The interplay between related party transactions and earnings management: The role of audit quality

Related Party Transactions (RPTs) are considered a potential tool for shareholder wealth expropriation as they offer opportunities to transfer wealth between the firm and related parties. While considerable evidence has reported on the negative consequences of RPTs (declines in shareholder wealth, lowered accounting quality and an increased likelihood of financial fraud), studies examining how RPTs may be used in earnings management are relatively rare. Consequently, we investigate whether RPTs are associated with real or accrual earnings management or used as a third alternative to manage reported earnings. Our study employs a sample of firms listed on the Athens Stock Exchange during the period between 2009 and 2014. Our results indicate that, on average, real earnings management and RPTs appear to be used as substitutes. However, additional tests show that this substitution is not significant if the firm is audited by one of the Big 4 auditors. Contrarily, we do not find any significant association between accrual earnings management and RPTs. Our evidence adds to understanding about the interplay between RPTs and earnings management and how audit quality can affect the relationships investigated.