Silence is golden? Evidence from disclosing related-party transactions in China

The significance and the manipulative nature of related-party transactions (RPTs) render transparent disclosure necessary and relevant for investors who infer firm value from accounting disclosures. However, the full disclosure of RPTs may not be cost effective because not all of the information that firms possess is value relevant to financial statement users. This study provides new evidence on the value relevance of additional disclosure on RPTs by using a unique, mandatory disclosure requirement of transfer pricing policies in China. We hypothesize and find that, compared to the mere disclosure of amounts for related-party sales, the disclosure of transfer pricing methods provides incremental value-relevant information beyond total sales. We also show that the disclosure of transfer pricing details complements weak corporate governance mechanisms and improves the prediction of abnormal returns. Our findings are robust to various model specifications, and demonstrate the significance of transparent and relevant RPT disclosure in inferring firm value.