Elaine Henry

RELATED PARTY TRANSACTIONS AND CORPORATE GOVERNANCE

Transactions between a firm and its own managers, directors, principal owners or affiliates are known as related party transactions. Such transactions, which are diverse and often complex, represent a corporate governance challenge. This paper initiates research in finance on related party transactions, which have implications for agency literature. We first explore two alternative perspectives of related party transactions: the view that such transactions are conflicts of interest which compromise management’s agency responsibility to shareholders as well as directors’ monitoring functions; and the view that such transactions are efficient transactions that fulfill rational economic demands of a firm such as the need for service providers with in-depth firm-specific knowledge. We describe related party transactions for a sample of 112 publicly-traded companies, including the types of transactions and parties involved. This paper provides a starting point in related party transactions research.

The Role of Related Party Transactions in Fraudulent Financial Reporting

Motivated by mixed findings in the auditing literature about the importance of related party transactions as red flags indicating potential fraud, this study examines 83 SEC enforcement actions involving both fraud and related party transactions. In addition to comparing the characteristics of firms in this sample with firms examined in other fraud studies, we describe generally how each type of related party transaction might potentially be used to misstate financial reports and then document the types of related party transactions actually occurring in these fraud cases. Overall, the most frequent type of transactions in the enforcement actions were loans to related parties, payments to company officers for services that were either unapproved or non-existent, and sales of goods or services to related entities in which the existence of the relationship was not disclosed. Misappropriation of the companys assets are most often related to transactions where the cash flow is outward, while instances of misstatement of financial reports are more often related to transactions where the cash flow is expected to be inward. Generally, related party transactions are not necessary as mechanisms for fraud, and their presence need not indicate fraudulent financial reporting. An implication is that it is important for the auditing profession to understand the benign nature of most related party transactions, the differentiating features between benign and fraudulent transactions, and the importance of evaluating a companys related party transactions in light of its broader corporate governance structure.

Accounting’s Tower of Babel: Key Considerations in Assessing Non-GAAP Earnings

The increasingly pervasive reporting of non-GAAP earnings poses fundamental challenges for investors and analysts. Non-GAAP earnings lack comparability, and related disclosures lack sufficient transparency to add comparability. In addition, non-GAAP earnings disclosures may raise potentially troubling questions about management’s motivation. We incorporate relevant research in our discussion and conclude with key prescriptions in assessing non-GAAP earnings. Disclosure: One of the authors is the publisher of The Analyst’s Accounting Observer, and we refer to certain data from that publication, as indicated where appropriate. Editor’s Notes: This article was externally reviewed using our double-blind peer-review process. When the article was accepted for publication, the authors thanked the reviewers in their acknowledgments. Alok Kumar Agarwal, CFA, and Stephen R. Foerster, CFA, were two of the reviewers for this article. Submitted 1 December 2015 Accepted 21 November 2016 by Stephen J. Brown

Structural Comparability of Financial Statements

This study investigates comparability of firms’ financial statement structure, i.e. similarity of line items, and its effects on accounting information users. Prior research demonstrates a relationship between accounting-function comparability (i.e., earnings comparability) and analysts’ forecast properties. Given the importance of financial statements as a source of information for analysts, we examine whether and how structural comparability of firms’ financial statements affects that relationship. Using a dataset of 7,797 firm-year observations from 2009 to 2015, our results indicate that structural comparability mediates the relation between earnings comparability and analysts’ coverage, forecast accuracy, and forecast dispersion. While our findings imply that structural comparability enhances financial statement informativeness to analysts, we also provide evidence suggesting that uniformity reduces financial statement informativeness. Overall, this study provides evidence on the underlying mechanism by which accounting-function comparability affects analysts’ forecast properties as well as some perspective on the distinction between comparability and uniformity in informative financial reporting.

Revenue Recognition: A Brave New World

We examine the market reaction to the discussions and deliberations during the period 1998 to 2015 surrounding the new revenue recognition standard issued simultaneously by the FASB and IASB. We find that market reactions to events leading to the joint standard differ for US GAAP and IFRS firms. The reaction is a net negative reaction for US GAAP reporters but a net positive reaction for IFRS reporters. US GAAP (IFRS) firms in high litigation industries experience negative (less positive) market reactions to those in low risk industries. In certain high-impact industries in the U.S. including medical equipment and telecommunications, the market reaction is positive suggesting benefits in these industries. Further, the results for the most visible and significant events are consistent with those based on the full set of events. The evidence suggests that the new revenue recognition standard imposes net costs to the U.S. firms, except in those industries expected to benefit the most, while it provides net benefits to IFRS reporters.