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CORPORATE GOVERNANCE AND DISCLOSURE OF RELATED PARTY TRANSACTIONS

Masood Fooladi Chaghadari1 Zaleha Abdul Shukor2
Regarding the dual effect of related party transactions (RPTs), it is difficult to prescribe such transactions are beneficial or detrimental to the firm performance. However, disclosure of RPTs can provide stakeholders with necessary information to either discipline firms that engage in RPTs or take precautions against them. In effect, information asymmetry between related parties who involved in RPTs and other stakeholders is the main issue in these transactions. On the other hand, an important role of corporate governance (CG) is monitoring financial information disclosure as a means to relieve this information asymmetry. However, the theoretical literature in RPTs over the last decades has not given considerable attention to the relationship between CG and disclosure of RPTs. Therefore, the objective of this study is to explore the perceptions of experts on the relationship between CG and disclosure of RPTs. A Delphi method is adopted, drawing on semi-structured interviews with four experts to obtain a consensus on the opinion of experts. Analyzing of interviewees response suggests that these transactions can be done under the supervision of CG mechanisms to make more benefit for the firm. Furthermore, CG requires managers to make an appropriate disclosure of RPTs to help investors making their own judgments, whether the RPTs are value enhancing or value destroying. Interestingly, this study points that regulators and researchers should consider the diverse nature of relationships between company and its related parties in different countries because of cultural or social characteristics. In addition, the evidence indicates that the interviewees placed a great importance on the factors such as the competency, knowledge, and political agenda of management, ethic of CEO and psychological attributes of the top managers in CG. Field of Research: Corporate Governance, Related Party Transactions

1. Introduction Although it commonly viewed as conflict of interest between managers and stakeholders, there are two alternative perspectives of related party transactions (RPTs) (Gordon et al. 2004). The first is consistent with the conflict of interest view that RPTs jeopardize managements agency responsibility to shareholders or a board of directors monitoring function. Another perspective is referred to as the efficient transactions view that RPTs fulfill underlying economic needs of the organization between parties who have built up trust and shared private information. The conflict of interest view images RPTs as potentially harmful to the interests of the shareholders. In contrast, Ge et al. (2010) suggest that RPTs among companies can optimize internal resource allocation, improve return on assets and reduce transaction costs. Regarding the dual effect of RPTs, it is difficult to prescribe such transactions are beneficial or detrimental to firm performance (Yi Lin et al. 2010). Opportunistic behavior 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 & Watkins 2003). In most of these frauds, manager used RPTs to generate misleading financial statements and enrich themselves.
1

. Masood Fooladi Chaghadari, Islamic Azad University, Mobarakeh Branch, Department of Accounting, Isfahan, Iran. PhD candidate, School of Accounting, Faculty of Economics and Management, Universiti Kebangsaan Malaysia, Email: foladim57@gmail.com
2

. Dr. Zaleha Abdul Shukor, School of Accounting, Faculty of Economics and Management, Universiti Kebangsaan Malaysia, Email: zbas@ukm.my

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Therefore, related parties can extract firm wealth through the transactions at the expense of other shareholders (Kohlbeck & Mayhew 2010). In contrast, RPTs can be value-enhancing by creating strategic partnerships, enhancing risk sharing, and facilitating contracting. However, the management opportunistic view suggests that market will view RPTs negatively and the appropriate disclosure of RPTs and potential for litigation makes it difficult to believe that a firm would engage in value reducing RPTs. Kohlbeck & Mayhew (2010) argue that disclosure of RPTs can provide investors with necessary information to make a decision about firms that engage in RPTs. In effect, RPTs issue, same as corporate governance (CG) importance, arises because of information asymmetry between managers and stakeholders (Gordon et al. 2004). This asymmetric situation is well explained by Jensen and Meckling (1976) as an agency problem. The root of this problem is established because of the separation between those who control and those who own the residual claims in a firm. Among this separation, agency theory assumes an opportunistic behavior of managers that leads to conflict of interests between stakeholders and managers (Jensen & Meckling 1976). One of the most important monitoring systems suggested by agency theory to mitigate the opportunistic behaviors and reduce the agency problems is CG (Brickley & James 1987). The two alternative views of RPTs have significantly different senses for CG and make the issue of whether RPTs benefit firm performance. In effect, if the RPTs are efficient transactions, there would be no concern about these transactions but the conflict of interest view of RPTs requires an efficient information system to make sure the stakeholders that related parties not exercise any value decreasing behavior. However, in efficient transactions view, a firm can also apply the CG as a controlling system to avoid the appearance of conflict of interests. In addition, international evidence suggests that regulations on related party disclosure mitigate the negative effects of self-dealing (La Porta et al. 2006) and inhibit the ability of insiders to secretly remove firm assets (Kohlbeck & Mayhew 2010). When managers know that these RPTs will be monitored and have to be disclosed, they may avoid engaging in certain transactions creating questions of a conflict or impropriety, even when the firm would benefit or at least not to be harmed (Gordon et al. 2004). Based on agency theory, one important aspect of CG is financial information disclosure as a means to relieve the information asymmetry by providing reports from the managers (directors) to fund suppliers (Zubaidah et al. 2009). Eventually, CG plays a crucial role in improving the efficiency and quality of financial reporting (Rezaee 2004). This monitoring system can prevent the financial statement manipulation and assure investors about the quality of information disclosed by companies. Based on the above, a CG mechanism can mitigate the negative effect of RPTs and as well lead to disclose relevant information about RPTs to users of financial statements making suitable judgment about these transactions. The theoretical literature in RPTs over the last decade has not given considerable attention to the relationship between CG and disclosure of RPTs in financial statements. Therefore, investigating the relationship between CG and disclosure of RPTs is the focus in the present study. Conducting semi-structured interviews with four experts, the objective of this study is to obtain consensus on the opinion about the relationship between CG and disclosure of RPTs. This paper proceeds with following sections. The next section provides a background on CG and RPTs and discusses the relevant literature. Section 3 describes the data collection and research method. In section 4, this study presents the analysis of findings through the interview. Finally, section 5 provides the conclusion of study. 2. Literature Review Shleifer and Vishny (1997) define CG as a way in which suppliers of finance to corporations assure themselves of getting a return on their investment. Irrespective of the particular definition, the importance of CG arises in a firm because of the distance between stakeholders and managers (Epps & Cereola 2008). The distance between ownership and control causes the inability of the stakeholders to have a full control over managerial actions (Abdullah 2004). Furthermore, agency theory assumes a self dealing where individuals want to maximize their own expected interests and are resourceful in doing so leading to an opposition between those who are interested (McCullers & Schroeder 1982). In addition, there will be an information asymmetry between the stakeholders and managements because the managers have the competitive advantage of information within the company over that of the owners (Zubaidah et al. 2009). Kathleen (1989) argues that this situation arises because of an ineffective information system to control the management behavior. This information asymmetric problem is also an issue for

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RPTs leading to conflict of interest between those who are engaged in RPTs and other parties (Gordon et. al. 2004). From the agency perspective, deputation of managerial responsibilities by principals to agents necessitates a system to better control the managerial discretions and prevent the opportunistic behavior of agents to assure that they make the best rate of returns for the owners (Judge et al. 2003). Therefore, researchers have suggested various governance mechanisms within the agency contract to align managerial motives with the interests of stockholders (Demsetz & Lehn 1985; Fama & Jensen 1983). Agency theory suggests CG as a mechanism to reduce these conflicts by monitoring managers' performance to align management's goals with those of the stakeholders (Brickley & James 1987). The first contribution of agency theory is the treatment of information (Kathleen 1989). In this theory, information is referred as an object that can be purchased and organizations can invest in information systems such as board of directors in order to control agent's opportunism. Williamson (1985) has provided the framework of linking disclosure quality to CG. A good CG mechanism has an effective role to mitigate the opportunistic behavior of managers, improve firms reporting quality and increase firm value. Rezaee (2004) in his article argues that the main purpose of CG is based on the accountability and responsibility rather than the image of who has the power and who is responsible. Under effective CG, management is accountable to the board of directors and the board of directors is accountable to the stakeholders to align the interests among managers, directors, and stakeholders. In addition, CG has a crucial role in improving the efficiency of the capital market through its impact on corporate operating efficiency, and on the integrity and quality of financial reporting. Financial reporting is an interactive supply chain process involving all CG factors to prepare and certificate the financial statements by corporate management under the supervision of the board of directors. Zubaidah et al. (2009) argue that there is a fundamental information asymmetry between the directors who have direct access to information and fund suppliers who are external to the firm. Financial information is a means to relieve this asymmetry by providing reports from the managers (directors) to fund suppliers. Another big source of the agency problem because of conflict of interests between related parties and other stakeholders arises from RPTs in a firm (Gordon et al. 2004). Therefore, regulations about RPTs and monitoring system have also been largely influenced by the conflict of interest view and agency theory (Pizzo 2009). In fact, standard setters introduced some rules and principles to improve disclosure and execute more effective monitoring systems, represent a clear attempt to mitigate the opportunistic behaviors in RPTs. In addition, requirements of detailed disclosure about RPTs in both SEC and FASB regulations indicate that information on RPTs is relevant and useful for financial statement users to make an appropriate decision. This full disclosure of RPTs helps stakeholders to determine the implications of these transactions on the firm (Gordon et al. 2004). Based on the conflict of interest view, RPTs can make misleading operating results and adversely affect minority shareholders wealth if managers or stakeholders use these transactions for their opportunistic objectives (Ge et al. 2010). Based on FASB (1982), the importance of disclosure on RPTs is that potential wealth transfers can occur between the firm and related parties because RPTs enable the firm to manipulate its financial statements. By accounting manipulation associated with RPTs, resources can be transferred between different stakeholders resulting in gains to some and losses to others (Agnes et al. 2010). Moreover, these manipulations destroy financial statements and make a greater information asymmetry leading to general waste of confidence in the firm. As a result, appropriate disclosure of information about RPTs is an important aspect of protecting minority shareholders rights that is expected from a proper CG (Shan 2009). A strong CG would expect the board of directors to strongly monitor and support related-party disclosures by the firm to obstruct any potential expropriation. In addition, Gordon et al. (2004) believe that an appropriate disclosure of RPTs in financial statements can protect the stakeholders' interest by providing them with necessary information to judge about the effect of these transactions. Firms should accept an efficient measure to prevent its shareholders and their affiliates from misappropriating or transferring the capital, assets or other resources of the firm through various means. One means could be monitoring the disclosure of related-party relationships and transactions through the CG system (Shan 2009).

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Therefore, it can be concluded that CG as a monitoring system reducing the information asymmetry has an important role in ensuring the quality of the financial reporting process and the extent of disclosure. In addition, information of RPTs disclosed in financial statements is value relevance to the users, and they can predict the effect of these transactions on the firm. As a result, another area of interest related to RPTs is the relationship between CG and disclosure of these transactions. This issue needs to be more considered because the CG as a monitoring system and through an appropriate disclosure can give the assurance, whether the RPTs are beneficial or detrimental to other stakeholders. Thus, the aim of this study is to make a consensus on the opinion of experts on the relationship between CG and disclosure of RPTs. 3. Research Method This study employs Delphi method, drawing on semi-structured interviews with four experts in 2010 to explore their perceptions on the relationship between CG and disclosure of RPTs. Since there are two alternative perspectives on RPTs and individuals may have different opinions on this subject, Delphi method was utilized to obtain consensus on the opinion of experts. The Delphi method was developed at the RAND Corporation in the early 1950s. It is a technique for systematically soliciting, organizing, and structuring judgments and opinions on a particularly complex subject matter from a panel of experts to reach a consensus on the topic (Helmer & Rescher 1959), or until it becomes evident that further convergence is impossible. The selection of expert panel members for the study is the first step in the administration of the Delphi method. This initial step is crucial because this panel lends content validity to the task (Tersine & Riggs 1976). In the present study, to gain a better understanding on perception of the effect of CG on disclosure of RPTs, it was deemed useful to seek viewpoints derived from experts who have studied in this area or have experienced this situation. Consequently, data required for the current study was collected in two rounds from these experts. In the first round, we contacted the interviewees personally and invited them to participate in the research. For getting preliminary approval from them, an interview protocol explaining the nature and scope of the research was sent to interviewees. Each interview consumed on the average one hour, was conducted in English, tape-recorded, and subsequently transcribed by the researcher. While the interview guide entails the purpose of leading discussions around the subject, semi-structured nature of interviews also provides the interviewer with the opportunity to decide on the sequence/wording of questions during the interview. Appendix 1 provides a common subject around which interpretive could be made, with the option available to explore in more depth areas of significance to particular interviewees. Most of the questions allowed significant room for interpretation. Interviewees are asked by nine questions to give their opinion on the relationship between CG and disclosure of RPTs. In the second round, the four experts responding to the first round were sent feedback showing the results of the first round. Based on the findings in the first round, 13 questions were asked from the experts through a questionnaire. In eight questions, they were asked to rank the statements inferred from the first interview in order of importance. In the other five questions they were asked to choose each statement that they agree upon. In the framework of this methodology, we present our main findings in the following sections. In addition, the four experts are referred to as interviewee 1 to 4 in this study. Interviewee 1 is an associate professor who has done many studies on CG and corporate reporting related to earnings management. He is currently studying on the effect of RPTs and family ownership on business. Interviewees 2 and 3 are both senior lecturers at a university who have worked on CG and financial reporting research. Interviewee 4 brings over 20 years experience in the IT industry mainly concentrating in Telecommunications. Throughout his years of experience, he has covered areas in engineering, maintenance, sales and marketing and project management. 4. Analysis of Findings Respondents were requested to answer nine questions in the first round and 13 questions in the second round to give their opinion on the relationship between CG and disclosure of RPTs. In this section, we analyze the respondents view based on 12 topics as shown in Appendix 1. These 12 topics covered three main areas. The first area is about the related parties and RPTs including definition, value enhancing or decreasing of RPTs, pricing asset transfers in RPTs and opinion on how to control these transactions. Additional question include the banning of RPTs versus setting strong rules and disclosures on these transactions. Respondents were also asked whether information on RPTs disclosed by the companies is value relevance. The second area is on the definition of CG

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and the magnitude of this mechanism. The last area concerns about the role of CG in mitigating the negative effect of RPTs and in making appropriate disclosure on these transactions. 4.1. Definition of related party All respondents define RPTs as transactions occurring between a company and its related parties. Interviewee 2 defines RPTs as transfer of any resources such as assets and inventory between a company and its related individuals or related companies. Therefore, to categorize a transaction as a RPT, the other party in the transaction should be a related party. Interviewee 1 defines related parties as the parties related to persons who control the organization such as family members of board of directors and CEOs. Interviewee 3 mentions that the entities which are controlled by or in control of the company are also called related parties. In addition, companies transactions between parents and their subsidiaries or joint ventures in one group, can be categorized as RPTs. Interviewee 1 points out the environmental factors in definition to related parties. He asserts that: The relationship among entities in different countries is not the same. Entities in Eastern countries take care of their friends and have very collective understanding and there are some informal relationships that should be considered as related parties. For example, transaction with the managers friend is not defined as RPTs even though it could be one. Therefore how can we control these kinds of transactions? These transactions could exist because of culture or religious understanding and researchers should pay more attention to this kind of hidden relationships and in different cultures. Although a definition of each item in financial reporting is based on regulation or standards, a countrys national characteristics should also be of concerned in these definitions. Gray (1988) proposes the cultural theory providing a good foundation to incorporate culture as an explanatory variable in studies. Wallace and Gernon (1991) further suggest the use of national character to explain differences in the accounting system. In addition, interviewee 4 explains: I think that the related parties affiliated to major shareholders can have more effect on the firm because of voting rights of those shareholders; that is, the decision making is on these shareholders. In other cases, if the decision making is at the manager level, then the related parties affiliated to managers are more detrimental to the company. The importance and effectiveness of different related parties in each company depend on the form of its ownership, management structure, and in one word, decision making level and the related parties affiliated to main decision makers are stronger than other related parties. In the case of Malaysia, quite a number of the public companies are controlled by family members, which are not likely to accept obligations towards outsiders/society (Haniffa & Cooke 2002). While agency problems in Western countries arise because of the conflict of interest between external investors and corporate management that owns minor shares, the agency problems in East Asian countries such as Malaysia lie in the conflict between controlling shareholders and minority shareholders (Claessens et al. 2000, Faccio & Lang 2002). In Malaysian companies, the protection of minority shareholders rights remains a key issue because the controlling shareholders exercise dominant power via cross-holdings of share ownership or pyramiding and try to expropriate the companys assets at the expense of minority shareholders (Haniffa & Hudaib 2006; Tam & Tan 2007; Chen & Chien 2007). Therefore, another area of interest related to RPTs is the relationship between CG and RPTs where the separation of cash flow and control rights is crucial. 4.2. Value enhancing or value decreasing of RPTs With regards to RPTs value, three of the respondents believe that RPTs can be either value enhancing or value destroying. However one respondent asserts that all RPTs are detrimental to other stakeholders. In this regard, interviewee 1 explains that same transactions may be either value enhancing or value damaging based on incentives of related parties involved in these transactions. He says that: Whether RPTs can generate value to the companies, or they are value damaging to the companies, depends on the incentives of the parties involved in the RPTs. The same transactions could be value damaging if related parties have incentives to channel the wealth away from the current organization that they are working with. In other words, they have a private benefit on these transactions. However, if

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related parties involved in same transactions dont have any incentives, then the transaction could be arms length transactions, and it could generate more values to the company. Interviewee 2 asserts that RPTs could be beneficial to the company if it is carried out properly according to a clear set of guidelines or proceedings. According to her, harmful transactions are only those that are carried out at the expense of other shareholders and tunneling profit to support the related parties private entities. In addition, interviewee 3 in a same view expresses that we cannot really say whether a RPT is beneficial or detrimental. Finally, interviewee 4 in an alternative view suggests that: These transactions do not really reflect true value (arms length) transactions because related parties have tendency to undertake these transactions to their benefits and harm other stakeholders. Even if the RPTs reflect true value but afterwards could harm reputation of the company and its managers because of the issue of favoritism and ethically it is not good in business. Prior studies support these views. Gordon et al. (2004) assert that there is no certain position on whether RPTs are detrimental or beneficial to the firm and its shareholders. It means that regulators and standard setters accept the possibility of the efficient transaction view of RPTs. Therefore, they prefer disclosure rather than limiting RPTs and required disclosure of information to allow financial statement users to make their own judgments regarding whether the RPTs are efficient or potential conflicts of interest. In another study, Cheung et al. (2006) classify RPTs into three broad categories including transactions that result in expropriation, transactions that are likely to benefit the listed firm, and transactions that may have been driven by strategic rationales. Yi Lin et al. (2010) distinguish between RPTs which result in expropriation of firms minority shareholders and other RPTs and provide empirical support for the two alternative views of RPTs. In addition, there is no country that completely forbids RPTs because these transactions can be value enhancing (Djankov et al. 2008). 4.3. Beneficial RPTs In terms of beneficial RPTs, interviewee 2 reports that RPTs are beneficial because the company can rely on related parties and trust on them. These parties know the company needs and can provide the company with better terms and conditions. According to interviewee 3, the most important benefit of RPTs is the continuous supply of needs and the knowledge from related parties about the essentials of a company. She says that: It could be beneficial if we can transact with related parties at a lower cost because we do not need to pay some additional expenses such as advertisement to third parties. An important factor in transactions with related party is the continuity supply of requirements for the company. In addition, when the company transacts with related parties, these parties are familiar with the needs of the company and this knowledge help them to provide the requirements for the firm at acceptable level of quality. Interviewee 1 gives an example of beneficial RPTs as follows: Supposed I am the CEO and I want to buy raw materials for the current company. I also have a company of my own which can give better terms. I know the costs and quality. At least because of the volume I can charge at very minimum profit. The current company is very big and if my own company can sell at lower price, with appropriate volume I can still get a lot of profit. So, in this situation which is called a win-win situation, both companies can get benefits. In contrast, if I want to buy from others, they may charge more than market price because I do not know the price and quality. This opinion refers to the efficient transactions view as discussed above (Gordon et al. 2004; Ge et al. 2010). 4.4. Detrimental RPTs In terms of detrimental RPTs, interviewee 2 asserts that tunneling and propping can occur through the RPTs because related parties can use the firm resources to provide their private companies with special benefits such as loans at a small rate of interest. In addition, interviewee 3 stated that: These transactions can be harmful because related parties may use these transactions for their own interest but detrimental to others. Another important subject is the credit transactions. Related parties may cheat the firm through this kind of transactions and do not perform their commitment perfectly.

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Further, interviewee 4 felt that related parties are so closed to the company that the company could become too dependent on the related parties for product and services. When the only supplier to the company is the related party, the company might miss opportunity for competitiveness. With regards to this view, opportunistic behavior of related parties who are engaged in RPTs is an important reason in the expropriation of assets and extraction of firm wealth at the expense of other shareholders (Swartz & Watkins 2003; Kohlbeck & Mayhew 2010). 4.5. Pricing asset transfers in RPTs When asked about the pricing of asset transfers in RPTs, all respondents agree that the price of transferred assets in RPTs may be different from an arms length transactions because of the incentives or opportunistic behavior of related parties involved in these transactions. In detrimental transactions, company transfers resources to related parties by selling assets to related parties at a lower price or buying from related parties at a higher price. In this way, related parties can channel away resources from the company for their own benefit. According to interviewee 2, RPTs can be used to manipulate financial statements at the end of the year. She narrates that: Related parties have a tendency to transfer the assets from the company for their own benefits but in some cases the company wants to show more profit or get money at the end of the year and sell the assets to its related parties. So, unexpectedly the selling price may be higher than the market price. In the subsequent year, it reverses back and the company will buy the asset from the related party at a different price. Cheung et al. (2009) show that firms acquire assets from related parties at a higher price and also sell assets to related parties at a lower price in comparison to similar arms length transactions. They document that RPTs can be detrimental to the value of minority shareholdings. Furthermore, FASBs concern about RPTs focuses on the lack of an arms length transaction which makes managers capable of manipulating RPTs for their own benefit. Accounting manipulation regarding to RPTs is where resources can be transferred between different stakeholders leading to gains for some and losses for others (Agnes et al. 2010). 4.6. Opinion on how to control RPTs (Banning of RPTs or setting strong rules) With regards to the control on RPTs, three of the respondents agree to setting rules rather than banning of RPTs. They report that if we ban the RPTs, then we cannot get any benefit from the value enhancing transactions and company may not get better terms from firms that they own outside the organization. Interviewee 2 asserts that being in business, we cannot really avoid from RPTs and it is necessary in some cases but we need some rules and better governance to supervise the transaction. In reality, it is not logical to ban RPTs and most of the respondents agree that these transactions can be either value enhancing or value decreasing but under the right supervision of a monitoring system, RPTs can become arms length transactions. Interviewee 1 explains that: If we ban the RPTs, companies might not get a better price from the companies that they own and the win-win situation may not be materialized. However, he agrees to the setting rules rather than banning because the advantages of the banning approach is that company has to transact with firms unrelated to anybody inside the organization or unrelated even to the organization itself. In this way, we can avoid from questionable transactions. Interviewee 4, who has a negative view on RPTs, when asked about situation if a related party is the only supplier, answers that: It is better to ban the RPTs to protect the shareholders benefit. In our company, we do not ban the transactions with related parties directly, but we as managers do not accept any deals or transactions with related parties. When there is no alternative to transact with third parties, we approve the RPT but we certainly put certain rules on the process of these transactions. Chen and Chien (2007) also believe that conducting RPTs through the supervision of a well-designed controlling mechanism can be value enhancing for the firm. In addition, when regulators approve some rules and guidelines to improve disclosure and accomplish more effective monitoring systems, it clearly indicates an attempt to reduce the opportunistic behaviors in RPTs. Ge et al. (2010) investigate whether disclosure of RPTs made by firms are value relevant before and after the 2001 RPT Measurement Regulation. They suggest that this information is value relevant because stakeholders discount earnings when valuing firms engage in RPTs

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during the period of 1997 to 2000. However, they found that after 2001, the valuations of firms engage in RPTs are not significantly different from the valuation of firms without these transactions. It means that the regulations for these transactions are effective and investors make sure that the opportunistic behavior of managers will be reduced with these rules. Therefore, disclosure of RPTs through an efficient information system can mitigate the opportunistic behavior in the financial reporting process and lessen the information asymmetry and give more relevant information to the users. Furthermore, Yi Lin et al. (2010) argue that applying control mechanisms can mitigate the negative effect of RPTs which might result in expropriation of firms minority shareholders wealth. 4.7. Value relevance of RPT disclosures When asked about the value relevance of RPTs disclosures, all respondents agree to the value relevance of information about RPTs. They concur that companies with more RPTs need to be critically analyzed by investors to make sure that there is no expropriation through the RPTs. Hence, this item could become value relevant. Interviewee 1 explains that: If value relevance is measured by share market price, we are actually talking about investors actions. Investors should look at the financial statements of companies and any information contained in the annual reports. They must also look for any possibility of expropriation to make sure that the company will be accountable in managing investors money. One way to check on the accountability is by looking at the RPTs. I would imagine that this item should be seriously examined by the investors. If a company has huge RPTs, investors should be a bit worried about that company and investigate more. In addition, interviewee 3 believes that disclosure on RPTs can clarify the terms and conditions for investors to make an appropriate decision about their investment. Accordingly, the analysis of firms with more RPTs may involved or create more expenses to investors. On the other hand, interviewee 4 with the negative view on RPTs feels concern that the information on RPTs is bad news in financial statements and can destroy firms share market price. He believes that: Earnings of firms that have RPTs are less value relevant compared to the earnings of firms that do not engage in such transactions. The financial statements of companies with RPTs have to be investigated more. In general, investors prefer to invest in companies without RPTs. Regarding the value relevance of RPTs information in financial reporting, Kohlbeck and Mayhew (2010) examined the stock markets valuation of firms that disclose RPTs in comparison to those that do not. They found that information of RPTs are value relevant to the market and also argue that disclosure can prevent insiders from making destroying transactions that may lower firm valuations even more. This information provides the opportunity for interested parties to either discipline insider behavior or takes precautions against it. Ge et al. (2010) document that investors use the information of RPTs to investigate the reliability of accounting numbers reported for valuation purposes. 4.8. Definition of Corporate Governance With regards to the definition of corporate governance, interviewee 1 stated that CG is a controlling mechanism in a company with the aim of ensuring that company will achieve the objective of the stakeholders since stakeholders should be represented by the board of directors. In another definition, interviewee 2 asserts that CG is any rule, law and factor that controls the operation of the company or ensures that company operates in a proper manner in terms of using the money provided by investors. Interviewee 3 defines CG as both structure and process. According to her: As a structure it involves in board of directors, audit committee, internal and external auditors. As a process it is a controlling mechanism to ensure investors interests are being taken care. CG can control the operations to achieve the goal of a company. Therefore, the existence of CG is important to protect the shareholders wealth. Finally, interviewee 4 describes CG as a mechanism requiring companies to follow some rules and guidelines to monitor the management behavior and enhance commitment to stakeholders. These definitions align with the two definitions of CG presented by Gillan and Starks (1998); Shleifer and Vishny (1997). 4.9. Importance of CG

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Irrespective of the different definitions as suggested in the discussions above, the main objective of CG is to protect the stakeholders benefit in a firm and reassure them about their investment. Not only should the company be profitable for the investors but the company must also ensure that all its administrative mechanisms are working toward value creation in the future. Interviewee 1 asserts that investors will look at the CG mechanism because a good CG can make sure that management will behave towards enhancing the company in the future. Interviewee 2 explains that: Only with the existence of rules is not enough and not effective. What we need is an effective implementation of CG itself. The results of company operations can imply an effective CG. Achieving better performance, better disclosure, higher level of earning quality means that CG is working properly and it is effective. Interviewee 1 notes that there are some weaknesses in CG reflected from the issue of real independence or competency of board of directors. He redefines a good CG apart from the issue of independency or CEO duality as follows: Other factors in a good CG should be the experience, competency, knowledge, and political agenda of management, ethic of CEO and psychological attributes of the top managers. Those attributes can show whether they have propensity to mismanage the company psychologically because of their background, education and belief. Management knows about ethics but they do not appreciate it. If managers are not ethical then we have to come up with many mechanisms to detect and control their actions. This ethical issue goes back to the influence of many factors, for example, family, living in a corruptive or civilized society. Therefore, besides the individual characteristics, we should be concern about the social characteristics in the code of CG. Irrespective of the definitions discussed above, the necessity of CG in a firm is to monitor the agency relationship in which stakeholders employ an agent to execute some services on their behalf which involves delegating some decision making authority to the agent. In a balance sheet model of the firm, Gillan (2006) argues that the board of directors is the apex of internal governance system and is responsible to monitor and compensate management. Important characteristics for a good board of directors found in previous research include board independency, directors ownership and CEO duality (Zubaidah 2009; Abdullah 2004; Nuryanah 2007). Haniffa and Cooke (2002) in their study incorporate both CG and personal characteristics of directors such as ethnic and education into the voluntary disclosure model. Recently, beside the concept of CG, the environmental and cultural factors have attracted considerable attention and introduced into empirical studies on CG as explanatory variables. Haniffa and Cooke (2002) suggest that the thinking of Malaysian managers is influenced by values, beliefs, race, culture, education and type of organization they work for. Therefore, it is important to consider national and individual characteristics beside regulations in different countries. Liew (2007) in his study on corporate governance reforms in Malaysia indicates that the interviewees placed greater importance on the social aspect of corporate governance (namely, corporate social responsibility) than the traditional notion of shareholder accountability. 4.10. CG and RPTs The last area in the interview process was linking the role of CG towards RPTs as a whole. This part present finding associating CG and RPTs. Interviewee 1 proposed that one of the ways to expropriate wealth is through RPTs. The issue of RPTs is one example of mismanagement in a company where CG should be able to detect before it happen. All respondents agree that CG can mitigate the negative effect of RPTs in a firm by setting certain monitoring guidelines when undertaking these transactions. In addition, interviewee 1 asserts that: CG mechanism should be able to detect problems in RPTs even before related parties commit to the transaction. Hence, these transactions should have been done at arms length and the CG entity should be accountable to shareholders. Meaning to say, RPTs should not expropriate wealth from the current company to another company and should be value enhancing and this is the role of CG. So, if CG is working properly, they should be able to detect the expropriation of wealth. Interviewee 3 asserts that if the CG is placed properly, there would not be any question about the RPTs because good CG can monitor these transactions and prevent the expropriation of other stakeholders. In addition,

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interviewee 2 says that approval of transactions by certain group similar to the board of directors or professional team can assist in controlling and improving the efficiency of these transactions. The role of CG to mitigate the negative effect of RPTs has been explored in prior research. Gordon et al. (2004) embarked upon the study on RPTs in the context of the firms CG environment related to agency literature. One of the issues investigated was whether CG characteristics such as board composition, CEO compensation, or large shareholder ownership concentration lessen the extent of agency problems and enhance the monitoring function in companies engage in RPTs. In another study, Chen and Chien (2007) show that CG structure can mitigate the negative effect of RPTs on business performance. Cheung et al. (2009) argue that if stakeholders cannot accurately predict the impact of RPTs to the value of firms, at least they should consider it as a signal of poor CG and accordingly reduce all companies valuation engage in such transactions. 4.11. CG and disclosure of financial information In the case of CG and disclosure of financial information generally, actually existence of good CG can improve the quality of financial reporting. Interviewee 2 suggests that managers in Eastern countries have a tendency towards a very high level of secrecy but are required by the regulations to disclose relevant information. Interviewee 3 explains that: CG characteristics follow certain rules and provisions. However, quality of disclosure is not dependent only on these rules. Other important factors reflecting a good CG include ethic, integrity and conscience. By only setting strong rules on financial disclosure could not be efficient enough to monitor and affirm disclosure quality because managers can manipulate the financial statements and disclose information for their own benefits. Interviewee 4 stated that the main entity in a CG mechanism is internal auditors. Internal auditors can detect any questionable event in the financial statement before reporting to the users. While, interviewee 1 asserts that: At first level, all problems should be detected by internal auditors. The internal auditors can then raise the problem or issue in the audit committee meeting where both external and internal auditors come together. If they detect any mismanagement of transactions, they should report the matter to the board level. All of these members have important roles in detecting earnings manipulation or RPTs which is value damaging. This process will occur only after the effect, that is, when things have happened. Normally, before a particular transaction occur, such as developing software for a company, it should be discussed first at the boards level. Hence, it is finally the board that can control the event, before as well as after a transaction. With regards to the relationship between CG and disclosure, Forker (1992); Chen and Jaggi (2000) and Eng and Mak (2003) support the argument that CG can widely affect the extent of disclosure. In addition, Cohen et al. (2004) argue that CG has an important role in ensuring the quality of the financial reporting process and the extent of disclosure. Finally, Rezaee (2004) introduces a CG system involving seven interrelated mechanisms of oversight, managerial, compliance, audit, advisory, assurance, and monitoring functions. In an effective CG, these seven interrelated functions can create a responsible CG, reliable financial reports, and credible audit services. 4.12. The effect of CG on disclosure of RPT Finally, in terms of the effect of CG towards disclosure of RPTs, at the highest level of confidence, respondents believe that CG can require managers to disclose RPTs. Interviewee 4 asserts that: Managers prefer to hide the RPTs because they are concerned about their reputation within and outside the company. They do not want to lose the market funds because investors do not like to invest their money in companies with RPTs. CG can force managers to disclose detailed information of RPTs when managers have to follow rules and guidelines. Since investors want to be sure that the company is making profit, interviewee 1 says that: Therefore, company should bring up the issue of RPTs in the board meeting and then all the board members should agree with the terms and conditions. Therefore, it is done with integrity. Later, a more transparent way to disclose the information should be done to let everybody knows about it. This can happen only when the CG is well in place. If we trust the CG in a company, then it should be able to detect any mismanagement of the transactions early in the board meeting when they want to decide about RPTs.

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Then, they have to also make clear about the RPTs to the shareholders. Therefore, RPTs should be disclosed in the annual reports because if the management knows that they have done something wrong, it will be disclosed in the annual report. Hence, if they are asked about it, then they would be more cautious before they decided to commit in any mismanagement of transactions. Based on the accounting literature, the two important characteristics for accounting information which are relevance and reliability will require an appropriate disclosure of RPTs in firms financial statements or annual reports (MIA & MACPA 1993). Shan and Taylor (2008) believe that disclosing more information about related party relationships and transactions is an important means to protect minority shareholders rights. Therefore, there must be certain rules or guidelines to ensure management will disclose the RPTs. In a single study, Shan (2009) tested a set of key determinants that affect the extent of disclosure on RPTs and based on agency theory, he documents that ownership structure and board composition are two CG factors that can influence the extent of disclosure on RPTs. 5. Conclusion Based on the analysis of the respondents comments, this study found that the related parties affiliated to main decision makers are stronger than other related parties. In the case of Malaysia, there might be tendency that the dominant control of main shareholders via cross-holdings of share ownership or pyramiding is an important factor to expropriate the companys assets at the expense of minority shareholders. Another important conclusion found from the interviews is that cultural and other social characteristics in different countries should be of concern to researchers in studying the RPTs. In this study, most of the respondents accept both views on RPTs and imply that related parties engaged in these transactions are concern about their benefits. If their benefits are better protected in the current company, the transaction will be value enhancing but if they have interests conflicting with the company, the transaction might harm the other stakeholders interest. Therefore, one solution suggested for this problem could be for the related parties to declare their involvement in these transactions, and assure other stakeholders that they have no conflict of interest in the RPTs. Otherwise these transactions must be investigated by a controlling mechanism. Since all interviewees agree to some extent that RPTs can be either value enhancing or value decreasing, therefore it is not logical to ban these transactions. By banning RPTs we can avoid from questionable transactions but we should also consider the value enhancing character of it. Respondents mentioned that under the supervision of a monitoring system, RPTs can be arms length transactions. What is important here is the accountability and integrity of people inside the organization rather than setting strict rules. One of the ways to check for accountability of management is by looking at the RPTs to make sure that the company will be accountable in managing the money. Since, the issue of RPTs is one example of mismanagement in a company and the objective of CG is controlling the opportunistic behavior of individuals, CG should be able to detect the expropriation of stakeholders wealth through the RPTs. In effect, managers have a tendency to have a very high level of secrecy and prefer to hide the RPTs because they are concerned about the market reaction to the information of RPTs. A reliable CG should be able to detect any mismanagement of transactions and made it clear by disclosure to the shareholders. Therefore, certain rules or guidelines can require companies with more RPTs to disclose more information making sure that there is no expropriation through these transactions.

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APPENDIX 1: Topics Addressed in Interviews

Related party transaction: The definition of related party Value enhancing or value decreasing of related party transactions Beneficial related party transactions Detrimental related party transactions Pricing asset transfers in related party transactions Banning of related party transactions or setting strong rules and disclosures on these transactions Value relevance of related party transactions Corporate governance: Definition of corporate governance Importance of corporate governance Corporate governance and disclosure of related party transactions Relationship between corporate governance and related party transactions Corporate governance and disclosure of financial information Corporate governance and disclosure of related party transactions

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