Corporate Governance of Asian REITs:Introducing a New Framework of Analysis

Patrick Lecomte* & Joseph Ooi#

* ESSEC Business School (Singapore)# National University of Singapore

1. Introduction

• This paper addresses the issue of corporate governance practices in emerging Asian REIT markets.

• It deals with two important questions:– How can we gauge the quality of corporate

governance of Asian REITs?– How effective are governance mechanisms in

fostering performances of the listed property sector in Asia?

Outline• PART I

– Introduces an original framework to measure the quality of corporate governance amongst externally managed Asian REITs: the R-Index of Corporate Governance.

– As a pilot study, the framework is applied to REITs listed on the Singapore Stock Exchange (S-REITs).

– A project done in collaboration with the Asian Public Real Estate Association (APREA) as well as major global investors being part of an adhoc Advisory Committee (Asset Managers, Institutions, SWFs).

• PART II– Examines the relationship between corporate governance

and performances: equity performances (stock returns), operating performances (ROA, ROE).

2. Literature Review

• Moral hazard problem arises due to separation of ownership from management:– Managers do not always act in the best interest of the owners.

• Governance mechanisms are designed to monitor managers and mitigate the potential conflict of interest between owners and managers:– Internal governance provisions: board of directors, various monitoring

committees, role separation of CEO from Chairman, stock ownership by managers, performance-based compensation.

– External governance provisions: takeover threat will remove inefficient management.

REIT Evidence Authors (Year) Data, Proxies, and Results

McIntosh, Rogers, Sirmans & Liang (1994)

55 REITs traded on NYSE and AMEX (1969-1990). Inverse relationship between stock price performance and the probability of a management change.

Friday, Sirmans & Conover (1999)

399 Equity REITs; 276 hybrid and mortgage REITs (1980-1994). Nonlinear relationship between firm value and ownership structure. Inside ownership reversely affects M/B ratio.

Ghosh & Sirmans (2003)

122 equity REITs (1999). Independent directors, block and institutional ownership weakly enhance performance, whilst higher stock ownership and control of the board adversely affect performance (ROA/ROE).

Hartzell, Sun & Titman (2006)

153 Equity REITs (1995-2004). Strong links between investment behaviors (real estate asset growth, equity growth and debt growth proxy for investment rate) and ownership structure. Well-governed REITs invest more.

Bianco, Ghosh & Sirmans (2007)

58 REITs in 2004 & 53 REITs in 2006. G-index has but a weak effect on REIT performance (ROA, ROE, stock return and FFO/total revenue). Impact diminishing over time.

Bauer, Eichholtz & Kok (2010)

> 220 REITs and 5000 firms (2003-2005). For the full sample, a strong and significantly positive relation between CGQ index and performance (Tobin’s q, ROE, ROA, Net Profit Margin and 5-year SALES, Fund-for-operations growth). For the REIT sample, this relationship is only found in the case of REITs with low payout ratios.

Ooi (2010) 20 externally managed SREITs. Market rewards REITs that pay managers a low base fee + a high incentive fee that is benchmarked against a pre-determined level of performance.

Measures of Corporate Governance in REIT Studies

• Past research analyzes corporate governance of REITS by looking at:– Individual governance provisions: e.g. Anglin, Edelstein,

Gao, Tsang (2010).– Academic indices of corporate governance such as the G-

Index developed by Gompers, Ishii and Metrick (2003): e.g. Bianco, Ghosh and Sirmans (2007).

– Commercial indices of corporate governance such as the Corporate Governance Quotient Index (CGQ) developed by RiskMetrics: e.g. Bauer, Eichholtz, and Kok (2010).

• REIT studies have been based on measures which are not REIT specific.

3. Rationale for the R-Index• A corporate governance index specifically designed for

externally managed Asian REITs.• The R-Index encompasses both internal and external

provisions. Corporate governance literature shows that they are strong complements in generating abnormal long term returns (Cremers and Nair, 2005):– Individual provisions miss interactions among provisions (Larcker,

Richardson, Tuna; 2007)– G-Index focuses on external governance, which makes it irrelevant for

most REITs (Bianco, Ghosh and Sirmans, 2007), especially in Asia.– Commercial indices present many shortcomings:

• US centric whereas governance practices are country/ region specific (Doidge, Karolyi, Stulz; 2007)

• Inability to properly capture effects of corporate governance resulting in measurement inconsistencies (Larcker et al., 2007; Daines, Gow and Larcker, 2009).

• Black boxes: comparative studies mostly (e.g. « REIT effect »).

Idiosyncracies of Asian REITs• External management

(Singapore, Japan, Malaysia, South Korea, and most Hong Kong REITs as of December 2009)

• Strong pivotal shareholder (Sponsor)

• Oligopolistic property markets with relatively narrow space markets (e.g. Singapore, Hong Kong)

Entrenchment of ManagerFee Structure Alignement of Manager’s and unitholders’ interests

Involvement of Sponsor in REIT management (Manager)Transparency of management policiesRelated Party Transactions

Related Party Transactions Board Matters

Externally Managed Asian REITs: Generic Trust Structure

TRUST

SPONSOR OTHER UNITHOLDERS

TRUSTEE

(*) The Sponsor has a significant holding in the REIT.(**) Including base fee, performance fees and acquisition / divestment fees.(***) Property management fees might include leasing commissions.

REIT Sponsor typically has significant control

over Trust Manager (*)Distributions Distributions

Investment in REIT

Acts on behalf of unitholders

Trustee’s FeesManages the

Trust

MgmntFees (**)

Purchases & sells assets

Net Property Income

Manages properties

PROPERTYMANAGER

TRUSTMANAGER

Ppty Mgmnt Fees (***)

Source: The authors and JP Morgan (2009)

4. Methodology of the R-IndexThe R-Index encompasses 27 governance provisions spanning 8 categories of both external and internal corporate governance. The score is the sum of 99 (objective) elements including 75 core elements, 13 bonuses and 11 penalties.

1. Fees (24%)2. Related Party Transactions (16%) 3. REIT Organization (15%)4. Gearing (6%)5. Board Matters (19%)6. Remuneration Matters (8%)7. Audit Committee (6%)8. Ownership (5%)

Specific to externally managed REITs

For each category, the scorecard provides a sub-score. The higher the score and sub-scores, the better the corporate governance practices of the REIT. The index range [-11; +88] with a

median at 38.5.

R-Index Scores  2003 2004 2005 2006 2007 2008R-INDEX [-11; 88]

Minimum 12 12 12 13 13 13Mean 18.5 19.33 21.14 22.13 22.71 23.38

Median 20 22.5 22.5 22 23 24Maximum 23.5 23.5 28 30 29.5 29.5

Std Deviation 5.89 6.37 4.97 4.52 4.34 4.14

SUB-SCORESBoard Matters [-1; 18] 6.5 7.17 6.64 7.58 7.79 8.1

Audit Committee [-1; 5] 1.33 1.5 2.21 1.75 2.38 2.38Remuneration [-1; 7] 0 0 1 0.83 0.79 0.55

REIT Org [-1; 14] 2 2.33 2.71 3.33 3.29 3.67Fees [-3; 21] 4 3.33 2.71 2.83 2.68 3.19

RPTs [-1, 15] 2.67 3 3.29 2.88 3.12 2.98Gearing [-1; 5] 1 1.33 1.71 2.08 1.88 1.81

Ownership [-2; 3] 1 0.67 0.86 0.83 0.76 0.71

5. Effectiveness of Governance

• Main hypothesis: “Corporate governance, by aligning the interestof owners and managers, has a positive impact

on S-REITs performances.”• Univariate analysis:

– Portfolio returns (based on two portfolios partitioned according to R-Index total scores) indicate governance has an impact on REIT stock performance.

– Specifically, S-REITs that are ranked above the median score registered 1.6 percentage points stock outperformance over those ranked below the median score (significant at the 10% level).

Regression results

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OLS Regression 2SLS RegressionExplanatory Variables

Excess Returns

Abnormal Returns

Excess Returns

Abnormal Returns

Intercept -0.1658 -0.0581*** -0.3283 -0.1106***R-Index Score -0.0007 0.0006* 0.0095* 0.0009**Market-to-book ratio 0.1176 0.0041 0.052 -0.0012Firm size 0.0273 0.0055*** 0.0095 0.0117***Debt-to-equity ratio -0.0020* 0.00004 -0.0014* 0.0001

R2 0.261 0.529 0.53 0.651No. of Observations 64 64 43 43

Results

• No significant relationship between R-Index and accounting returns proxied by ROA and ROE: consistent with literature (e.g. Gompers et al., 2003; Bauer et al., 2010).

• Why do S-REITs with higher R-Index register better stock returns? Several hypotheses:– Attractiveness to foreign investors (Leuz, Lins, and Warnock, 2008) :

lack of public data.– Information asymmetry: the bid-ask spread is significantly narrower

for REITs with appropriately structured governance (-0.013 on average over the 2004-2008 period). Hence, better corporate governance practices foster the market efficiency of Singapore’s listed real estate sector.

6. Concluding Remarks• The paper introduces the R-Index which is the first index of

corporate governance specifically designed for externally managed REITs / Asian REITs.

• Pressing issue for institutional investors as well as market authorities:Where will be the center for REIT listing/trading in Asia?

• Ongoing project: consultations with S-REITS’ managers and the Singapore government under the umbrella of APREA.

• Current research is adapting the scorecard to other Asian REIT regimes and benchmarking the scores.