Does the Regulation Change Play a Role in the Dividend Policy?: Empirical Study of REITs

According to Modernization Act (RMA) of 1999, real estate investment trusts (REITs) must distribute at least 90% of their taxable income to be exempt from tax at the corporate level, less than the percentage required prior to 2001 (95%), implying more funds from operation (FFO) are kept by REITs for growth and profitability. This study examines whether REITs disburse more cash by means of dividends after the tax regulation changes in 2001 to reduce agency problems. Our study reveals that excessive dividends paid by REITs increase with the excess funds from the operation. Furthermore, we document that managers pay excessive dividends after the change in required distribution from 95% to 90% of taxable income, implying that the tax regulation changes in REITs industry do impact excess dividends paid to reduce agency issues. These findings support the agency cost theory. In addition, our findings also imply that policy makers should consider not only stakeholders subject to regulations but also market reactions.