By Paul Wanner

(Editor's Note: Corporate governance continues to be a topic of interest with institutional investors and the media, both in the U.S. and internationally. Once again, the numbers confirm that REITs operate at or above the level of good governance seen in other industries. Independent, third-party data from Institutional Shareholder Services (ISS) shows the real estate industry for the second year ranked second only to the utilities industry in the ISS Corporate Governance Quotient rankings. In this column, ISS Ratings Manager Paul Wanner looks inside the numbers at how real estate companies stack up against other industries in specific governance areas.)

Institutional Shareholder Services' Corporate Governance Quotient (CGQ) is a rating system designed to assist institutional investors in evaluating the quality of corporate boards and the impact their governance practices may have on corporate performance. CGQ features corporate governance rankings on nearly 8,000 companies worldwide (5,300 U.S. companies and 2,400 international companies); companies do not pay a fee to be voted. ISS analyzes 63 data points to derive each U.S. issuer's CGQ score. Ratings are calculated on the basis of eight core categories: board of directors, audit, charter and bylaw provisions, anti-takeover provisions, executive and director compensation, progressive practices, ownership, and director education. Each company is ranked relative to its index and industry peer groups.

The group of real estate companies ISS tracks, which primarily includes REITs, exhibits superior governance practices relative to the entire universe of companies ranked by ISS. Real estate companies have an average CGQ of 61.0 as of April 20, 2006, higher than every other industry except utilities, which has an average CGQ of 69.0. The average CGQ for all industries is 50.5. Real estate also ranked second behind utilities at this time last year.

Overall, the real estate industry has much stronger governance practices across the board than the U.S. CGQ coverage universe as a whole. In particular, the real estate industry stands out in the areas of takeover defenses and shareholder rights. The two areas where real estate is lagging are its higher-than-average option grant burn rate and compensation plan costs, as well as its higher likelihood that real estate companies will have related-party transactions involving the CEO and other officers and directors. The table below lists the five variables where the industry most strongly outperforms other companies. Four out of the top five variables are in the takeover defenses category.

Board Composition

One of the front burner governance issues ISS tracks is the independent director composition of the board and key committees. REITs and other publicly traded real estate companies are more likely than the "all-company" group to have between 50 percent to 75 percent independent outsider composition of the board, but less likely to have more than 75 percent independent outsider composition. The fact that real estate companies are more likely to have fully independent nominating, compensation and audit committees is a major contributor to the industry's higher average CGQ. Real estate firms are also more likely–by 15 percentage points–to have established governance committees.

Board Governance Practices

The Board Governance Practices category evaluates progressive governance practices that have been adopted by corporate boards to ensure that they are run as effectively as possible. Real estate companies are more likely to adopt progressive governance practices such as having a board-approved CEO succession plan, reviewing the performance of the board as a whole as well as the performance of individual directors, and limiting the service of outside directors on other boards.

There are two areas in the Board Governance Practices category where REITs have weaker than average governance practices: having a combined CEO/chairman role and the existence of related-party transactions. CGQ considers having a combined CEO/Chairman role to be a weak governance practice. The best practice is to have separate Chairman and CEO roles where the Chairman is an independent outsider. CGQ considers the existence of related-party transactions to be possible indicators of risk and thus a weak practice. Therefore, real estate companies would be better ranked if fewer companies had related-party transactions.

Real Estate vs. Other Industries
CGQ Rating Factor	% Of Real Estate Companies Meeting This Criteria	% Of All U.S. Companies Meeting This Criteria	Difference
Incorporation in a state with stakeholder laws but company has opted out	56.4%	3.8%	52.5%
Company has no poison pill	63.9%	25.3%	38.6%
Incorporation in a state with a control share acquisition statute, but company has opted out	43.6%	8.1%	35.5%
Governance guidelines have been publicly disclosed on the company website	74.4%	43.3%	31.1%
Shareholders may call special meetings	74.9%	44.1%	30.8%
Source: ISS Data as of April 20, 2006

Not only are real estate firms more likely to combine the CEO and chairman position, but when the roles are separated, the chairman is less likely to be an independent outsider. From the larger governance perspective, the checks and balances provided by the prevalence of other progressive and shareholder-friendly practices should mitigate the effect of having a combined CEO/chairman position.

Compared to all other U.S. companies, real estate firms are 21 percentage points more likely to have CEOs involved in related-party transactions, and also more likely to have other (non-CEO) officers and directors involved in related-party transactions. This remains an area for improvement within the industry.

Average CGQ Ranked By Industry
Industry Group	Total
Utilities	69.0
Real Estate	61.0
Pharmaceuticals & Biotechnology	54.0
Banks	53.0
Materials	52.9
Capital Goods	52.5
Technology Hardware & Equipment	51.6
Insurance	51.0
Consumer Durables & Apparel	50.5
Average	50.5
Semiconductors & Semiconductor Equipment	50.4
Food & Staples Retailing	50.2
Health Care Equipment & Services	50.0
Commercial Services & Supplies	49.5
Software & Services	48.9
Transportation	48.7
Diversified Financials	47.8
Automobiles & Components	47.5
Consumer Services	46.5
Energy	46.1
Retailing	45.3
Telecommunication Services	40.2
Food Beverage & Tobacco	40.1
Media	37.2
Household & Personal Products	35.6
Source: ISS. Data as of April 20, 2006

Takeover Defenses & Shareholder Rights

Takeover Defenses and Shareholder Rights is the category that assesses the access that shareholders have to the ballot and the types of anti-takeover measures adopted by the company. On average, REITs have fewer takeover defenses and are more likely to adopt shareholder-friendly practices than U.S. companies as a whole. Real estate firms are less likely to have classified boards (structure of ignoring majority supported shareholder proposals), unequal voting rights and poison pills. The REITs with poison pills are more likely to have three-year independent director evaluation (TIDE) provisions, which mitigate the effects of the pills. While real estate companies are slightly more likely to be incorporated in states with anti-takeover statutes, they also are more likely to opt out of those statutes.

Compensation & Ownership

Compensation & Ownership appraises the extent to which managers' interests are aligned with those of shareholders through the ownership structure and policies of the company and its compensation practices. The real estate industry underperforms on two key compensation rating factors. Compared to other U.S. companies, REITs and other publicly traded real estate companies are more likely to have excessive option grant burn rates, as well as a compensation plan deemed excessively costly by ISS—despite the fact that real estate companies are more likely to have stock-based incentive plans approved by shareholders.

ISS Leads the Pack on Governance Rankings Institutional Shareholder Services, Inc. (ISS) is an advisor to big shareholder on corporate elections. It also provides proxy-voting and corporate governance services, and has more than 20 years of experience. ISS serves more than 1,600 institutional and corporate clients worldwide with its core business—analyzing proxies and issuing informed research and objective vote recommendations for more than 35,000 companies across 115 markets worldwide. It's core businesses include global proxy services and database and research tools for institutional investors. The company has more than 15 years of experience with a team of domestic and international research analysts. ISS provides accurate research on proxy issues and corporate governance. The company's research and proxy voting policies are designed on the premise that good corporate governance ultimately results in increased shareholder value. Good corporate governance is the foundation of a solid, well-run corporation. While independent directors bear much of the responsibility to ensure good corporate governance, shareholders also play a critical role in the governance process. As the largest shareholders, institutional investors monitor the performance of both management and the board of directors. ISS' assists institutional investors and corporations in meeting their governance responsibilities.

Stock ownership by officers and directors is viewed favorably by governance experts on the theory that stock ownership aligns the interests of management with the interests of shareholders. Many real estate companies pay their directors with stock, as well as subject their executives and directors to stock ownership guidelines. Additionally, real estate companies are more likely to require recipients of stock options to hold a portion of their options/grants for a specified period of time after exercise/vesting, but less likely to require holding restricted stock for a mandatory period of time after grants are issued. They also are likely to disclose the hurdle rates that must be reached for incentive equity awards to be granted, further aligning the long-term interests of shareholders with management.

Top 50 Real Estate Companies, Ranked By Industry CGQ
Company Name	Ticker	Index Group	Index CGQ	Industry CGQ
Duke Realty Corporation	DRE	Russell 3000	99.9	100.0
Equity Office Properties Trust	EOP	S&P 500	97.9	100.0
Developers Diversified Realty Corporation	DDR	S&P 400	99.2	99.2
Colonial Properties Trust	CLP	S&P 600	99.0	98.7
National Retail Properties, Inc.	NNN	S&P 600	98.7	98.3
Equity Residential	EQR	S&P 500	86.0	97.9
Parkway Properties, Inc.	PKY	S&P 600	97.2	97.5
AMB Property Corporation	AMB	S&P 400	92.2	97.0
Nationwide Health Properties, Inc.	NHP	Russell 3000	98.2	96.6
Ventas, Inc.	VTR	Russell 3000	98.0	96.2
United Dominion Realty Trust, Inc.	UDR	S&P 400	87.7	95.8
Plum Creek Timber Company, Inc.	PCL	S&P 500	69.5	95.3
Capstead Mortgage Corporation	CMO	CGQ Universe	99.8	94.5
Liberty Property Trust	LRY	S&P 400	83.6	94.1
Simon Property Group, Inc.	SPG	S&P 500	58.1	93.6
Fieldstone Investment Corporation	FICC	Russell 3000	96.1	93.2
Shurgard Storage Centers, Inc.	SHU	S&P 600	90.0	92.8
Health Care REIT, Inc.	HCN	Russell 3000	95.6	91.9
RAIT Investment Trust	RAS	Russell 3000	95.3	91.5
Brandywine Realty Trust	BDN	Russell 3000	94.6	91.1
Apartment Investment & Management Company	AIV	S&P 500	48.9	90.7
iStar Financial Inc.	SFI	Russell 3000	94.4	90.3
EastGroup Properties, Inc.	EGP	S&P 600	85.5	89.8
Redwood Trust, Inc.	RWT	Russell 3000	93.9	89.4
Lexington Corporate Properties Trust	LXP	S&P 600	85.3	89.0
BRE Properties, Inc.	BRE	Russell 3000	93.6	88.6
Reckson Associates Realty Corp.	RA	Russell 3000	93.5	88.1
Entertainment Properties Trust	EPR	S&P 600	84.5	87.7
Weingarten Realty Investors	WRI	S&P 400	68.0	87.3
AvalonBay Communities, Inc.	AVB	Russell 3000	93.0	86.9
Rayonier Inc.	RYN	S&P 400	66.8	86.4
ProLogis	PLD	S&P 500	40.0	86.0
Federal Realty Investment Trust	FRT	Russell 3000	92.3	85.6
American Campus Communities, Inc.	ACC	Russell 3000	92.3	85.6
Sizeler Property Investors, Inc.	SIZ	Russell 3000	92.1	84.7
PS Business Parks, Inc.	PSB	Russell 3000	92.0	84.3
New Plan	NXL	S&P 400	63.2	83.5
Heritage Property Investment Trust, Inc	HTG	Russell 3000	90.8	83.1
Mack-Cali Realty Corporation	CLI	S&P 400	59.7	82.6
Pan Pacific Retail Properties	PNP	Russell 3000	88.5	82.2
Glenborough Realty Trust Inc.	GLB	S&P 600	73.3	81.8
Government Properties Trust, Inc	GPT	Russell 3000	88.3	81.4
DiamondRock Hospitality Company	DRH	Russell 3000	88.2	80.9
Pennsylvania Real Estate Investment Trust	PEI	Russell 3000	88.1	80.5
Acadia Realty Trust	AKR	S&P 600	70.3	80.1
Lasalle Hotel Properties	LHO	Russell 3000	87.7	79.7
Trammell Crow Co.	TCC	Russell 3000	86.6	79.2
Home Properties, Inc.	HME	Russell 3000	86.5	78.8
Kite Realty Group Trust	KRG	Russell 3000	85.9	78.4
The St. Joe Company	JOE	Russell 3000	85.7	78.0
Source: ISS. Data as of April 20, 2006.

Audit

The Audit category examines key audit practices of the company. REITs and other publicly traded real estate companies tend to pay a higher percentage of non-audit fees (as a percentage of the total fees) to auditors, and are less likely to ratify auditors at annual meetings. This last point is surprising, given that the REIT industry is generally very shareholder-friendly. Also, real estate companies are more likely to have audit committees comprised entirely of financial experts.

In conclusion, the real estate industry continues to exhibit stronger governance practices than almost all other industry sectors rated by CGQ. The two areas where the real estate sector can improve the most are lowering its higher-than-average option grant burn rate and compensation plan costs, and ensuring that related-party transactions do not evolve into serious conflict-of-interest problems. Overall, the shareholder-friendly practices adopted by REITs and other publicly traded real estate companies, the high degree of independence on key board committees, and the optimal ownership structures prevalent in the real estate industry make this sector a model of strong governance practices.