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Dividends, Values and Agency Costs in REITs

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Abstract

This study examines the market value of REIT dividends conditional on transparency of operating structure and effectiveness of boards. Results suggest that total, mandatory and discretionary dividends are valued by the market. Consistent with agency cost theory, results provide some evidence that discretionary dividends paid by REITs with greater principal-agent conflicts have greater market value. Specific results suggest an increased value of excess dividends paid by firms with more complex organizational structures (UPREITs) and, to some degree, less independent boards. This evidence implies the equity market recognizes REITs’ substitution of discretionary dividends for stronger governance.

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Notes

  1. A REIT must meet three other provisions, in addition to the dividend payout restriction, to maintain their tax-preferenced status. First, five-or-fewer shareholders may not hold more than 50 percent of the REIT’s stock. Second, at least 75 percent of the total assets of the REIT must consist of real estate, mortgages, cash, or federal government securities, and a minimum of 75 percent of the REIT’s gross annual income must be derived from the ownership of real estate properties. Last, REITs must derive their income from passive sources such as rents and mortgage interest and not from the short-term trading or sale of property assets.

  2. Bradley et al. (1998), Ghosh and Sirmans (2006), Feng et al. (2007) show that REIT dividends are greater than taxable income. Downs et al. (2000), Hardin and Hill (2008), Boudry (2010, and Roark (2010) explicitly examine REIT discretionary dividends.

  3. Fama and French (1998) use the model to value dividends for US firms while Pinkowitz et al. (2006) estimate differences in dividend values across countries. We use the framework to examine the value of dividends for REITs after conditioning on degree of agency conflicts. Further, we do not examine investor tax issues associated with distributions as this is examined by Gentry et al. (2003).

  4. For robustness, we present a few models that account for unobservable heterogeneity via random effects.

  5. Ling and Ryngaert (1997) discuss the significant changes in REIT operations and size during the mid-1990s.

  6. Hardin and Hill (2008), Boudry (2010), and Roark (2010) emphasize that the portion of dividends that are of interest are the ones in excess of the mandatory dividend distribution.

  7. The corporate governance measures used in this study has come under criticism as a measure of corporate governance (Core et al. (2006); Bebchuk et al. (2009) and others).

  8. Pinkowitz et al. (2006) value regression framework builds on Fama and French (1998). Whereas Fama and French (1998) use the spread of market value of assets minus book value of assets divided by book value of assets as their dependent variable specification, Pinkowitz et al. (2006) use the market-to-book ratio.

  9. This understatement is due to the capital intensity of REIT investment and existing growth strategies that imply large depreciation expenses. Furthermore, depreciation expense does not have the same economic meaning for REITs as real estate properties are less prone to obsolescence than non-REIT assets and land value tends to increase over time.

  10. The SNL keyfields (in parentheses) used in the analysis are provided: Operating Partnership (74), Assets (220), Market Value of Equity (6111), FFO (6116), Interest Expense (7271), Net Income before Gains or Losses from Sale of Properties, Minority Interest, and Taxes (8434), Net Income (833), Common Dividends Paid (14126), Preferred Dividends Paid (14129), Total Liabilities (18083).

  11. Most analysts focus on FFO. Recent literature, for example, Gyamfi-Yeboah et al. (2011) provide results that show that FFO is a more meaningful measure for REITs than net income.

  12. Prior to 2001, the mandatory dividend was ninety-five percent of taxable income and calculations reflect this.

  13. We emphasize that our measure of discretionary dividends (based on Net Income before Gains or Losses from Sale of Properties, Minority Interest, and Taxes (8434) as taxable income) is an estimate as taxable income may vary based on differences in financial and tax accounting. We also recognize that this is only an estimate and may contain some measurement error, but valuing only total dividends without an adjustment is also problematic given that dividends have a mandatory component that cannot be attributed solely to management discretion. NAREIT provides the decomposition of REIT dividends (taken from 1099 forms), which we use and discuss in the robustness section. A drawback to the NAREIT data is that REITs are not required to provide this information to NAREIT and a large number do not, which may introduce self-selection bias. Use of the NAREIT data would also substantially decrease the observations available for analysis. Nonetheless, we re-estimate the models using the restricted data, as discussed later. Results are retained.

  14. The marginal effect of a change in dividends on firm value is found by taking the partial derivative of the regression equation with respect to dividends. Since the regressor and regressand are scaled by assets, the incremental change in firm value attributable to a $1 increase in dividends is the β coefficient.

  15. See Brueggeman and Fisher (2008) and Chan et al. (2003) for more detail on the unique features of the UPREIT structure.

  16. Feng et al. (2005) and Ghosh and Sirmans (2003) and (2006) examine various issues involving the percentage of independent directors, which is similar to InsAffG50 used in this study.

  17. See Wang et al. (1993), Bradley et al. (1998), Ghosh and Sirmans (2006), Feng et al. (2007), and Hardin and Hill (2008).

  18. Under catering theory, we would expect required dividends to have greater value as the market desires consistent dividends (Baker and Wurgler (2004) and Li and Lie (2006)). This is also implied by Boudry’s (2010) smoothing conclusion with respect to REIT discretionary dividends. In fact, dividends can only be smoothed if more than the mandatory amount is paid since dividends would be otherwise forced to fluctuate based on taxable income.

  19. See page 624 of Brueggeman and Fisher (2008) for more details.

  20. We thank a reviewer for pointing this out.

  21. We thank an anonymous reviewer for highlighting this limitation in the data analysis.

  22. The discussed results are estimated using random effects. Using the NAREIT data, the sample size is drastically reduced (80 observations) as many REITs did not provide their 1099-form to NAREIT over the sample period. This reduced sampled size coupled with fixed firm effects (42 REITs) leads to inefficient standard errors. The reduced sample size coupled with the lack of a mandate to disclose their 1099 forms to NAREIT, which may suggest self-selection problems (Heckman (1979)), are the primary drivers for our use of the financial accounting estimate of mandatory-discretionary dividends. The mandatory disclosure of this information may be a prudent policy recommendation given the interest in REIT dividend policy. In the present case, the results are consistent with either measure.

  23. Pinkowitz et al. (2006) report negatively signed and statistically significant estimates for the change in dividends. Fama and French (1998) do not find a negative relation between value and the prior period change in dividends.

  24. Results from Hausman’s (1978) test, used to determine whether unobservable heterogeneity is correlated with the independent variables, indicate fixed effects is preferred to random effects.

  25. In column 6 results (Tables 4 and 5), we present random effects results for the nested board independence variables and UPREIT.

  26. We thank our reviewer for suggesting several of the robustness tests, including institutional ownership, falsification tests, the dependent variable scaling concern, and the event study approach.

  27. REIT institutional ownership data is taken from Thomson Reuters 13F filings, which report quarterly security holdings at the institution level for all financial institutions. In the present study, institutional ownership is measured as the number of shares owned by all institutions from 13F at the end of each year divided by total shares outstanding.

  28. Chan et al. (1998) find that the institutional ownership in REITs increased significantly over their sample period.

  29. The EXDIV-institutional ownership is still insignificant once the other governance interactions are dropped. The expected negative EXDIV-institutional ownership relation is obtained if the equation is estimated using OLS and without the other governance interactions. Thus, it appears that the governance effect of institutional ownership is absorbed by the firm effect accounted for in Equation (2).

  30. Boudry (2010) indicates smoothing is part of REIT dividend policies.

  31. Cici et al. (2011) indicate that there is little difference between using the NAREIT REIT Index and using CRSP/Ziman REIT index as benchmark to calculate abnormal returns.

  32. Although unreported, the mean CAR associated with increased quarterly dividends is 0.010 percent, which is economically significant. Further, the null hypothesis of excess returns equivalent to zero is strongly rejected (t-statistic=15.23).

  33. The sample sizes listed in Table 6 vary from those in previous tables as we merge the dividend increase file to the governance data.

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Authors and Affiliations

  1. Department of Finance and Real Estate, Florida International University, 11200 SW 8th Street, RB 208, Miami, FL, 33199, USA

    Wen-Hsiu Chou

  2. Department of Finance and Real Estate, Florida International University, 11200 SW 8th Street, MARC 231, Miami, FL, 33199, USA

    William G. Hardin III

  3. Department of Finance, University of Mississippi, Oxford, MS, 39730, USA

    Matthew D. Hill

  4. Department of Finance and Economics, Mississippi State University, Mississippi State, MS, 39762, USA

    G. Wayne Kelly

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  1. Wen-Hsiu Chou
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Correspondence to William G. Hardin III.

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Chou, WH., Hardin, W.G., Hill, M.D. et al. Dividends, Values and Agency Costs in REITs. J Real Estate Finan Econ 46, 91–114 (2013). https://doi.org/10.1007/s11146-011-9314-3

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