Corporate Governance, Institutional Ownership and their Effect on Financial Performance; Evidence from U.S. Equity REITs by A.shkreta

Corporate Governance, Institutional Ownership and their Effect on Financial Performance: Evidence from US Equity REITs

Supervised by: Prof. Dr. Joseph McCahery

Prepared by: Alfio Shkreta

Relevance Summary Statistics

Variable Average Median S.D. Low Value High Value Skewness

BRDSIZE 8.28 8.00 1.74 5.00 13.00 0.13NMOUTSIDER 7.11 7.00 1.67 4.00 11.00 0.21PCTOUTSIDER 85.50% 87.50% 6.21% 62.50% 100.00% -1.24TENUREBRD 9.74 9.00 3.90 2.00 24.00 0.79WOMENBRD 0.79 1.00 0.85 3.00 3.00 0.83TENUREWOMEN 5.38 4.00 5.27 0.00 19.00 1.16STGRDBRD 0.30 0.00 0.46 0.91

CEO_AGE 55.90 56.00 8.31 34.00 81.00 0.42CEO_TENURE 8.92 8.00 6.13 0.00 26.00 0.55CEO_CHAIRMAN 0.39 0.00 0.50 0.46CEO_FOUNDER 0.10 0.00 0.31 2.62CEO_CHAIRMAN_FOUNDER 0.08 0.00 0.27 3.24

ROAA 2.01% 2.01% 3.04% -4.89% 14.62% 1.01ROAE 4.59% 5.72% 13.11% -50.51% 85.59% 1.34MARKETCAP 2,847.2 1,585.6 4083.92565 12.3 27,319.8 3.20TD/TA 0.53% 0.56% 0.19% 0.00% 1.11% -0.49

INSIDER_OWN 7.56% 2.29% 0.12 0.25% 64.20% 2.82INSTITUT_OWN 32.30% 34.75% 0.11 0.00% 49.56% -1.22

Build - up

Study sample: 105 U.S. Equity Real Estate Investment Trusts (REITs)Time frame: 2007 - 2012

Hand collected data SNL Database Annual Reports

Literature review Corporate Governance Institutional Ownership

Methodology Univariate regression Multivariate regression Pooled OLS regression

Two main findings

1- Corporate governance and the inclusion of women in the board of directors have a positive and statistically significant impact on firm performance

2- Institutional ownership, in levels between 30% and 50%, is associated with higher financial returns, both in terms of ROA and ROE

Literature review – Corporate Governance

Positive Effect Negative Effect

Bauer et al (2009) used a sample of 5000 U.S. companies and found strong and positive relation between corporate governance and financial performance

Gompers et al (2003) concluded that a qualitative corporate governance environment would lead to shareholder wealth maximization. Core et al (2006) conducted a similar research and reached the same conclusion

Feng et al (2005) constructed a corporate governance using as inputs the size of the board, the presence of outside directors and CEO duality. The result showed that high corporate governance scores are associated with 5-year higher returns on assets

Nielsen and Huse (2010) acknowledge the positive effect of women presence in the board of directors on financial performance of entities. Rose (2007) confirms the findings

Sirmans (1998) reports a positive relationship between the performance of the entity and a large independent director representation

Eisenberg et al (1998) concluded that firms with small boards have better financial ratios and present a stronger monitoring to Chief Executive Officers

Bauer et al (2009) constructed a sub-category out of their sample of 5000 U.S. firms composed out of REITs. They concluded that corporate governance does not have any effect on this form of entity, in terms of financial performance

Hermalin and Weisbach (2003) concluded that there is little to suggest that board composition has any cross-sectional relationship with firm performance

Jensen (1993) found that the presence of large boards, even independent composed ones, suffer from the lack of cohesiveness and coordination. The notion of the a large board being less effective in monitoring management was proved by Campbell et al (2009)

Bhagat and Black (2002) conducted a research that stretches from the early 1980s to the beginning of the early 200s. They concluded that the impact of the board of directors on performance is anything but resolved

Feng et al (2005) argue that the presence of outside directors has a weak impact on firm performance

Ghosh and Sirmans (2003) bring further evidence of a weal relation between the presence of independent directors, block ownership and financial performance

Literature review – Institutional Ownership

Positive Effect Negative Effect

Chan et al (1998) documented that institutional investors have invested more in REITs that they have in any other type of stock and the impact has been positive on firm performance

Shleifer and Vishny (1986) recognized the greater incentives that institutional investors have to monitor the management because the investment of the former is much more lager

Grossman and Hart (1980) were among the first to argue that monitoring costs are a crucial aspect of investment decisions and institutional investors are adequately equipped to recoup such investments

Nesbitt (1994) and Smith (1996) have tested the effect of institutional ownership on firm performance and have concluded that constant monitoring will limit managers ability to engage in deviant behavior

McConnell and Servaes (1990) tested the effect of institutional ownership and firm performance and found a positive relation as measured by the Tobin’s Q

According to Ling and Ryngaert (1997) the presence of institutional holders would facilitate takeovers and also the reputational benefits would facilitate entry in the capital markets, ultimately lowering borrowing costs

Graves and Waddock (1994) found in their study that an increase in the level of institutional ownership has resulted in a decline in the performance of American companies

Maug (1998) argue that monitoring and enforceability from institutional holders will be proportional to the size of shares they control. That could lead to a decrease in the marketability of shares and lower valuations

Coffee (1991) and Demirag (1998) concluded that institutional investors will engage in buy – sell strategies if they are profitable and will not engage in proper monitoring

Agrawal and Knoeber (1996) and Faccio and Lasfer (2000) could not find any significant relation between the performance of companies and the presence of institutional holders

REIT Requirements

5 – 50 Rule: No more than 100 individuals / institutions can own more than 50% of the outstanding shares of a REIT

Ownership test: A REIT must have at least 100 different owners of its outstanding shares

Hypotheses

Hypothesis I

Because the literature has no consensus on the effect of corporate governance I will develop a Corporate Governance Index where I will include a variable capturing the presence of women in the Board of Directors. This topic has not been researched in the context of REITs and to my knowledge this is the first attempt to do so

Hypothesis II

I will test the effect of institutional ownership in the financial performance of Real Estate Investment Trusts. The institutional ownership level will not be taken at absolute level but I will concentrate to the top 10 institutional holders

Univariate Regression

The Effects of CG on Financial Performance

Corporate Governance Index Staggered Board CEO Entrenchment Women on Board of Directors

3 Groups

Results as measured by ROAA CG – Index = 3 3.17% CG – Index = 2 1.98% CG – Index = 1 1.47%

Women on BoD

CG - Index ROAE

ROAA

Univariate Regression

Institutional Ownership and Financial Performance

3 Groups IO > 50% IO > 30% & < 50% IO < 30%

The reasons to do so: It has never been done before To capture the difference between effective control and pure

control

Results as measured by ROAA Group 1 n/a Group 2 2.51% Group 3 1.16%

More Data

For the year 2012 leads to this results

ROAA Group 1

1.78% Group 2

3.32% Group 3

2.91%

ROAE Group 1

5.34% Group 2

8.30% Group 3

6.65%Institutional Ownership ROAE

Multivariate Regression

The Effects of CG on Financial Performance

Board Size Small boards are more effective in monitoring the CEO,

appointing and/or removing the CEO and deliver better financial performance as measured by ROA and Tobin’s Q

CEO Tenure Longer staying CEO influence BoD decision making Undermine its independence

Insider Ownership Alignment of interest and elimination of principal-agent

problems Health rates of 5% lead to positive financial performance

Corporate Governance Index Better governed REITs will result in higher ROA

More Data

Correlation ROAA CEO_TENURE CEO_CGINDEX INSTITUTOWN BRDSIZE

ROAA 1.00CEO_TENURE 0.23 1.00CEO_CGINDEX -0.02 -0.38 1.00INSTITUT_OWN 0.20 0.14 0.00 1.00BRDSIZE -0.12 0.00 0.03 -0.04 1.00

Control variables Market capitalization TD/TA

2007 2008 2009 2010 2011 2012

BRDSIZE (-0.34) (-0.72)* 0.39 (-0.93)* (-1.26)** (-1.56)***0.52 0.42 0.62 0.56 0.61 0.46

CEO_TENURE 0.09 (0.19)* 0.03 0.13 0.10 0.020.11 0.11 0.17 0.15 0.14 0.15

CG-INDEX (0.18)* -0.26 (0.24)* (0.33)* (0.30)* (0.24)*0.10 0.24 0.15 0.18 0.20 0.14

INSIDER_OWN 0.06 0.04 (0.25)*** 0.33 0.06 (0.2)*0.08 0.08 0.10 0.12*** 0.12 0.11

Nr. of Obs 89 89 89 89 89 89 R-Squared 0.30 0.30 0.28 0.27 0.33 0.34

Pooled OLS Regression

CG – Index Excluded Results

Women on BoD Statistically significant Low standard errors Positive effect on

financial performance

Institutional Ownership Statistically significant High standard errors

for ROAE Positive impact on

financial performance

Corporate Governance Index Statistically significant Low standard errors Positive impact on

financial performance

CG – Index Included

ROAA t-statistic ROAE t-statistic

CG-INDEX (0.92)*** 3.75 (3.29)*** 3.440.24 0.95

CEO_TENURE 0.04 0.82 0.06 0.510.04 0.11

INSTITUT_OWN (2,86)** 1.93 (17.43)*** 2.451.48 7.10

INSIDER_OWN -1.03 -0.29 -0.74 -0.043.56 16.96

BRDSIZE 0.11 0.18 1.80 1.190.04 1.34

TENUREBRD (0.51)*** 5.36 (1.91)*** 4.480.09 0.42

NMOUTSIDER -0.51 -1.25 (-2.61)* -1.880.35 1.39

D_2007 0.55 -1.14 -1.88 -0.601.11 3.11

D_2008 1.21 -1.21 -1.74 -0.581.02 2.97

D_2009 -1.19 -1.23 -1.59 -0.570.97 2.81

D_2010 -1.31 -1.58 -2.55 -1.020.73 2.50

D_2011 -0.71 -0.97 -2.70 -1.140.63 2.38

Nr. of Obs 404 404 R-Squared 0.37 0.41

Wrapping up

Robustness Main Findings

For every regression where ROAA used as an independent variable, ROAE was tested. No difference in terms of positive/negative effect

Tobin’s Q was used an independent variable. The results very similar to the ones of the ROAA

Dividend Payout Ratio and Free Funds from Operation were included as control variables in both the multivariate and OLS Pooled Regression. Statistically no significant change in results

Corporate Governance has a positive impact on performance The strongest impact comes from the inclusion of women in the BoD The presence of a classified board is positively related with financial performance CEO duality has no significant impact on ROAA or ROAE

On average the increase in term of the CG-Index with 1 point leads to an improvement of Returns on Assets equal to 0.30% on a yearly basis

The presence of institutional ownership has a positive impact on financial performance REITs where the top 10 institutional owners control between 30% and 50% of the

outstanding stock will result in return on assets increasing with nearly 2.50% but the standard error stands around 1.50% for this variable

Suggestions

Further research must be conducted to capture the effect of Women in the financial performance of Real Estate Investment Trusts

The data for the institutional ownership was limited to only 4 years. Having a larger time-frame could present a more detailed effect of this variable on the financial performance of REITs

This research would have not been anchored successfully without the unconditional help and support of Prof. Dr. Joseph McCahery. His advice and his support have been the funding stone of this paper. The data was made available by Dr. Nils Kok. Throughout the building process and the finalizing phase his insights were of great value in terms of helping tackle the research question from a new and untapped angle. The entire GRESB team was simply amazing in creating the perfect working environment and backing me up in this lengthy process. My dear friends, Alban, Daniel, Diedrik, Mert, Stasia and Orkhan, proved to be tremendously crucial as they helped to ensure that the robustness of the research is unchallengeable and reviewed the paper from cover to back to assure its uniqueness. Thank you!