Buy High, Sell Low: How listed firms Price Asset transfer in Related Party Transactions

Yan Leung Cheung

Department of Economics and Finance

City University of Hong Kong

Agenda

• The Evidence– Market reacted very negatively by the listed

firms when they announced different types of related party transactions

• The Question– What is the process through which controlling

shareholders extract resources from publicly listed firms they control?

To compare transaction price and “Fair” value

• Asset acquisitions

• Asset sales

Between

• Related parties

• Arms’ length (non related parties)

“Fair” value estimation

• Problems– Not publicly listed firms– No observable market value

• “Fair” value is a function of accounting bock value and past operating earnings of these assets

Short-term market responseAsset acquisitions by the listed company from

Asset sales by the listed company to

Related party

Arms’ length party

Difference (p-value)

Related

party

Arms’ length party

Difference (p-

value)

(1) (2) (3) (4) (5) (6)

Price of traded assets (HK$ mil) – median

84 99 (0.59) 73 151 (0.00)

Book value of traded assets (HK$ mil) – median

28 22 (0.71) 39 87 (0.06)

Earnings of traded assets (HK$ mil) – median

2 1 (0.20) -2 0 (0.47)

Return on assets (ROA) of traded assets – median

0.08 0.04 (0.49) 0.12 0.01 (0.22)

Percent CAR [0,+1] – median -1.5% 2.0% (0.03)** -2.1% 1.7% (0.01)***

Regression Analysis (1)

Dependent variable: Transaction price

(1) (2) (3) (4) (5)

Book value of acquired assets

1.33 *** 1.35 *** 1.47 *** 1.33 ** 1.34 ***

Earnings of acquired assets

0.41 * 0.51 * 0.45 ** 0.40 * 0.40 *

Related party deal

0.22 * 0.22 * 0.38 ** 0.22 * 0.24 *

Industry control None 1-digit SIC code

2-digit SIC code

Fama and French 10-industry

classification

Fama and French 12-

industry clasification

Asset acquisitions by the listed company from related and arms’ length parties

Regression Analysis (2)

Dependent variable: Transaction price

(1) (2) (3) (4) (5)

Book value of divested assets

0.42 *** 0.40 *** 0.32 *** 0.40*** 0.40 ***

Earnings of divested assets

0.04 0.00 0.05 0.04 0.01

Related party deal

-0.25 ** -0.22 ** -0.32 *** -0.27 *** -0.25 ***

Industry control

None 1-digit SIC code

2-digit SIC code

Fama and French 10-industry

classification

Fama and French 12-industry clasification

Asset sales by the listed company to related and arms’ length parties

Remark

• Controlling shareholders appear to benefit directly at the expense of publicly listed firms by selling (acquiring) assets to (from) them at above (below) market price

Do corporate governance practices matter?

• Corporate governance variables have limited impact on the pricing of the deal. Only firm with an audit committee on the board and firms with large number of analysts following conclude related party transaction at a more favorable price

An article in the Wall Street Journal titled “Even good insider deals raise doubts”

commented

• “… Such related-party transactions raise questions about whether corporate insiders are fully focused on the interests of shareholders, experts say. The deals, no matter how small, can create the impression that insider is using company assets for personal benefit, and that the company is getting the short end of the stick. …”

END