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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 and performance of REITs, however, is scarce. For REITs, special regulation, including mandatory distribution of income, limits free cash flow, while restrictions on source of income and asset structure results in widely dispersed stock ownership. This makes external monitoring through the takeover market less likely such that alternative monitoring mechanisms, including external directors, must be in place to discourage deviant managerial behavior. Using a simultaneous equation system, we conclude that while outside directors on REIT boards enhance performance, the effect is weak. Consistent with the evidence on other industry sectors, we find that higher CEO stock ownership and control through tenure and chairmanship of the board reduces the representation by outside members on REIT boards, and adversely affects REIT performance. Institutional ownership or blockownership fails to serve as alternate disciplining mechanism to (inadequate) monitoring by outside 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 Chinmoy@sba.uconn.edu.

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 a single 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

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 of stock 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.

2. Determinants of Board Independence


The board of directors includes the CEO, who often serves as the chairman of the board, nonCEO 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. Nonaffiliated 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,

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 hypothesis lead 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 hypothesis holds 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, and Sirmans (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

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 550 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-five mergers 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

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 stock can 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 and firm 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

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 older Equity 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

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 holding periods 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

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 the REITs 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,

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 than that 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 as monitoring 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 share ownership, 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 recalled that 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 these directors 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

15

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 results from 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

17

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 it is 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

18

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 other firms: 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
1. Distribution Test

Description
A REIT must distribute at least 95 percent of taxable income to its shareholders annually

Impact on Corporate Governance


Limits the availability of free cash to managers. Reduces the need to monitor. Positive effect on Governance. Results in dispersed share ownership. Increases managers bargaining power which may result in fewer outsiders on Board. Negative effect on Governance. Restricts takeovers to mostly similar firms within the industry. Discourages hostile takeovers (Whidbee, and CGS). Negative 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

3. Income Test

4. Asset 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 other REITs, and mortgages) and at least 95 percent of its income must be in those sources plus nonmortgage interest and dividend and gains from non-REIT securities 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 full data 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 Return on Assets (ROA, %) Return on Equity (ROE, %) SIZE MKT-to-BOOK OUTDIR (%) RELTENR AFFOWN (%) NAFFOWN (%) AFFBLK (%) NAFFBLK (%) INTNOWN (%) EXCEOOWN (%) CEOOWN (%) CEOTEN (yrs) CEODUAL Mean 3.853 9.425 6.135 0.539 61.030 1.843 2.346 1.816 3.300 2.435 16.838 2.228 6.154 5.333 0.615 Std. Deviation 2.668 11.205 1.279 0.293 15.091 2.418 6.012 3.382 11.021 8.113 16.762 6.434 9.622 5.347 0.489 Minimum -3.550 -24.190 1.970 0.110 16.670 0.000 0.000 0.010 0.000 0.000 0.000 0.000 0.020 0.000 0.000 Maximum 14.280 104.58 8.740 1.950 88.890 17.330 37.370 28.820 58.290 67.460 67.960 56.480 51.680 37.000 1.000

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Table 3 Pearson Correlation Coefficient between the variables


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. ROE is return on average total equity. Size is logarithm of total market capitalization. Market-to-Book ratio is market value 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.
ROE LNSIZE MKTBOOK OUTDIR EXCEOOWN AFFOWN NAFFOWN CEOOWN CEOTEN CEODUAL INTNOWN AFFBLK NAFFBLK

ROE 1.000 LNSIZE 0.206* 1.000 MKTBOOK 0.503* 0.284* OUTDIR 0.105 0.021 EXCEOOWN -0.121 -0.150* AFFOWN 0.432* 0.164* NAFFOWN -0.144 -0.407* CEOOWN -0.220* -0.484* CEOTEN -0.037 -0.027 CEODUAL -0.104 -0.153* INTNOWN -0.040 0.183* AFFBLK 0.260* -0.009 NAFFBLK -0.083 -0.140 * Significant at the 10% level.

1.000 0.016 -0.155* 0.179* -0.121 -0.105 0.182* -0.060 -0.216* 0.238* -0.059

1.000 -0.097 -0.282* 0.122 -0.178* -0.070 -0.100 0.120 -0.139 0.041

1.000 -0.045 0.151* 0.204* -0.007 -0.068 0.187* -0.001 -0.034

1.000 -0.016 0.003 -0.014 -0.206* -0.064 0.198* -0.066

1.000 0.344* 1.000 -0.036 0.220* 1.000 -0.028 0.178* 0.213* 1.000 -0.089 -0.136 -0.016 -0.075 1.000 -0.109 0.179* -0.023 0.068 -0.203* 1.000 0.038 0.020 0.009 0.003 -0.151* 0.004

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 shares owned 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 = + 1 ROE + 2 SIZE + 3 CEOOWN + 4 CEOTEN + 5 CEODUAL Model 2: OUTDIR = + 1 ROE + 2 SIZE + 3 CEOOWN + 4 CEOTEN + 5 CEODUAL + 6 EXCEOOWN + 7 AFFOWN + 8 NAFFOWN Model 3: OUTDIR = + 1 ROE + 2 SIZE + 3 CEOOWN + 4 CEOTEN + 5 CEODUAL + 6 EXCEOOWN + 7 AFFOWN + 8 NAFFOWN + 9 INTNOWN + 10 AFFBLK + 11 NAFFBLK + 12 MKTBOOK Model 4: RELTENR = + 1 ROE + 2 SIZE + 3 CEOOWN + 4 CEODUAL + 5 EXCEOOWN + 6 AFFOWN + 7 NAFFOWN + 8 INTNOWN + 9 AFFBLK + 10 NAFFBLK + 11 MKTBOOK (T-statistics are presented in parentheses)

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Table 4 (Contd.)
Independent Variables

Dependent Variable: OUTDIR Model 1


70.346** (8.844) 0.028 (0.231) -1.133 (0.977) -0.198 (1.324) -0.009 (0.038) -2.281 (0.831)

Dependent Variable:

Model 2
59.874** (7.533) 0.252** (2.298) 0.407 (0.359) -0.145 (0.991) 0.157 (0.681) -4.679* (1.777) -0.266* (1.627) -0.929** (5.589) 1.033** (2.382)

Model 3
59.563** (7.398) 0.331** (2.502) 0.363 (0.301) -0.102 (0.669) 0.210 (0.884) -4.322* (1.620) -0.311* (1.872) -0.928** (5.372) 0.938** (2.025) -0.027 (0.246) 0.041 (0.263) 0.083 (1.038) -3.850 (0.718) 0.227

RELTENR Model 4
1.809** (4.159) 0.020** (3.120) 0.049 (0.840) -0.025** (5.089)

CONSTANT ROE SIZE CEOOWN CEOTEN CEODUAL EXCEOOWN AFFOWN NAFFOWN AFFBLK NAFFBLK INTNOWN MKT-to-BOOK R-squared (Adj.)

0.043

0.211

-0.022 (0.134) -0.003 (0.381) -0.017 (1.381) 0.003 (0.269) -0.022** (4.527) -0.025** (6.160) -0.017** (3.458) 0.038 (0.187) 0.047

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

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Table 5 Heteroskedastically Corrected Estimates of the Association Between Board 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 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 = + 1 SIZE + 2 MKTBOOK + 3 OUTDIR + 4 CEODUAL Model 2: ROE = + 1 SIZE + 2 MKTBOOK + 3 OUTDIR + 4 CEODUAL + 5 EXCEOOWN + 6 AFFOWN + 7 NAFFOWN Model 3: ROE = + 1 SIZE + 2 MKTBOOK + 3 OUTDIR + 4 CEODUAL + 5 EXCEOOWN + 6 AFFOWN + 7 NAFFOWN + 8 CEOOWN + 9 CEOTEN Model 4: ROE = + 1 SIZE + 2 MKTBOOK + 3 OUTDIR + 4 CEODUAL + 5 EXCEOOWN + 6 AFFOWN + 7 NAFFOWN + 8 CEOOWN + 9 CEOTEN + + 10 AFFBLK + 11 NAFFBLK + 12 INTNOWN + 13 CROUDUAL Model 5: ROE = + 1 SIZE + 2 MKTBOOK + 3 OUTDIR + 4 CEODUAL + 5 EXCEOOWN + 6 AFFOWN + 7 NAFFOWN + 8 CEOOWN + 9 CEOTEN + 10 CROUDUAL + 11 RETD + 12 RESD + 13 OFFD + 14 INDD + 11 HOTD + 12 UPREITD (T-statistics are presented in parentheses)

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


Independent Variables CONSTANT SIZE MKT-to-BOOK OUTDIR AFFOWN NAFFOWN AFFBLK NAFFBLK INTNOWN EXCEOOWN CEOOWN CEOTEN CEODUAL CROUDUAL RETD -4.288** (2.685) -4.554** (5.310) 0.027 (0.979) 0.201** (4.001) -0.152** (11.120) 0.024 (0.396) -4.242* (1.766) Model 1 -3.64** (2.685) 1.064** (7.241) 3.411** (2.520) 0.085** (6.717) Model 2 -3.387** (2.729) 0.497** (3.137) 24.458** (9.625) 0.015* (1.662) 0.029 (0.426) -0.246** (5.649) Model 3 -6.892** (2.360) -0.307 (1.183) 21.392** (10.770) 0.119** (3.835) 0.559** (5.428) -0.288** (3.503) Model 4 3.879 (1.311) -1.091** (4.046) 15.938** (9.411) 0.043 (1.501) 0.772** (8.368) -0.302** (4.319) 0.138** (5.176) -0.042** (2.738) 0.445** (5.278) 0.035 (1.233) -0.176** (8.064) -0.129** (2.714) -9.882** (3.789) 0.174** (4.423) Model 5 3.874 (1.512) -1.169** (4.721) 15.715** (9.583) 0.052* (1.767) 0.777** (7.603) -0.457** (8.948) 0.136** (6.129) -0.036** (2.361) 0.062** (5.008) 0.022 (0.809) -0.188** (8.789) -0.116** (2.232) -10.343** (4.615) 0.170** (5.124) 1.502** (2.711) 1.360** (1.999) 1.029 (1.104) -0.702 (0.663) 7.632** (8.443) -1.789** (3.698) 0.113 0.269 0.417 0.486 0.524

RESD OFFD INDD HOTD UPREITD R-Squared (adjusted)

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

27

Table 6 Heteroskedastically Corrected Estimates of the Association Between Board 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. 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. 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 = + 1 SIZE + 2 MKTBOOK + 3 RELTENR + 4 CEODUAL Model 2: ROE = + 1 SIZE + 2 MKTBOOK + 3 RELTENR + 4 CEODUAL + 5 EXCEOOWN + 6 AFFOWN + 7 NAFFOWN Model 3: ROE = + 1 SIZE + 2 MKTBOOK + 3 RELTENR + 4 CEODUAL + 5 EXCEOOWN + 6 AFFOWN + 7 NAFFOWN + 8 CEOOWN + 9 CEOTEN Model 4: ROE = + 1 SIZE + 2 MKTBOOK + 3 RELTENR + 4 CEODUAL + 5 EXCEOOWN + 6 AFFOWN + 7 NAFFOWN + 8 CEOOWN + 9 CEOTEN + 10 AFFBLK + 11 NAFFBLK + 12 INTNOWN + 13 CROUDUAL Model 5: ROE = + 1 SIZE + 2 MKTBOOK + 3 RELTENR + 4 CEODUAL + 5 EXCEOOWN + 6 AFFOWN + 7 NAFFOWN + 8 CEOOWN + 9 CEOTEN + 10 AFFBLK + 11 NAFFBLK + 12 INTNOWN + 13 CROUDUAL + 14RETD + 15 RESD + 16 OFFD + 17 INDD + 18 HOTD + 19 UPREITD (T-statistics are presented in parentheses)

28

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


Independent Variables CONSTANT SIZE MKT-to-BOOK RELTENR AFFOWN NAFFOWN AFFBLK NAFFBLK INTNOWN EXCEOOWN CEOOWN CEOTEN CEODUAL CROUDUAL RETD -1.601** (2.623) -1.628** (2.829) -0.068** (5.258) -0.003 (0.129) -0.212** (9.950) -0.172** (2.517) 0.598 (1.124) Model 1 -3.101** (3.892) 0.527** (5.804) 18.256** (12.140) 0.245* (1.620) Model 2 1.589* (1.849) -0.086 (0.766) 15.073** (10.750) 0.335** (2.031) 1.373** (6.446) -0.309** (11.970) Model 3 5.391** (3.955) -0.765** (3.437) 17.104** (9.536) 0.700 (0.436) 0.712** (5.468) -0.212** (4.143) Model 4 6.350** (3.832) -1.095** (4.139) 15.309** (8.892) 0.250* (1.777) 0.788** (7.741) -0.351** (5.346) 0.147** (4.898) -0.047** (4.464) 0.051** (4.160) 0.033 (1.177) -0.156** (8.283) -0.083 (1.350) -13.958** (11.930) 0.231** (10.830) Model 5 6.681** (4.835) -1.141** (4.574) 15.238** (9.219) 0.231* (1.654) 0.778** (7.891) -0.453** (8.227) 0.141** (6.455) -0.031** (2.321) 0.063** (4.645) 0.019 (0.756) -0.173** (9.343) -0.072 (1.240) -14.844** (12.130) 0.235** (11.910) 1.298** (2.329) 0.789 (1.161) 0.883 (0.915) -0.893 (0.892) 7.287** (7.649) -1.388** (2.801) 0.265 0.356 0.424 0.496 0.530

RESD OFFD INDD HOTD UPREITD R-Squared (adjusted)

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

29

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 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. 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 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. CROUDUAL is a cross product of Board Independence (OUTDIR or RELTENR) and the CEODUAL dummy. The following system of equations are estimated:
Equation 1: ROE = + 1 SIZE + 2 MKTBOOK + 3 CEOTEN + 4 AFFOWN + 5 AFFBLK + 6 CEOOWN + 7 OUTDIR (or, RELTENR) Equation 2: OUTDIR (or, RELTENR) = + 1 SIZE + 2 CEODUAL + 3 CEOTEN + 4 AFFOWN + 5 AFFBLK + 6 CEOOWN + 7 ROE Equation 3: CEOOWN = + 1 SIZE + 2 MKTBOOK + 3 CEODUAL + 4 CEOTEN + 5 NAFFOWN + 6 ROE + 7 OUTDIR (or, RELTENR) Exogenous Variables: SIZE, MKTBOOK, CEODUAL, CEOTEN, AFFOWN, NAFFOWN, AFFBLK, NAFFBLK, CROUDUAL. (T-statistics are presented in parentheses)

30

Table 7 (Contd.): 2SLS Estimates


Board Independence: OUTDIR (n = 122) Board Independence: RELTENR (n = 118)

Exogenous Variables CONSTANT ROE SIZE MKT-to-BOOK OUTDIR CEOOWN CEOTEN CEODUAL AFFOWN NAFFOWN AFFBLK RELTENR R-Squared

ROE 4.303 (0.325)

OUTDIR 102.96** (4.856) 0.707* (1.710) -6.101** (2.170)

CEOOWN 31.386** (5.611) 0.071 (0.467) -2.769** (4.234) -1.274 (0.322) -0.199** (3.311)

ROE 22.408** (2.288)

RELTENR -1.041 (0.384) 0.088* (1.633) 0.423 (1.180)

CEOOWN 24.912** (3.321) -0.182 (0.818) -2.637** (2.927) 7.440 (0.963)

-1.744 (1.293) 14.676** (4.892) 0.142* (1.679) -0.545* (1.600) 0.029 (0.149)

-2.833* (1.880) 15.265** (2.212)

0.769** (5.379)

-1.602** (2.092) 0.477 (1.134) -2.101 (0.555) -1.088** (2.415)

0.349** (2.380) 1.231 (0.792)

-0.896** (2.591) 0.046 (0.063)

0.712** (4.243) 0.706** (2.896)

0.107 (1.096) -0.196** (3.620) 0.298 (0.610) -0.068 (1.145)

-0.252 (0.434) 2.665 (1.190)

0.519* (1.600) 0.219 (1.370) -0.493 (0.130) 0.167 -0.052* (1.732) -3.262 (1.083) 0.247

0.199** (2.239)

0.001 (0.005)

0.376

0.637

0.267

0.068

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

31

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McIntosh, W., R. C. Rogers, C. F. Sirmans, and Y. Liang. (1994). Stock Price and Management Changes: The Case of REITs, Journal of the American Real Estate and Urban Economics Association 22, 515-526. Mehran, H. (1992). Executive Incentive Plans, Corporate Control and Capital Structure, Journal of Financial and Quantitative Analysis 27, 539-560. Melms, G.G. (1994). Board of Directors Composition and Other Agency Cost Control Mechanisms in the Investment Company Industry, University of Oregon Working Paper (September). Mishra, Chandra S., and James F. Nielsen. (2000). Board Independence and Compensation Policies in Large Bank Holding Companies, Financial Management (Autumn) 51-70. Rosenstein, S., and J.G. Wyatt. (1990) Outside Directors, Board Independence, and Shareholder Wealth, Journal of Financial Economics 26, 175-191. Shivdasani, A. (1993). Board Composition, Ownership Structure, and Hostile Takeovers, Journal of Accounting and Economics 16, 167-198. Smith, C. and R. Watts. (1992). The Investment opportunity set and Corporate Financing, dividend, and Compensation Policies, Journal of Financial Economics 32, 263-292. Stulz, R.M. (1988). Managerial Control of Voting Rights: Financing Policies and the Market for Corporate Control, Journal of Financial Economics 20, 25-54. Subrahmanyam, V., N. Rangan, and S. Rosenstein. (1997). The Role of Outside Directors in Bank Acquisitions, Financial Management (Winter) 20, 461-492. Weisbach, M.S. (1988). Outside Directors and CEO Turnover, Journal of Financial Economics 20, 431-460. Wei, P., C. Hsieh, and C. F. Sirmans. (1994). Captive Financing Arrangements and Information Asymmetry, Journal of the American Real Estate and Urban Economic Association 22, 385394. Whidbee, D.A. (1997). Board Composition and Control of Shareholder Voting Rights in the Banking Industry, Financial Management (Autumn) 27-41. White, H. (1980). A Heteroskedasticity-Consistent Covariance Matrix and a Direct Test for Heteroskedasticity, Econometrica 48, 817-838.

1 Further support for this notion derives from Shivdasani (1993) who finds evidence that for companies where share ownership by outside directors is relatively lower, monitoring by hostile takeovers is more prevalent. Whidbee argues that the potential for an incumbent CEO to exclude outsiders from the board is greater concern in the banking industry because takeover markets are not an effective mechanism for removing a poorly performing CEO. 2

This definition follows Weisbach (1988), Rosenstein and Wyatt (1990), Byrd and Hickman (1992), Shivdasani (1993), Mayers, Shivdasani, and Smith (1997), Bacon, Cornett, and Davidson (1997) and Whidbee (1997). This has been reduced to 90% as of January 2001.

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The equivalent of free cash flow for REITs is Funds from Operations (FFO). The most commonly accepted and reported measure of operating performance, FFO is defined by NAREIT as a REITs net income, excluding gains or losses from sales of property, and adding back real estate depreciation. The average payout as a percent of Funds from Operations (FFO) is in the 74% for our sample of REITs. An exception to this rule since 1993 is financial institutions such as pension funds or mutual funds, where each owner in the fund is held to own his share of the REIT separately. Other REITs are also exceptions, but not other corporations. The impact of mutual fund rule changes is still unclear, since while mutual funds provide monitoring, they may be subject to agency problems of their own. See Downs (1998) for details of the 1993 relaxation in the ownership qualifications for REITs and the valuation effects induced by it.

6 Whidbee attributes the absence of disciplinary takeovers in banking sector to the highly regulated nature of the industry and the fact that bank acquisition markets exclude non-financial firms. 7

For a sample of 85 REIT IPOs over the period 1991-1004, Ling and Ryngaert (1997) report average institutional ownership of 41.7%, which is significantly higher than average institutional ownership of 10.1% for 68 REIT IPOs during 1980-88 analyzed by Wang, Chan, and Gau (1992). Ghosh, Nag, and Sirmans (1998) report average institutional ownership of 51.1% for a sample of 100 secondary issues from 1991 to 1995. Chan, Leung, and Wang (1998) report that over the years 1984 to 1995, average institutional ownership of REITs increased from 9% to 30%, and that the institutional ownership of REITs during the nineties is significantly higher than a sample of non-REITs matched on market value of equity. The same is true for the average number of institutional investors.

Agency problem between external advisors and REIT management has been the subject of several papers. These include Howe and Shilling (1990), Hsieh and Sirmans (1991), Wei, Hseih and Sirmans (1995), and Ambrose, Ehrlich, Hughes, and Wachter (2000). The SNL Datasource is maintained by SNL Securities of Charlottesville, VA, USA. It provides comprehensive and historical data on GAAP financials and mergers and acquisitions, individual Equity REIT property level information, capital issues, dividend history, officer total compensation, over 100 corporate, financial, and NAV fields, and ownership of shares by directors and large institutions. More details can be found on www.snl.com/ds.

It is customary in literature to use one years data for governance and performance studies. Whidbee (1997), Mishra and Neilsen (2000), Loderer and Martin (1997), Cho (1998), Agarwal and Knoeber (1996) employ data for one year for their analyses. One advantage of using single year data is that changes in other firm specific variables over a period of time can be controlled. Further, our focus is to measure the impact of Board independence, which is proxied by the number of independent members in the Board, which does not change significantly over time, since companies tend to replace an outsider member with another outsider. No paper, to our knowledge, has attempted to measure the influence of individual board members on firm governance and performance. Bers and Springer (1997) study REITs over 1992-94, and find significant evidence for economies of scale for all years examined. In a more comprehensive analysis focusing on firm size, Ambrose, Ehrlich, Hughes, and Wachter (2000) find that smaller REITs generate revenue and operating economies, but larger REITs fail to do so.
12 11

10

Friday, Sirmans, and Conover (1999) do not report an overall average for their data. But, it appears from the results for subgroups of equity REITs that the average ROA for their sample would be a little over 5%. They do not report return on equity (ROE) for their sample.

13 This number is significantly smaller than the average market-to-book ratio of REITs reported by Friday and Sirmans (1998), and Friday, Sirmans, and Conover (1999) over the period 1980-1994. One potential explanation is that our sample includes the new REITs, which operate on a higher asset base. 14 We note that this number is driven mainly by two outlier values of 17.33 and 12.83. Without these two observations, the average drops to 1.62, which is still higher than extant evidence. However, if we account for the significantly short tenure of REIT CEOs, the average tenure of outside directors looks reasonable. 15 Our data is consistent with the sample of banks analyzed by Misra and Neilsen (2000). For example, Misra and Neilsen (2000) reported a Market-to-Book ratio of 0.88. The maximum for their sample is 1.85. For Banks, the average percentage of outside directors is 64%, the total shares owned by inside directors excluding the CEO for our sample is 2.29%, and the ownership by affiliated and unaffiliated outside directors are, on average, 0.94% and 1.32%, respectively. These numbers compare with the corresponding numbers for REITs in our sample. Friday, Sirmans, and Conover (1999) focus on the impact of blockowner (defined as 5% or more of a REITs outstanding common shares) monitoring on firm value. Adding the average ownership by banking, insurance, and pension and money manager blockholders, we infer that the average institutional blockholding in their sample of REITs is about 6%, which is significantly lower than the average institutional holding in our sample. 16 Chan, Leung, and Wang (1998) come to the same conclusion that institutional investors prefer to invest in REITs with larger market capitalization. 17 It may be argued that there is a potential simultaneity problem in the relationship between number of outside directors and the number of shares owned by non-affiliated directors. Does more outside directors lead to greater voting power, or does greater voting power help get more outside directors elected? A precise determination of the causality may require a pooled cross-sectional time series analysis. We are grateful to an anonymous referee for pointing this out. 18

Results are presented for ROE only. Results are essentially unchanged when ROA is used as a measure of REIT performance.

35

19 The management style (self-manager or external-managed) is not included in the regression model since the vast majority of REITs in our data set are internally managed. 20

These results are in contrast with Friday and Sirmans (1998), who report significantly negative relations between REIT market-to-book ratio and percentage of outstanding shares owned by inside directors, and percentage of outstanding shares owned by affiliated directors. Friday and Sirmans, however, include CEOs in inside director group, which may explain the difference in result with regard to affiliated directors. To gain further insight, we segregated our sample into three subsamples based on ownership of nonaffiliated directors. There is significant difference in performance between the low (<5%) and high (>20%) levels of nonaffiliated ownership groups of REITs. There is no significant difference in the percentage of outside directors between the groups, but the significantly positive relation between performance and percentage of outside directors holds for each subsample. A significant portion of CEO compensation in recent times is in the form of executive stock options. REITs are no exception. In our sample, CEO stock options average 3% of outstanding shares with minimum and maximum values of 0% and 14.5%. Our measure of CEO stock ownership includes stock options. However, if CEO stock options is included separately in the regression model, we get the following estimates: ROE = -0.863 + 1.92*SIZE + 17.66*MKTBOOK + 0.10*OUTDIR 16.40*CEODUAL 0.25*CEOTEN + 1.08*OPTIONS All the variables have the predicted signs and are significant at 5% levels. The significantly positive coefficient of OPTIONS contrasts with the adverse effect of CEO stock ownership.

21

22

23

As pointed out by a referee, it may be argued while CEO share ownership in percent of outstanding shares is suitable as a determinant of board structure, the change in the value of CEOs wealth tied in company stock is more appropriate when firm performance is the focus. To address this, we estimate the performance model with CEO ownership measured as the value of the company stock owned by him. The coefficient estimates are as follows: ROE = -9.18 + 0.10*SIZE + 16.04*MKTBOOK + 0.14*OUTDIR + 1.06*CEODUAL + 0.07*EXCEOOWN + 0.71*AFFOWN 0.32*NAFFOWN 0.02*CEODOL 0.18*CEOTEN CEODOL measures CEO wealth in millions of dollars. The variable is significant at the 5% level. All the other variables are significant with the same signs as the ROE model except CEODUAL.

24 Accounting based measures are most commonly used in performance studies. One potential criticism of return on equity (ROE) or return on assets (ROA), however, is that these measures do not reflect the performance of the common stock and do not adjust for risk. We also used an alternative measure of performance - annual return including dividends of the REIT in excess of the rate of return on the NAREIT Index including dividends over the same period. The mean excess return for our sample of REITs is 4.52%, with maximum and minimum values of 62.71% and 56.51%. Using the excess return (EXCRET) as the performance measure, we get the following OLS estimates:

EXCRET = 30.526 2.58*SIZE + 20.01*MKTBOOK + 0.21*OUTDIR 29.42*CEODUAL 1.14*EXCEOOWN 2.28*AFFOWN + 0.24*NAFFOWN 0.01*CEOOWN + 0.11*CEOTEN All the variables except CEOOWN are significant. The signs of OUTDIR, and CEODUAL are consistent with the ROE model. The signs of EXCEOOWN, AFFOWN, NAFFOWN, and CEOTEN are reversed, however.

36