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Information Asymmetry and Corporate Liquidity Management: Evidence from Real Estate Investment Trusts

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Abstract

We examine the impact of information asymmetry on a firm’s choice between cash and credit lines for corporate liquidity management using a panel data set from real estate investment trusts (REITs). Information asymmetry, as measured by analyst forecast error and dispersion, is negatively related to the use of lines of credit. Specifically, firms with more severe information asymmetry are less likely to have access to bank credit lines. Concurrently, more transparent firms are more likely to utilize bank credit lines as opposed to cash for liquidity management. The results are robust to alternative information asymmetry proxies and specifications. These findings suggest that information asymmetry plays an important role in corporate liquidity management.

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Fig. 1
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Notes

  1. 1.

    Faulkender and Petersen (2006) suggest that banks and lending relationships can partially mitigate capital market frictions, but it is unlikely that these distortions are eliminated completely. Sufi (2007) shows that loan structure with lead bank(s) and borrower reputation cannot eliminate information asymmetry problems and information symmetry can affect prices in the syndicated loan market. Sufi (2009a) suggests that bank credit lines are a viable liquidity substitute only for firms that maintain high cash flow. Moreover, Sufi (2009b) shows the introduction of bank loan ratings reduces information asymmetry in the syndicated loan market.

  2. 2.

    Sufi (2009a) uses firm age, an indicator variable for whether the firm’s equity trades only over the counter, and an indicator for whether the firm is not included in one of the main S&P indices to measure information asymmetry.

  3. 3.

    There are two major types of REITs: equity REITs and mortgage REITs. In this paper, we focus on equity REITs. Equity REITs are public operating firms that are mainly engaged in the development, acquisition, management, and sale of real estate assets. Mortgage REITs invest in a variety of mortgage products, consisting of lending, buying and selling mortgage backed securities, and loan servicing.

  4. 4.

    The 90% dividend payout requirement is based on taxable income. As REITs often have a large amount of depreciation, which is a non-cash flow item, the taxable income of a REIT is typically much lower than its actual cash flows. Funds From Operations (FFO) measures operating cash flow and is often used to measure REIT performance. Note that the dividend payout requirement was 95% before 2001.

  5. 5.

    UPREITs refer to umbrella partnership real estate investment trusts. The UPREIT structure was created in 1992 to avoid recognition of taxable income on the transfer of real properties to a REIT. In a typical UPREIT structure, one or more individuals and partnerships owning real estate contribute their holdings to an “umbrella partnership” in exchange for limited partnership units. A REIT is formed and issues shares to the public. The REIT serves as a general partner and is responsible for property management and investment. The limited partners receive rights to “put” their partnership interest to the umbrella partnership or to the REIT in exchange for cash or REIT shares.

  6. 6.

    Banks attempt to match loans with the typical term of the asset that support this credit extension. For instance, sound banking practices would have plant and equipment investment financed with long-term debt and equity (permanent capital). However, a major departure from strict adherence to this model can be seen in the current financial crisis as a number of commercial and investment banks are stuck with short-term commercial real estate loans financing long-term projects. The situation is exacerbated by some of these lenders’ not underwriting these credits based on long-term project cash flows and the cost of longer term debt.

  7. 7.

    The authors recognize the existence of data constraints, but that does not reduce the limitations these constraints create.

  8. 8.

    Many revolving debt facilities are termed “commercial paper back up lines” within the commercial banking community, so these results are not unexpected. In essence, firms obtain these credit facilities to reduce liquidity management risks and pay fees for these facilities accordingly.

  9. 9.

    The earlier theoretic literature focuses on relationship-driven bank loans, where an informed lender retains the entire loan. Most of recent bank loans are syndicated loans. In the syndicated loan market, firms with limited public information require monitoring by an “informed” lender before uninformed lenders invest in the firm. However, the efforts of an informed lender are unobservable. Hence, Information asymmetry due to moral hazard cannot be eliminated by lead banks or borrowers’ reputation (Sufi (2007)).

  10. 10.

    Separate regressions are run using the original data to check for robustness. The results are not sensitive to these alternative data treatment procedures.

  11. 11.

    The credit lines (used, unused, and total available) as a percentage of book assets are not tabulated since they are not included in the regressions.

  12. 12.

    Table 1 shows the mean of NbrAnal is 1.435, at which the number of analysts is 3.2.

  13. 13.

    The results are similar using Dispersion scaled by stock price.

  14. 14.

    To address the potential selection-bias issue, we also conduct estimation using a Heckman two-stage procedure. The results are qualitatively similar.

  15. 15.

    When the random-effect model is used, the estimated coefficient of ResidualD is statistically significant with Total as the dependent variable.

  16. 16.

    Following Jones (1991) and An et al. (2010), we calculate discretionary accruals as a measure of information asymmetry. Our results are also consistent.

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Correspondence to Heng An.

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An, H., Hardin, W. & Wu, Z. Information Asymmetry and Corporate Liquidity Management: Evidence from Real Estate Investment Trusts. J Real Estate Finan Econ 45, 678–704 (2012). https://doi.org/10.1007/s11146-010-9284-x

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Keywords

  • Information asymmetry
  • Liquidity management
  • REITs

JEL Classifications

  • G21
  • G32