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Italian REITs Governance and Regulatory Structure:

Effects on Nav Discount

Massimo Biasin, Emanuela Giacomini, Anna Grazia Quaranta

University of Macerata

emanuela.giacomini@unimc.it

ERES 2009Stockholm, 24th -27th June 2009

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Syllabus

Research question

The Italian REITs market and regulatory environment

Literature Review and Theoretical Framework

Data and methodology

Results and conclusions

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Research Objective

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The investigation of the effects of the Italian REITs governance and regulatory

structure on NAV discount

In particular we focus on:

1) Governance structure (shareholders’ meeting);

2) Leverage limitation;

3) Closed-end form (finite life);

4) Mandatory listing;

5) Size

Effects (we argue) depend on the valuation perspective:

Net Asset Value (NAV)

Market (financial) Value (MV)

Main references of previous works e.g.: Capozza, Lee (1995); Clayton, MacKinnon (2001), Barkham, Ward (1999), Bond, Shilling (2004), et al.;

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The Italian REITs NAV discount

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The Italian REITs NAV Discount – December 2007

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The European Public REITs Market

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The Italian REITs Market: Relevant Regualtory and Market Features

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Main regulatory and market features relevant for the analysis:

Closed-end structure (externally managed) refers to the finite life of the REIT

Agency cost and conflicts of interest – Governance implications

New equity offerings admittedù

Mandatory listing for “retail” REITs

To increase shares liquidity

To favor shareholders’ way-out

Leverage limitations (D/A ≤ 60% or, alternatively, D/EBOOK ≤ 1.5)

Tax-free (pass-through) entities (corporate-level).

No mandatory pay-out. Pay-out ratios defined at articles of association level.

REITs share mandatory valuation standard: net asset value

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Literature Review and Theoretical framework

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Governance mechanisms

Italian REITs suffer from severe agency problems and potential conflict of interest

situations which can influence the NAV discount by trading off the benefit of

professional management

External-advised REITs vs internal-advised REITs [Howe, Shilling (1990); Cannon, Vogt (1995); Ambrose,

Linneman (2001); Capozza, Seguin (2000)]

Mandatory provision of a shareholders’ meeting entitled to fire the management

company (2003)

This rule aims to limit managers’ opportunistic behaviour when market discipline comes into play by

inducing takeovers of poorly managed REITs

This incentive does not affect traditional REITs not having shareholders’ control mechanisms

Hypothesis: the foreseeing of a general shareholder meeting can reduce the NAV

discount through a (potential) higher protection for investors against adverse

management activity

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Literature Review and Theoretical framework

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(1) Leverage [LEV]

D/A ratio Uncertain effect on NAV Discount

(2) Market Liquidity Shares’ turnover (proxy) [TURN]

Positive effect on NAV Discount (via market price) (3) Correlation between market excess return and stock market index (Mibtel) [BETA(P)]

Negative effect on NAV Discount (via market price) (4) Correlation between NAV excess return and stock market index (Mibtel) [BETA(NAV)]

Positive effect on NAV Discount (via NAV figures)

(5) Time to Maturity [TIME] negative effect on NAV Discount (via inverse relation with market prices path).

(6) Size [SIZE] REIT’s portfolio investment (total asset value/total REITs market)

Uncertain effect on NAV discount

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Data and empirical methodology

Market price NAV discount was calculated on the following basis:

where:

NAVit = net asset value of each share of the ith REIT at time t;

Pit = market price of the ith REIT at time t.

Data: daily market prices (Italian Stock Exchange)

half-year NAV figures (Assogestioni)

proxy for daily NAV through data linear interpolation

Italian public REITs (21) - Period from 30th of June 2006 to 31st of December 2007

Explicative variables are normalized

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it

ititit NAV

PNAVNAVDISC

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(1) Preliminary separated time series and cross-section analysis of the of the two NAV Discount determinants:

Market Price [P] Relevance of TURN, TIME, BETA(P), LEV and SIZE (according to our theoretical expectation)

Data and empirical methodology

NAV Relevance of SIZE, LEV and BETA(NAV) (according to our theoretical expectation)

),)(,)(,,,,,(f itititititititit ASSEMBNAVBETAPBETASIZETIMETURNLEVCONSTNAVDISC

(2) We expressed the NAV Discount [NAVDISC] as follows:

Dummy variable:

0 if the REIT’s articles of association foreseen the general shareholder meeting

1 otherwise

We used a panel data of 21 Italian REITs (378 periods - 7.938 observations)

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Results and conclusions

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The panel fixed effects results pointed out the relevance of all the explicative variables assumed in explaining NAVDISC

NAVDISC increases as the time to maturity, the REIT market price correlation

with the stock market index increases and is positively related to SIZE.

NAVDISC decreases when the REIT share liquidity, the leverage and the NAV correlation with the stock market index increase.

The shareholders’ meeting mechanism also shows a negative correlation with the NAVDISC.

Relevant regulatory policy implications Shareholders’ meeting mandatory provision improved investors’ governance capability

Results and conclusions

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