Abstract
This paper investigates the non-GAAP performance measures of the REIT industry, specifically the difference (FFO adjustment) between concurrent FFO and Net Income (NI). Using the U.S. Equity REIT data from 1993 to 2018, we first find evidence that both NI and FFO are associated with REIT market-adjusted stock returns, suggesting both contain information that is valuable to investors. Second, we document a significant and positive relationship between contemporaneous FFO adjustment and NI, indicating a possible “selective” and “intentional” inclusion and/or omission of “good” vs. “bad” news in FFO reporting. Third, we find direct evidence that more powerful CEOs are indeed associated with higher FFO adjustments, suggesting CEOs’ involvement in hiding subpar performance. Finally, we focus our attention on a more recent period, when the National Association of Real Estate Investment Trusts (NAREIT) provided additional clarifications and guidelines, and the U.S. Securities and Exchange Commission (SEC) increased scrutiny on FFO reporting. Our results show a diminished “manipulation” for the majority of the REITs, suggesting these guidelines and scrutiny have achieved their intended purposes. While non-GAAP performance measures might supply additional information to investors, our results indicate that providing continuous guidance and monitoring is essential.
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Notes
Under “labeling”, the SEC is concerned with non-GAAP financial measures that are further adjusted from commonly understood non-GAAP financial measures and are referenced with a label that superficially mischaracterizes the adjusted non-GAAP financial measures. Under “adjustment to core earnings”, the SEC requests that REITs explain and specify adjustments used to arrive at core earnings in order to clarify the items that an issuer is designating as non-recurring (and thereby excluded from the core earnings calculation). Under “TBA forward contracts, the SEC may comment if there is not an enhanced discussion of income generated from to-be-announced (“TBA”) forward contracts. Under “undue prominence”, the SEC requests that GAAP financial measures are placed before, and given greater prominence than, non-GAAP financial measures. Finally, under “usefulness of the metric”, the SEC will also ask how non-GAAP financial measures are used and how useful these are to investors. More details can be found at https://www.mayerbrown.com/on-point%2D%2Dnon-gaap-financial-measures-used-by-reits-frequent-sec-comments-08-13-2018/.
We follow current literature and use the same firm characteristic variables as those of Danny Ben-Shahar et al. (2011), Price et al. (2015), etc. Furthermore, we do not include institutional ownership as an additional firm characteristic variable in our models for the following reasons, (1) Institutional ownership is highly correlated with other firm characteristic variables, such as firm size and firm performance (Hartzell et al. 2014; Feng et al. 2019). (2) Institutional investors are informed investors, thus do not solely rely on the information content of the FFO (Christensen et al. 2014).
None of the VIFs exceeds 2.03 (Mansfield and Helms 1982).
We also use NI-based ROA in the model 1 to 3 as robustness check. The coefficients retain the same sign and more statistically significant. Results are available upon request.
Our results remain the same if we exclude 2007 and 2008 instead of 2008 and 2009 in model (2). These results are available upon request.
The results from this robustness check are available upon request. The main result (the coefficient for the change in NI-based ROA is not significant) is consistent with what we report in model 2 of Table 10 panel b. Since model 2 also includes other years when REITs do not receive SEC comment letters, we believe the results are more inclusive and generalizable.
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Acknowledgment
We thank Dr. John DeJoy from Reh School of Business, Clarkson University for providing additional insights and relevant studies into our discussions.
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Feng, Z., Lin, Z. & Wu, W. CEO Influence on Funds from Operations (FFO) Adjustment for Real Estate Investment Trusts (REITs). J Real Estate Finan Econ 65, 524–547 (2022). https://doi.org/10.1007/s11146-020-09795-0
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DOI: https://doi.org/10.1007/s11146-020-09795-0