Academic journal article Real Estate Economics

Focus, Transparency and Value: The REIT Evidence

Academic journal article Real Estate Economics

Focus, Transparency and Value: The REIT Evidence

Article excerpt

Dennis R. Capozza [*]

Paul J. Seguin [**]

We trace the effects of corporate focus by examining the relationships among focus, cash flows and firm value. In contrast to past studies that examine the effects of diversifying across SIC-code-defined industries, we show that diversification, even within a single industry, reduces value. Our evidence, drawn from a panel of real estate investment trusts, indicates that this reduction is not due to poor managerial performance. Project-level cash flows are actually higher for less focused firms. However, these gains are offset by higher management, administrative and interest expenses. Thus, the corporate cash flows available to shareholders are not related to focus. Finally, we provide empirical evidence that links the effect of focus on value to informational asymmetries which cause the equity of diversified firms to be less liquid. We attribute some of the effect of focus on the cost of both debt and equity to informational asymmetries or transparency costs.

Arguably, no one topic has attracted attention from more of the disciplines making up business administration than the topic of corporate focus. Leading journals in the fields of accounting, business economics, business history, law, marketing, manufacturing, planning, statistics and corporate strategy have all published articles dealing with the costs and benefits of the concept variously described as corporate focus, diversification, product line width or core competency. [1] Across the dramatic range of analytic paradigms used in the investigation of corporate focus and performance in these disciplines, only moderate consensus has emerged. Montgomery (1994, p. 169) summarizes the empirical literature and concludes that there is a neutral or negative, not a positive, relationship between diversification and firm performance." Firms that have been less focused or more diversified either underperform or perform as well as their more focused, less diversified counterparts.

Researchers in finance have also investigated the link between focus and performance, but have reached conclusions that are more uniform than those reached in other disciplines. Recent research regularly documents a strong, negative relationship between value and diversification. For example, Berger and Ofek (1995) estimate standalone values for individual business segments of conglomerates. They then compare the sum of these imputed values with the conglomerate's market value and conclude that diversification results in a 13% to 15% value loss. Comment and Jarrell (1995) examine the relationships between changes in focus--as measured by year-to-year changes in asset-based Herfindahl indices--and stock returns. They conclude that an increase in focus of 0.1 is associated with a 3.5% increase in shareholder wealth over a two-year horizon. Lang and Stulz (1994) examine q-ratios (the ratio of the market value of equity plus the book value of debt to the estimated asset replacement cost) and find that they are lo wer for less focused firms: average q-ratios for firms with one line of business exceed 1.5, but are uniformly below 0.95 for firms with multiple lines of business. Their results are not attributable to industry effects or to differences in size or R&D expenditure.

Previous studies generally measure focus by analyzing diversification across SIC-defined lines of business. [2] Our study, in contrast, examines diversification within a single SIC-defined line of business, namely real estate investment trusts (REITs). Although the diversification benefits of adding real estate investments to a portfolio have been extensively examined [see Corgel, McIntosh and Ott (1995, pp. 28-29) for a review of this literature], we are unaware of academic studies of the role of focus within this industry.

Limiting our study of focus to one industry provides both advantages and disadvantages. One disadvantage is a limited sample size and a possible reduction in statistical power. …

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