Self-dealing occurs when those in positions of power breach their fiduciary duty by advancing their personal interests at the expense of those they serve. This illegal act may manifest in a corporate setting in various forms of tunneling, explained below.
These are transactions that take away from the company’s cash flow. Cash-flow tunneling may take the form of transfer pricing, where senior members directly transact with the firm at off-market prices. For instance, they may take out loans at below-market interest rates or purchase firm outputs at below-market prices. When done at a large scale, cash-flow tunneling reduces the firm’s internal capital, which can hinder future profitability as inadequate money is plowed back into the business.
This form of self-dealing occurs when insiders and decision-makers in a company take out productive assets from a company for a value lesser than the market price, or they inflate the prices of productive assets invested into the company for their gain. Asset tunneling is not exclusive to tangible assets. In fact, it is even more convenient for intangible assets, such as intellectual property, since their value is more difficult to evaluate. Unlike cash-flow tunneling, which can go unnoticed when done discreetly and at a small scale, asset tunneling reduces the company’s value and can affect future performance as the removal of productive assets reduces the company’s ability to make money.
In this version of self-dealing, the major decision-makers expand their ownership claims over the company’s assets without following due procedure and often at the expense of minority shareholders. For instance, they may issue themselves shares at prices below the market, conduct insider trading and take out loans that will not be repaid but act as put options.
Why laws don’t always punish corporate self-dealing
While there are laws against corporate self-dealing, there are certain loopholes that insiders may manipulate. For instance, corporate law is lenient on related party transactions if approved through a proper process, making it possible for insiders to get away with cash tunneling if they manage to convince the board.
Disclosure rules such as securities law and accounting rules may also consider certain amounts immaterial when they do not sum up to the required threshold. Insiders can therefore get away with self-dealing if the amount is not deemed material under the various disclosure laws. Similarly, tax laws may not always be keen on asset tunneling as long as the requisite tax is paid.