REIT Capital Budgeting and Equity Marginal q

Abstract

Equity marginal q is the change in the market value of a company's equity in response to a one-unit unexpected change in its asset base. Hence, it is a profitability index that evaluates a firm's capital budgeting decisions at the margin. We estimate the equity marginal q for real estate-managing public corporations, namely, real estate investment trusts (REITs), in an attempt to understand how the various costs and benefits of being a public corporation play a role in managing this important asset class. Using the universe of equity REITs for the period from 1993 to 2005, we find that REITs with greater idiosyncratic volatility, higher stock turnover and smaller bid-ask spread have a higher equity marginal q. In addition, both the holdings of institutional investors and their investment horizons are respectively positively related to equity marginal q. With these firm characteristics taken into account, firm size is found to be negatively related to equity marginal q. Our findings are economically important as well, because the equity marginal q ratio alone accounts for approximately one-third of the total REIT shareholder wealth change during the study period.