INTRODUCTION
1 The reason for choosing the topic:
Businesses require capital for operations, which can come from retained earnings, debt, or equity While debt can enhance production and improve business conditions, excessive reliance on it may lead to financial risks and potential bankruptcy An optimal capital structure, balancing equity and debt, can reduce capital costs and increase business value Therefore, determining the right capital structure is crucial for promoting effective production and business activities Each organization may need a different capital structure influenced by macroeconomic conditions, industry trends, or cultural factors Consequently, financial researchers are examining the factors that affect capital structure and the use of financial leverage Understanding these relationships enables organizations to choose between borrowed and internal capital, ensuring effective financial leverage and maximizing asset value.
Modern capital structure theory has primarily focused on developed countries, with limited attention given to developing nations, particularly in specific industries like raw materials Each industry possesses unique characteristics that influence its capital structure, necessitating tailored studies In Vietnam's economic context, factors such as a complicated global situation and a slowly recovering world economy impact corporate capital structure decisions While the macro-economy remains stable and inflation is controlled, challenges persist in the business environment, affecting productivity and efficiency In the construction industry, which demands significant investment capital, financial managers are particularly concerned with optimizing capital structure to enhance profitability and create business value.
Vietnam's economy has shown a positive outlook in recent years, particularly following the signing of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) However, the terms of the CPTPP stipulate that domestic companies must utilize local materials or import from CPTPP member countries to benefit from preferential tax rates.
Vietnamese companies are currently characterized by small scale and limited capital, leading to a lack of interest in investing in raw material supply However, the raw materials industry presents significant potential for investment and development in the near future.
In the era of increasing global integration, companies in the Raw Materials industry are crucial for addressing the economic, political, and social challenges faced by the country Thus, fostering research, creating a supportive environment, and facilitating the growth of these businesses is essential.
I focused my research on "Factors Affecting the Capital Structure of Companies in the Raw Materials Industry" to provide insights that can guide listed companies in establishing an optimal capital structure.
This study aims to assess the influence of capital structure on stock price volatility among select companies in the materials industry within the Vietnamese stock market from 2012 to 2019 Understanding the relationship between capital structure and stock price volatility is crucial for developing effective stock valuation models By concentrating on a specific industry in Vietnam, the research seeks to answer the key question: “What factors influence the capital structure of enterprises in the materials industry?”
Examine the factors that play an important role in the capital structure of companies
As a result, specific capital structure orientations and conclusions are provided for Vietnamese companies in the Raw Materials industry a Detailed objective
Summarize the theoretical system of capital structure and the factors affecting capital structure
The relationship between capital structure and financial factors is crucial, as it reveals how a business's operational strategies influence its capital configuration Analyzing this relationship helps to understand the impact of management decisions on financial stability and growth potential By examining various financial metrics, businesses can optimize their capital structure to enhance performance and mitigate risks.
Evaluate and analyze the impact of factors on the capital structure of raw materials industry companies listed on the Vietnamese stock market using econometric models
3 Subject and scope of the study a Research subject:
Factors affecting the capital structure of a business b Research scope:
+ Research space: Companies operating in the field of raw materials listed on Vietnam's stock market
+ Research period: During the period from 2012 to 2019.
In addition to the introduction and conclusion, the thesis includes the following main contents:
- Chapter 2: Theoretical Framework and literature review
- Chapter 4: Results and Discussion of empirical testing of factors affecting capital structure in Raw Materials industry companies in Vietnam
- Chapter 5: Conclusion and Recommendations for listed Raw Materials industry companies in Vietnam
THEORETICAL FRAMEWORK AND LITERATURE REVIEW
Theoretical Framework
2.1.1 Definition of company capital structure
Capital structure refers to the mix of debt and equity financing that a firm utilizes, as defined by Brealey, Myers, and Allen (2010) and further elaborated by Ross, Westerfield, and Jordan (2013) It encompasses the long-term debt and equity employed to finance a company's operations Essentially, capital structure is a financial concept that highlights the sources and methods of capital development within a business, emphasizing the impact of the debt-to-equity ratio on its overall performance.
Capital structure refers to a company's strategy for financing itself through a mix of equity and debt to enhance its value Managers play a crucial role in determining the optimal balance of these financing sources to attract investors and creditors An effective capital structure can reduce the cost of capital, which is essential for increasing shareholder value Therefore, it is vital to achieve a balance between equity and debt that minimizes costs and maintains acceptable risk levels in line with market conditions Ultimately, a well-structured capital framework is critical for a company's competitiveness, as its profitability relative to capital costs influences its ability to thrive in a competitive landscape.
2.1.2 Measurement of company capital structure
The basic components of a capital structure consist of two main parts: liabilities and equity Liabilities:
Liabilities refer to the financial obligations that companies owe to one another, as noted by Brigham and Houston (2008) These obligations are categorized based on their payment terms, which include both short-term and long-term debt, according to Ross et al (2013).
Current liabilities are obligations due within one year, encompassing short-term bank loans, payables to suppliers or government employees, and short-term bonds While managing short-term debt is typically straightforward, the brief repayment period can pose challenges for businesses if the funds are not utilized effectively In contrast, long-term liabilities extend beyond five years and cater to long-term investment needs, such as infrastructure development and large-scale production expansion These liabilities often include medium- and long-term debts from external credit sources like banks and finance leasing institutions.
7 companies, bond issuers, or other funds Long-term liabilities often have a higher cost of capital than short-term liabilities However, businesses are under pressure to make short- term payments
Shareholders are defined as equity investors and financial contributors (Brealey, Myer, and Allen, 2010) Equity represents the difference between total assets and total liabilities (Hall and Lieberman, 2012; Ross et al., 2013) Different types of businesses develop equity in various ways, which primarily includes three main types: charter capital, retained earnings, and capital from stock issuance and other equity sources.
Charter capital refers to the amount contributed by founders when establishing a company, as specified in the company rules In a joint-stock company, this capital is primarily provided by shareholders purchasing shares, making them the owners of the company with limited liability to the value of their shares Unlike debt, charter capital can be utilized freely in production and business activities, allowing joint-stock companies significant financial autonomy Consequently, a higher equity contribution enhances this autonomy in operations.
Capital from retained earnings refers to the income that shareholders agree to reinvest in the company rather than receiving as dividends This source of capital is both active and advantageous for businesses However, companies are required to offer interest rates that exceed the current dividend payouts.
Issuing new shares allows enterprises to enhance their equity, serving as a crucial source of long-term capital mobilization in their financing strategy Joint stock companies can further issue additional shares via the stock market.
Other equity encompasses various funds and specialized financial reserves primarily derived from profit distributions This category includes investment funds, financial reserve funds, capital construction investment funds, and adjustments for exchange rate differences.
Basic theories of company capital structure
2.2.1 The capital structure theory of Modigliani and Miller
In 1958, economists Modigliani and Miller introduced the Modigliani & Miller (MM) theory, which explores capital structure The MM theory posits that in a perfect capital market, a company's value remains largely unaffected by the capital funding choices made by investors.
8 theory is thought to be unsuitable for the activities of corporate administrators for the capital structure to develop corporate value
The following assumptions underpin the development of MM theory:
- Expenses for purchase and sale transactions are almost zero
- Information on the market is public, no fee, and always meets the search needs of investors
- The dynamic market with a large number of investors to avoid the decisions of some individual investors will have a great impact on the price movements of the securities
A key assumption of this theory is that the market applies the same interest rate for both borrowing and lending to investors This equal treatment diminishes any competitive advantage for businesses, as the impact of financial leverage becomes negligible; investors can leverage their positions similarly.
- Assuming the homogeneity in this case, businesses must operate in the same condition and will bear the same level of risk in business activities
This assumption is based on the prevailing information conditions, transparency, and the absence of costs When investors possess similar calculations and judgments regarding profits, they tend to make identical business decisions This reflects a fundamental assumption about how investors perceive business profitability.
MM theory in the case of no tax: Based on the above assumptions, the theory of MM can be described in two sentences:
In a tax-free environment, a company's value remains unchanged regardless of its debt levels, indicating that the debt-to-capital structure does not influence the company's overall value Consequently, there is no optimal capital structure, and altering the capital structure will not enhance the company's value.
- Clause II – Cost of capital:
Clause II indicates a positive correlation between a firm's financial leverage and the required return on equity The authors assert that the value of a business is determined by its assets rather than the price of its securities They argue that when managers are confident in their investment decisions, the enterprise's value does not depend on its capital structure This aligns with the law of conservation of value, which posits that a business's total assets remain unchanged despite being divided into various parts Under ideal capital market conditions, Modigliani and Miller suggest that capital structure is entirely independent of a firm's value In 1963, the authors further explored the influence of tax factors on corporate capital structure decisions.
When enterprises incur income tax, leveraging debt capital can enhance their overall value This occurs because interest expenses on debt are excluded from taxable income, allowing businesses to lower their tax liabilities while simultaneously redistributing a portion of corporate income to investors.
The theory of MM in the case of taxes: is also stated in the following two Clauses:
- Clause I: The value of the enterprise in the taxable case
The author examines the impact of taxes on the debt-to-equity ratio, specifically how this change influences the overall value of a business According to Clause I, when a firm's income is subject to taxation, the value of firms with debt is equivalent to the combined value of firms without debt plus the present value of the tax shield.
- Clause II: The firm's cost of capital in the case of taxes
This Clause examines the hypothesis that a positive relationship exists between the required return on equity and a firm's capacity to utilize financial leverage, both in scenarios without income tax and in taxable business cases The findings indicate that for taxable firms, an increase in the required return on equity positively influences the firm's ability to employ financial leverage effectively.
The present value of the tax shield positively correlates with the increase in debt capital proportion within a company's capital structure, influencing corporate managers' borrowing decisions However, this theoretical perspective does not account for the real-world costs associated with a higher debt ratio, which can negate the advantages of the tax shield Consequently, excessive borrowing may lead to a decline in the company's overall value, prompting the need for a new capital structure theory known as the trade-off theory.
2.2.2 The trade-off theory of capital structure
The capital structure trade-off theory elucidates why firms utilize a mix of debt and equity financing While the debt tax shield offers benefits, businesses face additional costs, particularly bankruptcy costs, which can be direct or indirect This theory posits that the optimal debt ratio varies among firms, with those possessing tangible collateral and higher profit margins typically maintaining a greater debt ratio Consequently, tangible fixed assets and profitability significantly influence capital structure decisions Firms with substantial tangible assets enjoy improved solvency and are more inclined to leverage debt for tax advantages, leading to lower bankruptcy costs as profits increase.
10 companies will tend to use more debt to take advantage of tax shields The trade-off theory of capital structure includes the following advantages and disadvantages:
The advantages of the theory included:
This theory highlights the variations in capital structure across different industries, indicating that sectors with a high proportion of tangible fixed assets tend to favor debt financing Conversely, when tangible assets are insufficient to serve as collateral for loans, companies are more likely to opt for equity financing over debt capital.
The capital structure trade-off theory examines businesses acquired through leveraged buyouts (LBOs) and suggests that established companies with a stable market position and high net present value (NPV) should increase their debt ratio to enhance enterprise value For businesses struggling with excessive debt, it is advisable to issue shares to attract investors, maintain healthy capital, limit dividend payments, or sell assets to boost cash flow, thereby facilitating a balanced capital restructuring.
According to the capital structure trade-off theory, a higher profitability ratio leads to a greater tendency to utilize debt, as it allows for more taxable profit deductions, thereby increasing business value However, this theory fails to account for firms with high operating income but low debt usage, which forgo tax shield benefits This contradiction prompted the development of a new theory known as the pecking order theory.
The pecking order theory suggests a hierarchy in funding preferences, where businesses first utilize internal capital, primarily retained earnings, followed by new debt, and lastly, issuing new shares This theory highlights a negative correlation between profitability and funding sources, indicating that growth opportunities and profitability significantly influence capital structure Companies with promising growth prospects may increase their debt ratio by opting for loans when retained profits are insufficient Conversely, higher profitability enables firms to retain more earnings, leading to reduced reliance on debt, thus demonstrating that profitability negatively impacts capital structure.
The agency cost theory was perfected by Jensen and Meckling (1976), and it explains the mutual influence of the owner and the agent, specifically in this case, the company's director
This theory posits a negative correlation between growth rates and debt, as shareholders tend to be hesitant to share profits with creditors during periods of strong company growth Additionally, larger firms are more inclined to incur debt due to conflicts between shareholders and managers, with loan contracts serving to regulate managerial behavior Consequently, firm size positively influences the level of debt.
Factors affecting company capital structure
Empirical studies indicate that an organization's capital structure is influenced by various factors, including socio-economic developments, tangible assets, taxes, growth size, profitability, and income changes Research by Harris and Raviv (1991) demonstrates that tangible assets positively impact financial leverage, alongside the non-debt tax shield and organizational size Conversely, factors such as income fluctuations, advertising expenses, insolvency, profitability, and production monopolies negatively affect financial leverage Additionally, previous research often reveals inconsistencies that contradict established theories, resulting in an unstable relationship between these factors and capital structure.
In addition, it should also pay attention to the different issues of countries' political and
12 economic institutions that may affect the relationship between these factors and the ability of enterprises to use organizational leverage
This study identifies the key factors influencing the capital structure of enterprises, drawing on capital structure theories and previous research findings.
In the globalized economy, companies with a large reach enjoy a competitive advantage, as their size is a crucial factor for foreign investors Titman and Wessels (1988) noted that larger firms have easier market access and can secure loans on more favorable terms, prompting many businesses to scale up A study by Rajan and Zingles in 1995 revealed that larger firms are more diversified and less likely to fail, justifying their increased use of debt Ahmed Sheikh and Wang (2011) highlighted that smaller companies face higher borrowing costs, which investors consider when evaluating businesses According to trade-off theory, larger firms can leverage more capital to benefit from debt tax, while agency cost theory suggests that conflicts between shareholders and managers lead large companies to borrow more, establishing a positive relationship between firm size and leverage This has been supported by studies from Deesomsak (2004), Eriotis et al (2007), and Serrasqueiro & Rogão (2009) Conversely, pecking order theory posits that larger, well-known firms experience fewer issues with asymmetric information and possess sufficient internal capital, making them more likely to use equity for financing Chen (2004) found a negative correlation between firm size and long-term debt ratio, while Tran and Ramachandran (2006) demonstrated a positive relationship between firm size and capital structure in Vietnam.
The author makes two hypotheses about this relationship as follows:
Hypothesis H1a: There is a positive relationship between firm size and financial leverage
Hypothesis H1b: There is a negative relationship between firm size and financial leverage
- Return on total assets (ROA):
Titman and Wessels (1988) argue that "Return on total assets is an essential determinant of capital structure because it indicates the level of earnings retained by the
The pecking order theory posits that highly profitable firms prioritize internal financing over external borrowing, utilizing retained earnings first, followed by loans and issued shares This indicates a negative correlation between profitability and capital structure, a view supported by studies from Ahmed Sheikh and Wang (2011), Saeed et al (2014), Titman and Wessels (1988), Wald (1999), Booth et al (2001), Viviani (2008), and De Jong et al.
Research indicates a negative relationship between profitability and capital structure in Chinese companies, as demonstrated by studies from Chen (2004), Tong and Green (2005), and Huang and Song (2006) Conversely, the Trade-off Theory suggests a positive correlation between profitability and leverage, indicating that companies with high returns on total assets should utilize more debt to benefit from tax depreciation and lower expected bankruptcy costs (Frank and Goyal, 2003; Fama & French, 2002) In Vietnam, similar findings are reported by Pham and Nguyen (2015) and Vo.
(2017) demonstrated that there is a negative relationship between profitability and capital structure
The author proposes a pair of two hypotheses as follows:
Research indicates a complex relationship between profitability and financial leverage According to the trade-off theory, studies by Frank and Goyal (2003) and Fama & French (2002) suggest a positive correlation, where increased financial leverage can enhance profitability Conversely, the pecking order theory, supported by the findings of Ahmed Sheikh and Wang (2011), Saeed et al (2014), Titman and Wessels (1988), Wald (1999), Booth et al (2001), Viviani (2008), and De Jong et al (2008), highlights a negative relationship, indicating that higher financial leverage may lead to reduced profitability.
- Cash holding ratio (Cash_holdings):
The revenue growth rate of a business is an indicator that reflects the revenue growth of the business over the years
Table 2.1: Synthesize predictionsof theories about factors affecting capital structure
Variable Trade-off theory Pecking order theory
Table 2.1 illustrates the connections between enterprise factors and capital structure, where a "+" signifies a positive relationship between the explanatory and dependent variables, while a "-" indicates a negative relationship The notation "n.a." is used to represent instances where no applicable relationship exists.
The model operates without assumptions regarding the correlation between variables It presents a summary table that outlines predictions related to the relationship between various factors and a firm's capital structure, drawing insights from trade-off theory, pecking order theory, and agency cost theory.
Empirical research related to the factors affecting company capital structure
2.4.1.Research projects in the world
Besides the concepts and theories of capital structure, there are many empirical studies such as Frank and Goyal (2009), Akhtar and Oliver (2009), Cheng and Green
Numerous studies have explored capital structure in both developing and developed countries, highlighting key factors that influence it Research by Chen (2003), Bevan and Danbolt (2002), and others indicates that business risk, tangible asset ratio, growth potential, tax shield, current solvency, profitability, and business size are critical determinants Frank and Goyal (2009) found that in the U.S from 1950 to 2003, profitability and growth potential negatively correlate with capital structure, while tangible assets, firm size, and expected inflation positively affect it Additionally, Akhtar and Oliver (2009) revealed that in Japan, capital structure inversely relates to risk, with multinational companies facing higher foreign exchange risk Jong (2008) further confirmed that a higher ratio of tangible assets positively impacts financial leverage, while corporate risk, profitability, growth, liquidity, and corporate income tax negatively correlate with capital structure, aligning with established capital structure theory.
Research by Rajan and Zingales (1995), Ozkan (2002), and Deesomsak (2004) indicates a positive relationship between the fixed asset ratio and the leverage ratio of firms across various countries, including studies focused on the Asia-Pacific region.
Chen's 2003 study investigated the factors influencing the capital structure of publicly listed companies in China The research found that firm size, taxes, and tax shields positively affect capital structure, whereas retained earnings exhibit a negative correlation.
Research by Bancel (2002) indicates that approximately 75% of financial institutions in Europe have a target debt-to-equity ratio, with around 50% of companies adhering to this target Additionally, Graham and Harvey (2007) found that in the United States, financial flexibility and credit ratings are crucial factors influencing directors' decisions on debt financing, while concerns about earnings per share (EPS) dilution and recent share prices are paramount when considering equity financing Furthermore, Imtiaz et al (2016) explore the factors impacting the capital structure of listed pharmaceutical companies in Bangladesh from 2009 onwards.
In 2013, a study revealed that six independent variables—profitability, growth, scale, liquidity, tangibles, and operating leverage—affect capital structure Notably, profitability, tangibles, and operating leverage significantly influence capital structure in contexts where size, growth, and liquidity do not Additionally, profitability, tangibles, and growth negatively impact financial leverage, whereas size and liquidity positively affect the leverage of pharmaceutical companies in Bangladesh.
Research by Pacheco & Tavares (2017) identifies key determinants affecting the business base of SMEs in the hospitality sector, including profitability, the ratio of tangible fixed assets, institution size, total liquidity, and risk In contrast, factors such as growth, tax benefits, and age showed no significant relationship Additionally, the study highlights a negative correlation between size and short-term debt, suggesting that SMEs tend to rely more on leverage in the short term.
In Vietnam, Tran Hung Son (2008) conducted a study on "Factors Affecting the Capital Structure of Companies Listed on the Vietnam Stock Exchange," using data from
In July 2007, a study of 45 non-financial companies listed on the HOSE stock exchange revealed key factors influencing corporate capital structure, including liquidity, profitability, company size, state ownership rate, tangible fixed assets, and asset characteristics Notably, current solvency was found to be inversely related to total debt and total assets, while profitability exhibited a negative relationship with the debt-to-assets ratio, supporting the pecking order theory that organizations prefer using retained earnings for investments, thereby reducing debt levels Additionally, company size was inversely related to both short-term and long-term debt ratios, indicating that larger enterprises have a greater capacity to access debt capital compared to smaller ones, aligning with the trade-off theory Furthermore, a positive correlation was observed between the state's ownership ratio and total debt to total assets.
Enterprises with greater government investment capital are able to mobilize more substantial funding, particularly from long-term sources A higher ratio of tangible assets is inversely related to both short-term and long-term debt ratios in relation to total assets This phenomenon occurs because organizations with a significant proportion of tangible fixed assets tend to minimize their reliance on long-term debt, aligning their financing strategies with the nature of their assets and appropriate loan terms.
In recent years, research on the relationship between capital structure and firm value has also been carried out by a number of authors (Nguyen Tan Vinh (2011), Le Thi Phuong
Numerous studies have explored the factors influencing the capital structure of Vietnamese enterprises, including works by Vy and Phung Duc Nam (2011), Vo Hong Duc and Vo Tuong Luan (2014), and Nguyen Huu Huan and Le Nguyen Quynh Huong (2014) Additional research contributions come from Tran Dinh Khoi Nguyen and Ramachandran (2006), Biger, Nam V Nguyen and Quyen X Hoang (2008), Okuda and Lai Thi Phuong Nhung (2012), Dzung et al (2012), and Tran Hung Son (2013).
Research gap
Vietnam, a developing country, has been undergoing economic renovation since the mid-1980s, yet its financial market remains relatively small compared to developed nations The stock and bond markets in Vietnam are underdeveloped, leading companies to primarily depend on bank loans for growth This reliance raises questions about the applicability of previous research conducted in developed countries, which found a negative relationship between the liquidity of corporate shares and debt usage in capital structure This article aims to explore how these factors specifically influence the capital structure of businesses in Vietnam, considering the unique context of its financial landscape.
Recent studies on modern capital structures have predominantly focused on developed countries, with limited attention given to developing nations Mouamer (2011) highlights that there is a scarcity of research examining capital structures in emerging markets In Vietnam, such studies are particularly rare.
In recent years, both domestic and foreign investors have shown increasing interest in Vietnam's raw materials industry, driven by capital and technology needs This influx of new investors is poised to impact the capital structure and operations of businesses within this sector, necessitating informed decision-making for sustainable development in a competitive economic landscape As noted by Vo (2017), the ongoing financial liberalization in Vietnam introduces new policies that could influence the bond and stock markets, thereby affecting the capital structure of Vietnamese enterprises However, there has been a lack of analysis regarding the capital structure of Vietnamese raw material companies, highlighting the necessity of this study Furthermore, many enterprises in this sector have not prioritized the establishment of an appropriate capital structure While various models for determining optimal capital structure exist globally, their application to Vietnamese raw material enterprises has proven inadequate This study aims to present comprehensive criteria for determining the optimal capital structure and propose a suitable model for contemporary material enterprises.
In the first chapter, I outlined theoretical findings and research experiments on capital structure, establishing a foundation for subsequent reviews in chapter 3 This chapter also identifies key search terms and validates previous experimental insights into the factors influencing business capital structure Additionally, it incorporates global and Vietnamese research results to provide a solid basis for verifying the most effective economic model Consequently, the research model and hypotheses are applied to evaluate the impact of these factors on the capital structure of publicly listed businesses in the Raw Materials industry.
DATA AND METHODOLOGY
Research data
Research using the financial statements of 188 leading companies in the raw materials industry's ratio is listed on the Vietnamese stock market within 8 years from 2012–2019
The data for this research was sourced from the code of cophieu68.com, resulting in an unbalanced dataset comprising 188 companies and 1,259 observations due to insufficient data from some businesses during the survey period To analyze and test the regression model regarding the factors influencing the capital structure of raw materials companies listed in Vietnam, Stata software was utilized for data calculations.
Research models
Leverage = f(Size, ROA, Cash_holdings, Growth)
Leverage = Financial leverage Size = Business size
The study examines the relationship between the returns on total assets (ROA), cash holding ratio, and revenue growth rate using panel data To estimate the panel data regression model, three common methods are employed, including Pooled Ordinary Least Squares (Pooled OLS).
Fixed Effects Model (FEM) and Regression Estimation Model (REM) With the factors affecting capital structure indicated in this analysis, the OLS method model is illustrated as follows:
LEV = 𝛽 0 +𝛽 1 𝑆𝐼𝑍𝐸 𝑡 + 𝛽 2 𝑅𝑂𝐴 𝑡 + 𝛽 3 𝐶𝐴𝑆𝐻_𝐻𝑂𝐿𝐷𝐼𝑁𝐺𝑆 𝑡 + 𝛽 4 𝐺𝑅𝑂𝑊𝑇𝐻 𝑡 + 𝑒 𝑖,𝑡 (1) The index i represents each ENTERPRISE, the index t represents the year of observations In which, the representative variables for the study of the topic are listed as follows:
2 Dependent variable: Financial Leverage ratio LEVERAGE
Table 3.1: Definition of research variable
The total debt to total assets ratio indicates the proportion of an enterprise's assets that are financed through debt rather than equity This metric reflects the enterprise's capacity to grow and generate assets over time.
Larger enterprises tend to favor long-term debt over short-term debt, leading to significant cost savings and enhanced economies of scale In contrast, small and medium-sized enterprises primarily rely on short-term debt.
Calculated as profit after tax on total assets This ratio is a measure of the profitability of a business
Calculated in cash and cash equivalents on total assets This ratio shows the cash holding ratio of the business
The revenue growth rate significantly influences an enterprise's capital structure As growth opportunities increase, companies are likely to decrease their reliance on debt capital to support operations Consequently, the relationship between growth potential and the leverage ratio is inversely related.
The OLS regression model assumes that businesses are homogeneous, which often misrepresents reality since each enterprise operates under unique conditions that influence its capital structure Consequently, neglecting these external factors can lead to inaccuracies in OLS estimates To address these external influences, we can utilize fixed effects models (FEM) or random effects models (REM) for more accurate estimations.
In the equation \$\omega_{i,t} = v_i + e_{i,t}\$, \$v_i\$ represents the time-constant and unobserved effects of each business entity \$i\$ The key distinction between Ordinary Least Squares (OLS) and the Fixed Effects Model (FEM) and Random Effects Model (REM) lies in the presence of \$v_i\$ Both FEM and REM assume the existence of \$v_i\$, but their applicability depends on its correlation with independent variables FEM is appropriate when \$v_i\$ is correlated with the independent variables, while REM is suitable when there is no correlation To determine whether to use OLS, FEM, or REM, the LM test is employed, with a p-value threshold of less than a specified value guiding the choice.
0.05, the OLS method is not suitable And to choose between REM and FEM, Hausman test is used, when p-value of test > 0.1, use REM and