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The Journal of Real Estate Finance and Economics

Erschienen in:

01.08.2016

Capital Structure and Political Risk in Asia-Pacific Real Estate Markets

verfasst von: George D. Cashman, David M. Harrison, Michael J. Seiler

Erschienen in: The Journal of Real Estate Finance and Economics | Ausgabe 2/2016

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Abstract

This study investigates the determinants of capital structure decisions by real estate firms, with a specific focus on the impact of political risk on leverage. Using a sample of Asia-Pacific REITs and listed property trusts, we find those firms with properties located in countries characterized by relatively high degrees of political risk, such as political instability, and/or greater uncertainty in the ability to repatriate and monetize profits from international investment activities, employ less debt than their counterparts operating in more politically stable environments. This core finding remains robust to alternative sample selection criteria including the division of the sample into high versus low market-to-book value firms, and also holds within the subset of organizations that are active in raising additional capital in the secondary markets.

Nächster Artikel Debt Raising and Refinancing by Japanese REITs: Information Content in a Credit Crunch

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While one could easily foresee such constraints manifesting themselves in the form of performance differentials across firms, that does not have to be the case. More specifically, limited access to capital may also serve to mitigate potential diseconomies of scale and/or agency problems related to managerial empire building.

Burgman (1996) measures political risk as the ratio of the Euromoney 20 safest countries invested in to total countries invested in.

Similarly, Deng et al. (2013) argue organizational form and operational transparency are inextricably related. To the extent political risk influences a firm’s optimal organizational structure, it could easily result in observable differences in firm transparency and/or performance.

The theoretical foundations of trade-off theory date back to the seminal work of Modigliani and Miller (1958, 1963). For a broad overview of alternative capital structure theories, see Harris and Raviv (1991). They not only discuss trade-off theory, but also leverage models based upon agency costs, corporate control considerations, and product/input market interactions.

Specifically, Lou (2008) and Tan (2009) report Australian and Singapore REITs are generally exempt from REIT level taxation, while Japanese REITs are subject to tax, but their distributions are often deductible. In South Korea, general REITs are subject to regular income tax provisions, however corporate restructuring REITs (CR-REITs) are exempt provided the minimum 90 % distribution requirements are met. Hong Kong REITs also enjoy tax advantages as they do not face withholding taxes, capital gains taxes, or income taxes on earnings generated from overseas operations.

For further discussion and insight into the limitations of applying trade-off theory to REIT markets, see Howe and Shilling (1988)

See, for example, Feng et al. (2007), Boudry et al. (2010), and Harrison et al. (2011).

Interestingly, while conventional wisdom amongst both academics and real estate industry practitioners holds that REITs are effectively capital constrained in the sense they cannot retain large shares of annual operating profits, Wang et al. (1993) and Bradley et al. (1998) both report average REIT dividend payout ratios well in excess of 100 % of taxable income. Given the large depreciation and amortization allowances real property investments often provide, cash flow (and funds from operations) frequently exceeds reported taxable income by vast amounts. To the extent this phenomenon holds within the Asia-Pacific market, concerns over the applicability of pecking-order theory may be overblown.

Empirical and anecdotal support for the market timing hypothesis within non-REIT firms may be found in Graham and Harvey (2001) and Baker and Wurgler (2002).

Additional studies suggesting a positive relation between firm size and leverage ratios include Maris and Elayan (1990), Jaffe (1991), Fama and French (2002), Baker and Wurgler (2002), and Barclay et al. (2006).

Consistent with this reasoning, Titman and Wessels (1988), Fama and French (2002), and Barclay et al. (2006), among others, all document a negative relation between firm profitability and leverage.

While the preponderance of the evidence seems to suggest a negative relation between growth options and firm leverage, the findings are not unanimous in this conclusion. For example, Titman and Wessels (1988) fail to find statistically significant evidence, either positive or negative, of a relation between growth options and leverage. Similarly, Feng et al. (2007) present evidence suggesting these relations within their REIT market sample appear to be context specific with some model specifications resulting in positive observed relations between growth options and leverage, while other specifications come to exactly the opposite conclusion.

Faulkender and Petersen (2006) arrive at similar conclusions for non-REIT firms.

See, for example, Livingston et al. (2007) and Helwege and Liang (1996).

Credit rationing, in this context, can take the form of either volume or price restrictions. Volume restrictions, by definition, will reduce observed debt ratios. Similarly, price adjustments will drive borrowing costs up, leaving fewer firms ready, willing, and able to profitably deploy the borrowed funds. Thus, regardless of the nature of the credit rationing, lower debt ratios are expected to prevail.

Note, of the 187 sample firms, 119 hold investment properties located exclusively within a single country and hence have index values which correspond directly to that country’s Political Rights Index, Political Change Index, and R-Factor. For the remaining 68 firms holding assets across multiple jurisdictions, we weight location specific index values for our Political Rights Index, Political Change Index, and R-Factor metrics by the fraction of each firm’s investment portfolio located within each specific country. These property weighted averages are each designed to capture alternative dimensions of political risk, and taken together should provide unique insight into the influence of political risk on firm capital structure decisions.

We readily acknowledge that to the extent restrictive economic environments erect artificial barriers to entry for new firms, existing firms may be insulated from competitive market pressures, enjoy monopolistic or oligopolistic market power, and thus exhibit an enhanced debt capacity.

A broad literature exists addressing the dynamics and differences between bank dominated and market dominated economic systems. For further details, discussion, and analysis of these issues, see Allen and Gale (2001), Levine (2002), Demirguc-Kunt and Levine (1999, 2004), and Chakraborty and Ray (2006).

For the purposes of the current investigation, in the spirit of Demirguc-Kunt and Levine (1999, 2004), we define an economic system as being bank dominated if the ratio of domestic assets of deposit money banks to market capitalization is less than 1.10. Alternative proxies using differential cut-off values, or employing classifications provided by Demirguc-Kunt and Levine (1999, 2004), produce virtually identical results.

See, for example, Senbet (1979) for further discussion of the role of international tax differentials on the optimal capital structure of the firm.

All significance tests presented in the multivariate analysis are based on standard errors clustered at the firm level. Additionally, we note that we do not include year and country fixed effects, as these are perfectly correlated with several of our control variables. However, in unreported tests where we remove these controls and include fixed effects we find qualitatively similar results. See Petersen (2009) for further discussion of these issues.

Additionally, we note that in unreported tests splitting the sample between firms that invest in a single country and those that invest across multiple countries we find qualitatively similar results for our Political Risk metrics.

We observe similar, but somewhat less statistically significant results when we split the sample between debt and equity issuers.

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Titel: Capital Structure and Political Risk in Asia-Pacific Real Estate Markets
verfasst von: George D. Cashman
David M. Harrison
Michael J. Seiler
Publikationsdatum: 01.08.2016
Verlag: Springer US
Erschienen in: The Journal of Real Estate Finance and Economics / Ausgabe 2/2016
Print ISSN: 0895-5638
Elektronische ISSN: 1573-045X
DOI: https://doi.org/10.1007/s11146-013-9436-x

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