Related party transactions and the cost of debt: evidence from China

This paper investigates the interrelationship between related party transactions (RPTs), costof debt, and state ownership in the Chinese setting. Using data from listed Chinesecompanies during the period 2003 to 2013, we find that total RPTs increase firms’ cost ofdebt financing and that such a result is mainly driven by abnormal RPTs. Hence, thevalue-destroying argument with respect to the use of RPTs is empirically supported. Wefurther partition our sample on the basis of the nature of ownership and find that stateownership plays a moderating role in the positive association between RPTs and cost of debt.Such a moderating effect remains significant for firms with tunnelling activities. Finally, wedocument that the adverse effect of RPTs on the cost of debt capital is more pronounced forfirms with weak, as opposed to strong, internal control environments. Again, state-ownedenterprises (SOEs) with lower internal control quality are found to have a higher cost ofdebt when they report a higher level of total RPTs. Our research contributes to theinconclusive literature on the influence of state ownership on the cost of debt bydocumenting a detrimental impact of RPTs on the cost of debt for SOEs; thus, it also haspolicy implications. We suggest that stricter regulation of SOE bankruptcies may enhancethe credibility of SOEs and hence improve lenders’ credit risk assessments of those SOEswith reported RPTs. Our study also provides practical implications to corporate boards andsenior management teams by highlighting the detrimental effect of opportunistic RPTs onthe cost of debt financing