Reference-Dependent Analysis of Capital Structure and REIT Performance

29 Pages Posted: 19 Aug 2015 Last revised: 20 Aug 2015

See all articles by Helen X. H. Bao

Helen X. H. Bao

University of Cambridge - Department of Land Economy

Cynthia Gong

Loughborough University

Date Written: August 17, 2015


Using prospect theory, we develop a theoretical framework to examine the relationship between leverage and Real Estate Investment Trust (REIT) returns by introducing the concept of reference point. We postulate that firms’ capital structure decisions are affected by a target leverage ratio (i.e., the reference point) as well as the observed leverage ratio. Firm-specific and time-varying target leverage determines a firm’s leverage position, which when combined with market conditions will put firms in either loss or gain domains, where firms behave differently. In general, the effect of leverage on returns is positive in the gain domain and negative in the loss domain. Two hypotheses are derived and tested by using US REITs data from 1993-2013. Our empirical evidence shows strong support for our theoretical model. Compared to the conventional approach where only observed leverage is used, our model is more flexible and realistic in revealing the underlying structure of the leverage-returns relationship. It is also a potential solution to reconcile conflicting findings in the literature.

Keywords: capital structure, prospect theory, reference point, loss aversion, REITs

JEL Classification: G32, G02

Suggested Citation

Bao, Helen X. H. and Gong, Cynthia, Reference-Dependent Analysis of Capital Structure and REIT Performance (August 17, 2015). Available at SSRN: or

Helen X. H. Bao (Contact Author)

University of Cambridge - Department of Land Economy ( email )

19 Silver Street
Cambridge, CB3 9EP
United Kingdom

Cynthia Gong

Loughborough University

Epinal Way
Leics LE11 3TU
United Kingdom

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