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An analysis of REIT CEO stock-based compensation.

Article Excerpt
Academic research findings on the determinants of executive compensation are mixed. Some researchers attribute this to the inclusion of stock-based compensation in the more recent studies. We study the determinants of stock-based compensation schemes in the REIT industry for the period 1997-2000. While previous research analyzes REIT CEOs' cash-based compensation, we concentrate on option compensation structures. Using the Tobit method, we study both the level of option awards and the mix of option awards to total compensation. We find that REIT CEOs receive larger option awards when they increase growth opportunities, funds from operation, earnings per share and when there is greater variability of returns. Thus, our results validate most of the theories on stock-based compensation.

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The growth in CEO compensation over the past decade can be ascribed mostly to stock option awards. Indeed, Yermack (1995) documents that option awards represent approximately one-third of CEO compensation for 1990 and 1991. In a similar vein, Hall and Liebman (1998) credit the dramatic rise in CEO compensation to the increases in stock option grants. Thus, any examination of executive compensation is incomplete without a study of stock-based compensation. Further, a perusal of the academic research on executive compensation also documents mixed findings on the determinants of CEO salary structures. For instance, while Jensen and Murphy (1990b) state that compensation of top executives is not linked to performance, Hall and Liebman (1998) report a strong relation between the "fortunes of CEOs and the fortunes of the companies they manage" (p. 654). They attribute this divergence in their findings from earlier research to the inclusion of option awards in their compensation measures.

In this study, we examine the relation between CEO stock-based compensation and industry-specific performance measures for the Real Estate Investment Trust (REIT) industry. The REIT industry saw a period of remarkable growth in the 1990s, and today there are approximately 300 REITs in the United States. Two-thirds of the REITs trade on national stock exchanges, and their assets total over $300 billion. The last decade witnessed an explosive increase of more than 15% in the market capitalization of REITs. After experiencing double-digit stock returns for much of the 1990s, REITs recorded falling stock prices in 1998 and 1999. Yet, as the tech bubble burst and investors moved to safe-haven investments, REITs rebounded in 2000 and 2001. The NAREIT index posted a total return of 15.5% in 2001, with an average dividend yield of 7.38% for REITs, over five times the average for stocks in the S & P Index. (1)

Equally important is the documentation by the 2001 Executive Compensation Review by SNL Securities reporting that approximately 46% of REIT CEO option-adjusted compensation is derived from the option component of the compensation package, while base salary accounts for approximately 19% and bonuses compose about 17%. Pennathur and Shelor (2002) examine REIT CEO cash-based (base plus bonus) compensation over the period 1993-1999, while Hardin (1998) examines REIT CEO salaries and bonuses for 1995. Similarly, Scott, Anderson and Loviscek (2001) examine REIT CEOs' base and incentive compensations (total compensation minus base salary) for 1999; however SNL does not include option awards in the calculation of total compensation. To our knowledge, there is no study that investigates REIT stock-based compensation. As REITs increasingly use stock-based compensation as part of their total compensation package, an analysis of the determinants of option awards becomes important. This study attempts to fill this gap in REIT CEO compensation analyses.

Using both traditional finance variables and a set of explanatory variables that are specific to the REIT industry, we examine several theories regarding the award of stock-based compensation to REIT CEOs for the period 1997-2000. Because the majority of the growth of REITs occurred in the mid-1990s, there are insufficient data for meaningful inferences for earlier years. We examine both Option Awards and Option Awards Mix (Yermack 1995, Bryan, Hwang and Lilien 2000) via the Tobit estimation procedure. The Tobit procedure is appropriate for analyzing stock option awards as it allows for censored observations in cases where CEOs are not awarded any stock options.

Our results strongly verify most of the theories on stock-based compensation. Our analysis of Option Awards finds that REIT CEOs are significantly rewarded for increasing Real Estate Investment and Funds from Operation (FFO). We also find a positive relation between Option Awards and increases in REIT Earnings per Share (EPS). Prior studies find that executives who take on risky projects, proxied by variability in stock returns, receive larger option awards as a means of aligning their interests with that of the firm. Our results support this theory, and we show that CEOs who take on riskier projects receive higher levels of stock-based compensation. However, we fail to document any relation between Option Awards and CEO age. While other researchers (Dechow and Sloan 1991) find that older CEOs receive higher stock-based compensation, our results are similar to those of Bryan, Hwang and Lilien (2000) and Yermack (1995), who do not find such an association between option compensation and CEO age.

Our second model analyzes...

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