Related party transactions, agency problem, and exclusive effects

This paper examines the incentives for, and economic impact of related-party transactions (RPTs) by controlling shareholders (CSHs) of corporate groups. We analyze a theory model of RPTs transacted on ‘market terms’ by two affiliate firms in a group, one of which belongs to an upstream and the other to a downstream market. We show that RPTs of this kind, although non-advantageous to the CSH of the group in terms of transfer price, may be abusive in that they serve the interests of the CSH by sacrificing minority shareholders. This is due to the exclusive effects of such RPTs. We show that a CSH has a strong incentive to exclude upstream rivals for his/her own sake rather than the group’s when he/she is allowed to implement such RPTs. The results shed light on regulation of RPTs: distortions of RPTs arise not only from unfair transfer-pricing but also from large transaction volume. This further implies that competition policies regarding the leverage of market power and anti-competitive vertical mergers may be applied to regulate harmful RPTs.