Share:


Pass-through business entity choice and earnings management: evidence from UK real estate investment trust conversion

    Jian Liang Affiliation
    ; Zhi Dong Affiliation
    ; Mo Zheng Affiliation

Abstract

This empirical study innovatively investigates how the choice of a pass-through business entity and corresponding regulatory regime influence firms’ earnings management (EM) behaviors by testing on the UK Real Estate Investment Trust (REIT) conversion. A substantial proportion of UK non-REIT publicly traded property companies (LPCs) have chosen to become REITs since the UK REITs were launched in 2007. We conduct a series of tests on a database containing UK LPCs and REITs from 2000 to 2019 and find that conversion into pass-through business entity regimes like REITs that enjoy more favorable tax treatment but face more restrictions leads to more accrual earnings management (AEM) activity, but less real earnings management (REM) activity.

Keyword : pass-through entity, REIT, accrual earnings management, real earnings management, REIT regulatory regime

How to Cite
Liang, J., Dong, Z., & Zheng, M. (2022). Pass-through business entity choice and earnings management: evidence from UK real estate investment trust conversion. International Journal of Strategic Property Management, 26(3), 188-202. https://doi.org/10.3846/ijspm.2022.16834
Published in Issue
May 26, 2022
Abstract Views
79
PDF Downloads
87
Creative Commons License

This work is licensed under a Creative Commons Attribution 4.0 International License.

References

Aharony, J., Lin, C. J., & Loeb, M. P. (1993). Initial public offerings, accounting choices, and earnings management. Contemporary Accounting Research, 10(1), 61–81. https://doi.org/10.1111/j.1911-3846.1993.tb00382.x

Ambrose, B., & Bian, X. (2010). Stock market information and REIT earnings management. Journal of Real Estate Research, 32(1), 101–138. https://doi.org/10.1080/10835547.2010.12091271

Anglin, P., Edelstein, R., Gao, Y., & Tsang, D. (2011). How does corporate governance affect the quality of investor information? The curious case of REITs. Journal of Real Estate Research, 33(1), 1–24. https://doi.org/10.1080/10835547.2011.12091298

Anglin, P., Edelstein, R., Gao, Y., & Tsang, D. (2013). What is the relationship between REIT governance and earnings management? The Journal of Real Estate Finance and Economics, 47(3), 538–563. https://doi.org/10.1007/s11146-012-9367-y

Austin, P. C. (2011). An introduction to propensity score methods for reducing the effects of confounding in observational studies. Multivariate Behavioral Research, 46(3), 399–424. https://doi.org/10.1080/00273171.2011.568786

Barkham, R. J., & Geltner, D. M. (1996). Price discovery and efficiency in the U.K. housing market. Journal of Housing Economics, 5, 41–63. https://doi.org/10.1006/jhec.1996.0003

Bauer, R., Eichholtz, P., & Kok, N. (2010). Corporate governance and performance: the REIT effect. Real Estate Economics, 38(1), 1–29. https://doi.org/10.1111/j.1540-6229.2009.00252.x

Baum, A., & Devaney, S. (2008). Depreciation, income distribution and the UK REIT. Journal of Property Investment & Finance, 26(3), 195–209. https://doi.org/10.1108/14635780810871597

Bhattacharya-Mis, N., & Lamond, J. (2016). Risk perception and vulnerability of value: a study in the context of commercial property sector. International Journal of Strategic Property Management, 20(3), 252–264. https://doi.org/10.3846/1648715X.2016.1188174

Bianco, C., Ghosh, C., & Sirmans, C. (2007). The impact of corporate governance on the performance of REITs. The Journal of Portfolio Management, 33(5), 175–191. https://doi.org/10.3905/jpm.2007.699613

Borden, B. T. (2018). Income-based effective tax rates and choice-of-entity considerations under the 2017 Tax Act. National Tax Journal, 71(4), 613–634. https://doi.org/10.17310/ntj.2018.4.02

Brounen, D., & De Koning, S. (2012). 50 years of real estate investment trusts: an international examination of the rise and performance of REITs. Journal of Real Estate Literature, 20, 197–223. https://doi.org/10.1080/10835547.2014.12090324

Burgstahler, D., & Dichev, I. (1997). Earnings management to avoid earnings decreases and losses. Journal of Accounting and Economics, 24(1), 99–126. https://doi.org/10.1016/S0165-4101(97)00017-7

Burke, K. C. (2019). Section 199A and choice of passthrough entity. Tax Lawyer, 72(3), 551–588. https://doi.org/10.2139/ssrn.3432013

Burns, N., & Kedia, S. (2006). The impact of performance-based compensation on misreporting. Journal of Financial Economics, 79(1), 35–67. https://doi.org/10.1016/j.jfineco.2004.12.003

Chan, S. H., Leung, W. K., & Wang, K. (2005). Changes in REIT structure and stock performance: evidence from the Monday stock anomaly. Real Estate Economics, 33(1), 89–120. https://doi.org/10.1111/j.1080-8620.2005.00113.x

Cheng, Q., & Warfield, T. D. (2005). Equity incentives and earnings management. The Accounting Review, 80(2), 441–476. https://doi.org/10.2308/accr.2005.80.2.441

Clark, S., Hackemann, T., Mesmin, O., Roche, M., & Road, T. (2010). Progress on REIT regimes in Europe. In Global trends in real estate finance. Blackwell Publishing. https://doi.org/10.1002/9781444315301.ch3

Cohen, D. A., & Zarowin, P. (2010). Accrual-based and real earnings management activities around seasoned equity offerings. Journal of Accounting and Economics, 50(1), 2–19. https://doi.org/10.1016/j.jacceco.2010.01.002

Cohen, D. A., Dey, A., & Lys, T. Z. (2008). Real and accrual‐based earnings management in the pre‐and post‐Sarbanes‐Oxley periods. The Accounting Review, 83(3), 757–787. https://doi.org/10.2308/accr.2008.83.3.757

Danielsen, B., Harrison, D., Van Ness, R., & Warr, R. (2014). Liquidity, accounting transparency, and the cost of capital: evidence from real estate investment trusts. Journal of Real Estate Research, 36(2), 221–252. https://doi.org/10.1080/10835547.2014.12091389

Dechow, P. M., Sloan, R. G., & Sweeney, A. P. (1995). Detecting earnings management. Accounting Review, 70(2), 193–225.

Degeorge, F., Patel, J., & Zeckhauser, R. (2005). Earnings management to exceed thresholds. Princeton University Press. https://doi.org/10.1515/9781400829125-021

Deng, X., & Ong, S. E. (2018). Real earnings management, liquidity risk and REITs SEO dynamics. The Journal of Real Estate Finance and Economics, 56(3), 410–442. https://doi.org/10.1007/s11146-017-9649-5

Derwall, J., Huij, J., Brounen, D., & Marquering, W. (2009). REIT momentum and the performance of real estate mutual funds. Financial Analysts Journal, 65(5), 24–34. https://doi.org/10.2469/faj.v65.n5.4

Dong, Z. (2012). Capital structure decisions of LPTs in a small economy. Journal of Property Investment & Finance, 30(5), 493–504. https://doi.org/10.1108/14635781211256756

Edelstein, R. H., Liu, P., & Tsang, D. (2008). Real earnings management and dividend payout signals: a study for U.S. real estate investment trusts. In CAAA 2008 Annual Conference (pp. 1–40). https://doi.org/10.2139/ssrn.1079984

Edwards, T. (1999). REITs modernized. National Association of Real Estate Investment Trusts. https://www.reit.com/sites/default/files/media/Portals/0/Files/Nareit/htdocs/policy/government/RMA-2.pdf

European Public Real Estate Association. (n.d.). Global REIT survey. Retrieved October 19, 2021, from https://www.epra.com/public-affairs/global-reit-survey

Feng, Z., Ghosh, C., & Sirmans, C. (2007). On the capital structure of real estate investment trusts (REITs). The Journal of Real Estate Finance and Economics, 34(1), 81–105. https://doi.org/10.1007/s11146-007-9005-2

Franklin, E. H. (2015). A rational approach to business entity choice. Kansas Law Review, 64, 573–662.

Giambona, E., Harding, J. P., & Sirmans, C. (2008). Explaining the variation in REIT capital structure: the role of asset liquidation value. Real Estate Economics, 36(1), 111–137. https://doi.org/10.1111/j.1540-6229.2008.00209.x

Glascock, J. L., Lu, C., & So, R. W. (2000). Further evidence on the integration of REIT, bond, and stock returns. The Journal of Real Estate Finance and Economics, 20(2), 177–194. https://doi.org/10.1023/A:1007877321475

Gunny, K. A. (2010). The relation between earnings management using real activities manipulation and future performance: evidence from meeting earnings benchmarks. Contemporary Accounting Research, 27(3), 855–888. https://doi.org/10.1111/j.1911-3846.2010.01029.x

Hainmueller, J. (2012). Entropy balancing for causal effects: a multivariate reweighting method to produce balanced samples in observational studies. Political Analysis, 20(1), 25–46. https://doi.org/10.1093/pan/mpr025

Healy, P. M., & Palepu, K. G. (2001). Information asymmetry, corporate disclosure, and the capital markets: a review of the empirical disclosure literature. Journal of Accounting and Economics, 31(1), 405–440. https://doi.org/10.1016/S0165-4101(01)00018-0

Jadevicius, A., Sloan, B., & Brown, A. (2017). Century of research on property cycles: a literature review. International Journal of Strategic Property Management, 21(2), 129–143. https://doi.org/10.3846/1648715X.2016.1255273

Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305–360. https://doi.org/10.1016/0304-405X(76)90026-X

Jones, J. J. (1991). Earnings management during import relief investigations. Journal of Accounting Research, 29(2), 193–228. https://doi.org/10.2307/2491047

Jones, K. L., Krishnan, G. V., & Melendrez, K. (2008). Do models of discretionary accruals detect actual cases of fraudulent and restated earnings? An empirical evaluation. Contemporary Accounting Research, 25(2), 499–531. https://doi.org/10.1506/car.25.2.8

Kara, A., Karimov, N., & Nguyen, A. P. (2021). Brexit referendum and the U.K. securitization market. Applied Economics Letters, 28(13), 1092–1097. https://doi.org/10.1080/13504851.2020.1798340

Keating, A. S., & Zimmerman, J. L. (1999). Depreciation-policy changes: tax, earnings management, and investment opportunity incentives. Journal of Accounting and Economics, 28(3), 359–389. https://doi.org/10.1016/S0165-4101(00)00004-5

King, G., & Nielsen, R. (2019). Why propensity scores should not be used for matching. Political Analysis, 27(4), 435–454. https://doi.org/10.1017/pan.2019.11

Koh, P. S. (2003). On the association between institutional ownership and aggressive corporate earnings management in Australia. The British Accounting Review, 35(2), 105–128. https://doi.org/10.1016/S0890-8389(03)00014-3

Koo, K. M., & Liang, J. (2021). The effect of bilingual education on housing price-a case study of bilingual school conversion. The Journal of Real Estate Finance and Economics, 62(4), 629–664. https://doi.org/10.1007/s11146-020-09754-9

Kothari, S. P., Leone, A. J., & Wasley, C. E. (2005). Performance matched discretionary accrual measures. Journal of Accounting and Economics, 39(1), 163–197. https://doi.org/10.1016/j.jacceco.2004.11.002

Kunze, F., Basse, T., Gonzalez, M. R., & Vornholz, G. (2020). Forward-looking financial risk management and the housing market in the United Kingdom: is there a role for sentiment indicators? Journal of Risk Finance, 21, 659–678. https://doi.org/10.1108/JRF-10-2019-0191

Laffont, J. J., & Martimort, D. (2009). The theory of incentives. Princeton University Press. https://doi.org/10.2307/j.ctv7h0rwr

Lee, M.-T., Kuo, S.-H., Lee, M.-L., & Lee, C. L. (2016). Price discovery and volatility transmission in Australian REIT cash and futures markets. International Journal of Strategic Property Management, 20(2), 113–129. https://doi.org/10.3846/1648715X.2015.1106989

Li, V. (2019). The effect of real earnings management on the persistence and informativeness of earnings. The British Accounting Review, 51(4), 402–423. https://doi.org/10.1016/j.bar.2019.02.005

Liang, J. J., & Dong, Z. (2018). How the 2007 global financial crisis changed the financial disclosure behavior: the case of US equity REITs. Property Management, 36(2), 156–172. https://doi.org/10.1108/PM-05-2017-0034

Liang, J., & Dong, Z. (2014). Property portfolio composition and earnings management for listed property portfolios. Journal of Real Estate Literature, 20(2), 111–124.

Liang, J., & Dong, Z. (2019). The impact of the stapled security structure on the quality of financial disclosure: evidence from Australian real estate investment trusts and listed infrastructure funds. Journal of Contemporary Accounting & Economics, 15(2), 206–223. https://doi.org/10.1016/j.jcae.2019.100155

Liang, J., Jain, A., & Wu, H. (2021). Does corporate social responsibility vary by real estate asset types? Evidence from real estate investment trusts. Sustainability, 13(22), 12836. https://doi.org/10.3390/su132212836

London Stock Exchange Group. (n.d.). REITs on London Stock Exchange. Retrieved October 19, 2021, from https://www.lseg.com/markets-products-and-services/our-markets/london-stock-exchange/real-estate-hub/reits-london-stock-exchange

Muellbauer, J., & Murphy, A. (1997). Booms and busts in the U.K. housing market. Economic Journal, 107(445), 1701–1727. https://doi.org/10.1111/j.1468-0297.1997.tb00076.x

Newell, G., & Marzuki, M. J. B. (2016). The significance and performance of UK-REITs in a mixed-asset portfolio. Journal of European Real Estate Research, 9(2), 171–182. https://doi.org/10.1108/JERER-08-2015-0032

Niskanen, J. (2012). Liquidity of European real estate equities: REITs and REOCs. International Journal of Strategic Property Management, 16(2), 173–187. https://doi.org/10.3846/1648715X.2011.587906

Ooi, J. (1999). The determinants of capital structure evidence on UK property companies. Journal of Property Investment & Finance, 17(5), 464–480. https://doi.org/10.1108/14635789910294886

Ooi, J. (2001). Dividend payout characteristics of UK property companies. Journal of Real Estate Portfolio Management, 7(2), 133–142. https://doi.org/10.1080/10835547.2001.12089633

Pain, N., & Westaway, P. (1997). Modelling structural change in the UK housing market: a comparison of alternative house price models. Economic Modelling, 14(4), 587–610. https://doi.org/10.1016/S0264-9993(97)00007-2

Richardson, V. J. (2000). Information asymmetry and earnings management: some evidence. Review of Quantitative Finance and Accounting, 15(4), 325–347. https://doi.org/10.1023/A:1012098407706

Ruddock, L., Kheir, A., & Ruddock, S. (2014). UK construction companies’ strategies in the face of business cycles. International Journal of Strategic Property Management, 18(3), 225–237. https://doi.org/10.3846/1648715X.2014.927400

Sakaki, H., Jackson, D., & Jory, S. (2017). Institutional ownership stability and real earnings management. Review of Quantitative Finance and Accounting, 49(1), 227–244. https://doi.org/10.1007/s11156-016-0588-7

Sha, Y., Wang, Z., Bu, Z., & Mansley, N. (2020). Does default risk matter for investors in REITs. International Journal of Strategic Property Management, 24(5), 365–378. https://doi.org/10.3846/ijspm.2020.13504

Shipman, J. E., Swanquist, Q. T., & Whited, R. L. (2017). Propensity score matching in accounting research. The Accounting Review, 92(1), 213–244. https://doi.org/10.2308/accr-51449

Sloan, R. G. (1996). Do stock prices fully reflect information in accruals and cash flows about future earnings? Accounting Review, 289–315.

White, M. (2015). Cyclical and structural change in the UK housing market. Journal of European Real Estate Research, 8(1), 85–103. https://doi.org/10.1108/JERER-02-2014-0011

Wong, W. C. (2021). UK REIT conversion and institutional ownership dynamic. Journal of Property Investment & Finance, 39(4), 349–365. https://doi.org/10.1108/JPIF-05-2020-0061

Zhang, W., Sun, T., Goh, P. H. L., Wang, Z., & Mansley, N. (2021). Can rainmakers justify their pay? The role of investment banks in REIT M&As. International Journal of Strategic Property Management, 25(4), 254–266. https://doi.org/10.3846/ijspm.2021.14883

Zhu, Y. W., Ong, S. E., & Yeo, W. Y. (2010). Do REITs manipulate their financial results around seasoned equity offerings? Evidence from U.S. equity REITs. The Journal of Real Estate Finance and Economics, 40(4), 412–445. https://doi.org/10.1007/s11146-009-9227-6