Fee Structure, Financing, and Investment Decisions: The Case of REITs

Abstract

Purpose. We focus on different compensation structures for real estate mutual fund Management Companies and assess whether management fees paid on NAV or GAV generate distorted incentives relative to those generated by performance fees paid on the market value of the fund. Design/methodology/approach. To test whether management fees induce Management Companies to opportunistic behaviors, we compare the relative effect of NAV-based and GAV-based fees over time using a plethora of econometric models. Findings. We find that Management Companies that are paid GAV-based fees start with higher leverage, in order to expand assets under management, then subsequently drive leverage and over-investment down as fund maturity approaches to minimize the negative impact of negative NPV investments on the final market value of the fund and therefore on performance fees paid at maturity. Research limitations/implications. We use a dataset of Italian listed real estate mutual funds. While the Italian market can be considered an ideal setting for our empirical analysis, studies on other countries would make it possible to test implications of the model that are only weakly identified in our setting. Practical implications. Our results could be important when designing managerial contracts. Originality/value. We show that Management Companies actively manage the size of their balance sheet in order to maximize fees, and that NAV-based fees produce effects similar to market-based fees in terms of managerial incentives.