1. Elective Stock Dividends and REITs: Evidence from the Financial Crisis Desmond Tsang, McGill University

2. Authors Erik Devos, University of Texas – El Paso Andrew Spieler, Hofstra University Desmond Tsang, McGill University

3. The Financial Crisis The recent financial crisis and credit crunch which started in 2007 has created unprecedented liquidity problems for many industries REIT industry is not immune to the crisis: Many REITs have capital shortfalls of more than $500 millions (e.g., Apartment Investment and Management Co.; Developers Diversified Realty Corp.) Even financially stable REITs have serious concerns about future market uncertainties (e.g., Simon Property Group, Inc.)

4. REIT Structure in US US REITs are exempted from corporate level income tax However, they have to satisfy various requirements under the rules of US Congress: In particular, they have to distribute a minimum of 90% of taxable income as dividends to investors The requirements represent significant financial commitment and pose huge liquidity constraint for REITs, especially at times of market downturn

5. Introduction of Elective Stock Dividends To provide REITs with temporary relief of the liquidity problems, the IRS introduced RP 2008-68: The new rule allows REITs to offer investors to pay dividends using a mixture of cash and stock dividends REIT managers decide the proportion of stock dividends (no more than 90% of total dividends) Investors make election to receive dividends all in cash or in stock If too many investors electing cash dividends, every investor will get a mixture of cash and stock in the pre- determined proportion

6. Are Elective Stock Dividends Good or Evil? Share dilution effect Worse when REIT prices have fallen significantly Lower attractiveness of REITs REIT investors typically search high dividend paying stocks Bad signal to market Some REITs have deficient cash flows Risk of being “de- REIT” Preserve cash to address funding needs Refinancing maturing debts Investing in new properties

7. Objective of the Study Given the costs and the benefits of Elective Stock Dividends, how does the REIT industry react to its introduction? i.e., are REITs really adopting this new, unique dividend strategy? What are the REIT characteristics that prompt REITs to adopt (or not to adopt) ESD? i.e., are REITs adopting ESD really cash-constrained? Or they adopt ESD for other reasons?

8. Adoption of ESD: We find that ESD is surprisingly unpopular There are only 17 REITs have chosen to adopt ESD from end of 2008 through taxable year of 2009! Determinants of ESD: Contrary to prediction, liquidity is NOT a determinant Maturing debt position drives ESD decision REIT size, growth and performance matters Summary of Results

9. Determinants of REIT Dividend Policy: Wang, Erickson and Gau 1993; Bradley, Capozza and Seguin 1998; Ooi 2001; Ghosh and Sirmans 2006; Hardin and Hill 2008; Edelstein, Liu and Tsang 2008 We examine the effect of ESD on REIT dividend policy Rationale of REIT Stock Split and Dividend Decision: Hardin, Liano and Huang 2005; Li, Sun and Ong 2006 We examine determinants of a special form of stock dividends (ESD) Related Literature

10. Empirical Equation: ESD = α + β 1 LIQ_FFO + β 2 LIQ_CFO + β 3 SDEBT +β 4 LDEBT + β 5 SIZE + β 6 MTB + β 7 GROWTH + β 8 PRICEΔ + β 9 ROA + β 10 DIV + β 11 PAYOUT + β 12 PROP_TYPE + β 13 TIME (1) Research Design

11. ESD: Decision to declare elective stock dividends LIQ_FFO & LIQ_CFO (-): cash flows proxied by FFO and cash flows from operations respectively SDEBT (+): Debt maturing in one year LDEBT (+): Long term liabilities SIZE (+): Log Market capitalization MTB & GROWTH (+): Market-to-book ratio and change in total assets PRICE∆ (+/-): Percentage change in quarterly stock price ROA (-): Return-on-assets Key Variables of Interest

12. ESD_RATIO = α + β 1 LIQ_FFO + β 2 LIQ_CFO + β 3 SDEBT +β 4 LDEBT + β 5 SIZE + β 6 MTB + β 7 GROWTH + β 8 PRICEΔ + β 9 ROA + β 10 DIV + β 11 PAYOUT + β 12 PROP_TYPE + β 13 TIME (2) ESD_AMT = α + β 1 LIQ_FFO + β 2 LIQ_CFO + β 3 SDEBT +β 4 LDEBT + β 5 SIZE + β 6 MTB + β 7 GROWTH + β 8 PRICEΔ + β 9 ROA + β 10 DIV + β 11 PAYOUT + β 12 PROP_TYPE + β 13 TIME (3) Ratio and Amount of ESD

13. Sample Sample period: 2007-2008 (8 quarters) ESD information: SNL Financials, NAREIT website Financial data: Compustat and SNL Financials Total sample observations: 395 17 firms have chosen ESD 13.16% of observations report ESD

14. List of Firms Adopting ESD

15. Descriptive Statistics (Total Sample)

16. Descriptive Statistics (Sub-Sample)

17. Regression Results: ESD Dependent VariableESD Constant-14.93***-13.40*** (5.27)(4.72) LIQ_FFO36.2451.65 (0.93)(1.37) LIQ_CFO1.1412.09 (0.04)(0.30) SDEBT12.23**10.90** (2.29)(2.19) LDEBT4.97***1.84 (2.62)(0.95) SIZE1.25***1.78*** (4.70)(5.08) MTB0.03** (2.55)(2.34) GROWTH1.111.48 (0.44)(0.61) PRICEΔ-0.03*-0.08*** (1.92)(3.11) ROA-0.63**-1.15*** (2.27)(3.32) DIV0.74*-0.12 (1.82)(0.24) PAYOUT0.00030.0002 (1.24)(0.44) Property Type Effect NoYes Time Effect NoYes Number of Observations 395 Pseudo R 2 0.290.46

18. Empirical Findings Cash positions have nothing to do with ESD, but maturing debts significantly affect ESD decision Larger REITs and those with greater growth opportunities adopt ESD, as they may have greater funding needs ESD more apparent in firms under price pressure ROA significantly negative, indicating worse performing firms may issue ESD for signaling Similar findings for ESD_RATIO and ESD_AMT

19. Additional Analysis Controls for new debt or equity issue Controls for borrowing costs and for line of credit (Riddiough and Wu 2009) Controls for extreme cash flows Results remain robust and these factors have little influence on ESD decision Controls for cash flow volatility (Bradley, Capozza and Seguin 1998)

20. Additional Analysis on Cash Flows Volatility

21. Why firms are reluctant to adopt ESD? Calculate abnormal returns around the announcements dates for all ESDs We find positive returns, indicating investors do not discount ESD The positive returns can be due to higher combined dividends of these ESD firms Analysis of ESD Announcements

22. We document only a small portion of REITs adopt ESD These firms do not have immediate cash flow problems They have maturing short term debts Larger firms with growth opportunities ESD does not seem to lead to negative price reactions Further research: Why REITs have lukewarm reactions to this new dividend strategy? Concluding Remarks