Real Earnings Management and Dividend Payout Signals: A Study for U.S. Real Estate Investment Trusts

40 Pages Posted: 3 Jan 2008

See all articles by Robert H. Edelstein

Robert H. Edelstein

University of California, Berkeley - Fisher Center for Real Estate and Urban Economics

Peng Liu

Cornell University - S.C. Johnson College of Business

Desmond Tsang

McGill University - Desautels Faculty of Management

Date Written: January 1, 2008

Abstract

U.S. Real Estate Investment Trusts are required by federal law to distribute 90% of taxable income as dividends to common shareholders. We examine if firms subject to a binding dividend constraint, engage in real earnings management (REM) to reduce taxable income to meet dividend requirements. Since taxable income typically is not publicly reported by REIT's, we use dividend payout ratios based on FFO, a voluntary measure commonly used by the REIT industry, and net income, a measure required by GAAP, to serve as signals for the unobserved dividend-to-taxable income ratio. Using the dividend-to-FFO ratio to identify firms that may confront difficulties meeting dividend requirements, we find that these firms are more likely to participate in REM activities by reducing revenue and increasing expenses; both actions of which would reduce taxable income. We also provide evidence that firms generating less cash flow from operations and having fewer opportunities to obtain funding from the general capital markets are more likely to employ REM by selling fixed assets at a loss to generate the necessary cash flow for dividend payments, as well as to alter the dividend payment requirements. Overall, our findings suggest REM is a viable strategy that REIT managers utilize to meet regulatory dividend constraints. Managers are more likely to choose REM when there are limited alternative funding sources. We find that average returns in the three years following reduced income through REM are substantially positive, implying investors may not fully realize that current income reduction created by REM activities.

Keywords: Keywords: Real Estate Investment Trusts (REITs), Regulation, Dividend Payout, Real Earnings Management, Taxable Income

JEL Classification: G12, G35, M41, M43

Suggested Citation

Edelstein, Robert H. and Liu, Peng and Tsang, Desmond, Real Earnings Management and Dividend Payout Signals: A Study for U.S. Real Estate Investment Trusts (January 1, 2008). (CAAA) 2008 Annual Conference Paper. Available at SSRN: https://ssrn.com/abstract=1079984 or http://dx.doi.org/10.2139/ssrn.1079984

Robert H. Edelstein

University of California, Berkeley - Fisher Center for Real Estate and Urban Economics ( email )

Haas School of Business
Berkeley, CA 94720-1900
United States
510-643-6105 (Phone)
510-643-7357 (Fax)

Peng Liu

Cornell University - S.C. Johnson College of Business ( email )

448 Statler Hall
Ithaca, NY 14853
United States
6072542960 (Phone)

Desmond Tsang (Contact Author)

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada

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