Board Independence Ownership Structure and Performance in REITs 032702

8/2/2019 Board Independence Ownership Structure and Performance in REITs 032702

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Board Independence, Ownership Structure and Performance:

Evidence from Real Estate Investment Trusts

Journal of Real Estate Finance and Economics, forthcoming 2002

Chinmoy Ghosh

and

C. F. Sirmans

Abstract

REITs experienced phenomenal growth in the l990s. Evidence on ownership structure, board composition andperformance of REITs, however, is scarce. For REITs, special regulation, including mandatory distribution ofincome, limits free cash flow, while restrictions on source of income and asset structure results in widelydispersed stock ownership. This makes external monitoring through the takeover market less likely such thatalternative monitoring mechanisms, including external directors, must be in place to discourage deviantmanagerial behavior. Using a simultaneous equation system, we conclude that while outside directors on REITboards enhance performance, the effect is weak. Consistent with the evidence on other industry sectors, we findthat higher CEO stock ownership and control through tenure and chairmanship of the board reduces therepresentation by outside members on REIT boards, and adversely affects REIT performance. Institutionalownership or blockownership fails to serve as alternate disciplining mechanism to (inadequate) monitoring byoutside board members, although their presence seems to enhance performance.

March 25, 2002

Both authors at Department of Finance and the Center for Real Estate and Urban Economic Studies

University of Connecticut, Storrs, CT 06268, USA. Comments from Piet Eichholtz, participants at the 2001

Cambridge-Maastricht Conference, and an anonymous referee are gratefully acknowledged. Address

correspondence and comments to [email protected].


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Board Independence, Ownership Structure and Performance:

Evidence from Real Estate Investment Trusts

1. Introduction

We examine the impact of board composition and monitoring on the performance of Real Estate

Investment Trusts (REITs). Agency problems between shareholders and managers, and their impact

on firm performance, have been an area of intensive research in finance. One important mechanism

designed to reduce agency problems is the appointment of independent directors on the corporate

board. Both theoretical and empirical analyses suggest that outside members on the board of

directors serve a critical role in the monitoring and disciplining of senior managers, and thereby

influence firm performance. Early evidence in this area, however, has come under serious scrutiny

because of an inherent endogeneity problem: Do better performing firms attract more outside

directors, or does a larger number of outside directors result in better monitoring and improved

performance? Do managers make better decisions because they own more stock, or, do they own

more stock because their firms have better prospects? There is growing evidence that issues of

performance, board independence, ownership structure, and CEO characteristics and compensation

are interrelated. For example, Agarwal and Knoeber (1996) argue that the various mechanisms to

control agency problems are interdependent, and demonstrate that except for outside directors, other

control mechanisms are maintained at optimal levels in a cross section of firms. Loderer and Martin

(1997) explore the relation between executive stock ownership and firm performance. They find no

significant relation after allowing for endogeneity of both ownership structure and performance. Cho

(1998) hypothesizes and provides evidence that ownership structure, investment, and corporate value

are endogenously determined. Mishra and Nielsen (2000) develop a model to capture the

interdependence between performance, board independence, and managerial compensation in banking

firms. In the spirit of these papers, we use two separate models to examine how board independence,

CEO characteristics and ownership structure influences performance. In the first model, we use asingle equation approach to investigate the interaction of various ownership measures and CEO

characteristics with board independence, and performance. The second model estimates a

simultaneous equation system of board independence, CEO characteristics, and performance to

address potential endogeneity issues


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Our analysis of REITs makes several contributions to the literature on corporate governance.

First, the evidence on corporate governance in regulated industries is limited. Demsetz and Lehn

(1985) argue that regulation restricts the investment options available to managers; Smith and Watts

(1992) hypothesize that a restricted investment opportunity set helps mitigate agency problems. In

essence, the need for incentive and monitoring mechanisms to motivate performance is reduced in

regulated industries. REITs must restrict their investments to real estate assets by regulation. As

such, focusing on REITs allows us to control the variation in managers motivation, and in turn,

performance resulting from differences in investment opportunities. Second, Agarwal and Knoeber

(1996) argue that the existence and firms use of alternative monitoring mechanisms imply that these

mechanisms are substitutable. Whidbee (1997), however, notes that the effectiveness of external

monitoring mechanisms is at best weak in some industry sectors. To corroborate the premise,

Whidbee cites evidence that the market for corporate control, which exerts influence and control on

senior managers through hostile takeovers, is barely active in the banking industry, in that the

majority of bank acquisitions are friendly takeovers. In this environment, alternative external

monitoring mechanisms including outside independent directors assumes additional significance.1 In

a recent paper, Campbell, Ghosh and Sirmans (2001) report that in a sample of eighty-five mergers

and combinations between publicly traded Equity REITs and both public and private target REITs in

the l990s, not one was a hostile deal. This raises the specter that, similar to the banking industry, the

natural disciplinary forces of the capital market are relatively ineffective for the real estate sector, and

as such, outside and unaffiliated directors have special roles and responsibilities to protect

shareholder interest in REITs. Finally, restricting attention to firms in a single industry helps reduce

inter-industry heterogeneity. In their studies of banking firms, Whidbee (1997) and Mishra and

Nielsen (2000) argue that industry factors account for a large proportion of performance variability in

a sample of firms, and may obscure the relation between board structure and performance.

The paper is developed as follows. In the next two sections, we review the evidence on the

determinants of board structure, and the significance of board monitoring on performance to develop

the hypotheses on the potential impact of the unique regulatory environment of REITs on corporate

governance and performance. The sources of data and descriptive statistics are presented in section 4.

In section 5, we develop an ordinary least squares (OLS) model of board composition as a function ofstock ownership of CEO, other officers, and affiliated and unaffiliated outsiders and institutions. The

impact of board composition on firm performance is explored in section 6. In section 7, we estimate a

simultaneous equations system using two-stage least squares (2SLS). Section 8 concludes the paper.


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2. Determinants of Board Independence

The board of directors includes the CEO, who often serves as the chairman of the board, non-

CEO officers of the company, affiliated outside directors and non-affiliated outside directors. We

define affiliated directors as all directors who are former employees of the firm, relatives of

employees of the firm, or individuals who have some business relationship with the firm. Non-

affiliated outside directors have no relationship with the firm, past or present, outside their

directorship.2 Throughout this study, outside directors and non-affiliated directors represent the same

individuals.

If the main responsibility of the outside Board members is to monitor the activities of the

CEO and senior managers, non-value-maximizing CEOs and managers have the incentive to use their

stockownership to reduce outsider representation on the board. Under the shareholder voting

hypothesis, CEOs bargaining power in the director selection process increases as the CEO ownership

of the firms shares increases, and the CEO can use this bargaining power to get preferred candidates

and fewer outsiders appointed to the board. Indeed, the CEO can exert influence on the voting

process in ways other than and in addition to his own shareholdings [Stultz (1988)]. For example, the

CEO can arrange with shareholders at large to vote shares owned by them. Often, a manager acts as a

trusty for the employee stock ownership plans (ESOP). As such, this hypothesis predicts that outsider

director presence on the board decreases with higher CEO ownership, longer CEO tenure, and the

creation of affiliated blockholders. Hermalin and Weisbach (1988) demonstrate that as the CEO

becomes more entrenched over his career, his bargaining power increases and the proportion of

independent outside directors on the board declines. Hermalin and Weisbach (1998) report evidence

consistent with this. Conversely, outsider board membership should increase with the creation of

outside blockholders, greater institutional ownership, and outside director share ownership. As

Grossman and Hart (1980) note, for a shareholder with a substantial stake in the firm, the benefits of

monitoring senior managers are greater, and consequently, managers are unlikely to have large

control over the voting outcome.

Support for this hypothesis also comes from Whidbee (1997) who analyzed 1990 proxy

statements for 190 banking firms and found significant evidence for the adverse effect of CEO

shareholding on outside board membership, and a positive relationship between outsider board

membership and outside director share ownership. Mishra and Nielsen (2000) report that proportion

of outside directors in a sample of banks decreases significantly with longer CEO tenure. Auxiliary

corroboration draws from Brickley, Lease, and Smith (1988) who report that institutional investors

vote more actively on anti-takeover amendments than do non-institutional investors. Similarly,


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Gordon and Pound (1993) report that institutional shareholders and large outside blockholders are

more likely to vote in favor of proposals initiated by shareholders.

Alternatively, the substitution hypothesis posits that as share ownership by officers and

managers increases, managers incentives become more aligned with the shareholders interests so

that the need to monitor them diminishes. This predicts a negative relationship between managers

shareholding and outsider directors representation on the board. The negative relationship between

outsider board membership and insider share ownership in Bathala and Rao (1995) and Melms (1994)

supports this view.

The shareholder voting hypothesis and the substitution hypothesislead to the same prediction

of negative relationship between CEO and insider share ownership and outsider board membership.

To differentiate between the two, we note that under the premise that outside board members

substitute for other control mechanisms, the substitution hypothesis implies a negative relationship

between outsider board membership and alternative monitoring mechanism including active outside

investors, large blockholders, and institutional investors. The shareholder voting hypothesisholds the

opposite viewpoint because the increase of outside control may make election of outsider directors

more likely.

Consistent with the shareholder voting hypothesis, Whidbee reports a significantly positive

relationship between outsider board membership and affiliated blockholder share ownership.

Conceivably, active outside investors put pressure on the board to appoint more outside directors as

their shareholding increases. His data do not support the notion that outside board membership acts

as a substitute for monitoring by active outside investors.

To our knowledge, there is no evidence on the determinants of board structure of REITs.

Friday and Sirmans (1998) report the average total number of directors and outside directors in REITs

from 1980-1994, but do not attempt to explain any cross sectional differences. Friday, Sirmans and

Conover (1999) examine the relationship between ownership structure and valuation, but do not

control for board structure. As such, our analysis should reveal important information on REIT

governance structure, particularly for the new breed of REITs formed during the nineties. In

addition, there is a persistent notion in popular press that REITs industry operates as a close-knit

family, where cross holdings are common. The absence of hostile takeovers (Campbell, Ghosh, andSirmans (2001)) among the new REITs is consistent with this notion. Our results shed new light on

this issue.

3. Board Monitoring, Corporate Performance and the Regulatory Environment of REITs


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Literature on corporate governance identifies four broad mechanisms to alleviate the agency

problems between managers and shareholders. These are debt covenants, market for corporate

control, labor market for managers, and a fourth category encompassing monitoring by the firms

shareholders insiders, institutional owners, blockholders, and outsider directors. Agarwal and

Knoeber (1996) hypothesize that since alternative mechanisms exist, relatively less use of one

mechanism need not adversely affect corporate performance. It is particularly interesting to study this

hypothesis for REITs because, as we argue below, the unique regulatory environment of REITs

renders certain monitoring mechanisms more or less effective than others.

Jensens (1986) free cash flow theory predicts that agency problem is severe in companies

where management has access to significant discretionary cash flow. The use of debt mitigates this

problem by making interest payment mandatory. REITs do not pay taxes. However, to maintain their

tax-exempt status, REITs must pay out 95% of net taxable earnings each year.3 If the regulatory

requirement limits REIT managements capacity to generate free cash flow to finance large

investments, the typical agency problem that plagues other corporations is reduced.4 This in turn may

render outside director monitoring less critical for REIT performance.

The market for corporate control operates through hostile takeovers of poorly managed firms.

Inefficient management succumbs to acquirers who create synergistic gains by exploiting untapped

opportunities. The threat of potential takeover disciplines management. REITs are subject to the

excess share provision rule, which restricts the maximum number of shares that any shareholder can

acquire, which is usually 9.8% of outstanding shares. Any shares acquired in excess of the maximum

amount lose all voting privileges. This is intended to prevent a REIT from violating the 5-50 rule

which mandates that during the last half of the taxable year, the five biggest owners of the REIT's

common stock together may not own more than 50% of the total shares outstanding.5 A related rule

provides that REITs must have at least 100 different owners in the aggregate. It is argued that the 5-

50 limitation intensifies agency problems and hurts performance, since the fragmented ownership

makes it more difficult for large blockholders to acquire stakes and pose a serious takeover threat, and

for shareholders to form alliances and govern and discourage deviant managerial behavior.

Absence of hostile takeovers among REITs lends credence to the above argument. Consistent

with this, Campbell, Ghosh and Sirmans (2001) find no hostile transactions in a sample of eighty-fivemergers and combinations between publicly traded Equity REITs and both public and private target

REITs over the last decade. As such, similar to the banking industry, the rare occurrence of

disciplinary takeovers makes other monitoring mechanisms critical to REIT performance.6

The managerial labor market motivates managers to improve performance and enhance their

reputation among prospective employers. Greater opportunities in the external managerial labor


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market may make managers less apprehensive of the takeover threat. Conversely, smaller the labor

market, more likely is the manager to resist a hostile takeover. To qualify as a REIT, at least 75

percent of income must come from real estate related sources and at least 75 percent of a REITs

assets must be cash, government securities, and real estate related assets, including direct ownership,

leaseholds, or options in land or improvements, shares in other REITs, and mortgages. This restriction

deters inter-industry mergers and affords REIT managers only limited opportunities to gather

experience in diverse industries; Whidbee (1998) and Campbell, Ghosh and Sirmans (2001) attribute

their finding of no hostile takeover, and absence of inter-industry mergers in banking and real estate

in large part to this rule. In effect, the restricted labor market induces REIT managers to insulate

themselves from hostile takeover threats, and reduces their incentive to exert themselves to greater

performance.

Managerial ownership of company stockcan affect performance in at least two ways. First,

ownership of stock is the most direct way to align managers interests with the shareholders, and, the

effect depends on the proportion owned. For very low levels of ownership, the effect is negligible,

while very high levels lead to entrenchment. The empirical evidence on the favorable effects of

managerial stock ownership, however, is rather weak. As Loderer and Martin (1997) note, the

empirical design must take into account the simultaneity of the relationship -- managerial ownership

enhances performance, and superior performance induces higher ownership. Developing tests to

incorporate the simultaneity issue, Loderer and Martin (1997), Cho (1998), Agarwal and Knoeber

(1996), Beatty, and Zajac (1994), and Mehran (1992) report no significant relation between

managerial equity holdings and firm performance. Mishra and Neilsen (2000) find weak evidence for

banks.

Second, insider ownership can influence the outcome of a takeover attempt. Whether a large

insider-manager ownership stake enables or deters a takeover attempt depends on managers potential

gains from the deal. If managers feel threatened of loss of job, power, and other perquisites, they will

resist the takeover attempt. On the other hand, if managers gain more from potential price

appreciation, greater insider shareholdings might assist the market for corporate control by making

insiders less obstructive. The evidence of no hostile takeovers in REITs suggests that the effect of

larger insider shareholding has been to thwart such attempts. This would impact performance andfirm value adversely.

Friday, Sirmans and Conover (1999) explore the relation between ownership structure and

firm value as proxied by market-to-book ratios for REITs over the period 1980-1994. Their results

are generally consistent with a positive impact of insider ownership on corporate value, except at high

ownership levels where firm value drops. Cannon and Vogt (1995) find that ownership has no impact


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on the value of self-administered REITs, but low insider-owned advisor managed REITs significantly

underperform. These authors attribute the result to greater agency problems in advisor REITs.

The outside directors on a board are primarily charged with ensuring that the top

management decisions are consistent with maximization of shareholder wealth. Conceivably, the

monitoring effectiveness of an outside director depends on the number of outsiders on the board.

Agarwal and Knoeber (1996), Subramanyam, Rangan and Rosenstein (1997), however, find that

performance is negatively related to the proportion of outside directors. They also report that when

CEO serves as the chairman of the board, performance suffers. Analyzing board composition data

on REITs from 1980-1994, Friday and Sirmans (1998) find that increased outside director

representation on the board is associated with greater firm valuation. But, high outsider

representation on the board is not conducive to firm value. They do not, however, address the

simultaneity problem inherent in these models. McIntosh, Rogers, Sirmans and Liang (1994) report

an inverse relationship between probability of top management changes and share price performance,

an indication of the monitoring value of external directors.

In addition to the unique regulatory aspects, the ownership and management structures of REITs

has undergone significant changes in the last decade with the formation, public offerings, and

unprecedented growth of the new REITs. Ling and Ryngaert (1997) observe that REITs of the

1990s are different from the REITs of earlier decades in important ways, including management style,

organization, and ownership structures. The new REITs have relatively large insider and institutional

stockholding.7 According to Ling and Ryngaert (1997), the structural changes that have occurred in

these REITs have important implications for firm value. For example, greater institutional

shareholdings might facilitate takeovers as could larger blocks held by outsiders both because of

possibly lower transaction costs, and because the size of these holdings would reduce the free-rider

problem that could lead small shareholders to refuse to tender. The consolidation in the REIT sector

in the nineties bears out this argument. Chan, Leung, and Wang (1998) document that during the

nineties, institutional investors invested more in REITs than in other stocks, and that performance is

positively impacted by institutional ownership.

Equity REITs are more prevalent today than Mortgage REITs. As Equity REITs have increased

in number, they have also become more similar to conventional corporations. Specifically, the olderEquity REITs were not permitted to manage the properties they owned, but were required to use

external management. Under external management, agency problems exist between shareholders and

REIT management, and also between REIT management and external management. In contrast, the

Equity REITs of the 1990s are self-managed corporations. In self-managed REITs, the second source

of agency problem is eliminated. Self-management, in conjunction with higher managerial and


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institutional ownership should induce more responsible managerial behavior, reduce agency costs,

and improve performance. Cannon and Vogt (1995) demonstrate that self-administered REITs

outperformed externally-advised REITs over the period 1987-1992. Bers and Springer (1997) find

that management style of a REIT affects its scale economies. In corroboration of this evidence,

Copozza and Seguin (2000) report that REITs managed by external advisors significantly

underperform internally managed REITs. Authors attribute their findings to the asset based

managerial compensation structures. Ambrose and Linneman (2001) come to similar conclusions.8

A significant change in the Equity REIT structure to evolve during the 1990s is the use of the

Umbrella Partnership REIT, or "UPREIT". The UPREIT structure is not a direct product of the tax

code, but a REIT structure pioneered by Taubman Centers, a shopping mall REIT, in 1992. The

popularity of the UPREIT structure has steadily increased, and by the end of the 1990s more than

60% of Equity REITs use it. An UPREIT is a special kind of limited partnership, in which a REIT is

the general partner, but all of the properties are owned by an operating limited partnership in which

the REIT itself owns a controlling interest. The limited partnership shares have a convertibility

feature that allows their holders to exchange them for the UPREIT's common shares later.

An advantage of this structure is that UPREITs can obtain private real estate interests in

exchange for tax-deferred limited partnership shares. Were the seller of privately held real estate to

exchange this property for a REIT's common shares, recognition of a taxable gain would normally be

triggered. However, when these assets are exchanged for partnership shares, no taxable gain is

realized until the shares are sold or converted. Industry observers feel that the UPREIT form results

in complex organization structures, where cross holdings are common and accountability is often

compromised. This would exacerbate agency costs.

Finally, UPREIT partnership shares have frequently been used in REIT merger transactions.

Newly registered stock is normally subject to a six-month minimum holding period enforced by the

SEC. However, the required holding period for UPREIT shares is effectively determined by the

earliest conversion date, which is not determined by the SEC, but by contract, and the holding periods

used are usually longer, commonly extending for at least one year, and sometimes for as long as five

years. Campbell, Ghosh, and Sirmans (2001) attribute the high incidence of cash-financed REIT

mergers to the long inconvertibility of UPREIT shares. These ownership stakes with long holdingperiods can effectively discipline management, but they also deter future takeovers.

In summary, the unique regulatory environment of REITs gives management limited discretion

over cash flow, causes dispersed share ownership, and precludes disciplinary takeovers. In addition,

the new REITs are characterized by relatively high institutional holdings, self-management style, and

complex ownership structure. Taken in conjunction, these factors have the potential to materially


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affect the style, the incentives, and the power and structure of governance of REIT management, and

especially the REIT board. We investigate the impact of these factors on the extent of monitoring that

outside directors can exercise on REIT managers, and how that affects performance.

We list the various regulatory requirements of REITs in Table 1. Their potential impact on

corporate governance and performance is summarized. The distribution requirement has a potentially

positive effect on monitoring, and performance. The other three requirements relating to stock

ownership, source of income, and asset structure, have adverse effects on the effective of disciplining

by outside board members.

4. Data

The data on the number and shareholdings by officers and directors, outside blockholder

shareholdings, affiliated blockholder shareholdings, board composition, institutional shareholding,

CEO characteristics, and option holdings are collected from the 1999 Proxy statements and the SNL

Datasource for traded Equity REITs.9, 10 Control variables include size of the REIT measured as the

natural logarithm of market value of equity, ratio of market value of equity to book value of equity,

and various characteristics of individual REITs including type of organization structure (traditional or

UPREIT), and the type of property owned by the REIT. The inclusion of size as a control variable is

motivated by the evidence of significant economies of scale in the REIT industry reported by several

authors.11 Market-to-book ratio is used as a proxy for growth and investment opportunity set. Smith

and Watts (1992) demonstrate agency problems in a firm reflect its investment opportunity set. These

data are collected from the SNL database, and NAREIT yearbooks.

Our final data set includes 122 equity REITs. This includes 16 office, 29 retail, 24 residential,

14 hotel, 9 industrial, and 30 other (15 diversified, 8 healthcare, 1 restaurant, 4 self-storage, and 2

specialty) REITs. 76 of these REITs have the UPREIT structure. The summary statistics for the data

are presented in Table 2. The analyses are based on the data from the proxy statements in 1999, and

financial data as of year-end 1998. ROA is the return on average assets for the year. The average

ROA for the sample is 3.853%, which is lower than the average ROA reported in Friday, Sirmans and

Conover (1999).12

ROE is return on average of total equity for the year. The average ROE for theREITs is a healthy 9.425%, which is much higher than the 7.74% for a sample of 67 banking firms

during 1991 analyzed by Misra and Neilsen (2000). This data are consistent with the superior

performance by REITs during the recent years. Size is measured as the logarithm of total market

capitalization. The market capitalization of REITs ranges from $7.2m to $6.2b, with an average of a

little less than $900m. The market-to-book ratio is market value per share to book value per share,


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and represents the growth prospects of the firm. The average market-to-book ratio is 0.539 with the

maximum of 1.95, as of year-end 1999.13

CEO shareholdings include all shares owned by the CEO and his immediate family, shares

owned by firms of which CEO is a major shareholder, shares owned by CEO through stock

ownership plans, restricted stock, and shares that CEO can acquire by exercising options. The same

procedure is followed to measure share ownership by other directors. CEOOWN, the number of

shares owned by the CEO as a percent of the total number of shares outstanding, averages 6.15%.

EXCEOOWN is the number of shares owned by officer directors excluding the CEO as a proportion

of the total number of shares outstanding. These inside directors own, on average, 2.23% of the

outstanding shares. The total insider ownership of 8.4% for our sample is lower than the average

ownership of 12% in Friday and Sirmans (1998).

The average tenure of the REIT CEO is 5.33 years, considerable lower than that for other

firms. This possibly reflects the fact that most of the REITs in our sample are relatively new. Most

of them went public during the 1990s boom in the capital market activity of REITs. CEODUAL is a

dummy variable which has a value 1 when the CEO is also the Chairman of the board of directors and

zero otherwise. The average for CEODUAL -- the proportion of REITs where the CEO is also the

Chairman of the Board -- is 0.615. This number is considerably lower than that for Banks (0.95).

This is a favorable trait from the perspective of Board independence.

Independent (non-affiliated) outside directors are identified as those directors whose only

relationship with the firm is their board position. We use two proxies to measure Board independence.

First is OUTDIR, which is the number of outside unaffiliated directors as a percentage of all directors

in the board. The average value is 61%, with minimum and maximum values of 16.7% and 89%.

These numbers are comparable with banks, and higher than reported by Friday and Sirmans (1998)

for REITs over the period 1980-1994. The average percentage of outside directors reported by Friday

and Sirmans (1998) ranged from a high of 60% in 1984 to a low of 34% in 1992, with an overall

average for their data of about 50%. The increase in outside directors is possibly attributable to

increasing institutional ownership of REIT shares. The second proxy for board independence,

RELTENR, is the average tenure of outside directors as a ratio of the tenure of the CEO. The average

relative tenure of outside directors is 1.84, with a maximum of 17.33. These numbers are higher thanthat for other regulated industries.14

AFFOWN is the number of shares owned by affiliated outside directors as a proportion of the

total number of shares outstanding. NAFFOWN is the number of shares owned by non-affiliated

outside directors as a proportion of the total number of shares outstanding. The ownership by

affiliated and unaffiliated outside directors are, on average, 2.35% and 1.82%, respectively. These


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numbers are higher for affiliated directors and lower for outsiders than in the Friday and Sirmans

(1998) REIT sample. It is significant to note that in REITs, affiliated directors hold a larger

proportion of outstanding shares than non-affiliated directors. This may make outside unaffiliated

director election to REIT boards relatively more difficult.

AFFBLK is the number of shares owned by affiliated blockholders as a proportion of the total

number of shares outstanding. NAFFBLK is the number of shares owned by non-affiliated

blockholders as a proportion of the total number of shares outstanding. INTNOWN is the number of

shares owned by institutional investors as a proportion of the total number of shares outstanding. It is

apparent from our data that REIT shares have significant ownership by both affiliated and unaffiliated

blockholders, and as much as nearly 17% of REIT shares are held, on average, by institutions. This is

possibly a reflection of the superior performance by REITs in recent years.15

The Pearson correlation coefficients between board composition, ownership structure, and

performance variables are presented in Table 3. For space considerations, results are henceforth

presented only for one measure of performance, Return on equity (ROE). Results for Return on Asset

(ROA) are essentially similar. Data reveal several significant relationships. Consistent with other

studies and the shareholder voting hypothesis, the correlation between number of outside directors

and CEO ownership is significantly negative. The correlation between number of outside directors

and ownership by affiliated outside directors is significantly negative, as well, which conforms to the

substitution hypothesis. The ownership by CEO is significantly and positively related to the tenure of

the CEO, and the dual position of the CEO as the Chairman if the board. This evidence is clearly an

indication of the agency problem of the CEO wielding power to get entrenched over time. CEO

ownership is significantly and positively correlated with ownership of shares by non-affiliated

blockholders; and, positively with ownership by non-CEO insiders in the board. The latter

relationship is indicative of a potential alignment between the CEO and the non-CEO insiders in the

board. The significantly positive correlation between CEOTEN and CEODUAL suggests that a dual

position as CEO and Chairman of the board gives the CEO added power to lengthen his tenure.

Larger REITs are significantly less owned by CEOs and non-CEO insiders, and are significantly more

institutionally owned.16 The correlation between institutional ownership and ownership by

blockholders is significantly negative, which is consistent with the notion that these are substitutes asmonitoring mechanisms.

The correlation between ROE and CEO ownership is significantly negative, suggesting that

high CEO ownership is not conducive to performance. A higher market-to-book ratio, which

indicates better access to growth opportunities, enhances performance. Consistent with the findings of

the REIT economies of scale studies, our data suggest that larger REITs perform better. The


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correlation coefficients between stock ownership of affiliated directors and blockholders and

performance, and market to book ratios are significantly positive.

5. Determinants of Board Composition

Although the correlation analysis reveals significant association between board composition,

ownership structure, and performance, the univariate analysis fails to capture interactions among

variables. To address that, we estimate multivariate ordinary least squares (OLS) estimates. We first

examine the impact of share ownership by both insiders and outsiders on board independence. We use

two alternative measures of board independence OUTDIR, the percentage of outside directors on

the board, and RELTENR, the average tenure of outside directors as a ratio of the tenure of the CEO.

Specifically, we investigate how these variables are impacted by CEO influence, and CEO shareownership, and other indicators of ownership structure. We estimate the four models shown in Table

IV. Models 1-3 use OUTDIR as the dependent variable - model 1 focuses on CEO characteristics,

model 2 introduces ownership by other directors, and model 3 adds ownership by institutions and

blockholders. Model 4 uses RELTENR as the dependent variable and includes the full set of

explanatory variables. Each model is estimated using the ordinary least squares method adjusted by

Whites (1980) heteroskedastic correction. Models 1-3 use the full date set of 122 observations;

model 4 uses 118 observations, 4 observations being excluded because of lack of data on director

tenure.

In each model, return on equity (ROE) is used as a proxy for REIT performance. Hermalin

and Weisback (1988) argue that number of outside directors in the board increases as performance

declines, apparently because insiders are fired. This would imply a negative coefficient for ROE.

Friday and Sirmans (1998) find that high market-to-book ratio REITs use a significantly higher

percentage of outside directors than low market-to-book firms. This is an indication that REITs with

better growth prospects employ more outside talent for their boards. Under this scenario,

MKTBOOK should have a positive coefficient. Under the shareholder voting hypothesis, increases in

CEO ownership and CEO tenure will have a negative impact on board independence. Longer CEO

tenure will allow him to acquire a larger number of shares, making it easier for him to keep

unaffiliated directors at bay. Similarly, the substitution hypothesis implies a negative impact of

greater CEO ownership on the number of outside directors as a larger share ownership by managers

aligns their interests with the shareholders, rendering monitoring by outside directors less important.

A Chairman CEO will have a negative impact as well, if the CEO chooses to fill the board with


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outsiders loyal to him. The impact of increasing power of other officer directors on the composition

of the board is similar. Shareholder voting hypothesis predicts a negative coefficient for share

ownership by directors and blockholders affiliated with the management, and the opposite for the

nonaffiliated outside directors and blockholders. In contrast, the substitution hypothesis implies that

monitoring mechanisms are substitutable so that increases in ownership by nonaffiliated outside

directors and blockholders will make outside director disciplining less critical, and predicts negative

signs for these variables. Shareholder voting hypothesis implies a positive coefficient for institutional

ownership if institutions are sympathetic to outside directors; substitution hypothesis predicts a

negative sign if institutions are active and effective in monitoring managers.

Heteroskedastically corrected OLS estimates are presented in Table 4. In model 1, the

coefficients of ROE, ownership of shares by CEO, CEOs tenure, and CEO duality have the predicted

signs, but none of these variables is significant. Models 2 and 3 reveal that as the performance (ROE)

of the company improves, significantly more outside directors get elected. The effect of CEODUAL

is significantly negative in Model 2 and 3, an indication that the CEO exercises power to minimize

outside director representation on the board when he controls it. Consistent with shareholder voting

hypothesis, the ownership of shares by other board members who are officers of the company has a

significantly negative effect on percentage of outside directors, which corroborates the notion that

insiders are not eager to invite unaffiliated outsiders into their corporate board. The significantly

negative coefficient associated with ownership of shares by affiliated directors and the significantly

positive coefficient for share-ownership by nonaffiliated directors is also consistent with shareholder

voting hypothesis. These results are intuitive in that the incidence of outside directors on the board

increases as fewer shares are controlled by board members that are affiliated with the company

insiders. We find from Model 3 that blockholders and institutional shareholders are not significant in

ushering in outside individuals into REIT boards.

Overall, we conclude from these results that outside directors are not very welcome into

REIT boards. If the CEO controls the board as the chairman, he seems to discourage outside

representation, and the other officer directors of the board use their shareholdings to similar end. The

best chance for the outside director to get on the board is through the voting power of the unaffiliated

directors, as the affiliated directors appear to side with the insiders, as expected.17

It may be recalledthat the affiliated directors hold, on average, more shares than unaffiliated directors in REITs, and

affiliated blockholders also hold more shares than their unaffiliated counterparts. This disparity

exacerbates the difficulties for outsiders to get elected to REIT boards.

In model 4, the independent variable is RELTENR, the average tenure of outside Board

members relative to CEO tenure. While the results are similar in nature to the model for the


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percentage of outside directors, the variables that are significant differ. Better performing REITs are

able to retain outside directors longer. High CEO stock ownership reduces the average tenure of

outside directors. Most significantly, high institutional and block ownership of REIT stock adversely

impacts the tenure of outside directors. One potential explanation is that when these shareholders

become active, changes in the board are more frequent.

Our results are consistent with the shareholder voting hypothesis: when the CEO and insiders

own a significant share of the company shares, the board of directors includes a smaller proportion of

outside directors. Outside board representation is higher when unaffiliated outsiders own more

shares. We find no conclusive evidence that outside investors and outside directors are substitutes in

monitoring of REIT managers.

6. Board composition and Performance

What is the impact of board composition on firm performance? We measure performance by

ROA and ROE and estimate the impact of board composition.18 We adjust for several control

variables including the size of the firm, and market-to-book ratio as a proxy for growth. Also, as the

previous section indicates, the number of outside directors in REIT boards is significantly impacted

by whether the CEO controls the board chairmanship, and the ownership of common shares by the

CEO and other inside directors, and affiliated and unaffiliated outside directors. To isolate the effect

of board independence on performance, these control variables are included as well. We estimate

five models shown in Table 5. Each model is based on 122 observations and estimated using the

ordinary least squares method adjusted by Whites (1980) heteroskedastic correction.

The central hypothesis we test is whether greater board independence enhances firm

performance. The explanatory variables are introduced into the models to highlight specific aspects of

corporate control and governance, with SIZE and MKTBOOK included in all models. SIZE adjusts

for any potential pattern in the differential performance between smaller and larger REITs. In

accordance with REIT economies of scale studies, SIZE should have a positive coefficient.

MKTBOOK captures performance attributable to growth prospects. High MKTBOOK reflects REIT

managements superior skill in identification and management of assets, which should impact

performance positively. CEODUAL is included as a control variable in all models to incorporate the

effect that a chairman CEO has greater opportunity to exclude outside independent directors from the

board, to the detriment of firm performance. In model 2, we include the ownership by other officer

directors and affiliated and non-affiliated directors. CEO characteristics, specifically his stock

ownership and tenure are the focus in model 3; both variables may adversely affect performance if the


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CEO is entrenched. Model 4 examines if the ownership by blockholders and institutional investors

affects performance. In models 4 and 5, we include CROUDUAL, an interaction term of CEODUAL,

and OUTDIR. If the outside directors can mitigate the abuse of power by a Chairman CEO, this

variable should have a positive coefficient. Finally, in model 5, we introduce REIT property type and

corporate structure.19

Model 1 shows that performance is significantly related to all the included variables. Larger

REITs perform significantly better, as do those with better potential growth prospects. The

contribution made by outside directors is to significantly improve performance. This result, which is

robust in all the five specifications, supports McIntosh, Rogers, Sirmans and Liangs (1994)

contention that internal monitoring by directors can create shareholder wealth for REITs, and

corroborates Friday and Sirmans (1998) finding that increased outsider director representation on the

board is associated with increased market-to-value ratios as outsider representation climbs to 50%,

beyond which the benefits decline. Apparently, the inadequacy of the takeover market to monitor

REIT management makes the role of outside directors critical. The significantly negative coefficient

for the CEODUAL variable suggests that when the CEO is also the chairman of the board,

performance suffers significantly.

In model 2, we explore if the share ownership by outside directors and insider directors

excluding CEO can mitigate the adverse effects of the dual role by the CEO. All the variables from

model 1 continue to be significant with their signs unchanged. Among the new variables, share

ownership by non-CEO insider directors has no impact on performance, an indication of the

ineffectiveness of these insiders. In models 3, 4, and 5, ownership by affiliated outside directors

makes a significant contribution to performance. This result supports the notion that relationships

with outside directors can result in improved performance through possible cost savings, and other

partnership gains.20 The significantly negative association between performance and NAFFOWN,

share ownership by non-affiliated directors is intriguing. Recall that higher share ownership by

unaffiliated directors helps get more outside directors elected to the board, which improves

performance. However, on average, share ownership by both non-affiliated directors and

blockholders is less than ownership of affiliated counterparts. One explanation that is consistent with

the combined evidence is that while stock ownership by outside directors is crucial in getting thesedirectors elected to the board, high levels of ownership interferes with the operations.21

In model 3, we expand the scope of the CEOs control through his share ownership and

tenure in the position. Both variables have a significantly adverse impact on performance, as does

CEODUAL. It appears that even after we control for CEOs ownership and tenure, chairmanship by

CEO is harmful in and by itself. Overall, this corroborates our earlier contention that too much power


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concentrated in the CEOs hands is detrimental to corporate performance. To examine further the

potential for CEO retrenchment, we examine CEO share ownership against his tenure (t-statistics are

in parentheses):

CEOOWN =31.975 3.621*SIZE 0.174*MKTBOOK + 0.349*CEOTEN + 1.032*CEODUAL 0.962*OUTDIR(17.34) (17.05) (0.06) (7.91) (5.21) (12.98)

SIZE, CEOTEN, CEODUAL, and OUTDIR are all significant at 5% level. This is a strong

indication that when the CEO is the Chairman of the board, he also controls relatively higher

proportion of voting shares, and the effect gets more pronounced as the CEO retains the position over

a number of years. This evidence, in conjunction with the evidence that high CEO ownership hurts

performance raises a disturbing specter.22, 23 However, in models 4 and 5, the coefficient of

CROUDUAL, the interaction term between CEO duality and the percentage of outside directors on

the Board, is significantly positive which suggests that monitoring benefits of outside directors offset

the adverse effects associated with CEO being the chairman.

Model 4 focuses on the effectiveness of blockholders and institutional investors as additional

monitoring mechanisms. Consistent with the evidence for outside director stock ownership, affiliated

blockholders significantly contribute to performance, and so do institutional owners. But, similar to

non-affiliated directors, the impact of non-affiliated blockholders is significantly negative. Friday,

Sirmans, and Conover (1999) explore the impact of blockholders on REIT performance. Irrespective

of blockholder type, for ownership levels less than 5%, they identify some benefits; but, ownership

levels higher than 25% lead to entrenchment and hurt performance.

In model 5, we find that among REIT property types, Hotels, Retail and Office REITs are

significantly superior performers. REITs are predominantly of the UPREIT structure. Consistent

with our hypothesis, UPREIT structure does not seem to be conducive to performance. To check the

robustness of this result, we examine the effect of UPREIT on performance including only the basic

control variables. The coefficient for UPREIT is significantly positive. This would suggest that the

other control and structure variables are capturing the effect of UPREITs, and after controlling for

these effects, the complex UPREIT structure affords little benefit.

In Table 6, we present five similar models to explore the relationship between REIT

performance and the relative tenure of outside directors (RELTENR) as the proxy for Board

independence. The results corroborate the findings with percentage of outside directors. The impact

of the tenure of outside directors is significantly positive in all five models. This suggests that firms

benefit more from longer serving directors, apparently because they acquire firm-specific knowledge

and expertise. Longer serving directors may also be better aligned with shareholders interests. The


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impact of CEO ownership, CEO tenure, and CEO duality are significantly negative. Ownership of

shares by affiliated directors and blockholders has positive impact, ownership by nonaffiliated

directors and blockholders are negatively associated with performance.24

We summarize our findings on the impact of board composition on performance as follows:

1. The impact of outside directors, both in terms of the percentage of shares owned by them and

their tenure, is significantly positive. Thus, REIT shareholders benefit from the monitoring

activities of outside directors.

2. High stock ownership by CEO, long tenure of CEOs, and the structure where CEO is also the

chairman of the board, are detrimental to performance. This is attributable to agency

problems associated with the CEO garnering more power.

3. The effect of insider directors, other than the CEO, on performance is inconsequential.

4. Affiliated outside directors and blockholders enhance performance. This possibly resultsfrom cost savings and other synergistic gains from these partnerships.

5. Although non-affiliated directors and blockholders help get more outside directors elected to

the board, too much influence by these directors is detrimental to performance.

7. Simultaneous equations analysis

The results discussed above are generally consistent with the extant evidence on the

relationship between ownership structure, and board composition and performance reported recently

in Friday and Sirmans (1998), and Friday, Sirmans, and Conover (1999). However, our results are

not entirely in agreement with the conclusions in other papers in this area. Evidence on positive

relation between outside directors and valuation includes Rosenstein and Wyatt (1990; addition of

outside directors induce valuation gains), Byrd and Hickman (1992; bidders with majority of outside

directors make better acquisitions), Brickley, Coles and Terry (1994; valuation effect of poison pill

announcements is positively related to fraction of outside directors), and Cotter, Shivdasani, and

Zenner (1997; outside directors enhance shareholder gains in tender offers). Authors who report

negative/neutral relationship between performance and outsiders on the board include Shivdasani

(1993; probability of takeover is a decreasing function of additional outside directors), Agarwal and

Knoeber (1996; more outside directors is detrimental to firm performance), Loderer and Martin

(1997; significantly negative relation between acquiring firm returns and percentage shareholding of

shareholders and directors), Cho (1998; corporate value affects ownership structure, but not vice

versa), Subramanyam, Rangan and Rosenstein (1997; negative relation between abnormal returns and


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proportion of outside directors), and Misra and Neilsen (2000; negative to no significant relation

between performance and percentage of outside directors, although performance is significantly and

positively related to the tenure of outside directors).

A potential problem with our results based on ordinary least squares is the simultaneity of

relationships. The model for performance includes board independence and the ownership of shares

by the CEO, while the model for board independence includes performance and CEO ownership of

shares, and it may be argued that ownership of shares by the CEO is itself a function of corporate

performance, among other variables. Agarwal and Knoeber (1996), Loderer and Martin (1997), Cho

(1998) and Mishra and Nielsen (2000) recognize this possibility and develop simultaneous regression

models.

In tune with these authors, we estimate a simultaneous system of equations with performance

(ROE), board independence (OUTDIR/RELTENR), and CEO stock ownership (CEOOWN) as

endogenous variables and nine exogenous variables: Size, growth opportunity (market to book), CEO

Tenure, CEO duality, percent of shares owned by affiliated directors, percent of shares owned by

non-affiliated directors, percent of shares owned by affiliated blockholders, and percent of shares

owned by non-affiliated blockholders, and the interaction of CEO duality and board independence.

These equations are shown in Table 7. We use two stage least squares (2SLS) to estimate this

equation system. In order for the equations to be estimated, at least two exogenous variables must be

dropped from each equation. In our case, each equation is identified so that the 2SLS approach can

be used to estimate the system.

The model for each endogenous variable includes the other two exogenous variables. Board

independence enhances performance, while the impact of CEO ownership is an empirical issue. If

ownership of shares by the CEO aligns his interests with the shareholders, performance improves. If

high share ownership allows managers to entrench themselves, however, performance suffers. High

share ownership by affiliated directors deters election of independent directors, which, in turn,

adversely affects performance. Under the premise that affiliated directors and blockholders are

expected to be aligned with managers, ownership by these entities is detrimental to corporate

performance. Non-affiliated directors and blockholders should have the opposite effect.

The longer the tenure of the CEO, and the higher the ownership by the CEO, more difficult itis for outside directors to get elected to the board. The problem is exacerbated if the CEO also is the

chairman of the board. Superior performance of the firm, and greater growth opportunities may

induce the CEO to increase his holding of the firms shares. This will be facilitated if he is the

chairman of the board. Higher incidence of outside directors, and relatively longer tenure of outside


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directors may deter the CEO from controlling a large ownership of the firms shares to prevent

entrenchment.

Results are presented in Table 7. Two-stage least squares estimates are reported for both

measures of board independence. Performance is positively related to the percentage of outside

directors in the board, clearly the benefit of monitoring. The coefficient is significant only at the 10%

level, however. Performance is unaffected by the tenure of directors, however. REIT performance is

significantly and negatively related to ownership of shares of the CEO, a manifestation of potential

agency problems. REITs with better growth opportunities perform better. Finally, ownership by

affiliated directors and blockholders improve performance.

In the board independence equation, ownership of shares of the CEO has a significantly

negative coefficient. The effect of ownership by affiliated directors is similar. The significantly

positive coefficient of performance suggests that high-performance REITs generally have higher

percentage of outside directors. This result is consistent with the finding for banks by Mishra and

Nielsen (2000). The tenure of outside directors is negatively associated with the tenure of the CEO.

For the CEO ownership model, CEOs that are in the position for a longer period accumulate

larger number of company shares. As predicted, higher incidence of outside directors on the Board

deters accumulation of shares by the CEO. It is intriguing, however, that higher share ownership by

non-affiliated directors has a positive effect on share ownership by the CEO. A potential explanation

is that the CEO may increase his share holding to offset increasing control by outside directors.

We examine several different specifications of the three models, and the signs and

significance of the parameters remain comparable in all specifications. Two of the important

variables that are not in the models reported include shareholding by the inside directors other than

the CEO, and percentage holding by institutions. Inclusion of these variables in the models does not

make any significant changes in our results.

Overall, while the results from the two-stage model are similar to those of the single equation

model, the evidence on monitoring benefits of a higher percentage of outside directors on REIT

boards is weak at best. As we discussed, REITs operate in a highly regulated environment with

restrictive provisions on distribution policy, asset allocation, and ownership composition. Our results

indicate that the overall effect of these provisions is not significantly different from that for otherfirms: if outside directors on the Board enhance performance, the effect is weak. CEO characteristics

and ownership are more significant determinants of performance.


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8. Summary and Conclusions

This paper makes two important contributions. First, to our knowledge, this is the first

attempt to explore the determinants of board structure in the REIT world. Second, it develops a

comprehensive model to examine the impact of board structure on firm performance. Specifically,

our model incorporates both board structure and ownership structure simultaneously. Given the

phenomenal growth of REITs, both in number and market capitalization over the 1990s, the lack of

systematic examination of board structure, and the impact of ownership structure and board

independence on performance of REITs is surprising. This paper fills that void.

More significantly, the regulatory environment makes the study of REITs particularly

interesting. On one hand, special regulations, including mandatory distribution of REITs taxable

income, limit their free cash flow. Thus managers may not need to be closely monitored. On the

other hand, restrictions on ownership structure results in widely dispersed stock ownership, which

makes external monitoring through the takeover market less likely. Restricting sources of income to

real estate activities also constrains the effectiveness of the takeover market. The resulting absence of

hostile takeovers requires that alternative mechanisms, including external directors, must be in place

to monitor managerial behavior.

Our data reveal that greater representation by outside directors on REIT boards enhances

performance, although the relationship is weak. Similar results have been reported for banks.

Conceivably, the absence of a strong takeover market makes director monitoring critical. Consistent

with other studies, higher CEO stock ownership and control through tenure reduces the representation

by outside members and their tenure on REIT boards, and adversely affects REIT performance.

Institutional ownership (or blockownership) fails to serve as an alternate disciplining mechanism to

offset (inadequate) monitoring by outside board members. We conclude that, despite the various

regulatory restraints that REITs operate under, the CEO exerts a greater influence both on board

composition and performance, than do outside directors.


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Table 1

Summary of Restrictions for a Corporation to Qualify as a REIT

Regulation Description Impact on CorporateGovernance

1. Distribution Test A REIT must distribute at least 95 percent of

taxable income to its shareholders annually

Limits the availability of free

cash to managers. Reduces

the need to monitor.Positive

effect on Governance.

2. Ownership Test

A REIT must have at least 100 shareholders and

any 5 shareholders are prohibited from owning

more than 50 percent of a given REIT

Results in dispersed share

ownership. Increases

managers bargaining power

which may result in fewer

outsiders on Board. Negative

effect on Governance.

3. Income Test

At least 75 percent of a REITs income must

come from real estate related sources (including

rents or gains from real property, mortgage

interest, dividends or gains from owning otherREITs, and mortgages) and at least 95 percent of

its income must be in those sources plus non-

mortgage interest and dividend and gains from

non-REIT securities

Restricts takeovers to mostly

similar firms within the

industry. Discourages

hostile takeovers (Whidbee,and CGS). Negative effect on

Governance.

4. Asset Test

At least 75 percent of a REITs assets must be

cash, government securities, and real estate

related assets, including direct ownership,

leaseholds, or options in land or improvements,

shares in other REITs, and mortgages. At least

95 percent of its assets must be in those sources

plus non-mortgage interest and dividends and

gains from non-REIT securities. Also, a REIT

cannot own more than 10 percent of the voting

shares of a company or invest more than 5

percent of its assets in another company.

Restricts takeovers to mostly

similar firms within the

industry. Discourages

hostile takeovers (Whidbee,

and CGS). Negative effect on

Governance


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Table 2

Descriptive Statistics for REITs

Data are based on 1999 statements from SNL Data Services for accounting variables. Board and control

variables are based on the 1999 Proxy statements. Analysis includes 122 Equity REITs for which fulldata are available. ROA is return on average total assets. ROE is return on average total equity. Size is

logarithm of total market capitalization. Market-to-Book ratio is market value per share to book value

per share as of year-end 1999. OUTDIR is a proxy for board independence which is the ratio of the

number of outside directors to the total number of directors on the Board. RELTENR is a proxy for

board independence which is the ratio of average tenure of independent outside directors to the tenure of

the CEO. Independent (non-affiliated) outside directors are defined as those directors whose only

relationship with the firm is their board position. EXCEOOWN is the number of shares owned by officer

directors excluding the CEO as a proportion of the total number of shares outstanding. CEOOWN is the

number of shares owned by the CEO as a proportion of the total number of shares outstanding.

AFFOWN is the number of shares owned by affiliated outside directors as a proportion of the total

number of shares outstanding. NAFFOWN is the number of shares owned by non-affiliated outside

directors as a proportion of the total number of shares outstanding. CEOTEN is the number of years the

CEO has been in the position. CEODUAL is a dummy variable which has a value 1 when the CEO is

also the chairman of the board of directors and zero otherwise. AFFBLK is the number of shares owned

by affiliated blockholders as a proportion of the total number of shares outstanding. NAFFBLK is the

number of shares owned by non-affiliated blockholders as a proportion of the total number of shares

outstanding. INTNOWN is the number of shares owned by institutional investors as a proportion of the

total number of shares outstanding.

Variable Mean Std. Deviation Minimum Maximum

Return on Assets (ROA, %) 3.853 2.668 -3.550 14.280

Return on Equity (ROE, %) 9.425 11.205 -24.190 104.58

SIZE 6.135 1.279 1.970 8.740

MKT-to-BOOK 0.539 0.293 0.110 1.950OUTDIR (%) 61.030 15.091 16.670 88.890

RELTENR 1.843 2.418 0.000 17.330

AFFOWN (%) 2.346 6.012 0.000 37.370

NAFFOWN (%) 1.816 3.382 0.010 28.820

AFFBLK (%) 3.300 11.021 0.000 58.290

NAFFBLK (%) 2.435 8.113 0.000 67.460

INTNOWN (%) 16.838 16.762 0.000 67.960

EXCEOOWN (%) 2.228 6.434 0.000 56.480

CEOOWN (%) 6.154 9.622 0.020 51.680

CEOTEN (yrs) 5.333 5.347 0.000 37.000

CEODUAL 0.615 0.489 0.000 1.000


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Table 4

Heteroskedastically Corrected Estimates of the Association Between Board

Independence and Insider and Institutional Ownership

The Dependent Variable is Proportion of Independent (non-affiliated) Outside Directors on the Board of

Equity REITs (OUTDIR). OUTDIR is a proxy for board independence which is the ratio of the number

of outside directors to the total number of directors on the Board. RELTENR is a proxy for board

independence which is the ratio of average tenure of independent outside directors to the tenure of the

CEO. Independent (non-affiliated) outside directors are defined as those directors whose only

relationship with the firm is their board position. Three different specifications are presented. Data is

based on 1999 statements from SNL Data Services for accounting variables. Board and control variables

are based on the 1999 Proxy statements. Analysis includes 122 Equity REITs for which full data are

available. SIZE is logarithm of total market capitalization. MKT-to-BOOK ratio is market value per

share to book value per share as of year-end 1999. CEOOWN is the number of shares owned by the

CEO as a proportion of the total number of shares outstanding. CEOTEN is the number of years the

CEO has been in the position. CEODUAL is a dummy variable which has a value 1 when the CEO is

also the Chairman of the board of directors and zero otherwise. EXCEOOWN is the number of sharesowned by officer directors excluding the CEO as a proportion of the total number of shares outstanding.

AFFOWN is the number of shares owned by affiliated outside directors as a proportion of the total

number of shares outstanding. NAFFOWN is the number of shares owned by non-affiliated outside

directors as a proportion of the total number of shares outstanding. AFFBLK is the number of shares

owned by affiliated blockholders as a proportion of the total number of shares outstanding. NAFFBLK

is the number of shares owned by non-affiliated blockholders as a proportion of the total number of

shares outstanding. INTNOWN is the number of shares owned by institutional investors as a proportion

of the total number of shares outstanding.

The following models are estimated:

Model 1: OUTDIR = + 1111 ROE + 2222 SIZE + 3333 CEOOWN + 4444 CEOTEN + 5555 CEODUAL

Model 2: OUTDIR = + 1111 ROE + 2222 SIZE + 3333 CEOOWN + 4444 CEOTEN + 5555 CEODUAL + 6666 EXCEOOWN

+ 7777 AFFOWN + 8888 NAFFOWN

Model 3: OUTDIR = + 1111 ROE + 2222 SIZE + 3333 CEOOWN + 4444 CEOTEN + 5555 CEODUAL + 6666 EXCEOOWN

+ 7777 AFFOWN + 8888 NAFFOWN + 9999 INTNOWN + 10101010 AFFBLK + 11111111 NAFFBLK + 12121212 MKTBOOK

Model 4: RELTENR = + 1111 ROE + 2222 SIZE + 3333 CEOOWN + 4444 CEODUAL + 5555 EXCEOOWN

+ 6666 AFFOWN + 7777 NAFFOWN + 8888 INTNOWN + 9999 AFFBLK + 10101010 NAFFBLK + 11111111 MKTBOOK

(T-statistics are presented in parentheses)


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Table 4 (Contd.)

Dependent Variable: OUTDIR Dependent Variable:

RELTENRIndependentVariables

Model 1 Model 2 Model 3 Model 4CONSTANT 70.346**

(8.844)

59.874**

(7.533)

59.563**

(7.398)

1.809**

(4.159)

ROE 0.028(0.231)

0.252**

(2.298)

0.331**

(2.502)

0.020**

(3.120)

SIZE -1.133(0.977)

0.407

(0.359)

0.363

(0.301)

0.049

(0.840)

CEOOWN -0.198(1.324)

-0.145

(0.991)

-0.102

(0.669)

-0.025**

(5.089)

CEOTEN -0.009(0.038)

0.157

(0.681)

0.210

(0.884)

CEODUAL -2.281(0.831)

-4.679*

(1.777)

-4.322*

(1.620)

-0.022

(0.134)

EXCEOOWN -0.266*(1.627)

-0.311*(1.872)

-0.003(0.381)

AFFOWN -0.929**(5.589)

-0.928**

(5.372)

-0.017

(1.381)

NAFFOWN 1.033**(2.382)

0.938**

(2.025)

0.003

(0.269)

AFFBLK -0.027(0.246)

-0.022**

(4.527)

NAFFBLK 0.041(0.263)

-0.025**

(6.160)

INTNOWN 0.083(1.038)

-0.017**

(3.458)

MKT-to-BOOK -3.850(0.718)

0.038

(0.187)

R-squared (Adj.) 0.043 0.211 0.227 0.047

** (*): Significant at the 5% (10%) levels.


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Table 5


Independence and REIT Performance

The dependent variable is return on equity (ROE). Data are based on 1999 statements from SNL Data

Services for accounting variables. Board and control variables are based on the 1999 proxy statements.

Analysis includes 122 Equity REITs for which full data are available. SIZE is logarithm of total market

capitalization. MKT-to-BOOK ratio is market value per share to book value per share as of year-end

1999. OUTDIR is a proxy for board independence which is the ratio of the number of outside directors

to the total number of directors on the board. Independent (non-affiliated) outside directors are defined

as those directors whose only relationship with the firm is their board position. EXCEOOWN is the

number of shares owned by officer directors excluding the CEO as a proportion of the total number of

shares outstanding. CEOOWN is the number of shares owned by the CEO as a proportion of the total

number of shares outstanding. AFFOWN is the number of shares owned by affiliated outside directors as

a proportion of the total number of shares outstanding. NAFFOWN is the number of shares owned by

non-affiliated outside directors as a proportion of the total number of shares outstanding. CEOTEN is

the number of years the CEO has been in the position. CEODUAL is a dummy variable which has a

value 1 when the CEO is also the chairman of the board of directors and zero otherwise. AFFBLK is the

number of shares owned by affiliated blockholders as a proportion of the total number of sharesoutstanding. NAFFBLK is the number of shares owned by non-affiliated blockholders as a proportion

of the total number of shares outstanding. INTNOWN is the number of shares owned by institutional

investors as a proportion of the total number of shares outstanding. CROUDUAL is a cross product of

percentage of outside directors and the CEODUAL dummy. RETD, RESD, OFFD, INDD, HOTD are

dummy variables which have a value 1 for Retail, Restaurant, Office, Industrial, and Hotel REITs and

zero otherwise. The control sample includes mainly Diversified Equity REITs. UPREITD is a dummy

variable which has a value 1 for REITs with UPREIT structure. The control sample includes REITs

with Traditional and DownReit Structures.

The following five models are estimated:

Model 1: ROE = + 1111 SIZE + 2222 MKTBOOK + 3333 OUTDIR + 4444 CEODUAL

Model 2: ROE = + 1111 SIZE + 2222 MKTBOOK + 3333 OUTDIR + 4444 CEODUAL + 5555 EXCEOOWN + 6666 AFFOWN

+ 7777 NAFFOWN


+ 7777 NAFFOWN + 8888 CEOOWN + 9999 CEOTEN


+ 7777 NAFFOWN + 8888 CEOOWN + 9999 CEOTEN + + 10101010 AFFBLK + 11111111 NAFFBLK + 12121212 INTNOWN

+ 13131313 CROUDUAL


+ 7777 NAFFOWN + 8888 CEOOWN + 9999 CEOTEN + 10101010 CROUDUAL + 11111111 RETD + 12121212 RESD

+ + + + 13131313 OFFD + 14141414 INDD + 11111111 HOTD + 12121212 UPREITD



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27

Table 5 (Contd.): Board independence (OUTDIR); n = 122

Independent Variables Model 1 Model 2 Model 3 Model 4 Model 5

CONSTANT -3.64**

(2.685)

-3.387**

(2.729)

-6.892**

(2.360)

3.879

(1.311)

3.874

(1.512)

SIZE 1.064**

(7.241)

0.497**

(3.137)

-0.307

(1.183)

-1.091**

(4.046)

-1.169**

(4.721)

MKT-to-BOOK 3.411**

(2.520)

24.458**

(9.625)

21.392**(10.770)

15.938**(9.411)

15.715**(9.583)

OUTDIR 0.085**

(6.717)

0.015*

(1.662)

0.119**(3.835)

0.043(1.501)

0.052*(1.767)

AFFOWN 0.029

(0.426)

0.559**

(5.428)

0.772**

(8.368)

0.777**

(7.603)

NAFFOWN -0.246**

(5.649)

-0.288**

(3.503)

-0.302**

(4.319)

-0.457**

(8.948)

AFFBLK 0.138**

(5.176)

0.136**

(6.129)

NAFFBLK -0.042**

(2.738)

-0.036**

(2.361)

INTNOWN 0.445**(5.278)

0.062**

(5.008)

EXCEOOWN 0.027

(0.979)

0.201**

(4.001)

0.035

(1.233)

0.022

(0.809)

CEOOWN -0.152**

(11.120)

-0.176**

(8.064)

-0.188**

(8.789)

CEOTEN 0.024

(0.396)

-0.129**

(2.714)

-0.116**

(2.232)

CEODUAL -4.288**

(2.685)

-4.554**

(5.310)

-4.242*

(1.766)

-9.882**

(3.789)

-10.343**

(4.615)

CROUDUAL 0.174**

(4.423)

0.170**

(5.124)

RETD 1.502**

(2.711)

RESD 1.360**

(1.999)

OFFD 1.029

(1.104)

INDD -0.702

(0.663)

HOTD 7.632**(8.443)

UPREITD -1.789**

(3.698)

R-Squared (adjusted) 0.113 0.269 0.417 0.486 0.524



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Table 6


Independence and REIT Performance

The dependent variable is return on equity (ROE). Data are based on 1999 statements from SNL Data


Analysis includes 122 Equity REITs for which full data are available. SIZE is logarithm of total market

capitalization. MKT-to-BOOK ratio is market value per share to book value per share as of year-end

1999. RELTENR is a proxy for board independence which is the ratio of average tenure of independent

outside directors to the tenure of the CEO. Independent (non-affiliated) outside directors are defined as

those directors whose only relationship with the firm is their board position. EXCEOOWN is the number

of shares owned by officer directors excluding the CEO as a proportion of the total number of shares

outstanding. CEOOWN is the number of shares owned by the CEO as a proportion of the total number

of shares outstanding. AFFOWN is the number of shares owned by affiliated outside directors as a

proportion of the total number of shares outstanding. NAFFOWN is the number of shares owned by

non-affiliated outside directors as a proportion of the total number of shares outstanding. CEOTEN is

the number of years the CEO has been in the position. CEODUAL is a dummy variable which has a

value 1 when the CEO is also the chairman of the board of directors and zero otherwise. AFFBLK is thenumber of shares owned by affiliated blockholders as a proportion of the total number of shares

outstanding. NAFFBLK is the number of shares owned by non-affiliated blockholders as a proportion

of the total number of shares outstanding. INTNOWN is the number of shares owned by institutional

investors as a proportion of the total number of shares outstanding. CROUDUAL is a cross product of

percentage of outside directors and the CEODUAL dummy. RETD, RESD, OFFD, INDD, HOTD are

dummy variables which have a value 1 for Retail, Restaurant, Office, Industrial, and Hotel REITs and

zero otherwise. The control sample includes mainly diversified equity REITs. UPREITD is a dummy

variable which has a value 1 for REITs with UPREIT structure. The control sample includes REITs

with Traditional and DownReit Structures.

The following five models are estimated:

Model 1: ROE = + 1111 SIZE + 2222 MKTBOOK + 3333 RELTENR + 4444 CEODUAL

Model 2: ROE = + 1111 SIZE + 2222 MKTBOOK + 3333 RELTENR + 4444 CEODUAL + 5555 EXCEOOWN + 6666 AFFOWN

+ 7777 NAFFOWN


+ 7777 NAFFOWN + 8888 CEOOWN + 9999 CEOTEN


+ 7777 NAFFOWN + 8888 CEOOWN + 9999 CEOTEN + 10101010 AFFBLK + 11111111 NAFFBLK + 12121212 INTNOWN

+ 13131313 CROUDUAL


+ 7777 NAFFOWN + 8888 CEOOWN + 9999 CEOTEN + 10101010 AFFBLK + 11111111 NAFFBLK + 12121212 INTNOWN

+ 13131313 CROUDUAL + 14141414RETD + 15151515 RESD + + + + 16161616 OFFD + 17171717 INDD + 18181818 HOTD + 19191919 UPREITD



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29

Table 6 (Contd.): Board independence (RELTENR); n = 118

Independent Variables Model 1 Model 2 Model 3 Model 4 Model 5

CONSTANT -3.101**

(3.892)

1.589*

(1.849)

5.391**

(3.955)

6.350**

(3.832)

6.681**

(4.835)

SIZE 0.527**

(5.804)

-0.086

(0.766)

-0.765**

(3.437)

-1.095**

(4.139)

-1.141**

(4.574)

MKT-to-BOOK 18.256**

(12.140)

15.073**

(10.750)

17.104**(9.536)

15.309**(8.892)

15.238**(9.219)

RELTENR 0.245*

(1.620)

0.335**

(2.031)

0.700(0.436)

0.250*(1.777)

0.231*(1.654)

AFFOWN 1.373**

(6.446)

0.712**

(5.468)

0.788**

(7.741)

0.778**

(7.891)

NAFFOWN -0.309**

(11.970)

-0.212**

(4.143)

-0.351**

(5.346)

-0.453**

(8.227)

AFFBLK 0.147**

(4.898)

0.141**

(6.455)

NAFFBLK -0.047**

(4.464)

-0.031**

(2.321)

INTNOWN 0.051**(4.160)

0.063**

(4.645)

EXCEOOWN -0.068**

(5.258)

-0.003

(0.129)

0.033

(1.177)

0.019

(0.756)

CEOOWN -0.212**

(9.950)

-0.156**

(8.283)

-0.173**

(9.343)

CEOTEN -0.172**

(2.517)

-0.083

(1.350)

-0.072

(1.240)

CEODUAL -1.601**

(2.623)

-1.628**

(2.829)

0.598

(1.124)

-13.958**

(11.930)

-14.844**

(12.130)

CROUDUAL 0.231**

(10.830)

0.235**

(11.910)

RETD 1.298**

(2.329)

RESD 0.789

(1.161)

OFFD 0.883

(0.915)

INDD -0.893

(0.892)

HOTD 7.287**(7.649)

UPREITD -1.388**

(2.801)

R-Squared (adjusted) 0.265 0.356 0.424 0.496 0.530



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30

Table 7

Two-Stage Least Squares (2SLS) Estimates of the Association Between

Board Independence, CEO Ownership and Performance of REITs

The system consists of three equations: Return on equity (ROE), board independence (OUTDIR and

RELTENR), and CEO ownership (CEOOWN). Data are based on 1999 statements from SNL Data


Analysis includes 122 Equity REITs for which full data are available. We use the following variables as

exogenous: SIZE is logarithm of total market capitalization. MKT-to-BOOK ratio is market value per

share to book value per share as of year-end 1999. Board Independence is measured as either OUTDIR

which is the percentage of shares owned by the CEO, or RELTENR which is the ratio of average tenure

of independent outside directors to the tenure of the CEO. Independent (non-affiliated) outside directors

are defined as those directors whose only relationship with the firm is their board position. EXCEOOWN

is the number of shares owned by officer directors excluding the CEO as a proportion of the total

number of shares outstanding. CEOOWN is the number of shares owned by the CEO as a proportion of

the total number of shares outstanding. AFFOWN is the number of shares owned by affiliated outside

directors as a proportion of the total number of shares outstanding. NAFFOWN is the number of shares

owned by non-affiliated outside directors as a proportion of the total number of shares outstanding.

CEOTEN

Documents

Board Independence Ownership Structure and Performance in REITs 032702