Do Capital Markets Punish Tunneling Behaviour of Business Groups? Agency Perspective of Related Party Transactions

Abstract

This study examines that do capital markets punish the tunneling behaviour of business groups in a unique institutional setting of Pakistani group firms. For this purpose, data of 207 non-financial firms belonging to various business groups were taken as a sample from 2006 to 2018. The Ordinary Least Square and Two Stages Least Square regression models are estimated. The results of various estimated models showed that both accounting performance and market valuation of the sample firms are negatively influenced by related party transactions (RPTs). Therefore, these transactions are assumed to be a means of conflict by the market participants and consistent with the tunneling perspective and conflict of interest hypothesis. These results support the notion that capital market pressure acts as a disciplinary device and punish the tunneling behaviour of the group firms. Besides capital markets, the regulatory framework and corporate governance (CG) mechanisms, therefore, should be improved in such a way to reduce the tunneling of minority shareholder's wealth. Moreover, external auditors shall devise stringent procedures to evaluate the reported RPTs to minimize its negative effects. This study also contributes to agency theory and tunneling aspect of RPTs in case of emerging markets. Main limitation of the current study is small sample size because majority of the group firms are not listed with Pakistan Stock Exchange and their annual reports are not publically available.