| Related party transactions (hereafter RPTs) are common business practices. If misused, however, they can result in significant losses for investors. This study attempts to examine empirical issues pertaining to RPTs. Specifically, the paper has two goals. The main goal is related to a 2006 Securities and Exchange Commission (SEC) regulation mandating public firms to disclose their governance policies on RPTs. I intend to investigate whether firms change their RPT behaviors in response to this mandated RPT governance disclosure and whether investors update the implied cost of capital on these RPT behaviors accordingly. Employing hand-collected RPT data for S&P 1500 firms, I find the initiation of RPT governance disclosure significantly reduces the occurrence of RPTs, suggesting an ex-post improvement in RPT governance. This reduction is more pronounced on firms with higher agency costs. I also find the types of RPTs and the identities of related parties play a role in the detected disclosure effect, suggesting certain types of RPTS could be more likely to be used as expropriation. Furthermore, I document that the disclosure of RPT governance reduces the implied costs of capital premium (ICC) associated with RPTs. Taken together, this analysis provides initial evidence about the effects of the SEC's 2006 regulation on RPT governance disclosures, and shows how the disclosures on RPT governance can enhance firms' governance on RPT activities and whether investors could recognize the firm behavior change by reducing firms' implied cost of capital.;The second goal is to assess whether independent directors' compensation is associated with the occurrence of RPTs. Studying independent directors attracts my interest because they are responsible for reviewing and approving RPTs in most companies. By decomposing independent directors' compensation into the market-level component and the over-compensated component, I show that firms with over-compensated directors or with a lower portion of equity-based compensation in contrast to cash-based compensation incur more RPTs. These results suggest that independent directors' overcompensation reduce directors' independence and equity-based compensation aligns directors' interests with those of shareholders, consistent with the private benefit theory. This study provides novel evidence that appropriate directors' compensation design can better control RPT behaviors. |
