Insider Ownership, Risk, and Leverage in REITs

Abstract

We investigate the relative importance of managerial entrenchment and incentive alignment as indicated by REIT risk-taking. The two theories make contradictory predictions about the sign of the relation between insider ownership and risk. We test for the possibility of diminishing entrenchment returns to insider ownership. Empirical results for equity and asset betas soundly reject linear models in favor of nonmonotonic relations with reversals at insider ownership of 36%. Up to that point, increasingly entrenched insiders mitigate their own risk aversion. Above 36%, incentive alignment emerges as managers become more substantial owners. Leverage declines at an accelerating rate above 20% insider ownership. Together these results suggest a shift in the composition of risk, from leverage risk to asset risk, reflecting comparative advantage and a crossover in the relative monitoring costs of debt and equity. Problematically for linear models, the coefficient of insider ownership is not significant for most risk measures, producing the misleading appearance of no relation between insider ownership and risk. Institutional ownership is significantly negatively related to leverage. Thus incentives are aligned between insiders and institutional owners at insider ownership above 20%.