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Insider Ownership, Risk, and Leverage in REITs

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Abstract

We investigate the relative importance of managerial entrenchment and incentive alignment as indicated by REIT risk-taking. The two theories make contradictory predictions about the sign of the relation between insider ownership and risk. We test for the possibility of diminishing entrenchment returns to insider ownership. Empirical results for equity and asset betas soundly reject linear models in favor of nonmonotonic relations with reversals at insider ownership of 36%. Up to that point, increasingly entrenched insiders mitigate their own risk aversion. Above 36%, incentive alignment emerges as managers become more substantial owners. Leverage declines at an accelerating rate above 20% insider ownership. Together these results suggest a shift in the composition of risk, from leverage risk to asset risk, reflecting comparative advantage and a crossover in the relative monitoring costs of debt and equity. Problematically for linear models, the coefficient of insider ownership is not significant for most risk measures, producing the misleading appearance of no relation between insider ownership and risk. Institutional ownership is significantly negatively related to leverage. Thus incentives are aligned between insiders and institutional owners at insider ownership above 20%.

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Notes

  1. See Knyazeva and John (Working paper, Simon Graduate School of Business, University of Rochester 2006), for empirical evidence on risk reduction through underinvesting and Friend and Lang (1988) for reduction through reduced leverage.

  2. See Friday et al. (1999), Capozza and Seguin (2003), Han (2006), Hartzell, Kallberg, and Liu (University of Texas working paper, 2004), Ghosh and Sirmans (2003), and Hartzell et al. (2006).

  3. Hartzell et al. (2006), page 2. See also Capozza and Seguin (2003).

  4. The market portfolio includes all non-financial stocks listed on the NYSE, AMEX or NASDAQ which are also included in the CRSP database.

  5. We also estimated models for a Herfindahl index of diversification over property types, another ex ante indicator of management risk decisions. These property type data are not available for the first half of sample period, resulting in substantially reduced degrees of freedom. Estimated on this reduced sample, none of the coefficients are statistically significant, so we omit these results below.

  6. We exclude depreciation and tangible assets from our list of control variables. Depreciation, included in other studies because depreciation is tax deductible, is inapplicable for REITs, which are not taxed at the corporate level. Also, since the vast majority of the REITs don’t have any intangible assets, we have excluded tangible assets as a control variable.

  7. (http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html).

  8. We could have eliminated all observations that didn’t have complete accounting and market data for all eight quarters. However, this would have significantly reduced the sample size for many of our tests.

  9. Our insider and institutional ownership data are drawn from the most recent filings. Our understanding from the data supplier is that asynchronous SEC filings may occasionally lead to double counting. The results below are unaffected by eliminating REITs with very high institutional ownership. However, we should point out that measurement error may bias coefficients downward toward zero and have an effect on other coefficient estimates (Greene 2008).

  10. Using STATA, for each estimation we divide the data into 30 quantiles and perform 1,000 replications. See Greene (2008) for a description of bootstrapped median regressions.

  11. For the quadratic form beta = a(insider ownership squared) + b(insider ownership) + constant, the minimum occurs where insider ownership equals −(b/2a).

  12. Schrand and Unal suggest that thrift institutions have a competitive advantage at loan origination and credit risk, but no competitive advantage as interest rate risk.

  13. The direct coefficient of Insidr, a 1 , is not statistically significant. For inferences about the asset beta, the dependent variable is unlevered in the usual manner.

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Acknowledgements

The authors are grateful for support from the Center for Real Estate and Urban Economic Analysis at the University of Connecticut.

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  1. Department of Finance, University of Connecticut, Stamford, CT, 06901-2315, USA

    Walter Dolde & John D. Knopf

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  1. Walter Dolde
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Correspondence to Walter Dolde.

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Dolde, W., Knopf, J.D. Insider Ownership, Risk, and Leverage in REITs. J Real Estate Finan Econ 41, 412–432 (2010). https://doi.org/10.1007/s11146-009-9170-6

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