I RESEARCH SUPPORT UNIVERSITY OF MICHIGAN BUSINESS SCHOOL MARCH 1997 WHY Focus MATTERS WORKING PAPER #9705-07 BY DENNIS R. CAPOZZA UNIVERSITY OF MICHIGAN AND PAUL J. SEQUIN UNIVERSITY OF MICHIGAN

I Why Focus Matters Dennis R. Capozza* Professor of Finance and Ross Professor ofReal Estate Finance University of Michigan Business School Ann Arbor, MI 48109-1234 313 764 1269 Capozza@umich.edu Paul J. Seguin Associate Professor of Finance University of Michigan Business School Ann Arbor. Ml 48109-1234 313 764 9286 Pseguin@umich.edu 06/14/96 3:11 PM *The authors thank Allan Afuah, Sugato Battacharyya, Larry Benveniste and participants in a seminar at the University of Michigan for helpful comments. The usual disclaimer applies.

Why Focus Matters In this study, we trace the impact of corporate focus by estimating the relationships of focus with cash flow and firm value. In contrast to past studies that examine the effects of diversifying across SIC code defined industries, we show, using Tobin's q, that diversification even within a single industry negatively affects value. Our evidence indicates that this value reduction is not due to poor managerial performance. Project level cash flows are actually higher for less focused firms. However, these gains are exactly offset by higher management, administrative and interest expenses. Thus the corporate cash flows available to shareholders are not related to focus. Finally, we provide empirical evidence that links the effect of focus on value to informational asymmetries which cause the equity of diversified firms to be less liquid. Arguably, no one topic has attracted attention from more of the disciplines making up business administration than the topic of corporate focus. Leading journals in the fields of Accounting, Business Economics, Business History, Law, Marketing, Manufacturing, Planning, Statistics and Corporate Strategy have all published articles dealing with the costs and benefits of the concept variously described as corporate focus, diversification, product line width or core competencyl. Across the dramatic range of analytic paradigms used in the investigation of corporate focus and performance across these disciplines, only moderate consensus has emerged. Montgomery (1994, p. 169) summarizes the empirical literature and concludes that there is '*a neutral or negative, not a positive, relationship between diversification and firm performance." Firms that have been less focused or more diversified either under perform or perform as well as their more focused, less diversified counterparts. ISee, for examples, Amit and Livnat (1988) and Palepu (1985) in accounting, Boyle (1970) and Berry (1971) in law, Bass, Cattin and Wittink (1978). Day (1977) and Varadarajan (1986) in marketing, Amey (1964) in statistics, Gorecki (1975. 1980) in manufacturing, Didrichsen (1972) in history, Hako (1972) and Hedley (1977) in planning, Montgomery (1982 and 1985), Prahalad and Betis (1986) and Rumelt (1982) in strategy, and Ravenscraft and Scherer (1982a, 1982b) and Wernerfelt and Montgomery (1988) in business economics. -2 -

Why Focus Matters Researchers in finance have also investigated the link between focus and performance, but have reached conclusions that are more uniform than those reached in other disciplines. Recent research regularly documents a strong, negative relationship between value and diversification. For example, Berger and Ofer (1995) estimate stand-alone values for individual business segments of conglomerates. They then compare the sum of these imputed values to the conglomerate's market value and conclude that diversification results in a 13% to 15% value loss. Comment and Jarrell (1995) examine the relationships between changes in focus- as measured by year-to-year changes in asset-based Herfindahl indices- and stock returns. They conclude that an increase in focus of.1 is associated with a 3.5% increase in shareholder wealth over a two year horizon. Lang and Stulz (1994) examine q-ratios (the ratio of the market value of equity plus the book value of debt to the estimated asset replacement cost) and find that they are lower for less focused firms: average q-ratios for firms with one line of business exceed 1.5, but are uniformly below.95 for firms with multiple lines of business. Their results are not attributable to industry effects nor to differences in size or R&D expenditure. Previous studies generally measure focus by analyzing diversification across SICdefined lines-of-business2. Our study, in contrast, examines diversification within a single SIC-defined line-of-business, namely real estate investment trusts. Limiting our study of focus to one industry provides both advantages and disadvantages. One disadvantage is a limited sample size and a possible reduction in statistical power. Specifically, our sample consists of only 75 publicly- traded REITs over eight years. Secondly, the results from an investigation into only one industry may not be generalizable to all industries. It is conceivable that one of the unique features of the REIT industry (e.g., tax-exempt status, minimum dividend restrictions) may impact the relationship between focus and valuation. 2An exception is Palepu (1985), who examines 30 fiums in the food products industry group.

I Why Focus Matters These disadvantages are outweighed by the many advantages of examining this industry. First, the simplicity of the REIT industry and the availability of detailed financial accounts allow us to measure project level cash flows. As a result we analyze the effect of focus on project level performance as well as on corporate-level performance. Second, because the underlying assets —real properties —are traded in an active primary market, we are able to obtain estimates of the replacement cost of assets with much greater precision than previous studies. Since active markets for underlying assets do not exist for the majority of industries, previous studies could only coarsely estimate replacement costs by accumulating historical capital investment and adjusting for inflation and estimated economic depreciation (Lindenberg and Ross, 1981). In contrast, our replacement cost estimates are based on recent market transactions prices of assets similar to those underlying each REIT. The third advantage stems from our ability to measure not only project-level and corporate level cash flows, but also the cost of the management team. By examining reported general and administrative (G&A) expenses, we can determine whether managing a diversified portfolio of projects is more costly, and can measure the economic significance of those costs. An additional advantage of examining a single industry is that we are able to circumvent a potential problem identified by Lang and Stulz (1994). They argue that firms in industries with poor growth prospects may be more inclined to diversify. If so, a negative relationship between diversification and performance may be spurious. That is, it is possible that it is not diversification that causes poor performance, but poor performance in the underlying line of business may be "causing" diversification. By concentrating in a single line-of-business, the cross-sectional variation in growth opportunities is diminished. Thus, the probabilities that any documented relationship is due to the spurious "industry effect" are like-wise diminished. -2 -

Why Focus Matters Finally, limiting our investigation to a single industry can provide important evidence on the upper bounds of synergistic gains to diversification. Since all firms and projects in our sample are within a single SIC classification, the gains from synergy should be great. As a result, we have essentially "stacked the deck" towards finding advantages to diversifying. If we are unable to detect any advantages even under these presumably favorable experimental conditions, then we have strong evidence that synergistic gains are not economically meaningful. Our study extends previous research on focus along a number of dimensions. Although the statistical link between focus and performance has been well established, uncovering the latent economic channels between the two has proved illusive. In this study we examine three possible avenues through which focus affects value. We provide evidence that rejects two of the three candidates and that supports the remaining one. Specifically, we find no evidence that diversification leads to managers choosing less profitable projects due to limited or over-extended expertise. Indeed, our estimates suggest that project-level returns-on-investment are larger for firms with diversified asset bases. We interpret this finding as being consistent with the joint hypothesis that managers prefer to hold focused asset bases, and choose diversified assets only when tempted by larger project-level expected returns. Although less focused firms realize higher project-level rates-of-return, we find that corporate-level expenses (General and Administrative expenses and interest expenses) increase with diversification. Further, this increase occurs at a rate that is sufficient to offset the increase in project-level yields. As a result, corporate level cash flows (cash flows available to claim holders) do not vary with focus. The previous two findings are consistent with the following scenario. When diversifying, a manager must choose between (i) stretching her expertise across a greater range of investment types and suffering lower yields (perhaps due to asymmetric information or adverse selection problems), or (ii) acquiring more (and more specialized) -3 -

I Why Focus Matters managerial talent. Our results suggest that the later course of action is predominantly chosen. However, the gains in project-level yields due to increased managerial expertise are on average offset by their attendant costs. Thus, for our sample, there is no reliable evidence linking focus to corporate-level cash flow performance. The third avenue that we investigate involves linking focus to liquidity. Arnihud and Mendelson (1988) argue that a reduction in liquidity acts like a tax on the proceeds of the sale of security, and so, is reflected in current market value. We empirically demonstrate that equity value is related to liquidity, and that liquidity is, in turn, related to asset focus. Firms with more focused asset bases enjoying greater equity market liquidity, and higher equity market value. Further, once the indirect effects of focus on value via liquidity are explicitly accommodated, focus does not have a statistically significant impact on value. In the following section, we present an economic model of the effect of focus on value. The third section describes our database and provides some details about the REIT industry pertinent to this study. We next describe our empirical results linking focus and performance. The analysis of focus, value and liquidity based on Tobin's-q follows. Our study ends with a discussion of conclusions and implications. An Economic Model of the Effects of Focus Data available to previous researchers has limited the analysis of the effects of focus to measuring the relationship between focus and either return data or q ratios. Such analyses are intrinsically important; however, by concentrating on aggregate performance measures, earlier research has been unable to definitively identify why focus affects value. With our comparatively detailed data set, we are able to not only identify the effects of focus on value, but also to identify those economic channels through which focus affects value. The standard dividend-discount model of value posits that equity value is the present value of future dividends. Since, by law, REITs are required to distribute 95% of earnings -4 -

Why Focus Matters to maintain their tax-exempt status, the correlation between cash flow available to shareholders and dividends is high. As a result, the value of REIT equity is closely tied to the present value of future cash flows. Therefore, if focus affects equity value, it can do so through two channels; through corporate level cash flows or through the rate used to discount future cash flows. As illustrated in Exhibit 1, corporate-level cash flows, or cash flows available to shareholders3, are calculated as project-level cash flows minus both G&A expenses and interest expenses. If focus affects corporate level cash flows, it must affect at least one of these three components of corporate-level cash flows. For example, it is possible that more diversified firms realize lower property-level cash flows, perhaps due to the stretching of property-level managerial expertise across a wide range of property types and regions. Alternatively, more diversified firms could enjoy higher property-level cash flows. One scenario consistent with this outcome is that firms prefer to hold focused portfolios but increase their diversification only if non-core projects offer abnormally large returns. It is also possible that focus is unrelated to property-level cash flows but does affect corporate level cash flows. Under this scenario, focus must be related to at least one of the corporate level expenses: G&A expense and interest expense. The second channel through which focus can affect value is through the discount rate. Following Amihud and Mendelson (1988), we posit that one determinant of the appropriate discount rate for equity is the liquidity of that equity. If, due to greater informational asymmetries (Harris, Kraebol and Raviv (1982)) or through increased costs to collecting information (Ippolito (1989)), greater diversification leads to higher required rates of return, then focus can affect value, even if cash flows are unaffected. 3 Cash flow available to shareholdes is sometimes called funds from operalons (FFO) in the REIT industry. -5 -

Why Focus Matters Figures 1 depicts the economic channels though which focus can affect value. In Figure 1, focus affects value through two indirect channels. First, focus can affect at least one of the components of corporate-level cash flow (project-level cash flows, interest expenses and/or G&A expenses). Corporate-level cash-flows then affect value through the numerator of the dividend-discount model. The second indirect route by which focus can affect value is through the liquidity component of discount rate, which affects the denominator of the dividend-discount model. Our statistical tests are designed to distinguish between the above indirect effects and a direct effect of focus on value. We first show that focus has a significant but offsetting effect on the three components of corporate cash flow (project-level cash flow, interest expense, and G&A expense). Since there is no significant effect of focus on corporatelevel cash flow, the link between focus and value cannot be arising from the numerator or corporate cash flow channel. We then estimate specifications relating our variant of Tobin's-q to focus variables alone. Since the effect of focus on corporate cash flow has been ruled out, a significant relationship is consistent with focus affecting value either through a direct effect on the discount rate or indirectly through liquidity. To disentangle these possibilities, we estimate specifications linking Tobin's-q to both focus and liquidity variables. If the focus variables remain significant when liquidity is included, we can deduce that the impact of focus on value is not entirely attributable to the effect it has on liquidity. In contrast, if focus is significant when focus alone is included but insignificant when we control for cross-sectional variations in equity liquidity, we can conclude that focus affects value only through the liquidity component of the discount rate. The results support this latter case. Data The database is the same subset of the 209 REITs listed in the 1992 NAREIT (National Association of Real Estate Investment Firms) source book examined in Capozza -6 -

Why Focus Matters and Lee (1995) and Capozza and Seguin (1996). This database focuses on equity REITs and excludes all mortgage, hotel, restaurant, and health-care REITs; REITs that do not trade on the NYSE, AMEX, or Nasdaq;. and REITs for which property information is not available. Applying these exclusions results in a sample of 75 REITs, which are listed in Table I. This leads to a total of 298 usable observations. For each observation, balance sheet, income statement, and property variables were collected using 10-K reports, annual reports to shareholders, and proxy statements. The CRSP daily returns files were used to compute equity value information. One particularly powerful feature of this database is that it provides estimates of the market, or replacement, value of properties held. Capozza and Lee derived these estimates by first assigning property-specific capitalization rates to each property based on its location and type. They next calculated an individual REIT's average capitalization rate as the weighted average of the component property capitalization rates. For a particular portfolio, the market value of properties was estimated by dividing the property cash flow by the REIT's weighted average capitalization rate. Finally, net asset values were estimated by subtracting liabilities from estimated property assets plus other assets. Additional adjustments were make for joint ventures, differences between coupon rates and market yields on debt, and property turnover. We construct our analog of Tobin's q by dividing the equity-market value of equity by the real-estate-market or replacement value of properties plus the book value of other assets minus the book value of debt Other assets and debt are predominantly current assets or liabilities with low durations. Thus, deviations between book and replacement or market values for other assets and debt tend to be small. While we recognize that these estimates of replacement value contain measurement error, we believe that these estimates are the most sophisticated available. Further, given the homogeneity of the assets and the methodology employed, we posit that our estimates of market or replacement values of assets are less noisy than those used in previous estimates of Tobin's q. -7 -

I Why Focus Matters The proxy we use to measure focus in this study is the Herfindahl index based on product line also provided in the database. For each observation, we construct two 4 Herfindahl indices. The first, TypeHerf is computed as,t where St is the proportion of t=l a firm's assets invested in each of four real estate types: office, warehouse, retail or apartment. Higher levels of concentration by property type lead to higher levels of the index: If the firm is highly focused along one dimension, the index is close to one; while the index approaches.25, if the firm's portfolio of properties is equally diversified across the four property types. We also compute AreaHerf as V S 2 where Sr is the proportion r-l of a firm's assets invested in each of eight real estate regions: New England, Middle Atlantic, Southeast, Midwest, Plains, Southwest, South Pacific, and North Pacific. As with the TypeHerf variable, this concentration variable can vary from one for a geographically focused REIT to.125 for a REIT with holdings equally diversified across the nine regions. Table II contains mean, standard deviation and extreme value information on variables used in this analysis. There is a large dispersion in the size of the firms considered here; estimated market or replacement values of total assets vary from just under $7 million up to over $750 million. The weighted-average capitalization rates used to construct estimates of property values vary between 7.4% and 10.6%. There is considerable variation in the use of debt in the capital structure, with debt representing anywhere from zero percent to 94.4% of the capital structure. We also provide summary data on three income statement items. Project Cash flows (PCFs) represent property level cash flows and represent the difference between property level revenues and property level expenses (see Exhibit 1). These gross cash flows vary from under a half million to over $70 million. To determine funds available for distribution to equity holders, both interest expenses and corporate level or general and administrative (G&A) expenses are subtracted from the -8 -

I Why Focus Matters property cash flow, yielding corporate cash flows (CCFs). G&A expenses vary from $66,000 to $5.04 million, or, expressed as a fraction of assets, from zero to 4.7% with a mean of 1.1% Of perhaps greatest importance here are the two measures of focus and the estimates of Tobin's q. Both Herfmdahl's vary across almost their entire feasible ranges. Property type concentration varies from 15% to 100% with a mean of 67%, while the regional concentration metric varies from 15% to 100% with a mean of 58%. Estimates of replacement-to-book-values-of-assets average.99, but there is great variation, with estimates ranging from.11 to almost 2. Focus and Cash Flow Performance In this study, we investigate the impact of both product-line focus and regional focus in two ways. In this section, we examine the links between focus and cash flows. Gross, or property level cash flows are analyzed initially. We then investigate the role of focus on corporate level expenses (G&A expenses) and interest expenses. This section concludes with our investigation of focus and cash flows by examining the relationship between focus and corporate level cash flows. In the section that follows, we present the second direction of our investigation where we examine links between valuation and focus directly by employing our analog to Tobin's q. Project Level Cash Flows As a benchmark or baseline model, we regress property-level cash flows- the difference between property-level revenues (rents) and property-level expenses (maintenance, property taxes, advertising, etc.)- on our estimates of the real-estate-market or replacement values of the assets held by the REIT. The coefficient can be interpreted as a gross or property level yield. The results of estimating this specification using weighted-least-squares with asset replacement values used as weights and allowing for -9 -

I Why Focus Matters intercepts that vary annually, appear in the first column of Table 3. The estimated coefficient associated with real-estate-market value of assets indicates that REIT's earn, on average, a gross yield of 8.7%, which is consistent with the range of capitalization rates presented in Table 2. It is important to note that we are considering cash flow yields computed using a fair, objective measure of real-estate-market or replacement value as the denominator and not some measure of the actual price paid for the property. So, the notion of rates of return are based on the intrinsic value of the property and not based on return to the actual investment made. As a result, this specification does not allow us to consider whether managers paid a fair value for the properties originally, nor does it allow us to investigate rates of return based on original prices. Our final tests, based on Tobin's q will shed some light on these issues, however. Of primary interest is the interaction of yield with focus. It is possible that when diversification increases in the cross-section, managerial expertise in generating cash flows or in containing property-level expenses becomes over-extended. As a result, propertylevel cash flow yields might decline as diversification increases. Alternatively management may have a preference for a focused asset base, but can be induced to run more diversified, and therefore more complex, asset bases if lured by higher rates of return. In this-case, property-level cash flows will increase as diversification increases. To empirically distinguish between these alternatives, we modify the previous specification and allow the yield to vary with focus. Abstracting from our use of weighted-least-squares and annual intercepts, the benchmark specification was: Cash Flows = a + P Assets + e (1) In this specification, we allow P to vary along both dimensions of focus, so: - 10 -

Why Focus Matters p = PO + Pt (Type Focus) + [r (Regional Focus). (2) Substitution of (2) into (1) indicates that the proper specification includes not focus itself, but the interaction of our focus variables with the replacement value of the assets.4 Estimates of this specification are presented in the second column of Table III. The results are inconsistent with the hypothesis that overextended managerial expertise contributes to under-performance at the property level, but consistent with the hypothesis that managers choose to diversify only when the marginal property offers abnormally high property-level cash flows. The coefficients associated with both dimensions of focus are negative: increases in focus, as measured by movements in our Herfindahl indices towards one, are associated with declines in property-level cash flow yields. Each coefficient is significantly negative, and an F-test rejects the null that both coefficients are simultaneously equal to zero at any standard significance level. The coefficients are also economically significant. A trust that is perfectly focused along both dimensions (e.g.., a trust holding only apartment buildings in the Southwest) has an expected gross yield of 8.14% [= 9.71 - (1).77 - (1).80], while a trust that is equally diversified across the four property types and nine regions has an expected gross yield of 9.43% [= 9.71 - (.25).77 - (.125).80], or about 130 basis points higher. The third specification presented in Table Il augments the previous specification by including debt'and by allowing the gross yield to vary by the size of the asset pool. We include this specification for two reasons. First, this specification can be considered a test of robustness of our results to a few alternative functional forms. Second, and more 4 Non linear specifications with quadratics in focus were also tried. The quadratic terms were not significant. - 11 -

Why Focus Matters importantly, we include this specification since these additional variables are relevant in subsequent analyses. We will exploit this feature below. The results of this specification reinforce our previous estimates. Again, coefficients associated with focus are individually and jointly significant and negative. Consistent with independence between investing and financing decisions, neither of the debt variables are significant. Finally, the positive coefficient associated with squared assets represents weak evidence that gross or property-level cash flow yields increase with the size of the asset base. This is consistent with economies of scale at the property management level. Corporate Level Administration Expenses Although property-level cash flows are of inherent interest, equity valuation depends crucially on cash flows available to shareholders. There are two deductions from gross cash flows to determine net cash flows (alternatively called corporate level cash flows, or cash flows available to shareholders). The deductions are interest expense, which we examine in the next sub-section, and the cost of the corporate level management team, called general & administrative (G&A) expenses, which we examine here. This measure includes corporate-level asset management expenses (including salaries to the management team, filing and reporting costs) but excludes all property-level expenses (such as property management, mainternance, or taxes). Following Capozza and Seguin (1996). we consider three dimensions of firm "structure:" the size of the firm, the focus of the firm, and the amount of leverage employed in the capital structure. Size is relevant if there are economies of scale in managing real estate assets. If such economies exist, then total G&A expenditures would increase with firm size, but at a decreasing rate. We also consider the use of leverage in the capital structure. Capozza and Seguin (1996) argue that the often cited benefits of debt; the tax shield due to the deductibility of interest as an expense, and the reduction in agency costs due to the mitigation of "free - 12 -

Why Focus Matters cash flows," (Jensen (1986)) is of limited relevance in the context of REITs. First, REITs are not subject to corporate taxation, so there is no tax-shield benefit to issuing debt. Second, since REITs are required to pay out 95% of earnings as dividends, the temptation to accumulate cash is removed. Since the benefits of debt are limited, the use of debt only imposes costs on shareholders. First, increases in the amount of debt increase ex ante the expected value of wealth transfers due to bankruptcy-induced restructurings. More importantly, adding debt to the capital structure creates additional financial management, reporting and filing requirements. Capozza and Seguin argue and provide empirical evidence that the interplay of these costs creates a concave relationship between G&A expenditures and leverage. Of primary importance, however, is the relationship between corporate level expenses and focus. It is plausible that diversification across property types increases research and search costs perhaps due to asymmetric information or adverse selection problems. One set of options available to a manager of an increasingly diversified portfolio is to stretch her expertise across a greater range of investment types, increase her efforts expended and / or suffer reduced performance. Another alternative is to acquire more, specialized, managerial talent. Under this later scenario, holding assets under management fixed, increasing the diversification of a portfolio increases G&A expenditures. Estimates of our specification linking G&A expenditures to size, leverage and focus appear in the fourth column of Table m. As above, estimation is performed using WLS with the real-estate-market value of assets used as weights and annual intercepts are estimated but not reported. Consistent with the predictions and estimates in Capozza and Seguin, there is strong evidence of a concave relationship between the use of leverage and G&A expenditures. The annual intercepts, which are not reported, but provide estimates of a fixed-cost component of G&A expenditures, varied from $69,000 to $154,000. Marginal costs of corporate level management can be inferred from the coefficient associated with assets under management. This estimate slightly exceeds 1%. -13 -

Why Focus Matters Inconsistent with the notion of economies-of-scale, the quadratic term is insignificant, suggesting that the marginal corporate level cost of management is invariant to the size of the asset base and equals a constant 1% of real-estate-market value. There is, however, evidence that this marginal cost varies with focus. The coefficients associated with each dimension of focus are negative and significant. Further, the estimates are economically meaningful. Duplicating the analysis of the impact of focus on gross cash flows from above, a trust that is perfectly focused along both dimensions has an expected marginal G&A expense rate of.5% [= 1.09 - (1).38 - (1).21], while a trust that is equally diversified across the four property types and nine regions has twice the expected G&A expense rate, at.96% [= 1.09 - (.25).38 - (.125).21)]. Interest Expenses The second expense subtracted from property-level cash flows to calculate cash-flows available for shareholders is interest expense. We use the same functional form and set of independent variables in investigating the determinants of interest expense as we used in investigating gross cash flows and G&A expenses. Absent an obvious alternative functional form, we employ this specification for two reasons. First, since the specifications for gross cash flows, net cash flows, and the two corporate level expenses use (i) the same dataset of independent variables, and (ii) identical functional form, differences in the impact of a factor on gross versus net cash flows can be readily traced and attributed to one of the two corporate level expenses. The coefficient associated with a particular independent variable in the net cash flow specification must equal the coefficient associated with that same variable in the gross cash flow specification minus the coefficients in the interest and G&A expense specifications5. 5Assume that Y is a deterministic linear combination of a vector of random variables of length q, so Y = y0, where Y, y and 0 are Ixl, lxq and qxl respectively. The OLS parmeter estimates from regressing Y on a set of k independent variables, X, can be written as P = (X'X)-1X'Y = (X'X)-1X'ye = a9, where a = (X'X)-1X'y is the kxq matrix of parameters generated by regressing each y on the set of X's one-at-a -14 -

Why Focus Matters The second motivation for the use of this specification is that it is consistent with a simple model linking the rate of return required by debt holders to the quantity and quality of assets used as collateral. Assume that the rate of return required by debt holders is a function of the ratio of debt to the value of the assets as collateral to debt holders, or I = t(D/A) with t'>O and l">0. Partial differentiation yields the intuitively-consistent results that DaI/D > 0, aI/A < 0, and d2V1A2 > O0. Further assume that the value of the assets as collateral to the debt holders is related to their focus, so A=a(F). The sign of the relationship between interest expense and focus depends crucially on the sign of aA/aF = a'(F). It can be argued that, diversification reduces risk, so that a less focused asset base is of greater collateral value for debt holders. Alternatively, if a more diversified asset base is more difficult to value and monitor, perhaps due to increased informational asymmetries, then a less focused asset base would have, ceteris paribus, less collateral value. Therefore, the sign of the relationship between asset focus and interest costs may only be determined empirically. The fifth column of Table III contain estimates of parameters linking interest expenses to assets, liabilities and asset focus. As predicted by the simple model linking interest expenses to capital structure, the estimated coefficients associated with assets and squared-assets are negative and positive respectively, although the coefficient associated with asset levels is not significantly so. The coefficient associated with the amount of debt can be interpreted as a estimate of the marginal cost of debt There is evidence that this marginal debt servicing cost, estimated to be 8.8%, varies with the amount of debt in the capital structure. The coefficient associated with the quadratic debt term is significantly negative, suggesting that time, and then stacking the results. Since P = aD, the estimates from regressing Y on X must equal a linear combination of estimates from regressing each y on X. Further, the linear combination of estimates is the same linear combination mapping the y's into Y. In this case, if Y is net cash flows, and y is the vector of gross cash flows, G&A expenses and interest expenses, a ={ 1, -1, -1). The inutition extends to the case of WLS, employed here, or even GLS, since B = (X'Z1-X)-1X';-1Y = ((X'Z1X)I;Z-ly)0 = aS. - 15 -

I Why Focus Matters as the amount of debt in the capital structure increases, the marginal cost of this debt declines. This is consistent with a scenario where those trusts that have an advantage in securing debt financing, due to relationships with lenders, are those trusts that tend to issue more debt There is no evidence that greater diversification increases the collateral value of assets. However, the parameter estimates do provide some weak evidence that greater focus reduces borrowing costs. Both focus-related coefficients are negative, and the hypothesis that the two jointly equal zero is rejected at the 5% level. However, only the estimate associated with property-type focus is significant. These results are consistent with the hypothesis that an asset base that is more diversified along thte product line dimension has a lower collateral value, perhaps due to increased difficulty in valuing and monitoring. Funds Available to Equity Holders Consistent with the specifications used above for examining the relationships between focus and gross cash flows, corporate level expenses and interest expenses, we estimate a specification linking corporate level cash flows (cash available to shareholders) to quadratics in assets and liabilities, and to the two dimensions of focus. The results, again using WLS and annual intercepts, are reported in the sixth column of Table 3. The coefficient associated with the real-estate-market value of assets can be interpreted as a net return-on-asset yield estimate. For reasons outlined above, this estimate of 8.2% equals the estimated gross cash flow yield (9.1%) minus the marginal cost of G&A expenses (1.1%) and minus the (insignificant) marginal impact of interest expenses (-.2). The coefficient associated with assets-squared is insignificant, thus providing no statistical support for the existence of economies of scale at the corporate level. The coefficients associated with the first two moments of debt are negative and positive respectively, consistent with the concave relationship between debt and interest expenses. -16 -

I Why Focus Matters Of principal importance, however, is the link between focus and cash flows available to shareholders. Our evidence provides no evidence of any such relationship: both of the individual coefficients are insignificant and the null hypothesis that the two are jointly equal to zero cannot be rejected at any usual significance level. The lack of a relationship between focus and net cash flows may appear inconsistent with the evidence in column three that supports a significant relationship between diversification and gross cash flows. However, by exploiting the deterministic relationships among the coefficients in columns three through six, we can ascribe and apportion this difference to the relationships between diversification and the two corporate level expenses. Although increased diversification along both dimensions increases gross cash flows, these benefits are essentially offset by higher G&A expenses and, in the case of property-type diversification, higher interest costs, perhaps due to lower collateral value. Focus and Value Results in the previous section provide no support for the hypothesis that focus affects performance as measured by cash flows available to shareholders. However, previous literature suggests that diversified firms are valued lower than focused firms. For this result to hold in our sample, it must be the case that the cash flows from diversified firms are discounted at a higher rate than the focused firm. In this section we concentrate on two such explanations for differing discount rates. Recall that throughout this analysis, we have examined cash flows by controlling for the size of the asset pool. Our metric for the size of the asset pool has been the replacement value of assets which we have estimated using the real-estate-market value of assets, rather than the actual purchase price. As a result, we cannot directly measure wealth losses or gains due to systematic over- or under- priced asset acquisition. However, if increased diversification taxes managements' ability to accurately value proposed projects, then less-focused firms would be more vulnerable to acquiring - 17 -

I Why Focus Matters "lemons." If diversified trusts consistently overpaid for acquisitions, or, equivalently, consistently acquired negative NPV projects, then their net-cash flow yields based on replacement values would not be affected. However, the growth rate of their cash flows would be reduced6. Since discount rates are the difference between the no-growth discount rate and the cash flow growth rate, trusts that consistently overpaid for assets would command higher discount rates. The second hypothesized link between focus and discount rates stems from liquidity. Amihud and Mendelson (1987) argue that the costs of transacting act like a tax and that rational agents discount the present value of such taxes into their valuation calculus. They then demonstrate that less liquid securities command a higher required rate of return. We argue that increasing the diversification of the asset base could curtail liquidity. Our argument is an extension of the analysis of Harris, Kriebel and Raviv (1982), who contend that information is more dispersed in conglomerates. As a result, information asymmetry costs increase with the diversification of the asset base. Such increases stem from increases in the noise component of monitoring and signaling. Although their analysis focuses on asymmetries between central administration and divisional managers, we posit that the intuition underpinning their analysis can be extended to examine the informational asymmetries between management and shareholders. We argue that if the asset base is more diversified, the asymmetric information problem is exacerbated since the ability of management to clearly and credibly signal the value of the firm or the amount of effort they expend is diminished. As a result, the ability of shareholders to value the firm and evaluate managerial efforts is likewise diminished. 6As a simple example, assume a trust owned a $100 property and yielded a "correct" net yield of 8%. Their first year's cash flows for shareholders would be $8. Now assume that the second year they sell the property and buy an equivalent property that yields $4.80. The new property's fair market (replacement) value is $60, (since $60 x 8% = $4.80). but the trust overpays and buys it for $100. Using our methods, we would show this REIT as yielding a normal net rate of return ($4.80/$60 = 8%). However, the growth rate of earnings would be negative. -18 -

Why Focus Matters The empirical analysis in this section has two aims. First, using a variant of Tobin's-q, we examine whether value varies with diversification. Although such a link has been thoroughly documented in the literature, our analysis is the first to examine whether value varies with diversification within a single industry. We choose Tobin's-q for our method for reasons similar to those expounded by Lang and Stulz (1994) who argue that: By focusing on Tobin's q, rather than on performance over time, we avoid some of the problems of the earlier literature.... since q is the present value of future cash flows divided by replacement costs, no risk adjustment or normalization is required to compare q across firms. Given our evidence showing no relationship between focus and cash flows available to shareholders, finding that diversified firms are valued lower than their focused counterparts indicates that discount rates vary with focus; The second objective of our empirical analysis is to determine the contribution of a link between focus an liquidity on discount rates. We will investigate whether liquidity varies with focus, and whether, after controlling for the impact of liquidity on discount rates, focus has any remaining effect on valuation. We will attribute any such residual impact as evidence consistent with the belief that managers of diversified trusts consistently overpay for their investments. The first column of Table 4 presents estimates of a specification where our version of Tobin's-q is regressed against a series of annual intercepts. As discussed in the data section, the dependent variable is the equity-market value of equity divided by the net replacement value of equity. The denominator is calculated by adding the real-estatemarket value of real estate assets and the book value of other assets, and then subtracting the book value-of debt Since this first specification contains only annual intercepts, the estimated coefficients can be interpreted as annual averages of our ratio. These averages declined from their heights of 1986 and 1987 until 1991. This decline can be attributed to equity market agents correctly anticipating declines in real-estate-market values due to overbuilding throughout the 1980's (see Hendershott and Kane (1995)). - 19 -

Why Focus Matters In the second column of Table 4, we augment the specification by including Herfindahl indices to capture the two dimensions of focus. There is evidence, albeit weak, that valuation varies with property-type focus. The coefficient associated with the propertytype Herfindahl is significantly positive, indicating that as focus increases towards one, the value of the firm increases. The magnitude of the coefficient is also economically significant. Comment and Jarrell (1995) compute Herfindahl concentration indices across SIC-defined lines of business. Using stock return data, they find that a.1 increase in a line-of-business Herfindahl is associated with a 3.5% wealth gain in two years. Our estimates suggest that, within a single SIC-defined line of business, a similar increase of.1 is associated with a 1.6% wealth gain. Focus and Liquidity Our strategy for determining whether the negative valuation effects associated with diversification are attributable to reduced liquidity requires two steps. The first step is to examine whether there is a link between liquidity and focus. If such a relationship exists, the second step we would take would be to investigate whether focus has any residual direct impact on value after controlling for the indirect impact of focus on value through liquidity. Empirically measuring liquidity is, itself, not trivial due to the complexity and multidimensionality of liquidity. A common approach is to measure inputs or determinants of liquidity, including quoted, effective or realized bid-ask spreads, or quoted depths. In contrast, we choose to measure liquidity using a measure that reflects the outputs of the market exchange process; namely, dollar trading volume. We regress annual dollar volume against the replacement value of assets and assets multiplied by the two Herfindahl concentration indices. Estimation via weighted least squares yields: - 20 -

I Why Focus Matters 1992 $Vol = Eat Dt + 0.93 Assets + 0.30 Assets * Type Focus t=1985 (11.9) (4.2) -0.02 Assets*Regional Focus +e (-0.3) The coefficient associated with assets can be interpreted as a turnover ratio. It suggests that the annual trading volume for a firm that is fully diversified along both dimensions is roughly 93% of the replacement value of its equity. However, the coefficient associated with property type focus indicates that this turnover ratio increases by 30% for a trust that is focused. The coefficient associated with regional diversification is insignificant. These results are consistent with the joint hypothesis that increased diversification along the property type dimension makes monitoring and valuation more difficult, thus eroding liquidity. Given that focus affects both firm value and liquidity, the final step of our analysis involves determining whether the deleterious effects of diversification on value are entirely attributable to the impact of focus on liquidity, or whether focus effects value through avenues other than liquidity. To do so, we augment our Tobin's q specification by adding annual dollar trading value. The results appear in the third column of Table 4. Consistent with the body of literature linking valuation to liquidity, the coefficient associated with dollar volume is positive and highly significant Of primary significance, however, is the result that adding liquidity to the specification causes the significance of focus to disappear. These results indicate that focus affects value, but only indirectly, and through the avenue of liquidity. After controlling for this direction of causation, there is no evidence that focus has any additional impact on firm value. - 21 -

I Why Focus Matters Conclusions: In this study, we provide three contributions to the already extensive literature linking corporate focus to firm value or performance. First, we demonstrate that focus affects firm value, even when focus or diversification is measured not over lines-of-business, but within a single SIC-defined line. Using our sample of Real Estate Investment Trusts, we demonstrate that diversification across property types (office, warehouse, retail or apartment) adversely affects value. Since all firms are within a single SIC classification, the gains to synergy should be great. However, despite our attempt to "stacked the deck" towards finding advantages to diversifying, we are unable to detect any advantages to diversifying. Thus we conclude that even the upper bound to synergistic gains is not economically meaningful. Our second contribution stems from our analysis of the relationships between cash flows and focus. We find that diversification does not lead to under performance. Indeed, our results show that less focused trusts actually earn higher gross yields from their properties, where yields are calculated relative to fair real-estatemarket values for the properties. However, the higher gross cash flow yields are offset by higher corporate level expenses, especially general and administrative expenses, for more diversified trusts. We interpret the positive relationship between diversification and G&A expenses as supporting a scenario where management teams are relatively larger for more diversified trusts. Overall, we find no evidence that cash flows available to shareholders vary with focus. Since cash flows are invariant to focus but value varies significantly with focus, we deduce that focus affects value through the discount rate. Our final contribution is to provide a unique linkage between focus and the discount rate. We argue that focus affects value via liquidity. Less focused firms are harder to value and monitor. As a result, information is most costly to collect, informational asymmetries increase and liquidity suffers. Since less liquid investments command a higher required rate of return, cash flows - 22 -

Why Focus Matters from less focused trusts are discounted at a higher rate and equity claims to these perpetuities have a lower value. Since focus affects the discount rate primarily through an indirect effect on liquidity and not directly on the discount rate, our results are inconsistent with managers overpaying for assets as a possible explanation of the value reducing impact of focus. Finally, we return to the question posed by the title- Why does focus matter? Our results point to an answer that is surprising. Since past research concludes that diversification decreases performance at the firm level, it is unclear why managers would ever choose to diversify. However, our results identify a potential motive; diversification improves performance at the project level. These increases may be attributed to managerial ability to extract higher returns from projects when they are diversified, or, more credibly, because diversified firms can review a broader selection of projects. By choosing from the entire universe of available projects a fully diversified firm in our sample can increase project level yield by 160 basis points (.75*129+.875*.73). Unfortunately, the extra project-level yield associated with diversification is not an economic "free-lunch." Indeed, this increase in gross yield comes only with a cost in the form of added administrative expenses. Managers may be aware of the extra G&A expenses associated with increased diversification but may choose to diversify despite these costs since the administrative expenses are not large enough to offset the benefits. Our estimate of these costs for a fully diversified firm is 47 basis points (.75*38+.875*21), leaving a net yield gain of over 1%. However, managers may or may not be aware of the severe penalty imposed by capital markets on diversified firms. Both the cost of debt and the cost of equity increase with diversification. In contrasting a fully diversified firm relative to the undiversified firm, our estimates indicate that the interest rate on debt is 47 basis points larger for the fully diversified firm, while our q-ratio estimates imply that equity will be discounted by 32% from the net replacement value of the equity (replacement value of the assets minus the -23 -

Why Focus Matters liabilities). The tremendous magnitude of this impact probably explains why earlier studies are able to find a significantly negative effect of diversification despite noisy data and low statistical power. We hypothesize that lenders and shareholders impose this severe penalty due to the exacerbation of the costs of information acquisition and information asymmetries when firms diversify. If the assets underlying a diversified firms are more difficult or costly for investors to evaluate, the collateral value of the underlying assets is lower, so lenders rationally demand a higher rate of return. Similarly, as Ippolito (1989) argues, as the cost of information acquisition increases, informed equity investors rationally demand a higher rate-or-return to compensate them for their greater information acquisition costs. We believe that our results represent strong support for nominating liquidity as a key driver in the focus-value relationship. References: Amey, L., 1964, "Diversified manufacturing businesses." Journal of the Royal Statistical Society 127. 251-290. Amihud, Yakov and Haim Mendelson, 1988, "Liquidity and asset prices: Financial management implications." Financial Management Spring 88, 5-15. Amit. R., and J. Livnat, 1988, "Diversification, capital structure. and systematic risk: An empirical investigation." Strategic Management Journal 9, 99-110. Bass. F., P. Cattin and D. Wittink. 1978, "Firm effects and industry effects in the analysis of market structure and profitability." Journal of Marketing Research 15, 3-10. Berger. P.. an E. Ofek, 1995, "Diversification's effect on firm value," Journal of Financial Economics 37, 39-65. Berry, C., "Corporate growth and diversification." Journal of Law and Economics 14(2), 371-383. Boyle. S., "Pre-merger growth and profit characteristics of large conglomerate mergers in the United States 1948-1968," St. John's Law Review 44, 152-170. Capozza, D. R. and S. Lee. 1995,"Propery type, size and REIT value," Journal ofReal Estate Research, 10,4, 363-380. Capozza, D.R. and Y. Li, 1994, "The Intensity and Timing of Investment: the Case of Land, " American Economic Review, 84, 4, 889-904. -24 -

I Why Focus Matters Capozza, D.R. and P. Seguin, 1996, "Corporate Structure, Managerial Style and Firm Value." University of Michigan working paper. Comment, R., and G. Jarrell, 1995, "Corporate focus and stock returns," Journal of Financial Economics 37, 67-87. Day, G., 1977, "Diagnosing the product portfolio," Journal of Marketing 41, 29-38. Didrichsen, J. 1972, "The development of diversified and conglomerate finns in the United States," Business History Review 46, 202-219. Gorecki, P., 1975, "An inter-industry analysis of diversification in the U.K. manufacturing sector." Journal of Industrial Economics 24, 131-146. Gorecki, P., 1980, "A problem of measurement from plants to enterprises in the analysis of diversification: a note," Journal ofIndustrial Economics 28, 327-334. Hako, B., 1972. "Strategies for diversification," Long Range Planning 5, 65-69. Harris, M., C. Kriebel, and A. Raviv, 1982, "Asymmetric information, incentives and intrafirm resource allocation," Management Science, 602-620. Hedley, B., 1977, "Strategy and the business portfolio," Long Range Planning 10, 9-15. Hendershott, P. and E. Kane, "U.S. office market values during the past decade: How distorted have appraisals been?" Real Estate Economics, 23, 2, 101-116. Lang, L., and R. Stulz, 1994, "Tobin's q, corporate diversification and firm performance," Journal of Political Economy 102, 1248-1280. Montgomery, C., 1982, "The measurement of firm diversification: Some new evidence," Academy of Management Journal 25, 299-307. Montgomery, C., 1985, "Product-market diversification and market power," Academy of Management Journal 28, 789-798. Montgomery, C., 1994, "Corporate Diversification," Journal of Economic Perspectives, 163-178. Palepu, K., 1985, "Diversification strategy, profit performance and the entropy measure," Strategic Management Journal 6. 239-255. Prahalad, C., and R. Bettis, 1986, "The dominant logic: a new linkage between diversity and performance," Strategic Management Journal 7,485-501. Ravenscraft, D., and F. Scherer, 1982a. "Structure-profit relationships at the line of business and industry level," Review of Economics and Statistics 65, 22-30. Ravenscraft, D., and F. Scherer, 1982b. "Structure-profit relationships at the line of business and industry level," Journal of Applied Economics 14, 603-620. Rumelt, R., 1982, "Diversification strategy and profitability," Strategic Management Journal 3, 359-369. Stulz, R., 1990, "Managerial discretion and optimal financing policies," Journal ofFinancial Economics 26, 3-27. - 25 -

I Why Focus Matters Varadarajan, P., 1986, "Product diversity and firm performance: an empirical investigation," Journal of Marketing 50,43-57. Wernerfelt, B., and C. Montgomery, 1988, "Tobin's q and the importance of focus in firm performance." American Economic Review 78,246-254. -26 -

I Why Focus Matters Table 1 The sample of REITs, drawn from the Equity REIT Database project, described in Capozza and Lee (1994). This database is constructed from the 1992 NAREIT (National Association of Real Estate Investment Trusts) source book, which lists all publicly traded REITs (209 REITs) as of December 31. 1991. The database excludes all mortgage, hotel, restaurant, and hospital REITs, REITs that do not trade on NYSE, AMEX, nor NASDAQ, or for which property information is not available. These exclusions lead to a sample of 75 REITs, which are listed here. Given this list. the researchers then attempted to construct one observation per REIT for each of the years between 1985 and 1992. Of the 75 equity REITs. 32 appear in all eight years and are annotated with a star (*), with the remaining appearing for at least one year. *B R E Properties Inc Berkshire Realty Co Inc *Bradley Real Estate Trust Burnham Pacific Properties Inc *California Real Estate Invt Tr Cedar Income Fund Ltd Cedar Income Fund 2 Ltd Chicago Dock And Canal Trust *Clevetrust Realty Investors *Continental Mortgage & Eqty Tr Copley Property Inc Cousins Properties Inc Dial Reit Inc Duke Realty Investments Inc *E Q K Realty Investors 1 *Eastgroup Properties *Federal Realty Investment Trust *First Union Real Est Eq&Mg Invts Grubb & Ellis Realty Inc Trust *H R E Properties *I C M Property Investors Inc *I R T Property Co Income Opportunity Realty Trust Koger Equity Inc Landsing Pacific Fund Linpro Specified Pptys *M G I Properties Inc *M S A Realty Corp *Meridian Point Realty Tr 83 *Meridian Point Realty Tr 84 Meridian Point Realty Trust IV Meridian Point Realty Trust VI Meridian Point Realty Trust VII Meridian Point Realty Trust VIII *Merry Land & Investment Inc Monmouth Real Estate Invt Corp *New Plan Rlty Trust *Nooney Realty Trust Inc *One Liberty Properties Inc P S Business Parks Inc Partners Preferred Yield Inc Partners Preferred Yield II Partners Preferred Yield IIl *Pennsylvania Real Est Invt Tr *Property Trust Amer *Prudential Realty Trust Public Storage Properties VI Public Storage Properties VII Public Storage Properties VII Public Storage Properties IX Inc Public Storage Properties X Inc Public Storage Properties XI Inc Public Storage Properties XII Public Storage Properties XIV Public Storage Properties XV Inc Public Storage Properties XVI Public Storage Properties XVII Public Storage Properties XVIII Public Storage Properties XIX Public Storage Properties XX *Real Estate Investment Trust Ca Realty South Investors Inc. *Santa Anita Rlty Enterprises Sizeler Property Investors Inc *Trammell Crow Real Estate Invs *Transcontinental Rity Invstrs *U S P Real Estate Investmt Trust *United Dominion Realty Tr Inc Vanguard Real Estate Fund I Vanguard Real Estate Fund II Vinland Property Trust *Washington Real Est Invt Tr *Weingarten Realty Investors *Western Investment Real Est Tr Wetterau Properties Inc - 27 -

I Why Focus Matters Table II Summary Statistics This table reports means, standard deviations and extreme values for a number of summary statistics calculated across our sample of 298 observations for 75 firms. Market value of assets are measured by estimated market value of properties plus the book value of other assets. The leverage ratio is defined as total liabilities / (total liabilities + market value of the equity). Tobin's Q was estimated as the ratio of the market value of properties plus the book value of other assets to the book value of total assets. Variable Mean Maximum Minimum Standard Deviation Market Value of Assets ($ Mil.) 170.8 752.2 6.7 1591.2 Weighted Capitalization Rate (%) 8.9 10.6 7.4 0.5 Net Operating Income ($ Thou) 15,002 70,407 416 14,370 G&A Expenses ($ Thou) 1,315 5,038 66 1,137 G&A / Total Assets (%) 1.1 4.7 0.0.75 Funds from Operation ($ Thou) 8,887 44,998 0.0 8,973.0 Cash Flow Yield (%) 8.9 58.0 0.0 5.1 Leverage Ratio (%) 36.8 94.4 0.3 25.0 Property Type Herfmdahl (%) 66.7 100.0 26.0 24.1 Property Region Herfindahl (%) 58.2 100.0 15.0 28.0 Quarterly Dollar Volume ($ Thou) 131.260.6 925,086 1,255.0 152,793.8 Tobin's Q 0.99.11 1.98.23 - 28 -

Why Focus Matters Table II: The Effects of Focus on Cash Flow Components Estimates from weight-least-squares regressions, with the (inverse of) estimates replacement or real-estate market value of assets used as weights. Indicator variables capturing calendar year are used as intercepts, but estimates of their associated coeffcients are not reported. The market value of assets are estimates of replacement or real-estate market values, based on Capozza and Lee (1996). Liabilities are book values of total liabilities. Property-type focus is a Herfindahl coefficient generated by summing the squared proportions of a firm's assets invested in each of four real estate types. Regional-focus is similarly, a Herfindahl index computed across nine geographic regions. The "F-test for Focus Significance" tests whether the two coefficients associated with the two dimensions of focus are simultaneously equal to zero. Asterisks indicate whether these test-statistics exceed the 5% (*), 1%(**) or.1%(***) critical values. All coefficient estimates have been multiplied by 100, except for squared assets and squared liabilities which have been multiplied by 108. Dependent Variable: Property- level Property- level Property- level G&A Expenses Interest Expenses Corporate- level Cash Flows Cash Flows Cash Flows Cash Flows Market Value of Assets 8.70 9.71 9.08 1.09 -0.24 8.23 (91.0) (33.9) (23.4) (7.9) (-1.0) (21.2) (Market Value of Assets)2 1.34 -0.27 1.68 -0.07 (2.0) (-1.1) (4.0) (-0.1) Liabilities 1.02 0.53 8.77 -8.28 (1.5) (2.2) (21.6) (-12.6) Liabilities2 0.13 -1.89 -4.65 6.64 (0.0) (-2.1) (-3.1) (2.7) Assets * Property type Focus -0.77 -1.29 -0.38 -0.48 -0.41 (-2.5) (-3.8) (-3.2) (-2.4) (-1.2) Assets * Regional Focus -0.80 -0.73 -0.21 -0.12 -0.41 (-2.9) (-2.7) (-2.1) (-0.8) (-1.5) Adjusted R2 89.9% 90.0% 90.9% 18.1% 88.9% 81.5% F-test for Focus Significance n/a 7.33* 10.65* 7.23 3.09* 2.0( - 29 -

I Why Focus Matters Table IV: Focus, Liquidity and Tobin's q Dependent variable is Tobin's q. Estimation by ordinary least squares. Indicator variables capturing calendar year are used as intercepts Property-type focus is a Herfindahl coefficient generated by summing the squared proportions of a firm's assets invested in each of four real estate types. Regional-focus is similarly, a Herfindahl index computed across nine geographic regions. The "F-test for Focus Significance" tests whether the two coefficients associated with the two dimensions of focus are simultaneously equal to zero. Asterisks indicate whether these test-statistics exceed the 10% (*), 5%(**) or 1%(***) critical values. Equation 1 Equation 2 Equation 3 1985 1.01 0.85 0.79 1986 1.21 1.04 0.96 1987 1.27 1.11 1.02 1988 1.07 0.89 0.87 1989 1.05 0.87 0.82 1990 0.98 0.81 0.76 1991 0.76 0.58 0.54 1992 0.84 0.67 0.63 Property Type Focus 0.16 0.11 (1.8)* (1.3) Regional Focus 0.12 0.08 (1.6) (1.0) Dollar Volume (x 106) 0.77 (5.8)*** Adjusted R2.17.18.26 F Statistic for Focus Signifance 2.55* 0.23 -30 -

Why Focus Matters........"W..;.... v.'::"::..::..:...:....:::Rawe ftw Propenies a::-:-:<::.:'::-::m.;>::i:.: i.:'!:j!'!:::::'s:/..............-...*....., ',.,....................................... ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~...... Wopertyvfl costapite I........................................................................................I I~ ~~~areae~dttsg Proert.......fmcgnestsPrpn es Pw n Ca.:~ (Pa)............ Imemg J~~~~~............... Ge~~~erar and Adwinisrativ4 (Q&A)Exjenses~~~~~~..............C..p...... J......k...1fi t s Corporaf4 CGSKFIQWS (Ca)~~~~~~~~~~~~~~~~~........... Dcpreemuou (uon~~~~~~~~~~~~~~~~~~~~~eash~~~~~~~zpen...s..a.. Net. nc.me....N...I>..... - 31 -

I Why Focus Matters Figure 1 Recursive Model Structure - 32 -

I