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 response Asset acquisitions by the listed company from Asset sales by the listed company to Relate d party Arms’ length party Differen ce (p- value) Relate d party Arms’ length party Differenc e (p-value) (1)(2)(3)(4)(5)(6) Price of traded assets (HK$ mil) – median 8499(0.59)73151(0.00) Book value of traded assets (HK$ mil) – median 2822(0.71)3987(0.06) Earnings of traded assets (HK$ mil) – median 21(0.20)-20(0.47) Return on assets (ROA) of traded assets – median (0.49) (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 * Related party deal 0.22 * 0.38 **0.22 *0.24 * Industry controlNone 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*** Earnings of divested assets Related party deal **-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