INTRODUCTION
Problem statement
Businesses that incorporate debt into their capital structure can benefit from the debt tax shield, as interest expenses are deducted before calculating taxable profits, thus lowering corporate income tax obligations While some studies indicate that taxes influence capital structure, debates persist regarding this theory Early capital structure theorists, including Modigliani and Miller (1958) and DeAngelo and Masulis (1980), found that increased debt financing can lead to changes in capital structures driven by tax benefits Recent research, such as Princen (2012), suggests that equal tax treatment for debt and equity can reduce corporate debt usage by 2-7% compared to traditional tax systems Additionally, Panier, Perez-Gonzales, and Villanueva (2012) observed a significant increase in the equity ratio of Belgian firms following a tax reform, rising from 32.6% in 2004-2005 to 34.2% in the subsequent years.
Vietnam's corporate tax system is characterized as a traditional model, where companies are taxed on their profits, calculated as business income minus the costs incurred to generate that income Interest expenses paid to creditors are tax-deductible, which reduces taxable income However, dividends paid to shareholders are included in the taxable base and are subject to taxation.
In 2004, the Vietnamese government introduced Decree No 187/2004/NĐ-CP, which facilitated the transformation of state enterprises into joint stock companies by offering preferential corporate tax policies Specifically, Article 36 of this decree allowed after-equitization enterprises to benefit from tax incentives similar to those given to new business establishments, as outlined in Decree No 164/2003/NĐ-CP This included a corporate income tax rate of 28%, with reduced rates of 10-20% based on geographical and industry factors, resulting in a tax reduction of 8-18% for state enterprises undergoing equitization Various equitization methods were available, such as maintaining state capital while issuing additional shares, partially selling state capital with new share issuance, or completely divesting state capital while issuing more shares However, on February 14, 2007, Decree No 24/2007/NĐ-CP revoked these tax incentives for state enterprises transitioning to joint stock companies, as stated in Article 46.
According to Decree No 187/2004/NĐ-CP, joint stock companies formed from the equitization of state enterprises before the expiration of Decree No 24/2007/NĐ-CP are eligible to continue receiving tax incentives for the remaining duration Conversely, state enterprises that transitioned to joint stock companies after February 14, 2007, are not entitled to these tax benefits.
This study examines the effects of tax reform on the leverage of Vietnamese firms, revealing that preferential tax rates lead to a reduction in company leverage Utilizing a Difference in Difference identification strategy, the research compares the leverage of state enterprises, identified as the treated group, against other companies in the control group The analysis covers the period from 2001 onward.
2007 is divided into two stages, the sample related to the period 2001 to 2003 belongs to the pre-treatment data and those in the period 2004- 2007 is the post- treatment data.
This study aims to explore the relationship between preferential tax policies and corporate financing decisions in Vietnam, specifically examining whether this relationship is positive or negative Additionally, it investigates whether large companies or small and medium enterprises (SMEs) adjust their leverage ratios more significantly in response to tax changes.
Research objectives
There are two crucial research objectives of this study.
Firstly, investigating the effects of preferential tax policytax changes on companies’ capital structures.
Secondly, determining which type of companies respond their own financial decisions to tax changes more, among Large Companies and SMEs.
Organization of the study
This study is structured as follows: Chapter 2 reviews previous research on tax changes, exploring various approaches to their definition, capital structure measurements, and factors influencing capital structure decisions, while highlighting two common regression methodologies and their empirical findings on the impact of tax changes Chapter 3 outlines the research methodology and data, detailing the identification strategy and empirical specifications Chapter 4 presents the main regression results, and Chapter 5 concludes the discussions.
LITERATURE REVIEW
Tax changes
Tax changes significantly influence capital structure, serving as an independent variable in their relationship To assess this impact, two primary approaches have been utilized in previous studies The first involves analyzing tax changes over an extended period within a specific region to identify correlations with firms' capital structures The second approach treats tax reforms as exogenous events, examining companies' financial decisions both prior to and following a tax reform in a given country.
2.1.1 Tax changes are observed over a long period
Faccio and Xu (2015) highlighted significant changes in taxation among OECD countries, noting 84 adjustments in corporate tax rates and 298 modifications in personal tax rates from 1981 onward.
Utilizing a variety of shifts in statutory tax rates offers three key advantages at both corporate and personal levels First, it confirms the impact of tax changes on firms' financial decisions over time, minimizing the risk of spurious results Second, it addresses issues related to personal taxes while assessing the effects of different tax types on corporate leverage Lastly, the extensive range of tax changes over a prolonged period enhances data quality and boosts the reliability of empirical findings.
In 2015, Heider and Alexander highlighted the significance of taxes in influencing firms' capital structure choices by analyzing 121 changes in state corporate income tax rates across the U.S from 1989 to 2011, including both tax increases and cuts Their work built on earlier research by Roger and Lee (1999), who were pioneers in this field, examining how firms of varying sizes adjust their financial structures in response to tax incentives They found that smaller corporations typically face lower marginal tax rates compared to larger firms, based on extensive tax structure changes from 1954 to 1995 These tax changes are crucial in the empirical models used in such studies.
2.1.2 Tax change is considered as an exogenous event.
In 2006, the Belgian government implemented a tax reform known as the Notional Interest Deduction (NID), allowing both domestic and foreign firms established in Belgium to deduct a notional return based on their book value of equity This deduction is calculated using the average 10-year Belgian government bond rate from two years prior, capped at a maximum of 0.5 percent and limited to a 1 percentage point annual variation The NID aims to reduce tax discrimination between debt and equity, making it a significant exogenous event for researchers, including Panier, Perez-Gonzales, Villanueva (2012), and Katrien, Cauwenberge, and Christiaens.
(2012) applied this event However, each research has different samples from each other For example, the samples of Panier et al are Belgian companies while
Katrien et al examined the impact of tax systems on small and medium entrepreneurs, while Princen (2012) addressed a related concept known as Allowance for Corporate Equity (ACE), akin to Notional Interest Deduction (NID), which provides equity tax relief This tax framework allows for the same deductibility for returns on equity as is typically granted for interest expenses on debt, promoting tax neutrality between these two primary financing sources and eliminating the preferential treatment of debt over equity in corporate taxation.
In 2013, Lin and Flannery analyzed the impact of the 2003 Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) on corporate leverage, focusing on significant reductions in dividend tax rates from 38.6% to 15% and long-term capital gains tax rates from 20% to 15% for individual investors This tax reform serves as an exogenous event, creating an ideal scenario to investigate how individual taxation influences firms' capital structure decisions.
In 1997-1998, Italy implemented a tax reform known as the Dual Income Tax (DIT), which significantly altered the taxation of interest payments through the New Regional Tax on Value Added (IRAP) The DIT system lowered the tax rate on taxable income representing the opportunity cost of equity from 19 percent to a normal rate of 37 percent for income exceeding this cost In 1998, IRAP replaced the previous tax system (ILOR) with a 4.25 percent rate based on value added, resulting in a reduction of the overall profit tax from 53.2 percent to 41.25 percent This new tax regime favored debt over equity in corporate behavior.
More than two decades ago, there was an extremely legendary tax reform in US
1986 that inspired to the scientific communication to implement the workouts regarding to the relationship between taxes and financial structures’ companies.
The Tax Reform Act of 1986 (TRA) significantly transformed the U.S tax landscape by lowering corporate tax rates and reducing personal tax rates, which diminished the value of tax shields for firms (Givoly et al., 1992) According to Gordon and Jeffrey (1991), this legislation represented the most substantial alteration in U.S tax law since World War II Initially, the maximum tax rate decreased from 46% in 1986 to 40% in 1987, and further to 34% in 1988, now applicable to income exceeding $75,000 instead of $100,000 In empirical studies, tax changes are often represented by a dummy variable that indicates the period following the tax reform.
Measurements of capital structure and several elements have impact on capital
Capital structure is represented by a firm's leverage or debt ratios, which significantly influence the relationship between tax changes and capital structures Various metrics for measuring leverage ratios exist, reflecting differing perspectives among researchers.
The early discussion on the impact of taxes on corporate financing decisions involved calculating a firm's debt ratio by dividing the annual book value of long-term debt by the total of long-term debt and the market value of equity, as established by Bradley, Jarrell, and Kim (1984) This formula has since been utilized in various analyses, including a study by Givoly, Hayn, Ofer, and Sarig (1992) that examined the implications of the Tax Reform Act of 1986 (TRA).
The debate over whether book value or market value is more suitable for calculations and yielding accurate results is complex, influenced by varying perspectives in scientific discourse and the characteristics of the samples studied Despite the challenges, book value is often preferred due to its advantages, such as the ease of extraction from financial statements, as noted by researchers including Roger and Lee (1999) and Staderini (2001).
Cauwenberge and Christiaens (2011); Princen (2012) and Lin and Flannery
In 2013, leverage was assessed by calculating the average book debt relative to average book assets Frank and Goyal's analysis highlighted the importance of combining book value and market value to enhance the robustness of financial assessments.
In 2009, various financial ratios were analyzed, including total debt relative to the market value of assets, total debt compared to the book value of assets, long-term debt against the market value of assets, and long-term debt in relation to the book value of assets, highlighting the contributions of Heider and others in this area of study.
Ljungqvist (2015) introduces a unique approach to leverage calculations, including long-term book leverage, total book leverage, and long-term market leverage, all defined by similar formulas Notably, these calculations differ from traditional methods by using the value of equity divided by total assets, rather than the usual inverse This innovative perspective is evident in various studies.
Panier, Perez-Gonzales and Villanueva (2012) and Schepens (2016).
2.2.2 The impact of several elements on capital structure.
In addition to exploring the primary relationship between tax changes and firms' leverage, various independent variables have been incorporated into the regressions, aligning with established capital structure literature.
Firm size please give a subtitle for each element that you would like to consider
Firm size, often assessed through the logarithm of total assets, is a key factor influencing leverage Larger firms tend to exhibit a positive correlation with leverage due to their stable cash flows, which enables them to utilize more debt effectively to enhance tax benefits.
(Marsh, 1982) Studies of Schepens (2016), Lin and Flannery (2013), Princen
Research by Gorden and Lee (1999) indicates that firms of varying sizes adjust their financial structures in response to tax incentives, demonstrating a significant relationship between tax policies and corporate financial behavior.
Formatted: Font: Bold Formatted: Font: Italic Formatted: Font: Bold
The impact of taxes on debt levels is significant, particularly influencing the leverage of both small and large firms, while having a minimal effect on intermediate-sized companies.
Labor costs significantly affect a company's capital structure, as highlighted by Serfling (2013), who discovered that firms reduce their debt financing in response to increased labor expenses This trend may be attributed to the fact that higher employee costs can result in elevated financial distress costs, prompting companies to lower their leverage ratios.
The liquidity ratio, calculated by dividing the total value of assets excluding inventories by total debt, negatively impacts leverage This indicates that firms with higher liquid assets tend to rely less on debt for financing their operations.
According to Wessels (1988), firms with low liquidity may face significant bankruptcy costs during financial distress, which can arise from excessive leverage ratios Consequently, it is anticipated that liquidity negatively influences the debt ratio.
A key factor influencing investment value is the change in fixed assets from the previous year There tends to be a negative correlation between investment value and a firm's leverage; as investment increases, managers often reduce protective measures related to leverage ratios due to concerns about potential financial distress linked to new opportunities Consequently, firms may opt to decrease debt within their capital structure, as noted in Princen (2012).
Klemm and Parys (2011); Frank and Goyal (2009); Chirinko and Wilson (2008)
Tangibility, defined as the ratio of tangible assets (net property, plant, and equipment) to total assets, often negatively affects leverage This is largely due to the impact of deductible expenses from depreciation after tax, which can exert a more significant influence than debt financing (Princen, 2012).
Profitability (Ratio of earnings before interests, taxes, depreciation and amortization (EBITDA) to book value of total assets) appears in a mass of studies of Schepens (2016), Lin and Flannery (2013), Princen (2011), Katrien,
Cauwenberge and Christiaens (2011), Frank and Goyal (2009), etc According to
Rajan and Zingales (1995), causes companies tend to have a favor of using retaining earning for profitability target, leverage may have the negative correlation with profitability.
Two main methodologies and empirical results regarding the effect of tax changes on
tax changes on capital structure’s decision in prior researches
2.3.1 Two main methodologies in prior researches
A widely used method for analyzing the effects of tax changes on capital structure is Ordinary Least Squares (OLS) This approach assumes a causal relationship where tax changes (X) directly influence firms' leverage (Y) Research spanning extended periods, such as studies by Faccio and Xu (2015) and Phan (2011), supports this connection between tax modifications and corporate leverage.
The Difference in Difference (DID) methodology is widely utilized in analyzing companies' financial decisions surrounding tax reforms in various countries In this approach, tax reform is treated as an exogenous event, represented by a dummy variable that assigns a value of one to the period following the reform and zero to the period preceding it Typically, the tax reform impacts a specific group of enterprises, referred to as the treatment group, while unaffected companies serve as the control group, highlighting the inherent differences between them The effects of tax policy can be assessed by comparing the leverage ratios of these two groups before and after the reform This methodology has been employed in several prior studies, including those by Panier, Perez-Gonzales, and Villanueva (2013), Princen (2012), and Kestens, Cauwenberge, and Christiaens (2012).
2.3.2 Empirical results in prior researches’ summary
Previous research indicates that tax changes significantly influence firms' financial leverage, though the specific effects vary While some studies demonstrate a positive relationship between tax alterations and leverage, others reveal a negative correlation, highlighting the complexity of this relationship.
A 2015 study by Heider and Ljungqvist highlighted the significant impact of taxes on firms' capital structure decisions Analyzing data from 1989 to 2011, the researchers observed 121 changes in corporate income tax rates across various US states, employing a Difference-in-Differences (DID) approach to assess how these tax changes influenced firms' leverage The study categorized firms affected by tax changes as the treatment group, while those unaffected served as the control group Findings revealed that firms tend to increase their long-term leverage in response to rising tax rates and maintain their leverage levels when tax rates decrease.
In a contribution in 2013, Lin and Flannery compared companies’ leverages in
A study conducted in 2002 and 2004 analyzed the effects of a US tax decline in 2003 on firms' debt ratios, utilizing the Difference-in-Differences (DID) method The findings revealed that companies with individual owners experienced an approximate 5 percentage point decrease in their book leverage value, compared to an average of 19.9 percent across the entire sample in 2002 This empirical evidence clearly indicates that individual taxation leads to a reduction in firm leverage.
A series of analyses focused on the 2006 tax reform in Belgium reveal that Belgian companies significantly adjusted their leverage in response to changing tax incentives Notably, corporations are increasingly moving away from favoring debt over equity in their capital structures, resulting in a decrease in financial leverage (Panier, Perez-Gonzales, and Villanueva, 2013; Princen).
2012 and Kestens, Cauwenberge and Christiaens, 2012).
Staderini (2001) examined the impact of tax reforms implemented in 1997-98, specifically the reduction of tax rates, on corporate financial structures Analyzing data from 1992 to 1998, the study categorized firms into two groups: those meeting legal requirements to utilize the DIT tax system and those that did not The findings revealed that firms adjusted their leverage in response to the tax changes, indicating a significant relationship between tax policy and corporate financial behavior.
Driving from the Tax Reform Act of 1986 in US, Givoly, Hayn, Ofer, and Sarig
Research by Gordon and Mackie-Mason (1991) and others in 1992 indicates a positive correlation between leverage and corporate tax rates, highlighting incentives for firms to increase debt financing Additionally, the interplay between debt and non-debt tax shields, along with personal tax rates, significantly influences a company's leverage decisions.
In a study by Schepens (2016), the effect of tax on the capital structure decisions of financial institutions was analyzed using a Difference-in-Differences (DID) approach, focusing on a tax reform introduced in Belgium in 2006 The research involved data from Belgian banks (the treatment group) and European banks (the control group) from 2003 to 2007, with 2006-2007 representing the post-treatment period The findings revealed that tax shields significantly influence bank capital structure decisions, particularly by increasing the equity ratio Additionally, the study concluded that the changes in tax treatment led to an increase in bank equity rather than a reduction in activities.
Studies represent both positive and negative relationships
Faccio and Xu in a research the year 2015 based on the changes in corporate tax rates and personal tax rates among OECD countries from 1981 to 2009 (184 and
A study examining the impact of tax changes on firms' financial decisions identified 298 significant alterations The findings revealed that capital structure choices are influenced by both corporate and individual taxes, indicating a positive correlation between corporate taxes and firms' leverage, while personal dividend taxes exhibit a negative relationship with leverage.
In a study conducted by Phan (2011), the effect of income tax regimes on the capital structures of Vietnamese listed firms was analyzed from 2005 to June 2010, utilizing the OLS method with a sample of 219 firms listed on the Ho Chi Minh Stock Exchange (HOSE) The findings revealed a significant negative impact of personal income taxes on the debt ratios of these firms, while a positive correlation was observed between corporate income taxes and both long-term and short-term debt ratios in 2008.
Chapter remark
This study examines the impact of Vietnam's 2004 tax reform on firms' financial decisions, utilizing a Difference-in-Differences (DID) methodology The reform introduced preferential tax policies, reducing corporate income tax rates from 28% to between 10% and 18% for state enterprises undergoing equitization In this context, state enterprises serve as the treatment group, while unaffected companies act as the control group The analysis differentiates between pre-treatment (before 2004) and post-treatment (after 2004) periods, highlighting the relationship between tax changes and financial structure A conceptual framework will illustrate the key relationships and controlled elements discussed in this chapter.
Formatted: Font color: Text 1 Formatted: Font color: Text 1
Figure 1: The mechanism of the relationship between taxes change and financial structure
Formatted: Font color: Text 1 Formatted: Font color: Text 1 Formatted:
(number of employees) Balance sheet
Firm size, Liquidity ratio, Investment and Tangibility
+ Changing over long time (OLS)
+Debt ratio/leverage + Equity ratio
Profitability, ROE, Profit margin, Inventories turnover Net Operating Loss
DATA AND METHODOLOGY
Data source
Annual financial data used in this study are collected from the survey of
Vietnamese Small and Medium Enterprises (SMEs) in 2013 which is implemented by Center Institute Economic Management (CIEM) The quality of
Vietnamese firms are expected to have substantial data, as this dataset comes highly recommended by esteemed professors and graduate students from VNP, a collaborative project with the International Institute of Social Studies at Erasmus.
Rotterdam University and The University of Economics in Ho Chi Minh city
The database contains data for approximate 135,000 companies from the year
2001 to 2007 which gathers all types of enterprises and their annual financial information Tax new regime was enacted by Vietnamese government on
The study analyzes the impact of tax reform on state companies undergoing equitization between 2004 and 2007, using a balanced panel data approach that includes pre-treatment data from 2001 to 2003 The treatment group consists of state companies at the end of 2003, while the control group comprises other firms not affected by the reform To ensure data integrity, firms from the real estate and financial sectors were excluded due to their distinct financial characteristics Additionally, observations with extreme values or missing data were removed, resulting in a sample of 230 treatment firms and 680 control firms, each with seven observations The analysis examines the causal relationship between capital structures and tax regimes, incorporating various financial indices and macroeconomic factors such as inflation and GDP growth, sourced from the World Bank, to prevent distortion of the empirical results.
Empirical model
In the Literature Review section, particularly in part 3, I highlighted the Difference in Difference (DID) approach as a popular method for assessing the impact of tax reform on capital structure Following the studies by Princen (2012) and Panier, Perez-Gonzales, and Villanueva (2013), I identify the tax change in Vietnam in 2004 as an exogenous event that influences firms' leverage ratios, which can be analyzed as a function of tax-related factors Additionally, I categorize the sample into two distinct groups: the treatment group and the control group.
This study analyzes the impact of tax reform on state enterprises by comparing them with a control group of non-state companies Using the Difference-in-Differences (DID) methodology, the research evaluates the performance of both groups before and after the implementation of the tax reform The findings are derived from the application of the DID equation, providing insights into the effects of the reform on state-owned enterprises.
+ ��� (Financial leverage): the ratio of financial debt (long- term debt and loans) to total assets (Rajan and Zingales (1995)) of company i in year t.
+ ��� (State Enterprise) be a fixed effect dummy (equal to one if a state enterprise (the treatment group), equal to zero if a non-state enterprise (the un- treatment group),
+ �� (or Time) be a fixed year effect dummy (equal to one if after the tax reform (2004-2007), equal to zero if before the tax reform (2001-2003)
+ ����� (proxied for SEi * Tt) is a dummy variable, takes one if the observation is a state company and if it is done after the tax reform, zero otherwise.
The coefficient ρ quantifies the variation in outcomes for the treated group compared to the control group in the years following a tax reform, relative to the years prior This measurement highlights the marginal difference between pre- and post-reform periods, emphasizing the economic significance of tax changes It is anticipated that γ, representing time-invariant firm effects, will show a negative and significant value Figure 2 visually illustrates the differences observed between the two groups following this exogenous event.
When implementing an empirical strategy for tax reform analysis, it is crucial to recognize potential obstacles Although tax reform itself is a clear exogenous event, various concurrent events can significantly skew the results This distortion can occur if these events coincide with the tax reform, leading to misleading conclusions.
The adoption of a new tax regime is influenced by 29 varying characteristics, which may introduce bias in the analysis This study addresses the issue by comparing state enterprises (the treatment group) with un-state enterprises (the control group), ensuring that both groups face similar industry and external shocks This approach allows for a more accurate evaluation of the impact of the tax regime change.
Figure 12: The difference between two groups after exogenous event
Previous research on capital structure indicates that various individual control variables should be integrated into the model In addition to numerous financial indicators, factors such as the inflation index and GDP growth rate are included to account for macroeconomic shocks Each of these indicators possesses distinct values corresponding to specific years within the data period Key covariates of the model are outlined in Table 1.
Table 1: Variables’ definitions and measurements
Natural assets logarithm of Total Billion Vietnam dong
Labor The number of labor People Negative
Liquidity ratio (Total assets- Inventories)/
(Fixed asset of the current year
- Fixed asset of the previous year)/ Fixed asset of the previous year
Book value of tangible fixed assets over Book value of total assets
Ratio of earnings before interests, taxes, depreciation and amortization (EBITDA) to book value of total assets.
Net income (earning before tax) returned as a percentage of shareholders’ equity
Profit margin Net income (earning before tax)/ total sales
Inventories turnover Inventories/ total sales Positive/Negative
Net operating loss (NOL) Dummy variable equal 1 if (earning before tax) is greater than zero and equal 0 in other cases
Inflation The annual percentage of inflation in consumer prices Percentage Positive/Negative
GDP growth The annual percentage of GDP per capita growth Percentage Positive/Negative
Fixed effects (FE) and random effects (RE) models are utilized in regression analysis to account for all time-invariant differences among control variables This ensures that the estimated coefficients in both FE and RE models remain unbiased due to the absence of omitted time-invariant characteristics Additionally, the Hausman Test is employed to determine the preferred model between FE and RE.
RESULTS AND DISCUSSION
Descriptive statistics
Table 2 presents the descriptive statistics for all firms, detailing the means, standard deviations, and the maximum and minimum values for each variable used in the regression analysis The data is organized into three columns, with columns I, II, and III representing the treatment group, control group, and the overall sample, respectively.
Table 2 presents a comparison of the treatment and control companies from 2001 to 2007, highlighting the differences in mean values related to their balance sheet profiles and profitability indices.
The treatment group comprises significantly more employees than the control group, with 468 compared to 58 A review of the balance sheet reveals notable differences: the average asset value stands at approximately 126 billion dong for the treatment group and 42 billion dong for the control group This disparity is largely due to the treatment group being composed of state enterprises in Vietnam, which typically operate on a larger scale than private firms Additionally, the leverage of treated firms is slightly higher at 62 percent compared to 54 percent for the control group However, the un-treatment group demonstrates greater profitability, as evidenced by higher profit indices across all measures when compared to the treated companies.
Table 3 provides summary statistics for all companies in both groups for the year 2003, which is the year before the tax regime changes took effect Notably, the differences between the two groups are evident.
Formatted: Line spacing: 1,5 lines groups for the whole period and the year 2003 have parallels in relevant aspects.
As regard to the profile characteristics, companies in treated group seem to have considerably more number of employees than the ones in un-treatment group
(875 versus 58) Likewise, Table 3 highlights the consistent differences in value of assets between both groups for the whole period and the year 2003 In the year
In 2003, state enterprises (treatment group) exhibited significantly larger assets, averaging 105 billion dong compared to 13 billion dong for control firms Additionally, treatment firms demonstrated higher leverage at 62 percent versus 54 percent for control firms Notably, the control group outperformed the treatment group in productivity, as evidenced by superior profitability indices across the board.
In this study, the difference in difference method is utilized for regression analysis, complemented by graphical analysis to assess the annual common trend of leverage As illustrated in Figure 23, Panel A, the average evolution of leverage values for both groups is presented over the specified time period.
Between 2001 and 2007, the analysis reveals distinct trends in leverage for treatment and control groups, particularly noticeable after the 2004 tax reform Prior to 2004, both groups exhibited a gradual increase in average leverage However, post-2004, the treatment group experienced an upward trend in leverage, while the control group saw a decline This shift supports the empirical evidence of the preferential tax policy's influence on the capital structures of Vietnamese companies Additionally, in 2005, the asset values for the treatment group increased significantly compared to the control group, further highlighting the impact of the tax reform.
2004 (Panel B) The reason might come from the forms that state enterprises performed equitization as mentioned above such as issuing more firms’ shares.
Bivariate analysis
In an initial assessment of the effects of tax changes, bivariate analysis is employed to explore the empirical relationships between leverage (the dependent variable) and various control regressors (control variables), as well as their simultaneous variability Given that both the dependent and control variables are numerical, scatter plots are effectively utilized for visualization As illustrated in Figure 3 4, the scatter plots depict the relationship between leverage and control factors, revealing that most graphs exhibit random distributions.
Table 2: Descriptive Statistics and Means Differences for the period 2001-2007
Treatment (I) Control (II) Full Sample
Table 3: Descriptive Statistics and Means Differences for the year 2003
Dev Min Max Mean Std
Trend over time of Leverage
Trend over time of Assets
Figure 23: Common trend over time Panel A Leverage Panel B
Formatted: Right: 3 cm, Top: 2,46 cm, Bottom: 3,5 cm
Trend over time of Leverage
Treatment group: State Enterprises; Control group: otherrwises
Regression results
4.3.1 Impact of Corporate Tax Incentives on firms’ capital structure
Table 4 presents Difference in Difference estimations that analyze the impact of preferential tax policy on firms' capital structures, showcasing both coefficients and standard errors The dependent variable, book leverage, is defined as the ratio of total debt to total assets, and is examined through three regressions Regression (I) incorporates several variables, including a time dummy, a company type dummy for state enterprises, a tax reform dummy, firm size, labor count, investment, tangibility, profitability metrics, and liquidity ratios The results indicate a significant negative coefficient for the TAX variable (-0.041), suggesting that the introduction of incentive tax policy reduces companies' debt ratios by over 4 percentage points, aligning with existing literature on taxation's influence on leverage The SE variable shows a positive but insignificant coefficient (0.013), while the time dummy coefficient is significantly negative (-0.037) Most control variables align with empirical expectations, except for labor count and inventory turnover Notably, firm size positively correlates with leverage, indicating that larger firms leverage debt to maximize tax benefits, while a negative relationship exists between investment value and leverage, reflecting managerial caution in maintaining leverage ratios amidst high investment values.
Formatted: Font color: Text 1 investment They fear of facing financial distress associated with invested opportunities Hence, lowering debt in capital structure might be their choices.
Liquidity has negative effect on leverage that means the more liquid assets firms have, the less they use debt to finance their operation Titman and
Wessels (1988) suggested that firms with low liquidity face higher bankruptcy costs during financial distress, often exacerbated by excessive leverage Consequently, liquidity is anticipated to negatively affect the debt ratio Princen (2012) notes that the tax-deductible nature of depreciation can outweigh the impacts of debt financing, explaining the negative effects of tangibility Additionally, Rajan and Zingales (1995) indicate that companies often prefer using retained earnings to achieve profitability, leading to a negative correlation between leverage and profitability However, a positive and significant relationship exists between return on equity (ROE) and leverage, implying that firms with higher ROE are more inclined to increase their leverage.
Regression II not only possesses the same specification with regression II but also has another control variable- Net Operating Loss (NOL) It is a dummy variable, takes the value one if the company is loss- making and zero in other case This dummy variable indicates the “negative profit” for tax purposes as can be called tax losses carryforward which can reduces their tax expense for the next financial year The coefficient of NOL is negative (-0.0016) and has 1 percent significant level and totally consistent with expectation, therefore, companies with tax losses carryforward have 0.16 percentage point lower leverage value than the other ones.
In regression III, two macroeconomic variables were included to control for macroeconomic shocks that could lead to biased estimations The results revealed a negative coefficient for inflation at -0.005, which is statistically significant at the 10% level This finding aligns with the research conducted by Huizinga, Laeven, and Nicodeme (2008), suggesting that inflation does not encourage debt financing; rather, it tends to increase inflation itself.
Nominal interest rates play a crucial role in economic forecasting, as GDP growth is anticipated to positively correlate with leverage, according to Frank and Goyal (2009) However, it is important to note that the GDP growth coefficient in this analysis lacks significance.
The results of fixed effect, random effect regressions and Hausman test are presented in Appendix A1, A2 and A3 respectively.
Table 4: Impact of Corporate Tax Incentives on Company’s Capital Structure
*, ** and *** denote statistical significance at the 10%, 5% and 1% level, respectively.
4.3.2 Impact on Small and Medium Enterprises versus Large Companies
To identify the firms most affected by preferential tax policies, a dummy variable is utilized in the regression analysis, indicating a value of one for firms with total assets under 50 billion Vietnam dong and zero for others According to Decree No 56/2009/NĐ-CP, issued by the Vietnamese government on June 30, 2009, small and medium enterprises (SMEs) are defined as those with total assets less than 50 billion dong.
Coef Std Err Coef Std.
The study indicates a GDP growth of -0.008 to 0.187 among firms with fewer than 100 employees Previous regressions reveal that the employee count is statistically insignificant, leading to its exclusion from firm classification criteria Table 5 illustrates the impact of tax changes on SMEs compared to large companies, showing that after tax reform, SMEs reduce their leverage by 7 percentage points less than their larger counterparts, with a coefficient of 0.07 at a 1 percent significance level This finding aligns with existing literature on capital structures, such as the works of Princen (2012) and Almeida and Campello (2007).
Table 5: Small and Medium Enterprises versus Large Companies
*, ** and *** denote statistical significance at the 10%, 5% and 1% level, respectively.
After running those regressions, I have two main findings from the empirical results.
There is a significant relationship between preferential corporate tax policies and companies' financial decisions, evidenced by a reduction of approximately 4% in firms' leverage ratios following the adoption of such tax incentives This finding aligns with existing research in capital structure literature, which highlights the positive impact of taxes on firms' capital decisions.
(2015), Panier, Perez-Gonzales and Villanueva (2013); Princen (2012) and
Kestens, Cauwenberge and Christiaens (2012) also found this correlation in their researches To explain this relationship, I revert back to the well-known
Modigliani and Miller's propositions I and II highlight key principles in corporate finance Proposition I asserts that a firm's value remains unaffected by its capital structure, based on crucial assumptions such as the absence of taxes and financial distress costs However, these conditions rarely exist in real markets When accounting for taxes, Proposition I acknowledges that interest on debt is tax-deductible, allowing firms to capitalize on this benefit, known as the Debt Tax Shield or Interest Tax Shield.
Shield) and raise the value of firms (proxied by the value of a share of stock).
The essential focus of capital structure literature is the optimization of the debt-equity ratio in imperfect markets, considering factors like taxes and bankruptcy costs to enhance a firm's value Consequently, a reduction in corporate tax rates diminishes the advantages of the Interest Tax Shield, leading firms to favor equity over debt in their capital structures This aligns with the M&M proposition in the context of taxation.
The cost of equity is inversely related to the corporate tax rate and directly related to the debt ratio Consequently, when corporate taxes decline, firms are likely to lower their debt ratio to keep the cost of equity stable This relationship is supported by numerous studies, including those conducted by Bradley, Jarrell, and others.
Kim (1984); Harris and Raviv (1991), Fama and French (1998), etc Figure 1 below briefly describes the mechanism of the relationship between tax changes and financial structure.
The relationship between tax changes and financial structure is crucial for understanding economic dynamics This mechanism highlights how variations in tax policies can influence a company's financial decisions and overall structure By examining this interplay, we can gain insights into the broader implications for businesses and the economy.
+ Changing over long time (OLS)
(The negative correlation between the cost of equity and corporate tax rates)
+Debt ratio/leverage + Equity ratio
Firm size, Liquidity ratio, Investment and Tangibility
Profitability, ROE, Profit margin, Inventories turnover Net Operating Loss
The study reveals that large companies adjust their capital structure significantly more—by 7 percentage points—than small and medium-sized enterprises (SMEs) This disparity can be attributed to the fact that SMEs are typically younger and face greater financial constraints, limiting their flexibility in responding to tax incentives In contrast, large companies with stable cash flows tend to utilize more debt to fully leverage tax shields, as supported by previous research from Marsh (1982), Schepens (2016), Lin and Flannery (2013), and Princen (2012).
CONCLUSION AND POLICY IMPLICATIONS
Conclusion
The ongoing debate regarding the impact of changing tax rates on corporate financial decisions remains unresolved This study examines the preferential tax policy implemented in Vietnam in 2004, aimed at encouraging state enterprises to pursue equitization Following the tax reform, the corporate income tax rate for these enterprises was reduced by 8-18% Utilizing a comprehensive database of approximately 135,000 companies from 2001 to 2007, which includes diverse enterprise types and their annual financial data, the research employs a Differences in Differences identification strategy to analyze the debt ratios of the treatment group (state enterprises) versus the control group (other enterprises) The policy was validated from November 16, 2004, to February 14, 2007, allowing for a comparative analysis of pre-treatment (2001-2003) and post-treatment data (2004-2007).
2007) The graphical analysis is also used to observe the leverage trend over time in order to provide visual view regarding the changes of debt ratio after tax policy’s introduction.
The findings of this study align with previous theoretical frameworks on capital structure, indicating that leverage significantly responds to changes in tax incentives Specifically, the results show that preferential tax policies lead to a reduction in the debt ratio of state companies by approximately 4 percentage points, a finding that is statistically significant This tax reform ensures that state companies, as defined in 2004, utilize on average 4 percentage points less debt compared to other company types Furthermore, the evidence suggests that Large Companies reduce their leverage by 7 percentage points more than Small and Medium Enterprises following the implementation of the preferential tax policy.
204, and also are high significant level Particularly, Large Companies absorb the effect of tax reform more than Small and Medium Enterprises.
This study investigates the impact of tax changes on firms' financial leverage while also considering various factors, including firm characteristics like employee count and financial metrics from both the balance sheet (such as firm size, liquidity ratio, investment, and tangibility) and income statement (including profitability, ROE, profit margin, inventory turnover, and Net Operating Loss) To ensure unbiased results, two macroeconomic variables—inflation and GDP growth—are incorporated into the regression analysis to account for macroeconomic shocks, enhancing the reliability of the empirical findings.
Policy implications
The Vietnamese government enacted Decree No 187/2004/NĐ-CP on November 16, 2004, aimed at transforming state enterprises into joint stock companies by offering preferential corporate tax rates This policy encourages multi-owner business structures, facilitating capital mobilization and technological innovation Additionally, non-state operations enhance business efficiency and competitiveness The impact of this policy is evident in the trend of decreasing leverage ratios among firms, as they adjust their capital structures in response to the tax reforms Empirical findings indicate that companies have successfully reduced their debt ratios, aligning with policymakers' objectives.
4.1 percentage point Contemporarily, these regressions also indicate that the impact of this preferential tax on Large Companies that mostly state enterprises is more respectably (around 7 percentage point) than Small andMedium Enterprises This result reinforces somewhat that Vietnamese government encourages Large Companies which properly face higher financial distress cost making heathier capital structure with less debt than before.
Limitation of the study
This research explores the significant relationship between corporate tax and leverage, contributing to the literature on capital structures However, it faces notable limitations Firstly, the reliance on book value due to insufficient data may compromise the reliability of the results, as there is no definitive evidence indicating which valuation method yields more accurate outcomes Secondly, state-owned enterprises undergoing equitization benefit from tax incentives, which may skew the sample used for analysis The lack of an effective method to identify whether firms have undergone equitization raises concerns, as some companies in the treatment group may not be impacted by tax reforms Nevertheless, the influence of preferential taxes on encouraging state enterprises to pursue equitization is evident.
Almeida, H., and Campello, M (2007) Financial Constraints, Asset
Tangibility, and Corporate Investment NBER Working Paper No 12087.
Bradley, M., Jarrell, G., and Kim, E (1984) On the existence of an optimal capital structure: Theory and evidence Journal of Finance, 39:857-878.
Chirinko, R., and Wilson, D (2008) State investment tax incentives: a zero- sum game? Journal of Public Economics 92, 2362–2384
DeAngelo, H., and Masulis, R (1980) Optimal capital structure under corporate and personal taxation Journal of Financial Economics, 8:3-29.
Eriotis, N P., Frangouli, Z and Ventoura- Neokosmides, Z (2002) Profit margin and capital structure: An empirical relationship The Journal of
Applied Business Research, volumn 18, number 2
Fama, E., and French, K (1998) Taxes, financing decisions, and firm value Journal of Finance 53, 819–843
Faccio, M., and Xu, J (2015) Taxes and capital structure Journal of
Financial and Quantitative Analysis (forthcoming)
Frank, M., and Goyal, V (2009) Capital structure decisions: Which factors are reliably important? 1-67.
Gajurel, D P (2006) Macroeconomic influences on corporate capital structure Available at SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id9049
Graham, J (2003) Taxes and corporate finance: A review The Review of
Gordon, R H., and Mackie-Mason, J (1991) Effects of the Tax Reform Act of 1986 on Corporate Financial Policy and Organizational Form In Slemrod,
Joel, ed.: Do Taxes Matter? The Impact of the Tax Reform Act of 1986,
Givoly, D., Hayn, C., Ofer, R O., and Sarig, O (1992) Taxes and Capital
Structure: Evidence from Firms’ Response to the Tax Reform Act of 1986.
The Review of Financial Studies 1992, volume 5, number 2, paper 331-355.
Greene, W H (2008) Econometrics Analysis, Sixth edition Upper Saddle
Huizinga, H., Laeven, L., and Nicodeme, G (2008) Capital structure and international debt shifting Journal of Financial Economics, 88(1):80-118.
Heider, F., and Ljungqvist, A (2015), As Certain as Debt and Taxes:
Estimating the Tax Sensitivity of Leverage from State Tax Changes Journal of
Harris, M., and Raviv, A (1991) The theory of capital structure Journal of
Q., Li L and Sobel, M J (2011) Production/ Inventory management and capital structure The handbook of Integrated Risk Management in
Global Supply Chain, chapter twelve
Kestens, K., Cauwenberge, P V., and Christiaens, J (2012) The Effect of the
Notional Interest Deduction on the Capital Structure of Belgian SMEs.
Environment and Planning C: Government and Policy 2012, volume 30, pages 228- 247.
Klemm, A., and Parys, S V (2011) Empirical evidence on the effects of tax incentives Int Tax Public Finance (2012) 19: 393-423.
Lin, L., and Flannery, M (2013) Do personal taxes affect capital structure?
Evidence from the 2003 tax cut Journal of Financial Economics109.
Modigliani, F., and Miller, M (1963) Corporate income taxes and the cost of capital: A correction American Economic Review, 53:433-443.
Modigliani, F., and Miller, M (1958) The Cost of Capital, Corporation
Finance and the Theory of Investment American Economic Review 48, 261–
Miller, M (1977) Debt and taxes Journal of Finance 32, 261–275.
Marsh, P (1982) The choice between equity and debt: An empirical study.
Panier, F., Perez-Gonzales, and F., Villanueva, P (2013) Capital structure and taxes: what happens when you (also) subsidize equity? Unpublished working paper Stanford University.
Phan, T B N (2011) The impacts of income tax regime on capital structures of Vietnamese Joint Stock Companies Journal of Asian Business and
Princen, S (2012) Taxes of Affect Financing Decisions: The Case of Belgian
Roger, H G., and Lee, Y (1999) Do taxes affect corporate debt policy?
Evidence from U.S corporate tax return data Nber Working Paper Series, working paper 7433.
Rajan, R., and Zingales, L (1995) What do we know about capital structure?
Some evidence from international data Journal of Finance, 50:1421-1460.
Staderini, A (2001) Tax reforms to influence corporate financial policy: The case of the Italian business tax reform of 1997-98 Banca d’Italia Working
Schepens, G (2016) Taxes and bank capital structure Journal of Financial
Serfling, M A (2013) Labor adjustment costs and capital structure decisions.
Working paper, Department of Finance, University of Arizona
Titman, S., and Wessels, R (1988) The determinants of capital structure choice Journal of Finance, 43(1):1-19.
Formatted: Font: Italic Formatted: Font: Italic
Yogendraraja, R and Thanabalasingam, S (2011) The effect of profit margin on capital structure: A study of listed manufacturing companies of Colombo
Stock Exchange (CSE), Sri Lanka Available at SSRN: http://ssrn.com/abstract$33065
Field Code Changed Formatted: Hyperlink, Font: (Default) Georgia, 10 pt,
Formatted: Body Text, Justified, Right: -0,02 cm, Space
Trend over time of Labor
Trend over time of Liquidity Ratio
Figure 23: Common trend over time Panel C: Labor
Trend over time of Investment
Trend over time of Tangibility
Trend over time of profitability
Trend over time of ROE
Formatted: Line spacing: Multiple 1,08 li
Formatted: Line spacing: Multiple 1,08 li
Fig ur e 32- Panel K: Inventories Turnover
Panel I: Profit Margin Panel K: Inventories Turnover
Formatted: Line spacing: Multiple 1,08 li
Trend over time of Profit Margin
2001 end over time of Inventories Turnover
Formatted: Line spacing: Multiple 1,08 li
LE VE RA G E ge- Labor
Figure 43- Panel H: Leverage- Profit Margin
Figure 43- Panel I: Leverage- Inventories Turnover
Fixed-effects (within) regression Number of obs = 6370
Group variable: madn Number of groups = 910
R-sq: within = 0.1459 Obs per group: min = 7 between = 0.1962 avg = 7.0 overall = 0.1778 max = 7 corr(u_i, Xb) = -0.2565
The F-test results indicate that all coefficients are significantly different from zero, with an F-value of 12.31 and a probability of less than 0.0001 Among the variables analyzed, leverage has a negative coefficient of -0.0237 (p < 0.0001), while tax also shows a negative impact at -0.0167 (p = 0.047) Conversely, the variable lassets demonstrates a strong positive correlation with a coefficient of 0.1071 (p < 0.0001) Labor and tangibility exhibit negative coefficients of -0.00007 (p < 0.0001) and -0.0768 (p < 0.0001), respectively Profitability shows a significant negative relationship with a coefficient of -0.1730 (p < 0.0001) Other variables such as profit_margin and liquidity_ratio also reflect negative impacts, with coefficients of -0.0661 (p = 0.005) and -0.0007 (p = 0.013), respectively The overall model indicates a fraction of variance due to unobserved factors, with a rho value of 0.6980, suggesting a substantial portion of the variance is attributed to the individual effects.
Random-effects GLS regression Number of obs = 6370
Group variable: madn Number of groups = 910
R-sq: within = 0.1366 Obs per group: min = 7 between = 0.2656 avg = 7.0 overall = 0.2304 max = 7
The Wald chi-squared statistic is 1232.00 with a probability value of 0.0000, indicating significant results Key coefficients include a negative impact of tangibility (-0.1311) and profitability (-0.2666) on leverage, both statistically significant at p < 0.001 Additionally, labor and tax also show negative associations, with coefficients of -0.0000454 and -0.0248, respectively In contrast, total assets (lassets) positively influence leverage, with a coefficient of 0.0809, while investment exhibits a small positive effect (0.00039) Other variables, such as current ratio and inflation, do not demonstrate significant effects on leverage The model's overall fit is indicated by a rho value of 0.5793, suggesting that approximately 57.93% of the variance is attributable to unobserved factors.