Related party transactions and earnings quality: Moderating effect of corporate governance

This paper investigates the relationship between related party transactions (RPTs) and earnings quality (EQ). In addition, this paper examines whether there is a positive moderating effect of corporate governance on the relationship between RPTs and EQ. We use seven moderating variables to measure corporate governance mechanisms and suggest that the effect of RPTs on EQ is conditional on corporate governance mechanisms. Based on 294 firm-year sample for 2009-2010, we find evidence that the existence of RPTs represent potential conflict of interest which provides greater incentives to controlling shareholder to expropriate minority shareholders thus managing earnings to mask up such expropriations. However, the negative effect is mitigated with the presence of good governance namely level of board independence and audit quality.