Raise your game

A recent corporate governance study by the European Public Real Estate Association uncovered wide variances in standards, as Steve Hays reports

There is a wide divergence in corporate governance standards in listed property companies across Europe, with the biggest real estate markets generally heading the list of provisional new measurement rankings developed in a study by the European Public Real Estate Association (EPRA).

UK companies topped the rankings of corporate governance standards at 10.62, closely followed by the Netherlands at 10.33 and Switzerland at 10.23, though the results were so close that statistically they are a ‘dead heat', says Erasmo Giambona, assistant professor in the Finance Group of the University of Amsterdam and the author of the EPRA report.

"With the EU average corporate governance ranking at 9.73, from a possible top mark of 16, you could say European property companies just about get a pass based on a minimum standard of achieving 60% of our criteria," Giambona says.

Countries falling below the EU average level for corporate governance included France (9.57), Belgium (9.13), Italy (8.58), Austria (8.32), Germany (8.07) and Greece (5.78). 

The EPRA report ‘Corporate Governance of European Listed Property Firms', examined the annual reports and other publicly available data from 101 companies in the developed western European markets represented in the association's database. A weighting was then allocated to various corporate governance criteria ranging from executive compensation linked to performance, to disclosure standards and board structure and composition, to obtain a ranking.

Giambona says the report's methodology was similar to that of Heidrick & Struggles' biennial study of corporate governance across company sectors in Europe. Equal weighting was given to companies in the study regardless of size, as detailed research showed there was no link between size and performance.

"You could argue that smaller companies tend to be newer and are more flexible from the start when they come to the stock market in complying with governance regulations. Older and larger companies are maybe less able to change, but there is really no evidence to suggest size is an important factor in governance," EPRA researcher Ali Zaidi says.

"In some countries such as the UK there was a huge variance in rankings, with some companies achieving a rating of 14 or higher, and others as low as two. There are outliers who are doing really poorly," Zaidi adds.

A quarter of the study's weighting was allocated to the extent of the link between managerial compensation and performance and/or stock value as a key driver in corporate governance.

A high level of public disclosure of information on age, tenure, positions, shareholdings and compensation of directors is usually a signal of transparency and willingness of the management to be scrutinised by the market.

Germany notably stood out as a market where compensation is particularly well aligned within companies.

"This is one factor where we have really consistent evidence that if you don't link compensation and performance then you produce poor results for shareholders. It is strikingly clear in one other European market where this link is poor to non-existent and company performance is also weak," Giambona says.

The average age of a director in European real estate companies is 53 years and five months, ranging from 47 years in Germany to 69 years and two months in Sweden.  On average, 54% of companies across Europe disclose their directors' tenure, ranging from just 17% in Austria to 100% in Belgium.

Another driver in governance performance was the perceived independence of the company's board and whether there are anti-takeover provisions in place. In this area, there is a marked contrast between the Anglo-Saxon preference for unitary boards and the continental European two-tier board system.

Some 32% of the firms in the EPRA survey have adopted a two-tier board structure, which is based on a clear separation between the management board and the supervisory board, while 24% use a unitary system, which allows executives to sit on the supervisory board. The remaining 44% of real estate firms have adopted a set-up that draws on the two-tier system and the unitary system to produce a hybrid.

Therefore the results imply that about 68% of the property companies in the sample do not follow a governance practice of clear separation between management and supervisory board. The results of the study were more encouraging in the area of board composition, where an average 52% of directors were independent. European real estate companies also appear to generally be doing well in terms of public disclosure and the use of internal and external auditing systems.

The existence of auditing, remuneration, nomination and investment committees contribute to increased additional monitoring of the management.

About 74% of property companies across Europe have an audit committee to oversee external and internal audit reports. This is an important signal to outside investors that companies have mechanisms in place to ‘audit' the auditors. 

The adoption of the REIT structure itself, with its emphasis on high distribution of income to shareholders also seems to lend itself to better corporate governance, because of the limited accumulation of capital within companies compared with the manufacturing sector.

The level of internationalisation of European real estate boards is fairly low with non-national directors on average making up just 13% of their composition, and overwhelmingly these directors originate from Europe.

Almost a third of the non-domestic European group of directors were Dutch nationals, perhaps reflecting a combination of the high level of institutional capital in the Netherlands, which has traditionally treated real estate as an investment asset class in its own right, and invested extensively outside the limited domestic market. Other explanatory factors include the long history of the Dutch REIT and the high quality of real estate education in the country.

The representation of women on European real estate boards is rather low, with only 41% of companies having females occupying board seats, although evidence of this type of diversification is increasingly important for investors. Behavioural economics also shows evidence that males and females differ in important ways concerning attitude towards risk, investment style and trading behaviour, among other things.

There is clearly some way go in terms of improving corporate governance at European real estate companies, Giambona notes. "Even the highest ranking country - the UK - only achieves 66% of a possible top score of 16, and there are wide variations in good practice for companies within that market. We think firms should aim to achieve at least 80% of the maximum, to improve transparency in their operations and to attract more investment capital flows.

"We intend to test our methodology and findings with the industry to refine the corporate governance rankings model, so ultimately it can be used as an EPRA benchmark to measure improvements at the company and market levels from year to year," he concludes.

Steve Hays is a founding director of Bellier Financial based in Amsterdam