Newspaper article Pittsburgh Post-Gazette (Pittsburgh, PA)

Related-Party Transactions Come with Lots of Baggage

Newspaper article Pittsburgh Post-Gazette (Pittsburgh, PA)

Related-Party Transactions Come with Lots of Baggage

Article excerpt

In their earnest perusal of information regarding executive pay, proxy lovers may overlook an illuminating portion of the report where transactions with related parties are disclosed.

There, companies reveal what relatives of officers, directors and shareholders are on the payroll and what business they conduct with entities owned by officers, directors or major shareholders as well as their relatives.

The Securities and Exchange Commission requires companies to disclose related-party transactions involving an annual sum of $120,000 or more in their proxy statements.

The Financial Accounting Standards Board, which makes the rules governing corporate accounting, also requires disclosure of these transactions but does not set a dollar amount. Instead, it requires companies to report transactions that are "material." The less onerous mandate means more related-party transactions are disclosed in proxies than in 10-Ks, the annual financial reports public companies file with the SEC.

While generally accepted accounting standards assume a business conducts its affairs at arm's length, "When you're talking about related-party transactions, you just can't make that assumption," says Peter Kern, partner in the McCandless office of accounting firm BKD.

"There is specific guidance both not to assume they are done at arm's length and not to state that they are done at arm's length," he says.

Companies that assert a related-party transaction was done at arm's length must provide evidence that terms of the deal are comparable to what they could have obtained on the open market.

Doing business with relatives raises a red flag because it presents the possibility of insiders enriching themselves at the expense of shareholders.

"The more related-party transactions you see in a proxy, the more concern you should have," says Charles Elson, head of the University of Delaware's Center for Corporate Governance.

"Typically, there is no good reason, in my view, for most of these transactions," he says. "The company, in my view, usually ends up the loser."

There also is evidence that related-party transactions can lead to lower stock prices and shareholders returns, according to Florida Atlantic University's Mark Kohlbeck and Brian Mayhew of the University of Wisconsin-Madison. Their latest research found companies that did business with entities related to a director, officer or major shareholder were 15 percent more likely to restate their financial results.

While they found no direct relationship between related-party transactions and restatements, Mr. Mayhew says the willingness to engage in such transactions signals that a company's corporate governance is weaker and that a company is "more willing to cut corners to do other things." The potential hazards posed by these transactions can be avoided, he adds.

"You can hire a lawyer who is not on your board. You can hire a compensation consultant who is not your brother," he says. …

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