The level of representative underwriting and the underwriting costs of REIT SEOs
| DOI | https://doi.org/10.1108/14635781211194782 |
| Date | 03 February 2012 |
| Pages | 18-41 |
| Published date | 03 February 2012 |
| Author | Ranajit Kumar Bairagi,William Dimovski |
| Subject Matter | Property management & built environment |
The level of representative
underwriting and the
underwriting costs of REIT SEOs
Ranajit Kumar Bairagi and William Dimovski
School of Accounting, Economics and Finance, Deakin University,
Burwood, Australia
Abstract
Purpose – The purpose of this paper is to investigate factors influencing the underwriting discount
for US Real Estate Investment Trust (REIT) Seasoned Equity Offerings (SEOs).
Design/methodology/approach – The study provides new evidence on determinants of
underwriting discounts with a comprehensive dataset of 783 US REIT SEOs from 1996 until June
2010. Ordinary least squares regressions are performed to estimate the effect of the level of
representative underwriting along with other potential factors on underwriting discounts.
Findings – The study complements the well-documented notion of the economies of scale in SEO
underwriting discounts. The equally (value) weighted underwriting discounts averaged 4.21 per cent
(4.10 per cent) with a declining trend over time. The findings of this study show the statistically and
economically significant negative effect of the level of representative underwriting on the underwriting
discounts, as well as the significance of the structure of underwriting syndicate in determining the
underwriting discounts. The findings suggest that issuers can minimize the costs of raising secondary
equity capital by optimally allocating the underwriting business among the underwriters.
Originality/value – This paper adds to the international REIT SEO literature by exploring new
evidence behind underwriting discounts. The study includes data before and after the REIT
Modernization Act 1999 and during the recent global financial crisis period.
Keywords United States of America,Equity capital, Underwriting,Costs, Real estate, Investments,
Seasoned equityofferings, Underwriting syndicate,Level of underwriting, Underwritingdiscount
Paper type Research paper
1. Introduction
The direct costs of issuing seasoned equity offerings (SEOs) reduce the net proceeds to
the issuing firm. A major portion of the SEO direct costs is the underwriting discount,
76 per cent of total direct costs (Lee et al., 1996), which is the remuneration directly paid to
the investment banks involved in floating the offerings from valuation to hiring dealers.
This underwriting discount is also often refereed to as the “gross spread”. This
underwriting cost broadly ranges from 3 to 8 per cent of SEO gross proceeds (Lee and
Masulis, 2009) but Butler et al. (2005) report a range from 1 to 10 per cent. Unlike initial
public offerings (IPOs), which experience clustering at certain percentages, SEOs
experience modest clustering of underwriting costs with substantial cross-sectional
variation but very little was known about the determinants of these costs for SEOs until
Butler et al. (2005). Lee and Masulis (2009) suggest asymmetric information between
managers and outside investors to have a positive effect on these costs. The literature
on underwriting costs is, however, mainly centered on IPOs (Chen and Ritter,
2000; Torstila, 2001; Hansen, 2001; Butler and Huang, 2003; Kaserer and Kraft, 2003)
and SEOs (Smith, 1977; Eckbo and Masulis, 1992; Lee et al., 1996; Corwin, 2003;
The current issue and full text archive of this journal is available at
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JPIF
30,1
18
Journal of Property Investment
& Finance
Vol. 30 No. 1, 2012
pp. 18-41
qEmerald Group Publishing Limited
1463-578X
DOI 10.1108/14635781211194782
Mola and Loughran, 2004; Butler et al., 2005; Lee and Masulis, 2009) of industrial
companies.
Real estate investment trusts (REITs) which are entirely engaged in real estate
properties with relatively certain income from rent and mortgage payments have proved
a very active sector in the capital market during last two decades (Ghosh et al., 2000;
Laopodis, 2009). Over the last five years their daily trading volume has increased by
163 per cent and during first six months of 2010 their dividend yield has more than
doubled the dividend yield of S&P500 (REITWATCH, July 2010). It is worth mentioning
that during this same six-month period the REIT index experienced a 5.56 per cent gain
against a 6.65 per cent loss for the S&P500. The significance of REIT SEOs in the capital
market is also worth noting because during this six-month period, the industry raised
$22 billion in total, $9.8 billion of which was raised by secondary equity and preferred
offerings against $1.3 billion by IPOs. Additionally, because of hardly any tax-based
incentives, REITs need to issue frequent SEOs in comparison to industrial companies to
fund their growth opportunities. Hence, costs of raising secondary equity capital by
REITs are significant factor to their capital budgeting decision but there is a paucity of
study on the determinants of REIT SEO underwriting costs. The purpose of this study is
to investigate the determinants of underwriting costs of REIT SEOs and more
specifically the effect of the level of representative underwriting on underwriting costs.
The rationale behind this lies in the idea that offers size and underwriter reputation,
among others, are significant determinants of SEO underwriting costs but the empirical
evidence of the effect of lead underwriter’s reputation on the underwriting costs is
somewhat mixed[1].Mola and Loughran (2004) report the prior marketshare, reputation
and quality of analyst group of an investment bank to influence most of its subsequent
underwritingbusiness in seasonedofferings. Butler et al. (2005)assume investment banks
with better reputations have a larger market share. Despite the mixed effect on
underwriting costs, the empirical evidence shows that the underwriter reputation affects
the underwriting business of an underwriter. This led us to hypothesize that the
representativeunderwritingbanks (including thelead underwriter) maywell influence the
sizeof their remuneration.This paper addresses thisissue by relating the levelof the active
participationof the representative underwritersin an offer, to their compensation.We test
the significanceof the level of active participationby the representativeunderwriters with
a sample of 783 US REITSEOs from a period of January 1996 until June2010 and find a
statistically significant and robust negative effect on underwritingcosts.
We hypothesize that the underwriters emphasize on both their reputation and the
level of their volume of shares in an offer in determining their compensation. We also
hypothesize that the underwriters with higher reputation but lower proportion of shares
in an offer demand higher compensation. The rationale behind this lies in the fact that an
offer is usually underwritten either by a single underwriter or a syndicate of
underwriters, with a few of them acting as lead managers and or representatives. The
offer prospectus states the underwriting structure with the name and the respective
volume of each underwriter along with the name of the underwriter who will lead and
represent the underwriting syndicate. We have used the percentage of underwriting by
the representative underwriters because they underwrite a relatively large portion
(81 per cent in our case) of the offer and sometimes both lead and representative
underwriters equally underwrite the offer. Lead underwriters are always included
in the list of representative underwriters and they may need to incur some sunk cos ts
Underwriting
costs of REIT
SEOs
19
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