Entrenchment and incentives: How governance influences REIT capital structure

We examine the influence of managerial incentives, traditional managerial monitoring mechanisms and managerial entrenchment on the capital structure of Real Estate Investment Trusts (REITs). Using panel data, we estimate a system of simultaneous equations for leverage and maturity and find that firms with entrenched CEOs use less leverage and shorter maturity debt. This is consistent with the expectation that managers acting in their own self interest will choose lower leverage to reduce liquidity risk and use short maturity debt to preserve their ability to enhance their compensation and reputations by empire building. We find weaker evidence for an alignment effect: firms where the CEO owns more than five percent of the total firm use higher leverage. Although recent literature has confirmed the importance of viewing a firm's capital structure choices of leverage and debt maturity as jointly determined, to date there has been little analysis of the importance of traditional governance variables on a firm's capital structure decisions using a simultaneous equations approach. This paper contributes to cover this gap. Furthermore, confirming previous research in the area, our results are consistent with the claims that leverage and maturity are substitutes, that firms with growth opportunities use less leverage and that firms with illiquid assets use less leverage and shorter maturity debt.