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The Impact of the Sarbanes-Oxley Act on the Structure of REIT Boards of Directors

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Abstract

The changes in the board structure for REITs for the period 1999–2005 are presented. Post-SOX REIT boards have changed primarily in the form of greater independence, as fewer REIT boards are led by their CEOs due to SOX. In the relation between Post-SOX board structure and performance, the results show no improvement in performance for REITs whose boards have a majority of preferred features. That is, REITs with small boards, majority of outside directors, and not led by their CEOs do not perform better than their counterparts. These results provide additional fuel for the debate on the benefits and costs of SOX.

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Notes

  1. In accordance to the NAREIT library (available at www.nareit.com/library/industry/marketcap.cfm, accessed last time on February 1, 2010), there were 58 equity REITs with a total market capitalization of $5.5 billion as of December 1990. By December 2005, the number of equity REITs has increased to 152 with a total market capitalization of $301.4 billion.

  2. REIT charters enable management to suspend voting and dividends rights for shareholders who exceed a designated percentage (typically up to 10%) in order for the REIT to meet the five or fewer rule. (Campbell et al. 1998)

  3. Hermalin and Weisbach (1991), Mehran (1995), Klein (1998), Bhagat and Black (1998), Lehn et al. (2009) all report insignificant relations between accounting measures of performance and the proportion of outside directors on the board. However, Brickley and James (1987), Rosenstein and Wyatt (1990) and Shivdasani (1993) find a positive relation between performance and independent directors by measuring the impact of changes in the board composition of firm value. As far as the relation between board size and performance, the most significant study is conducted by Yermack (1996), who finds a negative relation between board size and a firm’s Tobin’s Q. In the case of REITs, the findings are more consistent. There is weak evidence that independent directors enhance performance, and that both the CEO leading the board and a larger board size deteriorates REIT performance (Ghosh and Sirmans 2005; Ghosh and Sirmans 2003; Friday and Sirmans 1998).

  4. The Sarbanes-Oxley Act was enacted in July 2002. In this paper, the Pre-SOX era includes years 1999, 2000, and 2001 and the Post-SOX era includes years 2003, 2004, and 2005.Year 2002 is left out to rule out confounding effects.

  5. For a comparison of NYSE corporate governance rules and details in SOX dispositions, refer to the 2003 IRRC document available at http://www.irrc.org/company/NYSE_Oxleychart.pdf last accessed on July 5th, 2008.

  6. As measured by return on assets (ROA). Both ROA and ROE are measures of operational performance. However, ROA may be preferable to ROE because ROA is not affected by leverage, extraordinary items and discretionary items and also has more desirable distributional properties than ROE (Core et al. 2006).

  7. Requiring sample firms to survive a sample period that includes a bear (2000–2003) and a bull stock market (1999 and 2004–2005) may bias the sample to better performing REITs.

  8. According to Hardin and Wu (2009), roughly one third of the total number of REITs in the 1994–2004 period were involved in a merger.

  9. Historical REIT Industry Market Capitalization: 1972–2007 available at www.nareit.com/library/industry/marketcap.cfm, accessed last time on February 1, 2010.

  10. During the data collection process, it was observed that there were more shareholder proposals included in Post-SOX proxies than in the Pre-SOX proxies. These shareholder proposals were mainly requests for annual elections for directors and a larger number of outside directors in the board. Interestingly, for all those cases read, the board of directors asked shareholders to reject such proposals.

  11. Recently, Lehn et al. (2009) find no robust relation between firm performance and either board size or percentage of outside directors sitting on the board while Faleye (2007) finds no relation between CEO duality and performance.

  12. However, they do find that governance does matter for the valuation of low-payout REITs presumably due to the opportunities that discretionary cash flows offer for mismanagement.

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Acknowledgements

The author thanks Oi Lin Cheung, Michael Highfield, Pattarake Sarajoti, and other participants at the 2007 Financial Management Association Meeting and the 2007 Southern Finance Association Meeting for helpful comments and suggestions. The author also thanks Michael Budden, Dennis Steele, and Erick Chang for their invaluable collaboration. Technical support for this project was provided by the Robert W. Warren Chair of Real Estate at Mississippi State University.

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  1. Southeastern Louisiana University, 2 Garrett Hall, College of Business, Post-Office Box 10468, Hammond, LA, 70402-0468, USA

    Magdy Noguera

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Correspondence to Magdy Noguera.

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Noguera, M. The Impact of the Sarbanes-Oxley Act on the Structure of REIT Boards of Directors. J Real Estate Finan Econ 45, 869–887 (2012). https://doi.org/10.1007/s11146-011-9303-6

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