Related Party Transactions and Stock Price Crash Risk: Evidence From China

Abstract

This paper investigates the association between related party transactions (RPTs) and stock price crash risk in China. Our investigation is motivated by controversy in the RPT-literature over whether RPTs are value-enhancing or opportunistic. Through the lens of stock price crash risk, we reveal that RPTs may violate the arm's length assumption of regular market-based transactions, impairing the representational faithfulness and verifiability of accounting data and, consequently, increasing the risk of future price crash. Importantly, we find that this detrimental economic consequence of RPTs is driven by abnormal RPTs that are opportunistic in nature. Our analyses also extend to operating RPTs, related party loans, and two types of opportunistic RPTs, including tunneling and propping. In addition, the positive association between RPTs and stock price crash risk is not mediated by financial reporting quality, suggesting that the risk factors associated with RPTs are operational. Our main results remain robust to a series of tests done to address the potential endogeneity between RPTs and stock price crash risk.

Keywords: related party transactions, stock price crash risk, propping, tunneling, earnings management