Institutional Investors and Firm Efficiency of Real Estate Investment Trusts

Richard Chung, Scott Fung and Szu-Yin Kathy Hung

Online First™, 6 May 2010

Abstract

This study investigates the effect of institutional ownership on improving firm efficiency of equity Real Estate Investment Trusts (REITs), using a stochastic frontier approach. Firm inefficiency is estimated by comparing a benchmark Tobin’s Q of a hypothetical value-maximizing firm to the firm’s actual Q. We find that the average inefficiency of equity REITs is around 45.5%, and that institutional ownership can improve the firm’s corporate governance, and hence reduce firm inefficiency. Moreover, we highlight the importance of heterogeneity in institutional investors—certain types of institutional investors such as long-term, active, and top-five institutional investors, and investment advisors are more effective institutional investors in reducing firm inefficiency; whereas hedge funds and pension funds seem to aggravate the problem. In sub-sample analysis, we find that these effective institutional investors can reduce inefficiency more effectively for distressed REITs, and for REITs with high information asymmetry, and with longer term lease contracts. Lastly, we find that the negative impact of institutional ownership (except for long-term institutional investors) on firm inefficiency reduces over time, possibly due to strengthened corporate governance and regulatory environment in the REIT industry.

Keywords  Institutional investors – Corporate governance – Stochastic frontier analysis – REITs

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