Positive Performance and Private Equity Placements Outside Monitoring

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					           Positive Performance and Private Equity
          Placements: Outside Monitoring or Inside

Executive Summary. This paper examines the perform-            by Dalia Marciukaityte*
ance of real estate investment trusts (REITs) making eq-          Eric James Higgins**
uity private placements. Since REITs are frequent issu-           H. Swint Friday***
ers of equity, we can control for the market’s reaction to        Joseph R. Mason****
underinvestment versus monitoring. Like previous stud-
ies of REIT public offerings, we find a significant nega-
tive abnormal return associated with the announcement
of an equity private placement, positive long-run abnor-       Private equity placements of industrial firms have
mal returns, and improved operating performance. The           presented a puzzle to researchers because they are
long-run abnormal returns are not associated with the          generally associated with positive abnormal re-
presence of an external monitor. It does appear, however,      turns. The two main explanations for this puzzle,
that REIT managers are able to time equity issues to           the underinvestment hypothesis and the monitor-
correspond with stock market performance and invest-           ing hypothesis, continue to produce mixed results.
ment opportunities in the real estate market.
                                                               According to the underinvestment hypothesis, pos-
                                                               itive abnormal returns are obtained because in-
                                                               dustrial firms rarely issue private equity place-
                                                               ments. Hence private equity placements are
                                                               signals of reduced Myers and Majluf (1984)-style
                                                               underinvestment problems (e.g., Hertzel and
                                                               Smith, 1993). According to the monitoring hypoth-
                                                               esis, positive abnormal returns are obtained be-
                                                               cause of increased monitoring provided by the new
                                                               block holder (e.g., Wruck, 1989). Furthermore, the
                                                               hypotheses themselves are not mutually exclusive.

                                                               The present paper investigates several implica-
                                                               tions of the monitoring hypothesis in the absence
                                                               of substantial underinvestment complications by
                                                               examining the effects of private equity placements
                                                               in real estate investment trusts (REITs). Several
* Louisiana Tech University,     Ruston,    LA    71272   or   institutional features of REITs limit the impor-
dmarciuk@cab.latech.edu.                                       tance of the underinvestment hypothesis in this
** Kansas State University,    Manhattan,    KS   66506   or   context. Since REITs distribute 90% of net taxable
ehiggins@ksu.edu.                                              income to shareholders, they are not required to
*** Texas A&M–Corpus Christi, Corpus Cristi, TX 78412 or       pay income tax at the corporate level (limiting cap-
sfriday@cob.tamucc.edu.                                        ital structure frictions) and are prevented from us-
**** Drexel University,   Philadelphia,     PA    19104   or   ing retained earnings to finance new investments
joe.mason@drexel.edu.                                          (limiting asymmetric information). Thus, REITs

                                                                          Journal of Real Estate Portfolio Management   389
Dalia Marciukaityte, Eric James Higgins, H. Swint Friday, and Joseph R. Mason

are largely indifferent between debt and equity fi-      2000), the findings of the current paper reveal that
nance and make frequent trips to the capital mar-       negative short-run market responses to private
kets. Previous empirical observations show that         placement announcements couple with positive
this is indeed the case. Ghosh, Nag, and Sirmans        long-run post announcement performance. The
(1997), for example, show that from 1992 to 1997,       findings also reveal that the positive long-run ab-
REITs issued equity three times more frequently         normal performance is not associated with long-
than debt and raised twice as much capital using        run price reversal. Furthermore, monitoring does
equity as debt.                                         not seem important since REITs that have good
                                                        governance characteristics and better operating
Even the previous REIT literature, however, is in-      performance at the time of the placement perform
conclusive regarding the effects of external moni-      better post placement. However, the REIT man-
toring. It is important to note, however, that pre-     ager’s ability to time investments in the real estate
vious studies have relied almost exclusively on         market seems to explain a substantial amount of
blockholder presence as the main proxy for moni-        positive ex post performance.
toring.1 While large blockholders may use their po-
sition to try and gain an advantage over smaller,
less informed shareholders, they are less likely to     Sample Selection and Description
do so in the presence of sound corporate gover-         The sample in this paper consists of all private
nance policies and procedures.                          placements of equity made by REITs available on
                                                        the Securities Data Corporation (SDC) database.
The present examination of private placements of        The issue date, the size of the issue, and the issue
equity by REITs therefore provides three signifi-        price are gathered from the database. The Wall
cant contributions. First, is an examination of the     Street Journal Index and Lexis-Nexis are searched
market’s view of private equity placements absent       by using the issue date to identify the earliest pub-
the underinvestment problems that exist for in-         lic announcement of the private placement. If no
dustrial firms. Second, is an examination of the         public announcement of the placement is found be-
market’s perception of the benefit of external mon-      fore the issue date, the issue date is assumed to be
itoring for REITs and, more generally, the effects      the announcement date.
of significant corporate governance problems.
Third, is the suggestion that REIT private place-       Exhibit 1 summarizes the characteristics of the
ments are driven by fundamental real estate mar-        private placements. There is a clustering of private
ket opportunities rather than by financial frictions,    placements in 1991 and again in 1999. This is con-
and positive financial performance after the issues      sistent with previous studies on equity issues
confirms management expertise.                           made by REITs, suggesting that there are hot is-
                                                        sue periods for REIT equity issues. The mean issue
The paper achieves these goals by investigating         size is roughly 20% of the issuer’s market value
the short-run and long-run price performance and        and the median issue size is 14.58% of the issuer’s
the long-run operating performance of REITs that        market value. Thus, the private placements in the
announce private placements of equity. The paper        sample are substantial. On average, the private
then investigates three hypotheses regarding post-      placements are sold at a discount relative to mar-
private placement performance: long-run price re-       ket value. However, when examining the median,
versal, real estate market timing, and corporate        the placements are sold at a premium above mar-
governance.                                             ket value. This finding is much different than what
                                                        is found for private placements made by industrial
Like previous studies of REIT initial public offer-     firms. While the lack of a discount suggests that
ings (IPOs) and public equity issuances (e.g., Howe     investors in REIT private placements are not ac-
and Shilling, 1988; Wang, Chan, and Gau, 1992;          tive investors, it could be that investors are willing
Ling and Ryngaert, 1997; Ghosh, Nag, and Sir-           to pay a premium to gain access to inside infor-
mans, 1999; and Friday, Howton, and Howton,             mation about the value of the firm’s assets.2

390   Vol. 13, No. 4, 2007
                              Positive Performance and Private Equity Placements: Outside Monitoring or Inside Expertise?

                               Exhibit 1                                 three-day announcement window, day 1 to day
 Descriptive Statistics for Private Placements of                          1, and a two-day window, day 1 and day 0, are
                 Equity by REITs                                         used to calculate the announcement period abnor-
Panel A: Distribution of Announcements by Year                           mal return.
Issue Year              Number of Issues             % of Total Issues
                                                                         Benchmarks consisting of matched control firms
1981                      2                           4.9%               are created to evaluate the long-run stock-price ab-
1982                      0                           0.0%               normal performance of REITs making private eq-
1983                      0                           0.0%               uity placements. Two sets of criteria are used to
1984                      0                           0.0%               create the matching samples: (1) industry and size
1985                      0                           0.0%               and (2) book-to-market and size. REITs making
1986                      1                           2.4%               private equity placements are excluded from the
1987                      1                           2.4%               matching samples for the five years before and five
1988                      1                           2.4%               years after the placement.
1989                      1                           2.4%
1990                      1                           2.4%               The industry and size matched sample is created
1991                    10                           24.4%               by finding all the firms with the same four digits
1992                      1                           2.4%               of the Standard Industrial Classification (SIC)
1993                      2                           4.9%               code for each placing firm and selecting the firm
1994                      4                           9.8%               with the closest size to the placing firm size. The
1995                      3                           7.3%               SIC codes are obtained from the Center for Re-
1996                      3                           7.3%               search in Security Prices (CRSP) database. Match-
1997                      1                           2.4%               ing is done at the end of the placement month.
1998                      2                           4.9%
1999                      8                          19.5%               The book-to-market and size matched sample is
Total                   41                                               created by first creating twenty size-sorted port-
Panel B: Descriptive Statistics                                          folios from the CRSP database for each month.
                                                                         Size is defined as the market value of equity. The
                                     Median             Mean
                                                                         number of firms in each size-sorted portfolio is the
Placing company size, $000           208,176            372,405          same. Firm size is found at the end of the place-
Placement size, $000                  26,925             31,088          ment month and book-to-market ratio at the end
Relative placement size                    14.58%              20.23%    of the fiscal year that ends after the placement.
Discount to market price                   2.29%                0.68%    Each placing firm is assigned to its appropriate
Notes: Panel A reports the number of REITs announcing an equity          size-sorted portfolio. The firm from the assigned
private placement by year. Panel B reports the size of the placing       portfolio with the book-to-market ratio closest to
companies, the size of the equity placement, and the discount relative
                                                                         the placing company’s book-to-market ratio is se-
to market price at which the private placement is sold.
                                                                         lected as the matching firm. If the book-to-market
                                                                         ratio is not available for a particular placing firm,
                                                                         the firm is matched by size only. If the chosen
                                                                         matching firm is delisted from CRSP during sam-
Short-Run and Long-Run Abnormal
                                                                         ple period, the next closest match with available
Stock Price Performance
                                                                         data is used.
A market model is used to estimate short-run ab-
normal returns. Market model parameters are es-                          Holding period abnormal returns are used to es-
timated during the period starting 30 days after                         timate abnormal stock price pre-placement and
the issue and ending 180 days after the announce-                        post-placement performance. Using a simulation
ment day. A post-announcement estimation win-                            methodology, Loughran and Ritter (2000) show
dow is used due to the stock price run-up that                           that multifactor models used in some studies (e.g.,
typically occurs prior to equity issues. Both a                          Eckbo, Masulis, and Norli, 2000) cannot be used to

                                                                                    Journal of Real Estate Portfolio Management   391
Dalia Marciukaityte, Eric James Higgins, H. Swint Friday, and Joseph R. Mason

test for market efficiency or the absence of abnor-         Panel B of Exhibit 2, however, shows that there are
mal returns. Such models, instead of estimating            significant, positive long-run abnormal returns for
‘normal’ returns, estimate the predictable part of         REITs making private placements using all three
returns that may consist of both ‘normal’ and ab-          control samples. This result is the opposite of the
normal returns. The procedure used here to cal-            result for industrial firm private placements found
culate abnormal returns is also used in Spiess and         by Hertzel, Lemmon, Linck, and Rees (2002). This
Affleck-Graves (1995). First, the holding period re-        suggests that while the market perceives the
turn is calculated for each firm in the placing and         placement as a negative event, there may be long-
matching samples:                                          run benefits to having a large blockholder in place.

                                                           Long-Run Operating Performance
          HPRi,a,b                 (1   Ri,t)   1,   (1)
                             t a                           In addition to examining the long-run stock price
                                                           performance of REITs following a private place-
where HPRi,a,b is the holding period return for firm        ment of equity, the long-run operating performance
i during the period from a to b; Ri,t is the monthly       of REITs is also examined. A methodology similar
return on common shares of firm i in month t.               to Loughran and Ritter (1997) is employed to find
                                                           a matching firm for each of the placing REITs. The
The abnormal return is calculated as the difference        difference between placing and matching firm op-
between the placing firm and matching firm hold-             erating income to assets, return on assets, and
ing period returns. As a matching firm is used for          debt to assets ratios is examined. The change in
each placing firm instead of a reference portfolio,         the differences in operating performance for plac-
a conventional t-statistic can be used to evaluate         ing and matching firms from year 1 to 1 relative
statistical significance for average abnormal re-           to the placement date is also examined.
turns (Barber and Lyon, 1997).
                                                           Exhibit 3 contains long-run operating performance
Positive post-issue abnormal returns indicate out-         results for placing firms relative to matching firms.
performance only if equity issuer risk is not higher       The results, while not as strong, support the con-
than matching company risk. Placing firms can               clusions found for long-run abnormal stock re-
have very high (low) abnormal returns not only be-         turns. Placing firms tend to perform better long-
cause it performed very well (poorly), but also be-        term than matching firms. This result is most
cause its matching firm performed abnormally bad            apparent in Panel B of Exhibit 3. From one year
(good). To reduce this variation in holding period         prior to placement to one year after placement,
abnormal returns, holding period abnormal re-              placing firms have a return on assets that in-
turns are also estimated relative to the National          creased 1.43%, relative to matching firms. An in-
Association of Real Estate Investment Trusts               teresting result that comes from Exhibit 3 is the
(NAREIT) index.                                            reduction in leverage that occurs around the time
                                                           of the private placement. It is possible that the rel-
Panel A of Exhibit 2 shows that investor reaction          atively large size of the placements may explain
to the announcement of private equity placements           this drop in leverage. However, it is worth noting
by REITs is negative and significant with a three-          that operating performance still improves even
day announcement period abnormal return of                 with less managerial discipline being provided by
  0.82%. While this finding is very different from          leverage.
the market reaction to private equity placements
by industrial firms, this negative announcement
period abnormal return is consistent with the work         Possible Explanations for Positive
of Barclay, Holderness, and Pontiff (1993) and Fri-
                                                           Long-Run Performance
day, Sirmans, and Conover (1999). Both of these            The finding of positive long-run performance runs
studies suggest that the costs of increased owner-         counter to the findings for industrial firms by Her-
ship concentration may outweigh the benefits.               tzel, Lemmon, Linck, and Rees (2002). However,

392   Vol. 13, No. 4, 2007
                        Positive Performance and Private Equity Placements: Outside Monitoring or Inside Expertise?

                                                              Exhibit 2
    Short-Run and Long-Run Abnormal Returns Associated with the Announcement of a Private
                                Placement of Equity by REITs
Panel A: Pre-Placement and Announcement Period Abnormal Returns

                          3 Years                 2 Years                  1 Year
Time Period               Pre-Placement           Pre-Placement            Pre-Placement           Days   1 to   1           Days    1 to 0

Abnormal Return           37.29%***               18.75%***                 7.91%**                  0.82%**                   0.66%**
                          (2.97)                  (2.86)                   (1.75)                  ( 2.45)                   ( 1.84)

Panel B: Post-Placement Abnormal Returns

                          Size and Industry Adjusted Holding Period Returns

                          1 Year                  2 Years                  3 Years                 4 Years                   5 Years
Time Period               Post-Placement          Post-Placement           Post-Placement          Post-Placement            Post-Placement

Abnormal Return           12.53%***               18.65%                   28.46%**                 35.32%**                  46.38%**
                          (2.41)                  (1.14)                   (1.74)                   (1.92)                    (2.13)

                          Size and Book-to-Market Adjusted Holding Period Returns

                          One Year                Two Years                Three Years             Four Years                Five Years
Time Period               Post-Placement          Post-Placement           Post-Placement          Post-Placement            Post-Placement

Abnormal Return           14.01%**                21.52%*                  16.32%                   13.80%                    46.83%
                          (1.82)                  (1.44)                   (0.86)                   (0.34)                    (1.14)

                          NAREIT Index Adjusted Holding Period Returns

                          One Year                Two Years                Three Years             Four Years                Five Years
Time Period               Post-Placement          Post-Placement           Post-Placement          Post-Placement            Post-Placement

Abnormal Return             2.74%                 11.44%***                19.24%**                 31.99%**                  29.82%**
                           (0.68)                 (2.34)                   (1.95)                   (2.28)                    (1.47)

Notes: This exhibit contains pre-placement, announcement period, and post-placement abnormal returns associated with the announcement
of an equity private placement made by REITs. Panel A contains announcement period and pre-placement abnormal returns. Two announce-
ment periods are examined, days –1 to 1 and days –1 and 0, where day 0 is the announcement date. Abnormal returns are calculated
using the market model. One-year, two-year, and three-year pre-placement abnormal holding period returns are examined. Returns are adjusted
using the National Association of Real Estate Investment Trusts (NAREIT) Index. Panel B contains post-placement abnormal returns using three
different matching samples: a size and industry matched sample, a size and book-to-market equity matched sample, and the NAREIT Index.
t-statistics appear in parentheses.
* Significant at the 10% level.
** Significant at the 5% level.
*** Significant at the 1% level.

the results are consistent with the hypothesis                         finding of a negative announcement period abnor-
made by Wruck (1989) that private equity place-                        mal return, there seems to be some ambiguity
ments improve governance and, thus, improve                            about the role that external monitoring plays for
long-run performance. Since REITs tend to have                         REITs. Possible explanations for the observation of
governance problems, it may not be surprising to                       positive long-run performance are explored next.
find benefits to external monitoring. Also, given
that REITs do not have the degree of information
                                                                       Long-Run Price Reversal
asymmetry typically associated with industrial
firms, it may be justified to conclude that the pos-                     One possible explanation for the positive post-
itive long-run performance is due to increased lev-                    placement performance is a reversal of previous
els of external monitoring. However, given the                         underperformance. This is not the case, however.

                                                                                       Journal of Real Estate Portfolio Management      393
Dalia Marciukaityte, Eric James Higgins, H. Swint Friday, and Joseph R. Mason

                                                                Exhibit 3
            Mean Operating Performance for REITs Making Private Placements and Matching
                                         Non-Placing REITs
Panel A: Operating Performance Ratios Pre and Post Placement

                                Issuer Means                                                Difference in Means
Fiscal Year Relative
to Placement                    OIBD / A          ROA                D/A                    OIBD / A              ROA                   D/A

 3                              4.85%             0.86%              59.6%                    1.50%                3.27%                14.7%**
 2                              6.15%             3.05%              52.1%                    0.85%                1.02%                  2.0%
 1                              6.48%             2.88%              53.1%                    0.96%                0.28%                  1.0%
 0                              5.74%             2.38%              47.6%                    0.76%                1.97%**                4.9%
 1                              7.32%             4.31%              42.5%                    0.99%*               0.04%                  5.8%
 2                              6.94%             4.58%              45.5%                    1.01%                0.01%                  4.0%
 3                              6.88%             3.31%              50.3%                    5.10%                3.27%                  8.8%
 4                              7.24%             4.06%              52.7%                    3.58%                0.06%                  7.2%
 5                              6.75%             3.83%              51.6%                    0.51%                1.09%                  5.5%

Panel B: Change in Mean Operating Performance from Year          1 to 1

                                Change in Issuer Means                                      Change in the Difference in Means

                                OIBD / A          ROA                D/A                    OIBD / A              ROA                   D/A

Year   1 to 1                   0.84%             1.43%*                  10.56%*           0.03%                 0.32%                   4.8%

Notes: Panel A reports average operating income to total assets (OIBD / A), return on assets (ROA), and debt to assets (D / A) for REITs privately
placing equity and differences in mean operating performance between placing REITs and matching non-placing REITs. The matching pro-
cedure used is similar to that of Loughran and Ritter (1997). Panel B reports the change in mean operating performance for placing REITs
and the change in the difference between the operating performance of placing REITs and matching non-placing REITs from year –1 to 1,
relative to the placement year.
* Significant at the 10% level.
** Significant at the 5% level.

Panel A of Exhibit 2 shows that there is a signifi-                          Real Estate Market Timing
cant abnormal price run up prior to the placement.                          A possible explanation for the positive long-run
The results differ slightly from Howton, Howton,                            performance is that REIT managers are adept at
and Friday (2000), who find a positive but insig-                            timing real estate markets and issue equity ac-
nificant abnormal price run up associated with                               cordingly. This argument can be thought of as
seasoned equity offerings made by REITs. Thus,                              the antecedent to the argument made by Schultz
counter to the price reversal argument, it appears                          (2003). If REIT managers are investing when there
that REIT managers may be attempting to time                                are favorable real estate opportunities, positive
the placement to correspond with a period of                                long-run stock price performance would be ob-
higher market expectations and is consistent with                           served, as REIT stock price performance reflects
the clustering of placements in hot issue periods                           the REIT’s real estate investments. Thus, follow-
for REITs. The potential for market timing by                               ing Schultz (2003), it is anticipated that equity
managers may explain the market’s negative re-                              placements by REITs are preceded by worse than
action to the placement announcement as they are                            average real estate market performance allowing
interpreting the placement as if it were a seasoned                         the REIT manager to capitalize on potentially un-
public equity offering. However, even if the REIT                           dervalued real estate.
managers are timing equity markets, they do
not appear to be taking advantage of their                                  The timing of the private equity placements is ex-
shareholders.                                                               amined relative to both national and regional

394      Vol. 13, No. 4, 2007
                          Positive Performance and Private Equity Placements: Outside Monitoring or Inside Expertise?

housing price index changes during the two years                        placements were made in favorable quarters, while
before the quarter when the placement occurred.                         only fifteen were made in unfavorable quarters;
Two-year changes in the value of indexes are cal-                       the difference is statistically significant at the 5%
culated from quarterly values of the Freddie Mac                        level. Thus, REIT managers seem to place equity
Conventional Mortgage Home Price Index over the                         when real estate prices are relatively low. This re-
period 1979 to 1999. Regional indexes cover nine                        sult and the previous result of managers timing
regions: New England, Middle Atlantic, South At-                        equity sales when equity markets are hot suggest
lantic, East South Central, West South Central,                         that REIT managers undertaking private place-
West North Central, East North Central, Moun-                           ments are very adept at market timing.
tain, and Pacific. A placing REIT’s region is deter-
mined by the location of the REIT’s headquarters.
                                                                        Governance Characteristics of Issuing and
The post-placement real estate market is defined
                                                                        Non-issuing REITs
as a favorable (unfavorable) real estate market if
the two-year pre-placement change in index value                        Wruck (1989) attributes the finding of a positive
is below (above) the average over the entire time                       market response to private placements of equity
period. If the real estate market timing argument                       to increased monitoring by outside blockholders.
is correct, most REIT placements would be asso-                         While the findings reveal a negative short-term
ciated with poor pre-placement real estate market                       market response to the private placement, it is
performance, resulting in relatively low real estate                    possible that the positive long-run post-issue per-
prices at the time of the placement.                                    formance may be due to the presence of an external
                                                                        monitor. For this to be the case, issuing REITs
Exhibit 4 contains a summary of the relationship                        would most likely have poorer governance charac-
between the pre-placement performance of the real                       teristics than non-issuing REITs. The presence of
estate markets and the number of private place-                         the outside blockholder would then increase post-
ments by REITs in the sample. When the national                         issue performance.
index is used to identify favorable and unfavorable
quarters to place equity, no significant evidence is                     For comparison with issuing REITs, the size and
found to support the hypothesis that REIT man-                          industry matched sample created in the calcula-
agers place equity when real estate prices are low.                     tion of long-run abnormal returns is used as the
However, more precise examination of this hypoth-                       non-issuing sample. The following governance var-
esis using regional indexes reveals that equity                         iables are gathered from proxy statements: total
placements are more frequent after poor perform-                        officer cash compensation, total director fixed com-
ance in the real estate markets. Twenty-six private                     pensation, total officer and director ownership, and

                                                              Exhibit 4
                                           Pre-Placement Real Estate Conditions
                                            Favorable Quarters              Unfavorable Quarters              Difference             z

Using U.S. Growth Index
Number                                      21                              20                                 1
Proportion                                   0.5122                          0.4878                            0.0244                0.1562
Using Regional Growth Indexes
Number                                      26                              15                                11
Proportion                                   0.6341                          0.3659                            0.2683**              1.7833

Notes: This exhibit contains private equity placements made by REITs categorized by the real estate environment at the time of the placement.
Using both national and regional housing price indexes we categorize the pre-placement real estate market for the REITs favorable (unfa-
vorable) when the two-year pre-placement change in housing price index is below (above) average.
* Significant at the 10% level.
** Significant at the 5% level.

                                                                                       Journal of Real Estate Portfolio Management       395
Dalia Marciukaityte, Eric James Higgins, H. Swint Friday, and Joseph R. Mason

the percentage of outside directors. If the issuing                       mean values of the governance and issuer-specific
REITs do have weaker governance characteristics,                          variables conditioned on positive or negative val-
they would have higher cash compensation, higher                          ues for the announcement period abnormal returns
fixed compensation for directors, higher inside                            and the one-year post-issue abnormal returns are
ownership concentration, and a lower percentage                           examined as an alternative. While this analysis
of outside directors.                                                     does not conclusively identify the determinants of
                                                                          short-run and long-run abnormal returns, it does
Exhibit 5 contains the mean values of the gover-                          provide descriptive evidence regarding possible
nance variables examined for both the issuing and                         determinants.
non-issuing REITs. Given the lack of proxy state-
ment availability, the sample sizes are relatively                        The governance variables examined are top man-
small and none of the differences are significant.                         ager compensation, a CEO/Board Chair duality
However, it does appear that the cash compensa-                           dummy variable, CEO tenure, and manager and
tion and the percentage of shares held by insiders                        director ownership percentage are used as explan-
are substantially higher for the issuing firms.                            atory variables.3 These variables are found from
While not significant, these differences do suggest                        proxy statements in the year in which the place-
that issuing firms may have more governance                                ment occurred. Both the short-run and long-run
problems than non-issuing firms and, thus, the is-                         abnormal returns are expected to be inversely
suing firms may receive some benefit from having                            related to the governance characteristics. Those
an external monitor.                                                      firms that have the worst governance characteris-
                                                                          tics should receive the most benefit from the added
The mean values of variables associated with gov-                         monitoring associated with the private placement.
ernance and issuer-specific characteristics for the
REITs making private equity placements are ex-                            Panel A of Exhibit 6 contains mean values for gov-
amined to further explore the potential benefits of                        ernance variables conditioned on positive (nega-
external monitoring for REITs privately placing                           tive) values for short-run and long-run abnormal
equity. There is substantial variation in both the                        returns. None of the governance variables explains
abnormal announcement period returns and the                              differences in the short-run abnormal returns. In
one-year post issue abnormal returns but there are                        general, it appears that both positive short-run
not enough usable data points to conduct a mean-                          and long-run abnormal returns are associated with
ingful regression analysis that controls for gover-                       better governance characteristics. Of particular in-
nance and issuer-specific characteristics. Thus, the                       terest are the results for CEO compensation and

                                                                Exhibit 5
                            Governance Characteristics for Issuing and Non-issuing REITs
                                                                                                                      z-Statistic for Difference
Variable                                              Issuing REITs                  Non-Issuing REITs                in Means

Total Officer Compensation                             $824,157                       $505,694                           1.296
                                                      N 20                           N 11
Total Director Fixed Compensation                      $63,447                        $80,358                           0.997
                                                      N 20                           N 12
Percent of Shares Held by Officers and                           0.30675                         0.20141                 1.144
                                                      N    19                        N     11
Percentage of Inside Directors                                  0.26403                         0.26665                 0.076
                                                      N    23                        N     16

Notes: This exhibit contains means for the total cash compensation for all officers, the total fixed salary for all directors, the percentage of
shares held by officers and directors, and the percentage of inside directors for REITs making private equity placements and a matched sample
of REITs not making private equity placements. An asterisk indicates significance at the 10% level, a double asterisk indicates significance at
the 5% level, and a triple asterisk indicates significance at the 1% level.

396        Vol. 13, No. 4, 2007
                         Positive Performance and Private Equity Placements: Outside Monitoring or Inside Expertise?

                                                                 Exhibit 6
                         Conditional Means for Governance and Issuer-Specific Variables
Panel A: Governance Variable Meansa

                                             Day    1 to    1 Abnormal Return                          One-Year Post Issue Abnormal Return

Variable                                     Negative                    Positive                      Negative                   Positive

CEO Compensation                             $394,401                    $516,646                      $370,719                   $510,648
                                                  (12)                         (8)                           (7)                       (12)
CEO / Chair Duality                                   7                              2                          3                            6
                                                    (13)                            (8)                        (8)                         (12)
CEO Tenure                                           11.833                          5.000                      5.286                        9.667
                                                    (12)                            (8)                        (7)                         (12)
Ownership %                                           0.211                          0.138                      0.205                        0.114
                                                    (12)                            (9)                        (7)                         (13)

Panel B: Issuer-Specific Variable Meansa

                                              Day    1 to     1 Abnormal Return                          One-Year Post Issue Abnormal Return

Variable                                      Negative                    Positive                       Negative                  Positive

Market / Book                                         1.475                         1.246                       1.350                        1.384
                                                    (16)                          (14)                        (11)                         (17)
Debt-to-Assets                                        0.493                         0.491                       0.543                        0.474
                                                    (16)                          (14)                        (11)                         (18)
Market Value (in $ thousands)                 436,145                     277,824                        348,107                   420,436
                                                  (19)                        (15)                           (11)                      (20)
Issue Size as % of Market Value                     0.294                       0.131                          0.239                     0.204
                                                   (7)                         (9)                            (4)                      (11)
ROA                                                   0.028                         0.011                       0.010                        0.041
                                                    (16)                          (14)                        (11)                         (17)

Notes: This exhibit contains mean values of governance and issuer-specific variables conditioned on positive or negative announcement period
and one-year post announcement abnormal returns across the issuing firms. Panel A contains means for the governance variables. The variables
examined are top manager compensation, a CEO / Board Chair duality dummy variable, CEO tenure, and manager and director ownership
percentage are used as explanatory variables. Panel B contains means for company-specific variables. The variables examined are the firm’s
market-to-book ratio, the issue size as a percentage of market value, the return on assets, the issuer’s market value, the debt-to-asset ratio,
and the one-year prior issue abnormal return.
  Sample size in parentheses.

insider ownership. CEO compensation is found to                          better post placement have better governance
be higher for firms that have positive short-run                          characteristics.
and long-run abnormal returns. Thus, there seems
to be greater sensitivity between compensation                           The market-to-book ratio, the debt-to-asset ratio,
and performance for firms that have positive short-                       the market value, the issue size as a percent of
run and long-run abnormal returns. Insider                               market value, and the return on assets for all firms
ownership is lower for firms that have positive                           in the sample conditioned on positive (negative)
short-run and long-run abnormal returns. Thus,                           short-run and long-run abnormal returns are ex-
consistent with the work of Barclay, Holderness,                         amined to determine if any issuer-specific charac-
and Pontiff (1993), firms that have more concen-                          teristic variables are driving the short-run and
tration problems prior to the private placement                          long-run abnormal returns. All issuer-specific var-
actually perform worse post-placement. Thus,                             iables are either measured at the time of the place-
counter to the external monitoring hypothesis of                         ment or in the year of the placement. The market-
Wruck (1989), it appears that firms that perform                          to-book ratio, the debt-to-asset ratio, and the

                                                                                             Journal of Real Estate Portfolio Management      397
Dalia Marciukaityte, Eric James Higgins, H. Swint Friday, and Joseph R. Mason

market value are included to control for potential      abnormal returns when a private placement oc-
systematic risk differences across firms. It is ex-      curs. Wruck suggests that the positive abnormal
pected that firms with a larger issue size will ex-      return is due to the presence of an external mon-
perience abnormal returns due to dilution. The re-      itor while Hertzel and Smith suggest that private
turn on assets is included as a control for firm         placements help eliminate the underinvestment
performance. Firms that perform better should           problem. Hertzel, Lemmon, Linck, and Rees (2002)
have higher abnormal returns.                           find, however, that the long-run performance fol-
                                                        lowing a private placement by industrial firms is
Panel B of Exhibit 6 contains mean values for the       negative. This casts doubts on the viability of the
issuer-specific variables conditioned on positive        theories of Wruck and Hertzel and Smith.
(negative) short-run and long-run abnormal re-
turns. It appears as if the book-to-market ratio and    The examination of REIT private placements pro-
the debt ratio are similar for all firms in the sam-     vides a unique opportunity to test possible theories
ple, regardless of the short-run or long-run abnor-     regarding private placements in a controlled en-
mal returns. Firms having positive short-run ab-        vironment. REITs go to the capital markets quite
normal returns appear to be smaller and firms            frequently due to their unique structure, thus,
having positive long-run abnormal returns appear        they do not face an underinvestment problem.
to be larger. If a systematic risk factor due to size   They also have a high level of agency problems
differences were explaining the results, the size       making external monitoring necessary. The short-
differences would be consistent across short-run        run and long-run stock price performance of REITs
and long-run abnormal returns. Thus, there do not       making private placements and long-run post
appear to be any systematic risk differences be-        placement operating performance are also exam-
tween firms with positive (negative) short-run or        ined. The findings reveal significant negative ab-
long-run abnormal returns.                              normal returns associated with the placement;
                                                        however, the long-run performance of REITs fol-
As expected, issue size as a percentage of market       lowing private placements is positive.
value has an inverse relationship with both short-
run and long-run abnormal returns. Thus, dilution       Following Wruck (1989), the possibility that the
of existing equity holders explains at least a por-     positive abnormal returns are associated with in-
tion of the results. There appears to be an inverse     creased monitoring and elimination of agency
relationship between return on assets and short-        problems is also examined. No support is found to
run abnormal returns and a direct relationship be-      support the hypothesis that the REITs benefit
tween return on assets and long-run abnormal re-        from external monitoring. It appears as if the long-
turns. The short-run abnormal return result is          run abnormal returns are most associated with
surprising, which suggests that the market per-         prior performance. REITs that have low ownership
ceives that firms that are performing better are         concentration, higher sensitivity between compen-
more likely to be seeking to issue overvalued eq-       sation and performance, and higher return on as-
uity. The direct relationship between return on as-     sets are found to perform better in the long-run.
sets and long-run abnormal returns suggests that        There is also evidence that REIT managers time
firms that are performing better are more likely to      the placements with hot equity markets and good
use the issue proceeds wisely and generate positive
                                                        real estate investment markets. Thus, REIT man-
abnormal returns.
                                                        agers who are performing better are simply better
                                                        able to use the proceeds from the private place-
                                                        ment and generate wealth for their shareholders.
This study examines private placements of equity
made by REITs. Previous research on private             Endnotes
placements has been contradictory. Both Wruck           1. Chan, Leung, and Wang (1998) suggest that increased mon-
(1989) and Hertzel and Smith (1993) find positive           itoring (higher institutional investing) will help to reduce

398   Vol. 13, No. 4, 2007
                      Positive Performance and Private Equity Placements: Outside Monitoring or Inside Expertise?

  agency problems in REITs. On the other hand, Friday, Sir-       ——. An Analysis of Seasoned Equity Offerings by Equity
  mans, and Conover (1999) find that monitoring (i.e., the         REITs (1991–1995). The Journal of Real Estate Finance and
  presence of outside blockholders) does not necessarily in-      Economics, 1999, 19:3, 175–92.
  crease value. In fact, for equity REITs monitoring (increased   Hertzel, M., M. Lemmon, J. Linck, and L. Rees. Long-Run Per-
  outside ownership concentration) is associated with de-         formance Following Private Placements of Equity. Journal of
  creases in value. Barclay, Holderness, and Pontiff (1993) find   Finance, 2002, 57:6, 2595–2617.
  a similar result for closed-end mutual funds.
                                                                  Hertzel, M. and R.L. Smith. Market Discounts and Share-
2. See Friday, Sirmans, and Conover (1999) for a discussion of    holder Gains for Placing Equity Privately. Journal of Finance,
   how inside information can be of value for blockholders of     1993:2, 48, 459–85.
                                                                  Howe, J. and J. Shilling. Capital Structure Theory and REIT
3. More governance variables are available for the placing sam-   Security Offerings. Journal of Finance, 1988, 43:4, 983–93.
   ple, thus, a broader set of governance characteristics are
   examined.                                                      Howton, S.D., S.W. Howton, and S. Friday. Long Run Under-
                                                                  performance in REITs Following Seasoned Equity Offerings.
                                                                  Journal of Real Estate Portfolio Management, 2000, 6:4, 355–
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                                                                                Journal of Real Estate Portfolio Management   399