UZH-Logo

Maintenance Infos

Agency Issues and Financing Constraints - Evidence from REITs


Gupta, Manish (2012). Agency Issues and Financing Constraints - Evidence from REITs. NCCR FINRISK Working Paper 743, University of Zurich.

Abstract

Given a firms investment policy, its dividend policy is irrelevant (Miller and Modigliani (1961)). REITs, by law, pay at least 90 % of their corporate income as dividends, so that their dividend policy is given. This is a reversal of the dividend irrelevance theorem through regulatory means. Such a high dividend payment also means lower retained earnings, leaving firms with little free cash flow. Jensen (1986) argues that lower free cash flow results in mitigated agency problems. In this paper, I ask two questions. First, how does an average REIT, given its dividend policy restricted through regulation, respond to its investment opportunities? Second, does an average REIT, with mitigated agency problems, face less severe financing constraints? In response to the first question, I find that an average REITs investment responsiveness (as measured by Tobins q) is higher than that of firms in other industries. In response to the second question, I find that, despite mitigated agency costs, an average REIT faces, in fact, more severe financing constraints (as measured by sensitivity to cash ow) than other firms. Finally, using the natural experiment provided by the 2001 REIT Modernization Act (RMA) that allowed REITs to own taxable REIT subsidiaries (TRS) and reduce their dividend distribution from 95% to 90%, I show that, for a given increase in internal funds, the negative impact arising from increased agency problems dominates the positive impact of the wealth effect, resulting in a lower overall responsiveness of REITs to their investment opportunities.

Given a firms investment policy, its dividend policy is irrelevant (Miller and Modigliani (1961)). REITs, by law, pay at least 90 % of their corporate income as dividends, so that their dividend policy is given. This is a reversal of the dividend irrelevance theorem through regulatory means. Such a high dividend payment also means lower retained earnings, leaving firms with little free cash flow. Jensen (1986) argues that lower free cash flow results in mitigated agency problems. In this paper, I ask two questions. First, how does an average REIT, given its dividend policy restricted through regulation, respond to its investment opportunities? Second, does an average REIT, with mitigated agency problems, face less severe financing constraints? In response to the first question, I find that an average REITs investment responsiveness (as measured by Tobins q) is higher than that of firms in other industries. In response to the second question, I find that, despite mitigated agency costs, an average REIT faces, in fact, more severe financing constraints (as measured by sensitivity to cash ow) than other firms. Finally, using the natural experiment provided by the 2001 REIT Modernization Act (RMA) that allowed REITs to own taxable REIT subsidiaries (TRS) and reduce their dividend distribution from 95% to 90%, I show that, for a given increase in internal funds, the negative impact arising from increased agency problems dominates the positive impact of the wealth effect, resulting in a lower overall responsiveness of REITs to their investment opportunities.

Downloads

1398 downloads since deposited on 20 Feb 2012
93 downloads since 12 months
Detailed statistics

Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:2012
Deposited On:20 Feb 2012 13:44
Last Modified:05 Apr 2016 15:37
Series Name:NCCR FINRISK Working Paper
Official URL:http://www.zora.uzh.ch/59080/
Related URLs:http://www.nccr-finrisk.uzh.ch/wps.php
Other Identification Number:merlin-id:6741
Permanent URL: https://doi.org/10.5167/uzh-59080

Download

[img]
Preview
Filetype: PDF
Size: 458kB

TrendTerms

TrendTerms displays relevant terms of the abstract of this publication and related documents on a map. The terms and their relations were extracted from ZORA using word statistics. Their timelines are taken from ZORA as well. The bubble size of a term is proportional to the number of documents where the term occurs. Red, orange, yellow and green colors are used for terms that occur in the current document; red indicates high interlinkedness of a term with other terms, orange, yellow and green decreasing interlinkedness. Blue is used for terms that have a relation with the terms in this document, but occur in other documents.
You can navigate and zoom the map. Mouse-hovering a term displays its timeline, clicking it yields the associated documents.

Author Collaborations