Does Corporate Governance Matter for REITs? Re-Examining 'The REIT Effect'

Abstract

This study tests corporate governance and performance relationships using a balanced panel of 2,779 REITs and non-REIT firms in the US over the period from 2005 to 2008. The results show that strong corporate governance dampens firm values. However, the marginal effect is weakest for REITs relative to the control sample firms in utilities and finance industries. The results weakly corroborate the “REIT effect” hypothesis, which argues that the regulated regime in REIT markets reduces the reliance on strong internal governance. The negative results are consistent with the “tunneling distortion” hypothesis, which predicts that dominant insiders (weak governance) could lead insiders/managers to carry out self-dealing activities that will siphon off cash flows from firms. The negative effects are reinforced when unobserved heterogeneity and self-selectivity of firms into REITs are corrected. The value-destroying effects by weakly governed REITs could be channeled through real estate investment, dividend payout and leveraging activities. Strong governance in REIT markets with strong investors’ protection (with dominant outside shareholdings) induces positive risk-taking behavior in REIT managers, which increases firm values.