What Drives CEOs to Take on More Risk? Some Evidence from the Laboratory of REITs

Authors

  • Roland Füss,

    1. Professor of Finance and holder of the Union Investment Chair of Asset Management at the EBS Business School, EBS Universität für Wirtschaft und Recht in Wiesbaden, Germany, and International Professor of Financial Econometrics at the Caledonian Business School, Glasgow Caledonian University
    Search for more papers by this author
  • Nico Rottke,

    1. Aareal Endowed Chair of Real Estate Investment & Finance at the EBS Business School, EBS Universität für Wirtschaft und Recht in Wiesbaden, Germany, and Adjunct Professor of Real Estate Finance at the University of Central Florida
    Search for more papers by this author
  • Joachim Zietz

    1. Adjunct Professor of Real Estate Econometrics at the EBS Business School, EBS Universität für Wirtschaft und Recht in Wiesbaden, Germany, and Professor of Economics at Middle Tennessee State University.
    Search for more papers by this author
    • The authors would like to thank Shaun A. Bond, Bernd Fitzenberger, Thomas Gehrig, Reint Gropp, Felix Schindler, Marcel Tyrell, and participants of the Research Colloquium at the University of Freiburg, the American Real Estate Society (ARES) Annual Meeting 2010, 2010 AREUEA Mid-Year Conference, the 19th Annual AREUEA International Conference 2010, and the 2nd ReCapNet Conference 2010 for helpful comments. All remaining errors are ours.


Abstract

Many have pointed to excessive risk-taking by the CEOs of financial firms as a contributor to the recent worldwide economic crisis. The same observers often blame questionable corporate governance structures and compensation practices for that risk-taking. But is this perception correct? And what is the relationship between CEO incentives and risk-taking outside of the financial industry, where the government guarantees provided by deposit insurance could have distorted incentives?

In an attempt to answer these questions, the authors analyze the relationship between CEO incentives and corporate risk-taking by 101 U.S. REITs during the period 2003 to 2007. Their main finding is that corporate risk-taking, as measured by the growth rate in corporate debt (the only measure of risk that is completely under the control of the CEO), is inversely related to CEO stock ownership—that is, the larger the CEO's equity ownership stake, the slower the growth in debt financing and financial risk-taking. At the same time, the authors find that financial risk-taking is positively related to large cash bonuses for the CEOs and to situations in which the CEO is also chairman of the board of directors. Finally, the authors also report that CEOs who are relatively new to the job grow more slowly and borrow less, suggesting that boards of directors can temporarily contain risky expansion plans by the CEO. These results provide support for those corporate governance reformers who wish to cut cash bonus payments for CEOs in favor of long-term stock ownership.

Ancillary