Related-party transactions
Business done with people connected to the company. Usually mundane, occasionally the single most revealing disclosure in the entire annual report.
If a company leases its head office from a building owned by the chief executive's family, that is a related-party transaction. It may be on perfectly normal terms. It has to be disclosed so that you can decide.
Who counts
- Directors and senior executives, and their close family members.
- Shareholders with significant influence, and companies those shareholders control.
- Subsidiaries, associates and joint ventures.
- Pension schemes operated for the company's employees.
Disclosure requires the nature of the relationship, the amounts involved, outstanding balances, and the terms.
Why the rule exists
An ordinary commercial transaction is disciplined by two sides each pursuing their own interest. When the same person, or a connected person, sits on both sides, that discipline is absent. The price may be fair — nothing forces it to be, and nobody in the negotiation is obliged to push back.
This is why disclosures emphasise whether terms were at arm's length: on terms equivalent to those available in a transaction between unconnected parties.
What to look for
- Scale. Occasional small amounts are ordinary. Material revenue or material purchases with connected entities change how you read the income statement.
- Revenue from related parties. Sales to an entity the founder controls are not independent evidence of demand.
- Loans in either direction. Company lending to executives, or borrowing from shareholder-controlled entities, both deserve reading in full.
- Assets bought from or sold to insiders. Valuation is the entire question, and there was no adversarial negotiation to establish one.
- Complex structures — entities that exist for no evident commercial reason, especially where obligations sit outside the consolidated group.
Several of the largest accounting failures of the past three decades involved connected entities used to move obligations off the reported balance sheet or to manufacture revenue. In each case the transactions were disclosed, in the footnotes, in public filings, before the collapse. The information was available and the reading was not done.
Governance context
Most jurisdictions require material related-party transactions to be approved by independent directors, and sometimes by shareholders, with the interested party excluded. The quality of that protection depends on how independent the independent directors actually are — which the governance section of the annual report describes, and which their tenure and other directorships often describe better.
Keeping it in proportion
The overwhelming majority of these disclosures are routine: a subsidiary's intra-group trading, a director's pension contributions, a joint venture's supply agreement. The point is not to treat every entry as suspicious. It is that this short section is one of the few places where the relationships behind the numbers are set out, and reading it costs almost nothing.