Agency Costs, Contracting, and Related Party Transactions

43 Pages Posted: 20 Sep 2004

See all articles by Mark J. Kohlbeck

Mark J. Kohlbeck

Florida Atlantic University - School of Accounting

Brian W. Mayhew

University of Wisconsin - Madison - Department of Accounting and Information Systems

Date Written: December 31, 2004

Abstract

We examine related party (RP) transactions using agency and contracting theory as guides. Agency theory suggests opportunistic behavior can generate RP transactions; however, RP transactions can also result from or be managed via contracting. We therefore investigate associations between RP transactions and compensation-based incentives, monitoring mechanisms, and links to executive compensation for a sample of 1,261 firms. We find RP transactions are associated with weaker corporate governance, CEO stock options, and inversely associated with CEO and director's cash compensation. In a direct analysis of CEO compensation, we find a positive association between unexpected CEO compensation and RP transactions with companies the firm partially owns (i.e. investments) suggesting that CEO's are compensated for running more complex organizations. Finally, we examine returns in the period following RP disclosure. The results suggest lower future returns for simple RP transactions involving directors, officers and major shareholders. However, future returns are marginally higher for companies engaged in RP transaction with investments. Our compensation and returns analyses suggest related party transactions with investments appear to be associated with efficient contracting, while simple transactions with directors, officers and shareholders are associated with opportunism.

Keywords: Related party, disclosure, governance

JEL Classification: M41, G34, J33, G38

Suggested Citation

Kohlbeck, Mark J. and Mayhew, Brian W., Agency Costs, Contracting, and Related Party Transactions (December 31, 2004). Available at SSRN: https://ssrn.com/abstract=592582 or http://dx.doi.org/10.2139/ssrn.592582

Mark J. Kohlbeck

Florida Atlantic University - School of Accounting ( email )

777 Glades Avenue
KH 119
Boca Raton, FL 33431-0991
United States
561-297-1363 (Phone)

Brian W. Mayhew (Contact Author)

University of Wisconsin - Madison - Department of Accounting and Information Systems ( email )

School of Business
975 University Avenue
Madison, WI 53706
United States
608-262-2714 (Phone)
608-263-0477 (Fax)

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