Does governance matter for companies involved in real estate investment activities

The external control mechanisms rely on parties outside the firm to monitor the performance of top management, which include the debt policy, the managerial labor market, and the market

INTRODUCTION

In this chapter we will give an executive summary the following subjects:

▪ Background of the study

▪ Motivation of the study

▪ Scope of the study

“Corporate governance’ as mechanisms devised to regulate the conduct of directors and management is thus important in corporations to mitigate agency problem Markets will reward companies with good governance system What does corporate governance exactly mean? Corporate governance comprises a system of mechanisms through which owners of a corporation can monitor and reward the corporation’s insiders and management, so to ensure that their capital funds are protected In the seminal article by Sheifer and Vishny (1997), the theory of corporate governance centers on three main questions:

(i) How do the suppliers of finance get managers to return some of the profits to them?

1 Coase’s (1937) theory of the firm which explains the underlying contractual view of firms is the foundation of making most of the studies of corporate governance and firm performance A corporation is made up of a nexus of contracts, it difficult to fully specify ex-ante any ex-post contingencies in those contracts Corporate governance, therefore, becomes an important and critical issue in the modern theory of firm

(ii) How do they make sure that managers do not steal the capital they supply or invest it in

bad projects?

(iii) How do suppliers of finance control managers?

The corporate governance literature identifies seven major mechanisms, which can be divided into two broad categories: internal monitoring and external control The external control mechanisms rely on parties outside the firm to monitor the performance of top management, which include the debt policy, the managerial labor market, and the market for corporate control The remaining four corporate control mechanisms are instituted inside the firm, which include shareholdings of managerial and institutions, large block-holders and the structure of board of directors These interdependent mechanisms aim to alleviate the agency problems between managers and shareholders Agrawal and Knoeber (1996) observed an optimal level of corporate governance across a section of firms

Despite the Anglo-American influence of the practice and philosophy of corporate governance in Singapore (Li, 1994), there are still apparent weaknesses in the structure and activities of

2 The payment that is received by a resource of production activity over the opportunity cost in the short run According

to Zingales (1997), “The difference between the value of the product and the cost of the contracted manufacturer

presents a quasi-rent, and it needs to be divided ex-post.”

Singapore’s corporations, which are not commonly observed in corporations in more developed economies in the UK and the US The high concentration of ownership and the weak take-over market activities favor the owner-manager3 structure in many public listed companies in Singapore (Mak and Li, 2001) This structure provides weak corporate governance on managers The unique institutional characteristics and market environment in Singapore may offer a different case for empirical tests of the theory of governance

Land is scarce in Singapore Many Singapore corporations own and invest in real estate as part of their portfolio strategy Although there are only 29 companies listed in property sector of the Singapore Exchange (SGX) However, evidence shows that over 100 listed non-property companies on SGX are highly property intensive with more than 20 per cent of property assets in their total assets.4 It is thus important to analyze how inherent characteristics in real estate investment will affect the constitution of the corporate structure, and the potential governance problems in a corporation This study also investigates the relationship between corporate governance system and performance of firms in Singapore

1.2 Motivations of the Study

Governance plays an increasingly important monitoring role in today’s corporate activities Theoretical and empirical studies examining the agent-principal conflicts have been well published

in corporate finance literature However, few of them have examined explicitly on the corporate governance problems associated with real estate investment, and this study thus attempts to fill-in the gap by using empirical data of listed companies in Singapore There are four main motivations for undertaking this study

3 An individual who makes all major decisions directly and monitors all activities.

4 The data are based on the annual report of the financial year 2001 for each corporation

Firstly, cross-country differences in laws and their enforcement create different ownership structure and government regulations, which may in turn affect in different ways how companies are controlled and the processes by which the corporate controls are implemented.5 Motivated by

the following comments by Sheifer and Vishny (1997, page 740), “Most of the available empirical evidence (on corporate governance) comes from the United States… More recently, there has been a great surge of work on Japan, and to a lesser extent on Germany, Italy, and Sweden Unfortunately, except for the countries just mentioned, there has been extremely little research done on corporate governance around the world.”

The question: “Do differences in institutional environment across countries affect the choice of corporate governance practices?” will be examined in this study

Secondly, based on the idea of Sirmans (1999) and Ghosh and Sirmans (2002), we believe that quasi-rents caused by unique characteristics of real estate may create difficult governance problems for firms with high concentration in real estate assets vis-à-vis other asset classes Alternative corporate mechanisms may be required to protect the equity holders’ interest in firms with exposure to real estate markets Studies of governance problems in Real Estate Investment Trust (REIT) are well explored However, the study of effects of real estate investment activities

on corporate governance in firms outside the US market is limited Property companies listed on SGX are not subjected to the same legal instructions of REIT, such as no free cash flow, lower level of the ownership concentration, and no self-management of property assets.6 In the absence

of these regulations, should more corporate mechanisms be installed to monitor the property companies’ management in Singapore?

5 For example, Roe (1990), Li (1994), Sheifer and Vishny (1999 a, b) and others

6 This self-management requirement is not applicable to REITs in the US and Australia, where internally-advised structure is common for some REITs

Thirdly, owning and investing real estate is an important portfolio strategy of many Singapore companies, and real estate constitutes a large proportion of corporations’ tangible assets in the financial statements There are only limited studies that test the governance problems in Singapore (Phan and Mak, 1999; Mak and Li, 2001), and none of them look at how real estate investment activities affect the effectiveness of the corporate governance of publicly listed firms It is, therefore, useful to empirically examine how inherent characteristics of real estate will influence corporate structure, ownership structure, and also performance of publicly listed firms with intensity property holdings

Finally, cross-industry studies of the effectiveness of corporate governance are still lacking Sirmans (1999) argues that governance issues may be more problematic in real estate than in other asset markets However, there is still dearth of empirical evidence to support the hypothesis that corporate governance is relatively less effective with firms involved actively in real estate investment activities This study compares the effectiveness of corporate governance for property and non-property firms with high concentration of real estate investment assets The findings will have significant implications on whether non-real estate companies should divest their non-core real estate assets, and outsource their real estate needs to professional real estate firms with specialized industrial knowledge

1.3 Scope of the Study

This study focus mainly on the governance issues associated with real estate investment activities Due to the small size of firms listed on the real estate sector of the SGX, which comprise only 29 firms at the time of the study, firms with high concentration of real estate assets, which is knows

as “property intensive companies” are also included in the empirical tests The “property asset

intensity” is measured by the proportion of property to total fixed assets held by a non real-estate company A 20 per cent cut-off point is used to define of “property intensive” non-real estate firms

in our sample Based on this definition, non-real estate firms listed on the SGX can be divided into two categories: property intensive firms and non-property intensive (other) firms

Since property assets of non real estate firms are generally grouped into three subtypes: fixed properties, investment properties and development properties, “property intensive” non-real estate firms are further divided into two groups: firms that account real estate assets as a cost center, and firms that take limited property market risk in holding investment and/or development properties

1.4 Testable Hypothesis

The following testable hypotheses are formulated in this study:

1) The substitution hypothesis, which states that since alternative mechanisms exists, the relatively lower reliance on one mechanisms will not adversely affect the effectiveness of total governance mechanisms, is firstly investigated;

2) Since real estate investment has its specific characteristics, such as asset specificity, fixity by location, and complex valuation method, the governance may be more problematic in real estate than in other type industries Therefore, real estate investment must be a significant determinant for some particular governance practices to eliminate the conflicts between owners and management;

3) CEO organizational control can be increased by adding more executive directors on the board, owning more equity, and serving in the position for a longer period Therefore, the

discretionary power of the CEO is entrenched This study also investigates that entrenchment hypothesis of the CEO control power;

4) Shareholder voting hypothesis, which states that directors’ decision control power in the nomination process as the directors’ voting rights increases by owning more common stocks

of the firm, is also tested in following studies

5) There are two perspectives in the literature for studying the relationship between governance mechanisms and firm performance One perspective explores the relationship based on the assumption that certain governance system is optimal for all firms, that firms that conduct it will have higher performance or value; an alternative view is that although governance mechanisms are endogenously determined, there is unlikely to establish significant relationship between those monitoring mechanisms and firm value This study tries to provide further evidence as to whether an endogenously determinants in the governance mechanisms will have possible effects on firm performance in Singapore market;

6) The hypothesis of the institutional impact on the corporate governance—institutional characteristics would influence the level of the performance of various corporate governance mechanisms

1.5 Sample Selection and Sources of the Data

Firms listed on the Singapore Exchange (formerly known as the Stock Exchange of Singapore) (SGX) are used as the sample of this study There are 386 firms listed on the main board and 106 firms listed on the SGX-SESDAQ as at end of 2001 Based on these 492 firms, we sieve out firms that meet the following criteria for our empirical analysis purposes:

1) The firms must have been listed on the SGX for at least two years by end of 2001;

2) There are annual reports for the firms;

3) Only Singapore dollar denominated stocks are selected; and

4) Annual report of the firms must contain information of chairman and CEO or its equivalence, such as the managing director or president

Based on the above criteria, 228 sample listed firms are selected in this study, which includes 20 firms listed on the property sector of the SGX

Cross sectional financial statements and firm-specific data for the 228 sample firms for the financial year ended in 2001 were collected The financial data on net income, fixed asset, total assets, total debt, market capitalization, and total number of common stocks were collected from the computer database, Datastream®, at the department of real estate of the National University of Singapore Corporate governance data such as the number of independent directors, characteristics

of CEO, shareholdings of large blockholders and management were extracted mainly from annual reports of the sample companies

1.6 Methodology

Three quantitative methodologies that include the simultaneous equations system, binary response regression model, and classical linear regression model are used in this study to empirically test the corporate governance hypotheses These models empirically test the significance of various corporate governance mechanisms They also evaluate the effectiveness of governance

mechanisms between listed property companies, listed property intensive non-real estate companies and other companies

1.6.1 Simultaneous Equations System

The issue of endogenity among governance mechanisms has been extensively discussed in the corporate governance literature As those mechanisms are jointly determined, there is a two-way causal relationship between the governance variables To deal with the endogeneity of the mechanisms, this study tests the internal and external corporate governance mechanisms proposed

by Agarwal and Knoeber (1996) using a simultaneous equations system technique Two-stage least squares (2SLS) approach is used to estimate the significance of various governance mechanisms, and at the same time, test the feed-back effects and bi-directional causality of the governance mechanisms

1.6.2 Binary Response Regression Model

The leadership structure of the board is considered by corporate governance literature as an important governance mechanism.7 It can be defined using a binary dummy variable that has a value of either one, if the same person in the board serves as both CEO and chairman; or zero, if there is a dual leadership structure A binary response regression model is employed to find the determinants for the dual leadership structure in the board This study uses the logit model to explain the likelihood of firms adopting a binary leadership structure in the management

7 Agrawal and Knoeber (1996), Mak and Li (2001) treated the leadership structure of the board as one of governance mechanisms and introduced this variable into their simultaneous equations system

1.6.3 Classical Linear Regression

The classical linear ordinary least squares (OLS) regression is also used to test the relationship between corporate governance and firms’ performance, which is represented by the Tobin q measure Different corporate governance variables are included in three independent OLS models

to separate the effects of different corporate governance variables The White’s test is used to test the heteroscedasticity in the model, when governance mechanisms are jointly included to explain the variations in firm performance Finally, by comparing the results from both OLS and 2SLS estimations, we can isolate the problem of endogeneity between governance mechanisms and firm performance, and evaluate how these determinants affect the explanatory relationship between the corporate governance and firm performance

1.7 Organization of the Study

The remainder of this study is organized as follows

Chapter One describes the background, motivations and scope of the study The testable hypotheses, the data sources and the empirical methodologies are also included in this chapter

In Chapter Two, relevant corporate governance literature is reviewed, which is followed by discussions of the knowledge and findings of current research in the subject

Chapter Three provides an overview of the institutional environment and the corporate governance system in Singapore The regulatory framework relating to corporate control, accounting standards, and various corporate governance initiatives are described in this chapter

The process of data collection and the sources of data are described in Chapter Four This chapter sets up the definitions of various variables The summary statistics of these variables, which include the Spearman correlations between the variables are also presented

Chapter Five discusses the steps and the techniques in the model building Firstly, the simultaneous equations system is applied to test the endogenous relationships among the governance mechanisms; Secondly, a dummy dependent variable model is used to test the determinants of the board’s leadership structure Next, the linear relationships between the corporate governance and firm performance are estimated Two regression techniques: the OLS regression and the 2SLS regression, are employed to empirically test the relationships between the governance mechanisms and firm performance and to examine the effects of endogeneity of the determinants

The empirical results are analyzed in Chapter Six, which includes the evaluation of the model fitness, and the significance of the testable hypotheses Differences in the results of the OLS and the 2SLS regressions on firm performance and various corporate governance mechanisms are also discussed

Chapter Seven concludes the study Contributions of this research are discussed Recommendations for further studies are presented, and limitations of this study are also highlighted

Chapter Two

LITERATURE REVIEW

In this chapter we will cover the following subjects:

▪ The theory of firm

▪ What is corporate governance?

▪ What constitutes corporate governance?

▪ The endogeneity issue

▪ Governance literature on real estate investment

▪ Corporate governance literature on Singapore Market

This literature review chapter sets up the framework for the theory of the corporate governance It covers the following questions: What causes the governance issue? What is the definition of the theory of corporate governance? What constitutes the corporate governance? The empirical analyses of the corporate governance are also presented As well as the importance of the study of the governance issue in real estate investment and the pervious studies on the corporate governance in Singapore market are described

Chapter Two

LITERATURE REVIEW

2.1 The Theory of Firm

The research into the causality of corporate governance is invariably dependent on the emergence and the form of business organization of a corporation of firms An understanding of the nature of the firm is essential in studying the question of why corporate governance matter There are many definitions of a firm in the economic and legal literature These definitions have been used in neoclassical economic theories that explain the transaction cost and principle-agent relationships

The classical theory of firm is introduced by Coase (1937) In his seminar paper, he suggested that the introduction of the firm was mainly because of the existence of marketing costs There are costs incurred when operating in a market Forming an organization and allowing entrepreneur to directly allocate the resources can reduce some marketing costs He also emphasized that an entrepreneur must exert efforts to reduce cost in operations He must attempt to obtain factors of production at a price lower than that attained in the open market transaction; otherwise it will not make economic sense for the firm to exist He also pointed out that writing a contract is itself costly The contract should only state the limits to the powers of an entrepreneur Within these limits, he can therefore have the flexibility to deploy the factors of production

Many researchers build their studies based on the work of Coase’s Jensen and Mechkling’s work (1976) is one of the examples They looked at a firm as a nexus of a set of contracting relationships among individuals They gave the definition of the agency relationship as a contract

in which a principal can engage an agent to perform some services on his behalf The ex-ante made contract is usually treated as a necessary instrument to ensure agents to align their interests with principals’ However such contract can never make a complete forecast of the ex-post divergence In order to eliminate the aberrant activities of the agent, principal must establish appropriate incentives and monitoring mechanisms Both of those activities are also costly The authors summarized the costs of the agency relationship as 1) the monitoring expenditures, 2) the bonding expenditures, and 3) the residual loss Such concept of agency costs just makes a room for governance in a firm

In 1980, Fama further extended the work on the theory of the firm He claimed that the classical agency theory fail to explain the functions of a large modern corporation, where the control of the firm is in the hands of managers who are separated from the firm’s security holders The author believed that this separation of security ownership and control can be an efficient form of economic organization within the “set of contracts” perspective According to Jensen and Meckling’s theory, the entrepreneur is not only a manager, but also a residual risk bearer However,

in the modern corporation, the separation of management and risk bearers exists So, Fama pointed out that when looking at the risk bearing from the viewpoint of the portfolio theory, the risk bearers are likely to spread their wealth across many firms, and not interested in directly controlling the management of any individual firms This efficient distribution of risk causes a large degree of separation of security ownership from control of a firm As a consequence, big agency problems rise in a modern corporation

Grossman and Hart (1986) come up with an alternative definition of firm, which states that a firm

is a collection of the assets that it owns Base on this theory, they classified the contractual rights into two categories, which are specific rights and residual rights Moreover, they define the ownership as the purchase of the residual rights Since it is impossible to prepare a comprehensive

contract ex-ante, the purchase of the residual rights is both meaningful and valuable The authors claimed that it is meaningful because the ownership based on this purchase confers the right to make decisions in all contingencies unspecified by the initial contract; it is valuable because these residual rights can be important in bargaining the size of the ex post surplus as well as its distribution Their incomplete contracting model creates a room for ex-post governance and because of the separation of contractual rights there may be incentives to optimally allocate the ownership among the firm

Rajan and Zingales (1998) put the theory of firm forward based on the concepts created by Grossman and Hart They define the firm both in terms of the unique assets and in terms of the people who have an access to these assets This definition expands the theory of firm by incorporating the theory of power in organizations It explicitly recognizes that a firm is a complex structure that cannot be instantaneously replicated In their paper, Rajan and Zingales interpreted the power within a firm, the role it plays and the origination of the firm They suggest that access can be a better mechanism than ownership because the power from having access may be more contingent on a specific investment than the power of ownership The ownership of physical assets

is no longer the only source of power within a firm This view of the firm well explains a variety

of institutional arrangements as well as highlights the role played by an internal organization in enhancing the value of the firm

Although there are different views about the concept of a corporation, there is a common element among the corporate structure That is when people enjoy the benefits of this business organization; they must pay for their loss of control Investors lose control over the use of their capital; managers lose control over their sources of funding The loss of control gives rise to conflicts between equity holders and managers Therefore, mechanisms that eliminate the conflicts become more valuable to the corporations Those mechanisms constitute the major part of the

governance, which is more and more considered by individual investors, funds, banks, and other financial institutions

2.2 What is Corporate Governance?

The firm’s security holders are diversified across many of firms and they may not take a direct interest in the management of a particular firm The ex post deviations from the contract set-up may also incentive a manager to consume more on the job than what has been agreed in his contract These central questions arise:

(i) How do the suppliers of finance get managers to return some of the profits to

them?

(ii) How do they make sure that managers do not steal the capital they supply or

invest in bad project?

8

(iii) How do suppliers of finance control managers?

Principal-agent problems arise from the separation of ownership and control between corporate outsiders and insiders Considering this inherent conflict, there may be checks and balances on managerial behavior Although economists and legal experts have raised concerns on the corporate governance, and its use as a defense of shareholders’ interests, there is no universally accepted definition of what the term corporate governance is defined

8 Sheifer and Vishny (1997)

Traditionally, corporate governance has been concerned with the issues of the exercise of choice and the creation of opportunities, and how choices and opportunities impact on institutions’ decision-making and accountability (Bird and Waters, 1987) Shleifer and Vishny (1997), however, consider corporate governance as an instrument that assures the suppliers of finance to corporations of getting a return on their investment Robert and Nell (2001), present the definition

of corporate governance as a relationship among various participants in determining the direction and performance of corporations

In Organization for Economic Co-operation and Development’s (OECD) definition, corporate governance structures are seen as mechanisms for making decisions that have not been specified

by contract between principals and agents Since it is costly to set up a comprehensive contract on exact tasks for the latter, Zingales (1998) defined the corporate governance as a complex set of constraints that shapes the ex-post bargaining over the quasi-rents generated by a firm Within his definition, the corporate governance is considered as corporate authorities’ allocation which affects the process through quasi-rents distribution Those authorities are include ownership, capital structure, managerial incentive schemes, takeovers, boards of directors, pressure from institutional investors, product market competition, labor market competition, organizational structure, etc

In summary, two conditions have made corporate governance critical to a firm Firstly, agency problems exist in any form of business organization, as long as the interests between principals and agents differ Secondly, because complete contracts are technologically infeasible, future contingencies are hard to describe and foresee

2.3 What Constitutes Corporate Governance?

Broadly speaking, the principles of corporate governance can be explained from two perspectives From a corporation’s perspective, corporate governance is about maximizing value subject to meeting the corporation’s financial, other legal and contractual obligations From a public policy’s perspective, corporate governance is about ensuring accountability in the exercise of power and patronage by firms Both perspectives provide a framework for corporate governance that reflects

an interplay between internal incentives (which define the relationships among the key players in the corporation) and external forces (notably policy, legal, regulatory, and market)), which together govern the managerial behavior

The roots of investigating the characteristics of the internal and external features can be traced back to at least Berle and Means (1932), who argued that management ownership in large firms is insufficient to create managerial incentives for value maximization

Agrawal and Knoeber (1996) summarized the total internal and external factors into seven control mechanisms The external mechanisms that discipline the firm’s performance include the production market competition, the market for corporate control, and the debt covenants The internal contents consist of the shareholdings of managers, institutions, and large block-holders, and the use of outside directors

2.3.1 External Forces

Hart (1983) proposed the idea that the competition in the product market reduces managerial slack The managerial slack is the outcome of the separation of ownership and control in a firm, and this separation gives the managers an opportunity to pursue their own objectives The manager’s goals

on growth maximization or effort minimization may be in conflict with the profit or market value maximization goals of the firm However, the author pointed out that when a firm operates in a market, it will face the competition from other firms in the same industrial, and the competition makes the performance of different firms interdependent Given this interdependency, when the cost of the firm is falls, other firm’s cost are also likely to be low The managers are only allowed

a partial reduction in the slack Thus, the competition in the product markets is a necessary but not enough form of discipline on managers Competition in capital markets also plays an important role in eliminating the managerial slack

Corporate control of firms is always considered as an important component of the capital market Economic evidence indicates that corporate control in the capital market benefit shareholders and society, and it has strong influence of the corporate organization form The market for corporate control is often referred to as the takeover market, which is defined as a market in which alternative managerial teams compete for the rights to manage the corporate resources (Jensen and Ruback, 1983)

Manne (1965) is one of the researchers who recognize the critical role of the market for corporate control The causality of this control mechanism is the existence of a high positive correlation between corporate managerial efficiency and the market price of the company shares The author interpreted that if the market price of the corporation’s common stock is low, and if a group of individuals or another corporation believes it could manage the corporation more efficiently, it has the incentive to purchase the corporation and increase its value from an improved management If the purchase were to occur, it is likely that the new owners would fire the management, because they believe that it is the poor management that causes the corporation’s suboptimal performance Consequently, the threat of a takeover installs a scheme for the market for corporate control, which

enforces competitive efficiency among corporate managers, and thereby protects the interests of the small and non-controlling shareholders

The findings of Grossman and Hart (1980), Jarrel, et al (1988), Jensen and Ruback (1983), Jensen (1988), and Instefjord (1999) also indicate that the market for corporate control induces wealth creation in various ways Which include a reduction in wasteful bankruptcy proceedings, a more efficient management of corporations, protections for non-controlling corporate investors, an increased mobility of capital, and a more efficient allocation of resources

Jensen’s (1986) free cash flow theory indicates that takeover is an imperfect mechanism for companies, where management has access to significant discretionary cash flows The management will be reluctant to use outside capitals, which will otherwise subject them to the monitoring of the capital market Since the existence of free cash flow has negative implications for takeover activity, Jensen advocates debt creation, which comes with mandating interest payments, as a good alternative control to minimize the agency conflict The threat of the failure to make debt service payments serves as an effective force that motivates the management of the firm

to be more efficient

Shleifer and Vishny (1997) also discussed the debt contracts as a specific governance arrangement They said the defining feature of debt that transfers the control rights to creditors reduces agency cost These controls prevent a manager from investing in negative net present value projects, and

on the other hand force him to sell assts that are worth more in alternative use

However, Jensen, Shleifer and Vishny also emphasize that while debt contracts may be beneficial

in reducing the agency problem; increased leverage also has its associated costs Firstly, debtors may prevent firms from undertaking new projects, because debt covenants restrict them from

raising additional funds Secondly, bankruptcy may also increase costs Because of these costs, debt contracts may not always have positive control effects Therefore, an optimal debt-equity ratio, as suggested by Jensen at a point where the marginal costs of debt just offset the marginal benefits, should be adopted by firms

While the external forces of corporate control are powerful instruments in disciplining managers and ensuring that they will behave corresponding closely to shareholders’ wishes However these mechanisms alone cannot solve the whole problems of corporate governance Whidbee (1997) finds that the effectiveness of external control mechanisms is weak in some industrial sectors For example, the market for corporate control through hostile takeover is rare in the banking industry The majority of bank acquisitions are friendly rather than hostile In this situation, alternative monitoring mechanisms like internal incentives and monitoring mechanisms assumes an important role

2.3.2 Internal Monitoring and Incentives

In its narrowest sense, corporate governance can be viewed as a set of arrangements internal to the corporation that defines the relationship between managers and shareholders At the center of this system is the board of directors, so the key internal governance mechanism is the rules for selecting the directors Since the most important right adhered to the shareholders is the right to select the board of the directors, ownership structure should be the foundation of the internal arrangements Since both ownership structure and board composition constitute a major part of internal mechanisms that reduces the agency problems in companies, an extensive theoretical and empirical research that investigates determinants of ownership structure and board composition has been conducted in recent years

2.3.2.1 Determinants of Managerial Ownership and the Link between Ownership

and Performance

The ownership structure is measured by the allocation of shares among insiders and outsiders (Jensen and Meckling, 1976) Agency problems arise when there is a potential conflict of interest between corporate managers and dispersed shareholders, and when managers do not have an ownership interest in the firm Jensen and Meckling divide stockholders into two groups—an inside shareholder who manages the firm as well as has exclusive voting rights, and the outside shareholders, who have no voting rights They also show how the allocation of shares among insiders and outsiders can influence the value of the firm

Following Jensen and Meckling paper, studies in the determinants of managerial ownership and the link between ownership and firm value have expanded rapidly in both the theoretical and the empirical fronts

Based on the theory of principal-agent, managerial ownership is well known as an important component of the ownership structure There is an extensive theoretical literature explaining the empirical link between managerial ownership and firm performance However, the interpretations

in these studies remain ambiguous The role of insider ownership is complex While it aligns the interests of managers and shareholders and thus enhances performance, it also creates managerial entrenchment, which adversely affects performance

Morck et al (1988) find evidence of a significant nonmonotonic relationship, when estimate a piecewise-linear relation between the fractions of shares owned by corporate insiders and Tobin's

Q, using cross-section data of 371 fortune 500 firms in 1980 The Tobin’s Q fist increases as

insider ownership increases up to 5%, then falls as ownership increases to 25% and increases

again slightly at a higher ownership level McConnell and Servaes (1990) examine a larger set of Fortune 500 firms than those examined by Morck et al and they find a significant curvilinear

relation between Tobin’s Q and managerial ownership, with an inflection point at between 40%

and 50% ownership Hermalin and Weisbach (1991) analyze 142 NYSE firms and find that

Tobin’s Q rises with ownership up to a stake of 1% The relationship is negative in the ownership

range of 1-5%, and it becomes positive again in the ownership range of 5-20% It turns into a negative region when ownership level exceeds 20%

Kole (1995) compares the results in the recent studies that use different management stock ownership data and he shows that differences in firm size can account for the differences in the results of those studies Holderness et al (1999) analysis the relationships using a comprehensive cross section of 1,500 publicly traded U.S firms in 1935 and compare the results with those using

a modern benchmark of more than 4,200 exchange-listed firms for 1995 The shape of the performance-ownership relation in 1935 is similar to the pattern identified by Morck et al However, the pattern was weaker in the 1995 samples These studies generally interpret the positive relation at low levels of managerial ownership as evidence of incentive alignment, whereas the negative relationship at high levels of managerial ownership as evidence that managers become ‘entrenched’ and can indulge in non-value-maximizing activities without being disciplined by diversified shareholders

In contrast, Demsetz (1983) argues that the ownership structure of the firm that ‘emerges is an endogenous outcome of competitive selection of an equilibrium organization of the firm that balances various cost advantages and disadvantages’ Therefore, Demsetz points out that there is

no relationship between ownership structure and profitability Demsetz and Lehn (1985) provide additional evidence to support Demsetz’s conclusion They investigate the accounting profit rate of

511 U.S companies in 1980 on different measure of ownership concentration, and find no

significant correlationship Himmelberg et al (1999) extend the cross-sectional results of Demsetz and Lehn (1985) using panel data and show that managerial ownership is explained by key variables in the contracting environment In other words, after controlling both for observed firm’s characteristics and firm’s fixed effects, they cannot find a relationship between changes in managerial ownership and firm performance

Lauterbach and Vaninsky (1999) empirically examine the effect of ownership structure on firm performance of 280 Israeli firms They separate the sample firms into family firms, firms controlled by partnerships of individuals, concern controlled firms, and firms where blockholders have less than 50% of the vote The results show that owner-manager firms are less efficient in generating net income than firms managed by a professional (non-owner) manager, and that family firms run by their owners perform (relatively) the worst

Associated with the ownership structure, the board of director is also an important internal device

in the agency literature to provide monitoring functions to resolve, or at least mitigate, agency conflicts between management and shareholders

2.3.2.2 The Determinants of Board Composition and Board Effectiveness

The agency theory describes a significant role of the board of directors in the organizational and governance structure of typical large corporation Fama and Jensen (1983a) discuss the role of market and organizational mechanisms in eliminating the agency conflicts and better aligning management interests with equity holders or residual claimants, who are largely diffused Among the most important organizational controls is the board of directors The board is considered to have three main missions in a firm, which includes providing advice and counsel to management, serving as disciplinarian, and acting in crisis situations

The primary role of the board of directors is presumed to carry out the monitoring function on behalf

of the shareholders Since it is difficult for shareholders to monitor the day-to-day decision made by the management, the board effectiveness in such function has attracted an extensive attention of scholars The board effectiveness is dependent on three characteristics of a board: board composition, board independence, and board size (Kose and Lemma, 1998)

Hermalin and Weisbach (1988) conduct an empirical study on the determinants of board composition by using 142 firms’ data from 1971 to 1983 Two general hypotheses have been presented in the paper Firstly, they find that the board composition is associated with the internal promotion and the CEO-tenure Insiders may leave the company at the beginning of a new CEO’s tenure if they feel that they have little chance to become the next CEO In addition, a new CEO may have less power than an established CEO in selecting his own board Their findings also show

a positive correlation between poor performance and the removal of insiders and the hiring of outsiders Since poor performance is an indication of ineffectiveness management behavior, there

is a need for greater monitoring of management Therefore, poor performance will cause insiders

to leave the board and outsiders to join the board Although, the authors provide the agency explanations for the factors that lead to changes among corporate directors, they also point out the limitations of the explanations

On the other hand, Bathala and Rao (1995) present empirical results that are consistent with the prediction of the agency theory The results support the relationship between board composition and a number of agency cost and financial variables By employing a cross-sectional estimation, they claim that the decision of individual firms to use an optimal board composition is not only depended upon alternative mechanisms employed by the firms, but also systematically related to the institutional holdings, growth opportunities, and CEO tenure

The common view in the empirical finance and agency literature is that the degree of board independence is closely related to its composition The degree of board independence is assumed

to be positively related to the presence of outside directors in the boardroom According to Mace

(1971), “the titles and prestige of (outside directorship) candidates are of primary important.”

Outside directors are valued not only for their ability to monitor, but also for their ability to advise, solidify business and personal relationships, and signal that the company is doing well While the impact of board effectiveness and the contribution of outside directorship to shareholder wealth and the discipline of top management have been widely examined, the evidence, thus far, on board composition and effectiveness is mixed

Fama and Jensen (1983) acknowledge the role of outside directors as arbitrators in disagreements among internal managers Since the value of the outside directors’ human capital depends primarily on how they are able to limit the decision discretion of individual top managers The authors hypothesize that the outside directors have incentives to develop their reputation as experts

in decision control Weisbach’s (1988) study on director incentives and CEO turnover supports the suggestion of Fama and Jensen After controlling for ownership, size, market, and industry effects,

he finds that CEOs are more likely to be removed following poor performance, if outside directors have voting control Thus, outside directors are assumed to be good at representing shareholder interests

The empirical work conducted by Brickley and James (1987) shows that there is a significantly negative relationship between the proportion of outside directors on boards of banks and the regulations of banking acquisitions This result suggests that outside directors play a major role in evaluating takeover proposals They also find that where corporate-control market is weak in disciplining poor management, boards dominated by outside directors improve managerial control

in the firm

Rosenstein and Wyatt (1990) use the Center for Research in Security Prices (CRSP) financial data and announcements of outside director appointments from the Wall Street Journal to measure the wealth effects of these announcements for the period 1980-1985 They find significant positive excess returns around the days of the announcements by using the standard event study methodology Thus, announcements of the appointment of an outside director are associated with

an increase in shareholder wealth

Additional evidence on the importance of corporate board, and particularly outside directors in improving shareholder wealth is also found by Byrd and Hickman (1992) Examining 128 tender offer bids made from 1980 through 1987 to 111 firms, they find that the average announcement-date abnormal return is significantly less negative for bidding firms, where at least half of the board seats are held by independent outside directors Using cross-sectional piecewise regressions, they find a curvilinear relationship between the proportion of independent directors on the board and the bidding firms’ announcement-date abnormal returns The positive relationship turns into negative when the fraction of the independent director reaches at a 60% level

Similar results have been reported by Brickley et al (1994) In order to shed some new lights on the debate of the monitoring function provided by outsider directors, the authors take an event study methodology by looking at a sample of firm adopting poison pill.9 The sample consists of

247 firms adopting poison pills over the period 1984-1986 The main finding of the paper is a statistically significant, positive relation between the stock-market reaction to the adoption of poison pills and the fraction of outside directors This is consistent with the hypothesis that outside directors represent shareholder interests

9 “A tactic used by a company that fears an unwanted takeover by ensuring that a successful takeover bid will trigger

some event that substantially reduces the value of the company”—Dictionary of Business, Oxford University Press,

2002

The same hypothesis has also been tested by other studies Borokhovich, et al (1996) documents a strong positive relationship between the percentage of outside directors and the frequency of outside CEOs’ succession Evidence from stock returns around succession announcements indicates that, on average, shareholders’ wealth increase due to the outside appointment, but the wealth is reduced when an insider replaces a fired CEO

Maug (1997) focuses monitoring function of outside directors on a corporate restructuring problem The model discussed in the paper shows how independent directors can be regarded as an institution that regulates the relationship between shareholders and managers, in a world where contracts are incomplete

Mayers, et al (1997) find that life insurance firms that change from stock to mutual ownership increase the percentage of outside directors, while property/casualty firms that switch from mutual

to stock ownership reduce the percentage of outside directors They suggest that monitoring by outside directors is compensated for the lack of a credible external monitoring mechanism in mutual firms

Although many scholars consider the board of directors as a potential mechanism to provide an effective monitoring of managers, several board and outside director characteristics suggest that outside directors will not necessarily act in shareholder interests Firstly, in a general situation, insiders (CEO, managers) inherently dominate the board’s decision in choosing the outside directors and providing the information they analyze If management incentives are not aligned with those of shareholders, they will nominate outside directors who are more inclined to support

10 11

their decisions Secondly, interlocking directorship may reduce the willingness of outside directors to challenge the CEO Finally, outside directors who are appointed for their expertise in a narrow area may feel uncomfortable in challenging the management’s decisions that are beyond their area of expertise

Demsetz (1983) suggests that “the board of directors can do very little to improve on the powerful incentives that presently guide management to serve the interests of shareholders” He further

interprets that since executive compensation contracts, the pressures of the competition of product market and the market for corporate control will provide adequate monitoring of corporate managers Additional monitoring function by the board of directors cannot improve and could possibly impose a harmful constraint on an optimal management

Fosberg (1989) employs a paired sample methodology to test the relationship between the proportion of outside directors and various measures of firm performance The study assumes that

if the management is poorly supervised by the board of directors, it will be easy for the management to act in ways benefiting itself personally and/or not engaging in value-maximizing investments Therefore, the value of a firm can be affected by each of these actions Firms with well-disciplined management will not experience these distortions in their cash flows Consequently, if outside directors are useful in disciplining management, there should be differences among the cash flows of companies where outside directors’ monitoring is strong vis-à-vis those with weak monitoring However, the empirical results do not confirm the hypothesis that the presence of outside directors enhances firm performance Specifically, no relationship is found between the proportion of outside directors in the board and various variables used to gauge the firm performance Two explanations are offered for the findings Firstly, the

10 This issue of outside directors’ independence has been discussed by Flanagan (1982), Vance (1983), Mace (1986), and Losrch and MacIver (1989)

11 The board of directors has careers that are tied with each other.

management may succeed in getting outside directors elected to the board who are either incapable

or unwilling to properly discipline management Secondly, other mechanisms for controlling the agency costs associated with the separation of ownership and control effectively work in disciplining management, thereby leaving little room for the role of outside directors

According to the research for strategic implementation and organization control, Baysinger and Hoskisson (1990) state that the outside directors do not have access to information that is normally privileged to inside directors They serve on several boards, but may not be able to have full understanding and knowledge of each business to be truly effective

Hermalin and Weisbach (1991) argue that the residual agency problems are similar in the individual firm and the variation in the firm performance should therefore not be correlated with the actions taken to reduce such agency problems through board composition They collect a panel data of 142 NYSE firms and test the differences in firm performance with regards to the board composition and ownership structure The findings of the paper show that both inside and outside directors is equally ineffective in representing the shareholders’ interest The results may be influenced by the top management’s control in the board-selection process

Jensen (1993) also claims that the board of directors, the center of the internal control system, cannot protect the corporation assets properly By referring to the cases of GM, Kodak and IBM, the author points out two shortcomings of the internal control systems Firstly, the reaction took by the internal control against the poor management is too late Secondly, it will take a long time for

the internal control system to make a change Therefore, the author claims, “ineffective governance is a major part of the problem with internal control mechanisms”

Warther (1998) builds a model to reconcile the opposing opinions on the board effectiveness for

the monitoring function As the two opposing camps concentrate on different dimensions of the board, the conclusions are not as contradictory The ineffectiveness-boards viewpoint focuses on the board’s behavior; however, the effective-boards viewpoint concentrates on the board’s disciplinary effect In the model, author assumes that because the board members’ utility is a

function of both the firm’s performance and their continued membership on the board, “the board

of directors occupies a position somewhere between perfect alignment with control management

or shareholders” Finally, the prediction of the model shows that although individual board

members are always reluctant to step forward to oppose the management, they can still be treated

as an important source of discipline

12

In order to increase the efficiency of the board of directors, the Cadbury Committee has put forward a number of suggestions for changing the structure of the board Among other things, the committee has recommended that the chairman of the board should (usually) be independent Since the premiere role of the board of directors is to monitor and discipline the performance of top management, allowing the CEO to fulfill the same role as chairperson of the board is thought

to compromise the desired system of checks and balances Thus, a dual leadership structure of a board is also considered as another important component that can affect the independency of the board of directors

The ‘dual’ board leadership structure is a case of having two different people in the chairman of the board and the chief executive officer (CEO) positions.13 The proponents of dual leadership structure maintain that the combination of the role of CEO and chairperson would limit the monitoring function of the board of directors Firstly, non-independent leadership may constrain the board independence and reduce the possibility that the board can properly execute its

12 The Cadbury Committee was appointed by the Conservative Government of the United Kingdom in May 1991 with a broad mandate to “…address the financial aspects of corporate governance”

13 The definition of the dual leadership structure used here is similar to the terminology used by Fosberg and Nelson (1999)

governance role (Lorsch and MacIver, 1989; Fizel and Louie, 1990) Secondly, this kind of leadership structure signals the absence of the separation of decision management and decision control (Fama and Jensen, 1983) Finally, insecure directors will not have the shareholders interests in mind when evaluating management performance, which in turn, erodes the long-term organizational wealth

Based on the earlier arguments, there is a hypothesis that the choice between the duality versus the non-independent board leadership will influence the organization performance Empirical tests of this hypothesis have been conducted in several papers

Rechner and Dalton (1991) examine the financial implications for the choices of board leadership structure with a sample of 141 corporations over a 6-year time period.14 The results indicate significant differences in the performance between the two groups of firms with different leadership structure in performance measures It is especially notable that firms adopting dual leadership consistently outperformed those relying upon non-independent leadership

Pi and Timme (1993) further contend that the unitary leadership structure (the same person wearing two hats—CEO and chairman of the board) exacerbates the principle-agent conflicts because of the consolidation of the decision management and the decision control processes The findings provide insights into the impact of concentration of decision making with decision control

on performance in banking sector It is evident that banks with a dual leadership structure are more profitable and are more cost efficient than those with a unitary leadership structure

Fosberg and Nelson’s (1999) study test two theories that explain why some firms adopt a dual

14 In this paper, authors use different terminology from Fosberg and Nelson Dual means that a board leadership structure

in which the CEO wears two hats—one as CEO of the firm, the other as chairperson of the board of directors.

leadership structure: the agency problem theory and the normal succession theory They employ time series data of leadership structure changes of 54 firms to investigate the relationship between leadership structure and firm performance Although the results in this study support both theories, the evidence, however, shows that firms that use the dual leadership structure to control agency problems experience statistically significant improvements in performance over the three-year period following the leadership structure change

The previous studies have provided strong evidence on how various governance mechanisms can limit the agent’s self-serving behavior, they do not; however, explain the relationship among those mechanisms Some recent studies on the issue of endogeneity governance mechanisms will give different perspectives of the theory of corporate governance with particularly respect to the interaction between governance mechanisms

2.4 The Endogeneity Issue

There is an interaction between internal and external corporate governance mechanisms In particularly, there is a substitution effect between the external devices for managerial control and internal mechanisms for control Hermalin and Weisbach (1991) recognize the endogeneity problem among firm performance, board composition and CEO share ownership The results offer further evidence on the substitution hypothesis Using the Tobin’s q variable as a performance measure, and the ownership of management and board composition as explanatory variables, the authors find an interrelationship between insider ownership and board composition

Similar results are found by Barnhart et al (1994) They also show that both managerial ownership and board composition may be endogenous to performance In the paper, they investigate the effect of board composition, which is determined by the proportion of independent outside

directors, on the overall corporate performance by controlling for the managerial ownership They use both ordinary least squares (OLS) and instrumental variable (IV) methods in the empirical analysis employing a sample of 369 firms Both of those estimates indicate significant curvilinear relationships between the board composition and the firm performance

Many of the previous studies that examine effects of the corporate governance mechanisms on the firm performance did not put sufficient on the importance of the endogenity of internal and external control mechanisms By considering the interactions of these mechanisms, Jensen et al (1992) empirically test the simultaneous relationships of insider ownership, debt policy, and dividend policy The insider ownership is not a firm-specific attribute, authors argue that insider ownership and the choice of financial policies are directly related the operating characteristics of firms The results support the proposition that financial decisions and insider ownership are endogenously determined The level of insider ownership has a negative influence on the firm’s debt and dividend levels

Shivdasani’s (1993) uses a choice-based sample to estimate the impact of board and ownership structure on likelihood of the hostile takeover Two significant results are found Firstly, outside directors in hostile takeover targets have lower level of ownership than those in the in the

nontarget This result shows that, “the outside directors of hostile targets have a lesser financial inventive in monitoring managers” Secondly, the ownership by large unaffiliated shareholders has

a significantly positive effect on the likelihood of a hostile attempt, which suggests that those two control mechanisms are substitutable

Hirshleifer and Thakor (1994) provide a rigorous theoretical analysis of relationship between the board of directors and the takeover market The paper develops a model in which the internal mechanism for corporate control (as represented by actions by the board of directors) and the

external market for corporate control (as represented by the actions of a takeover bidding) are considered simultaneously A sequential equilibrium is obtained as an outcome of this interaction between the board and the bidder The model implies that unsuccessful takeover attempts may be followed by a high frequency of management turnover The authors interpret this implication as that even though a takeover attempt is rejected, the board can infer form the bid that bidder possesses adverse information about the managers Another implication is that when the board acts

to maximize shareholder wealth, an active takeover market tends to substitute for the internal dismissal by the board All these results provide the theoretical support for the testable hypothesis that takeovers and boards are substitutions devices in corporate governance

Agrawal and Knoeber (1996) conduct another study on the endogeneity issue among corporate control mechanisms and firm performance by including a large and more complete set of control mechanisms They employ a sample of nearly 400 large U.S firms of which they measure insider shareholding, institutional shareholding, shareholding of large blockholders, the composition of the corporate board (represented by the representation of outside directors on the board), debt policy, and use of the external labor market for managers, and takeover activity An increase use of each mechanism yields a benefit by improving managerial incentives, but it also entails additional cost They assume that the choice of any of those sever control mechanisms may depend upon the choice of the other six Optimal choice is attained when marginal benefit of the use of an additional mechanism just offsets the marginal cost They analyze all the corporate mechanisms in

a system framework, and find evidence of interdependence among the control mechanisms However, when they add the firm performance into the same framework, the effects of insider shareholding, firm debt, and corporate control activity become statistically insignificant Only the effect of the outsiders in the board of directors persisted This finding suggests that when the endogeneity of corporate governance mechanisms is recognized in the empirical analysis, the monitoring mechanisms appear to be insignificant in affecting the firm value

2.5 Governance Literature on Real Estate Investment

Bathala and Rao (1995) have offered that firms may rely more on one or the other mechanism because of firm-specific marginal benefits and costs Thus, firm specific and industry characteristics might be a determinant of the varying degrees of the different control mechanisms chosen by the firm

According to the previous financial literature, three main factors influence the governance problem The first factor is asset specificity When the product is standardized, competition in the marketplace will reduce governance issues The second factor is information asymmetry When information about a product is more widely known, the governance is less problematic The final factor is contracts issue When it is possible to write complete contracts ex-ante, the governance mechanisms are less important

Based on those identifies, Sirmans (1999) claims that the effectiveness of those issues might greater in the real estate investment First, real estate is certainly specific because it is a fixed-in-location asset, it may be fitted with a specific tenant, and it may be of specific architecture Second, because the valuation of the real estate assets is quite complex to the outsiders and its value is highly consistent to the local nature of the market, so the information of the real estate asset may be costly to obtain So there do exist problem of information asymmetry Finally, although real estate market has developed a unique set of contracts, such as mortgages, leases, to resolve the contracting problem, do real estate markets create greater potential for quasi-rents that must be dealt with ex post, e.g., cyclical nature of real estate investing create unique governance problem

Similar as Sirmans, some other real estate scholars also recognize that since Quasi-rent is a common element in real estate investment, there may be an opportunity for the slack in strict governance in real estate investment (Sirmans, 1999) Most of the literatures on the governance issues in the real estate investment are based on the US market mainly focusing on REITs There are no or limited studies that examine the corporate governance in public property companies listed outside the US market However, those studies on REITs provide a new perspective of corporate governance research and constitute a useful academic framework to guide other studies

on governance issues in real estate investment activities around world

McIntosh et al (1994) test the relationship between a REIT’s stock price performance and the subsequent changes in top management As the top managers’ contributions to firm value cannot

be directly observed, the authors employed stock returns as a potential source of information in their empirical analysis Using a logit analysis, their findings indicate an inverse relationship between the probability of a REIT management change and the stock price performance, which imply that the termination of top managers’ career is more likely to be a response to poor management performance

Cannon and Vogt (1995) empirically test the agency conflicts in REITs and explore whether ownership structure reduces such conflicts They compared two REIT forms that are self-administered REITs and advisor REITs, and found that various forms of ownership do influence both performance and compensation In the self-administered REITs, the executive compensation is positively influenced by the REIT’s annual market return This explains that the use of ownership structure as a monitoring device among self-administered REITs is decreasing

In contrast, the ownership structure has significant influences on the market performance of advisor REITs

Friday et al (1999) report further evidence on the relationship between ownership structure and firm value, which is measured by market-to-book ratios for REITs over the period 1980-1994 Empirical estimations reveal a nonlinear relationship between the REIT market-to-book ratios and the ownership structure Low levels of inside ownership are associated with increased market-to-book ratios for equity REITs However, as inside block ownership rises above 5%, equity REIT market-to-book ratios decline This result provides evidence on the entrenchment hypothesis associated with increased inside ownership The authors claim that as inside ownership increases, the insiders become more entrenched and are able to pursue personal benefits at the expense of outside shareholders’, and they are also less prone to be ousted from their inside positions via the market for corporate control

Friday and Sirmans (1998) examine the influence of board of directors composition and characteristics on the real estate investment trust (REIT) shareholders’ wealth They assumed that

if the market perceives that if certain board characteristics represented by the percentage of outsider directors can effectively monitor and discipline the errant management behavior, the shareholders wealth can be maximized A positive relationship should exist between REIT shareholder wealth (measured by firm market-to-book ratios) and the levels of the alignment in the monitoring mechanisms Their empirical results also show that when outsider director representation increases above 50%, the benefits of additional monitoring provided by increased numbers of outside directors declines Therefore the authors conclude that the benefits associated with an increase in number of outsiders in the board may be outweighed by the corresponding costs caused by poorer communication

Ghosh and Sirmans (2003) explicitly deal with the endogeneity problem of performance, board independence, ownership structure, and CEO characteristics and compensation in real estate investment in their models They assume that the restrictions on the source of income, the asset,

and ownership structure make REIT’s agency problems different from other industries The effectiveness of alternative control and monitoring mechanisms is also varied with the REIT’s governance structure

The authors interpret that firstly, REITs are subject to the restrictive rule in the excess share provision, which makes the ownership structure quite dispersed in the REIT This rule makes it more difficult for large outside blockholders to acquire stakes and pose any serious takeover threat The rare occurrence of disciplinary takeover makes other monitoring mechanisms critical to the REIT performance Secondly, REIT managers are insulated from hostile takeover threats, and this unique managerial arrangement in REITs reduces their incentive to exert themselves for greater performance Therefore, internal monitoring mechanisms rather than externals are more important for REIT to reduce agency problems

In their empirical models they employ the managerial ownership structure (measured as CEO stock ownership), board composition (as represented by the proportion of the outside directors on the board), and firm performance (measured by ROI and ROE) in one simultaneous framework to address the endogeneity problems in the regression The two-stage least squares results show that higher CEO stock ownership and control through tenure and chairmanship of the board reduces the representation by outside members on REIT boards, which in turn adversely affect the REIT performance The greater representation by outside directors on REIT boards enhances performance, even though the relationship is weak