Evaluating the impact of economic factors on REITs' capital structure around the world
| Published date | 28 January 2014 |
| Pages | 5-20 |
| DOI | https://doi.org/10.1108/JPIF-08-2013-0050 |
| Date | 28 January 2014 |
| Author | Antonios Rovolis,Andreas Feidakis |
| Subject Matter | Property management & built environment,Real estate & property,Property valuation & finance |
Evaluating the impact of
economic factors on REITs’
capital structure around the world
Antonios Rovolis
Department of Geography, Harokopio University, Athens, Greece, and
Andreas Feidakis
Bank of Greece, Athens, Greece
Abstract
Purpose – This paper aims to examine the determinants of the capital structure of real estate
investment trusts (REITs) across the world and explore whether this structure is characterized by any
common factors.
Design/methodology/approach – Endogenous and exogenous factors that affect the financial
management of real estate firms are identified in the analysis. “Regular” (static) panel data regression
analysis, as well as dynamic panel data techniques, is applied to a panel of listed real estate firms from
2005 to 2010.
Findings – Empirical results showed that factors such as tangibility, size of the company, growth
opportunities, assets turnover affect positively the financial leverage of REITs; conversely, other
determinants, being debit’s cost, GDP, and long-term interest rates, are negatively correlated with the
financial gearing of the REITs.
Practical implications – This paper identifies factors that determine the capital structure of REITs
around the world. Firm executives and policy makers in different countries may wish to adjust their
policies (regarding capital structure) according to the empirical findings.
Originality/value – This study, using a comprehensive dataset from all over the world, investigates
whether there are solid and mutual factors that can characterize the capital structure of REITs.
Keywords Capital structure,Panel data, Real estate markets
Paper type Research paper
1. Introduction
Capital structure literature presents a paradox; the seminal paper of Modigliani and
Miller (1958) should have ended any theoretical research, as it argued that capital
structure is irrelevant in perfect capital markets (PCM). However, this topic has
produced since then a voluminous body of research based on the idea that the PCM
hypothesis is not empirically validated. In fact, current literature has provided ample
evidence that the optimal capital structure of a firm can be affected by a range of factors.
Some authors have argued that taxes and bankruptcy costs affect the capi tal structure of
firms (Miller, 1977; DeAngelo and Masulis, 1980); the tradeoff theory (optimization
theory) argues that firms seek debt levels that the tax advantages of additional debt
offset the costs of possible financial distress and thus set a target debt to value ratio and
gradually moving towards it (Kim, 1978; Kraus and Litzenberger, 1973). Agency costs
theory asserts that debt motivates managers to be efficient and calls these positive
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1463-578X.htm
The views expressed in this article do not necessarily represent the views of the Bank of Greece.
Received December 2012
Accepted August 2013
Journal of Property Investment &
Finance
Vol. 32 No. 1, 2014
pp. 5-20
qEmerald Group Publishing Limited
1463-578X
DOI 10.1108/JPIF-08-2013-0050
Impact of
economic factors
5
effects of debt “the Control Hypothesis” for debt creation – when firm managers have
substantial cash flow, they can waste the cash by consuming perquisites or by investing
in low return projects (Jensen, 19 86; Jensen and Meckling, 1976). The pecking order
theory (POT) discusses the information asymmetry between managers and investors.
In particular, managers possess privileged information about the firm value that
investors do not. For this reason, POT claims that firms prefer internal to external
financing and debt to equity, when issuing securities to avoid the potential valuation
discount associated with equity issues. By contrast, when firms use external funds, they
prefer to issue the safest security first (i.e. debt), then convertible securities and equity as
a last resort (Myers and Majluf, 1984; Myers, 1977).
This paper tries to identify the main determinants of capital structure, either
microeconomic or macroeconomic, utilizing a rather large dataset regarding real estate
investment trusts (REITs). The remainder of the paper is organized as follows;
Section 2 provides a short-presentation of the main theories regarding capital structure;
Section 3 presents the dataset and the variables used in the empirical analysis; Section 4
offers a compact presentation of the used econometric methods and of the empirical
findings; the last part summarizes the analysis.
2. Theoretical framework
As we argued above, a number of competing theories have been used in the capital
structure analysis. Tradeoff theory emphasizes on taxes, the pecking order theory on
asymmetric information and the free cash flow theory on agency costs. Several studies
attempt to find evidence in order to corroborate these theories.
Rajan and Zingales (1995) investigated the determinants of capital structure choice
in the G-7 countries and discovered that at aggregate level, firm leverage is fairly
similar across them. Antoniou et al. (2002) investigated the determinants of leverage in
France, Germany and the UK and found that the effects of possible determinants of
capital structure are country specific.
Titman and Wessels (1988) concluded that short-term debt is negatively related to
firm size. Rajan and Zingales (1995) stated that leverage increases with size because
larger firms are better diversified and have a lower probability of being in financial
distress; lower bankruptcy costs enable them to take on more leverage. Harris and Raviv
(1991), using a cross-sectional test, discovered that leverage increases with firm size.
Michaelas et al. (1999) test the capital structure of small firms in the UK and argued that
size and gearing is positively related in agreement with Antoniou et al. (2002) and Frank
and Goyal (2004).
Michaelas et al. (1999) noted that profitability and gearing are negatively related in
agreement with the pecking order theory and are consistent with the results of Titman
and Wessels (1988), Antoniou et al. (2002), Booth et al. (2001), Frank and Goyal (2004)
and Bevan and Danbolt (2004).
Fama and French (2002) argued that, due to their level of diversification, larger
firms are expected to have less volatile earnings, which in return induce a higher
leverage ratio.
Rajan and Zingales (1995) recommended that the greater the proportion of tangible
assets on the balance sheet, the more willing should lenders be to supply loans, and
leverage should be higher. Titman and Wessels (1998) provided evidence that firms in
possession of assets with high collateral value choose high debt levels in harmony with
JPIF
32,1
6
To continue reading
Request your trial