Related party transactions and income smoothing: new evidence from Korea

Abstract

We examine the relationship between related party transactions (hereafter, RPTs) and income smoothing using a sample of Korean firms from 2001 to 2013. We hypothesize that RPTs can be an efficient tool for income smoothing activity because both controlling shareholders and managers related to the execution of RPTs have incentives for income smoothing. Consistent with our conjecture, we find that RPTs are significantly associated with income smoothing. In particular, operating RPTs are shown to be an efficient tool to achieve smooth earnings path. We further document that income smoothing based on RPTs improves the informativeness of firms' reported earnings about their future earnings, which is measured by future earnings response coefficients (FERC).