Impact of capital structure on performance of listed material manufacturing enterprises in vietnam

The impact of capital structure including the short-term debt ratio, the long-term debt ratio on performance is measured by return on average assets ROA, return on average equity ROE, in

MINISTRY OF EDUCATION AND TRAINING STATE BANK OF VIETNAM

BANKING UNIVERSITY HO CHI MINH CITY

TRUONG THI KIM NGAN

IMPACT OF CAPITAL STRUCTURE ON PERFORMANCE

OF LISTED MATERIAL MANUFACTURING ENTERPRISES

MINISTRY OF EDUCATION AND TRAINING STATE BANK OF VIETNAM

BANKING UNIVERSITY HO CHI MINH CITY

TRUONG THI KIM NGAN

IMPACT OF CAPITAL STRUCTURE ON PERFORMANCE

OF LISTED MATERIAL MANUFACTURING ENTERPRISES

IN VIETNAM

MASTER THESIS

Major: Banking - Finance Code: 8 34 02 01

MENTOR: ASSOC PROF LE PHAN THI DIEU THAO

Ho Chi Minh City – 2023

DECLARATION OF AUTHENTICITY

This thesis is the author's own research, the research results are authentic, in which there is no previously published content or the content done by others except the citations cited in the thesis

I declare that all statements and information cited in this thesis are true, accurate and correct to the best of my knowledge and belief

I am fully responsible for the thesis’s authenticity

Ho Chi Minh City, February 25th, 2023

Student

TRUONG THI KIM NGAN

GRATEFULNESS

Firstly, in order to complete this graduation thesis, I would like to express my deep

gratitude to mentor Associate Professor Le Phan Thi Dieu Thao who has guided

me from writing outline, enthusiastically giving feedback, encouraging and following the plan to ensure that the thesis is completed in a best and timely manner

Next, I would also like to express my sincerest thanks to all the lecturers of Banking University of Ho Chi Minh City for imparting valuable knowledge to me during the course so that I have a good foundation in order to complete the graduation thesis

Finally, it is indispensable to the enthusiastic support from my friends and family who always accompany and facilitate to perform the graduation thesis perfectly

During implementing the thesis, due to some limitations in knowledge and experience, it is impossible to avoid shortcomings Therefore, I am very grateful to receive advice and suggestions from teachers and friends to help me complete the graduation thesis

Once again thank you

Ho Chi Minh City, February 25th, 2023

Student

TRUONG THI KIM NGAN

ABSTRACT

Title: Impact of capital structure on performance of listed material manufacturing

enterprises in Vietnam

Abstract: The thesis analyzes the impact of capital structure on performance of listed

material manufacturing enterprises in Vietnam Secondary data is extracted from annual reports, financial statements of listed material manufacturing enterprises selected as a sample for the 10-year period from 2012 to 2021 FGLS estimation method combined with matrix correlation is used to test the influence of the explanatory variables on the dependent variable The impact of capital structure including the short-term debt ratio, the long-term debt ratio on performance is measured by return on average assets (ROA), return on average equity (ROE), in addition, the thesis also uses additional control variables such as enterprise size (SIZE) and revenue growth (GROWTH) Regarding the level of influence, the impact of short-term debt ratio on performance is a non-linear relationship For long-term debt, because most enterprises use a very small ratio of long-term debt, only about 10%, the increase in long-term debt also has an impact on financial performance but follows a linear relationship For two control variables are firm size and revenue growth Both of these variables show a positive impact on financial

performance Therefore, creating better profitability than other businesses

Keywords: Capital structure, short-term debt ratio, long-term debt ratio

ABBREVIATIONS LIST

Pooled OLS Pooled ordinary least square

TABLE OF CONTENTS

DECLARATION OF AUTHENTICITY i

GRATEFULNESS ii

ABSTRACT iii

ABBREVIATIONS LIST iv

LIST OF TABLES vii

LIST OF CHARTS viii

CHAPTER 1 : INTRODUCTION 1

1.1 Introduction 1

1.2 The necessity of the research 2

1.3 Research objectives 3

1.4 Research questions 3

1.5 Research subjects and scope 4

1.6 Research method 4

1.7 Research structure 5

Chapter 1’s summary 6

CHAPTER 2 : THEORETICAL AND EMPIRICAL RESEARCHES 7

2.1 Theory of capital structure 7

2.1.1 Traditional approach 7

2.1.2 M&M theory 8

2.1.3 Trade-off theory 11

2.1.4 Pecking order theory 13

2.2 Empirical researches 15

2.2.1 Foreign researches 15

2.2.2 Domestic researches 24

2.2.3 Researches’ gaps 28

Chapter 2’s summary 29

CHAPTER 3 : RESEARCH METHOD 30

3.1 Research hypothesis 30

3.2 Description of variables in the research model 31

3.2.1 Dependent variable 31

3.2.2 Independent variables 32

3.2.3 Control variables 34

3.3 Theoretical research model 36

3.4 Research data 38

3.5 Research method 40

3.6 Data analysis sequence 42

3.6.1 Descriptive statistics 42

3.6.2 Correlation analysis 42

3.6.3 Regression Model Selection 43

3.6.4 Model’s deficiencies test 44

3.6.5 Model’s deficiencies remedy 45

Chapter 3’s summary 46

CHAPTER 4 : RESEARCH RESULTS AND DISCUSSIONS 47

4.1 Descriptive statistics 47

4.2 Correlation analysis 50

4.3 Regression analysis 51

4.3.1 The impact of short-term debt on ROA 52

4.3.2 The impact of long-term debt on ROA 60

4.3.3 The impact of short-term debt on ROE 67

4.3.4 The impact of long-term debt on ROE 75

Chapter 4’s summary 84

CHAPTER 5 : CONCLUSION AND POLICY RECOMMENDATION 85

5.1 Conclusion 85

5.2 Recommendations on capital structure for enterprises 87

5.3 Recommendations for relevant organizations 88

5.4 Limitations of the topic 89

Chapter 5’s summary 90

REFERENCES i

APPENDIX 1 viii

APPENDIX 2 x

LIST OF TABLES

Table 3.1: Description of variables in the research model 36

Table 4.1: Descriptive statistics of variables 47

Table 4.2: Correlation between variables 50

Table 4.3: Correlation between variables (after adjustment) 51

Table 4.4: Model regression results of short-term debt for the ROA 52

Table 4.5: Model’s selection for short-term debt on the ROA 53

Table 4.6: VIF test result for short-term debt on the ROA 54

Table 4.7: Heteroskedasticity test result for short-term debt on the ROA 55

Table 4.8: Auto-correlation test result for short-term debt on the ROA 56

Table 4.9: FGLS regression model for short-term debt on the ROA 57

Table 4.10: Regression results for long-term debt on the ROA 60

Table 4.11: Model’s selection for long-term debt on the ROA 61

Table 4.12: VIF test result for long-term debt on the ROA 62

Table 4.13: Heteroskedasticity test result for long-term debt on the ROA 63

Table 4.14: Auto-correlation test result for long-term debt on the ROA 64

Table 4.15: FGLS regression model for long-term debt on the ROA 65

Table 4.16: Model regression results of short-term debt for the ROE 67

Table 4.17: Model’s selection for short-term debt on the ROE 69

Table 4.18: VIF test result for short-term debt on the ROE 70

Table 4.19: Heteroskedasticity test result for short-term debt on the ROE 70

Table 4.20: Auto-correlation test result for short-term debt on the ROE 71

Table 4.21: FGLS regression model for short-term debt on the ROE 72

Table 4.22: Regression results for long-term debt on the ROE 75

Table 4.23: Model’s selection for long-term debt on the ROE 76

Table 4.24: VIF test result for long-term debt on the ROE 77

Table 4.25: Heteroskedasticity test result for long-term debt on the ROE 78

Table 4.26: Auto-correlation test result for long-term debt on the ROE 79

Table 4.27: FGLS regression model for long-term debt on the ROE 80

Table 4.28: Overall comparison results 83

LIST OF CHARTS

Chart 4.1: Average rate of return over 10 years 48 Chart 4.2: Average debt ratio over 10 years 49

CHAPTER 1: INTRODUCTION

1.1 Introduction

Capital structure decision is one of the essential decisions of every enterprise One

of the key issues of capital structure is determining the optimal structure to achieve good performance Capital structure decisions must be made well before the company is incorporated or when there is a capital requirement to meet the cost needs The CFO of a company must analyze the cost and profit factors of various sources before choosing the best one, the optimal capital structure or the capital structure that reduces the cost for the business Therefore, capital structure decision

is an ongoing process and must be done whenever the company has capital requirements for projects The capital structure is said to be optimal once it maximizes the market value of the firm (Chadha and Sharma, 2015)

Capital structure is the combination of debt and equity that a company uses to finance its business (Damodaran, 2001) In the capital structure decision, the term financial leverage is mentioned Financial leverage is the ratio between debt and equity, indicating the relationship between borrowed funds and owners’ equity in a firm’s capital structure (Chadha and Sharma, 2015) The owner has a commitment to the company in the belief that the company will grow in the near future In contrast, creditors do not have a solid and long-term commitment because they are more interested in paying their debt on time CFOs will want to invest cash in future projects to generate better returns, while shareholders are more interested in paying regular dividends (Chadha and Sharma, 2015) The impact of decisions on capital structure will help enterprises to cope with the harsh competitive environment to finance the company’s assets (Zuraidah et al., 2012) Thus, the basic objective of capital structure optimization is to decide the proportions of debt and equity in order

to maximize corporate value, improve business performance, and at the same time minimize the average cost of capital (Yu-Shu et al., 2010)

Capital structure has an influence on the performance of enterprises and has been researched by domestic and foreign authors Some of the foreign studies can be mentioned are Mireku et al (2014); Ramachandran and Candasamy (2011); Olokoyo (2013); Sheikh et al (2013); Pouraghajan et al (2012); Gill, Biger and Mathur (2011); Margaritis and Psillaki (2010) Meanwhile in Vietnam, assessing the impact of capital structure on the performance of enterprises is studied by many authors Nguyen Thi Thanh Vinh (2021); Tran Thi Kim Oanh and Hoang Thi Phuong Anh (2017); Doan Vinh Thang (2016); Quang et al (2014)

1.2 The necessity of the research

Theoretically, capital structure reflects the ratio of debt to equity that the business is carrying Prior studies focused on looking at factors affecting the capital structure of enterprises, making comments on the ratio between debt capital and equity or the ratio of short-term and long-term debt Theoretically, researchers have shown that a reasonable capital structure will contribute to increasing profits and increasing enterprise value However, what capital structure is reasonable in the economic environment in Vietnam has not been clarified Therefore, it is necessary to have an overall picture of the common types of capital structures currently applied by Vietnamese enterprises and specific to an industry

In terms of economic practice, firstly, materials are inputs for all production industries as well as having spillover effects, positive impacts promoting the development of many industries, such as: manufacturing, information technology, electronics, chemicals, high-tech industries, products for agricultural, forestry, fishery, livestock production, etc Secondly, the self-production for domestic production has also contributed to reducing the import of raw materials from other countries and optimizing investment costs in the production of some industries Thirdly, in general, the production capacity and quality of our country’s material industry is still limited The localization rate of production of materials for the manufacturing industry is still low, such as cast iron materials (under 30%); aluminum material, copper material (about 5%); chemicals for the plastic and rubber

industries still have to import up to 70%; raw materials for the textile industry have

to be imported nearly 90% of fabrics, 80% of yarns;

Based on the practices and recent researches, the thesis decided to choose the topic

“Impact of capital structure on performance of listed material manufacturing enterprises in Vietnam” This study provides both theoretical and practical

significance to know which factors in capital structure affect enterprises’ performance in order to make rational decisions about capital structure With the ultimate goal is to help businesses get the right strategies to maximize their value with the minimal capital cost

1.4 Research questions

Based on the purpose set out above, the study will make 3 corresponding questions

to solve 3 specific objectives, (i) What factors in capital structure affect performance

of listed material manufacturers in Vietnam? (ii) How do capital structure factors affect the performance of these firms? (iii) Determine the optimal capital structure based on the quadratic research model? (iv) What solutions will help improve performance in business activities of Vietnamese enterprises

1.5 Research subjects and scope

The object of the research are the capital structure’s factors that affect the performance of the listed material manufacturing enterprises in Vietnam The study will carry out sample, based on secondary data of listed material manufacturing enterprises on the Ho Chi Minh Stock Exchange (HoSE) Listed firms have a fairly significant effect on economies in term of scale or business activities (Choi et al., 2014) Using data from audited financial statements of listed companies will ensure the reliability and transparency of the information disclosed by the company Based

on data extracted from HoSE’s website, the total number of enterprises in the material manufacturing industry is 67 enterprises, ranking second among the overall

of 406 listed ones, so the research sample will be guaranteed In which, the research period is 10 years from 2012 to 2021 that ensures the representativeness of the selected sample to explain the research results (Chadha and Sharma, 2015; Choi et al., 2014)

Quantitative research method is to examine the extent of impact of capital structure’s factors on performance of enterprises It includes specific technical methods such as descriptive statistics, correlation analysis and panel data regression Then, the author performs regression analysis in the order of OLS model, FEM model and REM model Hausman test is used to select the model that fits the data Finally, when a

suitable model has been chosen, the thesis will test the defects of the model, including (i) the multicollinearity, (ii) the heteroskedasticity, (iii) the auto-correlation

1.7 Research structure

The thesis will focus on the following 5 detailed chapters Chapter 1 is the introduction In this chapter, the thesis will present the reasons for choosing the topic After that, the thesis sets out specific goals and objectives to be solved, meanwhile, the research questions corresponding are set out Next is about the research object and scope and research methods And finally the layout of the study Chapter 2 is about theoretical research and experimental research Firstly, the study performs a synthesis of theories of capital structure such as Modigliani Miller theory, pecking order theory, trade-off theory and examines relevant empirical studies to find research gaps and meanwhile gives out the factors in capital structure that will affect the performance of the business Chapter 3 presents the research methodology The thesis explains in detail the method used to solve the research questions After that, the thesis will mention the method used to collect the data From the factors obtained

in Chapter 2, the thesis sets out research hypotheses and builds a theoretical model

to test the impact of the set factors Chapter 4 is about the research results obtained from model regression, which will include the descriptive statistics, correlation analysis, regression analysis and the results’ explanations And finally, Chapter 5 is the conclusion and recommendations The thesis will make general conclusions about the achieved results and suggest appropriate recommendations and policies to build capital structure to improve the financial efficiency of Vietnamese enterprises

in general

CHAPTER 2: THEORETICAL AND EMPIRICAL

RESEARCHES

2.1 Theory of capital structure

Information about the financing for business operations, the enterprise’s capital source

is presented on the balance sheet and explained in detail in the financial statements’ notes, including two groups are liabilities and equity, sorted by increasing stability Liabilities reflect capital sources formed by enterprises borrowing, purchasing goods and services on credit from suppliers, accumulated debts (unpaid taxes to the State, salary and unpaid social insurance to employees) Liabilities are divided into two groups based on the repayment period, including short-term liabilities - with a maturity date of

1 year or 1 business cycle, and long-term liabilities – with a maturity is over 1 year or 1 business cycle Unlike debt, equity is formed by the contributions of owners or accumulated from business results during the operation Equity is a source of financing characterized by dynamic, non-repayable and high stability To reflect the combined relationship between different sources of financing, company often emphasizes the relationship between debt and equity for the entire invested assets, thereby finding out how the company’s management has decided to sponsor, and whether there will be positive or negative effects on the goals of the funding decision

Some assumptions from the traditional approach:

− Financial markets are not perfect, businesses and investors cannot borrow at the same interest rate

− Enterprises operate in an environment with corporate income tax

− Enterprises are at risk of falling into financial distress due to the use of debt However, when utilization increases but debt ratio remains low, shareholders and creditors can

either ignore the risk and either not increase the required rate of return, or increase it but not significantly

The traditional approach explains that firms can reduce the average cost of capital by using debt, because the cost of debt is lower than the cost of equity The reason for optimal capital structure theory indicates that the cost of debt is lower than the cost of equity is due to the tax savings from interest When firm uses debt, the interest will reduce the income tax payable Meanwhile, the profits that the business distributes to the shareholders do not generate tax savings Thus, in order to reduce the average cost

of capital, enterprises should use debt However, the use of debt will increase risks for creditors and shareholders, so the average cost of capital will only decrease when the level of debt use is still within the limit so that creditors and shareholders do not increase the required rate of return or insignificant increase In summary, the average cost of capital will change as the capital structure changes, the optimal capital structure must include debt and equity in an appropriate ratio so that the average cost of capital is lowest

Thus, the traditional approach admits and provides arguments to prove the existence of

an optimal capital structure for the firm, which is because (1) the cost of debt is lower than the cost of equity, (2) both of these costs will increase with an increase in debt utilization Although the traditional approach has been supported by some famous financial experts such as Ezra Solomon and Fred Westo, it has not been convinced by other researchers, and has even been rejected As in reality, there is not enough certain bases to confirm that when increasing the level of debt use, the cost of debt and the cost

of equity will increase

the information; (vi) all investors have as much information as the company’s management about the investment opportunities; (vi) companies with comparable business risks, operating in similar environments; (vii) the company distributes 100% of profits to shareholders, so the growth rate is zero M&M theory states that the average cost of capital and firm value are independent of capital structure However, an important and prominent point that increases the persuasiveness of M&M theory is that the two authors provide behaviour and technical evidence to explain why the average cost of capital and firm value do not change, when the degree of financial leverage is changed The reason is due to arbitrage activities

Arbitrage activities

Arbitrage is the process of buying securities in a low-priced market and then selling them in a higher-priced market, thereby restoring equilibrium to the market price of a security M&M theory illustrates that due to the existence of arbitrage, the value of firms with different capital structure will the same This is explained by M&M if there exist two companies with different values due to different capital structures, then investors will buy the shares of the low priced company and sell the higher ones This action will increase the stock price of the low value company and decrease the share price of the high value firm This buying and selling process is continued until the market prices of the two stocks are equal

The value reservation rules

Starting from the view that the value of the business does not depend on the capital structure and how the earning before interest and tax is divided among creditors and shareholders, M&M believes that changing capital structure only transfers value from shareholders to creditors or vice versa without changing firm value According to M&M, the value of a business is governed by two factors (i) its operating income and (ii) the level of business risk associated with the above operating income In a perfect capital market with no corporate taxes, no bankruptcy costs, a firm’s value is unaffected by its capital structure In other words, the value of the firm without debt and the value of the firm using debt is the same Thus, companies cannot increase its value depending on the change of capital structure, so enterprises cannot find the optimal capital structure

Financial leverage and the cost of capital

Since the expected annual operation return and the market value of the debt and debt firm are the same, the weighted average cost of capital of the two firms will also

non-be the same For equity, financial leverage increases expected earning per share, but also increases the standard deviation and variation’s coefficient of earning per share Thus, financial leverage increases the risk of equity As risk increases, the required rate of return on equity must increase In M&M’s view, in the absence of taxes, the required rate of return on equity of the company using debt, is equal to the one using no debt, plus risk premium In other words, the required return on equity is positively related to the level of financial leverage

M&M theory in tax environment

The original M&M theory was built with the assumption that the business operates in a tax-free environment and some other assumptions Based on these assumptions M&M concludes that firm value and average cost of capital are independent of capital structure

as discussed above The assumption that businesses do not have to pay taxes is unrealistic, because in reality most businesses have to pay income tax to the State Thus, the assumption of no taxes reduces the validity of the M&M theory Therefore, in the next section, the author will discuss M&M theory in an environment with corporate income tax, the remaining assumptions are unchanged In tax-free terms, the earning before interest and tax belongs to its creditors and shareholders If there are taxes, earning before interest and tax will be divided into three groups: creditors, the State and shareholders Tax law allows interest to be included in a deductible expense when calculating income tax Therefore, interest helps businesses create a tax shield or create

an interest tax savings Thanks to this savings, the use of debt will increase the return to creditors and shareholders M&M theory under tax conditions also has two postulates,

in which the postulate I deals with enterprise value and the postulate II deals with the capital cost

Postulate I – Enterprise’s value

In tax condition, the value of the leveraged firm is greater than the value of the unleveraged firm the amount of the present value of the tax savings from the interest

Without using debt, the operating profit will belong to the State and shareholders If debt

is used, the operating profit will belong to creditors, the State and shareholders When there is the participation of the State in the distribution of profits, the profit brings to both creditors and shareholders of the company that uses debt is greater than the one that does not use debt is the amount of tax savings from interest

Postulate II - Cost of capital

As the level of debt utilization increases as to tax and interest savings, the real cost of debt decreases, so the average cost of capital decreases of debt-using firms will be lower than the non-debt firms As debt utilization increases, financial risk increases, so the cost of equity increases This is stated by poposition II that iIn an environment with no taxes and no bankruptcy costs, the required rate of return or the cost of equity will fluctuate with the degree of financial leverage but taking into account the impact of the tax shield

Thus, M&M theory has given a new perspective in analyzing and explaining the

relationship between capital structure and firm value and cost of capital M&M theory applies arbitrage as an evidence to explain investor behavior, thereby drawing the following conclusions that in the absence of taxes, enterprise value and weighted cost

of capital is independent of capital structure However, the next section M&M removes the assumption of no taxes and concludes that firm value increases when using debt thanks to tax shield from interest; the weighted cost of capital of firm that uses debt is lower than the one that does not use the debt; the cost of equity increases with an increase

in the use of debt Although M&M theory offers many different perspectives on the impact of capital structure on firm value and cost of capital, it is built on many unrealistic assumptions Therefore, unrealistic assumptions need to be removed for more accurate and convincing conclusions In the next section, the author will consider capital structure

in terms of financial distress costs, agency costs and information asymmetric

2.1.3 Trade-off theory

The trade-off theory of capital structure proposed by many researchers is to explain the phenomenon in practice, that firms only use debt to a certain limit, while the M&M

theory suggests that the higher the firm value, the higher the level of debt usage To explain this phenomenon, researchers believe that the M&M theory is based on the unrealistic assumption that there is no financial distress that generates financial distress costs due to the use of debt In 1973, two researchers Alan Kraus and Robert H Litzenberger concluded that firms with optimal financial leverage reflect the trade-off between the benefit of the tax shield from interest and the costs of bankruptcy In 1984, Stewart C Myers stated that firms following the trade-off approach would establish a target debt ratio based on the balance between the benefits of the tax shield and the costs

of bankruptcy and gradually adjust the capital structure towards that goal Thus, according to the trade-off theory of capital structure, firms using debt will benefit from the tax shield of interest, but using debt incurs additional costs, especially the cost of financial distress Therefore, businesses need to use both debt and equity to balance the benefits of tax shields and bankruptcy costs, the value of the business will be highest, and that is the optimal capital structure

Financial distress occurs when a business is unable to fulfill its promises to creditors, or

is able to do so but very difficult Financial distress can be temporary, leading to a number of problems for operations such as feasible projects are delayed or canceled, labor productivity decreases, creditors do not continue to lend, suppliers tighten their credit policy But sometimes financial distress will lead to bankruptcy, in which case enterprises have to spend large amount of money on the lawyers, courts, auditors, business managers, etc Thus, in both cases, financial distress causes serious consequence to the business, and investors assume that a business uses debt can fall into financial distress, which is a factor that reduces firm value The cost of financial distress depends on the likelihood of financial distress and the magnitude of the costs involved Financial distress costs fall into two categories are direct costs and indirect costs Direct costs include decrease in asset value due to liquidation, decrease in selling price, increase in legal and administrative costs, some companies’ managers can reduce investment in research and development, market research and some other investments Indirect costs include the company’s reputation and reputation decline, possible loss of customers, suppliers of capital require higher returns leading to an increase in the cost

of capital, suppliers set out stricter credit standards and tightening terms of sale or

incurring losses due to competitive pressure When the level of debt utilization is low, the risk of financial distress is still negligible, the present value of the financial distress costs are lower than the present value of the tax shield from interest, so the firm’s value increases with the level of debt However, when the level of debt utilization exceeds the rapid increase of financial distress costs, when the present value of the marginal cost of financial distress equals the present value of the tax savings, the firm value is highest where the capital structure is optimal If the level of debt usage continues to increase, the value of the enterprise will decrease

Thus, the trade-off theory of capital structure indicates that firms must consider the

benefits from the tax shield and the costs of financial distress to choose the one with the highest firm value However, this theory also has limitations that (1) it is difficult to accurately determine the costs of financial distress, especially indirect costs such as loss

of customers, loss of suppliers, loss of reputation and reputation; (2) in practice many large and successful firms still use debt much lower than the optimal debt ratio determined by theory

2.1.4 Pecking order theory

The pecking order theory of capital structure was first proposed by Gordon Donaldson

in 1961 and revised by Stewart C Myers and Nicolas Majluf in 1984 The pecking order theory does not address the existence of whether there is optimal capital structure as a starting point in the approach, but this theory asserts that firms prefer to use internal financing such as retained earnings or excess liquid assets, rather than external funding

If internal capital is not enough to finance investment opportunities, firms can choose external sources in the direction of minimizing increasing costs due to asymmetric information In order to minimize the cost of external sources, businesses prefer to use debt, then to issue preferred shares, and finally to issue common shares Thus, the basic content of the pecking order theory provides managers with the priority order when deciding to choose funding sources, specifically businesses will choose first are internal funding sources (mainly retained earnings) to finance operations and investment in new projects, if internal capital is not sufficient, external funding is mobilized in which debt

is preferred first of all and then direct owners funding This prioritization reflects the

goals of financial managers who want to ensure control for existing owners, to reduce agency costs of new equity, and to avoid negative feedback from market if new shares are issued

The two basic assumptions of pecking order theory include (i) corporate managers acting in the interest of current owners; (ii) information asymmetry exists between managers and investors The pecking order theory states that managers know more information about a firm’s prospects, risks, and values than outside investors, and this information asymmetry affects decision between internal and external financing, debt and equity financing Internal funding is encouraged as the first choice, because the company does not have to disclose information about potential investment opportunities and the expected return from investment opportunities to shareholders or owners debt, except for the disclosure of dividend payments On the other hand, choosing internal capital sources also ensures control for existing shareholders, ownership rights to assets are not dispersed

The cost of the internal sources from retained earnings is less than the cost of newly issued shares Practical research shows that businesses in the service sector where products and services need to be kept confidential to avoid copying, such as computer software technology businesses prefer to retain profit to form internal capital, limiting mobilization of external sources For debt, this is the first preferred source of external financing over equity financing, since the cost of debt is lower than the cost of preferred equity and common stock On the other hand, like retaining earnings, using debt does not make the existing owners’ control dispersed, since creditors have no right to participate in the management of the business Although creditors need information about the business’s credit risk and managers are responsible for providing complete and reliable news to them On the other hand, the existence of asymmetric information also favors the use of debt rather than equity from owners As the company’s managers use debt instead of issuing new shares, considered by investors as a positive signal, show that the company has many investment opportunities that are expected to bring high returns and the company’s managers want to take advantage of debt to increase profits for existing shareholders, contributing to ensuring the goal of extending corporate’s

value Raising fund from owners through the issue of additional shares is the last option, because this source has a higher cost than debt In addition, the issuance of new shares

is considered by investors as a negative signal, indicating that the company’s prospects are not good, and it is likely that earnings will be reduced in the future Therefore, issuing new shares will reduce the share price compared to the current level, negatively affecting the asset value of existing shareholders, so this is the last choice

Thus, the pecking order theory does not provide a model for determining the optimal

capital structure for businesses, but rather guides the priority order of choosing funding sources for operation activities or future financing projects This theory has clarified the financing choices of managers, as well as explained the market’s reaction to the firm’s decision to raise fund from outside However, the pecking order theory does not consider the effects of income taxes and financial distress, ignore the negative problems that can arise if the managers keep too much cash… Thus, pecking order theory cannot replace other theories but supplement and clarify financing decisions of corporate managers

160 observations The data is collected from the financial statements of the companies published on the PEX’s website The independent variables used to measure capital structure include the ratio of short-term debt to total assets (STDTA), long-term debt to total assets (LTDTA), total debt to total assets (TDTA) Performance is measured by return on assets (ROA), return on equity (ROE), return on equity (ROI) In addition, the study uses firm size (SIZE) as the control variable

ROA = 𝛽0 + 𝛽1 CAPITAL + 𝛽2 SIZE + 𝜀 (2.1)

ROE = 𝛽0 + 𝛽1 CAPITAL + 𝛽2 SIZE + 𝜀 (2.2)

ROI = 𝛽0 + 𝛽1 CAPITAL + 𝛽2 SIZE + 𝜀 (2.3)

The results show that the capital structure of the company has a negative and statistically significant relationship with performance measured by ROA, which means the use of high debt will negatively affect the ROA of the company On the other hand, the results show that the capital structure of the company has a positive and statistically significant relationship with the return on equity (ROE) and the return of investment (ROI)

Berzkalne (2015) studied the capital structure and enterprises’ profitability through array data analysis The author studies on the non-linear relationship between capital structure and profitability by using threshold regression analysis with a sample of 58 listed companies in the Baltic, including 22 enterprises from the Baltic region, the rest are businesses in the vicinity, the research period is from 2005 to 2013 The study uses debt ratio as the ratio of total debt/total equity to represent capital structure and selects stock prices to be the best indicator of a company’s profitability The authors conclude that there is a non-linear relationship between capital structure and profitability For Baltic listed companies with small market capitalization, an increase in leverage will increase the company’s profitability and reach its peak value if the debt ratio reaches the rate of 24.64%

Mireku et al (2014) established the relationship between capital structure measures and performance in order to determine which capital structure measure has a stronger relationship with performance Two definitions of capital structure measures (book value and market value) and six measures of performance were used in the study The sample in this study was 15 companies on the Ghana Stock Exchange (GSE) that had been selected over a 6-year period (2002–2007) The results showed that the capital structure of firms affects their performance Many indicators showing the company's performance were negatively correlated with financial leverage That means, Ghana companies with less debt would have high profit margins and good performance The

findings of the study showed that firms rely more on short-term debt than on long-term debt This was probably due to the absence of a well-developed bond market in Ghana, where companies could raise long-term debt on demand Performance measures, especially profitability, have a negative relationship with financial leverage Firms with high profitability and good performance in Ghana had less debt and were more dependent on internal sources of financing according to pecking order theory This study concluded that the market value of capital structure should be considered more when assessing capital structure because it was more closely linked to financial performance than book value The author recommended future empirical research on other factors affecting the performance of companies in Ghana besides debt policy and a deeper investigation into capital structure trends and dependence on short-term liabilities that could be taken

Olokoyo’s study (2013) presented empirical findings on the impact of leverage (debt ratio) on the performance of firms The results were based on data from 2003 to 2007 of

101 listed companies in Nigeria along with pecking order theory and static trade-off theory of capital structure The study used panel data analysis using fixed-effect estimation, random-effect estimation and regression model Hausman's Chi-square and conventional tests were used to check whether the fixed-effects model is a suitable alternative to the random-effects model when calculating for each model In the research model, the author used the ratio of return on total assets (ROA), return on equity (ROE) and the ratio between market value to book value (Tobin's Q) to measure performance

In which, the variables used to explain the relationship between capital structure and performance included the ratio of total debt to total assets (TD/TA), the ratio of long-term debt to total assets (LD/ TA), the ratio of short-term debt to total assets (SD/TA) and firm size (S) Financial leverage had a negative effect on a company’s performance measure (ROA)

ROA it = 𝛼i + 𝛽1 TD/TA it + 𝛽2 LD/TA it + 𝛽3 SD/TA it + 𝛽4 S it + 𝜇it (2.4)

ROE it = 𝛼i + 𝛽1 TD/TA it + 𝛽2 LD/TA it + 𝛽3 SD/TA it + 𝛽4 S it + 𝜇it (2.5)

TobQ it = 𝛼i + 𝛽1 TD/TA it + 𝛽2 LD/TA it + 𝛽3 SD/TA it + 𝛽4 S it + 𝜇it (2.6)

All measures of leverage had a positive and significant relationship with the market performance measure (Tobin's Q) Nigerian companies were financed primarily with equity or a combination of equity and short-term funding A major difference between the capital structure of Nigerian firms and those in developed economies was that Nigerian firms tended to use shorter-term financing and significantly less long-term debt This showed that Nigerian companies mainly relied on short-term sources rather than long-term sources The difference in long-term versus short-term debt, to some extent, limited the validity of capital structure theories in Nigeria This suggested the theoretical basis remained largely unresolved

Sheikh et al (2013) conducted a study on the effect of capital structure on the performance of non-financial companies listed on the Karachi Stock Exchange in Pakistan in the period 2004-2009 With three econometric tools, namely the pooled ordinary least squares method, fixed effect estimation and random effect estimation, were used to estimate the relationship between capital structure and firm’s performance The model used return on assets (ROA) and market-to-book ratio (MBR) to measure performance In which, the independent variable used to represent capital structure included total debt ratio (TDR), long-term debt ratio (LDR) and short-term debt ratio (SDR), and the control variable included firm size (SIZE), the ratio of tangible assets (ATNG) and growth opportunities (GROW)

ROA it = 𝛽0 + 𝛽1 CAP it + 𝛽2 SIZE it + 𝛽3 ATNG it + 𝛽4 GROW it + 𝜀it (2.7)

MBR it = 𝛽0 + 𝛽1 TDR it + 𝛽2 SIZE it + 𝛽3 ATNG it + 𝛽4 GROW it + 𝜀it (2.8)

Empirical results showed that all capital structure measures (total debt ratio, long-term debt ratio and short-term debt ratio) were negatively correlated with return on assets in all regressions In addition, the total debt ratio and the long-term debt ratio both had a negative relationship with the market value to book ratio according to the OLS model, while these measures positively affect the market-to-book ratio under the fixed-effects model Short-term debt ratio was positively related to market-to-book ratio in all

regression methods, however, the relationship was not statistically significant As far as the control variables were used, the ratio of tangible assets had a negative effect, while firm size and growth rate were positively related to firm’s performance The study concluded that the relationship between capital structure and firm’s performance was inverse Furthermore, this finding was inconsistent with the proposition made by Modigliani and Miller (1958) Furthermore, the negative correlation between capital structure and performance may lead companies to adopt more than appropriate proportions in their capital structure This excessive disparity could increase the negative impact on performance, thereby limit the ability to manage operations effectively

The study by Pouraghajan et al (2012) examined the impact of capital structure on the performance of companies listed on the Tehran Stock Exchange For this purpose, the authors researched and experimented with 80 companies listed on the Tehran Stock Exchange and selected among 12 industry groups for 5 years from 2006 to 2010 In the study, return on assets (ROA) and return on equity (ROE) were used to measure the performance of companies For capital structure, the author used the debt ratio (DR) to represent and the control variables were used in the article included total assets turnover ratio (TURN), firm size (SIZE), age (AGE), tangible asset ratio (TANG), growth opportunity (GROW) In addition, the study also used a dummy variable of business industry (IND) to explain the difference between enterprises

ROA i,t = a 0 + b 1 DR i,t + b 2 TURN i,t + b 3 SIZE i,t + b 4 AGE i,t + b 5 TANG i,t

ROA i,t = a 0 + b 1 DR i,t + b 2 TURN i,t + b 3 SIZE i,t + b 4 AGE i,t + b 5 TANG i,t

+ b 6 GROW i,t b 7 IND + μ e

(2.11)

ROE i,t = a 0 + b 1 DR i,t + b 2 TURNi i,t + b 3 SIZE i,t + b 4 AGE i,t + b 5 TANG i,t

+ b 6 GROW i,t + b 7 IND + μ e

(2.12)

The results indicated that there was a significant and negative relationship between the debt ratio and the performance measure of Iranian firms (ROA and ROE) The debt ratio would help determine the financial health because it represented the risk ratio for the company Research indicated that a company with a high debt ratio would have a negative impact on operating performance and corporate value With the average debt ratio higher than 65%, the company’s performance would be affected In particular, when Iranian companies reduced their debt ratio, it could increase profits and improve ROA and ROE In addition, the results showed that there was a positive and statistically significant relationship between the total assets turnover ratio, firm’s size, tangible assets ratio and growth opportunities with other performance measures (ROA and ROE)

In which, the effect of company’s age (operating history) on performance was not statistically significant As a result, the long operating history of Iranian companies did not affect their performance Meanwhile, the results of the model showed that firms in the other non-metallic mining; food and beverage; base metals; auto parts and manufacturing sectors had a negative influence, and companies in the chemical products and materials industry had a negative impact on performance

Research by Gill et al (2011) showed the relationship between capital structure and profitability as two important factors because improving profitability is necessary for long-term viability of the enterprise This paper examined the effect of capital structure

on the profitability of manufacturing and service firms in the United States The author conducted a sample set of 272 companies listed on the New York Stock Exchange during the 3-year period from 2005 to 2007 Correlation and regression analysis were used to estimate the relationship between profitability (as measured by return on equity) with a measure of capital structure The study uses book value to measure variables, with return on equity (ROE) as a measure of profitability, in which the independent variable represents capital structure including the ratio of short-term debt to total assets (SDA), the ratio of long-term debt to total assets (LDA) and the ratio of total debt to total assets (DA) In addition, the study further used the firm’s size (SIZE) measured by

taking the company’s revenue logarithm, the revenue growth (SG) measured by calculating the revenue growth rate and the industry variable with the convention that 1

is the manufacturing industry and 0 is the remaining industries

ROE i,t = b 0 + b 1 CAP + b 3 SIZE + b 3 SG + 𝜇i,t (2.13)

The findings of this paper showed a positive correlation between firstly short-term debt

to total assets and profitability; secondly long-term debt to total assets; and thirdly total debt to total assets and profitability in the manufacturing industry This article provides useful insights for owners, operators and lenders based on empirical evidence

Ramachandran et al (2011) analyzed how capital structure affects the profitability of IT companies in India The study established a hypothetical relationship on the degree of influence of capital structure on firm’s revenue and tested the relationship between capital structure and profitability The author selected the sample based on two criteria were revenue and size Small, medium and large companies by revenue and small, medium and large companies by size The study used Multi - stage sampling technique

to select a sample of 102 companies Data for an 8-year period from 1999–2000 to 2006–

2007 were collected and reviewed for analysis Regression analysis method used to analyze the impact of capital structure on profitability is OLS regression, Pearson correlation coefficient is used to analyze the relationship between capital structure and profitability, multicollinearity test among independent variables, in addition, descriptive statistics such as mean, standard deviation and proportion were used To measure profitability, the author uses ROA and ROCE criteria Capital structure was measured through independent variables including debt to total assets ratio (TD_TA), debt to equity ratio (DER), expense to income ratio (EXP_INC), current asset ratio (CA) In which, the author used the expense to income ratio (EXP_INC) as a control variable

ROA e = a + b 1 EXP_INC + b 2 TD_TA + b 3 CR + b 4 DER + e (2.14)

ROCE e = a + b 1 EXP_INC + b 2 TD_TA + b 3 CR + b 4 DER + e (2.15)

Regarding the research results, based on business revenue, (i) low-income companies with low costs would have high profits but profits are independent to debt ratio in capital

structure Therefore, profitability represented by ROCE had a negative relationship with costs but was independent to the capital structure of firms with low turnover (ii) A mid-income company that generates substantial revenue with low debt The profitability of this company was significantly affected by its capital structure The higher the debt ratio

in the capital structure, the lower the profitability for the mid-income company (iii) The higher use of debt in the capital structure would negatively impact on profitability through the use of assets in this group An increase in the debt to assets ratio would reduce the profitability represented by ROCE while increasing costs and the use of current assets

For the size factor, (i) the profitability of a small-size company would be negatively affected by the increase in costs and in total debt to total assets Capital structure had the only effect on profitability when there was a significant negative effect of total costs

on profitability From the regression results, profitability (measured by ROCE) of this group of companies was negatively affected by the use of debt in capital structure (ii)

A medium-size company with a net profit of 10% of total assets and used capital, had a smaller proportion of debt Therefore, increasing the use of debt would reduce profitability (iii) Large-size companies do not depend much on the use of debt in their capital structure These companies had a higher yield than possible profits without debt The research results show that the more debt was used, the lower the net profit measured

by the total assets of large-size companies in India

For the revenue factor, research showed that an increase in total debt relative to total assets would tend to decrease net income relative to capital employed, when there is an increase in total costs and an in the use of short-term assets in the high revenue group

As for the size factor, the study showed that small-size companies were not efficient in generating revenue Profitability is negatively related by an increase in total costs and

in the ratio of total debt to total assets respectively Capital structure has a unique and significant effect on profitability when there is a negative effect of total cost on profitability for small-size firms The study demonstrated that there was a strong 1-1 relationship between capital structure and profitability, return on assets (ROA) and return on capital employed (ROCE) Capital structure had a significant effect on

profitability and increasing use of debt in capital structure would tend to reduce the net profit of companies listed on Bombay Stock Exchange in India

Margaritis & Psillaki (2010) studied the relationship between capital structure, ownership structure and performance using a sample of manufacturing firms in France The authors use the data envelopment analysis (DEA) method to measure a company’s performance The study examines whether increasing the debt ratio in the capital structure helps to increase the efficiency of enterprises The study tests the negative relationship between performance and capital structure based on two hypotheses: efficiency-risk hypothesis and franchise-value hypothesis The results show a positive impact of financial leverage on the performance of the business However, the dependent variable in the model does not use the profitability of the business, but rather the performance as measured by the DEA method In addition, the independent variable representing capital structure in the model is only total debt to total assets, does not mention the short-term debt ratio and long-term debt ratio

EFFi,t = a0 + a1LEVi,t-1 + a2LEVi,t−12 + a3Zi,t-1 + ui,t (2.16)

Ebaid et al (2009) studied the impact of capital structure choices on the performance of listed companies in Egypt, one of the emerging or transitioning economies Three reasons that the author did the research in Egypt, firstly, Egypt had moved to capitalism and open markets, decision making was still limited by the old management of government support about the financial leverage of companies, especially public companies before 1990, which were partially or fully private Secondly, the capital market in Egypt was not yet complete, so the level of asymmetric information would be more than in developed countries And thirdly, the capital market in Egypt was still the equity market, the debt market structure was still young, leading to inefficient and inaccurate financial decisions The dataset included 64 non-financial enterprises selected from 10 industries These enterprises were listed on the Egyptian stock exchange in the period 1997-2005 The study was based on sample data of listed companies in Egypt and used three of the performance measures return on assets (ROA), return on equity (ROE) and gross profit margin (GM) In which, the independent

variables to measure capital structure included the ratio of short-term debt to total assets, the ratio of long-term debt to total assets, the ratio of total debt to total assets together with the control variable was the firm’s size used by to build the research model

ROA i,t = 𝛽0 + 𝛽1.STD i,t + 𝛽2.logS i,t + ei i,t (2.17) ROE i,t = 𝛽0 + 𝛽1.LTD i,t + 𝛽2.logS i,t + ei i,t (2.18)

GM i,t = 𝛽0 + 𝛽1.TTD i,t + 𝛽2.logS i,t + ei i,t (2.19)

The empirical test results showed that capital structure (especially short-term debt and total debt) had a negative impact on the performance as measured by ROA On the other hand, capital structure (short-term debt, long-term debt and total debt) had no impact on performance as measured by ROE or measured by GM Therefore, the choice of capital structure, in general, had a weak to zero effect on the performance of listed companies

in Egypt The direction for further research is to take into account the determinants of capital structure of Egyptian enterprises such as size, growth rate, business risk and compared with the results achieved in developed markets The relationship between financial leverage and the value of Egyptian firms also needed empirical testing Subsequent studies may examine the relationship between the debt maturity structure and its decisions and performance Finally, future researches may consider deeper firstly the impact of capital structure and ownership structure on firm’s performance because

a large number of Egyptian companies were family companies Secondly is to include the variables of business size, development opportunities, business risks, etc in the capital structure components to compare with developed countries, and thirdly, to test the relationship between debt maturity structure and performance

levels on different percentiles At the higher percentile, with all other factors constant, capital structure had a strong impact on performance Conversely, the lower the percentile, the greater the decline in business activity, and the higher the solvency, corporate income tax, and business risk, the lower the enterprise’s performance

Doan Vinh Thang (2016) examined the effect of capital structure on profitability of 2,888 state-owned joint stock companies in Vietnam Estimation results by OLS regression model show that capital structure and profitability, represented by ROA and ROE ratios, have an inverted U-shaped relationship In addition, this study also shows the interactive influence of State ownership on the relationship between capital structure and performance, in which, the effect of debt to total assets ratio (capital structure) on profitability is even weaker in the case of state-dominated enterprises However, this study has not taken into account the influence of short-term debt and long-term debt on the profitability, therefore, the trade-off between these two items has not been explained

Le Thi Phuong Vy (2015) used unbalanced panel data from all listed non-financial institutions in Vietnam for the period 2007–2012 and applied the pooled ordinary least squares method (OLS), random effects estimation (REM), fixed effects estimation (FEM) and a dynamic panel generalized method of moments (GMM) for data analysis The author had taken many different approaches and all gave consistent results Specifically, the study showed that while the foreign ownership variable had a negative effect on financial leverage, the state ownership variable had a positive effect Although there was a positive relationship between manager ownership, the effect of owning a high debt ratio was not conclusive In addition, the results showed that foreign ownership affected ownership inside the company, which would have an impact on financial decisions In particular, the foreign ownership ratio would reduce the positive effect of the ownership’s level on the debt ratio of managers

PER it = 𝛽0 + 𝛽1 TLEV it + 𝛽2 MTLEV it + 𝛽3 GRO it + 𝛽4 INV it + 𝛽5 LIQ it

+ 𝛽6 RISK it + 𝛽7 DIV it + 𝛽8 CF it + 𝜀it

(2.20)

PER it = 𝛽0 + 𝛽1 LLEV it + 𝛽2 MLLEV it + 𝛽3 GRO it + 𝛽4 INV it + 𝛽5 LIQ it

+ 𝛽6 RISK it + 𝛽7 DIV it + 𝛽8 CF it + 𝜀it

(2.21)

PER it = 𝛽0 + 𝛽1 TLEV it + 𝛽2 TLEV it 2 + 𝛽3 SLEV it + 𝛽4 SLEV it 2 +

𝛽5 LLEV it + 𝛽6 LLEV it 2 + 𝛽7 GRO it + 𝛽8 INV it + 𝛽9 LIQ it +

𝛽10 RISK it + 𝛽11 DIV it + 𝛽12 CF it + 𝜀it

(2.22)

The research results also showed that the ratios of long-term debt, short-term debt and total debt at book value and market value were all statistically significant and had a negative relationship with the return on assets, return on equity and Tobin's Q The non-linear relationship between financial leverage and financial performance of an enterprise was evident only when performance was measured by return on equity and capital structure was measured by total debt ratio and short-term debt ratio The study also pointed to some limitations for future studies First, the duration of the study sample was relatively short The observation period lasted only 6 years from 2007 to 2012, which may have influenced the significance of the results Second, the author only tested experimentally in Vietnam, still not guaranteeing the convincingness of the research results Finally, although a number of different methods, including OLS, REM, FEM and GMM had been applied in the study, there were some defects of the model such as heteroscedasticity, potential problems with Endogeneity had not been completely controlled

Quang et al (2014) used a set of 134 samples of non-financial companies listed on the

Ho Chi Minh City Stock Exchange in the period 2009–2012 to study and analyze the impact of ownership structure, capital structure on the performance in the context of a transition economy The authors performed regression methods for all 3 research models measuring financial leverage using the ratio of total debt to total assets, the ratio of long-term debt to total assets and the ratio of short-term debt to total assets To measure financial performance, the study used return on assets (ROA) and return on equity (ROE) Meanwhile, the part of the ownership structure was represented by the ownership of the members of the Board of Directors and the State ownership is shown

in the model In addition, the study also used a number of control variables such as firm size (FSIZE), growth opportunity (GROW) and the ratio of tangible assets (TANG)

ROA it = 𝛽0 + 𝛽1 TDA it + 𝛽2 MaOW it + 𝛽3 STATE it + 𝛽4.GROW it

a negative relationship between manager ownership and performance as measured by ROE This showed that the level of authorization of managers in SOEs was higher than other types Especially, in the context of Vietnam, State ownership had a positive impact

on the performance based on ROA and ROE measures Therefore, enterprises with a high percentage of State ownership in the ownership structure would have a higher level

of performance Regarding developed and emerging economies, like many other previous foreign reseaches, this study also showed evidence of the influence of capital structure factors on performance such as the ratio of tangible assets, growth opportunities and firm size Evidence of a negative relationship between capital structure and performance would further explain the pecking order theory, showing that Vietnamese firms would prioritize using internal sources, then debt and finally stocks if necessary

Do Van Thang and Trinh Quang Thieu (2010) analyzed the empirical relationship between firm value (measured by Tobin's Q index) and capital structure of companies listed on The Ho Chi Minh City Stock Exchange The study was conducted on the unbalanced array data of 159 non-banking firms, with 407 observations from 2006

to 2009 The general regression results show that there is a close relationship between firm value and financial structure: (1) firm value has a ternary relationship with debt/equity ratio; (2) when the debt ratio increases and is less than 105%, the firm

value increases with the same direction of capital structure, but when the debt ratio

is greater than 105%, the opposite result will be obtained, (3) the capital structure will be optimal at the debt ratio of 105% This result is a strong support for the trade-off theory However, this study only takes the total debt to total assets ratio as the independent variable representing capital structure Moreover, with the data of 407 observations from 2006 to 2009, the results show that the regression coefficient of the total debt to total assets ratio (independent variable) order 1 in the quadratic regression model is not significant statistic In addition, some studies also show that the impact of capital structure on profitability metrics such as return on assets (ROA) and return on equity (ROE) can be different from the effect on Tobin’s Q

2.2.3 Researches’ gaps

The inefficient use of capital structure, especially debt capital, will cause the opposite effect of financial leverage The impact of capital structure on performance has been verified by many previous studies Studies have also produced mixed results including that capital structure has a positive, negative, or no statistically significant effect on performance According to the trade-off theory, an increase in debt will generate a tax shield benefit, but at the same time, the cost of distress will also increase (Myers, 1977) That means to a certain extent, the increase in the debt ratio will lead to the disadvantage for the company If the regression coefficients of the squared variables are not statistically significant, the relationship will return to linear form In order to consider the non-linear relationship with U-shaped or inverted U-shape, previous studies have included the debt squared ratio variable in the regression model According to previous researches, some authors consider the non-linear impact of capital structure on performance to determine the optimal point in capital structure (Margaritisa and Psillaki, 2010; Do Van Thang and Trinh Quang Thieu, 2010; Doan Vinh Thang, 2016) Most of studies only squared the proportion of total debt representing capital structure without considering the maturity of the debt Therefore, the thesis will build a model with the square of the long-term debt ratio and the short-term ratio as independent variables in the model

Chapter 2’s summary

In this chapter, the author has introduced a number of concepts related to capital structure including the traditional view, M&M theory, trade-off theory and pecking order theory Meanwhile, the thesis briefly reviewed previous studies including foreign researches and in Vietnam about the impact of capital structure on the performance of enterprises Each study will have different results due to differences

in economic conditions and characteristics of each country Based on a review of domestic and international studies, the authors use the variable total debt ratio to represent capital structure Most of the previous studies only squared the proportion

of total debt representing capital structure without considering the maturity of the debt In addition, most of the studies only consider the linear relationship between capital structure and performance, but have not exploited much to the nonlinear relationship Therefore, the study will build a model with the square of the long-term debt ratio and the short-term ratio as independent variables in the model At the end

of chapter 2, the thesis introduces the factors in performance that capital structure affects based on a dataset of 47 listed material manufacturing enterprises in Vietnam

CHAPTER 3: RESEARCH METHOD

3.1 Research hypothesis

According to author Berzkalne (2015), there is a non-linear relationship between capital structure and profitability Based on the research gap in chapter 2, the study hypothesizes the impact of capital structure on performance

ROA is calculated as profit after tax on average total assets, the use of debt will reduce profit after tax due to interest expense but does not affect the denominator Most firms that use debt will benefit from a tax shield so debt is expected to have a positive effect to a certain extent on ROA, but to have a negative effect beyond that level The hypothesis is put forward as follows:

H 1 : Short-term debt ratio (STD) impacts ROA in an inverted-U shape

ROA is calculated as profit after tax on average total assets, the use of long-term debt will reduce profit after tax due to long-term interest expense but does not affect the denominator So, ROA is expected to decrease with debt ratio or in other words, the relationship between debt ratio and ROA is linear The hypothesis put forward by the author is as follows:

H 2 : Long-term debt ratio (LTD) has a negative effect on ROA

For ROE, the use of short-term debt or long-term debt will reduce profit after tax in the numerator due to an increase in interest expense but decrease equity in the denominator due to the use of debt instead of equity Most firms that use debt will benefit from a tax shield so debt is expected to have a positive effect to a certain extent on ROE but to have a negative effect beyond that level Therefore, the study hypothesized the following:

H 3 : Short-term debt ratio (STD) impacts ROE in an inverted-U shape

ROE is calculated by profit after tax on average total assets, the use of long-term debt will reduce profit after tax due to long-term interest expense but does not affect the