.1 billion to
$7.1 billion – a 39% increase (Report of the Commerce Committee, 2011).
During the 2006-2011 period, a total of 66 finance and property firms declared
bankruptcy, affecting one person out of every 40 in New Zealand, with RPTs playing an
important part in their failure. Consequently, the Serious Fraud Office (SFO) and legislators
identified as noteworthy firms on the bankrupt list that were involved in RPTs where investors’
funds were misappropriated, allocated and utilized (Fletcher, 2013). Interestingly, there is scant
academic research examining the monitoring role in operating behaviours such as RPTs in New
Page 2 of 31
Zealand finance companies. The argument is that the misuse of RPTs occurred because of poor
corporate governance mechanisms.
To date, three studies have been conducted using the context of bankrupt finance firms in
New Zealand (Wu & Malthus, 2013; Yahanpath, 2010; Kabir & Laswad, 2014) and these
unanimously raised concern about the lack of accountability for failed finance companies.
Unfortunately, both Wu and Malthus (2013) and Yahanpath (2010) have a sampling bias. For the
most part, they use similar sources (such as Serious Fraud Office reports, reserve bank
documents, receivers’ or liquidators’ reports and published media reports) to collect research
samples but fall short of systematic sampling procedures to generalize their research findings.
However, Kabir and Laswad (2014) are more systematic in their research methodology and
provide evidence of inflated cash flows from operations and understated impairment losses, both
of which indicate aggressive accounting practices.
This research extends the accounting literature in several ways. First, the SFO
investigation found many of the collapsed firms were engaged in massive RPTs and often rolled
over non-performing interest-only loans that should have been declared as bad debts. Indeed, in
some cases, supervisory board committees unreservedly betrayed investors, apparently
undeterred by their internal watchdogs (Hickey, 2013). During the court trials of South
Canterbury Finance and Nathan Finance, the judge’s verdict was that collapsed finance firms
practised poor corporate governance which helped to misrepresent financial statements by non-
disclosure of inappropriate related party transactions (Gibson, 2011). When internal management
was reluctant to identify the fraud risk, external monitors also failed to blow the whistle, and so
the monitoring failed both internally and externally. Earlier research identified the failure of
internal mechanisms associated with board characteristics (Nekhili & Cherif, 2011), but
relatively little attention has been given to external monitors. This research aims to show that the
failure of New Zealand finance companies is due to joint negligence by internal and external
monitoring. Secondly, this research signals an association between RPTs and a pattern of poor
corporate governance behaviour, proxied by the interlocking board and auditor quality, leading
to finance companies’ failure in New Zealand. It is understood that not all RPT engaged firms
would collapse, but academic research advocates that audit risk increases accordingly. Whether
auditors respond to that risk is also a focus of interest here. Finally, corporate governance
compliance in New Zealand is regulated by the Corporate Governance Best Practice Code which
Page 3 of 31
is primarily a voluntary regulation and applies a ‘comply or explain’ approach that allows the
firm to operate in the non-mandatory regulatory environment. While earlier research studies have
focused on RPTs in a stricter environment (such as the USA where it is mandatory to comply
with the Sarbanes Oxley Act), this research fills the void of a softer regulatory environment. It is
noticeable that the SFO recently brought some executives of failed firms to accountability
through a series of trials, but the external monitors are yet to be held accountable as executives.
Using a sample of 65 finance firms and 219 firm-year observations in New Zealand, it is
found that almost half of the finance firms were engaged in RPTs. The RPT engaged firms had
more interlocking directors within the failed firms and were audited by non-Big4 auditors, which
implies that lower monitoring quality may promote such RPTs. The study also indicated that
having interlocking directors in failed finance firms has a positive association with RPT
engagement, while the auditor type (i.e., audited by Big4) is negatively associated with RPTs.
Interestingly, our results do not verify any statistically significant impact of accounting expert
director on related party transactions. Our findings are consistent with many alternative
measures.
The remainder of this paper is organized as follows: Section two explains the regulatory
environment of New Zealand financial institutions and Section three provides a brief literature
review and development of the study hypotheses. Research method, sampling, and variable
definitions are included in Section four, empirical results in Section five and conclusions,
discussion, and potential implications of the research are presented in Section six.
2. Regulatory Environment for Financial Institutes
A review of New Zealand’s legislative environment is important when attempting to

understand the causes and effects of the collapse of financial companies. In this country, the
legal environment for depositors and financial companies is considered weaker than in the
developed world (Wilson, Rose, & Pinfold, 2010). Wilson et al. (2010) describe New Zealand’s
legal system regarding Non-Bank Deposit Takers (NBDT) as retarded and unclear. Starting in
the last quarter of 2007, efforts were made to tighten up financial sectors, including financial
companies and financial brokers. However, the financial collapse officially started almost one
year before (Edmonson, 2008). Edmonson (2008) discusses past collapses of financial
Page 4 of 31
companies due to enormous loans obtained by directors, a practice which is a clear misuse of
company assets. The collapse of finance companies in 2007 is interpreted as excessive profit-
motivated greed by directors who pursued profit through an unlawful chain of borrowings,
linking companies together. Under these conditions, vulnerable members in the borrower chain
make others unstable and the sequence of the collapse was inevitable.
Common practice is that legislation is enacted reactively instead of proactively. New

Zealand legislators, like those of other countries, reactively tried to curb the collapse of financial
companies in the future by developing regulations to protect stakeholders, including investors.
For example, a new financial adviser disclosure regime was introduced to tackle the problem
(Financial Advisers Act 2008). Two government authorities, the Financial Market Authority
(FMA) and the Reserve Bank of New Zealand, are the pillars of the financial markets’ regulatory
system. The FMA oversees compliance with financial markets legislation, requiring advisers to
provide the investor client with primary and secondary disclosures. The primary disclosure
enables investors to decide about using the adviser, while secondary disclosure explains the
nature of the services provided by the adviser. Advisers are not required to disclose how and by
whom they are paid but should provide information about dispute procedures (FMA Disclosure
Statement, 2014).
Furthermore, the Financial Market Authority provides a vast range of useful advice,
enforcement law, and regulations for investors. The Financial Advisers (Fees) Regulations 2010
describes fees while the Financial Advisers (Code of Professional Conduct for Authorised
Financial Advisers) Notice 2010 describes a code of conduct for advisers. Other related
regulations are the Financial Advisers (Custodians of FMCA Financial Products) Regulations
2014 and Financial Service Providers (Registration and Dispute Resolution) Act 2008. It was in
2010 that the Deposit Takers (Credit Ratings, Capital Ratios, and Related Party Exposures)
Regulations defining a related party were introduced. These were revoked by the Non-bank
Deposit Takers Act 2013. In this Act, a related party is explained as any that has relations with
the Non-bank Deposit Takers in any of eight ways as described in the regulation (NBDT section
6.1). The Act of 2013 also defines a related party as having a “substantial interest” in a Non-bank
Deposit Taker with a direct or indirect 25% or more voice in the governing body (NBDT section
6.2 a), while 10% of the voting right or control is considered the threshold in defining a
substantial interest by a company or individual (i.e., not a company as described in the law)
Page 5 of 31
(NBDT section 6.2 b). Also, section 25.1 b of the 2013 Act indicates that independent directors
must not be selected from related parties or directors of related party companies as described
above. The requirements of regulations and maximum limits of related party exposures are
explained in detail in sections 36, 37, and 38 of this Act.
3. Literature Review and Hypotheses
Corporate failure has long been researched in different economic settings (Riahi-Belkauoi
& Picur 2000; Abbott, Park & Parker, 2000). The academic research has reemphasized fraud and
bankruptcy following the 2001 Enron collapse (Johnson, Ryan & Tian 2009; Cohen, Ding,
Lesage & Stolowy 2012). Conventional wisdom suggests that lack of integrity and managerial
greed causes firm failure. For example, Daboub et al. (1995) suggest that illegal corporate
behaviour can be best understood by examining the characteristics of top-management teams.
Earlier research studies show that RPTs are a red flag in financial reporting quality, suggesting a
positive association with the restatement and increased audit risk (Kohlbeck & Mayhew, 2017).
Kohlbeck and Mayhew (2017) also argue RPTs signal that management is willing to self-deal,
causing more self-centric action. The research results of Wilson, Rose, and Pinfold (2010) show
that shortcomings in regulations and corporate governance are the main sources of financial
company failure in the years before the global financial crises.
Academic research has shown that related party transactions represent a corporate
governance challenge (Gordon, Henry, & Palia, 2004). Challenges include the potential for
fraudulent financial reporting practices (Henry, Gordon, & Reed, 2007; Gordon et al. 2014) and
reduced operating performance (Chen, Chen and Chen, 2009). Worldwide, the negative impacts
of related party transactions have been observed in a similar way. Using a sample of 85
companies listed on the Paris Stock Exchange, Nekhili and Cherif (2011) show that related party
transactions are mainly influenced by the voting rights held by the main shareholders, resulting
in diminishing market value. The results from Aharony, Wang and Yuan’s (2010) study indicate
that related party sales of goods and services could be used opportunistically to manage earnings
upwards in the pre-IPO period. In Taiwan, Yeh, Shu and Su (2012) suggest that better corporate
governance eliminates the negative effects of related party transactions but finds that firms with
higher ownership concentration are more prone towards RPTs. While results of most of the
Page 6 of 31
research reveal the detrimental effect of related party transactions, Ryngaert and Thomas (2012)
argue that not all RPTs are the same and evidence that the overall volume of disclosed RPTs is
generally not significantly associated with shareholder wealth as measured by operating
profitability or Tobin's Q. They contribute to the literature by considering ex-ante versus ex-post
the impact of RPTs on firm profitability. They prove that ex-post RPT disclosures have a
significant negative impact on a firm’s share price immediately after publishing such disclosures,
while ex-ante RPT disclosure effects are not the same. Ryngaert and Thomas (2012) believe that
their results are consistent with the costs and benefits of RPTs for stakeholders other than direct
investors.
Academic research on related party transactions is scant in the New Zealand context.
Wilson et al. (2010) review characteristics of a sample of four failed finance companies that
entered into liquidation, receivership, or moratorium and concluded that, as these companies
share more or less the same characteristics, they have been involved in high-risk lending
alongside inadequate bad debt provision. NBDT failed companies suffered from a mismatch of
assets and liability maturities as they relied on deposits to cover the shortfall. Most importantly,
related party transactions are not disclosed properly. Wilson et al. (2010) consider information
asymmetry occurrence as another common characteristic of failed financial companies.
Furthermore, the composition of boards of directors, including few independent directors on
financial companies’ boards, is reported as a cause of failure that consequently creates a
condition where directors cover up their fraudulent activities (Wilson et al., 2010).
Most recently, academic researchers have paid attention to New Zealand failed firms in
order to identify determinants and pre-bankrupt earning behaviour (Kabir & Laswad, 2014;
Douglas, Lont & Scott, 2014; Wu & Malthus, 2013, Yahanapath, 2010). Douglas, Lont, and
Scott (2014) investigated failure predictability in the published financial information of New
Zealand finance companies failing in the years between 2006 and 2009. Their results indicate
that in a comparison of non-failed with failed finance firms, the latter firms suffer from
inadequacy of capital and asset quality as well as an imbalance in short-term funding, a lower
cash flow, and higher earnings. In terms of audit quality, failed non-bank deposit takers have
longer audit lags than their non-failed counterparts. Considering governance characteristics,
Douglas et al. (2014) report that failed companies have relatively younger trustees and they
Page 7 of 31
believe that the monitoring effectiveness of the directors, trustees, and financial advisers is
questionable.
Using a sample of failed finance companies in the New Zealand context, Kabir and
Laswad (2014) examine earning behaviour, accruals, and impairment loss, and reveal that
earnings and accruals are likely to decline while impairment losses are higher when compared
with the last two financial years before bankruptcy. Using a relatively smaller sample, Wu and
Malthus (2013) considered 13 failed financial companies and found that, as suggested by
previous studies in the same area, New Zealand’s failed NBDTs shared four common
characteristics: unwarranted lending, directors’ scams, inappropriate deletion of disclosure about
substantial lending, and breaches of legal requirements – all considered causes of collapse.
Moreover, shortcomings in the audit procedures that were not able to detect unlawful
transactions with the related parties opened the door for breaches of the statutory requirements.
The extant literature, however, states that related party transactions are difficult to externally
audit for many reasons, including identification of the RPTs and internal control shortcomings in
detecting such transactions (Gordon, Henry, Louwers, & Reed, 2007).
Yahanpath (2010) reported on accountability issues in collapsed New Zealand financial

companies, identifying weak corporate governance and unsuitable accounting practices as main
contributors. This was verified when four high profile managers were charged with the collapse
of one financial company in New Zealand (Wall Street Journal, 2010). The same result was
realized by Watson and Hirsch (2010) but from a legal standpoint. In addition, the researchers
blame weak corporate governance as the main cause of “corrupt behaviour”. Further, an analysis
of the Securities and Exchange Commission’s (SEC) enforcement related to fraud and related
party transactions in the US concluded that loans, unauthorized payments, and undisclosed sales
to the related parties are the most frequent activities in SEC enforcement (Henry, Gordon, Reed,
& Louwers, 2007). The most immediate consequences of unjustifiable related party transactions
are a misappropriation of assets and outward reported cash flow (Henry, Gordon, Reed, &
Louwers, 2007).
To date, academic research has demonstrated the abusive effects of related party
transactions in different regulatory environments by examining active listed companies. None of
the earlier research examines the effect of related party transactions when firms experience
Page 8 of 31
bankruptcy. Globally, active listed companies have a preponderance of monitoring mechanisms
available to facilitate proactive investigations when related party transactions occur. However,
unlisted companies are not usually monitored; therefore, shortfalls leading to bankruptcy are
often not discovered. This study argues that the abuse of related party transactions can be better
understood by analysing bankrupt companies rather than those that are operational. However, we
acknowledge that related party transactions are only one factor that can lead a company to
bankruptcy.
Chien and Hsu (2010) found that corporate governance acts as a conditional factor in the
statistical relationship between the firm performance and RPT disclosure; however, they present
statistical evidence that firm performance exhibits a negative relationship with RPT disclosure
and a positive relationship with corporate governance characteristics. Based on this finding,
Chien and Hsu (2010) conclude that independent boards have a moderating impact on related
party transaction disclosure. While their research highlights pre-bankruptcy operating cash flow,
earning behaviour and questionable accounting practices, here we focus on poor corporate
governance practices.
Morgan (2010) reports that only 14% of directors in failed finance firms had formal
training in governance skills, and emphasizes that these firms have a strong interconnection
among business activities. Stock (2012) explains that New Zealand legislative bodies have
limited resources to enforce oversight of directors and argues that a director who is banned for
inappropriate directorial roles has no requirement to notify the regulators. In the absence of silent
regulatory enforcement and more ownership concentration, non-banking financial institutions
had very close links through management control, with cheaper access to capital. Moreover,
other research studies show that failed firms have smaller boards and fewer external directors.
Gordon, Henry and Palia (2004) argue that interlocking among board members, which does not
fall strictly within the definition of a related party transaction, is clearly an obstacle to true board
independence. Further, they suggest that nepotism and family relationships within the boards
raise a similar concern in related party transactions. Boyle and Ji (2013) argue New Zealand
firms also have smaller boards, on a comparative global scale (Chhaochharia and Grinstein,
2007; Guest, 2009; Kusnadi, 2011; Kang et al., 2007), which indicates that those in management
have more opportunities to interact closely amongst themselves, with a higher possibility of
engaging in related party activities.
Page 9 of 31
There is empirical research evidence that interlocked directors lead to a detrimental effect
on firm performance. Beasley (1996) demonstrates that the existence of an interlocked director
increases the likelihood of accounting fraud, leads to excessive CEO remuneration (Core,
Holthausen, & Larcker, 1999), and, finally, affects the firm’s performance adversely (Fich &
Sivdasani, 2006). Kang (2008) argues that stakeholders are likely to hold the outside directors of
fraudulent firms responsible for failing to detect misleading accounting practices. Silvia, Majluf
and Pardes (2006) indicate board interlocking leads to higher operating performance when
shareholders’ voting rights are aligned towards controlling shareholders’ economic gains. While
the evidence overwhelmingly suggests adverse outcomes from the involvement of interlocking
directors, the competing argument indicates that interlocked directors often facilitate capital
sourcing, negotiation on debt maturity, and they may bring a wealth of experience which helps
improve monitoring activities. However, in further contrast, interlocking directors have relatively
less monitoring opportunities as they hold multiple directorships in other corporate entities,
leading to less engagement in strategic and operating decisions (Ferris, Murali & Adams, 2003).
Jiraporn, Davidsonm, DaDalt and Ning (2009) argue and find evidence that interlocked directors
are busier and often absent from board meetings. Faleye, Hoitash and Hoitash (2011) argue that
board interlocking reduces monitoring quality and raises earnings management practices. Finally,
Falato, Kadyrzhanova and Lel (2014) suggest that interlocked boards are distracted and weaken
monitoring quality which leads to an erosion in shareholder value. All the discussion sufficiently
substantiates the demerits of interlocking directors for firm performance. In brief, as interlocked
directors are naturally well connected to external entities and top-management teams, such
networking can direct and facilitate business activities to a related third-party organization where
the interlocked director holds a position, without considering the merits of the business. The
above discussion leads to the first hypothesis:
H1: Interlocked director affiliated finance firms have more related party transactions
in comparison to collapsed finance firms which are not monitored by interlocked
directors.
The auditor plays an important role in corporate accountability. Contrary to most Western
economies, New Zealand’s audit profession is mostly self-regulated and enjoys a less litigious
environment. Therefore, the incentive for auditors to take risks may be greater relative to more
litigious countries such as the USA. Financial company failures and scandals in New Zealand
Page 10 of 31
raise some concerns about the quality of financial reports and the role of auditors has been
questioned. Sharma, Sharma and Ananthanarayanan (2011) posit that investigations into several
recent financial company failures raise questions about the quality of audit in New Zealand.
Nevertheless, New Zealand auditing standards suggest that an auditor may inspect records or
documents that could provide information about related party transactions. Recently, Sikka
(2009) criticized the role of audit during the financial crisis and argues that claims from external
auditors relating to credible financial statements are questionable. Furthermore, Sikka and
Hampton (2005) maintain external auditors are not effective in restricting corporate opportunistic
behaviours such as tax avoidance and money laundering (Mitchell, Sikka, & Willmott, 1998).
The present study includes a sample of failed finance companies that were not actively
trading on the New Zealand Stock Exchange and therefore the market following was negligible.
Such relaxation may also contribute to a lower litigation risk and, potentially, fewer incentives to
protect the auditor’s reputation. Alternatively, the auditor might consider the audit service to be a
professional liability and be protective towards their own reputation in the absence of strong
legal enforcement (Piot, 2005). Fletcher (2013) reports that some of the failed finance firms
entered into unauthorized, non-commercial and highly imprudent related party transactions
which breached the requirements of business trust deeds. Such RPTs were incurred for the
benefit of management and intentionally disadvantaged investors (Fletcher, 2013).
New Zealand is a thinly traded market with much less analyst following and media
scrutiny compared to larger economic environments such as the US, UK, and Australia. Auditor
scepticism might work inversely to retain customer satisfaction in such a low-growth audit
market. In brief, auditors, as external monitors, fail to identify suspicious business activities due
to a lack of incentive and a less litigious environment. In New Zealand, related party transactions
are regulated but firms which are not listed on the stock exchange are often less monitored by
investors and regulators. Moreover, firms possibly benefit the least in more disclosure, especially
around related party transactions. In most cases, the related party transactions of collapsed New
Zealand finance firms were not disclosed until the beginning of their court trials. Wu and
Malthus (2013) indicate that collapsed firms engage in deliberate non-disclosure on related party
transactions and most of these transactions are excessive lending without satisfactory securities.
Louwers, Henry, Reed and Gordon (2008) raise concern that related party transactions are
complex to identify and auditors need to rely on management’s perspective for information
Page 11 of 31
supporting their identification and valuation. Beasley, Carcello and Hermanson (2001) point out
that identification of related party transactions is one of the top ten deficiencies for auditors.
Bennouri, Nekhili and Touron (2015) argue that Big4 firms are more concerned with a brand
reputation which may impact on litigation risk. They find evidence that external auditors replace
the usual corporate governance mechanisms to control for the reporting of abnormal related party
transactions. Therefore, the second hypothesis is:
H2: A Big4 auditor restricts abusive related party transactions.

4. Research Method
This section includes explanations of sample selection and research design.
4.1 Sample selection
We started with an initial sample of 66 failed firms available on the website

www.interest.co.nz. The details of the dates of inception and consequent failure through to
bankruptcy application are available on the list, known as the Deep Freeze List.2 To retrieve the
financial and governance related information, we used the website
www.business.govt.nz/companies. Failed firms were included in the sample if all the required
variables were available in the annual reports. To maximize the sample size, we used a Google
search and the New Zealand Herald, scoop.co.nz, comcom.govt.nz and interest.co.nz websites to
extract necessary information. Using the financial reports from the websites was very helpful in
tracking disclosures related to RPTs. We used a similar approach to identify interlocking
directorships with other finance and non-financial institutions. A total of 28 failed financial
institutions did not have any governance or financial information available on the Companies
Office website and were excluded from the sample. This provided a total sample of 38 financial
institutions. We extracted the necessary information for at least the three years before the firm
applied for bankruptcy and thus the total sample had 118 firm-year observations for the period
2006–2011. We also included a set of control firms which were operational and survived during
2006–2011. We were able to locate a total of 37 such financial institutions. A total of 10 healthy
2
Deep Freeze List is a publicly available source which includes a comprehensive list of bankrupt finance firms. The
list is an open source maintained by www.interest.co.nz (an independent business news website based in New
Zealand) and the details of the list are available at http://www.interest.co.nz/saving/deep-freeze-list
Page 12 of 31
firms were excluded due to a lack of available information on either corporate governance or
financial accounting variables. The remaining 27 financial institutions provided us with a total of
101 firm-year observations. Thus, the research includes 219 firm-years comprising 118 firm-
years related to the sample of bankrupt financial institutions and 101 firm-years included as a
control set of surviving firms. In brief, the sample includes 27 surviving and 38 bankrupted
financial institutions. Of note is that the sample does not include stock exchange listed financial
firms. Our samples are more comprehensive and robust in comparison to the work of Wu and
Malthus (2013) which uses 13 New Zealand failed finance firms, and Yahanpath (2010) who
includes all the firms which collapsed during 2006-2010 without any systematic sampling
procedure. Kabir and Laswad (2014) include 32 failed finance firms.
4.2 Research design
We develop the following related party transaction model with controlling governance
and other firm fundamental characteristics to test H1:
RPT = β 0 + β1 INTERLOCK + β 2 IDDIR + β 3 BODSIZE + β 4 LNTA + β 5 LEV + β 6 ROA + β 7 LIQ + β 8 CFO +

β 9 yeareffect + ε t ..........(1)
The study considers two different proxies to measure related party transactions (RPT).
First, RPTDUM is considered as a dummy variable equal to 1 if the failed finance firm had any
related party transactions within the 3 years before bankruptcy and 0 otherwise. Second, the
study uses RPTVAL, a continuous variable of $ value for the related party transactions scaled by
total assets if the failed finance firm had any related party transactions within the 3 years prior
bankruptcy. The variable of primary interest here is INTERLOCK. We define a firm interlocking
as existing when at least one of the directors serves in other similar companies in New Zealand.
We expect a positive coefficient on this variable if any of the directors are opportunistic and
utilize their governance mechanism for personal gain, thus supporting H1. We also include a set
of control variables commonly used in the related party transaction literature. Consistent with the
existing research, firms represented by independent directors are less likely to engage in related
party transactions, therefore a negative coefficient between the portion of independent directors
(INDDIR) and RPT is expected (Gordon et al., 2004, 2007; Lo, Wong & Firth, 2010). Firms
served by many board members might have higher proportions of independent directors and so
be less likely to approve related party transactions (Gordon et al., 2004, 2007). INDDIR is the
Page 13 of 31
proportion of independent directors over the total number of directors. The coefficient between
BODSIZE and RPT is expected to be positive as firms with a large board tend to have a diverse
group of board members, which might facilitate the incorporation of a well-networked director to
represent a firm. To avoid any possible impact of skewness, BODSIZE is the natural log of the
number of directors on the board. Following prior studies, related party transactions are expected
for the large (represented by LNTA and CFO) and profitable firms (represented by ROA), with
higher financial risk (represented by LEV and LIQ). We control for firm size (LNTA and CFO) as
large firms are more likely to have multiple segments in different geographic locations and more
investment opportunities with sufficient cash flow. A positive association for RPT with both
LNTA and CFO is expected. LNTA is the proxy for firm size and the natural log value of total
assets for the respective financial year. CFO is the cash flow from operating activities measured
by total cash flow during the financial year over total assets. A negative association between firm
profitability (ROA) and related party transaction (RPT) is expected as profitable firms have less
incentive to engage in related party transactions (Jia, Shi & Wang, 2013). ROA is the proportion
of net income (or loss) before extraordinary items over total assets (Ahmed, Billings, Morton and
Stanford-Harris, 2002). Finally, we expect a positive association between financial risk (LEV and
LIQ) and RPT as a firm in a vulnerable financial position might have more incentive to engage in
related party transactions to overcome financial difficulty (Gao & Kling, 2008). LEV firm
leverage is measured as the sum of the total debt over total assets. LIQ is the liquidity of the firm
measured by the proportion of total current assets over total current liabilities.
To investigate the effect of external monitoring on related party transactions for the failed New
Zealand firms, the model below is developed to test H2:
RPT = η 0 + η1 BIG4 + η 2 IDDIR + η 3 BODSIZE + η 4 LNTA + η 5 LEV + η 6 ROA + η 7 LIQ + η8 CFO +

η 9 yeareffect + ε t ..........(2)
This time, our variable of primary interest is BIG4. BIG4 is expected to be negative if
external monitoring is impaired by using non-BIG4 audit firms. A set of control variables
consistent with earlier research and as explained in the equation 1 description is also considered
relevant. We measure BIG4 as a dichotomous variable equal to 1 if the failed finance firm was
audited by a BIG4 audit firm and 0 otherwise. The remaining variables are explained above
following the equation 1.
Page 14 of 31
5. Results Discussion
Data in this section are explained first using descriptive analysis, then univariate, correlation and
regression analysis in order to present the results.
5.1 Descriptive Analysis
Descriptive statistics of the variables are presented in Table 1, where a total of 42% of the
sample observations have related party transactions (RPTDUM). This table also shows that 38%
of the firm-year observations for the failed finance firms involved interlocking directors
(INTERLOCK) serving on the boards. Although board members can provide extensive
experience to the company through interlocking, busy board members tend to devote less time to
providing advice on strategic activities in the firm. Regarding the other characteristics of the
board of directors (i.e., board independence), only 27% of the directors are independent,
indicating a lower representation of independent directors on the board. Boyle and Ji (2013)
show that an average proportion of independent directors are 55.6% per board in New Zealand.
Fewer independent board members indicate an increased possibility of higher RPTs.
[Table 1 about here]
The descriptive analysis indicates that only 39% of the sampled firms were audited by
Big4 auditors. Auditors need more time for control processes and it is likely that related party
transactions demand more audit activities. Busy directors via interlocking and a low proportion
of independent directors compromise internal controls; consequently, more audit activities
should be provided by internationally recognized auditors. In this situation, it seems that auditors
failed to send proper messages to the stakeholders about the financial status of the company that
may have increased the risk of failure. Not surprisingly, the average leverage for the sample
finances is 52%, indicating an alarming level of risk, while their average liquidity is 2.54 with a
standard deviation of 4.87, indicating satisfactory liquidity in comparison to the conventional
ratio of 2:1. Kabir and Laswad (2014) reported an increased impairment loss coupled with a
decline in earnings in failed New Zealand finance companies. Further they evidence that the
average profitability of the failed finance firms is -7% with a standard deviation of 2.05,
reflecting negative profitability for the sampled financial firms.
Page 15 of 31
5.2 Univariate Analysis
Table 2 represents the mean difference of the variables in terms of firms’ operations with
a related party and non-related party transactions. The study finds that firms operating with
related party transactions had higher board interlocking in comparison to firms which have no
related party transactions and the finding is statistically significant at the 1% level. Consistent
with our propositions, the RPT firms are mostly audited by non-Big4 audit firms. Both
aforementioned variables indicate that internal and external governance mechanisms contributed
to firms operating with related party transactions, with both statistically significant at a better
than 1% level. It is also revealed that, within the sample, firms engaged in RPTs are relatively
bigger than those not involved, with results statistically significant at a better than 5% level. We
also conducted a mean difference test between the failed and surviving financial institutions. The
results indicate that board interlocking is lower within the group of failed financial institutions in
comparison to the sample of surviving financial companies. Also, failed financial companies are
often audited by a Big4 auditor in comparison to the sample of surviving financial companies.
The findings are statistically significant at the 5% level. Results in this section reinforce our
proposition that it is possible that some related party transactions compromise the quality of
financial performance and increase the risk of failure in the wake of weak internal and external
governance mechanisms’ inability to detect such harmful activities.
5.3 Correlation Analysis
Table 3 presents the correlation analysis. In this table, RPTDUM has a significantly
positive correlation with INTERLOCK at a better than 1% level, indicating that firms involved in
related party transactions have a higher percentage of interlocking directors. The correlation
between RPTDUM and BIG4 is negative and statistically significant at the better than 1% level,
indicating non-Big4 auditors have audited most firms having RPT. Furthermore, RPTDUM has a
positive correlation with a firm size which is statistically significant at the better than 1% level.
Both INTERLOCK and ROA are negatively correlated and statistically significant at a better than
10% level, indicating that interlocked firms have unfavourable profitable ratios. None of the
correlation coefficients raise any concern for multicollinearity (the highest reported correlation
Page 16 of 31
coefficient is -0.67 between ROA and LEV) as the pairwise correlation between the independent
variables did not exceed 0.80 (Gujarati, 2006). Furthermore, the study also calculates the
variable inflation factors (VIF) for ROA and LEV at less than 4.0, ruling out the possibility of
multicollinearity concerns (Halcoussis, 2005).
The findings of this paper, therefore, indicate that most failed financial firms were
audited by non-Big4 auditors, and the unfavourable profitability ratio is correlated with
directors’ interlocking. These significant relationships could be considered as a potential reason
for inflated impairment loss and deflated earnings reported in the years before the financial
firms’ public bankruptcy announcement, as suggested by Kabir and Laswad (2014).
5.4 Regression Analysis
As mentioned earlier, the study uses two measures for RPTs (RPTDUM and RPTVAL).
First, a logistic regression model is used to capture the effect of related party transactions when
RPT is used as a dummy variable (RPTDUM). Further, an ordinary least squares regression was
conducted when RPT is used as a continuous variable (RPTVAL). The results are shown in Table
4. The Baseline Model incorporates only the variable of interest to see the original coefficients
between the variables and whether the coefficient changes when including other known factors
as highlighted in the recent literature, herein named as the Main Model. In the baseline
regression model, INTERLOCK shows a positive association (coefficient 1.72 and 1.19, z (t) -
statistic 5.65 and 1.71 respectively) for both the measures of RPT, and the findings are
statistically significant at the 10% level. In regard to H1 testing (the impact of internal corporate
governance mechanisms on RPT in the failed firms), the results indicate that INTERLOCK has a
positive coefficient with RPT (coefficient 2.06 and 0.24; z (t)-statistic 5.77 and 2.15
respectively), statistically significant at the better than 1% level, and therefore H1 is supported.
In the second step, H2 is tested to show any impact of external governance mechanisms
on RPT. In the baseline regression model, BIG4 shows a negative association (coefficient = -1.08
and -0.32, z (t) -statistic = -3.60 and -3.06 respectively) for both the measures of RPT and the
findings are statistically significant at the 1% level. Considering the other control variables
Page 17 of 31
indicated in equation 2, the results reveal that RPT and BIG4 have a consistent negative
association (coefficient = -1.15 and -0.29; z (t) -statistic = -3.40 and -2.58 respectively),
statistically significant at a better than 5% level, and therefore H2 is supported. The findings are
consistent with the existing corporate governance and audit research. In reference to the control
variables, operating cash flow efficiency (CFO) has a positive and statistical significance,
aligning with the existing literature. Firms with higher operating cash flow (CFO) had a positive
coefficient with RPT, statistically significant at the better than 5% level. Interestingly, both the
corporate governance variables BODSIZE3 and INDDIR show no statistical significance on RPT.
The Pseudo (or adjusted) R2 ranges between 7.98% and 36.84%, indicating the higher
explanatory power of the regression models. The results are consistent with the proposition that
firms with directors representing multiple corporate boards might have weaker corporate
governance practices (Jiraporn, Singh & Lee, 2009). Falato et al. (2014) argued that interlocked
directors are distracted, leading to impaired monitoring and results in poor shareholder value.
5.5 Additional Analysis
a. Endogeneity Concern
The results presented in Table 4 show the findings from ordinary least squares analysis
which estimates the determinants of RPT as a function of BIG4. However, such relations might
raise an endogeneity concern because BIG4 auditors might intentionally avoid high-RPT
companies during the client selection process, with the same applying to interlocking directors.
To address the self-selection problem, we employed the Heckman two-stage test (Heckman,
1979). At the first stage, we regress the choice of the BIG4 auditor on some of the likely
determinants of auditor choice decision. The following probit model is estimated.
PR ( BIG 4) = λ0 + λ1 INDDIR + λ2 BODSIZE + λ3 LNTA + λ4 LEV + λ5 ROA + η 6 LIQ +

η 9 yeareffect + ε t .......... (3)
3
We use an alternative measure for BODSIZE (a dummy variable assigned as 1 if the board size is above the median
and 0 otherwise). The findings are consistent considering alternative proxy. Results are untabulated for the sake of
brevity.
Page 18 of 31
It is considered that the choice of Big4 auditors is determined by the quality of corporate
governance (INDDIR & BODSIZE) and firm-specific characteristics such as complexity (LNTA),
finance risk (LEV), performance (ROA), and liquidity risk (LIQ). Based on the first-stage probit
regression results, the inverse mill ration (IMR) included in equation (2) as an independent
variable to control for the self-selection problem is computed. The results are presented in Table
5. The association between RPT and BIG4 shows a consistent negative relationship (coefficient =
-1.47*** and -0.32**, t-statistic = -3.75 and -3.10), and indicates that choice of auditor selection
given both random and primary evidence as shown in Table 4 is consistent. The findings are
statistically significant at the 1% level.
b. Joint effect of BIG4 and INTERLOCK
Arguably, both the variables of interest (BIG4 and INTERLOCK) might have a joint
effect on the determinants of RPTs. To examine whether there is a joint effect of interlocking
director and Big4 auditors, we considered adding an interaction term between BIG4 and
INTERLOCK. We re-ran equations 1 and 2 including the interacting variable
BIG4*INTERLOCK. Table 5, Panel C, presents the results of the joint effect test. We find that
BIG4*INTERLOCK does not indicate any statistical significance on RPT.
c. Additional Control for Corporate Governance Variables: CEO Duality and audit fees
The corporate governance literature often argues and finds evidence that CEO duality
impairs board monitoring ability (Grove, Patelli, Victoravich & Xu, 2011). In an additional
analysis, we control some governance variables to minimize the omitted variables problem and
to examine the impact of these additional corporate governance factors on firm bankruptcy. We
included CEO duality (CEODUAL), which is coded 1 if the CEO and the Chairman of the board
is the same person and 0 otherwise, and audit effort (AUDFEE), measured as a proportion of
audit fees to total audit and non-audit fees. Within the sample of bankrupt financial institutions,
the results show that annual reports for many of the sampled firm-years do not disclose the
biography of the directors and CEO. We extracted both the CEODUAL and AUDFEE for a total
of 92 firm-year observations. A logistic regression was re-run for both equations 1 and 2 (using
RPTDUM as a dependent variable) including CEODUAL and AUDFEE as control variables. An
Page 19 of 31
average of 58% of the sub-sample firms have CEO duality and the mean of AUDFEE is 0.09.
Untabulated results show that the coefficients for both INTERLOCK and BIG4 (coefficient =
1.41 and -1.75; z-statistic = 2.33 and -2.64 respectively) are statistically significant and
consistent with the main analysis.
d. Impact of financial expert directors on related party transaction
Audit committees represented by accounting expert members have been shown to

provide better financial reporting quality (Lo, Wong & Firth, 2010). Here, therefore, we test any
effect of accounting expert director on the practice of related party transactions within the
bankrupted financial institutions. The study was unable to identify any information about audit
committee members (or expertise) due to the lack of corporate governance disclosure. However,
it is possible to extract information (like the sample size of additional test (c)) for accounting
expert directors (ACCEXP) and code 1 if the board has at least one director who has accounting
expertise (accounting degree or affiliation of professional accounting degrees such as CA, CPA,
and CMA, etc), and 0 otherwise. A total of 52% firm-year observations have at least one
accounting expert director on the board. Further, the results indicate that firms with accounting
expert directors are less likely to practise related party transactions (RPTDUM). The coefficient
of ACCEXP is negative but insignificant (coefficient = -0.83 and t-statistic -1.62).
e. Regulatory Enforcement in Post-Bankruptcy Period
The collapses led to an overhaul of the finance company industry and laws, and the
creation of a new regulator, the Financial Markets Authority in 2011. To date, the Financial
Markets Authority initiates criminal prosecutions and in most cases, the directors of those
collapsed financial institutions were convicted and either served time in jail or received home
detentions or community service for their wrongdoing. During the court ruling, engaging in a
higher proportion of related party loans, breaches of cash reserve requirements, and lack of
disclosures were often identified as determinant factors of those collapses. To understand the
effect of related party transactions on the convictions of directors, we regress the following
model:
PR (CONVICT ) = D 0 + D 1 RPTDUM + D 2 INTERLOCK + D 3 BIG 4 + ε t .......... ( 4)
Page 20 of 31
The study considers a conviction (CONVICT) for director negligence is more likely when
firms have related party transactions (RPTDUM). We also control director interlock
(INTERLOCK) and audit quality (BIG4) as a corporate governance proxy. ‘Stuff.co.nz’, an
independent business news website, is used to search conviction details of directors. The
descriptive statistics reveal (results are not tabulated for the sake of brevity) that at least 1
director in 17 out of the 38 sample collapsed finance firms were convicted. The pairwise
correlation between CONVICT and RPTDUM (correlation = 0.61, p<0001) indicates that
financial firms which were engaged in related party transactions were found to have questionable
practices. The pairwise correlation between CONVICT and BIG4 shows a negative relationship
(correlation = -0.36, p<0.029) which is qualitatively consistent with our primary findings. A
logistic regression is run for equation 4 and finds that PRTDUM has a positive association with
CONVICT (coefficient = 3.05***, z-statistics = 3.17). Also, we find a negative association
(coefficient = -1.13*, z-statistic = -1.79) between CONVICT and BIG4, supporting the existing
literature that large auditors are more concerned about their reputation to deliver good quality
audit reports. Our findings indicate that firms with related party transactions were proven to be
opportunistic.
6. Conclusion and Implications

This paper examined the likely determinants of related party transactions in failed finance
companies in New Zealand. We used director interlocking and auditor’s role as the determinants.
While director interlocking is considered as a quality internal monitoring mechanism (i.e., an
internal control system installed by directors) and the presence of a reputable large auditor (i.e.,
Big4) as an external monitor, we expected that lower quality internal monitoring and relaxed
monitoring from the non-Big4 auditors contributes to a higher failure risk. The study
documented that lower quality of monitoring from a non-Big4 auditor and interlocking behaviour
of directors may facilitate related party transactions. Nevertheless, failed financial companies
have fewer independent directors. This research will be beneficial to the New Zealand Exchange
Ltd, to show the importance of good corporate governance practice. While the regulators are
more focused on the importance of corporate governance, there are no clear indicators of good
governance apart from board independence. Considering the higher risk inherent in financial
Page 21 of 31
institutions, corporate governance best practice codes need to address some good corporate
governance practice indicators - for example, ensuring more representation of truly independent
directors on the board and understanding the importance of good and efficient auditors. Further,
appropriate caution is required to avoid any social ties between CEO and independent director
(Bruynseels and Cardinaels, 2014). The association between board independence and the
existence of related party transaction shows negative but weak statistical significance which
justifies the importance of independent directors in practising good corporate governance. While
accepting the argument that all auditors have satisfactory levels of professional expertise and
care, the financial sector requires much higher attention from their external auditors. This
research also demonstrates the emphasis of related party transaction disclosures.
This research also helps the Institute of Directors to identify the drawbacks of
interlocking. Considering the small and more closed corporate environment, executives are
known to each other either professionally or personally, making it more challenging to be
independent and free from biased decision making. The results of this paper may encourage
authorities to scrutinize related party transaction disclosures by compiling rules such as those
developed and constantly updated by the US SEC (for example see McDermott, Dallett &
Gardella, 2006).
It should also be acknowledged that some limitations may raise the potential for future
research. The main limitation of this study were the limited available data regarding failed
financial firms. For this study, the researchers have managed to collect data from little more than
half of all the financial firms that failed during the six years of the study period. While the
findings are statistically significant using the collected samples, generalizations should be made
with caution. Our sample size is consistent with the Kabir and Laswad (2014) and Douglas, Lont
and Scott (2014) studies. While empirical research suggests that RPTs could be different in type
or operation in nature, particularly relating to the benefit of management incentives and
employees’ benefit, our research failed to segregate RPTs into separate forms due to the limited
available data. As mentioned earlier, related party transactions were not identified during the
process of bankruptcy but revealed via recent court trials. We suggest caution in generalizing our
findings.
Page 22 of 31
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Page 26 of 31
TABLE 1: Descriptive Analysis
Variable Mean Std. Dev. Min Max
RPTDUM 0.42 0.49 0 1
RPTVAL ($ million) 24.73 4.77 0 463.00
INTERLOCK 0.38 0.38 0 1
BIG4 0.39 0.48 0 1
INDDIR 0.27 0.28 0 1
LNBOD 1.46 0.49 0 2.64
LNTA 18.05 2.47 10.96 26.85
LEV 0.52 1.76 0 12.02
ROA -0.07 2.05 -4.69 3.50
LIQ 2.54 4.87 0.01 6.28
CFO 0.58 6.66 -1.88 97.36
Note: RPTDUM is a dummy variable equal to one if the failed finance firm had any related party transactions within
the 3 years before bankruptcy and 0 otherwise, RPTVAL is the dollar value of related party transaction scaled by
total assets, INTERLOCK as a dummy variable equal to one if the failed finance firm had any director who serves to
other New Zealand companies in similar role. BIG4 is a dichotomous variable equal to one if the failed finance firm
was audited by a BIG4 audit firm and 0 otherwise; INDDIR is the proportion of independent directors over the total
number of directors. BODSIZE is the natural log of the number of directors on the board. LNTA is the proxy for firm
size and the natural log value of total assets for the respective financial year. LEV firm leverage is measured as the
sum of the total debt over total assets. ROA is the proportion of net income (or loss) over total assets. LIQ is the
liquidity of the firm measured by proportion of total current assets over total current liability while CFO is the cash
flow from operating activities measured by total cash flow during the financial year over total assets.
TABLE 2: MEAN DIFFERENCE
Variables RPTDUM=1 RPTDUM=0 t-statistics Failed firm = 1 Surviving firm = 0 t-statistics
INTERLOCK 0.62 0.22 -6.29*** 0.31 0.49 3.76***
BIG4 0.25 0.50 3.78*** 0.34 0.45 2.01**
INDDIR 0.24 0.27 0.21 0.15 0.38 6.49***
BODSIZE 1.49 1.45 -0.62 1.27 1.69 7.08***
LNTA 9.99 9.07 -2.27** 17.52 18.65 3.45***
LEV 1.16 0.75 -1.73* 0.93 0.92 -0.06
ROA -0.35 -0.13 -1.79* 0.06 0.09 0.07
LIQ 2.94 2.25 -1.03 1.22 4.08 4.51***
CFO 0.05 0.95 2.11** 0.93 0.16 -0.89
Total 91 128 Total - 219 118 101 Total - 219
the 3 years before bankruptcy and 0 otherwise, INTERLOCK is a dummy variable equal to one if the failed finance
firm had any director who serves on the board of other New Zealand companies in a similar role. BIG4 is a
dichotomous variable equal to one if the failed finance firm was audited by a BIG4 audit firm and 0 otherwise;
INDDIR is the proportion of independent directors over the total number of directors. BODSIZE is the natural log of
the number of directors on the board. LNTA is the proxy for firm size and the natural log value of total assets for the
respective financial year. LEV firm leverage is measured as the sum of the total debt over total assets. ROA is the
proportion of net income (or loss) over total assets. LIQ is the liquidity of the firm measured by the proportion of
total current assets over total current liability while CFO is the cash flow from operating activities measured by total
cash flow during the financial year over total assets. ***, ** and * represent statistical significance at 1%, 5% and
10%.
Page 27 of 31
TABLE 3: Correlation Analysis

Variables RPT INTERLOCK BIG4 BODSIZE INDDIR LNAT LEV ROA LIQ CFO
RPTDUM 1
INTERLOCK 0.39*** 1
BIG4 -0.25*** -0.02 1
BODSIZE 0.04 -0.24 -0.10 1
INDDIR -0.03 -0.08 -0.02 0.08** 1
LNAT 0.18*** 0.34** 0.33* 0.47** -0.14** 1
LEV 0.11 0.15* -0.09 0.02 -0.04 -0.16* 1
ROA -0.11* -0.12** 0.11 0.03 -0.01 0.04*** -0.67*** 1
LIQ -0.06 -0.08 -0.08 0.05 0.17*** -0.07 0.07* -0.03 1
CFO -0.07 -0.07 0.09 0.03 -0.17 -0.19*** 0.01 0.21*** -0.04 1
Note: RPTDUM is a dummy variable equal to one if the failed finance firm had any related party transactions within the 3 years before bankruptcy and 0
otherwise, INTERLOCK is a dummy variable equal to one if the failed finance firm had any director who serves to other New Zealand companies in a similar
role. BIG4 is a dichotomous variable equal to one if the failed finance firm was audited by a BIG4 audit firm and 0 otherwise; INDDIR is the proportion if
independent directors over the total number of directors. BODSIZE is the natural log of the number of director on the board. LNTA is the proxy for firm size and
the natural log value of total assets for the respective financial year. LEV firm leverage is measured as the sum of the total debt over total assets. ROA is the
proportion of net income (or loss) over total assets. LIQ is the liquidity of the firm measured by the proportion of total current assets over total current liability
while CFO is the cash flow from operating activities measured by total cash flow during the financial year over total assets. ***, ** and * represent statistical
significance at 1%, 5% and 10%.
Page 28 of 31
TABLE 4 - Regression analysis

Expected Baseline Model Main Model
DEP = RPT DEP = RPTVAL
sign DEP = RPTDUM DEP = RPTDUM DEP = RPTVAL
Constant -1.12 -0.01 0.16 0.36 1.56 -1.81 0.73 0.23
(-3.76)*** (0.04) (1.58) (3.59)*** (1.23) (-1.41) (1.74)* (0.56)
INTERLOCK + 1.72 1.19 2.06 0.24
(5.65)*** (1.71)* (5.77)*** (2.15)**
BIG4 - -1.08 -0.32 -1.15 -0.29
(-3.60)*** (-3.06)*** (-3.40)*** (-2.58)**
INDDIR - -0.16 -0.22 -0.33 -0.36
(-0.28) (-0.41) (-1.81)* (-1.94)*
BODSIZE + 0.11 0.16 -0.07 0.08
(0.31) (0.45) (-0.65) (-69)
LNTA + 0.17 0.07 0.03 0.01
(2.21)** (1.84)* (1.77)* (0.40)
LEV + 0.05 0.18 0.02 0.03
(0.21) (0.79) (0.31) (0.69)***
ROA + -0.07 -0.30 -0.07 -0.06
(-0.23) (-0.76) (-1.80)* (-1.69)*
LIQ - 0.05 0.04 0.02 0.02
(1.78)* (1.86)* (2.30)** (2.03)**
CFO + 0.09 0.04 0.03 0.001
(2.17)** (2.09)** (2.14)** (2.03)**
YEAR YES YES YES YES YES YES YES YES
CONTROL
LR-CHI 35.04 14.04 46.75 21.07
PSEDU 0.1179 0.0472 0.0550 0.0693 0.1575 0.0798 0.3154 0.3684
(Adjusted) R2
FIRM YEAR 219 219 219 219 219 219 219 219
Note: RPTDUM is a dummy variable equal to one if the failed finance firm had any related party transactions within the 3 years before bankruptcy and 0
otherwise, RPTVAL is the dollar value of related party transaction scaled by total assets, INTERLOCK is a dummy variable equal to one if the failed finance firm
had any director who serves to other New Zealand companies in similar role. BIG4 is a dichotomous variable equal to one if the failed finance firm was audited
by a BIG4 audit firm and 0 otherwise; INDDIR is the proportion if independent directors over the total number of directors. BODSIZE is the natural log of the
number of director on the board. LNTA is the proxy for firm size and the natural log value of total assets for the respective financial year. LEV firm leverage is
measured as the sum of the total debt over total assets. ROA is the proportion of net income (or loss) over total assets. LIQ is the liquidity of the firm measured by
the proportion of total current assets over total current liability while CFO is the cash flow from operating activities measured by total cash flow during the
financial year over total assets. ***, ** and * represent statistical significance at 1%, 5% and 10%.
Page 29 of 31
TABLE 5 - Endogeneity Analysis
Panel A – First Stage Regression Model
Coefficients (z-value)
Variables
DEP = BIG4
Constant -0.42 (-0.73)
INDDIR 0.49 (2.09)**
BODSIZE -0.32 (1.69)*
LNTA 0.45 (4.80)***
LEV 0.48 (2.25)**
ROA 0.38 (1.32)
LIQ -0.01 (-1.36)
YEAR CONTROL YES

LR-CHI 39.53
PSEDU R2 0.1951
FIRM YEAR 219
Panel B – Second Stage Regression Model

Variables Dependent = Dependent =
RPTDUM RPTDUM
Coefficients [z-value]
Constant -20.45 (-2.15)** -1.06 (-1.31)
BIG4 -1.47 (-3.75)*** -0.32 (-3.10)***
INDDIR -1.23 (-1.90)* -0.46 (-2.41)**
BODSIZE 0.69 (1.43) 0.18 (1.77)*
LNTA 1.38 (2.08)** 0.08 (1.89)*
LEV 0.53 (1.66)* 0.09 (0.88)
ROA 1.69 (1.73)* 0.02 (0.34)
LIQ -2.02 (-1.86)* -1.09 (-1.71)*
CFO 0.03 (3.08)*** 0.01 (0.61)
IMR 191 (2.25)** 0.26 (1.78)*
YEAR CONTROL YES YES
LR-CHI/F-statistics 23.76 3.09
PSEDU (Adjusted) R2 0.2199 0.1030
FIRM YEAR 219 219
the 3 years before bankruptcy and 0 otherwise, INTERLOCK is a dummy variable equal to one if the failed finance
firm had any director who serves to other New Zealand companies in a similar role. BIG4 is a dichotomous variable
equal to one if the failed finance firm was audited by a BIG4 audit firm and 0 otherwise; INDDIR is the proportion if
independent directors over the total number of directors. BODSIZE is the natural log of the number of director on
the board. LNTA is the proxy for firm size and the natural log value of total assets for the respective financial year.
LEV firm leverage is measured as the sum of the total debt over total assets. ROA is the proportion of net income (or
loss) over total assets. LIQ is the liquidity of the firm measured by the proportion of total current assets over total
current liability while CFO is the cash flow from operating activities measured by total cash flow during the
financial year over total assets. ***, ** and * represent statistical significance at 1%, 5% and 10%.
Page 30 of 31
Panel C – Additional Test on Joint Effects of BIG4 and INTERLOCK
DEP = RPT
Expected
Variables DEP = RPTDUM DEP = DEP = DEP =
sign
RPTVAL RPTDUM RPTVAL
Constant 0.36 0.45 0.43 0.41
(1.78)* (1.06) (1.39) (3.97)***
INTERLOCK + 2.07 0.22 2.01 0.26
(5.64)*** (2.07)** (4.69)*** (1.81)*
BIG4 - -1.18 -0.26 -1.27 -0.23
(-3.17)*** (-2.39)** (-2.50)** (-1.73)*
INTERLOCK*BIG4 ? 0.20 0.08
(1.27) (1.12)
INDDIR - -0.31 -0.36 -0.30 -0.37
(-2.14)** (-2.00)** (-0.52) (-2.12)**
BODSIZE + 0.05 0.10 0.03 0.09
(1.31) (1.60) (0.08) (1.79)*

LNTA + 0.08 0.005 -0.09 -0.001
(2.09)** (1.24) (-1.07) (-0.15)
LEV + 0.02 0.018 0.02 -0.02
(0.05) (0.39) (0.07) (-0.36)
ROA + -0.09 -0.06 -0.09 -0.06
(-1.19) (-0.99) (-0.35) (-1.69)*
LIQ - 0.04 0.03** 0.04 0.02
(1.34) (2.19) (1.35) (2.16)**
CFO + 0.06 0.001 -0.03 0.01
(1.83)* (2.21)** (-0.29) (1.88)*
YEAR CONTROL YES YES YES YES
LR-CHI/F-statistics 57.51 3.91 57.85 4.98
PSEDU (Adjusted) 0.1997 15.35 0.1937 0.3529
R2
FIRM YEAR 219 219 219 219
the 3 years before bankruptcy and 0 otherwise, RPTVAL is the dollar value of related party transaction scaled by
total assets, INTERLOCK is a dummy variable equal to one if the failed finance firm had any director who serves
other New Zealand companies in similar role. BIG4 is a dichotomous variable equal to one if the failed finance firm
was audited by a BIG4 audit firm and 0 otherwise; INDDIR is the proportion if independent directors over the total
number of directors. BODSIZE is the natural log of the number of director on the board. LNTA is the proxy for firm
size and the natural log value of total assets for the respective financial year. LEV firm leverage is measured as the
sum of the total debt over total assets. ROA is the proportion of net income (or loss) over total assets. LIQ is the
liquidity of the firm measured by the proportion of total current assets over total current liability while CFO is the
cash flow from operating activities measured by total cash flow during the financial year over total assets. ***, **
and * represent statistical significance at 1%, 5% and 10%.
Page 31 of 31

Bhuiyan2018 RTP and Finance Company Failure New Zealand Evidence

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2. Regulatory Environment for Financial Institutes

A review of New Zealand’s legislative environment is important when attempting to

Common practice is that legislation is enacted reactively instead of proactively. New

3. Literature Review and Hypotheses

Yahanpath (2010) reported on accountability issues in collapsed New Zealand financial

H2: A Big4 auditor restricts abusive related party transactions.

4.1 Sample selection

We started with an initial sample of 66 failed firms available on the website

procedure. Kabir and Laswad (2014) include 32 failed finance firms.

4.2 Research design

RPT = β 0 + β1 INTERLOCK + β 2 IDDIR + β 3 BODSIZE + β 4 LNTA + β 5 LEV + β 6 ROA + β 7 LIQ + β 8 CFO +

RPT = η 0 + η1 BIG4 + η 2 IDDIR + η 3 BODSIZE + η 4 LNTA + η 5 LEV + η 6 ROA + η 7 LIQ + η8 CFO +

5.1 Descriptive Analysis

[Table 1 about here]

[Table 2 about here]

5.3 Correlation Analysis

[Table 3 about here]

5.4 Regression Analysis

[Table 4 about here]

5.5 Additional Analysis

PR ( BIG 4) = λ0 + λ1 INDDIR + λ2 BODSIZE + λ3 LNTA + λ4 LEV + λ5 ROA + η 6 LIQ +

[Table 5 about here]

b. Joint effect of BIG4 and INTERLOCK

d. Impact of financial expert directors on related party transaction

Audit committees represented by accounting expert members have been shown to

e. Regulatory Enforcement in Post-Bankruptcy Period

PR (CONVICT ) = D 0 + D 1 RPTDUM + D 2 INTERLOCK + D 3 BIG 4 + ε t .......... ( 4)

6. Conclusion and Implications

research also demonstrates the emphasis of related party transaction disclosures.

TABLE 3: Correlation Analysis

TABLE 4 - Regression analysis

YEAR CONTROL YES

Panel B – Second Stage Regression Model

(1.31) (1.60) (0.08) (1.79)*

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