Corporate Governance of Asian REITs:

1. Corporate Governance of Asian REITs: Patrick Lecomte* & Joseph Ooi# Introducing a New Framework of Analysis * ESSEC Business School (Singapore) # National University of Singapore

2. 1. Introduction • This paper addresses the issue of corporate governance practices in emerging Asian REIT markets. • It deals with two important questions: • How can we gauge the quality of corporate governance of Asian REITs? • How effective are governance mechanisms in fostering performances of the listed property sector in Asia?

3. Outline • PART I • Introduces an original framework to measure the quality of corporate governance amongst externally managed Asian REITs: the R-Indexof Corporate Governance. • As a pilot study, the framework is applied to REITs listed on the Singapore Stock Exchange (S-REITs). • A project done in collaboration with the Asian Public Real Estate Association (APREA) as well as major global investors being part of an adhoc Advisory Committee (Asset Managers, Institutions, SWFs). • PART II • Examines the relationship between corporate governance and performances: equity performances (stock returns), operating performances (ROA, ROE).

4. 2. Literature Review • Moral hazard problem arises due to separation of ownership from management: • Managers do not always act in the best interest of the owners. • Governance mechanisms are designed to monitor managers and mitigate the potential conflict of interest between owners and managers: • Internal governance provisions: board of directors, various monitoring committees, role separation of CEO from Chairman, stock ownership by managers, performance-based compensation. • External governance provisions: takeover threat will remove inefficient management.

5. REIT Evidence

6. Past research analyzes corporate governance of REITS by looking at: Individual governance provisions: e.g. Anglin, Edelstein, Gao, Tsang (2010). Academic indices of corporate governance such as the G-Index developed by Gompers, Ishii and Metrick (2003): e.g. Bianco, Ghosh and Sirmans (2007). Commercial indices of corporate governance such as the Corporate Governance Quotient Index (CGQ) developed by RiskMetrics: e.g. Bauer, Eichholtz, and Kok (2010). REIT studies have been based on measures which are not REIT specific. Measures of Corporate Governance in REIT Studies

7. 3. Rationale for the R-Index • A corporate governance index specifically designed for externally managed Asian REITs. • The R-Index encompasses both internal and external provisions. Corporate governance literature shows that they are strong complements in generating abnormal long term returns (Cremers and Nair, 2005): • Individual provisions miss interactions among provisions (Larcker, Richardson, Tuna; 2007) • G-Index focuses on external governance, which makes it irrelevant for most REITs (Bianco, Ghosh and Sirmans, 2007), especially in Asia. • Commercial indices present many shortcomings: • US centric whereas governance practices are country/ region specific (Doidge, Karolyi, Stulz; 2007) • Inability to properly capture effects of corporate governance resulting in measurement inconsistencies (Larcker et al., 2007; Daines, Gow and Larcker, 2009). • Black boxes: comparative studies mostly (e.g. « REIT effect »).

8. External management (Singapore, Japan, Malaysia, South Korea, and most Hong Kong REITs as of December 2009) Strong pivotal shareholder (Sponsor) Oligopolistic property markets with relatively narrow space markets (e.g. Singapore, Hong Kong) Entrenchment of Manager Fee Structure Alignement of Manager’s and unitholders’ interests Involvement of Sponsor in REIT management (Manager) Transparency of management policies Related Party Transactions Related Party Transactions Board Matters Idiosyncracies of Asian REITs

9. SPONSOR OTHER UNITHOLDERS TRUSTEE TRUST Externally Managed Asian REITs: Generic Trust Structure REIT Sponsor typically has significant control over Trust Manager (*) Distributions Distributions Investment in REIT TRUST MANAGER Mgmnt Fees (**) Trustee’s Fees (*) The Sponsor has a significant holding in the REIT. (**) Including base fee, performance fees and acquisition / divestment fees. (***) Property management fees might include leasing commissions. Manages the Trust Acts on behalf of unitholders Purchases & sells assets Net Property Income PROPERTY MANAGER Source: The authors and JP Morgan (2009) PptyMgmnt Fees (***) Manages properties

10. 4. Methodology of the R-Index The R-Index encompasses 27 governance provisions spanning 8 categories of both external and internal corporate governance. The score is the sum of 99 (objective) elements including 75 core elements, 13 bonuses and 11 penalties. • Fees (24%) • Related Party Transactions (16%) • REIT Organization (15%) • Gearing (6%) • Board Matters (19%) • Remuneration Matters (8%) • Audit Committee (6%) • Ownership (5%) Specific to externally managed REITs For each category, the scorecard provides a sub-score. The higher the score and sub-scores, the better the corporate governance practices of the REIT. The index range [-11; +88] with a median at 38.5.

11. R-Index Scores

12. 5. Effectiveness of Governance • Main hypothesis: “Corporate governance, by aligning the interest of owners and managers, has a positive impact on S-REITs performances.” • Univariate analysis: • Portfolio returns (based on two portfolios partitioned according to R-Index total scores) indicate governance has an impact on REIT stock performance. • Specifically, S-REITs that are ranked above the median score registered 1.6 percentage points stock outperformance over those ranked below the median score (significant at the 10% level).

13. Regression results

14. Results • No significant relationship between R-Index and accounting returns proxied by ROA and ROE: consistent with literature (e.g. Gompers et al., 2003; Bauer et al., 2010). • Why do S-REITs with higher R-Index register better stock returns? Several hypotheses: • Attractiveness to foreign investors (Leuz, Lins, and Warnock, 2008) : lack of public data. • Information asymmetry: the bid-ask spread is significantly narrower for REITs with appropriately structured governance (-0.013 on average over the 2004-2008 period). Hence, better corporate governance practices foster the market efficiency of Singapore’s listed real estate sector.

15. 6. Concluding Remarks • The paper introduces the R-Index which is the first index of corporate governance specifically designed for externally managed REITs / Asian REITs. • Pressing issue for institutional investors as well as market authorities: Where will be the center for REIT listing/trading in Asia? • Ongoing project: consultations with S-REITS’ managers and the Singapore government under the umbrella of APREA. • Current research is adapting the scorecard to other Asian REIT regimes and benchmarking the scores.