Corporate Governance and the Leverage of REITs: The Impact of the Advisor Structure [chapter]

Nicolai C. Striewe
2015 Corporate Governance of Real Estate Investment Trusts  
J R E R ͉ V o l . 3 5 ͉ N o . 1 -2 0 1 3 C o r p o r a t e G o v e r n a n c e a n d t h e L e v e r a g e o f R E I Ts : T h e I m p a c t o f t h e A d v i s o r S t r u c t u r e A u t h o r s A b s t r a c t This paper examines the impact of the advisor structure on the leverage of 265 real estate investment trusts (REITs) in the United States. The study employs panel data for the period 1994 to 2010. Externally advised REITs tend to choose lower leverage, a result that differs from that of
more » ... iffers from that of Capozza and Seguin (2000) for the old REIT era (1985)(1986)(1987)(1988)(1989)(1990)(1991)(1992). We find no evidence for an agency problem related to the choice of leverage for more recent data. The lower leverage makes economic sense since externally-advised REITs bear higher costs of debt than their internally-advised counterparts. The purpose of this paper is to investigate an important corporate governance issue: How does the advisor structure affect the leverage of real estate investment trusts (REITs). Advisors are expected to pursue personal goals, such as the maximization of their compensation and personal assets. If these personal goals of the advisors are not aligned with shareholder wealth maximization, agency conflicts may arise. Such agency conflicts can be identified by observing how the capital structure varies in conjunction with the advisor structure. The potential for agency conflicts in the external advisor structure of REITs has been highlighted by Finnerty and Park (1991) and Capozza and Seguin (2000, hereafter C&S). C&S go one step further and suggest that there is empirical evidence for this agency conflict. They find that externally-advised REITs choose higher leverage than internally-advised REITs. C&S interpret this as a serious conflict between the interests of shareholders and external REIT advisors. They suggest that the excessive leverage may be attributable to a misaligned compensation scheme of external advisors that neglects interest expenses. C&S's study period from 1985 to 1992 is characterized by a wave of externallyadvised REITs converting to the internally advised and internally managed form. A change in the regulation in 1986 first allowed REITs to operate and manage properties themselves. Ott, Riddiough, and Yi (2005) describe the early REIT
doi:10.1007/978-3-658-11619-4_3 fatcat:v3nantgkcbfxjitt5fv23s7jde