Economic functions of related party transactions

This paper examines the economic functions of related party transactions (RPTs) in Taiwan. Specifically, three possible reasons for firms to purchase material from their related parties are examined. The first reason is favoritism by owner/manager at the expense of the passive stockholders. Second reason is tax saving, and the third reason is to reduce contracting cost. The empirical results from the 1985-1991 financial data of firms listed on the Taiwan Stock Exchange are consistent with the tax saving hypothesis. When firms purchase more from their related parties, their inventories tend to be high and tax be low. However, when averaged over time, tax is not significantly related to the magnitude of RPTs across firms. It suggests that while firms may control the timing of their tax expenses, eventually they pay their fair share of taxes and no firms get an advantage over others. The regression coefficients of the surrogate variables for the favoritism and contracting cost hypotheses are not statistically significant at the five percent level.