The association between related-party transactions and control-ownership wedge: Evidence from Korea

In this study, we examine whether related party transactions (RPT) are used as a mechanism for tunneling among firms belonging to large business groups in Korea (chaebols). Using 982 firm-year data of publicly traded firms in Korea, we find that the control-ownership wedge is positively associated with the magnitude of RPTs. RPTs increase as voting rights increase, while RPTs decrease as cash flow rights increase. The control-ownership wedge is more closely related to RPTs among the top 5 chaebol firms where the agency conflicts between the controlling shareholders and the minority shareholders are more severe than in non-top 5 chaebol firms. While the significant positive association between the control-ownership wedge and RPTs holds for both operating and non-operating RPTs, we find that non-top 5 chaebols use only non-operating RPTs whereas the top 5 firms use both operating and non-operating RPTs. Finally, we find that RPTs of Korean chaebol firms, on average, reduce firm value, but this value destruction is observed only when the control-ownership wedge is high and is more pronounced with the top 5 chaebol firms. Overall, our results together suggest that RPTs occur when the agency problem is severe and they are used as a means of tunneling, thus destroying firm value.