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CEO Involvement in Director Selection: Implications for REIT Dividend Policy

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Abstract

This paper examines the relationship between CEO entrenchment and dividend policy of real estate investment trusts (REITs). We develop an index for CEO entrenchment using CEO tenure and duality and find that this index has significant impact on dividend policy. We further separate our sample into two sub-groups: REITs with and without nomination committees. Our analyses show a strong positive relationship between CEO entrenchment level and dividend payout for REITs without a nomination committee. In REITs with nomination committees, CEO entrenchment has less influence on dividend policy. We conclude that dividend policy serves as a substitution for other governance mechanisms. Further, our results are consistent with the evidence for other US firms—CEO that are more entrenched pay higher dividends to avoid shareholder sanctions and the threat of takeover.

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Notes

  1. Faleye (2004) discusses how cash can be used to deter or foil takeover attempts. Harford (1999) and Pinkowitz (2002) find that holding of excess cash reduces the probability of a hostile bid. Hartzell et al. (2005) find that REIT CEOs often follow their own agenda which includes pursuing negative NPV projects to enhance private benefits, greater prestige and compensation.

  2. John and Knyazeva (2006) and Harford et al. (2006) discuss anecdotal evidence on the takeover risk associated with high cash reserves. The latter provide evidence that entrenched managers dissipate cash on value-destroying acquisitions to minimize such risks.

  3. This line of reasoning implies that some entrenchment is desirable for value maximization (see Stein 1988, Knoeber 1986 and Almazan and Suarez 2003).

  4. Arguably, REIT management has little discretion in setting payout policy due to the requirement that 90% of taxable earnings must be distributed as dividends to be tax exempt. However, it is noteworthy that on average, REITs pay out only 70% of funds from operations (FFO).

  5. Unlike the ambiguous evidence on the monitoring strength of alternative disciplining mechanisms (Bhagat and Black 2002), there is compelling evidence that dividends mitigate agency costs. Rozeff (1982) demonstrates that increased dividends relative to earnings lower agency costs of external financing. Born and Rimbey (1993) find a significant relation between prior financing activity and the market response to initial dividends. Dewenter and Warther (1998) find that dividend policy announcements by Japanese firms contain less information and are more responsive to performance than those of US firms, partly because Japanese firms are subject to fewer agency conflicts.

  6. Excessive cash accumulation can be targeted by hostile suitors also, leading to lengthy fight for control. See Harford et al. (2006) for further elaboration of this point and examples of such incidents from the US capital market.

  7. Stein (1988) asserts that low cash reserves and strong governance make managers vulnerable to takeover attempts. Such vulnerability induces managers to focus on short-term goals at the cost of long-term objectives with potentially adverse effect on shareholder wealth. Protection from the takeover market refocuses managers to long-term value-maximization which enhances shareholder wealth.

  8. Several authors (i.e. Wang et al. 1993) argue that low levels of institutional ownership and analyst following exacerbate the uncertainty in REIT valuation. McDonald et al. (2000) and Downs et al. (2000) argue that despite mandatory high payout, dividend announcements of REITs contain material information. Han (2006) notes that it is difficult to determine the fair value of real property transactions which often include a wide range of heterogeneous and illiquid assets. Among authors who hold a contrary view, Gentry et al. (2003) argue that the value of a REIT is simply the aggregate fair market value of its assets. Hartzell et al. (2005) assert that REITs are easy to value due to their tangible assets and relatively transparent structure.

  9. Bradley et al. (1998) report mean dividends as a proportion of funds from operations (FFO) of 107%. Kallberg et al. (2003) report a range of 79 to 90%. Ghosh and Sirmans (2006) report average dividend payout as a proportion of FFO of around 70% for 1999 and 2000. Clearly, REIT managers have considerable discretion over dividend policy decisions. Bradley et al. (1998) and Wang et al. (1993) observe that the REIT industry may not be as unique as it appears initially, and these relations may be generalizable to a less restrictive environment as well. Downs et al. (2000) make similar observations.

  10. Recall that despite the high dividend payout set by regulation, REIT managers have considerable amount of free cash at their discretion.

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Authors and Affiliations

  1. School of Management, Union Graduate College, Schenectady, NY, 12308, USA

    Zhilan Feng

  2. Center for Real Estate and Urban Economic Studies, School of Business, University of Connecticut, Storrs, CT, 06268, USA

    Chinmoy Ghosh & C. F. Sirmans

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  1. Zhilan Feng
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  2. Chinmoy Ghosh
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  3. C. F. Sirmans
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Correspondence to Zhilan Feng.

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Feng, Z., Ghosh, C. & Sirmans, C.F. CEO Involvement in Director Selection: Implications for REIT Dividend Policy. J Real Estate Finan Econ 35, 385–410 (2007). https://doi.org/10.1007/s11146-007-9065-3

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