The impact of profitability on capital structure and target capital structure adjustment speed the empirical study of listed on the vietnam stock exchanges

Keywords: Financial leverage, Business results, Target capital structure, Adjustment speed...  Chapter 2: Overview of previous studies: Synthesize theories of capital structure and cap

MINISTRY OF EDUCATION AND TRAINING THE STATE BANK OF VIETNAM

HO CHI MINH UNIVERSITY OF BANKING

- -

VŨ PHẠM TRUNG HIẾU

THE IMPACT OF PROFITABILITY ON CAPITAL STRUCTURE AND TARGET CAPITAL STRUCTURE ADJUSTMENT SPEED: THE EMPIRICAL STUDY OF LISTED COMPANIES ON THE VIETNAM

MINISTRY OF EDUCATION AND TRAINING THE STATE BANK OF VIETNAM

HO CHI MINH UNIVERSITY OF BANKING

- -

Student: VŨ PHẠM TRUNG HIẾU

Student ID: 050606180115 Class: HQ6 – GE04

THE IMPACT OF PROFITABILITY ON CAPITAL STRUCTURE AND TARGET CAPITAL STRUCTURE ADJUSTMENT SPEED: THE EMPIRICAL STUDY OF LISTED COMPANIES ON THE VIETNAM

STOCK EXCHANGE

GRADUATION THESIS Major: FINANCE – BANKING

TÓM TẮT

Chủ đề cấu trúc vốn luôn thu hút rất nhiều nhà nghiên cứu và nhà làm chính sách, đặc biệt là các nhà hoạch định tài chính của doanh nghiệp cổ phần, đặc biệt kể từ nghiên cứu của Modigliani & Miller (1985) Cấu trúc vốn là một khái niệm tài chính phản ánh sự phối hợp giữa vốn chủ sở hữu và nợ mà doanh nghiệp sử dụng, điều này tạo ra một chi phí sử dụng vốn Hầu hết các doanh nghiệp dù thuộc nhóm ngành nào cũng muốn giữ chi phí vốn ở mức tối thiểu, từ đó tối đa hóa giá trị doanh nghiệp vì chi phí vốn ảnh hưởng gần như đến mọi hoạt động của doanh nghiệp, từ tính khả thi của

dự án, khoản đầu tư đến kết quả kinh doanh và cả những rủi ro tài chính mà doanh nghiệp phải đối mặt Chính vì thế, việc lựa chọn một cơ cấu vốn tối ưu giữa vốn chủ sở hữu và nợ vay là một nghệ thuật đối với các nhà quản trị tài chính Mục tiêu chính của nghiên cứu này là tìm hiểu tác động của cấu trúc vốn đến hiệu quả kinh doanh của các doanh nghiệp phi tài chính được niêm yết trên thị trường chứng khoán Việt Nam và cách các công ty này điều chỉnh cấu trúc vốn mục tiêu Bài nghiên cứu được xây dựng dựa trên lý thuyết đánh đổi cấu trúc vốn và lý thuyết trật tự phân hạng Tác giả kiểm định xem những lý thuyết này có phù hợp khi áp dụng vào các doanh nghiệp tại Việt Nam hay không Nghiên cứu chạy hồi quy theo mô hình Pooled OLS, mô hình tác động ngẫu nhiên (REM) và mô hình tác động cố định (FEM) để kiểm định, so sánh nhằm tìm ra mô hình phù hợp thông qua kiểm tra hiện tượng đa cộng tuyến, tương quan tự động và phương sai thay đổi Từ đó, phân tích các nhân tố ảnh hưởng đến cấu trúc vốn của các doanh nghiệp phi tài chính trên thị trường chứng khoán Việt Nam Cuối cùng, tốc độ điều chỉnh tỷ lệ nợ về mức mục tiêu được kiểm định bằng mô hình tĩnh Pooled OLS và mô hình động GMM để kiểm định tính đồng nhất của nghiên cứu

Thống kê mô tả cho thấy đòn bẩy tài chính chiếm 36,9% trong cơ cấu nguồn vốn của các doanh nghiệp phi tài chính, trong khi đòn bẩy tài chính chiếm ưu thế bởi đòn bẩy ngắn hạn Tốc độ điều chỉnh cấu trúc vốn mục tiêu được xác định bằng cách

sử dụng cả nhóm OLS và GMM để đảm bảo tính chắc chắn của phát hiện Tôi quan sát

thấy rằng khả năng sinh lời và cơ cấu tài sản có quan hệ ngược chiều với đòn bẩy trong khi quy mô của công ty và lá chắn thuế phi nợ có quan hệ thuận chiều với đòn bẩy Kết quả hồi quy cũng cho thấy rằng trong khi khả năng sinh lời có mối quan hệ ngược chiều với tỷ lệ nợ thì quy mô và cơ hội tăng trưởng lại tỷ lệ thuận với tỷ lệ nợ Tốc độ điều chỉnh cấu trúc vốn của các công ty phi tài chính hiện nay là 32,7%, tương đương với các nghiên cứu về các công ty phi tài chính được thực hiện ở hầu hết các nước phát triển

Từ khóa: Đòn bẩy tài chính, Kết quả kinh doanh, Cấu trúc vốn mục tiêu, Tốc

độ điều chỉnh

ABSTRACT

The topic of capital structure has always attracted a lot of researchers and policymakers, especially from the financial planners of joint-stock enterprises, especially since the research of Modigliani & Miller (1985) Most businesses regardless of industry group want to keep the cost of capital to a minimum, and thereby maximize the value of their business because the cost of capital affects nearly all activities of the business, from the feasibility of projects or investments to business results and also the main load risks that businesses face Therefore, choosing an optimal capital structure between equity and debt is an art for financial managers The main objective of this study is to understand the impact of capital structure on the business performance of non-financial firms listed on Vietnamese stock exchanges and how these companies adjust their target capital structure The research is built based on the trade-off theory and pecking order theory We test whether these theories are relevant when applied to enterprises in Vietnam The study runs regression according

to Pooled OLS model, the random effect model (REM), and the fixed effect model (FEM) to test and compare to find a suitable model through checking multicollinearity, automatic correlation and variance change From there, analyze the factors affecting the capital structure of non-financial enterprises on the Vietnamese stock market Finally, the speed of adjusting the debt ratio to the target level is tested by the Pooled OLS static model and the GMM dynamic model to test the homogeneity of the study

The descriptive statistics show that leverage constitutes 36,9% of the capital structure of non-financial firms, while leverage is dominated by short-term leverage The speed of adjustment to the target capital structure is determined using both pool OLS and GMM to ensure the robustness of the finding I observed that profitability and asset structure were negatively related to leverage while the size of the firm and non-debt tax shield were positively related to leverage The regression results also give found that while profitability has a negative relationship with the debt ratio, size and

growth opportunities are directly proportional to the debt ratio The adjustment speed

of the capital structure of non-financial firms is now 32.7% which compares well with

studies on non-financial firms done in most developed countries

Keywords: Financial leverage, Business results, Target capital structure,

Adjustment speed

PLEDGE

I reaffirm the thesis " THE IMPACT OF PROFITABILITY ON CAPITAL STRUCTURE AND TARGET CAPITAL STRUCTURE ADJUSTMENT SPEED: THE EMPIRICAL STUDY OF LISTED COMPANIES ON THE VIETNAM STOCK EXCHANGE " is my article and there are no copies from other authors' material

This thesis is the author's research work, the research results are honest, in which there are no previously published contents or the content made by others except for citations fully cited in the thesis

I will take full responsibility for my pledge

Author

Vu Pham Trung Hieu

THANK YOU

First, I would like to thank all the teachers at the Banking University of Ho Chi Minh City for providing and supporting me with the necessary knowledge during my study at the school Such knowledge is the luggage that helps me to complete the thesis

In particular, I would like to thank my instructor, PhD Duong Thi Thuy An, who helped me in the process of completing my thesis as well as guiding me to correct

TABLE OF CONTENTS

ABSTRACT……… ……iii

PLEDGE……….…v

THANK YOU………vi

TABLE OF CONTENTS……… ….vii

LIST OF ABBREVIATIONS……… ……….x

LIST OF TABLES……… ……….xi

CHAPTER 1: OVERVIEW OF THESIS 1

1.1 Research background 1

1.2 Research objectives 1

1.3 Research questions 2

1.4 Research subject and scope 2

1.5 Research method 3

1.6 Research contribution 3

1.7 Thesis structure 4

CHAPTER 2: LITERATURE REVIEW 5

2.1 Theoretical background 5

2.1.1 The Modiligani & Miller theory (M&M theory) 5

2.1.2 The pecking order theory 5

2.1.3 The trade-off theory 7

2.1.4 The market-timing theory 10

2.1.5 The signaling theory 10

2.1.6 The agency cost theory 11

2.2 Overview of previous research 11

2.2.1 Empirical evidences of the capital structure theory 11

2.2.2 Empirical studies on the determinants of the capital structure 13

2.2.3 Empirical studies on the determinants of the speed of adjustment 19

2.3 Differences from previous studies 21

2.4 SUMMARY CHAPTER 2 22

CHAPTER 3: RESEARCH METHOD 23

3.1 Research study 23

3.2 Data description 25

3.2.1 Data and sample 25

3.2.2 Independent variables 26

3.2.3 Dependent variables 28

3.3 Expected research models 28

3.3.1 Fixed effects model (FEM) 28

3.3.2 Random effects model (REM) 29

3.3.3 Model tests 30

3.4 SUMMARY CHAPTER 3 31

CHAPTER 4: RESEARCH RESULT 32

4.1 Descriptive statiscal analysis 32

4.2 Checking for model defects 34

4.2.1 Check for autocorrelation problem 34

4.2.2 Verification of variance 34

4.2.3 Checking for multicollinearity 35

4.3 Regression results 37

4.3.1 Factors affecting financial leverage 37

4.3.2 The adjustment speed rate of target capital structure 40

4.4 SUMMARY CHAPTER 4 44

CHAPTER 5: CONCLUSIONS 45

5.1 Conclusions 45

5.2 Policy Implications 46

5.3 Limitations of the study and directions for development 47

5.4 SUMMARY CHAPTER 5 48

LIST OF ABBREVIATIONS

Pooled OLS Pooled Ordinary Least Square

M&M The Modiligani & Miller theory

ETR Effective Corporate Income Tax Rate

LIST OF TABLES

Table 4.1: Descriptive statistic 32

Table 4.2: Correlation cefficient 33

Table 4.3: Variance magnification factor 35

Table 4.4: GLS – FEM – REM regression results 39

Table 4.5: OLS and GMM estimation results of adjustment speed 43

CHAPTER 1: OVERVIEW OF THESIS 1.1 Research background

The topic of capital structure has always attracted many researchers and policymakers, especially the financial planners of joint-stock enterprises Capital structure is a financial concept reflecting the combination of equity and debt that a business uses and this creates a cost of capital Most businesses in any industry group want to keep the cost of capital to a minimum, and thereby maximize the value of their business That's because the cost of capital affects almost every business activity, from the feasibility of projects or investments to business results and also the major load risks a business faces face to face Therefore, an optimal capital structure chosen between equity and debt is a form of art for financial managers

The topic of capital structure has also been studied a lot before, notably by Graham and Harvey (2001) and Cotei et al (2011) In addition, Salawu (2007), Salawu and Agboola (2008) and Akinyomi and Olagunju (2013) conducted a study in Nigeria

to determine capital structure but without adjustment speed towards balance In Vietnam, there has also been much research on capital structure and capital structure adjustment speed, notably Tran Hung Son (2012), Pham Tieng Minh and Nguyen Tien Dung (2015), Phan Thanh Hiep (2016), Nguyen Thi Minh Hue and Dang Tung Lam (2017) Further research on the speed of capital structure adjustment provides much more evidence in making decisions on choosing the optimal capital structure of enterprises

1.2 Research objectives

Capital structure theory is one of the new theories, but in Vietnam, the application of this theory is still very new and strange My purpose in conducting this research is to examine whether firms in Vietnam make adjustments in their financial performance to achieve their target leverage when capital structure theories still show

rather faintly their existence Since then, we have posed the following research questions with the role of leading the research paper to reach the final goal This research mainly focuses on examining the relationship between business performance and capital structure In addition, it considers assessing the adjustment speed of non-financial enterprises in Vietnam in the period (2010 - 2020) at two Vietnamese Stock Exchanges, Ha Noi and Ho Chi Minh City

1.3 Research questions

The srudy aims to answer two main questions:

Firstly, whether or not the existence of a target capital structure and the following internal factors affect the capital structure of enterprises in Vietnam:

• Is profitability proportional or inverse to capital structure?

• How do fixed assets affect capital structure? Do businesses that own a lot of fixed assets in total assets have low or high debt ratios?

• How does firm size affect capital structure? Do small businesses have high or low debt ratios?

• How does tax rate affect corporate capital structure? Does the tax shield benefit businesses?

• Is growth opportunity positively or negatively related to capital structure? Secondly, whether or not the capital structure adjustment is about the target capital structure and if so, what is the rate of capital structure adjustment for non-financial companies in Vietnam?

1.4 Research subject and scope

The data in the research paper is provided with annual financial statements from

150 non-financial enterprises listed on Hanoi Stock Exchange (HNX) and Ho Chi

financial enterprises in the Research article because the management of financial and banking enterprises has differences in income reporting standards as well as complexity in balance sheets The period of 6 years, from the period before and after the COVID period is long enough to determine the fluctuations and the actual state of the businesses, enhancing the significance and reliability of the research point

1.5 Research method

This study is based on the research of Oino and Ukaegbu (2015) on the impact

of profitability on capital structure and capital structure adjustment speed in different companies listed on stock exchanges in Nigeria Accordingly, the research method used in the article includes:

The method of least squares (OLS) to test the relationship between capital structure and internal factors affecting the capital structure The fixed effects model (FEM) and random effects model (REM) was also used to not only examine the above relationship but also to test the robustness of the findings from the Pooled OLS method However, to overcome the phenomenon of variance and autocorrelation appearing in the total, I will use the general least squares (GLS) model instead of the original OLS model To select the appropriate model among the above three models, I use F-test and Hausman test The rate of adjustment to the target leverage ratio of the business will be determined by two models, Pooled OLS and GMM

1.6 Research contribution

The empirical model in the study has shown the influence of theories and factors affecting capital structure in practice and also demonstrates the potentially dynamic nature of the capital structure The model is general enough that we can test whether target leverage exists and if it has this result, what rate of adjustment a firm applies towards its target Another contribution to this paper is to explain why previous studies have determined that the estimated adjustment rates are different from each other

1.7 Thesis structure

The study consists of 5 main parts:

 Chapter 1: Overview of the topic:

Introduce an overview of the research paper through research purpose, method, object and research scope

 Chapter 2: Overview of previous studies:

Synthesize theories of capital structure and capital structure adjustment speed, including capital structure trade-off theory, pecking order theory and some other related theories Then, the author will present the highlights of previous research papers on the same topic by domestic and foreign authors

 Chapter 3: Research Methods

The data source, the definitions and the meanings of the variables will be explained in chapter 3 Besides, the author will also present the models and how to use the models in the research paper Model-related tests will also be introduced

 Chapter 4: Research results

The research results obtained from the estimation models in chapter 3 will be presented in this chapter and comments will be made to answer the questions posed in the research objectives

 Chapter 5: Conclusions and recommendations

Summarize the highlights of the research paper and draw a conclusion In addition, the author also points out the limitations of the topic and suggestions for future research directions

CHAPTER 2: LITERATURE REVIEW 2.1 Theoretical background

2.1.1 The Modiligani & Miller theory (M&M theory)

Modern capital structure theory originates from the work of Modigliani and Miller (1958), also known as M&M theory Within the two cases studied, the business operates in a tax-free environment and a non-tax environment According to the M&M theory, without a tax environment, the choice between equity and debt is unrelated to the value of the firm, or in another way the value of a firm with the independence of the capital structure in the capital market conditions is perfect and there is no such thing as optimal capital structure In the absence of taxes, the value of the debt-laden enterprise is higher than the value of the unlevered firm due to the benefit of the tax shield However, the perfect market assumptions of the M&M theory such as no transaction costs, no asymmetric information, and the same lending and borrowing rates are very unlikely This leads to the limitation of the applicability of MM theory in practice Therefore, based on MM theory, later theories of capital structure have been extended in imperfect capital markets Given factors such as asymmetric information, bankruptcy costs, agency costs, etc…, the selection of an appropriate capital structure will be better explained in the trade-off theory of capital structure and the pecking order theory presented in the next section

2.1.2 The pecking order theory

The pecking order theory, developed by Stewart Myers and Nicholas Majluf (1984), explains the investment and financing decisions of firms based on information asymmetry between managers and outside investors about the true value of the Company, the business situation as well as the profitability of future projects Information asymmetry is the reason why external capital has a higher cost of capital than internal capital (retained earnings) When a company funds a project by issuing

new shares, these will be undervalued because investors will not appreciate the true value of investment opportunities communicated by management Adverse selection increases the cost of equity financing Therefore, if the projects have the potential to bring high returns, the best way to finance is in ranked order: Using retained earnings because businesses prefer to finance internally; Using resources loan with a fixed interest rate lower than the project's rate of return so as not to share profits with new shareholders Issuance of shares is considered a source of final financing when the company's shares are valued above the real market value According to the pecking order theory, it is difficult to determine the optimal capital structure in this theory Observations of a firm's debt ratio reflect the firm's cumulative need for external financing

Information asymmetry exists in all matters of corporate finance and this problem complicates the decisions of managers The pecking order theory is based on information asymmetry between managers and investors This asymmetric information affects choices between internal and external financing, and between debt and equity issues This leads to a “pecking order” whereby investment capital is first financed by internal equity, primarily from reinvested profits, new debt issuance and finally by issuing new equity Issuing new equity is often the last resort when the company has exhausted its debt capacity, i.e when the threat of financial distress costs causes existing creditors, as well as CFO, are so worried that they can't sleep

Shyam-Sunder and Myers (1999), Lemmon and Zender (2007) and Kamath's (1997) survey of NYSE firms find evidence to support this theory Frank and Goyal (2003) also find evidence for the above theory in large firms This theory explains why the most profitable firms tend to borrow less This is not because they have low target debt ratios but because they don't need outside money Therefore, internal funding ranks first among all funding sources When there is an announcement to issue shares,

investors often understand that the share price of the business is being set higher than its actual value, and the business issues to benefit from this difference Investors will assess the shares below the price announced by the company, causing a drop in the share price Therefore, debt ranks higher in the pecking order This view is supported

by the empirical observations of Masulis and Korwar (1986), Antweiler and Frank (2006) The above arguments do not rule out the issue of common equity, since asymmetric information is not only important but other forces are also at play

For instance, if a company has too much debt, it will go into financial distress Moreover, if it takes on more debt; this company has a good reason to issue common stock In this case, the announcement of an issue of common stock is not necessarily bad news, and while it still drives down the share price, the declines do not necessarily make the issue unwise or unfeasible In the pecking order theory, there is no well-defined target equity-debt mix because there are two types of common equity, internal and external, one at the top and one at the bottom of the pecking order class Each observed debt ratio for each firm reflects the firm's cumulative needs for external financing The pecking order theory also explains the negative correlation between profitability and financial leverage Given a given and inflexible dividend payout ratio, the least profitable firms will have less internal funding and have to borrow more

2.1.3 The trade-off theory

The trade-off theory developed by Kraus and Litzenberger (1973) argues that there exists an optimal capital structure to maximize firm value based on a trade-off between the benefits and costs of using debt The optimal leverage ratio is the balance between the benefits and costs of debt The benefits of debt are the advantages of the tax shield with interest, the potential costs of debt include financial distress costs and agency costs between creditors and owners The trade-off theory has explained the limitation of the M&M theory about the cost of financial distress of the debtor firm

Moreover, the theory also predicts the difference in capital structure between industries with various fixed assets Safe companies with more fixed assets and higher taxable income or those with larger sizes and more liquidity should have high debt ratios While companies are riskier, those with a lot of intangible assets whose value will disappear when liquidated should have low debt ratios The theory also predicts that more profitable firms should increase debt financing to take advantage of the tax shield while high-growth firms should borrow less because the value is easily lost during the main financial crisis However, this theory also has the limitation that it does not explain why some very successful firms in industries with very high operating incomes have very little debt and do not use tax shields

CFOs often view corporate debt-equity structuring decisions as a trade-off between the tax shield and the cost of financial distress The trade-off theory assumes that target debt ratios can vary between firms Large firms should borrow more than small businesses because large firms are generally better diversified and have a lower risk of default When businesses are in trouble, tangible assets are less likely to decline

in value, so companies with safe tangible assets and lots of tax-deductible income should have high target debt ratios In an unprofitable company, the asset is mostly intangible and high-risk, so companies should rely primarily on equity financing Experimental observations by researchers Rajan and Zingales (1995), Barclay et al (2006), Frank and Goyal (2007) have found evidence to support this view Firms often target their capital structure, but because of the existence of costs when adjusting target capital structure, firms do not respond immediately to changes that deviate from the target capital structure We can therefore see random differences in firms with the same target debt ratio (Fama and French, 2002) Graham and Harvey (2001) surveyed 392 CFOs and found that 45% of CFOs

According to the theory, when taxes increase, businesses should increase debt The higher the tax is, the greater the benefit derives from the shield As a result, businesses that are subject to high tax rates should be heavily leveraged, and inversely,

a business that has significantly different tax shields (apart from debt), such as depreciation, typically uses less debt Debt ratios in countries with large tax benefits are higher than in countries where benefits are small The profitability of the business also affects the level of leverage Profitable businesses should take on more debt, as they have lower costs of financial distress and higher tax shield benefits The theory of change assessment for firms should balance the benefits from the tax shield and the costs of financial distress However; the important points on this issue are still quite complicated Miller (1977), and Graham (2000) argue that the benefit from the tax shield should be larger because the direct cost of financial distress is usually very small Molina (2005); Almeida and Philippon (2007) argue that indirect financial bypass costs up to 25-30% of the asset value, which is close to the benefit of the loan

The trade-off theory is useful in several ways First, it explains differences in capital structure across industries Second, the trade-off theory also explains what types

of firms are privatized in leveraged buybacks (LBOs) It is the acquisition of joint stock companies by private investors and the acquisition is financed mainly by debt Third, this theory also holds that Companies with too much debt should issue shares, limit dividends or sell off assets to raise cash to balance the capital structure However, the trade-off theory does not explain some real phenomena A study by Wright (2004) shows that the level of leverage among firms in the industry is almost constant even though tax rates have changed significantly over time The empirical studies of Titman and Wessels (1988), Rajan and Zingales (1995), Fama and French (2002), Frank and Goyal (2007) again show a negative correlation between leverage and profitability These findings do not disprove the trade-off theory, but rather a new theory more suitable to explain

2.1.4 The market-timing theory

In recent years, the market timing hypothesis has become a relatively new research branch in the field of corporate finance The contradictory empirical conclusions have created much controversy, especially in traditional capital structure theory The market timing hypothesis assumes that managers take advantage of internal information of the enterprise, based on the deviation of market price from the real value of shares, will progress Thereby, efforts to adjust the timing of securities issuance in the past play an essential role in building the current capital structure This hypothesis assumes that overvalued firms will issue equity Undervalued businesses will wait until the benefits of new projects outweigh the losses from mispricing before releasing Empirical evidence also supports the view that price plays an important role

in the issuance of new equity (Rajan and Zingales (1995), Baker and Wurgler (2002), Kamath (1997), Graham and Harvey (2001)) Some researchers (Baker and Wurgler (2002), Teoh, Welch, and Wong (1998) find that investors tend to be over-optimistic, with analysts' forecasts often higher than the real ones Economists and managers often distort earnings with pre-disclosure accounting tricks on average, firms that are undervalued will have above-average earnings, as they wait for the price to rise before issuing shares Therefore; this prediction is supported by the studies of Korajczyk, Lucas, McDonald (1990), Loughran and Ritter (1995) In addition, many studies bring the results The argument is quite convincing: enterprises adjust the time to issue (repurchase) shares at appropriate times, leading to abnormal income with negative (or positive) results after a while

2.1.5 The signaling theory

According to the signal theory, the market will reflect positively on enterprises with internal resources, potential and large scale, high ratio of fixed assets to secure

loans At that time, creditors preferred and the company's access to loans was easier than that of companies with no growth opportunities, small size and no financial strength

2.1.6 The agency cost theory

The agency cost theory, studied by Jensen and Meckling (1976), states that costs are caused by conflicts of interest between creditors, shareholders and managers The agency's cost of equity is caused by conflicts between managers and shareholders Managers tend to make investment decisions to increase the size of the business instead

of paying attention to the dividend policy for shareholders The agency costs of debt also arise due to conflicts of interest between creditors and shareholders Creditors always want to be paid principal and interest on time, and shareholders by choosing riskier investment decisions thereby can occupy the assets of creditors

2.2 Overview of previous research

2.2.1 Empirical evidences of the capital structure theory

Capital structure is defined as the combination of current short-term debt, term debt, and equity that is used to finance corporate investment decisions with the object to minimize the cost of capital, risk and maximize business value The debate regarding capital structure and firm value are presented in a study by Modigliani and Miller (1958) titled "Cost of capital, corporate finance and investment theory" They argue that sponsoring decisions do not affect the firm value and the optimal capital structure is not an issue because the firm value is independent of capital structure and the company's financial options This argument is supported by the assertion that financial choice does not affect the question of whether investing is important However, they do note that there is a possibility that managers prefer this choice to the others Besides, the conclusions of the above study are based on unrealistic assumptions of the perfect market For instance, they assume that there are no transaction costs and the existence of a perfect market The study by Bailey (2010)

long-proved that the market was perfect by the postulates of the M&M theory If an investor simulates the effects of a company's economic behaviour, they will be able to borrow

or lend on the same terms as companies Therefore, it is important that the M&M theory assumes without an income tax because the tax is neutral and the tax rate is the same However, this assumption failed because of the different tax rates between the financial structure and the source of income The interest rate presented in the M&M theory led to their paper in 1963 with the assumption that the market is perfect

According to Chang (2004), the first postulate of the M&M theory can be satisfied in an environment in which there is no market for borrowing and lending, nor does it require investors as well as firms to use the same interest rate However, the M&M definitions opened up an academic topic that attracted much attention and led to the development of capital structure as an integral part of corporate finance Carpenter (2006) tests an unrelated claim that firm value is not affected by changes in leverage like M&M and the pecking order theory The study also argues that this relationship is not clear in predicting a causal relationship between the use of leverage and firm value The correlation between capital structure and performance is also tested in the research

of Kinsman and Newman (1999) They argue that examining the relationship between choosing the right capital structure and performance is essential for a variety of reasons The first is that the average level of debt of companies is now higher than in the past, which requires an explanation of the debt impact on business results, from which to decide the level of suitable debt for a company Moreover; managers and investors have different motivations, so any impact of debt on business results must be fully explained On top of that, the reason for studying debt ratios and profitability is to test the relationship between debt utilization and shareholders' assets because shareholders' property maximization must be the top goal of managers

For Europe, Chen et al (1998) studied 200 Dutch firms for the period from

1984 to 1995 Results of regression analysis showed that Dutch firms seem to prefer to finance their activities through retained earnings instead of issuing debts or equity Gunay (2002) analyzed 96 Turkish firms for the period from 1991 to 2001 and concluded that Turkish firms are better represented by the pecking order theory and that the static trade-off theory is irrelevant Sen and Oruc (2008) further confirmed the same findings in their study on 75 Turkish firms for the period from 1993 to 2007 Schoubben and Hulle (2004) supported the pecking order theory in their analysis of Belgian firms for the period from 1992 to 2002 Vasiliou et al (2009) found that Greek firms (represented by 89 firms) do not follow the pecking order theory through qualitative (questionnaire) and quantitative analysis Vasiliou et al questioned previous empirical efforts that argue that the pecking order theory is applicable They recommended future research in this regard considering that the data set previously used might not fully represent the order of financing preferences of the firms

For Asia, Saeed (2007) studied 22 listed companies in the energy sector of Pakistan for the period from 2001 to 2005 where results confirm the firms’ preference toward the use of internal financing over equity and debt issuing For Latin America, Elsas et al (2006) studied 185 US firms for the period from 1989 to 1999 and concluded that the pecking order and market timing theories apply to the data set but they are transitory

2.2.2 Empirical studies on the determinants of the capital structure

Numerous empirical studies have been published that focus on determining the capital structure of certain firms The most conclusively determined factors discovered

to significantly affect the leverage ratio were profitability, size of the business, asset tangibility, non-debt tax shield, and growth

In Europe, Schoubben and Hulle (2004) analyzed the Belgian firms as panel data for the period from 1992 to 2002 where all nonfinancial firms (quoted and non-quoted) that issue financial statements are included in the data set Schoubben and Hull concluded that leverage is positively correlated with current assets and is negatively correlated with intangible assets, size, profitability, and non-debt tax shield Song (2005) analyzed the Swedish firms, a list of 600 firms for the period from 1992 to

2000 He found that size of the firm holds a positive relationship with both short and total debts, while the tangibility effect on long-term debts is negative Song also concluded that a non-debt tax shield has a positive effect on short-term debt and a negative effect on long-term debt Teker et al (2009) analyzed 42 Turkish firms traded

on the Istanbul stock exchange (ISE100 index) for the period from 2000 to 2007 They concluded that size, tangibility, and profitability affect leverage positively, while depreciation is negatively correlated with leverage

In Asia and Vietnam, The study by Abbadi and Abu-Rub (2012) examines the association between market efficiency and capital structure of 8 out of 10 major Palestinian institutions between 2007 and 2010 The purpose of the study is to find out how efficiency and capital structure affect the Return on Assets (ROA) and Return on Equity (ROE) of the firm The results of the study show that the use of financial leverage has a negative effect on the market value of banks Furthermore, the relationship between market value, ROA and bank loan ratio is considerable and positive However, this study shows multicollinearity between ROA and ROE In the study by Atrill and Mclaney (2009), they confirmed the existence of agency problem when they observed that there is an expectation that managers' decision to maximize the return of shareholders However, in order to maximize the value of the business, they have to deal with agency costs, it seems that in order to increase the return on investment, managers will accept to expose the business to a higher level of risk This

model of the trade-off theory of capital structure and pecking order theory for 1325 non-financial firms in Japan in the past years from 2002 to 2006 but the quantitative model of the capital structure trade-off theory failed at explaining the negative correlation between profitability and leverage use In addition, the pecking order model also failed to explain for the low deficit coefficient This problem can be explained by the phenomenon of variance changes within firms each other Phan Thanh Hiep (2016) studies the factors affecting the capital structure of 95 manufacturing enterprises listed

on the Vietnamese stock exchange in the period (2007-2013) with a panel data model

of financial indicators and a number of external factors The author uses FEM and REM estimation methods Due to the appearance of variable covariance and autocorrelation, the GMM model is also used to overcome the aforementioned defect and uses the FGLS generalizable minimum method to check the stability of the model Research results show that corporate capital structure is positively correlated with firm size and negatively correlated with profitability A quite surprising result in this article

is that tangible assets have a negative effect on the capital structure of the firm From the above three results, it can be concluded that the pecking order theory will be more reasonable if the change in capital structure of manufacturing is tested enterprises in Vietnam Pham Tien Minh and Nguyen Tien Dung (2015) conducted a study of 47 real estate enterprises in the period (2008-2013) The two authors apply from static model

to dynamic model to expose the final conclusion For the static model, the study uses least squares estimation model (Pooled OLS), fixed effects model (FEM) and random effects model (REM).In contrast; for dynamic model, the two authors use the differential GMM model proposed in the study by Arellano and Bond (1991) and the systematic GMM model extended by Blundell and Bond (1998) The results obtained from the two static and dynamic models are quite different and combined with the analysis of the optimization of each method with short time data, GMM model (1998)

is the most optimal to analyze the data Research result shows that growth rate

positively affects debt ratio while profitability and risk negatively affect debt ratio In addition, the study also suggests that the adjustment speed to the target capital structure

of real estate firms in Vietnam is not high (α = 0.452), implying that the adjustment costs are relatively large compared to the cost of the imbalance Some research papers

on the topic “Capital structure adjustment speed”: Tran Hung Son (2012) researched the target capital structure adjustment speed of 187 manufacturing enterprises listed in Vietnam during the period (2007-2010) with a total of 748 observations using the two-country estimation method (1) Find the target capital structure of firms, (2) Estimate the rate of adjustment of the debt ratio to the target level The estimation methods used

in this paper are the least squares method, the random effect model (REM) and the fixed effect model (FEM) The research results show that when considering the impact

of the residual problem or capital deficit to the capital structure adjustment speed, whether the debt ratio is higher or lower than the target debt ratio, has an impact on the rate of adjustment of the target debt ratio of the enterprise The study also shows that firms adjust their target capital structure quickly when there is a shortage of capital and when the debt ratio is higher than the target debt ratio Nguyen Thi Huyen Trang et al (2016) analyze the speed of target structure adjustment of 202 companies listed on the Vietnamese stock market in the 5-year period from 2008 to 2012 with the same research method as in the research by Tran Hung Son The research results show that the adjustment speed of the financial leverage ratio of enterprises in Vietnam (2008-2012) was 99.04%, and the enterprises with high debt ratio had the adjustment speed of the target debt ratio faster than firms with low debt ratios Regarding the above article, this study also suggests that the deficit and surplus of capital when the enterprise has a debt ratio higher or lower than the target level has an impact on the speed of adjusting the target capital structure with regard to enterprise goals

For African countries, Ebaid (2009) argued How capital structure choice affects

regression analysis The research result shows that the relationship between capital structure and firm performance is not substantial Despite the long research period, structural fracture testing is tough An empirical study by Mary et al (2011) analyzed

37 Egyptian firms for the period from 1999 to 2007 and found that size and asset growth have a positive effect on leverage They also concluded that leverage is affected negatively by liquidity, business risk, industry average, cost of debt, and profitability Mary et al also analyzed the firms on the industry level and concluded that the significance and sign of the coefficient of the determinants of capital structure are not the same across the industries For example, in the food and beverages industry, the leverage ratio depends significantly on profitability (a negative relationship) and business risk (a positive relationship) Salawu (2007) also carried out a study by selecting 25 managers of financial firms in Nigeria to reveal the factors affecting the firm's capital structure Contrary to what has been achieved in Developed Western countries, this paper shows that the leverage of Nigerian firms is largely financed in the short term The main reason is the development of financial markets and the availability of long-term loans The results of the study show that there is a positive relationship between leverage and growth opportunities, between dividend payment and firm size Although the paper has a 100% response rate, there is still some uncertainty about how to select the financial managers included in the article Nevertheless, the results of this study are similar to those of Salawu and Agboola (2008) All studies use the fixed effects model (FEM) to test the theory of trade-off capital structure which may not form a causal connection Akiyomi and Olagunju (2013), a study of 24 non-financial firms in Nigeria spanning from 2003 to 2012, found that there is a negative relationship between leverage and firm size On the other hand, there is multicollinearity between the two variables of size and tangible fixed assets (TANG) and the autocorrelation as shown by the Durbin-Watson index is 2,371 It is also another test in the study of the static model that forwards the trade-off theory

regardless of the rate of adjustment of the target capital structure Buferna et al (2005) studied 55 Libyan firms for the period from 1995 to 1999 They used cross-sectional OLS regression and found that profitability and size maintain a positive relationship with both total debt and short-term debt ratios They also concluded that growth and tangibility have negative relationships with both total debt and long-term debt ratios Abor (2008) studied the publicly listed firms, unlisted firms and small enterprises in Ghana He focused on twenty-two quoted and fifty-five unquoted firms for the period from 1998 to 2003 Abor used Prais-Winsten regression and concluded that the leverage of publicly listed firms is positively related to the size of the firm He found that a higher leverage ratio is employed by the unlisted firms and is positively related

to growth Finally, Abor concluded that the leverage of small enterprises is positively correlated with size and growth Achy (2009) conducted the study of over 550 non-listed Moroccan firms for the period from 1998 to 2003 Achy found that leverage is positively correlated with growth and is negatively correlated with profitability and size

For Oceania and Latin America, Chiarella et al (1991) studied 226 Australian firms for the period from 1977 to 1985 They employed linear regression as well as structural model They concluded that size of the firm and cash holdings are positively correlated with leverage, while profitability and non-debt tax shields affect leverage negatively The negative effect is consistent with DeAngelo and Masulis (1980) who stated that non-debt tax shields is used by firms to substitute the interest tax shields Chiarella et al interpreted the negative relationship between profitability and debt ratio

in a sense that firms included in the study might have preferred to rely on the retained earnings before issuing debts This is concluding that the sample taken in this study follows the pecking order theory The concluded positive relationship between debt ratios and cash holdings is consistent with the findings of Jensen (1986) Dang (2013)

observed that unlevered firms can be normalized in their dividend payments It's payers and non-payers Dang also argues that these groups have different motivations for debt Non-payers may have zero leverage because of financial constraints while payers may have zero leverage in a calculated way to account for the lack of transparency in their investments; Cole (2013) examined the privately held firms in the USA from 1987 to

2003 and concluded that leverage is negatively correlated with profitability, size, and age of the firm Cole also detected that the leverage ratio for privately held firms and small publicly held firms are similar Bebczuk and Galindo (2010) analyzed 185 listed firms in six Latin American countries for the period from 1993 to 2009 They found that leverage is determined positively by size, tangibility, and market-to-book ratio, while profitability harms leverage They further analyzed the cost of debt and found it negatively related to growth, size, tangibility, and leverage ratio Espinosa et al (2012) analyzed 133 Latin American countries (including Argentina, Chile, Mexico, and Peru) for the period from 1998 to 2007 They concluded that the capital structure decision of Chilean firms is impacted positively by tangibility and size, while growth opportunities and performance have a negative impact The rest of the Latin American countries showed mixed results

2.2.3 Empirical studies on the determinants of the speed of adjustment

Some empirical research is carried out to determine what factors influence how quickly a target capital structure reaches its aim In the USA, Banerjee et al compare businesses between the United States and the UK (2000) They used non-linear models

to study 122 UK enterprises for the years (1990 - 1996) and 426 US firms for the years (1989 – 1996) According to Banerjee et al., while the distance variable is determined

to be minor in the US, it negatively influences the pace of adjustment for UK enterprises They also concluded that company size influences adjustment speed positively in both markets whereas projected growth has a negative impact In their analysis of 90 Swiss companies from 1991 to 2001, Drobertz and Wanzenried (2006)

used Arellano and Bond's one-step difference GMM calculation (1991) They employed initial differences and twice utilized lagging variables to instrument endogenous variables Drobertz and Wanzenried concluded that company size has no effect on the pace of adjustment, but growth and distance do On a macroeconomic level, term spread (a proxy for economic circumstances); a high term indicates excellent prospects showed a positive effect, while i-short (short-term interest rate) - a measure of the speed at which adjustments are decided to make a negative effect

For Asia, Mahakud and Mukherjee (2011) studied 891 Indian manufacturing firms for the period from 1994 to 2008 They employed different GMM estimations (Arellano& Bond, 1991) They concluded that dividends and tangibility have a negative impact on the speed of adjustment, while distance, profitability, size, growth opportunities, non-debt tax shield, business group affiliation (ownership structure), and macroeconomic conditions affect speed positively Haron et al (2013) studied 790 non-financial Malaysian firms for the period from 2000 to 2009 They employed a partial adjustment model using different GMMs They concluded that Malaysian firms adjust to a target capital structure at a rapid speed (57%) Haron et al also concluded that the closer the gap between current and target leverages, the higher the speed of adjustment They also concluded that profitability and firm size have a positive impact

on adjustment speed, while growth opportunity is insignificant Naveed et al (2015) studied 147 textile sector-listed Pakistanian companies for the period from 2003 to

2011 They employed different GMM and system GMM They concluded a rapid speed of adjustment (51%) Results also indicated the insignificant effect of tangibility

on the speed of adjustment, a positive impact on growth, while profitability, size, and liquidity showed a negative impact Naveed et al also focused on the crisis period to provide further evidence They defined the crisis from 2009 to 2011 During this period, 73% speed of adjustment is concluded, only profitability is found to affect the

2.3 Differences from previous studies

The capital structure of an enterprise directly reflects the results of its capital mobilization policy Information on the rapid or slow change of capital structure of an enterprise is very important, reflecting many dimensions of business activities, investments and risks of the enterprise This article summarizes the meaning of information from the rate of change of capital structure and factors affecting the rate of change of capital structure of enterprises

A change in the use of debt by an enterprise will lead to changes in loan interest, leading to a change in the amount of income tax that the enterprise has to pay It can be recognized that the fast or slow change of capital structure can become data for forecasting and analyzing the stock prices of enterprises Proposals to increase leverage appear to reduce investors' assessment of risk to the company's common stock, but are unlikely to change their expectations for cash flow; Proposals to reduce leverage appear to reduce investors' expected cash flows, but do not appear to change their assessment of risk

Capital structure is affected by many factors, changes in capital structure and speed of change are also affected by many factors both inside and outside the enterprise The characteristics of business operations, whether changes in capital structure take place quickly or slowly, are influenced by factors such as size, operational efficiency, cash flow and age of the enterprise From outside the enterprise, changes in the capital structure of enterprises are influenced by the macroeconomic environment, policy institutions as well as regional differences of enterprises However, there is a need for more general studies, development of the theoretical basis, additional studies as well as evidence on the impact of factors

In addition, the study uses the latest data on non-financial enterprises in the Vietnamese stock market in the period 2010 - 2020 which partly reflects the change in

the capital structure of enterprises in the period of 2010 – 2020, through the Covid-19 pandemic

SUMMARY CHAPTER 2

The research has conducted an overview of capital structure concepts, capital structure measurement and capital structure theories such as the theory of Modigliani and Miller, the trade-off theory of capital structure, the pecking order theory, and the agency cost theory At the same time, the study presents several related previous studies in Vietnam and international areas Thereby, the study briefly evaluates and identifies the determining factors of capital structure This chapter is the basis for the study, review and assessment of the influencing factors in the next chapter

CHAPTER 3: RESEARCH METHOD 3.1 Research study

 Qualitative method

Through the approach to MM model theory, trade-off theory, pecking order theory and through previous studies in Vietnam and other countries to conduct analysis and discussion of factors affecting the capital structure of non-financial enterprises in Vietnam On that basis, influencing variables, research hypotheses and conclusions are drawn

 Quantitative methods

Quantitative research methods are used to determine research results on influencing trends and influence levels of factors affecting the capital structure of non-financial enterprises, including technically specific methods are as follows: Descriptive Statistics, Correlation Analysis and Panel Data Regression

 Descriptive statistics

Descriptive statistics help to make a preliminary overview of the research sample This statistic shows the basic characteristics of the variable such as maximum value (Maximum), minimum value (Minimum), mean value (Mean), and standard deviation (Std)

 Correlation analysis

Correlation analysis estimates the correlation between the variables in the model The correlation between the independent variables and the dependent variable

is strong or weak, positive or negative

 Regression analysis of panel data

Regression analysis of panel data to determine the relationship between the independent variable and the dependent variable, and test the influence of the factors affecting the capital structure of a joint stock commercial bank in Vietnam Using least squares models (Pooled Ordinary Least Square - Pooled OLS), FEM (Fixed Effects Model), REM (Random Effects Model), then compare the selection of Pooled OLS and FEM models by testing F-test, select Pooled OLS and REM models by Breusch-pagan

LM Test, and compare FEM and REM models by Hausman Test

To test the hypothesis of research on factors affecting the capital structure of non-financial enterprises in Vietnam, the study uses the F-test with significance levels

of 1%, 5%, and 10% to determine the level reliability of the influence of the independent and dependent variables Based on the slope coefficient β determine the trend and the degree of influence in the same direction as well as the opposite direction The defects in the model will also be tested, which are multicollinearity, variable variance and autocorrelation

 The phenomenon of multicollinearity

Multicollinearity will be tested through the VIF-Variance Inflating Factor, if the VIF factor is less than 10, or 1/VIF is less than 0.1, the model does not have multicollinearity and vice versa

 The phenomenon of variance of error changes

This phenomenon will bias the T and F tests, making it impossible to give accurate results and the regression coefficient has a low level of confidence The phenomenon of variable variance will be tested by Wald with the hypothesis:

+ H0: there is no change in variance

+ Hi: There is a phenomenon of variable error variance

If p-value < α, then reject H0, accept H1 and vice versa, p-value > α, then accept H0, reject H1

 Autocorrelation phenomenon

In the presence of autocorrelation, the OLS model estimates are still linear but not efficient The phenomenon of autocorrelation will be tested through the Wooldridge test with:

+ H0: There is no autocorrelation

+ Hi: There is autocorrelation

If the result value is small < α, then reject H0, accept H1 and vice versa, value> α, then accept H0, reject H1

p-After testing for defects, to overcome the existence of variable variance defects

or autocorrelation, the study will use the GLS (Generalized Least) estimation, Squares model) when the model has variable variance and autocorrelation Finally, this model

is used to transform the original variables and estimate the parameter values to find

3.2 Data and variable selection

3.2.1 Data and sample

The data in the research paper is provided with annual financial statements from

150 non-financial enterprises listed on Hanoi Stock Exchange (HNX) and Ho Chi Minh City Securities Exchange (HOSE) during the period 2010 - 2020 Selecting non-

financial enterprises in the Research article because the management of financial and banking enterprises has differences in income reporting standards as well as complexity in balance sheets The period of 11 years, from the period before and after the COVID period is long enough to determine the fluctuations and the actual state of the businesses, enhancing the significance and reliability of the research point

This study is based on the research of Oino and Ukaegbu (2015) on the impact

of profitability on capital structure and capital structure adjustment speed in different companies listed on stock exchanges in Nigeria Accordingly, the research method used in the article includes:

The method of least squares (OLS) to test the relationship between capital structure and internal factors affecting the capital structure The fixed effects model (FEM) and random effects model (REM) was also used to not only examine the above relationship but also to test the robustness of the findings from the Pooled OLS method However, to overcome the phenomenon of variance and autocorrelation appearing in the total, I will use the general least squares (GLS) model instead of the original OLS model To select the appropriate model among the above three models, I use F-test and Hausman test The rate of adjustment to the target leverage ratio of the business will be determined by two models, Pooled OLS and GMM Based on the research of Oino and Ukaegbu (2015), I calculated the variables to include in the model

as follows:

3.2.2 Independent variables

The measures of factors affecting the capital structure of enterprises used in the article include: Profitability (PROF), Tangibility (TANG), Enterprise Size (SIZE), Effective Tax Rate of Corporate (ETR) and Business Growth Rate (GROWTH)

 Profitability of the business - PROF, calculated by the formula:

PRO = EAT / Total Assets

According to the capital structure trade-off theory, unprofitable firms are riskier and should rely mainly on equity as well as limited debt Therefore, profitability is directly proportional to financial leverage In contrast, according to the pecking order theory mentioned in the previous sections, a profitable company has enough capital to finance investment projects, so it does not need to borrow with low profitability Profit

is inversely proportional to financial leverage In a research paper by Phan Thanh Hiep (2016), profitability has a negative effect on corporate capital structure

 Tangibility in the enterprise's asset structure - TANG, is calculated by the formula:

TANG = Tangible fixed assets / Total assets

According to the trade-off theory of capital structure, tangible fixed assets have

a positive relationship with financial leverage because fixed assets guarantee the borrowing of enterprises However, according to the research results of Phan Thanh Hiep (2016), this factor has a negative impact on the capital structure of enterprises

 Enterprise size – SIZE, calculated by the formula:

SIZE = Natural Logarithm of Revenue

According to the pecking order theory, the larger the firms are, the less information asymmetry they have, so the ability to issue shares of these firms will be higher and less debt-bearing

 Effective corporate income tax rate – ETR, calculated by the formula:

ETR = CIT expense / Business profit before tax

Firms that pay high taxes will tend to have more debt in their capital structure to take advantage of the benefits of tax shields Therefore, tax costs have a positive relationship with financial leverage