Dividend policy and firm performance: Hotel REITs vs. Non-REIT hotel companies

1. Introduction
§ Mid-1990s → Real Estate Investment Trusts (REITs) à experienced rapid growth fueled by readily available external equity and debt financing
§ The authors → Economies of scale are the driving force behind recent mergers and acquisitions in the industry
§ REITs → over invest → must distribute 95% of their taxable income to shareholders in order to maintain their preferential tax status
i. Reits → less likely to suffer from agency problems associated with free cash flow
§ REITs have less internally generated equity financing and are more likely to seek external financing for acquisitions
§ Nobel and Tarhan (1998) → demonstrate improved operating performance for over-investing firms making larger distribution of cash to stockholders

2. Data and Methodology
§ Sample:
i. Sixteen hotel REITs and fifty-one non-REIT corporations from 1993 to 1999
ii. Examine whether differences in internally generated equity financing can explain differences in performance
§ The control group → consists of firms identified from COMPUSTAT as non-REIT corporations → whose primary business involves investment in hotels and motels
§ More than thirty variables of both types of companies have been collected
§ Examine the free cash flow hypothesis → create two sets of variables to capture the free cash flow for a company:
i. FCF1 → measures the total amount of post-tax free cash flow that is discretionary for mangers before they determine the amount of either interest or dividend payments
ii. FCF2 = EBITDA - TAX - INTEXP – TOTDIV
a. TOTDIV is the total dollar of dividends declared on common and preferred stock
iii. This definition → based on the assumption → depreciation and amortization expenses are at managers' discretions in both types of companies

3. Empirical Results
§ Structural differences
i. T-tests → conducted on collected variables → to examine the differences between the two types of firms
ii. Non-REIT hotel firms are about the same size as the hotel REITs
iii. Non-REIT companies produce higher income adjusted by firm size than REITs
iv. On annual returns of common stock (Stock Return) → non-REIT companies:
a. Perform marginally better than REITs
b. Riskier investments measured by Beta although the t-Statistic is insignificant
v. Return on assets (ROA) → REITs have significantly higher means than the non-REIT companies
vi. Mean of the market-to-book ratio → statistically higher for non-REITs than for REITs
vii. Non-REIT companies are more highly leveraged
a. Non-REIT companies have higher means than REITs on total liability, total debt and total interest expenses
viii. Non-REIT companies → higher means than REITs in total capital expenditure and total acquisition
ix. Non-REIT companies → higher depreciation and amortization expenses → which is typically considered an additional source of free cash flow
x. The means of dividend per share, common dividends and total dividends → higher for REITs than for non-REITs → maintaining high dividend payouts

§ The impact of free cash flow
i. Examine:
a. The relationship between a firm's market-to-book ratio and free cash flow controlling for whether the firm is a REIT
b. A firm's assets (size), leverage, debt coverage ratio, change in assets (growth) and profitability
ii. The asset growth variable → RASSET → proxies for opportunities for profitable reinvestment of cash flow
iii. Free cash flow has a negative impact on firm performance
iv. Market-to-book ratio is significantly greater for:
a. Larger firms (where size is measured by assets)
b. More heavily leveraged firms and more profitable firms
v. Market-to-book ratio → negatively related to free cash flow net of common dividends
vi. Market-to-book ratio decreases with the free cash flow measured at both before and after common dividend distribution levels
vii. Examine further → the relationship of the excess market value of the company and free cash flow
viii. Market-to-book ratio → positively dependent on the leverage level, the asset growth rate, the asset-adjusted operating income and the debt coverage ratio

4. Conclusion
§ Two types of companies statistically significant differences → in means across asset-adjusted earnings, leverage level, dividend policy, and most importantly, free cash flow levels
§ Non-REIT companies → more heavily leveraged and pay lower dividends than the REIT
§ Larger amount of free cash flow is retained by non-REIT firms than their REIT
§ Market-to-book ratio is negatively related to free cash flow