Abstract
We conduct three sets of analyses to compare the usefulness of net income, based on generally accepted accounting principals (GAAP), and the industry-advanced funds from operations (FFO) in the context of the real estate investment trust (REIT) industry. In our first set of tests, we find that FFO is more strongly associated with one-year ahead FFO and one-year ahead operating cash flows than is net income. Conversely, we find that net income explains more variation in one-year ahead net income and current stock price than does FFO. Second, in support of the claim that some REITs manipulate FFO, we document that young REITs and REITs that are likely to access capital markets are more likely to manage FFO. Third, we find that, for a sample of firms that disclose current value information, both net income and FFO fail to reflect holding gains or losses on unsold properties in a timely manner. Overall, our analyses suggest that the REIT industry's claim that FFO is more useful than net income is premature because the superiority of one measure over the other is highly contextual.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
References
American Institute of Certified Public Accountants. (1995). Proposed Statement of Position: Reporting of Real Estate Companies of Supplemental Current Value Information. New York, NY: American Institute of Certified Public Accountants.
Amir, E., and B. Lev. (1996). “Value-Relevance of Nonfinancial Information: The Wireless Communications Industry.” Journal of Accounting & Economics 22, 3–30.
Arnold, A. L., and D. Goscicki. (1995). “Current Value Reporting by Real Estate Companies.” Mortgage and Real Estate Executives Report 28, 5.
Barth, M., and G. Clinch. (1998). “Revalued Financial, Tangible, and Intangible Assets: Associations with Share Prices and Non-market-based Value Estimates.” Working paper, Stanford University.
Belsley, D. A., E. Kuh, and R. E. Welsch. (1980). Regression Diagnostics: Identifying Influential Data and Sources of Collinearity. New York, NY: John Wiley and Sons.
Bowen, R. M., D. Burgstahler, and L. A. Daley. (1986). “Evidence on the Relationships Between Earnings and Various Measures of Cash Flow.” Accounting Review 61, 713–725.
Brenner, M. J. (1984). “Real Estate Financial Reporting: User's Perspective.” CPA Journal 54, 32–35.
Christie, A. (1987). “On Cross-Sectional Analysis in Accounting Research.” Journal of Accounting & Economics 9, 231–258.
Damodoran A., and C. H. Liu. (1993). “Insider Trading as a Signal of Private Information.” Review of Financial Studies 6, 79–119.
Dechow, P. M. (1994). “Accounting Earnings and Cash Flows as Measures of Firm Performance: The Role of Accounting Accruals.” Journal of Accounting & Economics 18, 3–42.
Dechow, P. M., R. G. Sloan, and A. P. Sweeney. (1996). “Causes and Consequences of Earnings Manipulations: An Analysis of Firms Subject to Enforcement Actions by the SEC.” Contemporary Accounting Research 13, 1–36.
Dorfman, R. R. (1990). “Real Estate Trouble Spills Over as Worried Investors Shun REITs.” Wall Street Journal January 5, C1-C2.
Downs, A. (1991). “Appraisal Practices Need Revision.” Appraisal Journal 59, 454–457.
Easton, P. D., P. H. Eddey, and T. S. Harris. (1995). “An Investigation of Revaluations of Tangible Long-Lived Assets.” Journal of Accounting Research 31(Suppl), 1–38.
Easton, P. D., T. S. Harris, and J. A. Ohlson. (1992). “Aggregate Accounting Earnings Can Explain Most of Security Returns: The Case of Long Return Intervals.” Journal of Accounting & Economics 15, 119–142.
Edmunds, J. C. (1982). “Why REIT Stocks are Undervalued.” Real Estate Review 12, 96–99.
Fass, P. M., M. E. Schaff, and D. B. Zief. (1996). Real Estate Investment Trusts Handbook. New York, NY: Clark, Boardman, and Callaghan.
Financial Accounting Standards Board. (1980). Statement of Financial Accounting Concepts No. 2. Stamford, CT: Financial Accounting Standards Board.
Financial Accounting Standards Board. (1981). Reporting Income, Cashflows, and Financial Position of Business Enterprises. Exposure draft. Stamford, CT: Financial Accounting Standards Board.
Fisher, J. D. (1994). “Alternative Measures of Real Estate Performance: Exploring the Russell-NCREIF Data Base.” Real Estate Finance 11, 79–87.
Francis, J., J. D. Hanna, and L. Vincent. (1996). “Causes and Effects of Discretionary Asset Write-Offs.” Journal of Accounting Research 34(Suppl), 117–134.
Frees, E. W. (1995). “Assessing Cross-Sectional Correlation in Panel Data.” Journal of Econometrics 69, 393–414.
Gallant, R. A. (1987). Nonlinear Statistical Models. New York, NY: John Wiley and Sons.
Greenberg, R. R., G. L. Johnson, and K. Ramesh. (1986). “Earnings Versus Cash Flows as a Predictor of Future Cash Flows.” Journal of Accounting, Auditing and Finance 1, 266–277.
Hamilton, J. D. (1994). Time Series Analysis. Princeton, NJ: Princeton University Press.
Hawkins, D. F. (1998). Corporate Financial Reporting and Analysis: Text and Cases. New York, NY: Irvin/Mcgraw Hill.
Heckman, J. J. (1979). “Sample Selection Bias as a Specification Error.” Econometrica 47, 153–161.
Hodges, M. B. (1993). “Three Approaches.” Appraisal Journal 61, 553–564.
Jennings, R., J. Robinson, R. B. Thompson, and L. Duvall. (1996). “The Relation Between Accounting Goodwill Numbers and Equity Values.” Journal of Business, Finance, and Accounting 23, 513–533.
Judge, G. G., R. C. Hill, W. E. Griffiths, H. Lukepohl, and T. Lee. (1988). Introduction to the Theory and Practice of Econometrics. New York, NY: John Wiley and Sons.
Kothari, S. P., and J. L. Zimmerman. (1995). “Price and Return Models.” Journal of Accounting & Economics 20, 155–192.
Lipe, R. C. (1986). “The Information Contained in the Components of Earnings.” Journal of Accounting Research 24(Suppl), 37–64.
Martin, E. J. (1995). “Truth or Consequences.” Institutional Investor 29, 113–116.
National Association of Real Estate Investment Trusts. (1991). White Paper on Funds from Operations. Washington, D.C.: National Association of Real Estate Investment Trusts.
National Association of Real Estate Investment Trusts. (1995). White Paper on Funds from Operations. Washington, D.C.: National Association of Real Estate Investment Trusts.
Ohlson, J. A. (1995). “Earnings, Book Values, and Dividends in Equity Valuation.” Contemporary Accounting Research 11, 661–687.
Palmon, D., and L. J. Seidler. (1978). “Current Value Reporting of Real Estate Companies and a Possible Example of Market Inefficiency.” Accounting Review 53, 776–790.
Schwarzbach, H., and R. Vangermeersch. (1991). “The Current Value Experiences of The Rouse Company, 1973–1989.” Accounting Horizons 5, 45–54.
Searfoss, D. G., and J. F. Weiss. (1990). “Current Value Reporting for Real Estate.” Journal of Accountancy 170, 69–75.
Swanson, E. P., and F. Niswander. (1992). “Voluntary Current Value Disclosures in the Real Estate Industry.” Accounting Horizons 6, 49–61.
Templin, N. (1996). “Analysts Scrutinize Accounting Tactic Boosting REITs.” Wall Street Journal January 23, C1.
Tishman Realty & Construction Company. (1977). Prospectus.
Vincent, L. (1998). “The Information Content of Funds from Opertions for Real Estate Investment Trusts.” Working paper, University of Chicago.
Vinocur, B. (1995). “The Ground Floor: REITs' Earnings GAAP.” Barron's 75, 36.
Vuong, Q. H. (1989). “Likelihood Ratio Tests for Model Selection and Non-nested Hypotheses.” Econometrica 57, 307–333.
Watts, R. L., and J. L. Zimmerman. (1986). Positive Accounting Theory. Englewood Cliffs, N.J.: Prentice Hall.
Weingarten Realty Investors. (1995). Form 10-K.
Zani, W. M. (1993). “A Current Value Measure for Corporate Real Estate.” Real Estate Review 23, 44–49.
Author information
Authors and Affiliations
Rights and permissions
About this article
Cite this article
Fields, T.D., Rangan, S. & Thiagarajan, S.R. An Empirical Evaluation of the Usefulness of Non-GAAP Accounting Measures in the Real Estate Investment Trust Industry. Review of Accounting Studies 3, 103–130 (1998). https://doi.org/10.1023/A:1009680401226
Issue Date:
DOI: https://doi.org/10.1023/A:1009680401226