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How Does Corporate Governance Affect the Quality of Investor Information? The
Curious Case of REITs

Article in Journal of Real Estate Research · January 2011

DOI: 10.1080/10835547.2011.12091298 · Source: RePEc

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 How Does Corporate Governance Affect the Quality
of Investor Information?
The Curious Case of REITs

Paul Anglin Robert Edelstein

University of Guelph University of California at Berkeley

Yanmin Gao Desmond Tsang

University of Alberta McGill University

March 13, 2009

Draft – Not for Quotation

We thank the Department of Real Estate at Baruch College, CUNY, the National Association of Real Estate
Investment Trusts (NAREIT) and Ko Wang for choosing this paper as one of the recipients for the Best Research
Paper Awards on REIT Analysis. We gratefully acknowledge financial support from the University of Alberta
(Yanmin Gao) and McGill University (Desmond Tsang).
Contact Information: (Anglin) College of Management and Economics, University of Guelph, Guelph ON N1G
2W1, panglin@uoguelph.ca; (Edelstein) Haas School of Business, University of California at Berkeley, Berkeley,
CA 94720, edelstei@haas.berkeley.edu; (Gao), School of Accounting, University of Alberta, Edmonton AB T6G
2R6, yanmin.gao@ualberta.ca; (Tsang) Desautels Faculty of Management, McGill University, Montreal QC H3A
2T5, desmond.tsang@mcgill.ca
How Does Corporate Governance Affect the Quality
of Investor Information?
The Curious Case of REITs
March 13, 2009

Abstract

This study explores how corporate governance affects the quality of REIT’s
investor information. Information asymmetry engenders potential economic rent-
seeking advantages for corporate managers and other insiders vis-à-vis public
shareholders. Empirical and theoretical corporate finance claims that better
corporate governance enhances market efficiency by reducing information
asymmetry. Recent research suggests that the unique legal and organizational
structure of REITs may vitiate the need for and effectiveness of internal corporate
governance. Our results indicate that information asymmetry, as measured by the
percentage bid-ask spreads demanded by the market, is reduced by appropriately
structured REIT governance. Our key empirical findings for REITs during the
2003-2006 time period are:
1. The aligning of the financial incentives for the independent members of
the board of directors (i.e., direct compensation and stock ownership) with
those of the public shareholders reduces asymmetric information; and,
2. The combination of experienced board members and audit committees
with independent directors and financial expertise diminishes asymmetric
information.

Keywords: Real Estate Investment Trusts (REIT), Corporate Governance,

Information Asymmetry, Board Structure, Ownership Composition, Audit
Committee

JEL Classifications: G32, G34, M40

2
I. Introduction

This study explores how corporate governance affects the quality of REIT’s investor

information. Information asymmetry engenders potential economic rent seeking advantages for

corporate managers and other insiders vis-à-vis public shareholders. Empirical and theoretical

corporate finance claims that better corporate governance improves a firm’s performance (e.g.,

Gompers, Ishii and Metrick 2003; Cremers and Nair 2005), improves market efficiency, and

reduces information asymmetry. Two recent studies (Bianco, Ghosh and Sirmans 2007; Bauer,

Eichholtz and Kok 2008) fail to find a strong relation between the quality of a REIT’s corporate

governance and its value or operating performance. The special legal and organizational

structure of a REIT creates a unique perspective to examine the general role and effects of

governance and its relationship to market information asymmetry.

REITs differ from other C-Corporations in several pertinent ways. By law, REITs have

limited authority to invest in activities other than real estate. By their nature, they tend to focus

on a single real estate property type and/or concentrated geographic locations. REITs must

distribute 90 percent of taxable income to investors each year (95 percent before 1999). Bianco,

Ghosh and Sirmans (2007) argue that managers at a company where cash is distributed to

shareholders as soon as possible have less opportunity for mischief; and the managers must

provide precise and frequent public information to obtain external financing.

The five largest REIT shareholders are not allowed to own 50 percent of the company. 1

Although Jensen (1993) indicates that corporate takeovers and the “market” for corporate control

are important external mechanisms delimiting managerial actions, the lack of concentrated REIT

share ownership protects the managers of a poorly performing REIT from takeover or being

1
Bianco, Ghosh and Sirmans (2007) note that certain institutions, such as Pension Funds, are not considered to be
an individual investor for purposes of this limit.

3
ousted by majority shareholders (e.g., Campbell, Ghosh and Sirmans 2001). A small investor

would tend to have insufficient resources and incentives to monitor management. Without strong

and sophisticated external influences on governance, internal self-generated governance becomes

crucial to ensure that a REIT’s manager’s self-interests are aligned with those of shareholders.

We study the link between REIT governance and information asymmetry. 2 Good

corporate governance can affect market efficiency by decreasing the level of asymmetric

information between informed insiders, such as managers, and public shareholders. If insiders

cannot withhold or otherwise distort public information, shareholders may feel more confident

about understanding the risks of investing, and attendant adverse selection problems (Glosten

and Milgrom 1985). This hypothesis is significant because good governance is supposed to affect

the capital markets processing of available information in order to ensure proper resource

allocations to firms.

Our key issue is: Do the legal and regulatory REITs constraints serve as effective

substitutes for good corporate governance? Prior research has examined information asymmetry

without regard to governance and found that REIT insiders have considerable information

advantages relative to outside shareholders, as evidenced by lower liquidity and by fewer

analysts following REIT stocks (e.g. Damodaran and Liu 1993; Glascock, Hughes and Varshney

1998; Below, Kiely and McIntosh 1995; Wang, Erickson and Chan 1995; Wang, Erickson, Gau

and Chan 1995). Subsequent analyses (Below, Kiely and McIntosh 1996; Bhasin, Cole and Kiely

1997; and Clayton and MacKinnon 2000; Marcato and Ward 2007) show that the liquidity of the

public REIT market improved over time, at that same time as many large REITs were being

created.

2
Our study only incidentally examines the links between and among a company’s operational behavior, its stock
performance, and corporate governance.

4
 Our study adds to the limited existing empirical evidence about corporate governance’s

impact upon information asymmetry (e.g., Chung, Elder and Kim 2008; Kanagaretnan, Lobo and

Whalen 2007). We focus on the relationship between REIT internal governance, as measured by

characteristics of the board of directors and its audit committee, and the level of market

information asymmetry. We classify governance variables into four broad categories:

• board characteristics

• directors’ experiences

• directors’ compensation and

• audit committee characteristics.

Information asymmetry is measured by percentage bid-ask spread. Our empirical results

indicate that information asymmetry is related to the quality of corporate governance. We

generally find strong evidence that high quality governance on the board of directors and on the

audit committees significantly reduce information asymmetry. We also find that audit

committee characteristics, a previously-unexplored aspect of governance for REITs, exert the

strongest influences on information asymmetry. These findings suggest that the special features

of the REIT market do not completely obviate the need for good internal corporate governance.

The paper consists of five additional sections. The next section discusses the importance

of corporate governance for REITs, and reviews related real estate literature on corporate

governance and information asymmetry. Section III develops our key hypothesis and delineates

our empirical methodology. Section IV describes the sample data. Section V presents our

empirical results. We provide concluding remarks in Section VI.

II. Literature Review

5
The Importance of Corporate Governance

A large body of research has investigated the relationship between corporate governance

and firm performances. This line of research uses a principal-agent model to pose questions: e.g.

a manager reports to the board of directors, which represents shareholders, but this oversight is

incomplete because the managers know more about day to day company activities. This

environment of asymmetric information permits managers to act in their own self-interest, at

times, to the detriment of shareholders.

In principle, four different “forces” will guide managers to make decisions that benefit

shareholders. Competition in the product market drives managers to reduce waste and to

respond to demand. Second, the combination of board of directors’ overview and of other

managerial internal incentives keeps managers on track. Third, poor managerial decisions may

lead to a “take–over,” or managers may be replaced. Fourth, government regulation may

engender actions, which either have a direct effect or change the information publicly available,

which will enhance the effectiveness of the three other forces.

Incentives, such as bonuses paid or stock options issued to achieve specified goals, are

often used to align the interests of management and the shareholder. 3 Incentives are rarely used

in isolation. For example, workers on an assembly line are usually supervised because doing so

is thought to be a simpler and more effective way to produce the desired level of effort. This

mechanism works on an assembly line because the task is relatively well-defined and, unlike

stock options, does not expose a worker to risks which they cannot influence. The task of a CEO,

or other senior manager, is less well-defined and difficult to monitor. Since a board of directors

cannot monitor the CEO directly minute-by-minute, a board of directors monitors indirectly by

3
Recent events have led some commentators to discuss the idea of a “malus” to recoup some of a previously-paid
bonus in the event that the decisions which produced high profits in one year are due to a risky strategy whose bad
consequences appear in later years.

6
relying on reports generated by management or others. Reports may or may not be accurate or

complete; the famous examples of Enron, Parmalat and Nortel represent worst case outcomes.

The effectiveness of board monitoring depends on the information that is provided as well as the

ability and the effort of the directors.

Tautologically, a poorly managed organization would perform better, if shareholders

forced an improvement in management practices. In reality, hostile takeovers of REITs are rare.

As noted earlier, limitations on REIT ownership make it harder for an investor to effectuate a

takeover. Prior finance literature suggests the lack of anti-takeover provisions provides

information advantage to insiders, and creates incentives to collect private information (e.g.,

Ferreira and Laux 2007). Eichholtz and Kok (2008) investigate the role of takeovers in property

markets. Using an international dataset, they find a company that underperforms is more likely

to be taken over. 4 Even so, they conclude that real estate companies experience surprisingly few

hostile takeovers regardless of the organizational structure. Cremers and Nair (2005) investigate

the interaction between internal governance and the external regulations making it easier to take

over a poorly performing firm. Using a sample of non-REIT firms, they find that these

mechanisms complement each other: performance is highest amongst firms with internal

governance most favorable to shareholders, and with the least protection against takeovers.

Perhaps more importantly, they find this effect only for the highest quartile of protection.

Campbell, Ghosh, Petrova, and Sirmans (2008) investigate mergers and acquisitions by

REITs. Using data on 132 mergers between 1997 and 2006 and an event study methodology,

they find that the kinds of tactics often used by managers to defend against a takeover are not

only used less often by REITs but are also less effective. Moreover, commonly-cited

4
With such a small sample and the difficulty of creating a measure of likelihood, they cannot study a slightly
different question: do companies which are more likely to be taken over perform better before they are taken over?

7
characteristics of a board, such as the proportion of outside directors, do not seem to affect

abnormal returns to the bidder while the characteristics of the CEO do. Though Campbell et al

do not offer any specific theories to explain why familiar takeover tactics might be less effective,

the threat of a hostile takeover might be less effective on the management of a REIT because

legal requirements place a premium on maintaining a steady cash flow to shareholders. A hostile

takeover would tend to jeopardize the dividend’s stability. If the CEO has a greater discretionary

effect on the transition following a takeover, both compared to the REIT’s board of directors and

to the CEO of a non-REIT, it would not be surprising that Campbell et al. find that the

characteristics of a CEO would affect the returns to the bidder. Such discretion would be

virtually impossible to measure in commonly-available data sets.

Following some famous failures of governance, many governments decided that the

marketplace and internal governance were insufficient and enacted laws and regulations to

change the external corporate “environment.” For example, the Sarbanes-Oxley Act of 2002 in

the United States, and similar laws in other countries, increased the amount of reportable public

information and increased the legal responsibilities and potential liabilities of CEOs and the

board of directors. Other regulations require managers to provide additional regular reports

prepared according to common accounting standards.

Regulation can have direct and indirect effects. For example, we have noted the direct

effect of the CEO and board of directors adapting to a regulation which changes the distribution

of information. A regulation which affects all firms in an industry can be expected to have extra

indirect effects by changing the competitive environment because if managers at one firm are

forced to improve performance, the resulting change in the benchmark can be expected to cause

managers at other firms to improve their performance. If one firm discloses more information,

8
then potential investors would expect other similar firms to disclose more information.

Managers might complain about the extra costs of such regulations but, especially if managers

are earning rents due to their access to better information, these arguments may represent self-

serving rent-seeking rather than a genuine concern for shareholders.

Formally, we do not investigate the effects of the REIT regulations because it would be

difficult to match a REIT with another firm that is equivalent, but not active in real estate.

Therefore, our analysis looks at a more focused question: Are the regulations governing REITs

effective enough that internal governance becomes unimportant? If so, then these kinds of

regulations can be a substitute for the kinds of internal governance vehicles that managers might

oppose.

Empirical Literature: Corporate REITs Governance

If the principal-agent conflict is important, who owns the firm should matter. Capozza

and Seguin (2003) find that higher levels of insider ownership are associated with higher

valuation of REITs. Han (2006) finds a significant non-linear relation between firm values and

insider ownership. In contrast, Ghosh and Sirmans (2003) find that boards with independent

directors weakly enhance REIT performance, that concentrated CEO ownership adversely affects

performance, and that the presence of institutional investors improves performance. Feng, Ghosh

and Sirmans (2005) show that companies with better governance perform better on average, but

the effect is significant for the best and worst boards. Friday and Sirmans (1998) show that

increased representation on the board by outside directors generally increases a firm’s market-to-

book ratio. However, investors seem to discount REIT shares when outside representation

becomes too large. Again in contrast, Friday, Sirmans and Conover (1999) find limited empirical

support for the relationship between inside block ownership and market-to-book ratios and

9
company performance.

Bianco, Ghosh and Sirmans (2007) investigate the relationship between a corporate

governance index (widely known as the G-Index) 5 and REIT performance. They find a positive

relationship for the year 2004, but the effect disappears in 2006. Bauer, Eichholtz and Kok

(2008) examine the relation between the Corporate Governance Quotient Index (CGQ) 6 and firm

performance. They uncover a significant relationship but only for firms with low dividend

payout ratios. Ambrose and Linneman (2001) demonstrate that externally-advised REITs do not

manifest better operating performances vis-à-vis internally-advised REITs.

Hartzell, Kallberg and Liu (2008) show that firms with stronger corporate governance

have a higher IPO valuation and better operating performance. This result is interesting for two

reasons. First, it shows the importance of governance. Second, by specifically studying the cost

of raising financial resources, this study confirms the assumption that forcing firms to distribute

almost all earnings annually may affect finance related decisions over time. Their research also

uses data on management incentives and, as expected and in the direction expected, they find

that investors react to various incentives. Hartzell, Sun and Titman (2006) do not find a strong

relation between corporate governance and firm values for REITs; though they do find evidence

that the responsiveness of a REIT’s investment expenditures depends on its corporate

governance structure. Two papers provide insight into the process of raising funds through a

seasoned equity offering (SEO). Ghosh, Nag and Sirmans (2000) study 178 SEOs by 91

different REITs during 1991- 1996. In this sample, 47 percent of the REITs issued only one

SEO and three REITs issued six SEOs. Zhu, Ong and Yeo (2008) study 251 SEOs for 2001-

2006. Their data uses 140 REITs, where 90 issued an SEO; one third of these issued only one

5
The index, constructed by Gompers, Ishii and Metrick (2003), focuses on takeover provisions.
6
The index is produced by the Institutional Shareholder Services (ISS), which was acquired by the RiskMetrics
Group in 2007.

10
SEO and one issued 10 SEOs. The lack of SEO in the REIT market may have further weakened

the effectiveness of external mechanisms, reinforcing the need for internal corporate governance

for controlling managers’ behavior.

Empirical Literature: REIT Information Asymmetry

Damodaran and Liu (1993) show that REIT insiders have significant information

advantages compared to outside shareholders. Demsetz (1968) and Bagehot (1971) argue that

market makers suffer losses while trading with informed traders and will need to recover such

losses via a larger bid-ask spread. Hence, numerous studies utilize the percentage bid-ask spread

as the proxy for information asymmetry (e.g., Venkatesh and Chiang 1986; Welker 1995;

Affleck-Graves, Callahan and Chipalkatti 2002; Sunder 2002; Kanagaretnam, Lobo and Whalen

2007). In an early study, Ghosh, Miles and Sirmans (1996) find that the percentage bid-ask

spread for REITs is greater than for the general stock market. They conjecture that the greater

spread compensates for the higher volatility of the REIT market. In another early study,

Glascock, Hughes and Varshney (1998) find that the costs of information asymmetry, also

measured by the bid-ask spread, are significantly greater for REITs than for the general stock

market (after initial public offerings). Below, Kiely and McIntosh (1995; 1996) show that REITs

have greater spreads than other stock sectors, but that the spread has declined over time. Bhasin,

Cole and Kiely (1997) also find that percentage bid-ask spread declines significantly between

1990 and 1994. Cole (1998) further documents that the reduction in bid-ask spread is due to the

lower spread for the new REITs formed during the 1992 REIT boom. Clayton and MacKinnon

(2000) find that liquidity of REITs improved between 1993 and 1996 because the effects of an

increase in the number of liquidity traders dominate the effects of an increase in the presence of

11
more informed traders.

More recent research has focused on how the characteristics of a REIT might affect

information asymmetry. Yermack’s (1996) early work argues that firms with a smaller board

make better decisions regarding executive compensation, management turnover and other

matters, which lead to better financial performance. Friday and Sirmans (1998), Ghosh and

Sirmans (2003) and Feng, Ghosh and Sirmans (2005) illustrate the importance of board

independence. Conger, Finegold and Lawler (1998) suggest that a board of directors that meets

more frequently monitors the managers more effectively.

Downs, Güner and Patterson (2000) find that information asymmetry is lower for REITs

that distribute more capital to their shareholders, indicating real estate investors obtain important

information from the capital distribution policies of REITs. McDonald, Nixon and Slawson

(2000) show that REITs can signal private information to the market through its dividend

announcements. For small equity REITs, they find that the measure of information asymmetry

increases the day before the announcement and then declines subsequently.

Zhu, Ong and Yeo (2008) investigate the information provided by REIT managers when

preparing to raise funds through a seasoned equity offering (SEO). They find that both earnings

and FFO are manipulated, with Funds from Operations (FFO) being manipulated more, up to

three quarters prior to the financing. They find that manipulation is more common when the

auditor is not one of the Big 4 firms, when institutional investors are relatively unimportant

owners, when the REIT issues several SEOs and when its cash flow is “deteriorating”. This

research does not include any governance variables, and does not investigate whether investors

can anticipate the attempted manipulation with sufficient precision for the manipulation to have

no real effect on the level of the stock price. They confirm the existence of asymmetric

12
information since it would be a waste of effort to try to manipulate information if it could not be

manipulated!

Regardless of the activities of the REIT and its managers, investors need not be passive.

Prior research suggests that fewer analysts study REITs compared to other stocks (e.g. Wang,

Erickson, Gau and Chan 1995; Wang, Erickson and Chan 1995). Surprisingly, Downs and

Güner (1999; 2000) show that an increase in information-gathering activities, as measured by the

number of estimates of investment analysts, does not reduce information asymmetry.

III. Hypothesis and Empirical Methodology Development

Information asymmetry can be diminished either by external public sector, market or

internal corporate mechanisms. Our strategy is to develop a statistical model for testing the

effects of REIT internal governance upon information asymmetry.

REIT investors should prefer stronger governance because it should reduce the

“advantages” of insiders. Since public REITs raise funds in the capital market, one would expect

a significant relationship between corporate governance and the level of information asymmetry.

These notions are used to form our hypothesis:

H1: There is a significant relationship between corporate governance and information

asymmetry.

We investigate this relationship by regressing a proxy of information asymmetry (IA) on

a comprehensive set of corporate governance (CG) measures, controlling for other non-

governance variables (Controls):

IA = α + β CG + γ Controls + ε (1)

13
We follow the literature and measure IA as the percentage bid-ask spread: 7

SPREAD = (Ask Price– Bid Price)/((Ask Price+ Bid Price)/2)*100 (2)

CG is measured by a wide range of variables for the structure and activities of the board

of directors and its audit committee. We use variables available from the Corporate Library

database. Similar to prior research in this area, BOARD_IND, defined as the percentage of fully

independent directors on the board, is expected to be negatively related to SPREAD. Prior

research documents that BOARD_SIZE, measured as number of directors, is expected to have a

positive relationship with SPREAD. BOARD_MEET measures the number of full board meetings

held per year; we expect a negative relationship between BOARD_MEET and SPREAD.

The effectiveness of a board may depend upon its experience. We use two variables to

capture the board’s experience: DIR_TENURE, the percentage of directors with tenure exceeding

15 years; and DIR_EXP, the percentage of directors with more than 4 concurrent corporate

(public) directorships. 8 Plausibly, more experienced directors can monitor management more

effectively. We expect an increase in either of these variables to reduce SPREAD.

Linn and Park (2005) and Brick, Palmon and Wald (2006) show consistent evidence that

directors’ compensation is positively related to monitoring activity by directors. McConnell and

Servaes (1990) find that directors who own company stock are more likely to act in the interests

of shareholders. Hence, we include as independent variables DIR_COMP, the reported directors’

base compensation, and DIR_SHARE, values of company stock owned by the board of directors.

We expect higher directors’ base compensation and greater directors’ stock holdings to reduce

7
Gul and Qiu (2002) discusses several proxies of IA, including bid-ask spread, dispersion in analysts’ forecasts,
R&D expenditures and accounting disclosure indices. We choose to focus on bid-ask spread in this study to examine
outside investors’ evaluation of information.
8
The Corporate Library also calculates these variables based upon different tenure horizons and different numbers
of public directorships. In unreported robustness checks we replicate our analysis using different proxies for
DIR_TENURE and DIR_EXP and obtain similar results.

14
information asymmetry.

Begley, Cheng and Gao (2007) show that audit committee characteristics are important

determinants of corporate public information quality. We utilize two audit committee features:

audit committee independence (AUDIT_IND), equal to 1 if the audit committee is comprised

wholly of independent directors and 0 otherwise; and audit committee financial expertise

(AUDIT_EXP), the number of audit committee members who are designated financial experts.

Prior literature (e.g., Klein 2002) suggests that an audit committee consisting of independent

members is more effective for monitoring management. Defond, Hann and Hu (2005) show

further that markets react favorably to the appointment of financial experts to the audit

committee. Therefore, we expect higher AUDIT_IND and AUDIT_EXP to reduce information

asymmetry.

We use six firm variables to control for general corporate market effects: trading volume

(VOLUME), stock return volatility (STOCK_VOL), the number of analysts following a REIT

(ANALYST), 9 an indicator whether a firm’s actual Funds from Operations (FFO) meets or beats

analyst forecasts (D_MISS), dividend payout ratio (DIVPAY), and leverage ratio (LEV). Chung,

Elder and Kim (2008) suggest that stock trading VOLUME, measured as the average of daily

share volume in a given year (scaled by number of shares outstanding), is a determinant of bid-

ask spread. Ross (1989) provides evidence that stock price volatility, measured as the standard

deviation of daily stock return, reflects the effects of privately informed trading rather than

public information. We also expect the attention of stock market analysts should increase the

9
Prior research (Atiase 1985; Barron, Byard and Kim 2002; Barron, Byard, Kile and Riedl 2002) shows that larger
firms and firms with higher growth rates are followed by more analysts. Because LSIZE and GROWTH are highly
correlated with ANALYST, we do not include firm size (LSIZE) and growth rates (GROWTH), measured as the log of
total assets of a firm at the beginning of a given year and market-to-book ratio respectively, in our main regression
results. Moreover, Lehn, Patro and Zhao (2005) show that firm size and growth opportunities are highly correlated
with board characteristics. Nonetheless, we perform robustness check by replacing ANALYST with LSIZE and
GROWTH and obtain similar results.

15
quality and quantity of information available to outside shareholders (e.g., Atiase 1985).

Mohanram and Sunder (2003) find that uncertainty about earnings is higher when earnings

performance is poor. We follow Begley, Cheng and Gao (2007) and include a performance

dummy, D_MISS, measured as 1 if a firm’s actual FFO misses the analyst forecast (0 otherwise).

Dividend payout has long been considered as signal of firm performance and investment

opportunities in the REIT industry (e.g., Ghosh and Sirmans 2006). On the issue of information

asymmetry, Downs, Güner and Patterson (2000) find a significant negative relationship between

dividend distributions of a REIT and the adverse selection cost component of bid-ask spread; we

therefore include DIVPAY, dividend per share divided by earnings per share. Finally, we expect

that highly leveraged firms, where LEV is measured as total liabilities divided by total assets,

would be subject to more scrutiny from the capital markets. On other hand, highly leveraged

firms may rely less on equity financing and have fewer incentives to disseminate information to

investors, and can result in a positive relationship between LEV and SPREAD.

IV. Data Description

Our data are derived from several databases. The sample includes 149 REITs in the

United States between 2003 and 2006. The Corporate Library, the source of our governance data,

offers data only since 2003. By commencing our analysis with 2003, we also avoid the impacts

of the Sarbanes-Oxley Act of 2002. Financial information and stock market information are

obtained from Compustat and CRSP. We obtain analyst information from I/B/E/S. After deleting

firms with missing data, our final sample includes 109 distinct firms and 233 firm-year

observations.

Insert Table 1

16
 Table 1 depicts the sample selection process. We further classify the sample firms into

different property types from the classifications in the directory of the National Association of

Real Estate Investment Trusts (NAREIT) and from the websites of individual firms. The

majority of the REITs specialize in industrial/office (30 firms) or retail (29 firms) properties.

Table 1 also reports distribution of the firm-year observations.

Insert Table 2

Table 2, Panel A, contains descriptive statistics for our sample. The average total assets,

book value of equity and market value of equity of the sample REITs are $4,289m (millions),

$1,310m and $2,807m, respectively, with an average net annual income of $135m. The average

stock price over the sample period is $35.44.

Table 2, Panels B & C, presents descriptive statistics for information asymmetry and

governance variables. Panel B reports an average bid-ask spread of 0.28 and a median bid-ask

spread of 0.20. Panel C reports summary data for our governance variables. The sample REIT

firms have an average of 8.75 board members, and hold an average of 7.71 board meetings per

year. On average, 63 percent of the board members are independent. Seven percent of directors

have been on the board for at least 15 years, and 11 percent hold directorships on more than 4

corporate boards. Table 2 shows that this tenure is widely skewed with more than three-quarters

of REITs having no directors with 15 years experience. On the other hand, many REITs have

directors with experience as directors on many other public companies. On average, a director’s

base pay is only $23,000 but the median value of shares owned by a director is $20,000,000. 99

percent of REIT audit committees are entirely independent directors. On average, 1.10 members

per audit committee are designated financial experts but these experts are not evenly spread

across the REIT industry. More than three quarters of audit committees have none or one expert.

17
 Table 2, Panel D, reports descriptive statistics for our control variables. Trading volume

has a mean of 4.42 with a mean daily return volatility of 0.013. On average, 12.22 analysts

forecast the Funds from Operations for a firm in a given year; and the probability of a firm

missing analyst forecast averages 47 percent. Finally, the sample firms report an average

dividend payout ratio of 1.46 and a leverage ratio of 0.57.

Insert Table 3

Table 3 presents a Spearman correlation matrix showing relationships between and

among information asymmetry and the governance and control variables. The univariate

correlations show that better governance tends to reduce the bid-ask spread. We conclude that

most of the governance variables are not significantly inter-correlated with each other; each

governance variable captures a different “mechanism.” Among the control variables, we find

that bid-ask spread is significantly negatively related to trading volume, analyst following and

leverage ratio. We also find that bid-ask spread is positively related to whether the FFO meets or

beats the analysts’ forecasts.

V. Empirical Analysis

Multivariate Statistical Basic Model

Table 4 presents our basic empirical analysis, testing our hypothesis that better corporate

governance reduces information asymmetry. The empirical analysis is conducted using OLS

regression for the total sample of 233 observations. 10 In column 1, our statistical model employs

only director characteristics as the explanatory variables (excluding control variables).

Interestingly, none of the board characteristics variables (BOARD_IND, BOARD_SIZE and

10
Given that many of our independent variables are ordinal or skewed continuous variables, we use rank regressions
because it relaxes the assumption of linearity and assumes a monotonic relation (e.g. Lang and Lundholm 1993,
1996).

18
BOARD_MEET) are significantly related to the bid-ask spread. This finding confirms that, for

the REIT sector and perhaps unlike for other corporations, board characteristics may not be an

important determinant of information asymmetry. This is consistent with early studies by Friday

and Sirmans (1998), Ghosh and Sirmans (2003) and Feng, Ghosh and Sirmans (2005), who find

that board characteristics have only a weak effect on REIT valuation.

Insert Table 4

We find that DIR_EXP displays the expected negative relationship with bid-ask spread:

that is, more experienced directors monitor managerial decisions more effectively. We also find

that the coefficient for DIR_SHARE is negative and statistically significant, signifying that

directors’ shareholdings may align their interests with those of shareholders.

In contrast, to the general characteristics of the entire board, the characteristics of the

audit committee appear to be statistically important determinants of information asymmetry.

The audit committees of nearly all REITs consist of independent directors, the significance of

AUDIT_IND coefficient shows that the bid-ask spread adjusts for those REITs which do not have

an independent audit committee. Our findings complement those of a recent study by Vafeas

(2005) that shows audit committee independence represents an important factor of financial

reporting quality.

Sarbanes-Oxley Act in 2002 mandates the disclosure of “financial experts” among the

audit committee. Krishnain and Visvanathan (2008) show that accounting expertise on the audit

committee contributes to improved corporate monitoring. Our findings confirm that financial

expertise on a REIT audit committee reduces information asymmetry.

Column 2 of Table 4 presents empirical analysis with the inclusion of control variables.

We find results similar to those presented in Column 1. In addition, we find that the coefficient

19
for DIR_TENURE is now significantly negative. Despite the low average base salary, we find

also that directors’ base compensation (DIR_COMP) has a significant negative relationship with

bid-ask spread. Though the scales of these variables differ substantially, the coefficient for

DIR_SHARE is larger than the coefficient for DIR_COMP. In sum, when a director’s personal

financial incentives are aligned with those of shareholders, information asymmetry is reduced.

Inspection of the coefficients for the control variables in Column 2 shows that higher

trading volume improves market liquidity and reduces the spread required by market-makers as a

compensation for liquidity risks. The number of analysts following a REIT reduces the level of

information asymmetry. Our results contrast with those of Downs and Güner (2000) who claim

that increased information from analysts does not decrease the level of asymmetric information.

The difference between the results may be caused by the fact that they use the number of

earnings estimates to measure the attention a REIT receives from the investment community

while we use the number of analysts following a REIT. We prefer our measure because a single

analyst may issue multiple forecasts before earnings announcement dates.

Property Sector Effects

It is possible that the normal or necessary level of corporate governance varies

significantly across different REIT sectors. To address this possible omitted variable bias, Table

5 adds a set of dummy variables to account for REITs property sectors. We find that including

these sectoral dummy variables increases Adjusted R2 but, otherwise, has little qualitative effect

on our findings. For the control variables, we find that trading volume and analyst following

continue to exert a significant impact on the bid-ask spread. We find that D_MISS and LEV are

positively related to the bid-ask spread.

Endogeneity

20
 In this study, governance variables are exogenous reflecting the idea that corporate

governance is pre-determined and typically changes little within a firm for our three-year sample

time horizon. However, the same cannot be said for one of the significant control variables,

VOLUME. The bid-ask spreads and volume are likely to be endogenously determined (e.g.,

Chung, Jo and Shefrin 2002). To investigate the possible statistical effects of the endogeneity

between VOLUME and information asymmetry, we first replicate our analysis of specification (1)

with the exclusion of VOLUME. Table 6, column 1, shows that excluding VOLUME does not

affect the statistical results.

We next examine the effects of VOLUME endogeneity by using an Instrumental Variable

(IV) estimator. Our first stage regression estimates VOLUME using log total assets, market-to-

book ratios, as well as STOCK_VOL, DIVPAY and LEV as our instruments. We then estimate

equation (1) using the fitted values of VOLUME. Table 6, column 2, contains the IV estimation.

Our IV statistical results imply that corporate governance continues to exert a significant

influence on REIT information asymmetry.

Sensitivity Analysis

Because our analysis uses an unbalanced panel of data, some but not all firms appear in

multiple years. Hence, we recalculate the standard errors of the coefficients clustering at the

company level. In unreported results, we find that our findings remain qualitatively similar. Also,

by including annual dummy variables to account for systemic changes in asymmetric

information and macroeconomic conditions, the estimated relationship between corporate

governance and information asymmetry remains stable. Finally, adding variables to control for

the effect of firm size and growth opportunity, we find that the relationship between information

asymmetry and corporate governance is virtually unchanged.

21
VI. Concluding Remarks

One role of proper corporate governance is controlling and monitoring management‘s

withholding or distorting the distribution of corporate public information. Some vehicles for

controlling and monitoring firm disclosures are imposed externally by regulators and/or financial

markets. The firm also can institute internal “devices” for these purposes. The unique legal and

regulatory structure of a Real Estate Investment Trust vis-à-vis a normal C-Corporation may

alter the balance between internal and external governance “mechanisms.” On the one hand,

internal governance should become more important since REITs are less vulnerable to a takeover.

On the other hand, REITs are required to distribute dividends equal to at least 90% of taxable

income, lessening the opportunity for managerial mischief and reducing the need to mitigate the

principal-agent problem between REIT managers and shareholders.

Although the REIT’s structure may suggest that REIT’s managers need little internal

oversight, we find that the bid-ask spread demanded by the market varies with the amount of

oversight. Our key findings indicate that the level of information asymmetry is affected by the

board of directors’ experiences and compensation and the nature and structure of the audit

committee, the latter is a previously-unexplored aspect of governance. The superficial aspects of

how the board processes information, such as the number of meetings and the size of the board,

are not significant. Importantly, the quality of the audit committees affects information

asymmetry.

Two nuggets of advice are imbedded in our analyses. First, improving governance

diminishes asymmetric information, and the concomitant decline in the bid-ask spread should

reduce the cost of raising funds. Second, that boards of directors act in the interests of

22
shareholders when their financial incentives are similar to shareholders.

23
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Table 1: Sample selection and distribution

Number of REITs with complete data in Corporate

Library during the proxy year of 2003-2006* 149

Missing Compustat data (9)

Missing CRSP data (3)

Missing IBES data and firms with less than two analysts
following (28)
Sample firms 109

Classified by property type:

Industrial / Office 30
Retail 29
Residential 16
Specialty / Self Storage / Healthcare 16
Lodging / Resort 9
Diversified 7
Mortgage / Financing 2
Sample firms 109

Distribution by proxy year

2003 30
2004 50
2005 56
2006 97
Total 233 firm-year observations
* The Corporate Library dataset offers data for proxy year beginning in 2001. The complete data used in this paper
start in 2003.

29
Table 2: Descriptive statistics
This table reports descriptive statistics on firm characteristics, information asymmetry, corporate
governance, and control variables. The sample of 233 firm-years includes data with a proxy year
between 2003 and 2006 and that have sufficient data to estimate the variables. See data appendix
for the definitions of variables.

St.
Mean Dev. Min. Q1 Med. Q3 Max.
Panel A: Descriptive statistics on basic firm characteristics (in millions)
Total assets 4,289 4,769 197 1,526 2,801 4,637 25,719
Book value of equity 1,310 1,437 11 527 909 1,545 10,209
Market value of equity 2,807 2,815 156 1,081 1,810 3,383 16,886
Net income 135 153 -310 39 93 169 862
Price per share 35.44 16.37 9.01 24.32 33.75 43.39 92.2
All variables are measured in $ millions except price per share.

Panel B: Information asymmetry variable

SPREAD 0.28 0.25 0.07 0.14 0.20 0.31 2.51

Panel C: Corporate governance variables

BOARD_IND 0.63 0.14 0 0.56 0.64 0.71 0.92
BOARD_SIZE 8.75 2.16 5 7 9 10 15
BOARD_MEET 7.71 3.35 4 5 7 9 21
DIR_TENURE 0.07 0.15 0 0 0 0 0.67
DIR_EXP 0.11 0.12 0 0 0.09 0.17 0.6
DIR_COMP 0.023 0.015 0 0.018 0.025 0.03 0.125
DIR_SHARE 435 1,445 0 0 20 253 10,848
AUDIT_IND 0.99 0.09 0 1 1 1 1
AUDIT_EXP 1.10 1.05 0 0 1 1 5

Panel D: Control variables

VOLUME 4.42 1.23 0.55 3.64 4.28 5.17 8.21
STOCK_VOL 0.013 0.002 0.008 0.011 0.013 0.014 0.028
ANALYST 12.22 5.15 2 8 12 16 25
D_MISS 0.47 0.50 0 0 0 1 1
DIVPAY 1.46 2.19 0 0.78 1.05 1.45 21.37
LEV 0.57 0.13 0.04 0.50 0.57 0.65 0.90

30
 Table 3: Spearman correlations between information asymmetry and its determinants
This table displays Spearman correlations for our sample of 233 firm-years with a proxy year between 2003 and 2006 and that have
sufficient data to estimate the variables. See data appendix for the definitions of variables. Bold font indicates significance at the 10%
level or lower (two-tailed).

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

1. SPREAD

2. BOARD_IND -0.04

3. BOARD_SIZE -0.12 -0.19

4. BOARD_MEET 0.01 0.05 0.04

5. DIR_TENURE 0.01 -0.17 0.00 0.03

6. DIR_EXP -0.20 0.04 0.02 -0.02 -0.06

7. DIR_COMP -0.15 -0.09 0.09 0.12 -0.13 0.10

8. DIR_SHARE -0.12 -0.30 0.31 -0.19 -0.01 0.02 0.09

9. AUDIT_IND -0.12 0.09 -0.08 -0.02 -0.06 -0.02 0.05 -0.08

10. AUDIT_EXP -0.52 0.12 -0.01 -0.05 -0.03 0.15 0.06 -0.18 0.06

11. VOLUME -0.33 0.22 -0.01 0.07 -0.35 0.05 0.06 -0.14 0.02 0.22

12. STOCK_VOL -0.09 0.15 -0.21 0.01 -0.04 0.11 -0.01 -0.23 -0.01 0.39 0.14

13. ANALYST -0.21 -0.10 0.34 -0.10 -0.06 0.05 -0.02 0.55 -0.15 -0.16 -0.02 -0.28

14. D_MISS 0.11 0.10 -0.02 -0.04 -0.03 -0.01 -0.02 0.06 -0.10 -0.06 0.01 0.06 0.00

15. DIVPAY 0.03 0.04 -0.05 -0.11 -0.07 -0.05 0.01 -0.02 0.11 0.08 0.05 0.06 -0.13 0.18

16. LEV -0.12 0.02 0.10 -0.00 -0.16 -0.03 0.21 0.13 0.03 0.13 0.31 0.01 0.02 -0.14 0.05

31
Table 4: Effect of corporate governance on information asymmetry
This table reports results from the regression: IA= α+ β CG+ γ Controls+ ε.
This regression uses 233 observations for 109 REIT firms with a proxy year between 2003 and
2006 and that have sufficient data to estimate the variables. Column 1 reports the regression
results including only the CG variables. Column 2 reports the regression results while including
the control variables. See data appendix for the definitions of variables. t-statistics are reported in
parentheses.
Dependent Variable: Percentage Bid-Ask Spread
Estimated using Rank OLS Regression
*, **, and *** indicate significance at the 10%, 5%, and 1% levels (two-tailed).
(1) (2)
Intercept 143.06*** 159.90***
(7.51) (8.51)
Corporate Governance Variables
BOARD_IND -0.05 -0.007
(-0.85) (-0.13)
BOARD_SIZE -0.06 0.004
(-1.08) (0.07)
BOARD_MEET -0.05 -0.02
(-0.81) (-0.45)
DIR_TENURE -0.05 -0.18**
(-0.72) (-2.52)
DIR_EXP -0.12** -0.11**
(-2.15) (-2.00)
DIR_COMP -0.07 -0.10**
(-1.38) (-1.97)
DIR_SHARE -0.24*** -0.16**
(-3.73) (-2.24)
AUDIT_IND -0.67** -0.81***
(-1.98) (-2.59)
AUDIT_EXP -0.58*** -0.56***
(-9.61) (-9.35)
Control Variables
VOLUME -0.30***
(-5.29)
STOCK_VOL 0.05
(0.98)
ANALYST -0.23***
(-3.55)
D_MISS 0.08
(1.31)
DIVPAY 0.04
(0.78)
LEV 0.07
(1.23)
Number of Observations 233 233
Adj. R2 33.86% 44.78%

32
Table 5: Effect of governance on information asymmetry with property type fixed effects
This table reports results from the regression: IA= α+ β CG+ γ Controls+ φProperty+ ε.
This regression uses 233 observations for 109 REIT firms with a proxy year between 2003 and
2006 and that have sufficient data to estimate the variables. Column 1 reports the regression
results including only the CG variables and property type fixed effects. Column 2 reports the
regression results while including the control variables. See data appendix for the definitions of
variables. t-statistics are reported in parentheses.
Dependent Variable: Percentage Bid-Ask Spread
Estimated using Rank OLS Regression
*, **, and *** indicate significance at the 10%, 5%, and 1% levels (two-tailed).
(1) (2)
Intercept 147.30*** 148.85***
(5.85) (6.34)
Corporate Governance Variables
BOARD_IND -0.09 -0.06
(-1.56) (-1.19)
BOARD_SIZE -0.04 0.02
(-0.71) (0.36)
BOARD_MEET -0.07 -0.04
(-1.29) (-0.78)
DIR_TENURE 0.01 -0.10
(0.14) (-1.28)
DIR_EXP -0.12** -0.11**
(-2.11) (-2.09)
DIR_COMP -0.06 -0.09*
(-1.15) (-1.87)
DIR_SHARE -0.24*** -0.19***
(-3.68) (-2.84)
AUDIT_IND -0.41 -0.51*
(-1.20) (-1.62)
AUDIT_EXP -0.60*** -0.57***
(-10.10) (-9.72)
Control Variables
VOLUME -0.33***
(-5.78)
STOCK_VOL 0.01
(0.21)
ANALYST -0.24***
(-3.75)
D_MISS 0.10*
(1.75)
DIVPAY 0.02
(0.34)
LEV 0.12**
(2.00)
Property Type Variables Included Included
Number of Observations 233 233
Adj. R2 37.23% 49.02%

33
Table 6: Effect of corporate governance on information asymmetry using alternative
specifications
This table reports results from the regression: IA= α+ β CG+ γ Controls+ ε.
This regression uses 233 observations for 109 REIT firms with a proxy year between 2003 and
2006 and that have sufficient data to estimate the variables. Column 1 reports the regression
results with the exclusion of VOLUME. Column 2 reports the 2SLS regression results while
VOLUME is first estimated using IV regression. See data appendix for the definitions of
variables. t-statistics are reported in parentheses.
Dependent Variable: Percentage Bid-Ask Spread
Estimated using Rank OLS Regression
*, **, and *** indicate significance at the 10%, 5%, and 1% levels (two-tailed).
(1) (2)
Intercept 147.61*** 176.62***
(7.47) (8.12)
Corporate Governance Variables
BOARD_IND -0.04 0.03
(-0.65) (0.53)
BOARD_SIZE 0.001 0.007
(0.02) (0.12)
BOARD_MEET -0.04 0.005
(-0.81) (0.08)
DIR_TENURE -0.07 -0.33***
(-0.93) (-3.46)
DIR_EXP -0.11** -0.10*
(-1.98) (-1.69)
DIR_COMP -0.09* -0.11*
(-1.71) (-1.96)
DIR_SHARE -0.11 -0.22***
(-1.45) (-2.76)
AUDIT_IND -0.79** -0.84**
(-2.37) (-2.41)
AUDIT_EXP -0.61*** -0.50***
(-9.65) (-7.06)
Control Variables
VOLUME -0.71***
(-4.46)
STOCK_VOL 0.04 0.07
(0.71) (1.16)
ANALYST -0.25*** -0.19***
(-3.77) (2.63)
D_MISS 0.06 0.10
(1.00) (1.48)
DIVPAY 0.04 0.04
(0.69) (0.75)
LEV -0.02 0.18**
(-0.28) (2.47)
Number of Observations 233 233
Adj. R2 37.94% 38.67%

34
 Appendix: Variable definitions

Information asymmetry variable:

Bid-ask spread (SPREAD) = The average of the daily bid-ask spread in a given
year. Daily bid-ask spread is measured as the
difference between the closing bid and ask prices
scaled by the average of the closing bid and ask
prices and multiplied by 100
Corporate governance variables
Board independence (BOARD_IND) = Percentage of fully independent directors on the
board
Board size (BOARD_SIZE) = Total number of all directors on a given board
Board meetings (BOARD_MEET) = Number of full board meeting held in a given year
Directors’ tenure (DIR_TENURE) = Percentage of directors with tenure exceeding 15
years on a given board
Directors’ expertise (DIR_EXP) = Percentage of directors with more than 4 corporate
(public) directorships on a given board
Directors’ compensation (DIR_COMP)= Reported director base pay amount (in million
dollars)
Directors’ share (DIR_SHARE) = Value of shares of company stock owned by
directors (in million dollars)
Audit committee independence Indicates whether the audit committee is comprised
(AUDIT_IND) = wholly of independent directors
Audit committee financial expertise Number of audit committee members who are
(AUDIT_EXP) = designated financial experts, according to the
definition in the Corporate Library database
Control variables:
Trading volume (VOLUME) = The average of daily share volume in a given year,
where daily share volume is scaled by the number
of shares outstanding
Return volatility (STOCK_VOL) = Standard deviation of daily return in a given year
Analyst following (ANALYST) = The number of unique analysts issuing Funds From
Operations (FFO) in a given year
D_MISS = One if a firm’s actual FFO is below the mean
forecast for a given year, and zero otherwise
Dividend payout ratio (DIVPAY) = Dividend per share divided by earnings per share
Leverage (LEV) = Total liability divided by total assets.

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