An Empirical Investigation of the Role of Legal Origin on the … · An Empirical Investigation of the Role of Legal Origin on the Performance of Property Stocks within the Context

An Empirical Investigation of the Role of Legal Origin on the

Performance of Property Stocks within the Context of a Tactical Asset Allocation Strategy

by

Christopher K.L. Shun

ISBN: 1-58112-281-0

DISSERTATION.COM

Boca Raton, Florida USA • 2005

An Empirical Investigation of the Role of Legal Origin on the Performance of Property Stocks within the Context of a Tactical Asset Allocation Strategy

Copyright © 2005 Christopher K.L. Shun All rights reserved.

Dissertation.com

Boca Raton, Florida USA • 2005

ISBN: 1-58112-281-0

�An Empirical investigation of the Role of Legal origin on the performance of Property stocks within the context of a Tactical Asset Allocation Strategy�

by

Dr. Christopher K.L. Shun, CFP®

Thesis submitted to Henley Management College / Brunel University in partial fulfilment of the requirements for the degree of

Doctor of Business Administration

Henley Management College Brunel University,

United Kingdom

31st. October 2004

Abstract

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ABSTRACT

The role of legal origin was first introduced in the Law and Finance Literature by La Porta et al. (1997) in an original study of legal determinants of external finance. Their study is timely given that investor protection is crucial because in many countries, expropriation of minority shareholders and creditors by controlling shareholders or corporate insiders is extensive. This thesis intends to replicate the original La Porta et al. (1997) study for Property stocks in 23 countries whose legal jurisdictions falls into the four of the legal fraternities established by La Porta namely, English, French, German and Scandinavian. The primary motivations for this thesis, is that the Property stocks broadly captures several critical aspects of the original La Porta study. Specifically, Property stocks are very tangible assets that can easily be collateralised due to the direct property underpinning the net asset backing of Property stocks. The end result of this research endeavour is to provide a framework for institutional portfolio investors to determine the appropriate countries whose property markets have the most favourable investor climate to facilitate a more attractive environment for institutional investors given the Means Variance Optimisation (MVO) methodology. A tactical asset allocation strategy will be employed to determine the three stages that a global investor should undertake to arrive at the optimum proportions of funds to invest in Common stocks or Property stocks in any country firstly based on an Emerging/Developed country analysis then secondly, a geographic Regional analysis and finally on Legal Origin analysis to distil the appropriate proportions of funds that should be invested.

The Thesis has three original contributions, which are as follows: 1) An empirical investigation of role of Legal Origin on the performance of property stocks within the context

of a tactical asset allocation strategy. This thesis studies the impact that Developed versus Emerging, Regional markets and Legal Origin jurisdictions have on the results of the optimal MVO portfolios (based on the highest Sharpe ratio) and presents the research findings of this study, at the Primary, Secondary and Tertiary levels. This thesis is envisaged to fill the research gap between legal origin and the performance of Property stocks across four legal fraternities in 23 countries and make an original contribution in the Law & Finance and Portfolio Management Literature.

2) ACTIVE (Ex-Ante) versus PASSIVE (naïve) portfolio management strategy. The original contribution is

the application of this methodology to property stocks specifically within a Legal Origin and Regional market framework. Data is collated from 1984 to 2003 (20 years inclusive) from 23 countries with specific reference to the Common and Property stocks markets therein. A 5 year rolling Ex-Post analysis is computed to determine the optimum allocation weights in a multi-asset portfolio and subsequently an Ex-Ante analysis (next immediate year) of the portfolio weights applied to an Actively managed portfolio. This portfolio will be compared with actual portfolio performance from 1989 to 2002 (fifteen subsequent years) to determine whether the Ex-ANTE methodology which underpinned the Active management strategy is preferred over a Passive (equal investment in each asset class) strategy for property stocks portfolio management. The Ex-Ante analysis will be undertaken at two stages: Firstly, Legal Origin markets and Secondly, Regional markets.

3) A replication of the Gordon et al. (1995) study which determined the appropriate percentage based on the

Markowitz Portfolio Theory (MPT) that should be invested in the Property stock markets in 14 countries. The original contribution is the application of Gordon�s methodology to the Legal Origin markets proposed by La Porta et al. (1997). This research study encompasses 23 countries whose legal jurisdictions are derived from English, French, German and Scandinavian legal families. The legal frameworks are crucial in determining investor protection and consequently the likelihood for greater investor participation in the respective property markets.

Dedication

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This thesis is dedicated to

Stephan Le On Shun

(Firstborn and only son born in February 1998 at the commencement of my

Doctoral Programme as a reminder of my Doctoral journey and adventure)

and

Abbygail Sue Anne Shun

(Delightful and inspiring daughter born in October 2000 as an encouragement to

persevere and continue the lonely sojourn as a Doctoral student)

and

Choy Sook Leng

(Patient and long suffering wife who endured many personal hardships and at great

personal sacrifice to support me in this journey of self actualisation)

Acknowledgements

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ACKNOWLEDGEMENTS

My journey as a doctoral research associate at Henley Management College/Brunel University in the United Kingdom was filled with times of monumental jubilation and also moments of great discouragement. As I look back at the years of part time study, I cannot help but recognise many outstanding individuals who have contributed to the completion of this thesis. I formally acknowledge the significant contributions of the following people: • Professor Arthur H. Money, Professor of Management Studies, Henley Management

College. As my internal supervisor, your expert guidance, support and patient reply to my numerous queries concerning statistical techniques is gratefully acknowledged. Your warm and earnest encouragement facilitated the completion of this thesis.

• Professor John Affleck-Graves, Vice President, Associate Provost and Chair in

Finance at Notre Dame University, South Bend, Indiana, USA. As my primary external supervisor, your immutable support, complete guidance and your trenchant inputs on all aspects of this research was of paramount importance. Your thorough understanding of portfolio management issues, thought provoking feedback, and warm encouragement enabled the completion of this thesis. Thank you for managing to find time for me in your very busy schedule which is even more impressive when one considers that you are based 10,000 miles away from Malaysia. You have made an indelible mark on me as an outstanding scholar, mentor and role model. You have also made a life long friend in Asia Pacific.

• Dr. David Price, Director of Doctoral Studies, Henley Management College. Thank

you for your kind advice, nurturing encouragement and strategic inputs throughout the DBA Programme. Your friendship is very much valued and appreciated.

• Louise Child, Veronica Clarke and Jackie Coleman, the outstanding Doctoral Office

staff, for their warm and friendly efficiency and also making a stranger feel so at home whenever I visited Henley Management College.

• June Yan, my personal Executive Secretary for assiduously helping me with typing

parts of this Thesis and also proof reading my drafts to ensure grammatical accuracy. • Finally, my utmost gratitude to my Almighty creator, God, who is the author and

finisher of my faith for providing me with the intellectual curiosity, zest for life and personal stamina to keep me balanced in this most trying chapter of my life.

Table of Contents

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TABLE OF CONTENTS Page

Thesis Cover Page i Abstract ii Dedication iii Acknowledgements iv Table of Contents v List of Figures ix List of Tables x List of Appendices xii CHAPTER 1: INTRODUCTION 1

1.0 Introduction 1 1.1 Research Motivations and Problems 2 1.2 Asymmetric Information (Direct property market) 4 1.3 Overview of Research 8 1.3.1 Property Diversification 10 1.3.2 Thesis Contributions 11 1.4 Structure of Thesis 14

CHAPTER 2: LEGAL ORIGIN AND FOUNDATIONS 23 2.0 Introduction 23 2.1 La Porta et al (1997) Study of Legal Determinants of External Finance

As a Theoretical Antecedent 25

2.2 Johnson et al. (2000) Study of Tunnelling as a complementary research corollary

26

2.3 The Rule of Law 32 2.4 Legal systems and families 36 2.4.1 Rule of Law variable 37 2.4.2 Shareholder Protection 39 2.4.2.1 Accounting Standards and Disclosures 40 2.4.2.2 Asymmetric Information Disclosure 43 2.4.3 Agency Theory 45 2.4.4 One-Share, One-Vote rights 48 2.5 Creditor Protection 49 2.5.1 Property Rights and Collateral 49 2.5.2 Bankruptcy 50 2.5.3 France 52 2.5.4 Germany 53 2.5.5 United Kingdom 54 2.5.6 United States of America 55 2.5.7 Sweden 56 2.5.8 How Much Does Legal Protection Matter? 56

CHAPTER 3: RISK AND PORTFOLIO THEORY 60 3.1 Introduction 60 3.2 Modern Portfolio Theory 61 3.3 Combining Assets into a Portfolio 62 3.4 The Efficient Frontier and Optimal Tangency Portfolio 65

3.4.1 Practical Problems with the MPT 66 3.5 Summary of MPT Application into Research Methodology and Conclusions 67

CHAPTER 4: PROPERTY STOCKS INDICES 70

4.1 Introduction 70 4.2 Appraisal-based indices 71

Table of Contents

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4.2.1 The smoothing issue 71 4.3 Indices based on Transaction prices 72 4.3.1 Averages of Transaction prices 72 4.4 The Hedonic Method 74 4.4.1 Advantages and Disadvantages of the Hedonic Method 76 4.5 The Repeat Sales Method 76

4.5.1 Advantages and Disadvantages of the Repeat Sales Method 77 4.6 Indices of property company shares 78 4.6.1 Global Property Research (GPR) indices 80 4.6.2 Usage of indirect property indices as a benchmark 81 4.6.3 Advantages of property company securities 82 CHAPTER 5: PROPERTY PORTFOLIO DIVERSIFICATION 84

5.1 Introduction 84 5.2 Studies on Property returns versus other asset classes 85 5.3 Studies on Portfolio Diversification and Benefits of Property 85

5.4 Property in Mixed-Asset Portfolios 88 5.5 Securitised Property in the Portfolio 88 5.6 Return and Risk of REITs and Property Shares 89 5.7 Correlation with Equities and Bonds 91 5.7.1 Efficient sets 94 5.8 Suggested and Actual weights for a Portfolio 96 5.8.1 Limitations of data 96 5.8.2 Illiquidity 96 5.8.3 Transaction costs 97 5.8.4 Omitted assets 97 5.9 Property Company Shares 98 5.9.1 UK Property Companies 99 5.9.2 US Real Estate Investment Trusts (REITs) 100 5.9.3 Property Companies in other countries 102 5.9.4 Advantages and Disadvantages of Property company shares 104 5.10 International property diversification study by Gordon et al. (1998) as a primary Theoretical and empirical antecedent

106

5.10.1 Risk adjusted returns 107 5.10.2 Property diversification issues 110 5.11 Conclusion 112

CHAPTER 6: RESEARCH METHODOLOGY AND RESEARCH DESIGN 124

6.1 Introduction 124 6.2 The Philosophy of the Research Design 124 6.2.1 Positivism 125 6.2.2 Phenomenology 125 6.3 Research Design and Process 126

6.4 Tactical Asset Allocation Strategy 130 6.5 Characteristics of Emerging Countries 132 6.5.1 Research Questions for Emerging versus Developed countries (Stage One) 134 6.6 Characteristics of Regional Property Markets 134 6.6.1 European Property Markets 135 6.6.2 Asian Property Markets 136

6.6.3 Australasian Property Markets 137 6.6.4 Research Questions for Regional country analysis (Stage Two) 138 6.6.5 Research Questions for Legal country analysis (Stage Three) 139 6.7 The Data for Individual country analysis (Emerging versus Developed) 139 6.8 Limitations � Emerging country analysis 140 6.9 The Data for Individual country Regional analysis 141

Table of Contents

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6.10 The Data for Individual country Legal Origin analysis 141 6.11 The Research Methodology 142 6.12 Hypotheses Generation 143 6.12.1 Stage One (Emerging versus Developing) Hypotheses 144 6.12.1.1 Primary Hypotheses 144 6.12.1.2 Secondary Hypotheses 145 6.12.1.3 Aggregate (Tertiary) Hypotheses : Developed vs Emerging 146 6.12.2 Stage Two (Regional analysis) Hypotheses 147 6.12.2.1 Primary Hypotheses 147 6.12.2.2 Secondary Hypotheses 148 6.12.2.3 Aggregate (Tertiary) Level Hypotheses : Regional analysis 150 6.12.3 Stage Three (Legal Origin analysis) Hypotheses 152 6.12.3.1 Primary Hypotheses 152 6.12.3.2 Secondary Hypotheses 153 6.12.3.3 Aggregate (Tertiary) Level Hypotheses : Legal Origin markets 155 6.13 Statistical Significance Testing 157

CHAPTER 7: RESEARCH ANALYSIS AND FINDINGS 167 7.1 Introduction 167 7.2 Examining the MVO outputs 167 7.3 Analysis of Developed versus Emerging Markets (Stage One) 170 7.3.1 Averaged Analysis for Developed and Emerging Common Stocks

and Property Stocks from 1992 to 2002 171

7.3.2 Purpose of Combining 46 Asset Classes into 4 (Averaged) Asset Classes 171 7.3.3 Testing Tertiary Hypotheses 173 7.3.4 One-way ANOVA for Averaged Developed markets (AD) versus Averaged Emerging markets (AE)

174

7.3.5 One-way ANOVA for Averaged Developed Stocks (ADS) versus Averaged Emerging Stocks (AES)

176

7.3.6 One-way ANOVA for Averaged Developed Property stocks (ADP) versus Averaged Emerging Property stocks (AEP)

177

7.3.7 Summary of Tertiary Hypotheses Testing Results

178

7.3.8 Conclusions for Developed versus Emerging market analysis (Stage One) 178 7.4 Analysis of Regional Markets (Stage Two) 180

7.4.1 Averaged Analysis for Regional Common Stocks and property Stocks from 1992 to 2002

181

7.4.2 Testing Tertiary Hypotheses 184 7.4.3 One-way ANOVA Analysis for (four Averaged Regions) 185 7.4.4 One-way ANOVA Analysis for (Averaged Regional Stocks) 186 7.4.5 One-way ANOVA Analysis for (Averaged Regional Property stocks) 187

7.4.6 Two-way ANOVA (8 Asset classes: Averaged Regional Stocks and Averaged Property stocks)

189

7.4.7 Conclusions for Regional market Analysis (Stage Two) 191 7.5 Analysis of Legal Origin markets (Stage Three) 191 7.5.1 Averaged Analysis for Legal Origin Markets (8 asset classes) Common

Stocks and Property Stocks from 1992 to 2002 192

7.5.2 One-way ANOVA Analysis for (Averaged Legal Origin markets) 195 7.5.3 One-way ANOVA Analysis for (Averaged Legal Stocks) 196 7.5.4 One-way ANOVA Analysis for (Averaged Legal Property Stocks) 197 7.5.5 Two-way ANOVA (8 asset classes: Averaged Regional Stocks and

Averaged Property Stocks) 198

7.5.6 Conclusions for Legal Origin Analysis (Stage Three) 200 7.6 Replication of Gordon�s study for Legal origin on Common stocks & Property 200 Stocks for Legal Origin analysis

Table of Contents

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7.7 T-Tests analysis for AVERAGED Developed vs. Emerging, AVERAGED REGIONAL and AVERAGED LEGAL ORIGIN to evaluate if property stocks = 0 within the common stocks universe

204

7.7.1 The Problem 204 7.7.2 The New Hypotheses 205 7.7.3 The Rationale for T-Tests 205 7.7.4 The Results 206 7.7.5 The Conclusion 207 7.7.6 Future Reflection 209

CHAPTER 8: PORTFOLIO MANAGEMENT STRATEGY: ACTIVE VERSUS PASSIVE 210 8.1 Introduction 210 8.2 Empirical Precedent: Pagliari et al. (1995) 211 8.3 Methodology 213 8.4 Results of Analysis 216 8.4.1 Legal origin 216 8.4.2 Regional markets 219 8.5 Conclusion 221 CHAPTER 9: CONCLUSIONS AND RECOMMENDATIONS 223 9.1 Introduction 223 9.2 Purpose of the Research � A Summary 224 9.2.1 The Scope of the Research 224 9.3 Original Contributions of Research 226 9.3.1 Theoretical Contributions 226 9.3.2 Practical Contributions 228 9.4 Limitations of Research Study 229 9.4.1 Data Limitations 230 9.4.2 Means Variance Optimisation Limitation 231 9.5 Recommendations for Further Research 232 REFERENCES 284

List of Figures

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LIST OF FIGURES Page

Figure 2.1 The Financial System�s Legal Pyramid 34 Figure 3.1 The Optimal Tangency Portfolio 66 Figure 5.1 Shift in Efficiency frontier with inclusion of equity REITs 93 Figure 5.2 Property Risk Return Analysis: 1984 - 1997 (Quarterly) 109 Figure 6.1 Steps in the Quantitative Research Design 128 Figure 6.2 Tactical Asset Allocation Strategy 131 Figure 6.3 Global Market Capitalisation by Region 135 Figure 8.1 Active and Passive returns for Test years (Legal origin markets) 217 Figure 8.2 Active and Passive returns for Test years (Regional markets) 220 Figure 9.1 Conclusions of Tactical Asset Allocation Strategy at the Aggregate (Averaged) level

225

List of Tables

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LIST OF TABLES Page

1.1 The Maturity and Transparency of direct property markets 6 2.1 Corruption Indexes from Transparency International 38 2.2 Rating of Accounting Standards 41 4.1 Number of securities and market capitalisation for the GPR General Indices (as of the end of December 2002)

83

5.1 Average monthly return and risk for equity REITs, shares, small-value shares and bonds in the USA (January 1976 � June 1993)

91

5.2 Correlation coefficient between the return on property companies and the return on common stocks for 19 countries, three regions and the world (January 1987 � December 1996)

94

5.3 Types of REITs in volume and number (as of 31 January 1999) 102 5.4 Market capitalisation of Property and Common Stocks 107 5.5 Returns and Standard Deviations of Property and Common Stocks 108 5.6 Country Correlation (1984 through 1997) 111 5.7 World Correlation Matrix (1984 through 1997) 112 6.1 Size of European Property share markets sorted by Market Capitalisation 136 6.2 MVO Output for 1992 Common Stock and Property Stocks Allocation 161 6.3 MVO Output for finding Portfolio based on Targeted Volatility (Stocks) 163 6.4 MVO Output for finding Portfolio based on Targeted Returns (Stocks) 164 6.5 Matrix Table of Hypothesis testing (One Line Summaries) 165 7.1 Summary of Hypotheses Results 169 7.2 Basic Data for Averaged Developed and Emerging Stocks and Developed and

Emerging Property stocks in 1992 172

7.3 Mean allocation weights for 11 years from 1992-2002 (extracted from Appendix 9) 173 7.4 Descriptive Statistics of the means of Averaged Developed versus Averaged Emerging markets (4 Asset Classes)

175

7.5 ANOVA (Averaged Developed versus Averaged Emerging Markets) 175 7.6 Descriptive Statistics of the means of Averaged Developed Stocks versus Averaged Emerging Stocks markets

176

7.7 ANOVA (Averaged Developed Stocks versus Averaged Emerging Stocks Markets) 176

7.8 Descriptive statistics of the means for Averaged Developed Property stocks versus Averaged Emerging Property stocks markets

177

7.9 ANOVA (Averaged Developed Property stocks versus Averaged Emerging Property stocks markets)

177

7.10 1992 Data for Averaged Regional Stocks and Properties 182 7.11 Averaged 1992 Regional Stocks and Property allocation as per MVO output 183 7.12 Asset allocation and group weights for 1992 (extracted from Appendix 10) 183 7.13 Descriptive statistics of the group means of four Averaged Regions 186 7.14 ANOVA : Averaged four Regions 186 7.15 Descriptive statistics of the group means of Averaged Regional Stocks 187 7.16 ANOVA : Averaged Regional Stocks 187 7.17 Descriptive statistics of the group means of Averaged Regional Property stocks 188 7.18 One-way ANOVA Analysis for (Averaged Regional Property stocks) 188 7.19 Descriptive Statistics of the Between Subjects: Independent variables of

Regional and Asset Classes 189

7.20 Mean allocation weights for 11 years from 1992 � 2002 (extracted from Appendix 5) 193 7.21 Descriptive Statistics of the group means of the four Averaged Legal Origin markets 195 7.22 ANOVA: Averaged Legal Origin markets 195 7.23 Descriptive Statistics of the group means of Averaged Legal Stocks 196 7.24 ANOVA : Averaged Legal Stocks 196 7.25 Descriptive Statistics of the group means of Averaged Legal Property Stocks 197 7.26 One-way ANOVA Analysis for (Averaged Legal Property Stocks) 197 7.27 Descriptive Statistics of the Between Subjects: Independent variables of Legal and

Asset classes 199

List of Tables

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7.28 Tests of Between-Subjects using Two-way ANOVA 199 7.29 EX-POST Optimised Weights for 8 asset classes for 11 years (1992:1 to 2002:12),

and two sub-periods of 5.5 years; (1992:1 to 1997:6) and (1997:7 to 1997:12) 202

7.30 One-Sample T-Test Averaged Developed vs. Emerging markets 206 7.31 One-Sample T- test Averaged Regional markets 207 7.32 One-Sample T-Test Averaged Legal Origin markets 207 8.1 Tabulation of MVO weights both Active and Passive returns extracted from App. 18 216 8.2 One-Sample T-Tests on Legal Origin mean differences 218 8.3 Tabulation of MVO weights both Active and Passive returns extracted from App. 20 220 8.4 One-Sample T-Tests on Regional market mean differences 221

List of Appendices

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LIST OF APPENDICES PageAppendix 1 : A Review of La Porta et al. (1997) �Legal Determinant of External Finance� and Demirguc-Kunt and Maksimovic (1998) �Law Finance and Growth�

18

Appendix 2 : Literature review of Diversification Benefits and Portfolio Optimisation of Property (1985 to 2000)

115

Appendix 3 : Within Country (MVO) Analysis (2 asset categories) � 23 Countries (11 years) 235 Appendix 4 : Within Country (MVO) Analysis (2 asset categories) � 28 Countries (20 years) 238 Appendix 5 : Returns Matrix for 8 Asset Classes 1992 � 2002 (Averaged Legal Origin) 242 Appendix 6 : Averaged Legal Origin Optimised Portfolio Weights for 11 years (8 Asset

classes) 244

Appendix 7 : Stock Returns and Property Allocation Analysis ( Averaged Regional Analysis) 248 Appendix 8 : Stock Returns and Property Allocation Analysis (Averaged Emerging/Developed

Analysis) 254

Appendix 9 : Returns Matrix for Averaged Developed versus Averaged Emerging (4 asset classes) 1992-2002

259

Appendix 10 : Returns Matrix for Averaged Regional 8 Asset Classes 1992 � 2002 261 Appendix 11 : Data for Stocks & Properties in 1992 (Emerging and Developed) 263 Appendix 12 : Data in 1992 for 46 Individual Countries Stocks and properties (Regional Analysis)

265

Appendix 13 : 8 Asset Class 1984-1992 (5 year Rolling Average � Legal Origin) 267 Appendix 14 : MVO weights 5 year Rolling Average for Legal Origin 274 Appendix 15 : 6 Asset Class 1984-1992 (5 Year Rolling Average � Regional) 276 Appendix 16 : MVO weights 5 Year Rolling Average for Regional Markets 282

An Empirical Investigation of the role of Legal origin on the performance of Property Stocks Christopher K.L. Shun, 2004 Chapter One: Introduction

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CHAPTER 1

This chapter identifies the primary research motivations, provides the background and the key factors that motivated this study and describes the major problems with respect to asymmetric information in the property stock market. The chapter also describes the contributions of this research and gives an outline of the structure of this thesis.

Thesis Introduction 1.0) Introduction

Researchers have long examined a firm�s share performance in an attempt to

understand the reasons for differing levels of firm performance. The Finance

literature provides many different explanations for a firm�s performance.

Some of these factors relate to a firm�s product market share, CEO

characteristics, agency conflicts, diversification, institutional ownership of

firms as well as legal frameworks wherein these firms operate. The corporate

governance literature has established that diverse elements of countries�

financial systems like the breadth and depth of their capital markets, pace of

new security issues, corporate ownership structures, dividend policies and

specific securities laws provide varying levels of protection for outside

investors. Recent research in Law and Finance undertaken by La Porta et al.

(1997b) has empirically established that the legal system wherein a firm

operates is central to the understanding of the patterns of corporate finance in

different countries.

This thesis will focus and examine the role of legal origin that was first

introduced by La Porta et al. (1997b) with specific empirical data and analysis

of the traded securities within the Property sectors in 23 countries over an


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eleven year period from January 1992 to December 2002. This is an extension

of the research and model that were first examined and prescribed by La Porta

et al. (1997a) in their study of legal determinants of external finance. Investor

protection is crucial because in many countries, expropriation of minority

shareholders and creditors by controlling shareholders or corporate insiders is

extensive.

Expropriation can take many forms such as corporate insiders selling the

output, the assets or additional securities in the firm they control to another

firm at below market prices. Such transfer pricing, asset stripping and investor

dilution is all too common. Expropriation is a result of the agency problems

described by Jansen and Meckling (1976), whose seminal research focussed

on the consumption of �perquisites� by managers and other types of empire

building behaviour designed to utilise the profits and cash flow of the firm for

the insider�s benefits as opposed to returning the monies to shareholders

(dividends) and creditors (debt repayments). Thus, external investors

(outsiders) are more vulnerable to expropriation and therefore they are more

dependent on the legal frameworks in certain countries to protect their rights.

However, employees and suppliers remain useful to the firm and are at a lesser

risk of being mistreated. Thus, most of the risk falls onto the external

shareholders and bank creditors who provide the financing.

1.1) Research motivations and problems

This research proposal intends to replicate the original La Porta et al. (1997b) study

but focuses on Property stocks in approximately 23 countries whose legal

jurisdictions falls into four of the legal fraternities established by La Porta namely,

English, French, German and Scandinavian. The primary motivations for this

thesis, is that the Property stocks industry broadly captures several critical aspects


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of the original La Porta study. Specifically, Property stocks are very tangible assets

that can easily be collateralised due to the direct property underpinning the net asset

backing of Property stocks. Thus the empirical study and conclusions should be

able to shed light on the major factors that make for a more vibrant and broader

property market. Optimally, the end result of this research will provide a

comprehensive framework for institutional portfolio investors to determine the

appropriate countries whose property markets have the most favourable investor

climate and protections to facilitate a more attractive environment for institutional

investors given the means variance optimisation methodology. A tactical asset

allocation will be employed to determine the analytical stages that a global investor

would undertake to arrive at the optimum proportions of funds to invest in regular

stocks or Property stocks in any country.

The global investor will firstly determine whether to invest in two asset classes

namely Stocks (General Equities) and Property Stocks. At Stage one, the investor

will determine what proportions to invest in Emerging versus Developed Countries.

Then the investor at Stage two would consider Regional Analysis as to whether

investing in certain Regional groupings would enhance their returns. The investor

would have four regions to consider namely North America, Europe, Asia and

Australasia. Finally, at Stage three, the investor would consider Legal origin

analysis as to whether investing in certain legal fraternity groupings would enhance

their returns. The investor would have four legal frameworks to consider namely

English Law, French Law, German Law and Scandinavian Law. The primary

analysis for Stages one, two and three would be T-tests and F-tests. The F-tests is

employed to test the means for more than two groups and to determine if there is

statistical significance within the means of the various Regional and Legal origin

groupings. Also, the regional groupings in Stage two and the Legal origin groupings

in Stage three would be averaged to prevent any one country distorting the results

and providing spurious conclusions.


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1.2) Asymmetric Information (Direct property market)

At this juncture, it is important to recognise that the direct Property market is

fraught with asymmetric information, which creates imperfect markets. The

dependence on local legal infrastructure, market structures, conventions and other

formal regulatory barriers defined by Guerts and Jaffe (1996) as �institutional risk�,

makes the prospect of direct property investments rather daunting. Surveys of

foreign institutional investors by Worzala (1994), determined that the most

important factor deterring overseas investment is unfamiliarity with foreign market

structures and conventions and other formal regulatory barriers herein defined as

�institutional risk�. Guerts and Jaffe (1996) suggest that this �institutional risk�

should be a prime area of concern when contemplating investing into foreign

markets, especially into emerging markets where cultural and legal differences will

be even more pronounced. If foreign investors can become more informed of the

institutional structures and business practices of overseas markets they are more

likely to invest in those markets reinforcing the maxim that �familiarity breeds

investment�.

Without which, investors will avoid such markets, as the uncertainty that the lack of

transparency induces will increase the risk of investment to such a level that it

becomes unacceptably high. When considering investment into direct property

markets, especially emerging markets, many foreign institutional investors need to

consider transparency risks. Roulac and Eachempti (2002) state that lack of

transparency is �the single greatest obstacle to economic development� facing

emerging countries today. Consequently the question becomes how transparent are

the emerging property markets relative to the developed countries of the world.

This can partly be answered by assessing their level of property market maturity

defined by market infrastructure and the existence of sophisticated property

profession with their associated institution support networks and the amount of


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readily available level of information exchange (transparency) within in each

country. Transparency International undertook such a study with the results

highlighted in Table 1.1


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Table 1.1: The Maturity and Transparency of direct Property markets

Country Maturity Transparency

Australia

Belgium

Canada

China

Denmark

France

Germany

Greece

Hong Kong

India

Indonesia

Ireland

Italy

Japan

Malaysia

Netherlands

New Zealand

Norway

Philippines

Portugal

Singapore

South Korea

Spain

Taiwan

Thailand

UK

USA

Vietnam

Established

Nearly Established

Established

Emerging

Nearly Established

Nearly Established

Established

Emerging

Nearly Established

Emerging

Emerging

Emerging

Emerging

Nearly Established

Emergent

Emergent

Nearly Established

Emergent

Emerging

Emerging

Nearly Established

Emerging

Emergent

Emergent

Emergent

Established

Established

Emerging

Highest

High

Highest

Low

High

High

High

Opaque

High

Opaque

Low

High

Low/Opaque

Semitransparent

Semitransparent

High

High

High

Low

Opaque

High

Low

Low

Low

Low

Highest

Highest

Low/Opaque

Source: Transparency International (2002)


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The property markets of China, Vietnam, Indonesia, South Korea and the

Philippines are still at the emerging stage of maturity and also display the least

(Low) transparency. While the markets of Malaysia, Thailand and Taiwan have

moved to a stage of rapid development towards maturity (emergent) however still

displaying low to semi-transparent levels of transparency. Thus, these markets are

perceived unsuitable for institutional investors and are only of interest, to

individuals willing to take a higher risk or venture capital funds seeking out high

returns in a very short time before moving on to new markets.

In contrast the markets of Hong Kong, Singapore, New Zealand, Australia and

Japan have much more established markets and all show good to high levels of

transparency. All of which suggests that it is these markets that are likely to offer

the �best� form of investment opportunities to institutional investors considering

overseas investment in the Asian region. It is not surprising that these countries

feature prominently in the horizons of institutional property investors seeking to

diversity and invest externally.

As global markets develop, the established investors call for increased transparency

to reduce the risk of mispricing and to improve the reputation and credibility of the

market. In short, international property investment depends on the ability to

achieve immediate and full access to market information that can be verified and

can be confirmed in a shorter time than ever before. Indeed the free flow of

information is a necessary condition for market efficiency.

To mitigate some of the problems highlighted by Roulac and Eachempti

(2000), this research will focus on listed Property Stocks in 23 countries which

have had at least a 10 year track record and whose prices have been analysed

by Global Property Research in Amsterdam, the Netherlands, who have

incorporated a rigorous property stocks index for each country in order to

analyse as a separate asset class to incorporate into a multi asset Markowitz


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portfolio analysis to determine the efficient frontier. The rationale for such

analysis will be elaborated in Chapter Six: Research Methodology and Design.

1.3) Overview of Research

The seminal contribution of the original La Porta et al. (1997) research opined

that the legal framework is a crucial determinant as to which countries were

most likely to have the most attractive investment climate that would attract

foreign investment and engender a vibrant and healthy stock market with

greater breadth and depth and consequently, procure dynamic corporate

performance. In short countries with poorer investor environment, measured

by the character of the legal rules and quality of law enforcement, should have

smaller and narrower capital markets both for equity and debt markets.

Their empirical analysis have been further verified by numerous studies

applied in different sectors undertaken by Levine (1998) in the Banking

industry, Alesina et al. (1999) on Government Aid, Rajan and Zingales (1997)

on financial dependence and growth and Demirgüç-kunt and Maksimovic

(1998) in their World Bank study which concluded that countries whose legal

systems score high on an efficiency index, had a higher propensity to use long

term external financing. Their study also concluded that an active and large

banking sector was also associated with externally financed growth. A

thorough comparative review of the La Porta et al. (1997) paper and the

Demirgüç-kunt and Maksimovic (1998) paper is undertaken and analysed to

show the similarities and also their differences. Please see (Appendix 1).

This thesis represents an extension of two separate bodies of research; one

examining the role of legal origin on the performance of the equities markets

and external finance (La Porta et. al. 1997) and the other, the benefits that


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diversification accrues from international investing in Property Stocks across

both emerging and developed markets as elucidated by Eichholtz & Hartzell

(1996). To date, there has not been any comprehensive research undertaken to

assess the impact of the legal origin infrastructure on the performance of the

securitised property sector. Therefore this thesis is envisaged to fill the

research gap between legal origin and the performance of Property Stocks

across four legal fraternities and make an original contribution to the Law &

Finance and Portfolio management Literature.

The enforcement of �property rights� is important as there is an active

secondary market for property, which makes it relatively liquid as opposed to

manufacturing companies in the various 49 countries originally studied by La

Porta et al. (1997). The study on one industry (property) across many countries

removes industry differences, which could distort and or influence the

differences observed and discovered in the original La Porta (1997) study.

This is because certain countries have concentrations in certain industries like

mining extraction (Norway), or manufacturing (Germany), or financial and

general services (Hong Kong) that could have undue influences on the

independent variables examined by the La Porta study.

This current study is approximately seven years after the original 1997 study

and includes the period covered by the major economic crisis that afflicted the

Asia Pacific region from 1997 to 1999. Thus, this research will be beneficial

to property scholars and practitioners as the results will incorporate a

systematic shock (Asian financial crisis), which has brought about a

realignment of the factors that drive the property industry. Also the Asian

countries feature prominently in the Emerging countries, which is in Stage

One of the research evaluation process. Therefore the impact of the Asian

crisis would have a material impact on their risk adjusted returns measured by

the Means Variance Optimisation methodology. The benefits and


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contributions of this research is further elaborated later under 1.3.2) Thesis

contributions

1.3.1) Property diversification

The literature reveals that there is a need for property diversification beyond

one�s domestic shores as suggested by Eichholtz (1996b), in order to achieve

greater diversification benefits and to extend outwards the Markowitz efficient

frontier for Institutional Property investors. Giliberto (1990) and Giliberto and

Testa (1990) used the returns of international property shares over the time

period 1985 to 1989 to demonstrate the risk-reduction possibilities of

international property stocks within a property-only securities portfolio.

Gordon et al. (1998) undertook a study of the property markets in 14 countries

from 1984 to 1997 and concluded that risk reduction was clearly demonstrated

by including international Property Stocks into a mixed asset portfolio.

This thesis intends to review the research methods utilised by Gordon et al.

(1998) and to integrate them with the La Porta et al. (1997) study, to produce a

thesis, which will provide a comprehensive property investment framework

for institutional portfolio managers investing in the Property Stocks in 23

countries covered in this study. The research process would include

incorporating regional market analysis into legal frameworks to determine the

optimum proportions that should be invested by a global investor based on ex-

post analysis from data from 1992 to 1996 (5 years inclusive).

The EX-POST results based on the weights determined by the Means

Variance Optimisation (MVO) methodology would attempt to establish any

systematic shifts or trends that a global investor could observe to extrapolate

the future investment trends. An Ex-Ante analysis would be undertaken


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within the ambit of this thesis to determine if by employing a 5 year rolling

basis, whether a global investor could have employed the optimum MVO

weights to attempt to outperform the benchmark in the following year. So for

example, to determine the optimum weights to invest in 1997, the global

investor would undertake a 5 year analysis (1992 to 1996). Whilst, the global

investor might not be interested in the specific optimal outputs that the MVO

methodology suggests in that specific 5 year time period Ex- POST, in

contrast the global investor is very much concerned with the Ex-ANTE

analysis used to develop active management strategies wherein the optimal

MVO weights derived in the previous 5 years (1992-1996) are utilised to

allocate investment resources in the following year 1997. Thus this is in

contrast to a Passive management strategy of investing equal proportions in

each asset class in 1997. This thesis undertakes the EX-ANTE analysis for

1997 through 2002 (seven years) employing the 5 year rolling basis to outline

the trends of Active management versus Passive management strategies. This

is dealt with thoroughly in Chapter eight. The current priory assumption as

evidenced in the Literature as elaborated by Pagliari et al. (1995) is that the

Active management strategy does not outperform the Passive management in

the medium to long run. This thesis will explore the Active management

strategy utilising the MVO methodology to see if the assumption by Pagliari et

al. (1995) is valid when considering the impact of legal origin on the returns of

the Property Stocks in 23 countries.

1.3.2) Thesis Contributions

The Thesis endeavours to make three distinct original contributions, which are

as follows:

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