Moderating role of audit quality and firm size on pretax profit margin and related party transactions: evidence from Indonesia
Abstract
This study examines the effect of related party transactions (RPTs) on pretax profit margin (PPM). It analyzes the moderating effect of audit quality and firm size based on a large panel of Indonesian-listed firms. The sample of three representative business groups from 2010–2021 and analysis uses the Generalized Method of Moments (GMM) estimator to control PPM as a proxy of taxable income. We document that this study finds that PPM(t-1) and RPT Sales negatively impact and are significant on firms’ PPM, consistent with the incentive alignment hypothesis. However, RPTs, RPT Loan, and RPT Receivables affect positively. We also find that audit quality strengthens the impact of RPT Loan and RPT Receivables on the PPM negatively and positively significantly; however weakens RPTs, RPT Sales, and RPT Expenses. Moreover, firm size weakens the effect RPTs on PPM. RPTs and tax avoidance are complex and multifaceted phenomena of corporate finance. Additional business groups and variables may have moderating and mediating effects on the impact of taxable income on the business group. Stakeholders, especially the government, should supervise and control RPTs activities comprehensively, especially on the types of RPT Sales and RPT Expenses transactions. The paper offers two contributions. First, it gathers the first evidence on the taxable income and RPTs practices and offers insights into Indonesia’s business group behavior. Second, the analysis examines eleven years considering the sensitivity of audit quality and firm size to RPTs and pretax profit margin.
Keyword : pretax profit margin, RPTs, audit quality, firm size
How to Cite
Santosa, P. W., Rahayu, S. I., Simon, Z. Z., & Santoso, P. W. (2023). Moderating role of audit quality and firm size on pretax profit margin and related party transactions: evidence from Indonesia. Business: Theory and Practice, 24(1), 291–300. https://doi.org/10.3846/btp.2023.17946
This work is licensed under a Creative Commons Attribution 4.0 International License.
References
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Hendratama, T. D., & Barokah, Z. (2020). Related party transactions and firm value: The moderating role of corporate social responsibility reporting. China Journal of Accounting Research, 13(2), 223–236. https://doi.org/10.1016/j.cjar.2020.04.002
Jian, M., & Wong, T. J. (2010). Propping through related party transactions. Review of Accounting Studies, 15(1), 70–105. https://doi.org/10.1007/s11142-008-9081-4
Khaoula, F., & Moez, D. (2019). The moderating effect of the board of directors on firm value and tax planning: Evidence from European listed firms. Borsa Istanbul Review, 19(4), 331–343. https://doi.org/10.1016/j.bir.2019.07.005
Klassen, K. J., Lisowsky, P., & Mescall, D. (2017). Transfer pricing: Strategies, practices, and tax minimization. Contemporary Accounting Research, 34(1), 455–493. https://doi.org/10.1111/1911-3846.12239
Kohlbeck, M., & Mayhew, B. W. (2010). Valuation of firms that disclose related party transactions. Journal of Accounting and Public Policy, 29(2), 115–137. https://doi.org/10.1016/j.jaccpubpol.2009.10.006
Lo, A. W. Y., Wong, R. M. K., & Firth, M. (2010). Can corporate governance deter management from manipulating earnings? Evidence from related-party sales transactions in China. Journal of Corporate Finance, 16(2), 225–235. https://doi.org/10.1016/j.jcorpfin.2009.11.002
Löffler, C. (2019). Divisionalization and domestic transfer pricing for tax considerations in the multinational enterprise. Management Accounting Research, 45(November 2017), 100646. https://doi.org/10.1016/j.mar.2019.07.003
Minh Ha, N., Phuong Trang, T. T., & Vuong, P. M. (2022). Relationship between tax avoidance and institutional ownership over business cost of debt. Cogent Economics & Finance, 10(1). https://doi.org/10.1080/23322039.2022.2026005
Nekhili, M., & Cherif, M. (2011). Related parties transactions and firm’s market value: The French case. Review of Accounting and Finance, 10(3), 291–315. https://doi.org/10.1108/14757701111155806
Nugroho, W. C., & Agustia, D. (2018). Corporate governance, tax avoidance, and firm value. AFEBI Accounting Review, 2(2), 92. https://doi.org/10.47312/aar.v2i02.87
Park, S. (2018). Related party transactions and Tax avoidance of business groups. Sustainability, 10(10). https://doi.org/10.3390/su10103571
Pozzoli, M., & Venuti, M. (2014). Related party transactions and financial performance: Is there a correlation? Empirical evidence from Italian listed companies. Open Journal of Accounting, 03(1), 28–37. https://doi.org/10.4236/ojacct.2014.31004
Rathke, A. A. T., Rezende, A. J., & Watrin, C. (2020). Classification of transfer pricing systems across countries. International Economics, 164(September 2019), 151–167. https://doi.org/10.1016/j.inteco.2020.08.002
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Santosa, P. W. (2020a). The effect of financial performance and innovation on leverage: Evidence from Indonesian food and beverage sector. Organizations and Markets in Emerging Economies, 11(22), 367–388. https://doi.org/10.15388/omee.2020.11.38
Santosa, P. W. (2020b). The moderating role of firm size on financial characteristics and Islamic firm value at Indonesian equity market. Business: Theory and Practice, 21(1), 391–401. https://doi.org/10.3846/btp.2020.12197
Santosa, P. W., Rahayu, S. I., Simon, Z. Z., & Tambunan, M. E. (2021). The moderating role of audit quality and firm size in the effect of corporate governance on related party transactions: Evidence from Indonesia. Investment Management and Financial Innovations, 18(4), 166–176. https://doi.org/10.21511/imfi.18(4).2021.15
Santosa, P. W., Tambunan, M. E., & Kumullah, E. R. (2020). The role of moderating audit quality relationship between corporate characteristics and financial distress in the Indonesian mining sector. Investment Management and Financial Innovations, 17(2), 88–100. https://doi.org/10.21511/imfi.17(2).2020.08
Sari, D. K., Utama, S., & Rossieta, H. (2017). Tax avoidance, related party transactions, corporate governance and the corporate cash dividend policy. Journal of Indonesian Economy and Business, 32(3), 190. https://doi.org/10.22146/jieb.28658
Sayidah, N., Assagaf, A., & Possumah, B. T. (2019). Determinant of state-owned enterprises financial health: Indonesia empirical evidence. Cogent Business and Management, 6(1), 1–15. https://doi.org/10.1080/23311975.2019.1600207
Suk, K. S., Haryanto, M., & Purba, J. T. (2019). Cash holdings of business group-affiliated firms in Indonesia. DLSU Business and Economics Review, 29(1), 40–57.
Supatmi, M., Sutrisno, T., Saraswati, E., & Purnomosidhi, B. (2019). The effect of related party transactions on firm performance: the moderating role of political connection in indonesian banking. Business: Theory and Practice, 20, 81–92. https://doi.org/10.3846/btp.2019.08
Tambunan, M., Siregar, H., Manurung, A., & Priyarsono, D. (2017). Related party transactions and firm value in the business groups in the Indonesia stock exchange. Journal of Applied Finance & Banking, 7(3), 1–20. https://search.proquest.com/abicomplete/docview/1898416706/fulltextPDF/7011ACE8BAF9440BPQ/38?accountid=151027
Tariq, T. I., & Mousa, G. A. (2020). Can related party transactions be a matter for firm value? Evidence from emerging markets. In2020 International Conference on Decision Aid Sciences and Application (DASA) (pp. 258–263). IEEE. https://doi.org/10.1109/DASA51403.2020.9317048
Utama, C. A., & Utama, S. (2014). Corporate governance, size and disclosure of related party transactions, and firm value: Indonesia evidence. International Journal of Disclosure and Governance, 11(4), 341–365. https://doi.org/10.1057/jdg.2013.23
Wang, H. Da, Cho, C. C., & Lin, C. J. (2019). Related party transactions, business relatedness, and firm performance. Journal of Business Research, 101(January 2018), 411–425. https://doi.org/10.1016/j.jbusres.2019.01.066
Widadi, F. A., Subroto, B., & Rahman, A. F. (2022). Tax avoidance mediated by constitutional ownership as moderating variables. ETIKONOMI, 21(2), 411–430. https://doi.org/10.15408/etk.v21i2.25799
Wong, R. M. K., Kim, J.-B., & Lo, A. W. Y. (2015). Are related-party sales value-adding or value-destroying? Evidence from China. Journal of International Financial Management & Accounting, 26(1), 1–38. https://doi.org/10.1111/jifm.12023
Yeh, Y. H., Shu, P. G., & Su, Y. H. (2012). Related-party transactions and corporate governance: The evidence from the Taiwan stock market. Pacific Basin Finance Journal, 20(5), 755–776. https://doi.org/10.1016/j.pacfin.2012.02.003
Zimon, G., Appolloni, A., Tarighi, H., Shahmohammadi, S., & Daneshpou, E. (2021). Earnings management, related party transactions and corporate performance: The moderating role of internal control. Risks, 9(8), 146. https://doi.org/10.3390/risks9080146
Angelica, B., Gunawan, D., Christella, J., Chandera, Y., & Rachman, R. A. (2021). The effect of related party transactions on the performance of Indonesian listed companies. Jurnal Manajemen Teknologi, 20(1), 21–39. https://doi.org/10.12695/jmt.2021.20.1.2
Ashrafi, M., Abbasi, E., Hosseini, S. A., & Etemadi, M. P. (2020). The effect of related parties transactions on the firm value: Moderating role of audit committee. Iranian Journal of Finance, 3(2), 25–43.
Ayers, B. C., Jiang, J., & Laplante, S. K. (2009). Taxable income as a performance measure: The effects of tax planning and earnings quality. Contemporary Accounting Research, 26(1), 15–54. https://doi.org/10.1506/car.26.1.1
Baltagi, B. H. (2013). Econometric analysis of panel data. John Wiley & Sons. https://doi.org/10.1002/9781118445112.stat03160
Ben Cheikh, S., & Loukil, N. (2022). Political connections, related party transactions and firm performance: Evidence from Tunisian context. Journal of Accounting in Emerging Economies, 13(1). https://doi.org/10.1108/JAEE-10-2020-0287
Berkman, H., Cole, R. A., & Fu, L. J. (2009). Expropriation through loan guarantees to related parties: Evidence from China. Journal of Banking & Finance, 33(1), 141–156. https://doi.org/10.1016/j.jbankfin.2007.11.001
Bona-Sánchez, C., Fernández-Senra, C. L., & Pérez-Alemán, J. (2017). Related-party transactions, dominant owners and firm value. BRQ Business Research Quarterly, 20(1), 4–17. https://doi.org/10.1016/j.brq.2016.07.002
Chen, X., Hu, N., Wang, X., & Tang, X. (2014). Tax avoidance and firm value: Evidence from China. Nankai Business Review International, 5(1), 25–42. https://doi.org/10.1108/NBRI-10-2013-0037
Cheung, Y.-L., Jing, L., Lu, T., Rau, P. R., & Stouraitis, A. (2009). Tunneling and propping up: An analysis of related party transactions by Chinese listed companies. Pacific-Basin Finance Journal, 17(3), 372–393. https://doi.org/10.1016/j.pacfin.2008.10.001
Cheung, Y., Rau, P., & Strouraitis, A. (2006). Tunneling, propping, and expropriation: Evidence from connected party transactions in Hong Kong. Journal of Financial Economics, 82(2), 343–386. https://doi.org/10.1016/j.jfineco.2004.08.012
Fazli, A. (2019). Corporate governance, related party transactions and firm performance among family owned firms in Pakistan [PhD thesis, University of Malaya]. http://studentsrepo.um.edu.my/id/eprint/12094
Fooladi, M., & Farhadi, M. (2019). Corporate governance and detrimental related party transactions. Asian Review of Accounting, 27(2), 196–227. https://doi.org/10.1108/ARA-02-2018-0029
Freihat, F., & Razaq, A. (2019). Factors affecting price to earnings ratio (P/E): Evidence from the emerging market. Risk Governance and Control: Financial Markets and Institutions, 9(2), 47–56. https://doi.org/10.22495/rgcv9i2p4
Fuadah, L. L., & Kalsum, U. (2021). The impact of corporate social responsibility on firm value: The role of tax aggressiveness in Indonesia. Journal of Asian Finance, Economics and Business, 8(3), 209–216. https://doi.org/10.13106/jafeb.2021.vol8.no3.0209
Gaaya, S., Lakhal, N., & Lakhal, F. (2017). Does family ownership reduce corporate tax avoidance? The moderating effect of audit quality. Managerial Auditing Journal, 32(7), 731–744. https://doi.org/10.1108/MAJ-02-2017-1530
Gallemore, J., Maydew, E. L., & Thornock, J. R. (2014). The reputational costs of tax avoidance. Contemporary Accounting Research, 31(4), 1103–1133. https://doi.org/10.1111/1911-3846.12055
Hanlon, M., & Heitzman, S. (2010). A review of tax research. Journal of Accounting and Economics, 50(2–3), 127–178. https://doi.org/10.1016/j.jacceco.2010.09.002
Hendratama, T. D., & Barokah, Z. (2020). Related party transactions and firm value: The moderating role of corporate social responsibility reporting. China Journal of Accounting Research, 13(2), 223–236. https://doi.org/10.1016/j.cjar.2020.04.002
Jian, M., & Wong, T. J. (2010). Propping through related party transactions. Review of Accounting Studies, 15(1), 70–105. https://doi.org/10.1007/s11142-008-9081-4
Khaoula, F., & Moez, D. (2019). The moderating effect of the board of directors on firm value and tax planning: Evidence from European listed firms. Borsa Istanbul Review, 19(4), 331–343. https://doi.org/10.1016/j.bir.2019.07.005
Klassen, K. J., Lisowsky, P., & Mescall, D. (2017). Transfer pricing: Strategies, practices, and tax minimization. Contemporary Accounting Research, 34(1), 455–493. https://doi.org/10.1111/1911-3846.12239
Kohlbeck, M., & Mayhew, B. W. (2010). Valuation of firms that disclose related party transactions. Journal of Accounting and Public Policy, 29(2), 115–137. https://doi.org/10.1016/j.jaccpubpol.2009.10.006
Lo, A. W. Y., Wong, R. M. K., & Firth, M. (2010). Can corporate governance deter management from manipulating earnings? Evidence from related-party sales transactions in China. Journal of Corporate Finance, 16(2), 225–235. https://doi.org/10.1016/j.jcorpfin.2009.11.002
Löffler, C. (2019). Divisionalization and domestic transfer pricing for tax considerations in the multinational enterprise. Management Accounting Research, 45(November 2017), 100646. https://doi.org/10.1016/j.mar.2019.07.003
Minh Ha, N., Phuong Trang, T. T., & Vuong, P. M. (2022). Relationship between tax avoidance and institutional ownership over business cost of debt. Cogent Economics & Finance, 10(1). https://doi.org/10.1080/23322039.2022.2026005
Nekhili, M., & Cherif, M. (2011). Related parties transactions and firm’s market value: The French case. Review of Accounting and Finance, 10(3), 291–315. https://doi.org/10.1108/14757701111155806
Nugroho, W. C., & Agustia, D. (2018). Corporate governance, tax avoidance, and firm value. AFEBI Accounting Review, 2(2), 92. https://doi.org/10.47312/aar.v2i02.87
Park, S. (2018). Related party transactions and Tax avoidance of business groups. Sustainability, 10(10). https://doi.org/10.3390/su10103571
Pozzoli, M., & Venuti, M. (2014). Related party transactions and financial performance: Is there a correlation? Empirical evidence from Italian listed companies. Open Journal of Accounting, 03(1), 28–37. https://doi.org/10.4236/ojacct.2014.31004
Rathke, A. A. T., Rezende, A. J., & Watrin, C. (2020). Classification of transfer pricing systems across countries. International Economics, 164(September 2019), 151–167. https://doi.org/10.1016/j.inteco.2020.08.002
Richardson, G., Taylor, G., & Lanis, R. (2013). Determinants of transfer pricing aggressiveness: Empirical evidence from Australian firms. Journal of Contemporary Accounting and Economics, 9(2), 136–150. https://doi.org/10.1016/j.jcae.2013.06.002
Santosa, P. W. (2020a). The effect of financial performance and innovation on leverage: Evidence from Indonesian food and beverage sector. Organizations and Markets in Emerging Economies, 11(22), 367–388. https://doi.org/10.15388/omee.2020.11.38
Santosa, P. W. (2020b). The moderating role of firm size on financial characteristics and Islamic firm value at Indonesian equity market. Business: Theory and Practice, 21(1), 391–401. https://doi.org/10.3846/btp.2020.12197
Santosa, P. W., Rahayu, S. I., Simon, Z. Z., & Tambunan, M. E. (2021). The moderating role of audit quality and firm size in the effect of corporate governance on related party transactions: Evidence from Indonesia. Investment Management and Financial Innovations, 18(4), 166–176. https://doi.org/10.21511/imfi.18(4).2021.15
Santosa, P. W., Tambunan, M. E., & Kumullah, E. R. (2020). The role of moderating audit quality relationship between corporate characteristics and financial distress in the Indonesian mining sector. Investment Management and Financial Innovations, 17(2), 88–100. https://doi.org/10.21511/imfi.17(2).2020.08
Sari, D. K., Utama, S., & Rossieta, H. (2017). Tax avoidance, related party transactions, corporate governance and the corporate cash dividend policy. Journal of Indonesian Economy and Business, 32(3), 190. https://doi.org/10.22146/jieb.28658
Sayidah, N., Assagaf, A., & Possumah, B. T. (2019). Determinant of state-owned enterprises financial health: Indonesia empirical evidence. Cogent Business and Management, 6(1), 1–15. https://doi.org/10.1080/23311975.2019.1600207
Suk, K. S., Haryanto, M., & Purba, J. T. (2019). Cash holdings of business group-affiliated firms in Indonesia. DLSU Business and Economics Review, 29(1), 40–57.
Supatmi, M., Sutrisno, T., Saraswati, E., & Purnomosidhi, B. (2019). The effect of related party transactions on firm performance: the moderating role of political connection in indonesian banking. Business: Theory and Practice, 20, 81–92. https://doi.org/10.3846/btp.2019.08
Tambunan, M., Siregar, H., Manurung, A., & Priyarsono, D. (2017). Related party transactions and firm value in the business groups in the Indonesia stock exchange. Journal of Applied Finance & Banking, 7(3), 1–20. https://search.proquest.com/abicomplete/docview/1898416706/fulltextPDF/7011ACE8BAF9440BPQ/38?accountid=151027
Tariq, T. I., & Mousa, G. A. (2020). Can related party transactions be a matter for firm value? Evidence from emerging markets. In2020 International Conference on Decision Aid Sciences and Application (DASA) (pp. 258–263). IEEE. https://doi.org/10.1109/DASA51403.2020.9317048
Utama, C. A., & Utama, S. (2014). Corporate governance, size and disclosure of related party transactions, and firm value: Indonesia evidence. International Journal of Disclosure and Governance, 11(4), 341–365. https://doi.org/10.1057/jdg.2013.23
Wang, H. Da, Cho, C. C., & Lin, C. J. (2019). Related party transactions, business relatedness, and firm performance. Journal of Business Research, 101(January 2018), 411–425. https://doi.org/10.1016/j.jbusres.2019.01.066
Widadi, F. A., Subroto, B., & Rahman, A. F. (2022). Tax avoidance mediated by constitutional ownership as moderating variables. ETIKONOMI, 21(2), 411–430. https://doi.org/10.15408/etk.v21i2.25799
Wong, R. M. K., Kim, J.-B., & Lo, A. W. Y. (2015). Are related-party sales value-adding or value-destroying? Evidence from China. Journal of International Financial Management & Accounting, 26(1), 1–38. https://doi.org/10.1111/jifm.12023
Yeh, Y. H., Shu, P. G., & Su, Y. H. (2012). Related-party transactions and corporate governance: The evidence from the Taiwan stock market. Pacific Basin Finance Journal, 20(5), 755–776. https://doi.org/10.1016/j.pacfin.2012.02.003
Zimon, G., Appolloni, A., Tarighi, H., Shahmohammadi, S., & Daneshpou, E. (2021). Earnings management, related party transactions and corporate performance: The moderating role of internal control. Risks, 9(8), 146. https://doi.org/10.3390/risks9080146