How Does Corporate Governance Affect the Quality of Investor Information? The Curious Case of REITs

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H o w D o e s C o r p o r a t e G o v e r n a n c e A f f e c t

t h e Q u a l i t y o f I n v e s t o r I n f o r m a t i o n ?

T h e C u r i o u s C a s e o f R E I Ts

A u t h o r s Pa u l A n g l i n , R o b e r t E d e l s t e i n , Ya n m i n G a o , a n d D e s m o n d T s a n g

A b s t r a c t Recent research suggests that the unique legal and organizational structure of Real Estate Investment Trusts (REITs), relative to other types of corporations, may vitiate the need for and the effectiveness of internal corporate governance. Our results indicate that information asymmetry, as measured by the percentage bid-ask spreads demanded by the market, is reduced by appropriately structured REIT governance. Using data from the 2003 to 2006 period, we find that increasing the financial incentives for board members reduces asymmetric information, and that the combination of experienced board members and independent audit committees with financial expertise diminishes asymmetric information.

This study explores how corporate governance affects the quality of investor information for Real Estate Investment Trusts (REITs). In theory, information asymmetry facilitates economic rent seeking by advantaged corporate managers and other insiders vis-a`-vis public shareholders. Empirical research in corporate finance claims that better corporate governance improves a firm’s performance (e.g., Gompers, Ishii, and Metrick, 2003; and Cremers and Nair, 2005), improves market efficiency, and reduces information asymmetry. Surprisingly, two recent studies (Bianco, Ghosh, and Sirmans 2007; and Bauer, Eichholtz, and Kok, 2010) fail to find a strong relation between the quality of a REIT’s corporate governance and its value or operating performance. We use the special characteristics of a REIT as an opportunity to examine the role of governance and its relationship to market information asymmetry, in general.

REITs differ from other C corporations in several pertinent ways. By law, REITs have limited authority to invest in activities other than real estate. By their nature, they tend to focus on a single real estate property type and/or concentrated geographic locations. REITs must distribute 90% of taxable income to investors each year (95% before 1999). Bianco, Ghosh, and Sirmans (2007) argue that managers at a company where cash is distributed to shareholders as soon as

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possible have less opportunity for mischief; and the managers must provide precise and frequent public information to obtain external financing.

REITs also differ from C corporations in their ownership characteristics. The five largest REIT shareholders are not allowed to own 50% of the company.1Although Jensen (1993) indicates that corporate takeovers and the ‘‘market’’ for corporate control are important external mechanisms limiting managerial actions, the lack of concentrated REIT share ownership protects the managers of a poorly performing REIT from takeover or being ousted by majority shareholders (e.g., Campbell, Ghosh, and Sirmans, 2001). A small investor would tend to have insufficient resources and incentives to monitor management. Without strong and sophisticated external influences on governance, internal self-generated governance becomes crucial to ensure that a REIT’s manager’s self-interests are aligned with those of shareholders.

We study the link between REIT governance and information asymmetry.2 Good corporate governance can affect market efficiency by decreasing the level of asymmetric information between informed insiders, such as managers, and public shareholders. If insiders cannot withhold or otherwise distort public information, then shareholders may feel more confident about understanding the risks of investing, and attendant adverse selection problems (Glosten and Milgrom, 1985). This hypothesis is significant because good governance is supposed to affect the capital markets’ processing of available information in order to ensure proper resource allocations to firms.

Our key issue is: Do the legal and regulatory constraints on REITs serve as effective substitutes for good corporate governance? Prior research has examined information asymmetry without regard to governance and found that REIT insiders have considerable information advantages relative to outside shareholders, as evidenced by lower liquidity and by fewer analysts following REIT stocks (e.g., Damodaran and Liu, 1993; Below, Kiely, and McIntosh, 1995; Wang, Erickson, and Chan, 1995; Wang, Erickson, Gau, and Chan, 1995; and Glascock, Hughes, and Varshney, 1998). Subsequent analyses (Below, Kiely, and McIntosh, 1996; Bhasin, Cole, and Kiely, 1997; Clayton and MacKinnon, 2000; and Marcato and Ward, 2007) show that the liquidity of the public REIT market improved over time, at that same time many large REITs were being created.

Our study adds to the limited existing empirical evidence about corporate governance’s impact on information asymmetry (e.g., Chung, Elder, and Kim, 2010). We focus on the relationship between the internal governance of REITs, as measured by characteristics of the board of directors and the audit committees, and the level of market information asymmetry. We classify governance variables into four broad categories: (1) board characteristics, (2) directors’ experience, (3) directors’ compensation, and (4) audit committee characteristics.

Information asymmetry is measured by percentage bid-ask spread. The empirical results indicate that information asymmetry is related to the quality of corporate

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governance. We generally find strong evidence that high-quality governance on the board of directors and on the audit committees significantly reduces information asymmetry. We also find that audit committee characteristics, a previously unexplored aspect of governance for REITs, exert the strongest influences on information asymmetry. These findings suggest that the special features of the REIT market do not completely obviate the need for good internal corporate governance.

The paper contains a review of the related real estate literature on corporate governance and information asymmetry. There is also a discussion of the key hypothesis, as well as the empirical methodology. The data are described next and there is a discussion of the results. The paper closes with concluding remarks.

L i t e r a t u r e R e v i e w

C o r p o r a t e R E I Ts G o v e r n a n c e

The unique structure of REITs has attracted academics with an interest in corporate governance. However, the empirical evidence is mixed. Capozza and Seguin (2003) find that higher levels of insider ownership are associated with higher valuation of REITs. Han (2006) finds a significant non-linear relation between firm values and insider ownership. In contrast, Ghosh and Sirmans (2003) find that boards with independent directors weakly enhance REIT performance, that concentrated CEO ownership adversely affects performance, and that the presence of institutional investors improves performance. Feng, Ghosh, and Sirmans (2005) show that companies with better governance perform better on average, but the effect is significant for the best and worst boards. Friday and Sirmans (1998) show that increased representation on the board by outside directors generally increases a firm’s market-to-book ratio. However, investors seem to discount REIT shares when outside representation becomes too large. Friday, Sirmans, and Conover (1999) find limited empirical support for the relationship between inside block ownership and market-to-book ratios and company performance.

Bianco, Ghosh, and Sirmans (2007) investigate the relationship between a corporate governance index (widely known as the G-Index)3 and REIT performance. They find a positive relationship for 2004, but the effect disappears in 2006. Bauer, Eichholtz, and Kok (2010) examine the relation between the Corporate Governance Quotient Index (CGQ)4 and firm performance. They uncover a significant relationship but only for firms with low dividend payout ratios.

Hartzell, Kallberg, and Liu (2008) show that firms with stronger corporate governance have both a higher IPO valuation and better operating performance. These findings are interesting for two reasons. First, they show the importance of

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governance. Second, by specifically studying the cost of raising financial resources, this study confirms the assumption that forcing firms to distribute almost all earnings annually may affect finance-related decisions over time. Their research also uses data on management incentives and, as expected and in the direction expected, they find that investors react to various incentives. Hartzell, Sun, and Titman (2006) do not find a strong relationship between corporate governance and firm values for REITs, although they do find evidence that the responsiveness of a REIT’s investment expenditures depends on its corporate governance structure.

R E I T I n f o r m a t i o n A s y m m e t r y

Demsetz (1968) argues that market makers suffer losses while trading with informed traders and will need to recover such losses via a larger bid-ask spread. Thus, numerous studies utilize the percentage bid-ask spread as the proxy for information asymmetry (e.g., Venkatesh and Chiang, 1986).

Real estate research shows that the bid-ask spread for REITs has declined over the last two decades, though not always in a straight line, and it tends to be higher than that for other types of investments. Damodaran and Liu (1993) show that REIT insiders have significant information advantages compared to outside shareholders. In their early study, Ghosh, Miles, and Sirmans (1996) find that the percentage bid-ask spread for REITs is greater than for the general stock market. They conjecture that the greater spread compensates for the higher volatility of the REIT market. In another early study, Glascock, Hughes, and Varshney (1998) find that the costs of information asymmetry, also measured by the bid-ask spread, are significantly greater for REITs than for the general stock market (after IPOs). Below, Kiely, and McIntosh (1995, 1996) show that REITs have greater spreads than other stock sectors, but that the spread declined over time. Nelling, Mahoney, Hildebrand, and Goldstein (1995) show that the bid-ask spread increased between 1986 and 1990. Bhasin, Cole, and Kiely (1997) find that percentage bid-ask spread declined significantly between 1990 and 1994. Cole (1998) attributes this decline to the many new REITs formed during the 1992 REIT boom, while Clayton and MacKinnon (2000) find that the liquidity of REITs improved between 1993 and 1996 because the effects of an increase in the number of liquidity traders dominate the effects of an increase in the presence of more informed traders. Bertin, Kofman, Michayluk, and Prather (2005) use intraday data and, when the liquidity measure is friction-based, find that liquidity is lower for REITs than for common stock.

Some recent research has focused on how the characteristics of a REIT might affect information asymmetry. Downs, Gu¨ner, and Patterson (2000) find that information asymmetry is lower for REITs that distribute more capital to their shareholders, indicating real estate investors obtain important information from the capital distribution policies of REITs. McDonald, Nixon, and Slawson (2000) show that REITs can signal private information to the market through their

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dividend announcements. For small equity REITs, they find that the measure of information asymmetry increases the day before the announcement and declines subsequently. Danielson and Harrison (2000) show that REITs with more focused investment strategies and a higher percentage of direct property investments possess less private information and are more liquid.

H y p o t h e s i s a n d E m p i r i c a l M e t h o d o l o g y D e v e l o p m e n t

Information asymmetry can be diminished either by the external public sector, market or internal corporate mechanisms. Our strategy is to develop a statistical model for testing the effects of REIT internal governance on information asymmetry.

REIT investors should prefer stronger governance because it should reduce the ‘‘advantages’’ of insiders. Since public REITs raise funds in the capital market, one would expect a significant relationship between corporate governance and the level of information asymmetry. These notions are used to form the following hypothesis:

H1: There is a significant relationship between corporate governance and information asymmetry.

We investigate this relationship by regressing a proxy of information asymmetry (IA) on a comprehensive set of corporate governance (CG) measures, controlling for other non-governance variables (Controls):

IA⫽ ␣ ⫹␤CG ⫹␥Controls⫹␧. (1)

Our data are derived from several databases for the period 2003 to 2006. The Corporate Library, the source of our governance data, offers data only since 2003. By beginning the analysis with 2003, we can take the impact of the Sarbanes-Oxley Act of 2002 as a fixed historic event. Other data that are essential to construct the dependent and control variables are obtained from Compustat, CRSP, and I/B/E/S.

To measure the dependent variable, we follow the literature and proxy IA using the percentage bid-ask spread:5

SPREAD(Ask PriceBid Price)/((Ask PriceBid Price)/2)

* 100. (2)

We measure CG by using a wide range of variables for the structure and activities of the board of directors and its audit committee. Similar to prior research in this

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area, BOARD IND, defined as the percentage of fully independent directors on the board, is expected to be negatively related to SPREAD. Prior research documents that BOARD SIZE, measured as the number of directors, is expected to have a positive relationship with SPREAD. BOARD MEET measures the number of full board meetings held per year and we expect a negative relationship between BOARD MEET and SPREAD.

The effectiveness of a board may depend on the experience of its members. We use two variables to capture the board’s experience: DIR TENURE, the percentage of directors with tenure exceeding 15 years, and DIR EXP, the percentage of directors with more than four concurrent corporate (public) directorships.6 Since directors who have been on a board for a longer time are more familiar with more aspects of a company, they should be better able to interpret reports and ask significant questions of management; more experienced directors should be able to monitor management more effectively. Therefore, we expect an increase in either of these variables to reduce SPREAD.

Moreover, we include DIR COMP, the reported directors’ base compensation, and

DIR SHARE, values of company stock owned by the board of directors, as

independent variables. We expect higher directors’ base compensation and greater directors’ stock holdings to reduce information asymmetry.

The Sarbanes-Oxley Act mandates the disclosure of ‘‘financial experts’’ among the audit committee and several studies have looked at the effects of their presence. Vafeas (2005) and Begley, Cheng, and Gao (2007) show that audit committee characteristics are important determinants of corporate public information quality. Krishnain and Visvanathan (2008) show that accounting expertise on the audit committee contributes to improved corporate monitoring. Therefore, we include two audit committee features: audit committee independence (AUDIT IND), equal to 1 if the audit committee is comprised wholly of independent directors and 0 otherwise, and audit committee financial expertise (AUDIT EXP), the number of audit committee members who are designated financial experts. We expect higher

AUDIT IND and AUDIT EXP to reduce information asymmetry.

We use six firm variables to control for general corporate market effects: trading volume (VOLUME), stock return volatility (STOCK VOL), the number of analysts following a REIT (ANALYST ),7 an indicator whether a firm’s actual Funds from Operations (FFO) meets or beats analyst forecasts (D MISS), dividend payout ratio (DIVPAY), and leverage ratio (LEV). Chung, Elder, and Kim (2010) suggest that stock trading VOLUME, measured as the average of daily share volume in a given year (scaled by number of shares outstanding), is a determinant of bid-ask spread. Ross (1989) provides evidence that stock price volatility, measured as the standard deviation of daily stock return, reflects the effects of privately informed trading rather than public information. We also expect that the attention of stock market analysts should increase the quality and quantity of information available to outside shareholders (e.g., Atiase, 1985). Mohanram and Sunder (2003) find that uncertainty about earnings is higher when earnings performance is poor. We

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E x h i b i t 1 兩 Sample Selection and Distribution

Sample Distribution

Missing Compustat data 9

Missing CRSP data 3

Missing IBES data and firms with less than two analysts following 28 Number of Firms, Classified by Property Type

Industrial / Office 30

Retail 29

Residential 16

Specialty / Self-Storage / Healthcare 16

Lodging / Resort 9

Diversified 7

Mortgage / Financing 2

Number of Firm-Years, Distributed by Year

2003 30

2004 50

2005 56

2006 97

Notes:Number of REITs with complete data in Corporate Library during the fiscal year of 2003– 2006 is 149. The Corporate Library dataset offers data beginning in 2001. The complete data used in this paper start in 2003. There are 109 sample firms. There are a total of 233 firm-year observations.

include a performance dummy, D MISS, measured as 1 if a firm’s actual FFO misses the analyst forecast (0 otherwise). Dividend payout has long been considered as signal of firm performance and investment opportunities in the REIT industry (e.g., Ghosh and Sirmans, 2006). On the issue of information asymmetry, Downs, Gu¨ner, and Patterson (2000) find a significant negative relationship between the dividend distributions of a REIT and the adverse selection cost component of bid-ask spread; we therefore include DIVPAY, dividend per share divided by earnings per share. Finally, we expect that highly leveraged firms, where LEV is measured as total liabilities divided by total assets, would be subject to more scrutiny from the capital markets. On other hand, highly leveraged firms may rely less on equity financing and have fewer incentives to disseminate information to investors, and could result in a positive relationship between LEV and SPREAD.

S a m p l e S e l e c t i o n a n d D e s c r i p t i v e S t a t i s t i c s

Exhibit 1 depicts the sample selection process. The sample includes 149 REITs in the United States between fiscal year 2003 and 2006. After deleting firms with

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missing data, our final sample includes 109 distinct firms and 233 firm-year observations. We further classify the sample firms into different property types from the classifications in the directory of the National Association of Real Estate Investment Trusts (NAREIT) and from the websites of individual firms. The majority of the REITs specialize in industrial/office (30 firms) or retail (29 firms) properties. Exhibit 1 also reports the distribution of the firm-year observations.

Panel A of Exhibit 2 contains the descriptive statistics for the sample. The average total assets, book value of equity, and market value of equity of the sample REITs are $4,289 million, $1,310 million, and $2,807 million, respectively, with an average net annual income of $135 million. The average stock price over the sample period is $35.44.

In Exhibit 2, Panels B and C present descriptive statistics for information asymmetry and governance variables. Panel B reports an average bid-ask spread of 0.28 and a median bid-ask spread of 0.20. Panel C reports summary data for the governance variables. The sample REIT firms have an average of 8.75 board members, and hold an average of 7.71 board meetings per year. On average, 63% of the board members are independent. Seven percent of directors have been on the board for at least 15 years, and 11% hold directorships on more than four corporate boards. Exhibit 2 shows that this tenure is widely skewed, with more than three-quarters of REITs having no directors with 15 years of experience. On the other hand, many REITs have directors with experience as directors on many other public companies. On average, a director’s base pay is only $23,000 but the median value of shares owned by a director is $20,000,000. Ninety-nine percent of REIT audit committees are entirely independent directors. On average, 1.10 members per audit committee are designated financial experts but these experts are not evenly spread across the REIT industry. More than three quarters of audit committees have none or one expert.

Panel D of Exhibit 2 reports descriptive statistics for the control variables. Trading volume has a mean of 4.42, with a mean daily return volatility of 0.013. On average, 12.22 analysts forecast the Funds from Operations (FFO) for a firm in a given year; and the probability of a firm missing analyst forecast averages 47%. Finally, the sample firms report an average dividend payout ratio of 1.46 and a leverage ratio of 0.57.

Exhibit 3 presents a Spearman correlation matrix showing relationships between and among information asymmetry and the governance and control variables. The univariate correlations show that better governance tends to reduce the bid-ask spread. Most of the governance variables are not significantly inter-correlated with each other; each governance variable captures a different ‘‘mechanism.’’ Among the control variables, the bid-ask spread is significantly negatively related to trading volume, analyst following, and leverage ratio. The bid-ask spread is positively related to whether the FFO meets or beats the analysts’ forecasts.

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The Cu r i o u s C a s e of RE IT s

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N o . 1–2 0 1 1 E x h i b i t 2 兩 Descriptive Statistics

Mean Std. Dev. Min. Q1 Med. Q3 Max.

Panel A: Descriptive statistics on basic firm characteristics (in millions)

Total assets 4,289 4,769 197 1,526 2,801 4,637 25,719

Book value of equity 1,310 1,437 11 527 909 1,545 10,209

Market value of equity 2,807 2,815 156 1,081 1,810 3,383 16,886

Net income 135 153 ⫺310 39 93 169 862

Price per share 35.44 16.37 9.01 24.32 33.75 43.39 92.2

Panel B: Information asymmetry variable

SPREAD 0.28 0.25 0.07 0.14 0.20 0.31 2.51

Panel C: Corporate governance variables

BOARD IND 0.63 0.14 0 0.56 0.64 0.71 0.92 BOARD SIZE 8.75 2.16 5 7 9 10 15 BOARD MEET 7.71 3.35 4 5 7 9 21 DIR TENURE 0.07 0.15 0 0 0 0 0.67 DIR EXP 0.11 0.12 0 0 0.09 0.17 0.6 DIR COMP 0.02 0.02 0 0.02 0.03 0.03 0.13 DIR SHARE 435 1,445 0 0 20 253 10,848 AUDIT IND 0.99 0.09 0 1 1 1 1 AUDIT EXP 1.10 1.05 0 0 1 1 5

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Ang l i n , Ede ls tei n, Ga o , an d T s a n g E x h i b i t 2 兩 (continued) Descriptive Statistics

Mean Std. Dev. Min. Q1 Med. Q3 Max.

Panel D: Control variables

VOLUME 4.42 1.23 0.55 3.64 4.28 5.17 8.21 STOCK VOL 0.01 0.00 0.01 0.01 0.01 0.01 0.03 ANALYST 12.22 5.15 2 8 12 16 25 D MISS 0.47 0.50 0 0 0 1 1 DIVPAY 1.46 2.19 0 0.78 1.05 1.45 21.37 LEV 0.57 0.13 0.04 0.50 0.57 0.65 0.90

Notes:This table reports descriptive statistics on firm characteristics, information asymmetry, corporate governance, and control variables. The sample of 233 firm-years includes data between 2003 and 2006 and that have sufficient data to estimate the variables. All of the variables in Panel A are measured in $ millions except price per share. See data appendix for the definitions of variables.

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E x h i b i t 3 兩Spearman Correlations between Information Asymmetry and its Determinants

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 1.SPREAD 2.BOARD IND ⫺0.04 3.BOARD SIZE ⫺0.12* ⫺0.19* 4.BOARD MEET 0.01 0.05 0.04 5.DIR TENURE 0.01 ⫺0.17* 0.00 0.03 6.DIR EXP ⫺0.20* 0.04 0.02 ⫺0.02 ⫺0.06 7.DIR COMP ⫺0.15* ⫺0.09 0.09 0.12* ⫺0.13* 0.10 8.DIR SHARE ⫺0.12* ⫺0.30* 0.31* ⫺0.19* ⫺0.01 0.02 0.09 9.AUDIT IND ⫺0.12* 0.09 ⫺0.08 ⫺0.02 ⫺0.06 ⫺0.02 0.05 ⫺0.08 10.AUDIT EXP ⫺0.52* 0.12* ⫺0.01 ⫺0.05 ⫺0.03 0.15* 0.06 ⫺0.18* 0.06 11.VOLUME ⫺0.33* 0.22* ⫺0.01 0.07 ⫺0.35* 0.05 0.06 ⫺0.14* 0.02 0.22* 12.STOCK VOL ⫺0.09 0.15* ⫺0.21* 0.01 ⫺0.04 0.11* ⫺0.01 ⫺0.23* ⫺0.01 0.39* 0.14* 13.ANALYST ⫺0.21* ⫺0.10 0.34* ⫺0.10 ⫺0.06 0.05 ⫺0.02 0.55* ⫺0.15* ⫺0.16* ⫺0.02 ⫺0.28* 14.D MISS 0.11* 0.10 ⫺0.02 ⫺0.04 ⫺0.03 ⫺0.01 ⫺0.02 0.06 ⫺0.10 ⫺0.06 0.01 0.06 0.00 15.DIVPAY 0.03 0.04 ⫺0.05 ⫺0.11* ⫺0.07 ⫺0.05 0.01 ⫺0.02 0.11* 0.08 0.05 0.06 ⫺0.13* 0.18* 16.LEV ⫺0.12* 0.02 0.10 ⫺0.00 ⫺0.16* ⫺0.03 0.21* 0.13* 0.03 0.13* 0.31* 0.01 0.02 ⫺0.14* 0.05

Notes:This table displays Spearman correlations for our sample of 233 firm-years between 2003 and 2006 and that have sufficient data to estimate the variables. See the Appendix for the definitions of variables.

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E m p i r i c a l A n a l y s i s

M u l t i v a r i a t e M o d e l

Exhibit 4 presents the basic empirical analysis, testing the hypothesis that better corporate governance reduces information asymmetry. The empirical analysis is conducted using OLS regression for the total sample of 233 observations. Given that many of the independent variables are ordinal or skewed continuous variables, we use rank regressions because it relaxes the assumption of linearity and assumes a monotonic relation (e.g., Lang and Lundholm, 1996). In column 1, the statistical model employs only director characteristics as the explanatory variables (excluding control variables). Interestingly, none of the board characteristic variables (BOARD IND, BOARD SIZE, and BOARD MEET) are significantly related to the bid-ask spread. This finding confirms that, for the REIT sector and perhaps unlike for other corporations, board characteristics may not be an important determinant of information asymmetry. This is consistent with early studies by Friday and Sirmans (1998), Ghosh and Sirmans (2003), and Feng, Ghosh, and Sirmans (2005), who find that board characteristics have only a weak effect on REIT valuation.

The characteristics of individual board members, as summarized by DIR EXP, display the expected negative relationship with bid-ask spread: that is, more experienced directors monitor managerial decisions more effectively. The coefficient for DIR SHARE is negative and statistically significant, signifying that directors’ shareholdings may align their interests with those of shareholders. The findings are consistent with McConnell and Servaes (1990), who show that directors who own company stock are more likely to act in the interests of shareholders.

The characteristics of the audit committee appear to be statistically important determinants of information asymmetry. The audit committees of nearly all REITs consist of independent directors. The significance of the AUDIT IND coefficient shows that the bid-ask spread adjusts for those REITs that do not have an independent audit committee. The findings confirm that of prior general capital market literature (e.g., Klein, 2002), which suggests an audit committee consisting of independent members is more effective for monitoring management. DeFond, Hann, and Hu (2005) show that the market reacts favorably to the appointment of financial experts to the audit committee. Similarly, we find that the coefficient of AUDIT EXP is significantly negative, indicating that financial expertise on a REIT audit committee reduces information asymmetry.

Column 2 of Exhibit 4 presents empirical analysis with the inclusion of control variables. The results are similar to those presented in column 1. In addition, the coefficient for DIR TENURE is now significantly negative. Even though the average base salary of a director is low, directors’ base compensation (DIR

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E x h i b i t 4 兩Effect of Corporate Governance on Information Asymmetry

(1) (2)

Intercept 143.06*** 159.90***

(7.51) (8.51)

Corporate Governance Variables

BOARD IND ⫺0.05 ⫺0.01 (⫺0.85) (⫺0.13) BOARD SIZE ⫺0.06 0.004 (⫺1.08) (0.07) BOARD MEET ⫺0.05 ⫺0.02 (⫺0.81) (⫺0.45) DIR TENURE ⫺0.05 ⫺0.18** (⫺0.72) (⫺2.52) DIR EXP ⫺0.12** ⫺0.11** (⫺2.15) (⫺2.00) DIR COMP ⫺0.07 ⫺0.10** (⫺1.38) (⫺1.97) DIR SHARE ⫺0.24*** ⫺0.16** (⫺3.73) (⫺2.24) AUDIT IND ⫺0.67** ⫺0.81*** (⫺1.98) (⫺2.59) AUDIT EXP ⫺0.58*** ⫺0.56*** (⫺9.61) (⫺9.35) Control Variables VOLUME ⫺0.30*** (⫺5.29) STOCK VOL 0.05 (0.98) ANALYST ⫺0.23*** (⫺3.55) D MISS 0.08 (1.31) DIVPAY 0.04 (0.78) LEV 0.07 (1.23)

Notes:This table reports results from the regression:IA⫽␣⫹␤CG⫹␥Controls⫹␧. The Adj. R2

for column 1 is 33.86% and for column 2 is 44.78%.

This regression uses 233 observations for 109 REIT firms between 2003 and 2006 and that have sufficient data to estimate the variables. Column 1 reports the regression results including only the CG variables. Column 2 reports the regression results while including the control variables.

t-statistics are in parentheses. The dependent variable isPercentage Bid-Ask Spread. Estimated using rank OLS regression.

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COMP) has a significant negative relationship with bid-ask spread. This is

consistent with Linn and Park (2005) and Brick, Palmon, and Wald (2006), who show that directors’ compensation is positively related to the monitoring activity by directors. Though the scales of these variables differ substantially, the coefficient for DIR SHARE is larger than the coefficient for DIR COMP. In sum, when a director’s personal financial incentives are aligned with those of shareholders, information asymmetry is reduced.

Inspecting the coefficients of the control variables in column 2 of Exhibit 4 shows that higher trading volume improves market liquidity and reduces the spread required by market-makers as a compensation for liquidity risks. The number of analysts following a REIT reduces the level of information asymmetry. The results contrast with those of Downs and Gu¨ner (2000), who suggest that increased information from analysts does not decrease the level of asymmetric information. The difference between the results may be caused by the fact that they use the number of earnings estimates to measure the attention a REIT receives from the investment community while we use the number of analysts following a REIT. We prefer our measure because a single analyst may issue multiple forecasts before earnings announcement dates.

P r o p e r t y S e c t o r E f f e c t s

It is possible that the normal or necessary level of corporate governance varies significantly across different REIT sectors. To address this possible omitted variable bias, Exhibit 5 adds a set of dummy variables to account for REIT property sectors. Including these sectoral dummy variables increases adjusted R2 but, otherwise, has little qualitative effect on the findings. As shown in column 2 of Exhibit 5, the coefficients of DIR EXP, DIR COMP, DIR SHARE, AUDIT

IND, and AUDIT EXP remain statistically significant after controlling for property

type fixed effects. For the control variables, trading volume and analyst following continue to exert a significant impact on the bid-ask spread. D MISS and LEV are positively related to the bid-ask spread, indicating that managers of firms with poor performance and high leverage may have less incentive to disseminate information to stock investors, thereby increasing information asymmetry. E n d o g e n e i t y

In this study, governance variables are exogenous reflecting the idea that corporate governance is pre-determined and typically changes little within a firm for our three-year sample time horizon. However, the same cannot be said for one of the significant control variables, VOLUME. The bid-ask spreads and volume are likely to be endogenously determined (e.g., Chung, Jo, and Shefrin, 2002). To investigate the relevance of this endogeneity, we first replicate the analysis of specification (1) with the exclusion of VOLUME. Column 1 of Exhibit 6 shows that excluding

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Intercept 147.30*** 148.85***

(5.85) (6.34)

Corporate Governance Variables

BOARD IND ⫺0.09 ⫺0.06 (⫺1.56) (⫺1.19) BOARD SIZE ⫺0.04 0.02 (⫺0.71) (0.36) BOARD MEET ⫺0.07 ⫺0.04 (⫺1.29) (⫺0.78) DIR TENURE 0.01 ⫺0.10 (0.14) (⫺1.28) DIR EXP ⫺0.12** ⫺0.11** (⫺2.11) (⫺2.09) DIR COMP ⫺0.06 ⫺0.09* (⫺1.15) (⫺1.87) DIR SHARE ⫺0.24*** ⫺0.19*** (⫺3.68) (⫺2.84) AUDIT IND ⫺0.41 ⫺0.51* (⫺1.20) (⫺1.62) AUDIT EXP ⫺0.60*** ⫺0.57*** (⫺10.10) (⫺9.72) Control Variables VOLUME ⫺0.33*** (⫺5.78) STOCK VOL 0.01 (0.21) ANALYST ⫺0.24*** (⫺3.75) D MISS 0.10* (1.75) DIVPAY 0.02 (0.34) LEV 0.12** (2.00)

Notes:This table reports results from the regression:IA⫽␣⫹␤CG⫹␥Controls⫹␾Property

␧. The Adj. R2for column 1 is 37.23% and for column 2 is 49.02%. This regression uses 233

observations for 109 REIT firms between 2003 and 2006 and that have sufficient data to estimate the variables. Column 1 reports the regression results including only the CG variables and property type fixed effects. Column 2 reports the regression results while including the control variables.t-statistics are in parentheses. The dependent variable isPercentage Bid-Ask Spread. Property type variables are included in the regressions. Estimated using rank OLS regression. *, **, and *** denote significance at the 10%, 5%, and 1% levels (two-tailed).

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E x h i b i t 6 兩 Effect of Corporate Governance on Information Asymmetry using Alternative Specifications

(1) (2)

Intercept 147.61*** 176.62***

(7.47) (8.12)

Corporate Governance Variables

BOARD IND ⫺0.04 0.03 (⫺0.65) (0.53) BOARD SIZE 0.001 0.007 (0.02) (0.12) BOARD MEET ⫺0.04 0.005 (⫺0.81) (0.08) DIR TENURE ⫺0.07 ⫺0.33*** (⫺0.93) (⫺3.46) DIR EXP ⫺0.11** ⫺0.10* (⫺1.98) (⫺1.69) DIR COMP ⫺0.09* ⫺0.11* (⫺1.71) (⫺1.96) DIR SHARE ⫺0.11 ⫺0.22*** (⫺1.45) (⫺2.76) AUDIT IND ⫺0.79** ⫺0.84** (⫺2.37) (⫺2.41) AUDIT EXP ⫺0.61*** ⫺0.50*** (⫺9.65) (⫺7.06) Control Variables VOLUME ⫺0.71*** (⫺4.46) STOCK VOL 0.04 0.07 (0.71) (1.16) ANALYST ⫺0.25*** ⫺0.19*** (⫺3.77) (2.63) D MISS 0.06 0.10 (1.00) (1.48) DIVPAY 0.04 0.04 (0.69) (0.75) LEV ⫺0.02 0.18** (⫺0.28) (2.47)

Notes:This table reports results from the regression:IA⫽␣⫹␤CG⫹␥Controls⫹␧. The Adj. R2for column 1 is 37.94% and for column 2 is 38.67%. This regression uses 233 observations for

109 REIT firms between 2003 and 2006 and that have sufficient data to estimate the variables. Column 1 reports the regression results with the exclusion ofVOLUME. Column 2 reports the 2SLS regression results whileVOLUMEis first estimated using IV regression.t-statistics are in

parentheses. The dependent variable isPercentage Bid-Ask Spread. Property type variables are included in the regressions. Estimated using rank OLS regression.

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We next examine the effects of VOLUME endogeneity by using an instrumental variable (IV) estimator. The first stage regression estimates VOLUME using log total assets, market-to-book ratios, as well as STOCK VOL, DIVPAY and LEV as the instruments. We then estimate equation (1) using the fitted values of VOLUME. Column 2 of Exhibit 6 contains the IV estimation. Our IV statistical results reinforce the idea that corporate governance exerts a significant influence on REIT information asymmetry.

S e n s i t i v i t y A n a l y s i s

Because the analysis uses an unbalanced panel of data, some but not all firms appear in multiple years. To account for this issue, we recalculate the standard errors of the coefficients clustering at the company level and, in unreported results, we find that the findings remain qualitatively similar. By including annual dummy variables to account for systemic changes in asymmetric information and macroeconomic conditions, we find that the estimated relationship between corporate governance and information asymmetry remains stable. The level of information asymmetry in a firm can be related to firm size and growth opportunity. To account for this issue, we add the log market capitalization of firms and the percentage growth of total assets and find that the relationship between information asymmetry and corporate governance is qualitatively similar. Finally, the relationship between information asymmetry and some of the governance variables may be non-linear. If so, and even though we use a rank regression to partially address this issue, the linear regression may be unsatisfactory. We consider the issue of non-linearity by dividing the continuous corporate governance variables into two subgroups (i.e., high and low) based on the magnitudes of these variables and run separate sub-sample regressions for these subgroups. In unreported results, we find that this change has little impact on the findings.

C o n c l u s i o n

One role of proper corporate governance is controlling and monitoring management’s ability to withhold or distort the distribution of corporate information. Some vehicles for controlling and monitoring firm disclosures are imposed externally by regulators or by financial markets or both. The firm also can institute internal ‘‘devices’’ for these purposes. The unique legal and regulatory structure of a REIT vis-a`-vis a normal C corporation may alter the balance between internal and external governance ‘‘mechanisms.’’ On the one hand, internal governance should become more important since REITs are less vulnerable to a takeover. On the other hand, REITs are required to distribute dividends equal to at least 90% of taxable income, lessening the opportunity for managerial mischief and reducing the need to mitigate the principal-agent problem between REIT managers and shareholders.

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Although a REIT’s structure may suggest that REIT managers need little internal oversight, we find that the bid-ask spread demanded by the market varies with the amount of oversight. The key findings indicate that the level of information asymmetry is affected by the board of directors’ experiences and compensation and by the nature and structure of the audit committee.8The latter is a previously unexplored aspect of governance. The superficial aspects of how the board processes information, such as the number of meetings and the size of the board, are not significant.

Research must use historic data and we are constrained to use data from a time period with a relatively high rate of return on investments. During this period, the effects of bad governance could be hidden by good luck and a less critical attitude by investors. In the near future, a less rosy investment environment suggests that governance characteristics will have a greater effect on investor behavior. Two nuggets of advice are imbedded in the analyses. First, improving governance diminishes asymmetric information, and the concomitant decline in the bid-ask spread should reduce the cost of raising funds. Second, boards of directors act in the interests of shareholders when their financial incentives are similar to shareholders.

A p p e n d i x

兩兩

V a r i a b l e D e f i n i t i o n s

Variable Definition

Information Asymmetry Variable

Bid-ask spread (SPREAD) The average of the daily bid-ask spread in a given year. Daily bid-ask spread is measured as the difference between the closing bid and ask prices scaled by the average of the closing bid and ask prices and multiplied by 100.

Corporate Governance Variables

Board independence (BOARD IND) Percentage of fully independent directors on the board.

Board size (BOARD SIZE) Total number of all directors on a given board. Board meetings (BOARD MEET) Number of full board meetings held in a given

year.

Directors’ tenure (DIR TENURE) Percentage of directors with tenure exceeding 15 years on a given board.

Directors’ expertise (DIR EXP) Percentage of directors with more than four corporate (public) directorships on a given board. Directors’ compensation (DIR COMP) Reported director base pay amount (in million

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Variable Definition

Directors’ share (DIR SHARE) Value of shares of company stock owned by directors (in million dollars).

Audit committee independence (AUDIT IND)

Indicates whether the audit committee is comprised wholly of independent directors.

Audit committee financial expertise (AUDIT EXP)

Number of audit committee members who are designated financial experts, according to the definition in the Corporate Library database. Control Variables

Trading volume (VOLUME) The average of daily share volume in a given year, where daily share volume is scaled by the number of shares outstanding.

Return volatility (STOCK VOL) Standard deviation of daily return in a given year Analyst following (ANALYST) The number of unique analysts issuing FFO in a

given year.

D MISS One if a firm’s actual FFO is below the mean forecast for a given year, and zero otherwise. Dividend payout ratio (DIVPAY) Dividend per share divided by earnings per share. Leverage (LEV) Total liability divided by total assets.

E n d n o t e s

1 Bianco, Ghosh, and Sirmans (2007) note that certain institutions, such as pension funds,

are not considered to be an individual investor for purposes of this limit.

2 Our study only incidentally examines the links between and among a company’s

operational behavior, its stock performance, and corporate governance.

3 The index, constructed by Gompers, Ishii, and Metrick (2003), focuses on takeover

provisions.

4 The index is produced by the Institutional Shareholder Services (ISS), which was

acquired by the RiskMetrics Group in 2007.

5 There are several proxies of IA, including bid-ask spread, dispersion in analysts’ forecasts,

R&D expenditures, and accounting disclosure indices. We focus on the bid-ask spread because our analysis is concerned with the outside investors’ evaluation of information.

6 The Corporate Library also calculates these variables based on different tenure horizons

and different numbers of public directorships. In unreported robustness checks, we replicate our analysis using different proxies for DIR TENURE and DIR EXP and obtain similar results.

7 Prior research (e.g., Atiase, 1985) shows that larger firms and firms with higher growth

rates are followed by more analysts. Because LSIZE and GROWTH are highly correlated with ANALYST, we do not include firm size (LSIZE) and growth rates (GROWTH), measured as the log of total assets of a firm at the beginning of a given year and market-to-book ratio respectively, in our main regression results. Nonetheless, we perform a

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robustness check by replacing ANALYST with LSIZE and GROWTH and obtain similar results.

8 Kenneth Bernstein, our discussant at the NAREIT conference, also noted that using

measurable indicators of corporate governance would overlook other, more idiosyncratic, determinants. Incorporating issues related to specific individuals or the interaction between individuals, even if the characteristics of the board do not change, is beyond the scope of this research. This issue may be of particular concern with respect to the variable measuring financial expertise on the audit committee, where many REITs have none or one such designated expert. Our results may be interpreted as showing that the experts who were in place during 2003–2006 were particularly diligent or respected by the investment community.

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We thank the Department of Real Estate at Baruch College, CUNY, the National Association of Real Estate Investment Trusts (NAREIT) and Ko Wang for choosing this paper as one of the recipients for the Best Research Paper Awards on REIT Analysis. We also thank Michael Torres, Kenneth Bernstein, Jane Londerville and an

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N o . 1 – 2 0 1 1 anonymous referee for their helpful comments. We gratefully acknowledge financial support from the University of Alberta and the Social Sciences and Humanities Research Council of Canada (SSHRC) (Yanmin Gao) and McGill University (Desmond Tsang).

Paul Anglin, University of Guelph, Guelph ON N1G 2W1 or panglin@uoguelph.ca. Robert Edelstein, University of California at Berkeley, Berkeley, CA 94720 or edelstei@haas.berkeley.edu.

Yanmin Gao, University of Alberta, Edmonton AB T6G 2R6 or yanmin.gao@ ualberta.ca.

Desmond Tsang, McGill University, Montreal QC H3A 2T5 or desmond. tsang@mcgill.ca.

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