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The Journal of Real Estate Finance and Economics

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01-05-2016

Related Party Transactions and Firm Value: Evidence from Property Markets in Hong Kong, Malaysia and Singapore

Authors: David H. Downs, Joseph T. L. Ooi, Woei-Chyuan Wong, S. E. Ong

Published in: The Journal of Real Estate Finance and Economics | Issue 4/2016

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Abstract

This paper offers new evidence as to how RPTs can be value enhancing for minority shareholders. In doing so, we address an ongoing theoretical tension in the related party transaction (RPT) literature by focusing on real estate investment trusts (REITs) in Asia. The empirical evidence is mixed in the corporate finance literature on whether RPTs create or destroy firm value. On average, REITs in our sample engaged in RPTs amounting to 5.4 % of total assets, annually, between 2003 and 2010. This is not a trivial amount and is nearly double the 2.8 % RPT rate for U.S. industrial firms. We identify three main channels for REIT RPTs: real estate asset acquisitions from related parties (57.4 %), income earned from related parties (22.2 %) and management fees paid to related parties (14.8 %). The identification strategy we employ relies on two distinct methodologies when examining RPTs and firm value: a multivariate regression approach and, secondly, an exogenous wealth effects test for RPT announcements. Overall, the results suggest that REIT managers and sponsors do not expropriate wealth from their minority shareholders through RPTs. We find evidence that an ad hoc acquisitions pipeline from sponsor to REIT generally drives the value and wealth proposition, although the impact could be reversed in a credit crisis.

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Cheung et al. (2006) document that Hong Kong listed companies announcing “connected transactions” earn significant negative excess returns. Cheung et al. (2009) observe that firms listed in Hong Kong enter deals with related parties at unfavorable prices compared to similar Arms Length Transactions (ALTs). They also note that corporate governance variables have limited impact on the pricing of the deals. Berkman et al. (2009) show that the issuance of related guarantees by Chinese firms has a negative impact on firm value and financial performance. Jiang et al. (2010) document how controlling shareholders abuse inter-corporate loans to siphon billions of RMB from hundreds of Chinese listed companies.

From 2000 to 2005, the Mills Corporation (Mills), an owner and developer of “shoppertainment” centers throughout the US and Europe, publicly reported the financial results of a rapidly growing, highly profitable company. Between 2000 and 2004, Mills’ publicly-reported net income increased nearly 700 %, from $34.4 million to $232 million, and its Funds from Operations (FFO) more than doubled, increasing from $105.3 million to $260.5 million. Over the 3 years, Mills’ common stock price increased by more than 140 %. In August 2006, Mills announced that it would be filling a restatement that would, at a minimum, reduce the company’s previously reported net income for the years 2003 to 2005 by $210 million and would reduce its shareholders’ equity as of September 2005 by $295 million. Mills also announced that the projected costs on its key development project – Meadowlands Mills, which had been described as the company’s “crown jewel” – would be approximately $2 billion, an increase of $800 million over what had been publicly projected earlier. With the disclosure, the price of Mills common and preferred stock fell precipitously, causing hundreds of millions of dollars in losses for investors (see Barrack et al. 2009).

In a report on Asia-Pacific REITs, the CFA Institute (2011) highlights that the sponsor is typically a participant in the real estate industry, for example but not limited to: (1) an owner of properties, (2) a property developer, (3) a fund manager, or (4) an operating business with an investment in property.

We acknowledge a point made by our MNM discussant, Dan French, who reminds us that our results hold “on average.” We examine the generalizability of our RPT conclusions in the final empirical section.

La Porta et al. (1999) record a high probability of being a single controlling owner though holding only 20 % of the stock. This shows that control of East Asian corporations can be achieved with significantly less than an absolute majority share of the stock.

The IPO prospectus of a REIT, for example, cautions “The strategy and activities of the REIT may be influenced by the overall interests of the Sponsor. Moreover, the Sponsor may in the future, sponsor, manage or invest in other property funds which may also compete directly with the REIT. There can be no assurance that conflicts of interests will not arise between the REIT and the Sponsor in the future, or that the REIT’s interest will not be subordinated to those of the Sponsor, whether in relation to future acquisitions of retail malls or in relation to competition for tenants.”

In another REIT IPO prospectus, the following conflict of interest was flagged: “Further, the Property Manager, a direct wholly owned subsidiary of the sponsor, has been appointed to manage the Properties as well as all future properties in Singapore to be acquired by the REIT. There can be no assurance that the Property Manager will not favor properties that the sponsor has retained in its own property portfolio over those owned by the REIT when providing leasing services to the REIT, which could lead to lower occupancy rates and/or lower rental income for the properties owned by REIT as a whole and this could adversely affect distributions to Unitholders.”

It is important to note that Ooi et al. (2011) covers JREITs and SREITs until April 2007. In contrast, our current study covers SREITs, M-REITs and HK REITs from 2003 to 2010. While we are unable to observe the wealth effects of RPTs by JREITs that are excluded from this sample, our analysis on the sub-sample of acquisitions by SREITs shows that Related Acquisitions is insignificant in the first sub-period (pre-April 2007), which is consistent with Ooi et al. (2011), and weakly significant in the post-April 2007 sample, which suggests that the market is more receptive of RPTs in the latter period.

The circular has to contain information on the identity of the related parties and their relationship with the REIT; details of the asset (services) to be acquired or sold including description of the assets, location, transaction prices, valuation and rental yield; and any other matters that may be relevant in the decision to approve the proposed transaction.

The threshold to inform the stock exchanges immediately of RPTs varies from 0.25 % of asset value in the case of Malaysia, to 1 % and 3 % for Hong Kong and Singapore, respective. Individual REITs may seek a general mandate from the shareholders to waive the requirement for immediate announcements as well as approval for material recurring RPTs, but they still have to disclose the RPTs in their annual reports. Although the threshold requirement suggests that a portfolio or single-asset ownership interest might be “unbundled” or divided to fall below the threshold, this is not apparent in practice because the average size of a single property acquisition would have crossed the threshold.

OCBC Investment Research (2008) posits that sponsors play an important role by providing funding support for their sponsored REITs. Citing one incident where the key shareholder provided a new loan to help the subsidiary REIT refinance a bridge loan, the research house contends that strong sponsors could act as a “lender of last resort” for REITs, thus preventing an asset fire sale.

In comparison, the threshold value in the U.S. is $120,000. The exchange rate to US$1 is HK$7.752, S$ 1.252 and MYR 3.266, respectively as at May 2014.

An alternative measure of earnings used in the REIT industry is Funds from Operations (FFO). In a series of robustness tests, we examine the sensitivity of our results to using FFO in lieu of EBITDA. Although there is some variation between the two metrics in terms of statistical significance, the signs and overall results are robust. We report results here based on EBITDA as it is the standard in the corporate finance literature and is found in rigorous and scientific studies of REITs (e.g., Hartzell et al. 2006).

Table 1, by country, is available upon request from the authors. While cross-country variation in control variables are evident, the econometric approach address these potential effects.

We examine the VIF (i.e., variance inflation factor) across each of the RPT components. We find that the VIF is sufficiently low for each RPT variable so as to conclude that multicollinearity is not a concern in our results.

It should be noted that sponsors rarely provide financial assistance to REITs. In our sample, we only observed two REITs receiving loans from their sponsors and one REIT benefiting from the sponsor guaranteeing its loan.

The Table 6 results for the four-day event window are essentially the same and are available upon request.

Following the suggestion of our MNM discussant, Dan French, we also partition all RPT Acquisition announcements into positive- and negative-CAR subsamples and examine both a difference in means and medians for the two groups across all control variables shown in Tables 1 and 5. The only statistically significant differences are seen in a higher Performance measure and lower Transaction Size for the positive-CAR group. All other variables are not statistically different across the two groups. We thank Dan for suggesting this analysis and we defer any additional analysis on the characteristics of value-creating RPTs and REITs to future research.

We thank one of the anonymous reviewers for suggesting this point of clarification.

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Title: Related Party Transactions and Firm Value: Evidence from Property Markets in Hong Kong, Malaysia and Singapore
Authors: David H. Downs
Joseph T. L. Ooi
Woei-Chyuan Wong
S. E. Ong
Publication date: 01-05-2016
Publisher: Springer US
Published in: The Journal of Real Estate Finance and Economics / Issue 4/2016
Print ISSN: 0895-5638
Electronic ISSN: 1573-045X
DOI: https://doi.org/10.1007/s11146-015-9509-0

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