The current issue and full text archive of this journal is available on Emerald Insight at:

www.emeraldinsight.com/1321-7348.htm

ARA
27,2 Corporate governance
and detrimental related
party transactions
196 Evidence from Malaysia
Received 10 February 2018
Revised 31 July 2018
Masood Fooladi and Maryam Farhadi
10 November 2018 Department of Accounting, Mobarakeh Branch,
Accepted 17 January 2019 Islamic Azad University, Mobarakeh, Iran

Abstract
Purpose – Prior studies suggest that most expropriation of firm’s resources is conducted through
related party transactions (RPTs). Based on the conflict of interest view, related parties opportunistically
use their authorities to expropriate firms’ resources for their own benefits via RPTs subsequently
increasing agency costs and reduce firm value. One important monitoring system suggested by agency
theory to reduce the agency problem is corporate governance (CG). CG monitors firm’s performance to
align the interests of those who control and those who own the residual claims in a firm. The purpose of
this paper is to investigate the moderating effect of CG characteristics on the relationship between RPTs
and firm value.
Design/methodology/approach – In order to clarify the distinct effect of RPTs, this study categorises
RPTs into two groups including beneficial and detrimental RPTs (DRPTs). Applying “proportionate stratified
random sampling”, this study covers a panel of 271 firms listed on Bursa Malaysia over the period of
2009–2011, using a moderated multiple regression model.
Findings – This study documents that firm value is positively associated with beneficial RPTs (BRPTs)
and negatively related to detrimental RPTs (DRPTs). In addition, results show that divergence can
intensify the negative relationship between DRPTs and firm value. Findings support the necessity for more
scrutiny by regulators, policy makers and standard setters to monitor the conflict of interests in RPTs and
restrain the power of related parties to protect the firm’s wealth by introducing stricter regulations for
RPTs and improve CG practices especially to monitor RPTs in order to limit the opportunistic behaviour of
related parties.
Research limitations/implications – Research implications have been presented in Section 10. It has also
been summarised in practical implications and social implications sections.
Practical implications – The findings of this study indicate that investors, creditors and policy
makers should not consider all RPTs as harmful transactions and it seems necessary to categorise
RPTs into different groups including transactions which are detrimental and transactions which are
beneficial to the firm.
Social implications – The findings of this study support the necessity for more scrutiny by regulators,
policy makers and standard setters to monitor the conflict of interests in RPTs. They should restrain
the power of related parties to protect the firm’s wealth by introducing stricter regulations for RPTs
and improving CG practices especially to monitor RPTs in order to limit the opportunistic behaviour of
related parties.
Originality/value – This study contributes to the RPTs literature by showing that the effect of RPTs on
firm value depends on the types of RPTs, and market participants allocate different values to different types
of RPTs. Therefore, to fill the gap and clarify the distinct effect of RPTs, this study categorizes RPTs into two
groups including beneficial and detrimental RPTs.
Keywords Corporate governance index, Beneficial related party transaction,
Detrimental related party transaction, Divergence between cash flow and control rights
Paper type Research paper

Asian Review of Accounting 1. Introduction

Vol. 27 No. 2, 2019
pp. 196-227
Nowadays, separation of ownership from control causes the inability of shareholders to
© Emerald Publishing Limited have a full control over managerial actions (Abdullah, 2004). In addition, agency theory
1321-7348
DOI 10.1108/ARA-02-2018-0029 assumes an opportunistic behaviour that is individuals want to maximise their own
expected interests and are resourceful in doing so (McCullers and Schroeder, 1982). CG and
Therefore, there will be a conflict of interest between managers and shareholders when detrimental
managers use their authority to pursue their own benefits at the expense of shareholders’ RPTs
profitability (Grinyer, 1995). Furthermore, there will be an information asymmetry
between shareholders and management because the management has the competitive
advantage of information within the company over that of the owners (Zubaidah et al.,
2009). Eisenhardt (1989b) believes that this situation arises because of an ineffective 197
information system to control the management behaviour. They cited this position as a
moral hazard in which agents neglect the agreement with shareholders and make
decisions that are not in the best interest of shareholders. Therefore, this conflict of
interest creates agency problems in a firm ( Jensen and Meckling, 1976). In addition to the
conflict of interest between managers and shareholders, Shleifer and Vishny (1997) and La
Porta et al. (1998) emphasise another agency problem associated with the conflict of
interest between controlling and minority shareholders.
Claessens et al. (2000) find that corporate ownership in East Asian firms is
complicated by pyramidal and cross-holding structures and voting rights of controlling
shareholder exceed the size of shares in their hands. This situation is known as
divergence between cash flow and control rights providing controlling shareholders with
an opportunity to expropriate other minority shareholders because of the conflict of
interest between them. In an opportunistic behaviour case, controlling owners and
managers can tunnel benefits from a firm to another personally related firm or directly to
their own accounts through self-dealing. Prior studies suggest that most expropriation of
minority shareholders’ wealth is conducted through the related party transactions
(RPTs) ( Johnson, Boone, Breach and Friedman, 2000; La Porta et al., 2000). RPTs are
usually conducted through the complicated transactions between the firm and its related
parties and make it hard for outsiders to discover questionable or fraudulent
transactions. Managers and directors are responsible to enter into contracts that
maximise the shareholders’ wealth. In some cases, directors and managers may conduct
these transactions with themselves, their families, other personally related firms under
the control of directors and managers, or large shareholders.
Opportunistic behaviour of management is an important factor in the misappropriation
of assets and misleading financial reporting in the recent frauds at Enron, HealthSouth and
other firms (Swartz and Watkins, 2003). In most of these frauds, managers used RPTs to
generate misleading financial statements and enrich themselves. Therefore, related parties
can extract firm’s wealth through the transactions at the expense of other shareholders
(Kohlbeck and Mayhew, 2010). MASB (2008) is also concern about the opportunistic
behaviour of related parties and states that related parties may enter into transactions that
unrelated parties would not. A related party relationship may have an effect on the financial
position of a firm even if RPTs do not occur. In addition, Cheung, Jing, Lu, Rau and
Stouraitis (2009) conclude that related parties appear to tunnel resources away from the firm
for their personal purpose and impose residual loss to other stakeholders who are not
related to these transactions. This opportunistic behaviour of related parties will diminish
the firm value.
Therefore, it is necessary to use an efficient internal control system to execute an effective
monitoring system and mitigate the opportunistic behaviours of related parties in RPTs
(Kohlbeck and Mayhew, 2010). Brickley and James (1987) believe that one of the most
important monitoring systems suggested by agency theory to reduce the agency conflicts is
corporate governance (CG). CG can control the firm’s operations and align the interests of
those who control and those who own the residual claims in a firm. Huang and Liu (2010)
explain that CG has an important role to monitor the process of RPTs. They document that in
a defective CG mechanism, related parties have more expropriation opportunities via RPTs.
ARA In addition, Effiezal et al. (2011) in their study on Malaysian-listed firms find that CG
27,2 characteristics such as board independency and audit quality can moderate the negative effect
of RPTs on firm performance.
However, Fooladi and Farhadi (2017) could not find any significant relationship between
RPTs and firm value in their study on Malaysian-listed firms. They attribute their findings
to considering all RPTs as harmful transactions to the firm. They suggest that not all RPTs
198 should be considered as harmful transactions in a firm and different nature of RPTs should
be considered in future studies. In addition, Sharkar et al. (2007) believe that not all RPTs are
detrimental to the firm and type of RPTs as an important factor should be considered in the
efficiency of these transactions. Cheung et al. (2006) and Kohlbeck and Mayhew (2010)
categorise RPTs based on the nature of transaction and conclude that the market seems to
value the RPTs based on the type of these transactions. They believe that although RPTs
can be used as a means to expropriate firm wealth, there are some RPTs that are likely
beneficial to the firm. Considering all RPTs as detrimental RPTs (DRPTs) in a study cannot
clarify the distinct effect of detrimental and beneficial RPTs (BRPTs) on firm value.
Therefore, to fill the gap and clarify the distinct effect of RPTs, this study categorises RPTs
into two groups including beneficial and DRPTs. Finally, based on the above discussion,
investigating the moderating effect of CG characteristics on RPTs, which are categorised
into detrimental and BRPTs, seems to be essential.
Therefore, the present paper extends the works of prior studies (Gordon et al., 2004;
Effiezal et al., 2011; Hasnan et al., 2016; Balsam et al., 2017; Fooladi and Farhadi, 2017)
by categorising RPTs into two groups including detrimental and beneficial. In addition,
protection of minority shareholders’ rights is another key issue in Malaysian companies
which needs more consideration. The concentration of ownership in Malaysia develops a
new perspective on agency problem in which the main issue is the conflict of interests
between controlling and minority shareholders (Claessens et al., 2000; Fan and Wong,
2005). Corporate ownership in Malaysia is complicated due to pyramidal and cross-
holding structures. In this structure, voting rights (control rights) of controlling
shareholders exceed the size of shares in their hands (cash flow rights). This situation is
known as divergence between cash flow and control rights. Although the previous studies
investigate the moderating effect of CG characteristics on the relationship between RPTs
and firm value (Gordon et al., 2004; Yao, 2010; Effiezal et al., 2011; Hasnan et al., 2016;
Balsam et al., 2017), the effect of divergence between cash flow and control rights is still
not clear. Therefore, the current paper believes that investigating the issue of divergence
between cash flow and control rights may provide more information to explain the
moderating effect of CG on the relationship between RPTs and firm value.
Furthermore, Gordon et al. (2007) note that the nature and definition of RPTs vary across
regulatory bodies and these transactions should be studied in the context of the overall legal
system of each nation. Huang and Liu (2010) suggest that the impact of RPTs on firm value
in different nations depends on industry characteristics and political and cultural
environments. Therefore, studying the RPTs in different nations may result in different
findings. Due to the unique structure of ownership in East Asian countries, researchers are
interested in studying RPTs in these countries ( Jian and Wong, 2010; Cheung, Jing, Lu, Rau
and Stouraitis, 2009). Johnson, La Porta, Lopez-de-Silanes and Shleifer (2000) explain that
tunnelling is more probably conducted in emerging markets with weaker legal enforcement
through the expropriation of firm’s resources via RPTs. In addition, Sa’adiah et al. (2013) in
their study on RPTs and earnings quality concentrate on Malaysia due to the domination of
concentrated ownership and weak institutional structures in firms. These characteristics
provide more inducement to expropriate minority shareholders and suggest a proper
background for their study. Therefore, the focus of this paper is to study RPTs in the
context of Malaysian-listed firms.
 This study contributes to the RPTs literature by showing that the effect of RPTs on firm CG and
value depends on the types of RPTs and market participants allocate different values to detrimental
different types of RPTs. The findings of this study can assist shareholders, top managers RPTs
and directors to have a better understanding of approaches to improve the corporate
monitoring system especially regarding various RPTs. It is also important for regulators
and standard setters to be sure that common resources spent on regulations and rules are
effective and remedial on regularising the market. In spite of recent efforts to regulate RPTs, 199
this study provides useful implications of RPTs for accounting regulation setters who are
striving to improve CG and transparency. The results of this study display that which types
of RPTs are detrimental or beneficial to the firm. In other words, this study can help
regulators, policy makers and standard setters to formulate how to regulate and improve CG
practices especially to monitor RPTs.

2. Literature review
The most important issue in RPTs is the conflict of interest between related parties who are
engaged in RPTs and other stakeholders in a firm (FASB, 1982). One party is called related
party when he/she has an important influence on the operating policies of transacting parties
or holds an interest of ownership in one of the transacting parties. This situation can provide
related parties with a dominant influence on the appointment of contract terms and conditions
which may avert another transacting party from fully persevering its own interest
(FASB, 1982). Consequently, the reported values of transactions will differ from the value of
an arm’s length transaction. In other words, related parties can extract private benefits of
control at the cost of other stakeholders. Although market participants, regulators and other
corporate stakeholders commonly consider RPTs as potential conflicts of interest between
firm managers and their stakeholders, prior studies suggest that there might be two
alternative perspectives on RPTs (Gordon et al., 2004; Kohlbeck and Mayhew, 2010).
In the first viewpoint, which is based on the conflict of interest view, RPTs can exploit the
firm resources and raise moral hazard because these transactions are carried out to expropriate
the wealth from the company in the interest of special groups but at the expense of other
shareholders (Kohlbeck and Mayhew, 2010). Gallery et al. (2008) consider RPTs as the type of
agency costs, which are value destroying because directors and managers execute RPTs for
their own benefit at the expense of other shareholders’ interests. Although corporate owners
employ the officers and directors to enter into contracts that maximise shareholders wealth, in
some cases, related parties such as controlling shareholders, officers and directors may tunnel
the firm’s resources through the RPTs and impose a major risk to other stakeholders
(Baek et al., 2006; Cheung et al., 2006). As an example, managers or controlling shareholders
being related parties may transfer goods, products and assets from the company they control
to their own independent firms at below market prices. As another example, a firm may
purchase material with poor quality from a related party and the firm has paid high prices
equivalent to a high-quality material to the related party (Ryngaert and Thomas, 2012). Such
examples of RPTs impose residual losses to other shareholders due to the lack of arm’s length
terms and conditions. This perspective of RPTs is consistent with “potential wealth transfer”
indicated via FASB (1982) Statement No. 57 entitled “Related party disclosure” and the conflict
of interest as a type of agency problem considered by Berle and Means (1932) and Jensen and
Meckling (1976). Another problem due to RPTs is the falsification of the financial statements in
order to conceal the expropriation (Huang and Liu, 2010). This problem leads to potential bias
in financial statements and has a negative effect on the reliability and relevance of information,
which makes more uncertainty and fails to reduce the agency conflicts. Kohlbeck and Mayhew
(2017) investigate whether or not RPTs serve as “red flags” that warn of potential financial
misstatement. They find a positive correlation between these transactions and future
restatements, suggesting restatements are more likely when a firm engages in RPTs.
ARA Opposite to the conflict of interest view, the second viewpoint of RPTs is the efficient
27,2 transaction view. Based on this view, RPTs are considered as sound business exchanges,
fulfil underlying economic needs of the organisation such as securing in-depth skills and
expertise between parties who have built up trust and shared private information
(Gordon et al., 2004). As such, companies can engage RPTs to optimise the shareholders’
wealth. Based on efficient transaction view, RPTs have at least a lower dealer cost
200 comparing to arm’s length transaction and could be value enhancing by creating strategic
partnerships, enhancing risk sharing and facilitating contracting (Ge et al., 2010). In the case
of RPTs, there is less information asymmetry between the firm and related party compared
to the case of transaction between firm and unrelated party, which can mitigate the agency
problems. In addition, Ryngaert and Thomas (2012) believe that RPTs could be efficient
contracting arrangements including some potential advantages in deficient information
situations. The first advantage is to coordinate activities and get quick feedback from
related parties. This is due to easy access to information of contracting party, less argument
with related parties during the bargaining and more reliable information acquired from
related parties than those from unrelated parties. The second advantage is sharing
knowledge, improving the efficiency of contract and creating better conditions and terms for
both parties because of the familiarity with each other.
However, regarding the dual effect of RPTs based on the conflict of interest view and
efficient transactions view, it is difficult to prescribe that RPTs are detrimental or beneficial
to the firm and its shareholders (Gordon et al., 2004). Kohlbeck and Mayhew (2010) apply the
contracting and agency theory to explain that the type of RPTs is important to estimate its
potential to be detrimental or beneficial to a firm’s shareholders. They believe that
contracting theory considers RPTs as a part of efficient contracting with related parties. In
contrast, the lack of an arm’s length transaction in RPTs leads to potential agency costs
assumed in agency theory. In addition, there is no country that completely forbids RPTs
because some transactions can be value enhancing (Djankov et al., 2008). In addition,
regulators and standard setters do accept the possibility of the efficient transaction view of
RPTs and hence prefer disclosure rather than limiting RPTs (Gordon et al., 2004). Finally,
Balsam et al. (2017) examine the association between RPTs and CEO compensation over the
2001–2012 period. They find that the SEC RPT disclosure change appears to have had a
significant impact on reported RPTs, the determinants of those RPTs and the impact of
those RPTs on CEO compensation. They document while RPTs may be indicative of
weaknesses in CG, an alternative view is that these transactions are efficient contracting
mechanisms and hence, consistent with shareholder interests.
Therefore, the potential costs imposed by RPTs require an efficient monitoring on such
transactions. Prior studies document that the existence of an appropriate controlling
mechanism such as CG can monitor the process of RPTs and mitigate the expropriation
behaviour of related parties (Effiezal et al., 2011). Gordon et al. (2004) argue that under the
control of CG mechanism, RPTs can be changed from the conflict of interest view to the
efficient transaction view. In addition, agency theory suggests CG as a controlling system to
align the individuals’ goals with those of the firm and reduce the conflict of interests
(Brickley and James, 1987). Hasnan et al. (2016) examine whether there is a positive
moderating effect of CG on the relationship between RPTs and earnings quality. They find
evidence that the existence of RPTs represents a potential conflict of interest, which
provides greater incentives to related parties to expropriate minority shareholders thus
managing earnings to mask up such expropriations. However, the negative effect is
mitigated with the presence of good governance.
In the case of conflict of interest between managers and shareholders, independent
directors have a key role to improve the weight of legitimacy to decisions made by the board
because of directors’ independency from management performance (Effiezal et al., 2011).
Furthermore, the MCCG (2007) proposes a balance of executive and non-executive including CG and
independent directors in the board to make stronger the board in decision-making process detrimental
and prevent the individual or small group of individuals from a dominant control on the RPTs
board. Shamsul Nahar (2006) believes that board independency is a determinant factor of
board efficiency to protect the shareholders’ interests.
Since it is difficult to moderate agency problems between controlling and minority
shareholders through conventional CG mechanisms such as boards of directors, Fan and 201
Wong (2005) suggest that company may employ bonding mechanisms and credible
monitoring to assure the minority shareholders that their interests would be protected. In
order to find evidence on this suggestion, Fan and Wong (2005) examine whether external
auditors can contribute to CG role in dealing with the agency problems and verifying
accounting information in eight East Asian countries including Malaysia. Their results
support the agency theory and suggest that independent external auditors have an effective
governance role to moderate agency problems in East Asian countries. In addition, Defond
and Francis (2005) show that quality of external auditor is an important characteristic of CG
mechanism. Therefore, the quality of external auditor in a firm is another characteristic of
CG considered in this study.
The best practices of the MCCG (2007) propose that there should be a clearly accepted
division of responsibilities at the head of the company between chairman of the board and
CEO to ensure a balance of power and authority, such that no one individual has unfettered
powers of decision. The aim of these recommendations and regulations is to make an
efficient board of directors to carry out its stewardship duties and protect the shareholders’
interest. Agency theory suggests the separation of chairman position from the CEO to
provide a vital check and balances over the performance of managers (Stiles and Taylor,
1993). Abdul Rahman and Haniffa (2005) in their study on the effectiveness of internal
governance mechanism in Malaysian-listed firms document that where the CEO also serves
as chairman, the performance of the firm is weaker compared to the firms with separate role
for CEO and chairman. Separation between the role of CEO and chairman can increase the
quality of monitoring, decrease the withholding of information and consequently improve
the timeliness and quality of financial reporting. In addition, Dahya et al. (1996) find that
investors prefer the separation of the roles and have a negative reaction to the firms with the
combined role of these two positions. Hence, the potential effect of CEO duality on the firm
performance is an interesting subject strongly considered by researchers.
The number of directors in the board is another important characteristic affecting the
board efficiency. Lipton and Lorsch (1992) suggest that the maximum size of the board
should be ten directors. It is expected that board with less than ten directors can better
monitor and control firm performance. Smaller boards are more effective in improving the
firm performance and limiting the incentives of directors because the role function of each
director is easier to control and decision-making process can be done rapidly (Haniffa and
Hudaib, 2006). In contrast, larger boards are less effective to control the CEO and slower in
decision-making because it is difficult for the large board to make a consensus ( Jensen, 1993;
Yermack, 1996). In addition, previous studies in Malaysia consider the board size as an
effective factor in the function of board of directors (Effiezal et al., 2011).
The concentration of corporate ownership in East Asian countries such as Malaysia has
generated an additional agency conflict that is between majority and minority shareholders,
which are difficult to moderate through the conventional CG mechanisms such as boards of
directors (Claessens et al., 2000; Fan and Wong, 2005). There exists a high concentration of
ownership among publicly listed firms in Malaysia and cross-holdings of share ownership
or pyramiding is more common in this country (Haniffa and Hudaib, 2006). The problem
with ownership concentration in Malaysian companies is the authority of controlling
shareholders (Grossman and Hart, 1988; Shleifer and Vishny, 1997). They have the
ARA opportunity to impose on the election of board of directors and the ability to expropriate the
27,2 company’s assets at the expense of minority shareholders. As the controlling shareholders
acquire effective control by means of cross-shareholding and pyramidal ownership, their
control rights become greater than cash flow rights (Choi et al., 2008). More divergence
between cash flow and control rights makes more incentives for the controlling shareholders
to expropriate the firm benefits to their own accounts at the expense of minority
202 shareholders because the controlling shareholders receive the entire benefit of private rent
extraction, but only bear a fraction of the cost (Lee, 2007). Therefore, the separation of
ownership from control rights is another issue in CG mechanism in Malaysian companies
that need a more serious attention to protect the minority shareholders’ rights (Haniffa and
Hudaib, 2006; Tam and Tan, 2007).

3. Hypothesis development
Previous studies document that using RPTs to tunnel the firm’s resources by related parties
has a negative effect on firm value (Chiou and Huang, 2006; Cheung, Jing, Lu, Rau and
Stouraitis, 2009; Berkman et al., 2009). These studies discuss that related parties, who are
engaged in RPTs, can extract firm’s resources to their own accounts and impose residual
losses to other stakeholders who are not engaged in RPTs. These opportunistic behaviours
of related parties imply the conflict of interest view of RPTs and have a negative effect on
the value of firms. Huang and Liu (2010) discuss that RPTs are inconsistent with
shareholder wealth maximisation and may imply the misuse of firm resources in order to
transfer to related parties at the expense of other shareholders. They assert that related
parties may work against the interests of outside shareholders and RPTs have a significant
negative effect on business performance. Therefore, RPTs may result in weaker firm
performances (Chen et al., 2009) and abnormal stock returns (Cheung et al., 2006).
However, Sharkar et al. (2007) discuss that not all RPTs are detrimental for shareholders.
Although related parties may use RPTs to tunnel firm’s resources to their own accounts,
some RPTs can provide much benefit to the firm (Sharkar et al., 2007). Kohlbeck and
Mayhew (2010) categorise RPTs based on the nature of transaction and conclude that the
market seems to value the RPTs based on the type of these transactions. Therefore, some
classes of RPT are considered as likely detrimental while other classes are likely beneficial
to the firm. Lower risk of opportunism and less transaction costs in RPTs may increase the
efficiency of RPTs. In addition, Cheung et al. (2006) find that RPTs can be categorised into
different groups including transactions which are likely detrimental to the firm and
transactions which are likely beneficial to the firm. Therefore, the current study also
provides more details on RPTs and categorises these transactions into two groups including
detrimental and BRPTs and assumes that:
H1a. There is a negative relationship between DRPTs and firm value.
H1b. There is a positive relationship between BRPTs and firm value.
However, existence of a capable controlling mechanism and an efficient information system
to monitor the process of RPTs transactions can prevent the opportunistic behaviour of
related parties and moderate the negative effect of DRPTs on firm value (Fooladi and
Farhadi, 2017). In addition, under the supervision of a capable controlling mechanism,
BRPTs are expected to be more efficient and profitable. Prior studies document that CG as a
controlling system can monitor the process of RPTs to moderate the negative effects of
these transactions and increase the efficiency of RPTs (Effiezal et al., 2011). Abdullah (2004)
explains that CG system in Malaysia has closely followed the Anglo–American approach,
which is generally referred to as a “market model” or the “shareholder model”, where the
governance concept is based on the agency relationship. This is a one-tier (or unitary)
system where the board of directors is the highest governing body in the company because CG and
the shareholders do not have a full control on management’s decisions. detrimental
Judge et al. (2003) discuss that independent non-executive directors can provide better RPTs
monitoring function on RPTs because of their independence from management. These
directors have more tendencies to restrict the opportunistic behaviours of related parties
and prevent them from tunnelling firm’s resources (Kim et al., 2006). It is argued that
independent non-executive directors on the board can moderate the negative effect of RPTs 203
on shareholders’ interest (Effiezal et al., 2011).
In addition, prior studies discuss that it is difficult to moderate the conflict of interest
between majority and minority shareholders through the conventional CG mechanism in
East Asian countries (Claessens et al., 2000; Fan and Wong, 2005). Therefore, Fan and
Wong (2005) in their study on the role of external auditors in emerging markets support
the agency theory and suggest that independent external auditors have an effective
governance role to moderate the agency problems in East Asian countries. Willenborg
(1999) discusses that quality of audit services has an important role to mitigate
information asymmetry and agency problems arising from the separation of ownership
from control in a firm. Al-Ajmi (2009) argues that Big Four audit firms charge higher audit
fees to spend more time and effort in each audit engagement and hence provide higher
quality audit report. In addition, Big Four audit firms suffer from higher economic costs
and lose their reputation in the event of audit failure. Therefore, Big Four audit firms have
a high authority and tendency to detect the opportunistic behaviour of individuals and
report the expropriation of resources by related parties.
Gallery et al. (2008) argue that Big Four audit firms are expected to be able to detect the
expropriation behaviour of related parties and prevent managers, controlling shareholders
or other related parties from tunnelling the firm’s resources. Hasnan et al. (2016) find that the
presence of high-quality auditor can monitor the process of RPTs, decrease tunnelling
behaviours and improve the earnings quality. In addition, Effiezal et al. (2011) in their study
on RPTs in Malaysia discuss that size of audit firm as a proxy for audit quality within the
CG mechanism can mitigate the negative effect of RPTs on firm performance. Therefore,
this paper proposes a moderating effect of board independency and audit quality on the
relationship between RPTs and firm value:
H2a. There is a weaker negative relationship between DRPTs and firm value in companies
with a higher percentage of board independency and/or higher audit quality.
Independent directors provide managers with the relevant complementary knowledge and
expertise to specify the firm’s strategies and direction (Fama and Jensen, 1983; Abdullah,
2004). Consequently, the management performance is expected to be improved which results
in the enhancement of shareholders’ wealth. In addition to the supervisory function of
independent directors on DRPTs, these directors can provide consultant services to the
managers in order to enhance the efficiency of BRPTs. Therefore, with the presence of
independent non-executive directors on the board, BRPTs can provide more benefits to the
shareholders. In addition, the existence of more independent non-executive directors on the
board can provide better monitoring function (Abdullah, 2004; Zubaidah et al., 2009) to
increase the efficiency of BRPTs (Effiezal et al., 2011).
Additionally, when managers know that a professional team such as Big Four audit
firms will monitor RPTs, they may avoid engaging in certain transactions creating
questions of a conflict or impropriety. Big Four audit firms can provide a higher quality
monitoring function to increase the efficiency of firm’s operations. In this situation, BRPTs
can provide more benefits to the shareholders. Therefore, it is hypothesised that:
H2b. There is a stronger positive relationship between BRPTs and firm value in companies
with a higher percentage of board independency and/or higher audit quality.
ARA CEO duality is another source of agency problems (Eisenhardt, 1989a). Jensen (1993) finds
27,2 that separation between the roles of CEO and chairman of the board makes stronger the
internal control and significantly improves the board performance and efficiency. Haniffa
and Hudaib (2006) argue that the separation of chairman and CEO can provide
fundamental checks and balances over the performance of managements. The person who
holds both CEO and chairman positions is more likely to pursue his/her own benefits at
204 the expense of shareholders. This structure can help CEO to have a dominant control on
board’s decisions and influence the process of making consensus because CEO has a
legitimate power on both the board and top management team (Boyd et al., 2005).
Therefore, managerial initiatives can deviate from the interests of shareholders in this
structural context. Effiezal et al. (2011) discuss that when controlling shareholders aim to
expropriate firm’s resources through RPTs and the process of transaction is directed by
the CEO, who is also the chairman of the board, board of directors could not have any
effective monitoring role on these transactions.
In addition, information asymmetry between the board and CEO will be increased in the case
of CEO duality. Due to the opportunistic behaviour of CEO and weaker monitoring function of
the board, related parties have more opportunities to extract firm’s resources through the
DRPTs and hence intensify the negative relationship between DRPTs and firm value.
Furthermore, Lipton and Lorsch (1992) and Jensen (1993) believe that in a large board,
the problems of cooperation can dominate the advantages of large board size. Although the
larger board is more beneficial because of the more skills and knowledge of directors,
agency costs due to slower decision-making process in a large board exceed its benefits
(Lipton and Lorsch, 1992). Jensen (1993) asserts that large boards are less likely to perform
effectively because it is easier for CEO to dominate the board decisions. Therefore, agency
problems in firms with larger boards increase because the board plays a symbolic role only
rather than its controlling and monitoring duties.
Haniffa and Hudaib (2006) in their study on the CG structure and firm performance in
Malaysia find a significant negative effect of board size on firm value suggesting that larger
boards are ineffective due to their symbolic role rather than being effective in actual
managing process. In a small board, directors can easily monitor each other and make
decisions more quickly. Effiezal et al. (2011) conclude that larger boards are less efficient and
slower in monitoring function and decision-making process in a firm because it is more
difficult for the firm to arrange board meetings and for the board to reach a consensus
(Cheng, 2008; Amran and Ahmad, 2009). This situation provides related parties with more
opportunities to extract the firm’s resources through the DRPTs due to the lack of strong
monitoring function. In other words, DRPTs impose more losses to the firm in the case of the
larger size of the board.
In addition, divergence between cash flow and control rights is critical to CG of a firm
and makes more severe expropriation behaviours. Jensen and Meckling (1976) develop a
theoretical framework to demonstrate that investors with large cash flow rights have strong
incentives to maximise the firm value. When controlling shareholders have higher cash flow
rights of the company, they bear more costs in the case of expropriation of firm’s resources
(Choi et al., 2007; Fan and Wong, 2002). Therefore, controlling shareholders’ incentive will be
more aligned with minority shareholders. In other words, more cash flow ownership by
controlling shareholders mitigates their incentive to expropriate the firm’s resources. This
situation is called the alignment or incentive effect.
However, as the controlling owner acquires effective control by means of complicated
ownership structures such as cross-shareholding and pyramidal ownership, their control
rights become greater than cash flow rights (Choi et al., 2008). More divergence between
cash flow and control rights makes more incentives for controlling shareholders to
expropriate the firm’s wealth because controlling shareholders receive the entire benefit of
private rent extraction, but only bear a fraction of the cost due to their low cash flow rights CG and
(Lee, 2007). In addition, controlling shareholders are less tended to prevent the detrimental
expropriation behaviour of individuals in a firm in the case of more divergence between RPTs
cash flow and control rights ( Jensen and Meckling, 1976). This situation is known as the
entrenchment effect of control rights. More divergence between cash flow and control
rights of controlling shareholders results in the conflict of interest between controlling
shareholders and minority shareholders, which implies that the entrenchment effect 205
dominates the alignment effect.
Claessens et al. (2002) document that based on the alignment effect, firm value increases
with the cash flow ownership of the largest shareholder. However, based on the
entrenchment effect, firm value decreases when the control right of the largest shareholder
exceeds the cash flow ownership. La Porta et al. (2002) document a negative relationship
between divergence of cash flow rights from control rights of controlling shareholders and
firm value. In addition, Bertrand et al. (2002) document that controlling shareholders extract
the wealth of firm in which they have smaller cash flow rights to benefit the firm in which
they have larger cash flow rights. International studies document that tunnelling of
resources by controlling owners deteriorates the interest of minority shareholders and leads
to the lower market valuation of stocks for firms engaging RPTs ( Jian and Wong, 2010).
Furthermore, Cheung et al. (2006) show that RPTs are value destroying for minority
shareholders. Therefore, DRPTs impose more losses to the firm in the case of more
divergence between cash flow and control rights:
H3a. There is a stronger negative relationship between DRPTs and firm value in
companies with CEO duality, larger board and/or higher divergence between cash
flow and control rights.
When the CEO also directs the group of people in charge of evaluating and monitoring the
performance of CEO, the monitoring roles of the board will be severely impaired because of
the lack of independence ( Judge et al., 2003). This situation provides managers with the
opportunity to use BRPTs to tunnel firm’s resources to their own or related family accounts
and decrease the efficiency of BRPTs.
As discussed above, the size of the board has an impact on the relationship between
RPTs and firm value (Effiezal et al., 2011). Since larger boards are less efficient in monitoring
RPTs, the opportunistic behaviour of related parties may intensify the negative relationship
between DRPTs and firm value in firms with the large size of the board. This effect of board
size can be expanded to the relationship between BRPTs and firm value. Weaker monitoring
function of larger boards may result in reduction the efficiency of BRPTs and weaken the
positive relationship between BRPTs and firm value.
Finally, more divergence between cash flow and control rights may intensify the
negative effect of DRPTs on firm value in one hand and decrease the efficiency of the
BRPTs in another hand. Therefore, this study assumes that more divergence between cash
flow and control rights can weaken the positive relationship between BRPTs and firm value:
H3b. There is a weaker positive relationship between BRPTs and firm value in
companies with CEO duality, larger board and/or higher divergence between cash
flow and control rights.

4. Data and methodology

The required data for this study are collected from the annual reports of sample
companies published on their websites. We can find the shareholdings information in
financial statements published by companies listed on Bursa Malaysia but the ownership
data of ultimate owner in the chain of weakest link principle cannot be found in
ARA Bursa Malaysia. Therefore, this study uses the OSIRIS database to collect the ownership
27,2 data in the chain and calculate divergence between cash flow and control rights. The
population of this study consists of all companies listed on Bursa Malaysia with the
exception of firms belonging to financial industries. This practice is in line with related
studies in Malaysia such as Haniffa and Cooke (2002), Haniffa and Hudaib (2006),
Zubaidah et al. (2009) and Fooladi et al. (2013) which exclude finance firms from
206 sampling process because of different compliance and regulatory environment,
unique characteristics and different accounting procedures and reporting formats. Since
the population consists of firms from different industries, this study applies the
proportionate stratified random sampling design suggested by Cavana and Delahaye
(2001). The sample size is calculated based on the technique suggested by Sekaran (2001)
and Cochran (1977) for business research works. This technique for known population
(listed firms on Bursa Malaysia in the current study) is as follows:
n0
n¼ ;
1 þ N ðn0 1Þ
1

where n is sample size, N indicates population and:

Z 2 pq
n0 ¼ ;
d2
where Z is z-value of 95% confidence level, p indicates the percentage of selection in
points (0.5), q is equal to 1−p and d is margin of error (0.05) (Sekaran, 2001; Cochran, 1977).
Based on this formula, the appropriate sample size for this population equals 258 firms.
To be conservative, this study randomly selects 271 (5 per cent more than the appropriate
sample size) companies from the non-financial companies listed on Bursa Malaysia.
Therefore, this study covers a panel of 271 firms over the period of 2009–2011, which is
equal to 813 observations. It should be noted that 20 observations are removed from
the sample due to unavailability of the data. Consequently, the final sample includes
793 observations.
In 2007, the Malaysian Code on CG (MCCG) was reviewed to further strengthen CG
practices. On the other hand, in 2008, Malaysian Accounting Standard Board (MASB)
revised the Financial Reporting Standard 124 entitled “Related party disclosures”. The main
objective of MASB from revising FRS 124 is to monitor the process of RPTs and mitigate
the opportunistic behaviour of related parties. Therefore, the aim of this study is to
investigate the efficiency of CG characteristics and RPTs after the revision of MCCG and
FRS 124. To this purpose, the period of this study starts from 2009. In addition, MASB
requires all listed firms to apply a new version of Financial Reporting Standard 124 for
annual periods beginning on or after 1 January 2012. Therefore, the hypotheses proposed in
this study are examined for the period of three years from 2009 to 2011. The summary of the
variables definition and their measurements are presented in Table I.

5. Research model
An appropriate statistical technique to test the moderating effect of variables is to produce
an interaction between moderator and independent variables using moderated multiple
regression model (Bennett, 2000; Gerdin and Greve, 2004; Gani and Jermias, 2006).
Therefore, in this study the multiple regression analysis is first performed to test the
relationship between RPTs and firm value (Model (1)). Subsequently, to test the
moderating effect of CG characteristics on the relationship between RPTs and firm value,
this study includes the interaction terms of detrimental and BRPTs with each CG
Variable
CG and
name Description Measurement detrimental
RPTs
Panel A: dependent variables
F.V Firm value Tobin’s Q and market to book ratio
TQ Tobin’s Q ((Number of shares outstanding × Share price) + Book value of
total debt)/Book value of assets at the end of financial year
MBR Market to book ratio (Number of shares outstanding × Share price)/Book value of 207
equity at the end of financial year
Panel B: independent variables
BRPT Beneficial related party The amounts of RPTs which are likely beneficial, as reported in
transactions the annual reports scaled by total assets at the end of financial
year (Appendix 1)
DRPT Detrimental related party The amounts of RPTs which are likely detrimental, as reported in
transactions the annual reports scaled by total assets at the end of financial
year (Appendix 1)
BIND Board independence Number of independent non-executive directors/total number of
directors
CEO CEO duality Nominal variable: has the value of 1 if duality exists, 0 otherwise
BSize Board size Total number of directors in the board
AudQ The audit quality Has the value of one if the external auditor is 1 of the Big Four
audit firms, 0 otherwise
Div Divergence between cash flow Differences between control and cash flow rights based on
and control rights weakest link principle (WLP) Claessens et al. (2002) (Appendix 2)
Panel C: control variables
Fsize Firm size Natural log of total assets at the end of financial year
Age Firm age Number of years since incorporation of firm
Lev Leverage Total debt/Total book value of equity at the end of financial year
InsOwn Shareholding by Institutional Number of shares owned by institutional shareholders/total
Investors outstanding shares
ACIND Audit committee Proportion of independent directors in the audit committee
independency
REM Directors’ remuneration Natural log of total amount of executive directors’ remuneration at
the end of financial year
ROA Return on assets Profit before tax/Book value of assets at the end of financial year Table I.
MOWN Managerial ownership Percentage of shares held by executive directors Variables definition

characteristics, namely, board independency, CEO duality, board size, audit quality and
divergence between cash flow and control rights (Model (2)):
F:V ¼ a0 þa1 BRPT þa2 DRPT þa3 BIND þa4 CEO þa5 BSizeþ a6 AudQ þa7 Div

þa8 Fsizeþ a9 Ageþa10 Levþa11 InsOwn þa12 ACIND

þa13 REM þa14 ROA þa15 MOWN þe; (1)

F:V ¼ a0 þa1 BRPT þa2 DRPT þa3 BIND þa4 CEO þa5 BSizeþ a6 AudQ þa7 Div

þa8 Fsizeþ a9 Ageþa10 Levþa11 InsOwn þa12 ACIND

þa13 REM þa14 ROAþa15 MOWN þa16 RPT  CG þe; (2)
where RPT×CG indicates the interaction variables of detrimental and BRPTs with each
CG characteristics, namely, board independency, CEO duality, board size, audit quality
and divergence between cash flow and control rights.
ARA 6. Descriptive statistics
27,2 Table II shows the descriptive statistics to interpret the behaviour of key variables of
interest in the present study. Table II shows that the average number of directors in the
board is about eight persons in the sample of this study which is in line with Lipton and
Lorsch (1992) who suggest that the more desirable size of board to be effective is eight or
nine persons.
208 In addition, Table III shows that the majority of sample companies (90.2 per cent or
715 companies) have 33 per cent or more than 33 per cent independent non-executive directors
in the board. In addition, the average and minimum number of independent non-executive
directors are three and two persons, respectively. These findings support the recommendation
of Bursa Malaysia listing requirements, which requires at least two directors or one third of
directors in the board, whichever is the higher, to be independent directors.
The findings of this study show that 21.6 per cent of the firms in the sample experience
CEO duality. Another 78.4 per cent (622 firms) of the firms comply with the recommendation
of the MCCG (2007) by separating the roles of CEO and chairman of the company.
Regarding the board size, Minority Shareholders Watchdog Group (MSWG) in the
governance and transparency index published in 2009 specifies the desirable board size
between 6 and 11 members. MSWG (2011) believes that the existence of a board is necessary
to accomplish a monitoring role and protect the minority shareholders’ interests but
oversized boards are ineffective to achieve this objective. In this study, 82.5 per cent
(654 firms) of the sample firms have a range of 6–11 directors in their board (see Table IV ),
which is consistent with the notion of MSWG (2011).

Variables Min. Max. Mean SD Skewness Kurtosis

Tobin’s Q (ratio) 0.27 5.68 1.04 0.61 2.92 12.76

Market to book ratio 0.14 8.20 1.06 0.97 2.63 9.41
BRPTs scaled by assets (ratio) 0.00 1.78 0.41 0.17 3.76 20.53
DRPTs scaled by assets (ratio) 0.00 2.85 0.15 0.40 2.14 8.24
RPTs scaled by assets (ratio) 0.00 3.09 0.56 0.44 1.96 6.47
Board independence (ratio) 0.22 0.83 0.46 0.12 0.71 0.08
Board size (persons) 4 15 8 1.88 0.95 1.40
Divergence (%) 0.00 40.53 4.16 7.67 1.85 2.92
Firm size (RM million) 31 42,866 1,543 4,583 6.01 40.41
Age (years) 4 95 27 16.53 1.25 2.36
Leverage (ratio) 0.01 6.87 0.86 0.86 2.58 9.66
Institutional ownership (ratio) 0.00 0.40 0.03 0.06 2.38 6.68
Audit committee independency (ratio) 0.50 1.00 0.87 0.15 −0.50 −1.60
Table II. Directors’ remuneration (RM000) 0 46,705 2,084 3,677 7.66 79.28
Descriptive statistics Return on assets (ratio) −0.40 0.38 0.05 0.09 −0.22 2.86
for the sample firms Managerial ownership (%) 0 70 9 14.32 1.97 3.31
in 2009–2011 Note: n ¼ 793

Range of percentage No. of companies %

0 o33 78 9.8
Table III.
33 ⩽ 50 524 66.1
Percentage of
Independent More than 50 191 24.1
non-executive Total 793 100
directors of sample Notes: n ¼ 793. The average and minimum number of independent non-executive directors are three and two
firms in 2009–2011 persons, respectively
Table V shows that the findings for divergence between cash flow and control rights are in CG and
line with Claessens et al. (2000) and Fan and Wong (2002). The average divergence in the detrimental
sample of this study is 4.16 per cent with the maximum of 40.53 per cent. In addition, Table V RPTs
shows that the average value of cash flow and control rights are 24.85 and 29.01 per cent,
respectively, while the average ratio of cash flow rights over control rights is 0.84. These
findings are in line with Claessens et al. (2000). In their study on the corporate ownership
structure of East Asian companies, Claessens et al. (2000) show that the average percentage of 209
cash flow and control rights for Malaysian-listed firms are 23.89 and 28.32 per cent,
respectively, and the average ratio of cash flow rights over control rights is 0.85.
In another study by Fan and Wong (2002), the mean of cash flow and control rights for
Malaysian-listed firms were 26.03 and 30.73 per cent, respectively, while the average ratio of
cash flow rights over control rights was 0.84. Interestingly, the average divergence between
cash flow and control rights in Claessens et al. (2000) and Fan and Wong (2002) is about
4.7 per cent, which is close to the findings of this study.

7. Diagnostic tests
The present study covers a panel of 271 firms listed on Bursa Malaysia over the period of
2009–2011. Therefore, some assumptions regarding the data must be considered before
starting multivariate analysis. This study first runs the Chow test in order to test the
poolability of the data. The null hypothesis rejects for all models showing that the fixed
effect models are better than the pooled ordinary least squares model. Afterward, Hausman
test is applied to decide between random and fixed effects. The null hypothesis is that the
preferred model is random effects vs the alternative fixed effects (Greene, 2008; Baltagi,
2008). Since the null is rejected, it is better to use fixed effects vs random effects. Therefore,
this study applies the fixed effects method to estimate all the models.
This study applies the Pearson correlation matrix (Hill et al., 2001), variance inflation
factor (VIF) and tolerance (TOL) of the independent variables to detect multicollinearity
issues. Table VI displays the Pearson correlations among the independent variables
indicating that there is no multicollinearity among independent variables, because the
highest correlation observed is equal to 0.40, which is between the firm size (Fsize) and
board size (Bsize). Since the correlation coefficients are all lower than 0.8, it can be concluded
that there is no multicollinearity problem among independent variables (Hill et al., 2001).

Range of size (persons) No. of companies %

0–5 109 13.7

6–11 654 82.5 Table IV.
More than 11 30 3.8 Number of directors in
Total 793 100 the board of sample
Note: n ¼ 793 firms in 2009–2011

Claessens et al. (2000a) for Fan and Wong (2002) for Table V.
Variables Current study Malaysia Malaysia Comparison of
the average values
Cash flow rights (CFR) (%) 24.85 23.89 26.03 of divergence between
Control rights (CR) (%) 29.01 28.32 30.73 cash flow and
CFR/CR 0.84 0.85 0.84 control rights with
Divergence (CR−CFR) 4.16 4.70 4.70 other studies
 27,2

210
ARA

Table VI.
Pearson correlation
coefficients between
independent variables
BRPTT DRPT BIND CEO Bsize AudQ Div Fsize Age Lev InsOwn ACIND REM ROA

BRPT
DRPT 0.02
BIND 0.05 −0.01
CEO −0.10** 0.09* 0.08*
BSize −0.02 −0.06 −0.34** −0.12**
AudQ 0.02 −0.21** −0.03 0.04 0.13**
Div 0.04 0.06 −0.04 −0.08* −0.02 0.14**
Fsize −0.02 −0.10** 0.02 −0.11** 0.40** 0.32** 0.17**
Age 0.06 −0.09* 0.10** −0.12** 0.12** 0.14** 0.18** 0.29**
Lev 0.07 0.14** 0.01 0.02 0.03 −0.12** 0.02 0.19** −0.13**
InsOwn −0.10** 0.02 −0.03 0.03 0.14** 0.05 0.02 0.19** −0.01 0.07
ACIND −0.06 0.01 0.35** 0.08* 0.03 −0.03 −0.12** 0.05 0.00 0.02 −0.09*
REM −0.08* −0.07* −0.14** 0.04 0.25** 0.06 −0.02 0.17** 0.03 0.06 −0.03 0.15**
ROA −0.17** −0.28** −0.06 0.05 0.13** 0.16** 0.06 0.12** 0.05 −0.34** 0.03 −0.03 0.06
MOWN −0.12** 0.01 −0.11** 0.02 −0.08* −0.17** −0.27** −0.26** −0.30** −0.00 −0.10** 0.11** 0.11** −0.02
Notes: n ¼ 793. Period of study is the financial period of 2009–2011. *,**Significant at 5 per cent ( p o0.05) and 1 per cent ( p o0.01) levels, respectively
In addition, the product of variables in a moderated multiple regression model is highly CG and
correlated with the component variables resulting in a multicollinearity problem (Aiken and detrimental
West, 1991). It is strongly recommended transformation to reduce the correlation problem RPTs
between interaction variable and its components in moderated regression analysis is to
centre the independent variables (Aiken and West, 1991; Cohen et al., 2003).
Table VII shows the result of VIF. The values of VIF for all independent variables show that
the highest VIF is 1.68 belonging to the firm size (Fsize). Since there is no variable with the value 211
of VIF higher than 5, there is no serious multicollinearity problem in the regression models
(Gujarati, 2003). In addition, as shown in Table VII, the lowest value of tolerance equals 0.59
belonging to the firm size (Fsize). All other independent variables have the value of tolerance
higher than 0.59. Therefore, there is no multicollinearity between independent variables.

8. Multiple regression results and discussion

8.1 Related party transactions and firm value
Based on the regression results for Model 1 in Table VIII, there is a negative relationship
between DRPTs and Tobin’s Q, with the coefficient equals to −0.07, which is significant at
the 10 per cent level of significance. In addition, Model 1 of Table IX shows a negative
relationship between DRPT and MBR, with the coefficient equals to −0.17, which is
significant at the 5 per cent level of significance. These findings support H1a, which
proposes a negative relationship between DRPTs and firm value. It means that higher the
ratio of DRPTs results in a lower Tobin’s Q and MBR.
As hypothesised, the regression results in this study show a positive relationship
between (BRPTs and firm value as measured by Tobin’s Q and MBR. Based on the
regression results for Model 1 in Table VIII, there is a positive relationship between BRPTs
and Tobin’s Q, with the coefficient equals to 0.31, which is significant at the 5 per cent level
of significance. In addition, Model 1 of Table IX shows a positive relationship between
BRPTs and MBR, with the coefficient equals to 0.47, which is significant at the 5 per cent
level of significance. These findings support H1b, which proposes a positive relationship
between BRPTs and firm value. These findings document that not all RPTs are detrimental
and some types of these transactions are beneficial to the firm.

8.2 Moderating effect of corporate governance characteristics

As shown in Model 2 of Tables X and XI, this study could not find any significant
moderating effect of board independency on the relationship between DRPTs and firm
value. According to Haniffa and Hudaib (2006), most directors in Malaysian companies are
employed based on political reasons to legitimise business activities. These directors may
not have enough experience and expertise to monitor independently and lessen the agency
conflicts arising from the misallocation of resources. Therefore, they might not be able to
perform their monitoring role effectively. In addition, the findings of this study suggest that
related parties tend to have a dominant control on the board of directors, which may
compromise the monitoring role of directors on RPTs. Most probably, related parties use
their authorities in decision-making process and influence the board of directors in order to
expropriate firm’s wealth to their own accounts. Therefore, board of directors tends to play a
symbolic role only rather than its controlling and monitoring duties.

Variable RPT BIND CEO BSize AudQ Div Fsize Age Lev InsOwn ACIND REM ROA MOWN Mean VIF Table VII.
Variance inflation
VIF 1.18 1.46 1.08 1.52 1.22 1.16 1.68 1.26 1.31 1.08 1.28 1.16 1.31 1.28 1.28 factor (VIF) and
Tolerance 0.84 0.68 0.93 0.66 0.82 0.86 0.59 0.80 0.77 0.93 0.78 0.86 0.76 0.78 – tolerance of
Note: n ¼ 793 independent variables
ARA Model 1: Model 2: Model 3: Model 4: Model 5: Model 6:
27,2 no interaction interaction interaction interaction interaction
Variables interaction with BIND with CEO with BSize with AudQ with Div

Independent variables
BRPT 0.31** 0.32** 0.38** 0.26** −0.04 0.28**
DRPT −0.07* −0.07* −0.07* −0.06 −0.06 −0.07
212 BIND 0.03 0.04 0.02 0.06 0.06 0.04
CEO −0.09** −0.08** −0.10** −0.09** −0.07** −0.09**
BSize 0.02* 0.02* 0.02* 0.02* 0.02* 0.02**
AudQ 0.02 0.02 0.01 0.03 0.02 0.02
Div 0.06 0.07 0.05 0.01 0.03 0.07
Control variables
Fsize 0.00 0.00 0.00 0.00 0.01 0.00
Age −0.00* −0.00* −0.00* −0.00* −0.00* −0.00*
Lev 0.14*** 0.14*** 0.14*** 0.14*** 0.14*** 0.14***
InsOwn 0.58 0.58 0.58 0.53 0.59 0.56
ACIND −0.06 −0.06 −0.07 −0.08 −0.07 −0.07
REM −0.01 −0.01 −0.01 −0.01 −0.01 −0.01
ROA 3.15*** 3.14*** 3.19*** 3.16*** 3.19*** 3.14***
MOWN −0.13 −0.13 −0.12 −0.14 −0.14 −0.13
Moderator variables
BRPT×BIND – 0.65 – – – –
BRPT×CEO – – −0.39 – – –
BRPT×BSize – – – −0.14*** – –
Table VIII. BRPT×AudQ – – – – 0.51** –
Regression: results
BRPT×Div – – – – – 0.99
for the moderating
effect of CG on the Adjusted R2 0.281 0.280 0.280 0.286 0.283 0.280
relationship between F-statistic 7.33*** 6.89*** 6.97*** 7.92*** 6.98*** 6.89***
beneficial RPTs Notes: n ¼ 793. Period of study is the financial period of 2009–2011. *,**,***Significant at 10 per cent
and Tobin’s Q ( po 0.1), 5 per cent ( p o0.05) and 1 per cent ( p o0.01) levels, respectively

Model 5 in Table VIII shows that the interaction term of BRPTs and audit quality
(BRPT×AudQ) has a positive relationship with firm value as measured by Tobin’s Q, with
the coefficient equals to 0.51 which is significant at the 5 per cent level of significance. These
findings support H2b, which suggests that Big Four audit firms have a positive moderating
effect on the relationship between BRPTs and firm value. In other words, Big Four audit
firms provide higher quality monitoring function resulting in increasing the positive effect
of BRPTs on firm value. The findings of this study support the argument raised by Fan and
Wong (2005) that high-quality audit firms such as Big Five audit firms have an effective
monitoring role in a firm. Fan and Wong (2005) support the agency theory and propose that
Big Five audit firms have an appropriate role to mitigate the agency problems in emerging
markets including Malaysia. They believe that the market considers Big Five auditors as a
mechanism to alleviate the agency problems in East Asian countries and find that
appointing the high-quality auditors can mitigate the agency problems and improve the
value of firms. Hasnan et al. (2016) use the audit quality as the external CG mechanism in
their study on the role of CG in RPTs. They believe that high-quality auditors can monitor
the process of RPTs, decrease tunnelling behaviours and improve the earnings quality.
They document a significant positive relationship between RPTs and earnings quality in
firms with a higher audit quality.
Model 3 in Table X shows that the interaction term of DRPTs and CEO duality
(DRPT×CEO) has a negative relationship with firm value as measured by Tobin’s Q, with
the coefficient equals to −0.17, which is significant at the 10 per cent level of significance.
 Model 1: Model 2: Model 3: Model 4: Model 5: Model 6:
CG and
no interaction interaction interaction interaction interaction detrimental
Variables interaction with BIND with CEO with BSize with AudQ with Div RPTs
Independent variables
BRPT 0.47** 0.48** 0.55** 0.36** 0.29 0.45**
DRPT −0.17** −0.17** −0.17** −0.14** −0.17** 0.17**
BIND −0.11 −0.10 −0.12 −0.07 −0.10 −0.10 213
CEO −0.14** −0.14** −0.16** −0.15** −0.14** −0.14**
BSize 0.02 0.02 0.02 0.02 0.02 0.02
AudQ 0.07 0.07 0.06 0.07 0.07 0.07
Div 0.36 0.38 0.35 0.28 0.34 0.36
Control variables
Fsize 0.00 0.00 0.01 0.00 0.01 0.00
Age −0.00 −0.00 −0.00 −0.00 −0.00 −0.00
Lev 0.14** 0.14** 0.14** 0.14** 0.14** 0.14**
InsOwn 1.25** 1.25** 1.25** 1.17** 1.26** 1.24**
ACIND −0.04 −0.04 −0.04 −0.08 −0.04 −0.04
REM −0.02 −0.02 −0.02 −0.01 −0.02 −0.02
ROA 4.58*** 4.56*** 4.62*** 4.60*** 4.60*** 4.57***
MOWN −0.18 −0.18 −0.17 −0.20 −0.19 −0.18
Moderator variables
BRPT×BIND – 1.09 – – – –
BRPT×CEO – – −0.44 – – –
BRPT×BSize – – – −0.25*** – – Table IX.
BRPT×AudQ – – – – 0.26 – Regression results
for the moderating
BRPT×Div – – – – – 0.57 effect of CG on the
Adjusted R2 0.233 0.232 0.232 0.240 0.231 0.232 relationship between
F-statistic 7.43*** 6.98*** 7.06*** 8.65*** 6.98*** 6.96*** beneficial RPTs and
Notes: n ¼ 793. Period of study is the financial period of 2009–2011. **,***Significant at 5 per cent ( p o 0.05) market to book
and 1 per cent ( p o 0.01) levels, respectively ratio (MBR)

This coefficient is higher than the negative coefficient between DRPTs and firm value
(−0.07 which is significant at the 10 per cent level of significance) as measured by Tobin’s Q
in Model 1 in Table X. Furthermore, Model 3 in Table XI shows that the interaction term of
DRPTs and CEO duality (DRPT×CEO) has a negative relationship with firm value as
measured by MBR, with the coefficient equals to −0.41, which is significant at the 1 per cent
level of significance. This coefficient is higher than the negative coefficient between DRPTs
and firm value (−0.17 which is significant at the 5 per cent level of significance) as measured
by MBR in Model 1 in Table XI. These findings support H3a, which proposes a stronger
negative relationship between DRPTs and firm value in companies, where the CEO also
serves as board chairman and duality exist. This finding is consistent with the argument
that duality can facilitate CEO entrenchment and enable CEOs to leverage their power for
their own personal outcomes (Kim et al., 2009). Duality situation may provide CEOs with the
opportunity to self-serve and engage in opportunistic behaviours.
Model 4 of Table X shows that the interaction term of DRPTs and board size
(DRPT×BSize) has a negative relationship with firm value as measured by Tobin’s Q, with
the coefficient equals to −0.02, which is significant at the 10 per cent level of significance.
Furthermore, Model 4 of Table XI shows that the interaction term of DRPTs and board size
(DRPT×BSize) has a negative relationship with firm value as measured by MBR, with the
coefficient equals to –0.06, which is significant at the 5 per cent level of significance. These
findings support H3a, which proposes a stronger negative relationship between DRPTs and
firm value in companies with a larger board. Effiezal et al. (2011) find a significant negative
ARA Model 1: Model 2: Model 3: Model 4: Model 5: Model 6:
27,2 no interaction interaction interaction interaction interaction
Variables interaction with BIND with CEO with BSize with AudQ with Div

Independent variables
BRPT 0.31** 0.31** 0.32** 0.33** 0.31** 0.30**
DRPT −0.07* −0.07* −0.03 −0.09* −0.05 −0.02
214 BIND 0.03 0.03 0.02 0.04 0.04 0.01
CEO −0.09** −0.09** −0.08** −0.09** −0.09** −0.08**
BSize 0.02* 0.02* 0.02* 0.02* 0.02* 0.02*
AudQ 0.02 0.02 0.02 0.02 0.02 0.02
Div 0.06 0.05 0.07 0.05 0.05 0.07
Control variables
Fsize 0.00 0.00 0.00 −0.00 0.00 0.00
Age −0.00* −0.00* −0.00* −0.00* −0.00* −0.00
Lev 0.14*** 0.14*** 0.14*** 0.14*** 0.14*** 0.14***
InsOwn 0.58* 0.59* 0.62* 0.58* 0.58* 0.61**
ACIND −0.06 −0.06 −0.04 −0.06 −0.06 −0.01
REM −0.01 −0.01 −0.01 −0.01 −0.01 −0.01
ROA 3.15*** 3.16*** 3.14*** 3.16*** 3.16*** 3.22***
MOWN −0.13 −0.13 −0.13 −0.13 −0.13 −0.14
Moderator variables
DRPT×BIND – 0.15 – – – –
DRPT×CEO – – −0.17* – – –
DRPT×BSize – – – −0.02* – –
Table X. DRPT×AudQ – – – – −0.05 –
Regression results
DRPT×Div – – – – – −1.68***
for the moderating
effect of CG on the Adjusted R2 0.281 0.279 0.284 0.281 0.279 0.290
relationship between F-statistic 7.33*** 6.90*** 7.10*** 6.83*** 6.93*** 8.05***
detrimental RPTs Notes: n ¼ 793. Period of study is the financial period of 2009–2011. *,**,***Significant at 10 per cent
and Tobin’s Q ( po 0.1), 5 per cent ( p o0.05) and 1 per cent ( p o0.01) levels, respectively

relationship between the interaction term of RPTs by board size and firm performance in
their study on the moderating effect of CG characteristics on RPTs. They suggest that the
bigger the board, the more negative the effect of RPTs on firm performance. Amran and
Ahmad (2009) in their study on the board of directors and firm value in Malaysian-listed
firms discuss that larger boards are less effective in monitoring function, which cause more
agency problems and reduce the firm value.
Model 4 of Table VIII shows that the interaction term of BRPTs and board size
(BRPT×BSize) has a negative relationship with firm value as measured by Tobin’s Q, with the
coefficient equals to −0.14, which is significant at the 1 per cent level of significance.
Furthermore, Model 4 of Table IX shows that the interaction term of BRPTs and board size
(BRPT×BSize) has a negative relationship with firm value as measured by MBR, with the
coefficient equals to −0.25, which is significant at the 1 per cent level of significance. These
findings support H3b, which proposes a weaker positive relationship between BRPTs and firm
value in companies with a larger board. Effiezal et al. (2011) find a significant negative
relationship between the interaction term of RPTs by board size and firm performance in their
study on the moderating effect of CG characteristics on RPTs. They suggest that the bigger the
board, the more negative the effect of RPTs on firm performance. Amran and Ahmad (2009) in
their study on the board of directors and firm value in Malaysian-listed firms discuss that larger
boards are less effective in monitoring function, which cause more agency problems and reduce
the firm value. In addition, Cheng (2008) suggests that larger boards are less efficient and slower
in decision-making because it is more difficult for the firm to arrange board meetings and for the
 Model 1: Model 2: Model 3: Model 4: Model 5: Model 6:
CG and
no interaction interaction interaction interaction interaction detrimental
Variables interaction with BIND with CEO with BSize with AudQ with Div RPTs
Independent variables
BRPT 0.47** 0.47** 0.48** 0.51** 0.46** 0.44**
DRPT −0.17** −0.17** −0.06 −0.20*** −0.07 −0.11
BIND −0.11 −0.11 −0.14 −0.10 −0.08 −0.13 215
CEO −0.14** −0.14** −0.13** −0.14** −0.14** −0.14**
BSize 0.02 0.02 0.02 0.02 0.02 0.02
AudQ 0.07 0.07 0.07 0.07 0.07 0.06
Div 0.36 0.36 0.40 0.35 0.32 0.38
Control variables
Fsize 0.00 0.00 0.01 −0.00 0.00 0.00
Age −0.00 −0.00 −0.00 −0.00 −0.00 −0.00
Lev 0.14** 0.14** 0.14** 0.15** 0.14** 0.13**
InsOwn 1.25** 1.24** 1.34** 1.26** 1.25** 1.29**
ACIND −0.04 −0.04 0.01 −0.02 −0.03 0.03
REM −0.02 −0.02 −0.02 −0.01 −0.01 −0.02
ROA 4.58*** 4.58*** 4.55*** 4.62*** 4.60*** 4.66***
MOWN −0.18 −0.18 −0.18 −0.18 −0.18 −0.19
Moderator variables
DRPT×BIND – −0.08 – – – –
DRPT×CEO – – −0.41*** – – –
DRPT×BSize – – – −0.06** – – Table XI.
DRPT×AudQ – – – – −0.20 – Regression results
for the moderating
DRPT×Div – – – – – −2.07*** effect of CG on the
Adjusted R2 0.233 0.231 0.242 0.236 0.234 0.237 relationship between
F-statistic 7.43*** 6.95*** 7.68*** 7.17*** 7.20*** 9.24*** detrimental RPTs
Notes: n ¼ 793. Period of study is the financial period of 2009–2011. **,***Significant at 5 per cent ( p o 0.05) and market to book
and 1 per cent ( p o 0.01) levels, respectively ratio (MBR)

board to reach a consensus. In addition, it is easier for CEO to influence the board decisions.
Therefore, agency problems in firms with larger boards will be increased because the board
plays a symbolic role rather than its controlling and monitoring duties ( Jensen, 1993).
Model 6 of Table X shows that the interaction term of DRPTs and divergence between cash
flow and control rights (DRPT×Div) has a negative relationship with firm value as measured by
Tobin’s Q, with the coefficient equals to −1.68, which is significant at the 1 per cent level of
significance. This coefficient is higher than the negative coefficient between DRPTs and firm
value (−0.07 which is significant at the 10 per cent level of significance) as measured by Tobin’s
Q in Model 1 of Table X. Furthermore, Model 6 of Table XI shows that the interaction term of
DRPTs and divergence between cash flow and control rights (DRPT×Div) has a negative
relationship with firm value as measured by MBR, with the coefficient equals to −2.07, which is
significant at the 1 per cent level of significance. This coefficient is higher than the negative
coefficient between DRPTs and firm value (−0.17 which is significant at the 5 per cent level of
significance) as measured by MBR in Model 1 of Table XI.
These findings support H3a, which suggests that divergence between cash flow and
control rights intensifies the negative relationship between DRPTs and firm value. It means
that divergence between cash flow and control rights in the sample of this study can intensify
the negative relationship between DRPTs and firm value. These results are consistent with
the entrenchment effect of ownership concentration (Bebchuk et al., 2000). Based on the
entrenchment effect, more divergence between cash flow and control rights makes more
incentives for controlling shareholders to expropriate the firm’s wealth because controlling
ARA shareholders receive the entire benefit of private rent extraction, but only bear a fraction of the
27,2 cost due to their low cash flow rights (Lee, 2007). Therefore, controlling shareholders have a
tendency to enter into self-dealing transactions with the firm in which they can tunnel firm’s
resources to another personally related firm or directly to their own account (Fan and Wong,
2002) which may result in reducing the firm value (Cheung et al., 2006).
In addition, controlling shareholders may use their authority to exercise a non-value
216 maximising behaviour to pursuit their own interest but at the expense of other shareholders.
Prior studies suggest that most expropriation of minority shareholders’ wealth is conducted
through the RPTs ( Johnson, Boone, Breach and Friedman, 2000; La Porta et al., 2000). This
expropriation behaviour becomes more severe when the control rights exceed the cash flow
rights of controlling shareholders (Claessens et al., 2000, 2002; Choi et al., 2008). Sulong and
Fauzias (2010) explain that higher divergence between cash flow and control rights in
Malaysia will intensify the expropriation behaviour of individuals.
As shown in Model 5 of Tables X and XI, this study could not find any significant
moderating effect of audit quality on the relationship between DRPTs and firm value. Jeong
and Rho (2004) and Khurana and Raman (2004) discuss that Big and non-Big audit firms in
East Asian countries have the same quality in audit function. It is argued that the role and
efficiency of audit function in a country depend on the political and economic conditions.
These conditions have changed over the time and influenced the audit function in meeting
both global and local demands for audit services. Ali et al. (2006) discuss that the aim of
audit function in Malaysia is only to accomplish the legal requirements and furnish an
image of modern economy in order to attract the foreign investments rather than to fulfil the
needs of Malaysian social environment. In addition, improvements in the process of audit
function have been more focused on the form of auditing rather than substance.
Fan and Wong (2005) discuss that the independence of auditors in East Asian countries
is undermined due to the lack of adequate disciplinary mechanisms for auditors. For
example, the monitoring role of external auditors in East Asian countries may be in conflict
with their consulting services to client firms. Al-Ajmi (2009) discusses that consulting
services may affect the independence of auditors and hence spoil the quality of audit
function. The lack of independence of auditors implies that the clients may affect the results
of auditor’s report. Therefore, auditors fail to execute their independent audit function in
providing assurance that financial statements are reliable.
Another problem is that whether the legal institutions in East Asian countries give
sufficient supports to the governance functions of external auditing. A weak legal
enforcement fails to penalise violations recognised by auditors (Francis et al., 2003). As
another factor, the audit committee is considered as an important board committee in a firm
which has a key role in executing an independent and high-quality audit function
(Al-Ajmi, 2009). One of the most important functions of audit committee is to supervise
external and internal audit performance and notify the board on audit issues. According to
MCCG (2007), all directors in the audit committee should be non-executive directors, where
the majority of them are independent. However, most of the non-executive directors in
the board in Malaysian companies are not selected due to their experience and expertise.
Their selection is based on political reasons (Haniffa and Hudaib, 2006). Therefore,
these directors cannot contribute to the independent monitoring and the quality of audit
function. Table XII summarises all the results in order to clarify the findings of this study.

9. More analyses
Following Haldar and Raithatha (2017), this study considers five attributes of CG including
board independency, CEO duality, board size, audit quality and divergence between cash flow
and control rights to construct CG index (CGI). Board independency is the number of
 Dependent Hypothesis
CG and
Hypothesis variable Coefficient results detrimental
RPTs
H1a: there is a negative relationship between detrimental RPTs MBR −0.17** Accepted
and firm value TQ −0.07* Accepted
H1b: there is a positive relationship between beneficial RPTs and MBR 0.47** Accepted
firm value TQ 0.31** Accepted
H2a: there is a weaker negative relationship between detrimental RPTs MBR −0.08 Rejected 217
and firm value in companies with higher percentage of board independency TQ 0.15 Rejected
H2b: there is a stronger positive relationship between beneficial RPTs and MBR 1.09 Rejected
firm value in companies with higher percentage of board independency TQ 0.65 Rejected
H2a: there is a weaker negative relationship between detrimental RPTs MBR −0.20 Rejected
and firm value in companies with higher audit quality TQ −0.05 Rejected
H2b: there is a stronger positive relationship between beneficial RPTs MBR 0.26 Rejected
and firm value in companies with higher audit quality TQ 0.51** Accepted
H3a: there is a stronger negative relationship between detrimental MBR −0.41*** Accepted
RPTs and firm value in companies with CEO duality TQ −0.17* Accepted
H3b: there is a weaker positive relationship between beneficial RPTs MBR −0.44 Rejected
and firm value in companies with CEO duality TQ −0.39 Rejected
H3a: there is a stronger negative relationship between detrimental MBR −0.06** Accepted
RPTs and firm value in companies with larger board TQ −0.02* Accepted
H3b: there is a weaker positive relationship between beneficial RPTs MBR −0.25*** Accepted
and firm value in companies with larger board TQ −0.14*** Accepted
H3a: there is a stronger negative relationship between detrimental RPTs MBR −2.07*** Accepted
and firm value in companies with higher divergence between cash flow
and control rights TQ −1.68*** Accepted
Table XII.
H3b: there is a weaker positive relationship between beneficial RPTs MBR 0.57 Rejected Summary of results
and firm value in companies with divergence between cash flow and for the moderating
control rights TQ 0.99 Rejected effect of CG on the
Notes: n ¼ 793. *,**,***Significant at 10 per cent ( p o0.1), 5 per cent ( p o 0.05) and 1 per cent ( p o0.01) relationship between
levels, respectively RPTs and firm value

independent non-executive directors as reported in the companies’ annual report, divided by

the total number of directors. Then, companies with a higher value of board independency
than the average have the value of 0, 0 otherwise. In order to measure CEO duality, companies
with a separation between CEO and chair of the board have the value of 1, 0 otherwise. Size of
the board refers to the number of total directors employed in the board. Then, companies with
a smaller number of directors on the board than the average have the value of 1, 0 otherwise.
In order to measure audit quality, if the external auditor is one of the big four audit firms, it
takes the value of 1, 0 otherwise. The last but not least, companies with a smaller divergence
between cash flow and control rights than the average have the value of 1, 0 otherwise. In
order to measure the CGI, this study brings together five points on the attributes of CG
divided by five as total points.
Based on the regression results for Model 1 in Table XIII, there is a negative relationship
between DRPTs and MBR, with the coefficient equals to −0.21, which is significant at the
1 per cent level of significance. In addition, Model 4 of Table XIII shows a negative
relationship between DRPTs and TQ, with the coefficient equals to −0.09, which is
significant at the 10 per cent level of significance. These findings support H1a, which
proposes a negative relationship between DRPTs and firm value. Furthermore, Model 1 of
Table XIII shows a positive relationship between BRPTs and MBR, with the coefficient
equals to 0.66, which is significant at the 1 per cent level of significance. In addition, Model 4
of Table XIII documents a positive relationship between BRPTs and TQ, with the coefficient
equals to 0.47, which is significant at the 1 per cent level of significance. These findings
support H1b, which proposes a positive relationship between BRPTs and firm value.
ARA Dependent variable: MBR Dependent variable: Tobin’s Q
27,2 Model 2: Model 3: Model 5: Model 6:
Model 1: no interaction with interaction with Model 4: no interaction with Interaction with
Variables interaction BRPT DRPT interaction BRPT DRPT

Independent variables
BRPT 0.66*** −0.09 0.68*** 0.47*** −0.11 0.47***
218 DRPT −0.21*** −0.20*** −0.60*** −0.09* −0.08** −0.32***
CGI −0.02 −0.16 −0.34 0.02 −0.08 −0.16
BRPT×CGI – 1.25* – – 0.97** –
DRPT×CGI – – 0.69** – – 0.40**
Control variables
Fsize 0.07*** 0.07** 0.06** 0.03** 0.04** 0.03*
Age −0.00 −0.00 −0.00 0.00 −0.00 −0.00
Lev 0.21*** 0.21*** 0.20*** 0.11*** 0.11*** 0.11***
InsOwn 1.13** 1.12** 1.18** 0.60* 0.59** 0.62**
ACIND −0.15 −0.17 −0.12 0.11 −0.12 −0.09
REM −0.02 −0.02 −0.02 −0.01 −0.01 −0.01
ROA 5.45*** 5.49*** 5.47*** 3.76*** 3.78*** 3.77***
Table XIII.
MOWN −0.24 −0.23 −0.25 −0.20 −0.18 −0.20*
Regression results for
the moderating effect Adjusted R2 0.26 0.28 0.28 0.29 0.30 0.30
of CG index on the F-statistic 26.76*** 10.26*** 10.23*** 30.34*** 11.34*** 11.44***
relationship between Notes: n ¼ 793. Period of study is the financial period of 2009–2011. *,**,***Significant at 10 per cent
RPTs and firm value ( po 0.1), 5 per cent ( p o0.05) and 1 per cent ( p o0.01) levels, respectively

Regarding the moderating effect of CGI on the relationship between RPTs and firm value,
Model 2 of Table XIII documents a positive relationship between the interaction term of
BRPTs and CGI (BRPT×CGI) and MBR, with the coefficient equals to 1.25, which is
significant at the 10 per cent level of significance. Furthermore, Model 5 of Table XIII shows
that the interaction term of BRPTs and CGI (BRPT×CGI) has a positive relationship with
Tobin’s Q, with the coefficient equals to 0.97, which is significant at the 5 per cent level of
significance. Model 3 of Table XIII shows that the interaction term of DRPTs and CGI
(DRPT×CGI) has a positive relationship with MBR, with the coefficient equals to 0.69, which
is significant at the 5 per cent level of significance. In addition, Model 6 of Table XIII
documents a positive relationship between the interaction term of DRPTs and CGI
(DRPT×CGI) and TQ, with the coefficient equals to 0.40, which is significant at the
5 per cent level of significance. These findings document that CG as a controlling mechanism
may control the opportunistic behaviours of related parties from the expropriation of firm’s
resources, improve the RPT efficiency and reduce the agency problems.

10. Conclusion and implications

Interestingly, the regression results in this study show a positive relationship between
BRPTs and firm value. In addition, the findings of this study support the negative
relationship between DRPTs and firm value. These findings support the argument that
investors, creditors and policy makers should not consider all RPTs as harmful transactions
because different nature of RPTs may affect the efficiency of these transactions. Although
related parties have a tendency to use RPTs as a means to expropriate firm wealth, there are
some RPTs that provide much benefit to the firm. Therefore, it seems necessary for policy
makers to categorise RPTs into different groups including transactions which are
detrimental and transactions which are beneficial to the firm.
The findings of this study show that CEO duality provides CEO with the opportunity
to have a major influence on the board decisions and diminish the capability of the
board to control and supervise the opportunistic behaviours of related parties. CG and
These findings for CEO duality are consistent with Haniffa and Hudaib (2006) in detrimental
Malaysian-listed firms. It can be concluded that companies that combine the role of RPTs
CEO and chairman have a poor performance compared to the companies which
separate the positions of CEO and chairman. This argument is in line with the theory
proposed by Fama and Jensen (1983) who suggest that in order to make an effective
separation between decision control and decision management in a firm, CEO of the firm 219
and chairman of the board must be held by different persons. Therefore, it is necessary for
all companies to comply with the recommendation of MCCG to make a clear separation
between the CEO and chairman.
In addition, this study documents that larger boards are expected to be less efficient in
monitoring function and slower in decision-making. This situation provides related parties
with more opportunities to extract firm’s resources through the RPTs at the expense of
other shareholders. Therefore, this study suggests that each board should include an
appropriate number of directors which can efficiently monitor the firm’s operations.
Although the MCCG does not specify a desirable number of directors in the board, MSWG in
the governance and transparency index specifies the desirable board size between 6 and
11 members. Therefore, it is necessary that all companies consider these limitations in the
size of the board. It should be noted that the findings of the current study only indicate the
negative effect of board size on the relationship between RPTs and firm value. However,
determining the appropriate number of board size is out of the scope of this study and future
studies may determine the appropriate number of board size.
The findings of this study indicate that the entrenchment effect of divergence between
cash flow and control rights provides more incentives for controlling shareholders and more
opportunities for other related parties to expropriate firm’s resources through the RPTs.
Therefore, regulators and standard setters should establish an appropriate mechanism to
limit this opportunistic behaviour of controlling shareholders and protect the firm’s wealth
against the expropriation behaviours.
Finally, the findings of this study support the argument that Malaysian companies only
perform audit function in order to comply with the legal requirements because the audit
function in Malaysia is only a way to present an image of a modern economy to increase the
foreign investments.
As an implication for future studies, researchers may categorise RPTs based on different
types of related parties engaged in RPTs and investigate the effect of these transactions on
firm value. As an example, future studies can classify RPTs with primary and secondary
related parties. Since different countries have different political and cultural environments,
this study suggests that future studies may investigate the effect of RPTs as well as the
moderating effect of CG characteristics on RPTs in different countries. Future studies can
consider cultural and political characteristics in their models. In addition, future studies may
use CG indices published by authorities’ organisations as a measure of CG characteristics.
Finally, we should consider the short period of this study as a limitation which might impair
the usefulness and conclusion of the study.

References
Abdul Rahman, R. and Haniffa, R.M. (2005), “The effect of role duality on corporate performance in
Malaysia”, Corporate Ownership and Control, Vol. 2 No. 2, pp. 40-47.
Abdullah, S.N. (2004), “Board composition, CEO duality and performance among Malaysian listed
companies”, Corporate Governance, Vol. 4 No. 4, pp. 47-61.
Aiken, L.S. and West, S.G. (1991), Multiple Regression: Testing and Interpreting Interactions,
Sage Publication, Thousand Oaks, CA.
ARA Al-Ajmi, J. (2009), “Audit firm, corporate governance, and audit quality: evidence from Bahrain”,
27,2 Advances in Accounting, Incorporating Advances in International Accounting, Vol. 25 No. 1,
pp. 64-74.
Ali, A., Haniffa, R. and Hudaib, M. (2006), “Episodes in the Malaysian auditing saga”, Managerial
Auditing Journal, Vol. 21 No. 7, pp. 684-701.
Amran, N.A. and Ahmad, A.C. (2009), “Family business, board dynamics and firm value: evidence from
220 Malaysia”, Journal of Financial Reporting & Accounting, Vol. 7 No. 1, pp. 53-74.
Baek, J.S., Kang, J.K. and Lee, I. (2006), “Business groups and tunneling: evidence from private
securities offerings by Korean Chaebols”, The Journal of Finance, Vol. 61 No. 5, pp. 2415-2449.
Balsam, S., Gifford, R.H. and Puthenpurackal, J. (2017), “Related party transactions, corporate
governance and CEO compensation”, Journal of Business Finance & Accounting, Vol. 44 No. 5,
pp. 854-894.
Baltagi, B.H. (2008), Econometric Analysis of Panel Data, John Wiley & Sons.
Bebchuk, L., Kraakman, R. and Triantis, G. (2000), “Stock pyramids, cross‐ownership, and dual class
equity: the creation and agency costs of separating control from cash flow rights”, in Randall, M.
(Ed.), Concentrated Corporate Ownership, University of Chicago Press, Chicago, IL.
Bennett, J.A. (2000), “Focus on research methods, mediator and moderator variables in nursing
research: conceptual and statistical differences”, Research in Nursing & Health, Vol. 23 No. 5,
pp. 415-420.
Berkman, H., Cole, R.A. and Fu, L.J. (2009), “Expropriation through loan guarantees to related parties:
evidence from China”, Journal of Banking & Finance, Vol. 33 No. 1, pp. 141-156.
Berle, A.A. and Means, G.C. (1932), The Modern Corporation and Private Property, 2th ed., Transaction
Publishers, New York, NY.
Bertrand, M., Metha, P. and Mullainathan, S. (2002), “Ferreting out tunneling: an application to Indian
business groups”, Quarterly Journal of Economics, Vol. 117 No. 1, pp. 121-148.
Boyd, B.K., Gove, S. and Hitt, M.A. (2005), “Consequences of measurement problems in strategic
management research: the case of Amihud and Lev”, Strategic Management Journal, Vol. 26
No. 4, pp. 367-375.
Brickley, J.A. and James, C.M. (1987), “The takeover market, corporate board composition and
ownership structure: the case of banking”, Journal of Law and Economics, Vol. 30 No. 3,
pp. 161-180.
Cavana, R.Y. and Delahaye, B.R. (2001), Applied Business Research: Qualitative and Quantitative
Methods, 3th ed., John Wiley & Sons, Milton.
Chen, C.J.P., Su, X. and Wu, X. (2007), “Market competitiveness and Big 5 pricing: evidence from
China’s binary market”, The International Journal of Accounting, Vol. 42 No. 1, pp. 1-24.
Chen, Y., Chen, C.H. and Chen, W. (2009), “The impact of related party transactions on the operational
performance of listed companies in China”, Journal of Economic Policy Reform, Vol. 12 No. 4,
pp. 285-297.
Cheng, S. (2008), “Board size and the variability of corporate performance”, Journal of Financial
Economics, Vol. 87 No. 1, pp. 157-176.
Cheung, Y.L., Rau, P.R. and Stouraitis, A. (2006), “Tunneling, propping, and expropriation: evidence
from connected party transactions in Hong Kong”, Journal of Financial Economics, Vol. 82 No. 2,
pp. 343-386.
Cheung, Y.L., Yuehua, Q., Rau, P.R. and Stouraitis, A. (2009), “Buy high, sell low: how listed firms
price asset transfers in related party transactions”, Journal of Banking & Finance, Vol. 33 No. 5,
pp. 914-924.
Cheung, Y.L., Jing, L., Lu, T., Rau, P.R. and Stouraitis, A. (2009), “Tunneling and propping up: an
analysis of related party transactions by Chinese listed companies”, Pacific-Basin Finance
Journal, Vol. 17 No. 3, pp. 372-393.
Chiou, C.C. and Huang, H.T. (2006), “A study on the association among voluntary independent director CG and
appointments, related party transactions and firm value: agency theory vs signaling theory”, detrimental
Asian Journal of Management and Humanity Sciences, Vol. 1 No. 3, pp. 379-403.
Choi, J.H., Kwak, S.K. and Yoo, H.S. (2007), “The association between audit fee and the ownership
RPTs
structure”, Seoul Journal of Business, Vol. 13 No. 2, pp. 83-103.
Choi, J.H., Kwak, S.K. and Yoo, H.S. (2008), “The effect of divergence between cash flow right
and voting right on audit hour and audit fee per audit hour”, Seoul Journal of Business, Vol. 14
No. 1, pp. 55-77.
221
Claessens, S., Djankov, S. and Lang, L.H.P. (2000), “The separation of ownership and control in East
Asian corporations”, Journal of Financial Economics, Vol. 58 Nos 1/2, pp. 81-112.
Claessens, S., Djankov, S., Fan, J.P.H. and Lang, L.H.P. (2002), “Disentangling the incentive and
entrenchment effects of large shareholdings”, Journal of Finance, Vol. 57 No. 6, pp. 2741-2771.
Cochran, W.G. (1977), Sampling Techniques, 3th ed., John Wiley & Sons, New York, NY.
Cohen, J., Cohen, P., West, S.G. and Aiken, L.S. (2003), Applied Multiple Regression/Correlation Analysis
for the Behavioral Sciences, 3th ed., Erlbaum, Mahwah, NJ.
Dahya, J., Lonie, A.A. and Power, D.M. (1996), “The case for separating the roles of chairman and CEO:
an analysis of stock market and accounting data”, Corporate Governance: An International
Review, Vol. 4 No. 2, pp. 71-77.
Defond, M.L. and Francis, J.R. (2005), “Audit research after Sarbanes–Oxley”, Auditing: A Journal of
Practice & Theory, Vol. 24 No. S1, pp. 5-30.
Djankov, S., La Porta, R., Lopez-de-Silanes, F. and Shleifer, A. (2008), “The law and economics of
self-dealing”, Journal of Financial Economics, Vol. 88 No. 3, pp. 430-465.
Effiezal, A.A.W., Hasnah, H., Lok, C.L. and Sofri, Y. (2011), “Does corporate governance matter?
Evidence from related party transactions in Malaysia”, in John, K. and Makhija, A.K. (Eds),
International Corporate Governance (Advances in Financial Economics), Vol. 14, pp. 131-164.
Eisenhardt, K.M. (1989a), “Making fast strategic decisions in high-velocity environments”, Academic
Management Journal, Vol. 32 No. 3, pp. 543-576.
Eisenhardt, K.M. (1989b), “Agency theory: an assessment and review”, The Academy of Management
Review, Vol. 14 No. 1, pp. 57-74.
Fama, E.F. and Jensen, M.C. (1983), “Separation of ownership and control”, Journal of Law and
Economics, Vol. 26 No. 2, pp. 301-326.
Fan, J.P.H. and Wong, T.J. (2002), “Corporate ownership structure and the informativeness of
accounting earnings in East Asia”, Journal of Accounting and Economics, Vol. 33 No. 3,
pp. 401-425.
Fan, J.P.H. and Wong, T.J. (2005), “Do external auditors perform a corporate governance role in
emerging markets? Evidence from East Asia”, Journal of Accounting Research, Vol. 43 No. 1,
pp. 35-72.
FASB (1982), “Statement of financial accounting standard No. 57”, Related Party Disclosures, Financial
Accounting Standards Board, Norwalk, CT.
Fooladi, M. and Farhadi, M. (2017), “The moderating effect of corporate governance on the relationship
between related party transactions and firm value”, Afro-Asian Journal of Finance and
Accounting, Vol. 7 No. 3, pp. 201-226.
Fooladi, M., Shukor, Z.A., Saleh, N.M. and Jaffar, R. (2013), “The effect of corporate governance and
divergence between cash flow and control rights on firm performance: evidence from Malaysia”,
International Journal of Disclosure and Governance, Vol. 11 No. 4, pp. 326-340.
Francis, J.R., Khurana, I.K. and Pereira, R. (2003), “The role of accounting and auditing in corporate
governance and the development of financial markets around the world”, Asia-Pacific Journal of
Accounting & Economics, Vol. 10 No. 1, pp. 1-30.
Friedman, E., Johnson, S. and Mitton, T. (2003), “Propping and tunneling”, Journal of Comparative
Economics, Vol. 31 No. 4, pp. 732-750.
ARA Gallery, G., Gallery, N. and Supranowicz, M. (2008), “Cash-based related party transactions in new
27,2 economy firms”, Accounting Research Journal, Vol. 21 No. 2, pp. 147-166.
Gani, L. and Jermias, J. (2006), “Investigating the effect of board independence on performance across
different strategies”, The International Journal of Accounting, Vol. 41 No. 3, pp. 295-314.
Gao, L. and Kling, G. (2008), “Corporate governance and tunneling: empirical evidence from China”,
Pacific-Basin Finance Journal, Vol. 16 No. 5, pp. 591-605.
222 Ge, W., Drury, D.H., Fortin, S., Liu, F. and Tsang, D. (2010), “Value relevance of disclosed related party
transactions”, Advances in Accounting, Vol. 26 No. 1, pp. 134-141.
Gerdin, J. and Greve, J. (2004), “Forms of contingency fit in management accounting research: a critical
review”, Accounting, Organizations and Society, Vol. 29 No. 3, pp. 303-326.
Gordon, E.A., Henry, E. and Palia, D. (2004), “Related party transactions and corporate governance”, in
Hirschey, M., John, K. and Makhija, A.K. (Eds), Corporate Governance (Advances in Financial
Economics), Vol. 9, pp. 1-27.
Gordon, E.A., Henry, E., Louwers, T.J. and Reed, B.J. (2007), “Auditing related party transactions:
a literature overview and research synthesis”, Accounting Horizons, Vol. 21 No. 1, pp. 81-102.
Greene, W.H. (2008), Econometric Analysis, 6th ed., Prentice Hall, Upper Saddle River, NJ.
Grinyer, J.R. (1995), “A new concept for amortizing goodwill”, International Journal of Forecasting,
Vol. 12 No. 4, pp. 546-550.
Grossman, S. and Hart, O. (1988), “One-share, one-vote, and the market for corporate control”, Journal of
Financial Economics, Vol. 20 Nos 1/2, pp. 175-202.
Gujarati, D.N. (2003), Basic Econometrics, 4th ed., Tata McGraw-Hill, New Delhi.
Haldar, A. and Raithatha, M. (2017), “Do compositions of board and audit committee improve financial
disclosures?”, International Journal of Organizational Analysis, Vol. 25 No. 2, pp. 251-269.
Haniffa, R.M. and Cooke, T.E. (2002), “Culture, corporate governance and disclosure in Malaysian
corporations”, Abacus, Vol. 38 No. 3, pp. 317-349.
Haniffa, R.M. and Hudaib, M. (2006), “Corporate governance structure and performance of Malaysian
listed companies”, Journal of Business Finance & Accounting, Vol. 33 Nos 7/8, pp. 1034-1062.
Hasnan, S., Daie, M.S. and Mohamed Hussain, A.R. (2016), “Related party transactions and earnings
quality: does corporate governance matter?”, International Journal of Economics and
Management, Vol. 10 No. 2, pp. 189-219.
Hill, R.C., Griffiths, W.E. and Judge, G.G. (2001), Undergraduate Econometrics, 2th ed., John Wiley & Sons,
Chichester and New York, NY.
Huang, D.T. and Liu, Z.C.H. (2010), “A study of the relationship between related party transactions and
firm value in high technology firms in Taiwan and China”, African Journal of Business
Management, Vol. 4 No. 9, pp. 1924-1931.
Jensen, M.C. (1993), “The modern industrial revolution, exit, and the failure of internal control systems”,
Journal of Finance, Vol. 48 No. 3, pp. 831-880.
Jensen, M.C. and Meckling, W.H. (1976), “Theory of the firm: managerial behavior, agency costs and
ownership structure”, Journal of Financial Economics, Vol. 3 No. 2, pp. 305-360.
Jeong, S.W. and Rho, J. (2004), “Big six auditors and audit quality: the Korean evidence”, International
Journal of Accounting, Vol. 39 No. 2, pp. 175-196.
Jian, M. and Wong, T. (2010), “Propping through related party transactions”, Review of Accounting
Studies, Vol. 15 No. 1, pp. 70-105.
Johnson, S., Boone, P., Breach, A. and Friedman, E. (2000), “Corporate governance in the Asian financial
crisis”, Journal of Financial Economics, Vol. 58 Nos 1/2, pp. 141-186.
Johnson, S., La Porta, R., Lopez-de-Silanes, F. and Shleifer, A. (2000), “Tunneling”, The American
Economic Review, Vol. 90 No. 2, pp. 22-27.
Judge, W.Q., Naoumova, I. and Koutzevol, N. (2003), “Corporate governance and firm performance in
Russia: an empirical study”, Journal of World Business, Vol. 38 No. 4, pp. 385-396.
Kahle, K. and Shastri, K. (2004), “Executive loans”, Journal of Financial and Quantitative Analysis, CG and
Vol. 39 No. 4, pp. 791-811. detrimental
Khurana, I.K. and Raman, K.K. (2004), “Are big four audits in ASEAN countries of higher quality RPTs
than Non-Big four audits?”, Asia-Pacific Journal of Accounting and Economics, Vol. 11 No. 2,
pp. 139-166.
Kim, J. and Yi, C.H. (2006), “Ownership structure, business group affiliation, listing status, and
earnings management: evidence from Korea”, Contemporary Accounting Research, Vol. 23 No. 2, 223
pp. 427-464.
Kim, K.H., Al-Shammari, H.A., Kim, B. and Lee, S.H. (2009), “CEO duality leadership and corporate
diversification behavior”, Journal of Business Research, Vol. 62 No. 11, pp. 1173-1180.
Kim, W., Black, B.S. and Jang, H. (2006), “Does corporate governance predict firms’ market values?
Evidence from Korea”, Journal of Law, Economics, and Organization, Vol. 22 No. 2, pp. 366-413.
Kohlbeck, M.J. and Mayhew, B.W. (2010), “Valuation of firms that disclose related party transactions”,
Journal of Accounting & Public Policy, Vol. 29 No. 2, pp. 115-137.
Kohlbeck, M.J. and Mayhew, B.W. (2017), “Are related party transactions red flags?”, Contemporary
Accounting Research, Vol. 34 No. 2, pp. 900-928.
La Porta, R., Lopez-de-Silanes, F. and Shleifer, A. (1999), “Corporate ownership around the world”,
Journal of Finance, Vol. 54 No. 2, pp. 471-517.
La Porta, R., Lopez-de-Silanes, F. and Zamarripa, G. (2003), “Related lending”, Quarterly Journal of
Economics, Vol. 118 No. 1, pp. 231-268.
La Porta, R., Lopez-de-Silanes, F., Shleifer, A. and Vishny, R.W. (1998), “Law and finance”, Journal of
Political Economy, Vol. 106 No. 6, pp. 1113-1155.
La Porta, R., Lopez-de-Silanes, F., Shleifer, A. and Vishny, R.W. (2000), “Investor protection and
corporate governance”, Journal of Financial Economics, Vol. 58 Nos 1/2, pp. 3-27.
La Porta, R., Lopez-de-Silanes, F., Shleifer, A. and Vishny, R.W. (2002), “Investor protection and
corporate valuation”, Journal of Finance, Vol. 57 No. 3, pp. 1147-1170.
Lee, K.W. (2007), “Corporate voluntary disclosure and the separation of cash flow rights from control
rights”, Review of Quantitative Finance and Accounting, Vol. 28 No. 4, pp. 393-416.
Lipton, M. and Lorsch, J.W. (1992), “A modest proposal for improved corporate governance”,
The Business Lawyer, Vol. 48 No. 1, pp. 59-77.
McCullers, L.D. and Schroeder, R.G. (1982), Accounting Theory: Text and Reading, 2th ed., John Wiley,
New York, NY.
MASB (2008), “Financial Reporting Standard (FRS) 124”, Related Party Disclosures,
Malaysian Accounting Standards Board, Kuala lumpur.
MCCG (2007), “Securities commission”, Malaysian Code on Corporate Governance, Kuala Lumpur.
MSWG (2011), “Malaysian corporate governance index report”, Minority Shareholder Watchdog
Group, Kuala Lumpur.
Ryngaert, M. and Thomas, S. (2012), “Not all related party transactions (RPTs) are the same: ex ante
versus ex post RPTs”, Journal of Accounting Research, Vol. 50 No. 3, pp. 845-882.
Sa’adiah, M., Norman, M.S., Jaffar, R. and Yatim, P. (2013), “Family ownership, related-party
transactions and earnings quality”, Asian Academy of Management Journal of Accounting and
Finance, Vol. 9 No. 1, pp. 129-153.
Sekaran, U. (2001), Research Methods for Business: A Skill Building Approach, John Wiley & Sons,
New York, NY.
Shamsul Nahar, A. (2006), “Board structure and ownership in Malaysia: the case of distressed listed
companies”, Corporate Governance, Vol. 6 No. 5, pp. 582-594.
Sharkar, M.Z.H., Sobhan, M.A. and Sultan, S. (2007), “Association between corporate governance and
related party transactions: a case study of banking sector of Bangladesh”, BRAC University
Journal, Vol. 4 No. 1, pp. 31-37.
ARA Shleifer, A. and Vishny, R.W. (1997), “A survey of corporate governance”, The Journal of Finance,
27,2 Vol. 52 No. 2, pp. 737-783.
Stiles, P. and Taylor, B. (1993), “Maxwell – the failure of corporate governance”, Corporate Governance:
An International Review, Vol. 1 No. 1, pp. 34-45.
Sulong, Z. and Fauzias, M.N. (2010), “Corporate governance mechanisms and firm valuation in
Malaysian listed firms: a panel data analysis”, Journal of Modern Accounting and Auditing,
224 Vol. 6 No. 1, pp. 1-18.
Swartz, M. and Watkins, S. (2003), Power Failure, the Insider Story of the Collapse of ENRON,
Doubleday, New York, NY.
Tam, O.K. and Tan, M.G. (2007), “Ownership, governance and firm performance in Malaysia”,
Corporate Governance, Vol. 15 No. 2, pp. 208-222.
Wang, Q., Wong, T.J. and Xia, L. (2008), “State ownership, institutional environment and auditor choice:
evidence from China”, Journal of Accounting and Economics, Vol. 46 No. 1, pp. 112-134.
Willenborg, M. (1999), “Empirical analysis of the economic demand for auditing in the initial public
offering market”, Journal of Accounting Research, Vol. 37 No. 1, pp. 225-238.
Yao, S. (2010), “Two essays on corporate governance in Chinese listed firms”, PhD thesis: Economics &
Finance, University of Hong Kong.
Yermack, D. (1996), “Higher market valuation of companies with a small board of directors”,
Journal of Financial Economics, Vol. 40 No. 2, pp. 185-211.
Zubaidah, Z.A., Nurmala, M.K. and Kamaruzaman, J. (2009), “Board structure and corporate
performance in Malaysia”, International Journal of Economic and Finance, Vol. 1 No. 1,
pp. 150-164.

Appendix 1. Measurement of related party transactions

In order to analyse the data, this study categorises RPTs into two groups including detrimental and
BRPTs. To measure beneficial and DRPTs, first, the amounts of RPTs in the annual reports are listed
into two groups including beneficial and DRPTs. Subsequently, following Effiezal et al. (2011), this
study utilises the total amount of DRPTs scaled by total assets as DRPTs. With reference to the same
authors, the total amount of BRPTs scaled by total assets is applied as the BRPTs. Because of the
various sizes of companies in the sample, it is appropriate to scale the total amount of detrimental and
BRPTs by total assets to make a relative measure of RPTs.
In order to list RPTs as detrimental or beneficial, DRPTs are defined as transactions which are
likely detrimental to the firm value while BRPTs are defined as transactions which are likely beneficial
to the firm value (Cheung et al., 2006). In order to characterize a transaction as detrimental or beneficial,
the current study reviews and represents previous studies that investigate different types of RPTs.
The following subsections provide more a detailed discussion on the different category of RPTs.
The list of RPTs that are likely detrimental or beneficial to the firm based on the literature is shown
in Table AI.
Type of transaction Prior studies
CG and
detrimental
Panel A: list of RPTs that are likely detrimental to the firm RPTs
Cash payments (including loans and cash Gordon et al. (2004), Cheung et al. (2006), Gallery et al. (2008) and
assistance and the provision of cash Berkman et al. (2009) use loans and payments to related parties as
guarantees by the listed company for a direct measure of tunnelling in their study
debts owed by the related parties) to La Porta et al. (2003) and Kahle and Shastri (2004) discuss that
related parties, except subsidiaries loans issued by a company to its related parties have a 225
preferential rate compared with other loans to unrelated parties
Kim and Yi (2006) discuss that firms that supply the debt
guarantees among affiliated firms in a group, encounter with
financial risk
The balance of receivable accounts from Gao and Kling (2008) discuss that more receivable accounts in
related parties (except subsidiaries) in the financial statements signal the expropriating of the firm’s
financial statements resources which leads to a higher risk of failing to collect
The loss on doubtful receivables from receivable accounts in the future and impose loss to the firm
related parties, except subsidiaries Chen et al. (2007) and Wang et al. (2008) discuss that auditors’
consider the potential expropriation through the receivable
accounts and attribute a high audit risk to these firms
Asset acquisitions and sales from/to related Cheung et al. (2006) discuss that RPTs such as transfer of assets
parties except subsidiaries (including can expropriate the firm’s resources to the hands of related parties
tangible and intangible assets) at the expense of firm value
Purchases or sales of goods and services Cheung, Yuehua, Rau and Stouraitis (2009) find that firms pay a
from/to related parties except subsidiaries higher price than in similar arm’s length transaction when they
acquire assets from related parties and they receive a lower price
compared to similar arm’s length transactions when they sell
assets to related parties
Ge et al. (2010) find that reported earnings of firms with assets
sold or goods sold to related parties are associated with lower
valuation coefficient than firms that do not engage in such
transactions
Huang and Liu (2010) find a negative relationship between the
sales and purchases of goods and assets to/from related parties
with firm performance
Panel B: list of RPTs that are likely beneficial to the firm
Receiving direct loans or cash from their Cheung et al. (2006), Cheung, Yuehua, Rau and Stouraitis (2009),
related parties Cheung, Jing, Lu, Rau and Stouraitis (2009) and Friedman et al.
(2003) discuss that firms are likely to benefit from receiving direct
loans or cash from their related parties
All transactions in panel A between firm Bertrand et al. (2002) discuss that firms in a higher level of
and its subsidiaries pyramid may expropriate the firms in a lower level of pyramid but
not vice versa and resources flow only from low to high cash flow
right firms. Therefore, when the related party is a subsidiary of
company, minority shareholders of the listed firms may benefit
from RPTs
Cheung et al. (2006), Cheung, Yuehua, Rau and Stouraitis (2009)
and Cheung, Jing, Lu, Rau and Stouraitis (2009) discuss that listed Table AI.
firms can acquire benefits from the goods transfer, services or List of RPTs that are
assets from/to their subsidiaries under their control likely detrimental or
Chen et al. (2009) discuss that parent companies use RPTs to beneficial to the firm
tunnel resources from subsidiaries to their own account based on literature

Appendix 2
Divergence between cash flow and control rights refers to the difference between cash
flow rights and control rights of ultimate owner. In order to identify an ultimate owner and
measuring its cash flow and control rights in a firm, this study applies the weakest link principle
ARA (WLP) approach. In order to define ultimate owner based on WLP, first, one should find
27,2 shareholders who have more than 5 per cent of outstanding shares in a firm. If there is no
shareholder with more than 5 per cent of shareholdings, the firm is considered as widely held
without any ultimate owner (Claessens et al., 2000; Fan and Wong, 2005). Otherwise, among
shareholders who hold more than 5 per cent of outstanding shares in a firm, the largest
shareholder is defined as controlling shareholder (Fan and Wong, 2005). In most cases,
controlling shareholders of a firm are corporate entities, not-for-profit foundations or financial
226 institutions held by other shareholders (Claessens et al., 2000). For example, firm A holds part of
shares in firm B, which, in turn, firm B owns part of shares in firm C. This sequence of shareholdings
makes a chain of ownership. Following La Porta et al. (1999), this study traces the chain of
ownership to find the ultimate owner. La Porta et al. (1999) explain that ultimate owner has a certain
percentage of indirect control over firm A if ultimate owner directly controls firm B, which, in turn,
directly controls firm A (or a sequence of firms leading to firm A, each of which has control over the
next one, i.e., they form a control chain).
Figure A1 shows how to calculate the ultimate owner’s cash flow and control rights
based on WLP in a firm. In Figure A1, the focus is on firm B (one of the listed firms) as a
subject in the sample of the study. The aim is to calculate divergence between cash flow
and control rights in firm B. Suppose that D as the largest shareholder holds 40 per cent of the
shares of listed firm B. In turn, C (as the largest shareholder) owns 25 per cent of the shares of D.
Finally, Y (as the largest shareholder) holds 30 per cent of the shares in C. Suppose that each
shareholder of Y owns less than 5 per cent of shares. Therefore, Y is considered as the
ultimate owner of firm B. This ultimate owner has other direct (15 per cent) and indirect
(through firm A) shareholdings in firm B as shown in Figure A1. Based on the WLP approach,
control rights of ultimate owner are defined as the sum of the weakest level of shareholding along
the control chains linking the ultimate owner to the firm. Figure A1 shows that the ultimate owner
has 50 per cent of controlling rights in firm B, which is the sum of the lowest percentage of
shareholdings in each link (10% + 15% + 25% ¼ 50%). To measure the cash flow rights of ultimate
owner, one should sum the value of the products of the shareholdings of related shareholders from
each identified control chain. Figure A1 displays that the ultimate owner owns 21 per cent
((10%×30%) + (40%×25%×30%) + 15%) of the cash flow rights of firm B. Therefore, divergence
between cash flow and control right is 29 which is the difference between control rights (50 per cent)
and cash flow rights (21 per cent):
(1) Control rights of ultimate owner in firm B (CR): 10% + 15% + 25% ¼ 50%.
(2) Cash flow rights of ultimate owner in firm B (CFR): (10% × 30%) + (40%×25%×30%) +
15% ¼ 21%.
(3) Divergence between CR and CFR of ultimate owner ¼ (CR–CFR): (50%−21%) ¼ 29%.
 Y
CG and
Ultimate Owner detrimental
RPTs
30% 30%

15% C
A 227
25%

10% Figure A1.

D
Calculation of ultimate
B 40% owner cash flow and
control rights
Source: Claessens et al. (2002)
Corresponding author
Masood Fooladi can be contacted at: foladim57@gmail.com

For instructions on how to order reprints of this article, please visit our website:
www.emeraldgrouppublishing.com/licensing/reprints.htm
Or contact us for further details: permissions@emeraldinsight.com