In Closing
In Rating REITs, Governance Matters
by Steven Marks
The financial crisis has led to many questions about the effectiveness of risk management and corporate governance policies of publicly traded
companies.
In Fitch Ratings’ view, the
evaluation of a REIT’s corporate
governance revolves around five
categories related to how well the
company has embraced controls
to ensure sound policies and
procedures: board effectiveness,
board independence, integrity of
accounting and audit processes,
related-party transactions and
management compensation.
Moreover, Fitch has a more favorable view toward REITs that
incorporate credit risk management into their corporate governance practices.
Sound corporate governance
begins with the board of direc-
tors. An independent, active
and committed board signals
a robust governance frame-
work. In contrast, a board that
is not committed to fulfilling
its fiduciary responsibilities
can open the door for ineffec-
tive management behavior. The
board sets the tone for effective
controls, establishing for manage-
ment high standards that perme-
ate the REIT. At the same time,
employees involved in the REIT’s
day-to-day operations understand
the parameters within which they
are working, and individual re-
sponsibilities and reporting lines
are clearly communicated back
to management and, ultimately,
the board. Therefore, although
o management compensation.
d
o
begins with the board of direc-
tors. An independent, activel
l
t ilr
r e
tive management behavior. The
board sets the tone for effective
c g
m g
a
e i v
d o n
the parameters within which they
are working, and individual re-
sponsibilities and reporting lines
a y
t u
t r
sound policies and procedures are
established from the top down,
effective governance results in
REIT employees implementing
those policies from the bottom up
to improve transparency and accountability for the benefit of all
stakeholders.
While setting the tone of effective controls, a REIT’s board
should include various independent members. Generally, independent directors are not encumbered by personal motivations or
loyalties to executives. As a result,
they may be better positioned
to provide critical, impartial
oversight and feedback regarding
management performance.
The integrity of accounting
and audit processes also is an important element of corporate governance. Given the fluctuations
in commercial real estate values
during the past several years and
the complexity of certain REITs’
balance sheets, transparent and
accurate financial statements are
critical to informing investment
decisions. Such information provides a view of the company’s financial position and fundamental
risks related to credit.
Related-party transactions are
another element of corporate
governance. Such transactions
can give rise to potential conflicts
of interest. In particular, the
primary risk of a related-party
transaction is that it may enrich
the executive or related party at
the expense of the REIT.
Management compensation is
another important part of sound
governance. Compensation
levels may pose a concern if they
exceed market norms and stan-
dards or drain the company’s
financial resources.
Steven Marks is managing director with Fitch Ratings. Sean
Pattap co-authored this article.
To view a video
interview with Marks,
visit REIT.com.
