How Entrenchment, Incentives and Governance Influence REIT Capital Structure

Abstract

Although recent literature has confirmed the importance of viewing a firm's capital structure choices of leverage and debt maturity as jointly determined, to date there has been little analysis of the importance of traditional governance variables on a firm's capital structure decisions using a simultaneous equations approach. We examine the influence of managerial incentives, traditional managerial monitoring mechanisms and managerial entrenchment on the capital structure of Real Estate Investment Trusts (REITs). Using panel data, we estimate a system of simultaneous equations for leverage and maturity and find that firms with entrenched CEOs use less leverage and shorter maturity debt. This is consistent with the expectation that managers acting in their own self interest will choose lower leverage to reduce liquidity risk and use short maturity debt to preserve their ability to enhance their compensation and reputations by empire building. We also find evidence that traditional alignment mechanisms such as equity and option ownership have an offsetting effect; and that firms where the founder serves as CEO choose higher leverage and longer maturity debt. The results also provide evidence that leverage and maturity are substitutes, firms with high profitability and growth opportunities use less leverage and firms with liquid assets use more leverage and longer maturity debt.

CEO entrenchment and corporate liquidity management

“…Ghosh et al (2011) find that firms with an entrenched CEO use less leverage and issue debt with shorter maturities to reduce liquidity risk and to preserve their ability to enhance their wages and reputations through empire building. Kumar and Rabinovitch (2013) also find that firms with an entrenched CEO are more likely to engage in hedging to diminish firm risks.…”

The Role of Sponsor and External Management on the Capital Structure of Asian-Pacific REITs: The Case of Australia, Japan, and Singapore

“…On the contrary, externally managed REITs are associated with lower leverage and they pursue loans of shorter maturity. Our results are robust to the inclusion of other firm variables that influence debt decisions of Asian-Pacific REITs, and to alternative specifications which we model leverage and debt maturity as simultaneous decisions (Giambona et al 2008;Ghosh et al 2011;Alcock et al 2014).…”

“…We follow the framework of Ghosh et al (2011) but include two additional variables to proxy for the presence of sponsor and external management. Our model specifications are depicted as follows:…”

“…Nagano (2010) examines J-REITs and shows that REITs which invest in more liquid property types are able to issue longer-term debts. Ghosh et al (2011), using simultaneous equations for leverage and maturity, examine various corporate governance mechanisms (such as entrenchment and board effectiveness) on the capital structure of REITs.…”

Managerial Cash Compensation, Government Control and Leverage Choice: Evidence from Chinese Listed Firms

“…Moreover, all the above mentioned literatures are based on the experience of developed countries (Ghosh et al, 2011) [15]. China has had rapid and dramatic growth and has become world's largest developing economy.…”