As defined by the Legal Dictionary, self-dealing is:

the conduct of a trustee, an attorney, or other fiduciary that consists of taking advantage of his or her position in a transaction and acting for his or her own interests rather than for the interests of the beneficiaries of the trust or the interests of his or her clients.[1]

Self-dealing transactions do not necessarily result in damage to the corporation (Enriques, 2000, p. 299). By definition, however, they cause harm to the corporation when they are unfair. Self-dealing transactions are unfair when:

the[ir] outcome . . . is less advantageous [to the corporation] than the outcome would have been if the transaction had been agreed to, on [the corporation’s] behalf, by a rational, well-informed decision maker who was independent and loyal, that is, not affected by a conflict of interest (Clark, 1986, p. 149).

Enriques (2000, p. 299) states that a self-dealing transaction exists where “a transaction, other than that concerning directors’ compensation occur: (a) between the corporation and a director, or (b) between the corporation and another person, whenever a director has a “personal interest in the welfare of the other person involved in the transaction, or in certain collatteral consequences of the transaction” (Clark, 1986), or (c) between another entity whose welfare affects that of the corporation (e.g., because the latter has a controlling interest in the former) and a director or another person, as identified immediately above” (p. 299).

The emphasis on self-dealing in the literature is reflected in both theoretically and empirically based research. The momentum of many of these studies was the work of Djankov et al. (2008), who addressed the self-dealing as broadly meaning for any action of investor expropriation by managers, controlling shareholders, or both to realise private benefit of control through using their power to divert corporate wealth to themselves rather than sharing it with the other investors. In a similar manner, Hanouna et al. (2001) incorporate the different types of expropriation, even those which occur through dilution in the domain of self-dealing. They state that self-dealing occurs when a controlling shareholder uses his power over corporate management in ways that benefit them at the expense of minority shareholders. In closely-held corporations, perhaps the most common variety of self-dealing occurs when the controlling shareholder causes the corporation to employ him at a salary in excess of his productive contribution to the company. His excessive salary reduces corporate earnings to which minority shareholders have pro rata claims but at no loss to the control shareholder.

Another form of self-dealing involves ‘looting’ activities whereby controlling shareholders withdraw assets from the corporation either without paying anything for them or by paying less than fair market value. According to Hanouna et al. (2001), self-dealing also encompasses “freeze-out” and “squeeze-out” activities, whereby the controlling shareholders use fundamental corporate changes such as recapitalizations and mergers to actually increase their pro rata claims to income and assets and reduce the pro rata claims of minority shareholders.

Atanasov et al. (2008a) divide self-dealing transaction as defined by Johnson et al. (2000b) into two types: asset tunnelling and cash flow tunnelling. Cash flow tunnelling can be loosely defined as self-dealing transactions which divert what would otherwise be operating cash flow from the firm to insiders. From other side, asset tunnelling involves self-dealing transactions which either remove significant productive assets from the firm for less than fair value to the benefit of the controlling shareholder and/or manager (tunnelling “out”); or add overpriced assets to the firm (tunnelling “in”).

According to Atanasov et al. (2008a), the reasons for such separations have been highlighted as follows: firstly, tunnelling out of assets diverts all future cash flows associated with the asset in a single transaction. In contrast, diverting cash flows is an ongoing process, which can be modified in the future. Secondly, the extent that there is synergy between different aspects of a firm’s business; diverting productive assets may reduce the value of the firm’s remaining assets.

Following the 2002 corporate scandals, the U.S. Department of Justice issued a three-part formal definition which describes the illegal activities that encompass corporate fraud, which include: Accounting Fraud, Self-Dealing by Corporate Insiders, and Obstructive Conduct.



Table 3: Examples of Cash Flow and Asset Tunnelling


Transaction Type


Panel A: Cash Flow Tunnelling  
Transfer Pricing


– Overcharging for inputs.

– Undercharging for outputs.


Executive compensation – Excessive cash compensation.

– Excessive “perks”.


Other payments to insiders – Excessive payments for services

– Loans at below market interest rates.


Panel B: Asset Tunnelling  
Transactions involving tangible assets (often

within property, plant, and equipment (PPE))


– Sales of assets to related parties at discount.

– Granting use of PPE to related party at reduced rent/lease.

– Selling long-term assets to company at inflated prices.


Transactions involving intangible assets


– Providing trade secrets and other intellectual property to related parties for below fair value.

– Acquiring intellectual property from related parties for more than fair value.


Investments in affiliates – Equity investments in affiliates

– Loans to affiliates

– Diverting business opportunities to related parties


Source: Atanasov et al. (2008a)

The self- dealing activities include: (a) insider trading, (b) kickbacks, (c) misuse of corporate property for personal gain ( embezzlement, self-dealing transactions), or (d) individual tax violations related to the self-dealing.[2] Thus, self-dealing often finds its particular expression in everyday corporate actions and deals between corporations and their controlling parties, subsidiaries, directors, corporate officers, or any other entity in which shareholders may have an interest (Goshen, 2003, p 2).  Corporate self-dealing has often found itself the headlines of many news reports.  Classic cases being $51.8 million skimmed by Conrad Black, former chair and chief executive officer of publishing giant Hollinger International who was indicted in 2005. In the same year, the U.S. Securities and Exchange Commission accused the controlling shareholder of Mexico’s TV Azteca of engaging in an undisclosed debt transaction that netted him a $109 million personal profit. Similarly, in 2002, Merrill Lynch, one of the world’s biggest brokerage firms, agreed to pay $100 million to settle a case brought by the New York attorney general, Eliot Spitzer, accusing Merrill Lynch of defrauding retail brokerage customers by issuing misleading “buy” recommendations on over two dozen stocks.

Silanes et al. (2003) examines the benefits of related lending (bank loans to firms controlled by the bank’s owners). Using a dataset for Mexico, they find that related lending is prevalent (20 per cent of commercial loans) and takes place on better terms than arm’s-length lending (annual interest rates are 4 per cent points lower). Related loans are 33 per cent more likely to default and, when they do, have lower recovery rates (30 per cent less) than unrelated ones.

Boyko et al. (1998) find that the Russian Federation management could divert funds so successfully that privatised assets sold at a 99 per cent discount relative to Western counterparts in the late 1990s. Fedorov (2000) presents three Case Studies on abusive self-dealing: the first was on OAO NK YUKOS, the second-largest producer and the largest processor of oil in Russia; the second was OAO Vyksa Steel Works; and the third was on restructuring the Sibur Holding Company and actions of a group of shareholders of OAO Sibneftegazpererabotka (SNGP).

Russia accelerated the self-dealing process in the 1990s via the mass privatization of its largest enterprises, which was carried out cheaply by crooks who transferred their skimming talents to the enterprises they acquired, and used their wealth to further corrupt the government and block reforms that might constrain their actions. Similarly, widespread self-dealing drove the Czech Republic into recession in 1997 and 1998, while neighbouring Poland and Hungary, which were slower in privatising large firms, but built better controls on self-dealing, and continued to expand (Black et al., 2000).

In Italy, Zingales (1994) presents the self-dealing case of Italian firm IRI. In 1992, IRI sold its 83 per cent stake in software firm Finsiel to telecommunication firm STET, in which IRI had acquired 53 per cent. As the controller of both Finsiel and STET, IRI was in a position to set the terms of trade as it liked. Because of its larger stake in Finsiel, the deal was priced by IRI at large premium to the market values of similar firms, which in turn benefited IRI on the expense of STET’s Minority shareholders. Similarly, Bianco et al. (1997) reveals opportunities for the controlling shareholder in companies with a pyramidal structure to transfer resources across the subsidiaries, thus reducing the incentives for potential outside equity finance. In India, Bertrand et al. (2002) examine self-dealing activities between firms in Indian business groups by tracing the propagation of earnings shocks from group firms where the controlling shareholders have low cash flow rights to firms where they hold high cash flow rights. They find significant amounts of self-dealing, mostly via non-operating components of profits, such as miscellaneous and nonrecurring items.

The above discussion indicates that self-dealing transactions are the most prevailing and harmful form of minority shareholders expropriation. In the previous sections we discussed how the separation of control from ownership is associated with expropriation of minority shareholders by controlling shareholders. The discussion also showed how researchers had attempted to measure the extent of PBC and the relating difficulties. Moreover, a reasonable amount of evidences on such expropriation was presented. This chapter concludes by introducing corporate governance as a system tackling the detachment between ownership and control, and hence, opens the gates for the next chapter on the role of legal systems to prevent this expropriation and to develop financial markets as a major mechanism for corporate governance.

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