Abstract
This paper studies empirically the capital structure of Turkish REITs as they offer unique and so far untested angles. They do not have to pay out dividends, yet enjoy the exemption from paying corporate taxes since their legal foundation in 1998. Several financial meltdowns occurred in the last three decades, keeping investors with a doubt about Turkey’s financial and political stability. The last meltdown in 2001 is part of the sample period. Findings show that Turkish REITs employ little long-term debt in their capital structure. The legal requirement that a leader entrepreneur be present with a minimum equity position of 25% introduces the agency problem between the majority and minority owners. The leader entrepreneurs, as non-taxable institutional investors, appear to dictate Turkish REITs’ dividend and debt policies and deplete REITs’ dividends, causing them to go to the long-term debt market. The financial meltdown of 2001 exerts negative short-term and positive long-term influence on the debt ratios while inflation’s effect is negative. Firm size, REITs’ engagement in development and stock market development influence debt ratios positively; tangibility and a few firm, ownership, and country-specific determinants appear to have either mixed or no influence on Turkish REITs’ debt policies.
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Notes
See also Bradley et al. (1984) for the 1960s–1970s and Casey et al. (2006) for recent years. It would be difficult to detect any cross-sectional differences in firms’ use of debt in the absence of mainly taxes, bankruptcy costs, and agency costs (Modigliani and Miller 1958; Miller and Modigliani 1963). Capozza and Seguin (1999, 2001) suggest that these three conditions appear to hold for REITs. Howe and Shilling (1988) state that, as a non-tax-paying enterprise, the tax gain to corporate borrowing should be negative for REITs. Jaffe (1991), however, disagrees and shows that MM’s irrelevancy position should hold for REITs.
Max Biasin informed us that Italy also does not impose any dividend payout requirement on REITs, either.
The total debt ratio, which often includes items, such as accounts payable that, may be used for transactions rather than for financing purposes, is unlikely to be a good indicator of a firm’s default risk (Rajan and Zingales 1995). However, for robustness against high inflation’s potentially hindering effects on long-term debt financing in Turkey, this paper uses both total debt and long-term debt ratios. Book value measures help to keep the financial planning of the company free of the “distortions,” caused by the volatility of market prices (Barclay et al. 1995). Further, debt issued against the market value of the call option, on a firm’s future growth opportunities (Myers 1977), can distort the future real investment decisions. Hence, managers have good reasons to subscribe to book value debt ratios. Bowman (1980) provides direct evidence that book value measures of debt are statistically indistinguishable from market-value measures of debt.
On June30, 2008, the total volume of ISE stocks was US$ 310,115 million (see www.imkb.gov.tr and www.spk.gov.tr). Turkish REITs formed, and are also members of, the Association of Turkish Real Estate Investment Trusts, known as GYODER (short in Turkish for ‘Gayrimenkul Yatirim Ortakligi Dernegi’). GYODER represents the industry’s interests and maintains close ties with the European Public Real Estate Association (EPRA), NAREIT and all other relevant parties in Turkey and the World.
External equity has the highest cost, arising mainly from the asymmetric information for the firm value between managers and the investors as well as relatively high costs for equity issuance and compliance. Further, use of internal equity reduces a firm’s reliance on borrowing and, hence, its financial distress costs. The cost of debt for this firm should be cheaper than its external equity financing. In the pecking order, the tax benefits of debt financing also render debt financing cheaper than external equity. Since REITs’ cost of debt is not reduced by the tax deductibility of interest expense payments in Turkey, whether debt financing would be cheaper than external equity is not clear and remains an open empirical issue. Recent evidence is mixed. See Fama and French (2002) (Helwege and Liang 1996; Frank and Goyal 2003) for supportive (unsupportive) evidence, respectively.
There were only eight REITs in 2000. Five of them—IS REIT, Yapi Kredi Koray REIT, Garanti REIT, Vakif REIT and Atakule REIT—have been owned by Turkish commercial banks since at least 2000. Others also have strong ownership ties to their parent companies. Yurtoglu (2000) and Gonenc (2003) empirically show that ownership in the Turkish industrial firms is highly concentrated and that most of them have five (or few) large shareholders with at least 50% of the outstanding equity shares.
Leader entrepreneurs constitute almost always all institutional investors in this paper’s data. Other institutional investors’ incentives for monitoring are totally consistent with those of leader entreprenuers. The leader entrepreneur at the helm of a REIT—directly or indirectly via a right-hand manager—introduces the agency problem between the majority and minority equity-holders. There are very interesting research issues here; but these are beyond the scope of this paper. (See: Conference on Concentrated Ownership. (2005). http://www.cebr.dk/Events%20submenu/2005/Spring/Conference%20june%202005%20CorpGoV/Sider%20der%20linkes%20til/Programme.aspx).
Allen et al. (2005) point out that reputation and private relations between owners of private firms and their stakeholders, in particular creditors, play an important role for managerial self-discipline and bonding in China. Bhabra et al. (2008) offer evidence for the relevance of these non-formalized factors in China.
From the perspective of any REIT shareholder, receiving dividends would make sense if and when they face investment opportunities with a better risk-return combination than that on the REITs’ projects. Ordinary REIT shareholders in Turkey pay, without much delay after the dividend payment, ordinary income tax on the dividends received. Hence, REIT shareholders in Turkey should express, on average, a preference for receiving as little dividends as possible. These shareholders have incentives to let the REITs engage in investments, which would offer them long-term tax-favorable capital gains opportunities. Hence, there is very likely to be a divergence in incentives between concentrated owners and ordinary investors (see footnote 6).
The Fisher (1930) equation suggests a compensation for the expected inflation; a lack of proper compensation for the expected inflation will have adverse effects on the value of debt securities. Debt contracting under high and moderate inflation economies is difficult as the assessment of the expected inflation rate is not an easy task.
During the high inflation period in Turkey, there were episodes of ‘escaping from money’ to confront the decline in the purchasing power. The foreign debt obligation was, and still is, heavy. Fiscal discipline until recent years was very difficult to implement. Several governments introduced reforms to combat inflation and its effects over the years. These reforms were largely ineffective as the political structure and the will to enforce them were not bundled sufficiently tightly with the reforms. While Turkey has had a relatively successful and well-established banking system, several spectacular bank failures have occurred, especially, during the high inflation period.
The early-1980s witnessed a period of proliferation of so-called bankers, who were sometimes even teenagers without any banking know-how and any capital to run a private bankers’ business. These bankers constructed Ponzi schemes by promising interest rates beyond anyone’s imagination, collected large sums of deposits from a naive public, and then disappeared from country. In 1994, there was one major crisis, triggered by the lack of confidence in the government's budget deficit target and downgrading in Turkey’s credibility by the credit-rating agencies. This crisis resulted in large-scale capital flight and the collapse of the exchange rate (“Economic History of Turkey”, The Country Studies, Federal Research Division of the Library of Congress, USA).
Some aspects of the political reform agenda of this government have themselves become recently a source of major political instability in Turkey. It is still in power, holds all the key political posts, including the Presidency, and even enjoys a larger majority in the Parliament than when it was elected for the first time.
This figure includes the six months when foreign purchases were impossible because of a gap in the law. The more realistic figure might have been around $3–4 billion (IBS Research and Consultancy, 2006).
Gonenc (2003) reports that results for profitability, size, and asset tangibility are consistent with those for the developed and developing countries; that there exist a positive relation between debt ratios and growth opportunities; that firms with high equity ownership of financial institutions and of the government use less debt; and that there exist a significant positive relation between stock market activities and debt levels. Booth et al. (2001) report a positive but insignificant coefficient estimate for the log of sales for Turkey.
They offer two reasons. First, there exist fixed costs to run a REIT. If the REIT is small, these costs outweigh benefits of debt in its capital structure. As a result, only larger REITs would benefit from having significant debt. Second, the firm size, through diversification, can affect the capital structure and reduce bankruptcy costs. If larger REITs have a greater number of properties under management and the cash flows from these properties are less than perfectly correlated, then larger REITs should have less volatile cash flows. They will be in a position to both obtain debt cheaper than small REIT do and employ a greater proportion of debt.
Feng et al. (2007) find a negative significant estimate for tangibility.
Tobin’s q, defined empirically as the ratio of the sum of (1) the market value of equity, (2) current liabilities net of current assets, and (3) the book value of long-term debt to the book value of the sample firms’ total assets, is probably a more appropriate proxy to measure a firm’s growth option. Data limitations lead this paper to incorporate the M/B ratio as a proxy. This ratio is closely related to Tobin’s q anyway.
Rajan and Zingales (1995) note that countries with diffused ownership, such as the US, UK, and Canada, have a much more active market for corporate control while countries with more concentrated ownership, such as Japan and Germany, do not have a significant market for corporate control. Extant literature indicates that informed debt capital, mainly bank lending, is short-term while uninformed debt capital, mainly lending by pension funds or insurance companies, is usually long-term and publicly funded. In the US, the long-term public debt market was 207.3% of the GDP at the end of 2002. The primary owners were uninformed investors. Demirguc-Kunt and Maksimovic (1999) show that especially small firms in emerging countries obtain largely short-term debt.
Demirguc-Kunt and Maksimovic (1999) state: “Knowing the country of origin is more important than knowing the size of all the independent variables for both the total and long-term book-debt ratios”. Rajan and Zingales (1995) find results for G-7 countries are consistent with those for USA and indicate that institutional differences among the G-7 countries arise mainly from differences in tax code, bankruptcy laws, state of development of bond markets, pattern of ownership, and market- or bank-oriented countries. See also Wald (1999).
The total value of a REIT portfolio is equal to the total appraised value of (i) buildings, (ii) land, (iii) development projects, and value of liquid assets at time t. The market capitalization is the number of shares outstanding multiplied by price per share on that day. Since there are currently only a few REITs in Turkey, information on sector-based division, such as hotel REITs or apartment REITs, is not available at this time.
It was listed on ISE in April 2005 and has one asset, “the Akmerkez Complex” with 246 shops and several office spaces and a location in the highest income neighborhood in Istanbul and Turkey, in its portfolio.
The OLS results (available upon request) are overall consistent with those reported in the paper.
We thank both an anonymous referee and Desmond Tsang (one of the two referees), who suggested that we include dividends in our estimations. Turkish REITs pay dividends annually; therefore, estimations with annual data would reduce the sample size by half. Re-estimations use semi-annualized dividends to keep the sample size constant. Estimates for dividend payout ratio, defined as annual dividends / annual net income, across all (six) LTD (TD) models are negative and significant at 1%. Seven out of eight estimates for profitability are positive, but only two, those under Model 2 (i.e., with ownership variables) for LTD1 and LTD2, are significant at 10% and 5%, respectively. All M/B estimates for LTD ratios are positive and attain higher significance than those reported in Tables 7 and 8 while all estimates for the development indicator variable are positive but only one remains significant. All other results remain fundamentally and qualitatively the same as those (both for TD and LTD) in Tables 7 and 8 of the paper. Results for dividends and profitability provide robustness for the conclusions of this sub-section. These results are available from the authors upon request.
Results on exchange rate, as a proxy for financial crisis, are negative across all debt measures and significant for LTD1 and LTD2; results for GDP growth rate are also negative but insignificant across all debt measures. These proxies confine us to the overall effect of the financial crisis and fail to produce information about its unfolding effects over time. We thank Desmond Tsang for his comments on this matter.
We thank Desmond Tsang who suggested that tangibility might be capturing the life cycle of sample firms, rather than the collateral role, given that they were new public firms, needed asset acquisitions.
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Acknowledgment
We are grateful to James D. Shilling for his invitation to participate in the REIT Symposium at DePaul University, October 2008. We thank Desmond Tsang for his constructive discussion/referee comments at the REIT Symposium, an anonymous referee for highly relevant and constructive points, Burak Yildirim for his excellent research assistance, Gozde Altinsoy for her clarifications on data, Bob Edelstein, James D. Shilling, and Jean Canil for their detailed comments, and the feedback of all participants at the January 2009 Homer Hoyt Advanced Real Estate Studies Institute meeting in Florida. All remaining errors are ours.
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Erol, I., Tirtiroglu, D. Concentrated Ownership, No Dividend Payout Requirement and Capital Structure of REITs: Evidence from Turkey. J Real Estate Finan Econ 43, 174–204 (2011). https://doi.org/10.1007/s11146-010-9242-7
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DOI: https://doi.org/10.1007/s11146-010-9242-7