Trade off theory versus pecking order theory evidence from the construction and real estate industry in vietnam

Executive Summary The dissertation investigates empirical evidence of trade off and pecking order theory based on determinants of capital structure.. Using data of 234 listed constructio

Dissertation submitted in partial fulfillment of the

Requirement for the MSc in Finance

Supervisor: Dr Nguyen Quynh Tho

September 2022

Acknowledgments

First of all, I would like to express my gratitude to Dr Nguyen Quynh Tho – a

thoughtful supervisor who opened up to a lot of wonderful recommendations and

patiently guided me throughout the process of making this dissertation I couldn’t

have finished this research properly without your insights so once again, thank you

very much for your supervision

Second of all, I would like to express my appreciation to the members and staff of

ISB and MSc in Finance UWE-BAV programme for their enthusiastic and tireless

support throughout the entire course I wish all of you the best of luck and more

success to the programme in the future

Last but not least, I want to thank my family and friends, who have always been ny

my side to support me I will never forget what you have done for me and I hope

we can continue to share a lot of amazing moments together

Executive Summary

The dissertation investigates empirical evidence of trade off and pecking order

theory based on determinants of capital structure Using data of 234 listed

construction firms and 82 listed real estate firms in Vietnam from 2012-2021, an

estimation of pooled OLS, pooled OLS with fixed effects and random effects

indicates a significant relationship between capital structure and the selected factors

as a whole, but there are similarities and differences between industries While

capital structure in the previous year has a positive and significant impact on capital

structure in the current year, firm profitability has a negative and significant impact

on the debt ratio The size of the firm also has a positive and significant effect on

capital structure in both industries, but depends on the method of estimation Firm

growth matters only to capital structure of construction firms in a direct

relationship, while firm tangibility matters only to capital structure of real estate

firms in an inverse relationship The statistical results also indicate a higher

acceptance of hypotheses regarding the pecking order theory, but trade off theory

is proved to be essential as well and both theories are needed to explain the choice

of debt and equity It is expected that the outcomes of this research will be useful

to many subjects including managers, lenders, authorities and academics

Table of Contents

Acknowledgments i

Executive Summary ii

Table of Contents iii

List of Abbreviations 1

List of Figures 2

List of Tables 2

Chapter 1: Introduction 3

1.1 Research Motivation 3

1.2 Research Design 6

Chapter 2: Literature Review 8

2.1 Capital Structure Theories 8

2.1.1 Initial approaches 8

2.1.2 Modigliani & Miller (M&M) theorem 10

2.1.3 Financial distress, bankruptcy and agency theory 13

2.1.4 Trade off and pecking order theory 14

2.1.5 Signalling and market timing theory 16

2.2 Empirical evidence of trade off vs pecking order theory 16

2.2.1 Empirical evidence on Vietnamese firms 16

2.2.2 Empirical evidence on non-Vietnamese firms 19

Chapter 3: Methodology 22

Chapter 4: Results and Discussion 27

4.1 The construction industry in Vietnam 27

4.1.2 Regression outcomes 28

4.1.3 Hypothesis testing 30

4.2 The real estate industry in Vietnam 32

4.2.1 Descriptive statistics and correlation Matrix 32

4.2.2 Regression outcomes 33

4.2.3 Hypothesis testing 36

4.3 Comparison and contrast 38

Chapter 5: Conclusion and Recommendation 40

References 42

List of Abbreviations

NAICS North American Industry Classification System

Sum Sq Dev Sum Squared Deviation

List of Figures

1.1 GDP growth and inflation of Vietnam – Medium-term

1.2 Real GDP growth and the contribution of construction and real estate industry in Vietnam – quarterly 4

1.3 Program for Recovery and Development – Capital Distribution (%) 5

1.4 Corporate Bond Issuance Value – Classified by Industry (Bil VND) 6

2.3 Trade off theory – Optimal Capital Structure 15

List of Tables

2.1 Summary of selected empirical research regarding trade off vs pecking order theory topic 20-22

4.1 Descriptive Statistics – The construction industry in

4.2 Correlation Matrix – The construction industry in Vietnam 27 4.3 Regression outcomes – The construction industry in Vietnam 28-29 4.4 Fixed/Random Effect Testing – The construction industry in Vietnam 29 4.5 The Heteroscedasticity Test – The construction industry in Vietnam 29 4.6 Robust regression outcomes using White cross-section

(period cluster) – The construction industry in Vietnam 30 4.7 Descriptive Statistics – The real estate industry in Vietnam 32 4.8 Correlation Matrix – The real estate industry in Vietnam 32 4.9 Regression outcomes – The real estate industry in Vietnam 33-34 4.10 Fixed/Random Effects Testing – The real estate industry in Vietnam 34 4.11 The Heteroscedasticity Test – The real estate industry in Vietnam 34 4.12 Robust regression outcomes using White cross-section

(period cluster) – The real estate industry in Vietnam 35 4.13 Robust regression outcomes using White period (cross-

section cluster) – The real estate industry in Vietnam 36

Chapter 1: Introduction

1.1 Research Motivation

Before the COVID-19 pandemic, Vietnam has witnessed a robust economic growth, a stability in price and a low public debt ratio for a prolonged period, owing

to prudent policies from the authorities Additionally, the banking industry was also

in a relatively strong position at the time, while external buffers of the country were boosted by strong FDI and trade flows Although the pandemic led to a disruption

in the global economy, prudent policies including containing measures once again proved to be successful and made Vietnam the regional top-performing economy

in 2020 Nevertheless, the inevitable outbreak in April 2021 resulted in a historical contraction in Vietnamese economic activity in the 3rd quarter and a total real GDP growth of only 2.6% in 2021 Entering 2022, Vietnam is expected to have a strong recovery of approximately 6% in economic growth as the remarkable vaccination rollout from 2021 will continue to support the activity normalization and the implementation of Program for Recovery and Development (PRD) by the

government is already underway (IMF, 2022) It can be seen from figure 1.1 that

the output of the Vietnamese economy is projected to grow even higher in 2023 and remains stable in the medium term However, inflation of Vietnam is forecasted to double in 2022 and remains high in the following years since it has recently emerged from the global supply chain disruptions and the rising commodity prices

Figure 1.1: GDP growth and inflation of Vietnam – Medium-term projections

2018 2019 2020 2021 2022E 2023E 2024E 2025E 2026E 2027E

Real GDP growth (%) Average CPI (%)

It is also expected that the social-economic recovery program during the 2022-2023 period, including tax reduction, land rental free relief and preferential loans, will have a positive impact on the development of the construction and real estate

industries (Yen, 2022) It can be seen from figure 1.2 that after a dramatic decline

in the 3rd quarter of 2021 as a consequence of the COVID-19 outbreak within the country, both industries bounced back significantly in the 4th quarter of 2021 and continue the growing trend in the first half of 2022

Figure 1.2: Real GDP growth and the contribution of

construction and real estate industry in Vietnam – quarterly

Source: GSOVN – Monthly Report from 2019 to 2022

As for the construction industry in Vietnam, the first quarter of 2022 witnessed a

rapid climb in the price of construction materials including steel, coal and wood, owing to the fact that the conflict between Russia and Ukraine led to the disruption

of the global supply chain Despite these difficulties, it is pointed out that there are many opportunities for the industry to continue its recovery trend in the remainder

of 2022 and thrive in the future First, the flow of FDI is expected to increase in the last months of 2022 and the disbursed capital will be a very important source for construction this year Second, the urbanization process in Vietnam is relatively faster than other countries in South East Asia but the urban population is still relatively low compared to other nations in the region, thus the demand for housing, commercial buildings and urban infrastructure will promote the growth of the

construction industry Thirdly, in addition to the other benefits from the PRD

(figure 1.3), it is also emphasized that more than 30% of the public capital will be

invested in medium-term infrastructure projects for 2021-2025 and even for term projects in 2022-2023 that complete legal documents early (PSI, 2022)

short-Figure 1.3: Program for Recovery and Development – Capital Distribution (%)

Source: Resolution No 43/2022/QH15 – PSI (2022)

As for the real estate industry in Vietnam, credit tightening is stated to be an

obvious sign from the authorities, in terms of both bank loans and corporate bonds

At the end of 1st quarter, real estate credit increased only 2.24% since the beginning

of 2022 and much slower than total credit increase of 5% Although it can be seen

from figure 1.4 that corporate bonds of the real estate industry in Vietnam account

for the majority of issuance value in the last 3 years (only after the banking industry), there hasn’t been any bond issuance from any real estate companies in April 2022, not to mention a dramatic cancel in the bond issuance event of more than 10,000 billion VND from Tan Hoang Minh Group earlier this year In the second half of 2022, there is still room for development, especially in the industrial real estate segment as the government issued Decree 35/2022/ND-CP at the end of May 2022 on management of the economic industrial zone “Tech giants” including Apple or Samsung decided to build production plants and other facilities for expansion in Vietnam is just one of many examples that support a positive outlook

32.74 11.35 13.26 18.45 14.73

Infrastructure development Medical facilities upgrade Social security

Support cooperatives, businesses, households business Anti-epidemic medical supplies

Taxes, fees, charges reduction Telecommunications and internet infrastructure development Technological innovation, science and technology business incubation Other Policy

for this segment in particular and the growth of the real estate industry as a whole (VARS, 2022)

Figure 1.4: Corporate Bond Issuance Value – Classified by Industry (Bil

VND)

Source: VBMA/MOF – Annual Report 2019-2021

Based on the overview of the economy as well as the construction and real estate industries in Vietnam, the author finds it necessary to have research on these selected industries The research should focus on the topics regarding capital structure, since the source of finance is essential to the recovery trend of both industries, particularly in regard to capital distribution of the construction industry and capital tightening of the real estate industry in Vietnam Moreover, there are certain gaps in the empirical research on capital structure of Vietnamese firms, including trade off and pecking order theories, which will be discussed further in the next chapter

1.2 Research Design

The objective of the research is to examine whether the capital structure decisions

of Vietnamese listed companies in the construction and real estate industry are better explained by trade off theory or the pecking order theory The more hypotheses are accepted corresponding to the theory, the better the explanation of that theory in the given case Based on the empirical results, the author expects to provide several meaningful suggestions and recommendations, in turn become a

0 100,000 200,000 300,000 400,000 500,000 600,000 Real Estate

Securities Consumer goods and services

Energy Banking Construction Others

2019 2020 2021

useful reference for resolving problems regarding capital structure as well as open more avenues for research in the future The research will examine financial data from 2012 to 2021 of 234 listed companies in the construction industry and 82 listed companies in the real estate industry, respectively, using multiple linear regression including Pooled Ordinary Least Square (OLS), Pooled OLS with Fixed Effect (FEM) and Random Effect (REM)

The dissertation is organized as follow:

 Chapter 1: Introduction The chapter consists of 2 sections: motivation on

choosing the research topic based on an analysis of the economy as well as the construction and the real estate industries in Vietnam; a brief introduction on the design of the dissertation, including the objective, scope, methodology and structure of the research

 Chapter 2: Literature Review The chapter is also divided into 2 sections:

a review on capital structure theory, including trade off and pecking order;

a review on several notable empirical studies over the years relating to trade off vs pecking order theory in Vietnam and other countries

 Chapter 3: Methodology The chapter will give a description on data

collection, decide which variables will be chosen for the research, propose hypothesis for both selected industries and build a suitable statistical model for analysis

 Chapter 4: Results The results of each industry will be presented

separately, which include descriptive statistics and correlation matrix, regression outcomes, and hypothesis testing Then, the results are combined and compared in the analysis and discussion section Finally, the chapter discusses several limitations of the results as well as other remaining problems in the process of making this research

 Chapter 5: Conclusions and Recommendations The chapter gives a

summary and conclusion of the dissertation, then brings up some suggestions and recommendations to those considered to be important to the research including managers, lenders, regulators and scholars

Chapter 2: Literature Review

2.1 Capital Structure Theories

2.1.1 Initial approaches

Before going into the first-ever published theoretical research of capital structure,

it is essential to understand the initial approach on the relationship between capital structure and the value of the firm The choice of debt and equity, or capital structure, can be quantified by the weighted-average cost of capital (WACC) formula, whereas “k” is the cost of debt (D) or equity (E) and “w” is the proportion

of debt or equity in total amount of capital raised (Arnold & Lewis, 2019):

𝑊𝐴𝐶𝐶 = 𝑘𝐷 × 𝑤𝐷+ 𝑘𝐸× 𝑤𝐸

It is emphasized that the cost of debt is presumed to be cheaper than the cost of equity This seems to be reasonable enough under normal circumstances: when the debt holders are guaranteed to (usually) receive a fixed amount of payments after a particular period of time, no matter the business is doing well or not, then the cost

of raising capital from this source of finance should be relatively lower than raising capital from equity Since the equity owner, or shareholders in the case of joint stock companies, aren’t (usually) guaranteed any income in the future and depends

on the company’s performance, it is natural for them to demand a higher return – a higher cost to pay when the company decides to raise capital from equity instead of debt This assumption might not hold when it comes to a variety of financial instruments, such as convertibles, or under extreme economic conditions that there are possibilities of a higher cost of debt than cost of equity The company, as a result, should be leaning towards how to increase their proportion of debt Nevertheless, the more a company owes, the more financial risks they have to face

if they can’t meet the obligations in the future (Arnold & Lewis, 2019)

It is also pointed out that the firm is assumed to receive perpetual and constant cash flows in the future The value of the firm (V) can be calculated by discounting the future cash flow (C) to the present using the cost of capital By taking out the changes in the future cash flows, the initial approach establishes on the vital of WACC: the value of the firm will depend on the cost of capital only and they have

an inverse relationship (Arnold & Lewis, 2019):

𝑉 = 𝐶𝑊𝐴𝐶𝐶Combining all of the above factors, there are four scenarios can be derived from when the company decides to increase the proportion of debt in their total capital (Arnold & Lewis, 2019):

 Scenario 1: The cost of equity is assumed to remain constant Thus, when

the proportion of debt increases, the overall cost of debt will decrease or become cheaper As a result, the cost of capital will be lower and the value

of the firm will be higher

 Scenario 2: When the proportion of debt increases, the cost of debt will fall

and at the same time, the cost of equity will also rise owing to the fact there’s

an increase in the company’s financial risks Additionally, the rise in the cost of equity will be just enough to neutralize the effect of the low cost of debt Therefore, the cost of capital will remain unchanged, and so will the value of the firm

 Scenario 3: Similar to the mechanism in scenario 2, but the rise in the cost

of equity will be lower and not enough to offset the benefit from the low cost of debt Thus, the cost of capital will decrease and the value of the firm will increase

 Scenario 4: Similar to the mechanism in scenario 2, but the rise in the cost

of equity will be higher and more than enough to offset the benefit from the low cost of debt Thus, the cost of capital will increase and the value of the firm will decrease

Scenario 1 seems to be the most unrealistic one, hence the following theoretical research tends to have similar results to scenario 2, 3 and 4 The most common capital structure theories, which are widely recognized in empirical research and textbooks according to the author, are the Modigliani & Miller (M&M) theorem in

1958 and 1963, trade off theory and pecking order theory Other considerations that will be discussed in this dissertation include financial distress or bankruptcy theory, agency theory, signalling and market timing theory

2.1.2 Modigliani & Miller (M&M) theorem

In the first ever meticulous theoretical research on capital structure, Modigliani &

Miller (1958) assumed their theorem to be set in a frictionless world: there is no

tax, no transaction cost, no financial distress or bankruptcy cost, no agency cost and

symmetric information (information is available to everyone)

Based on these assumptions, the authors came to three conclusions:

 Proposition I: The value of the firm is independent from its capital

structure

 Proposition II: The expected return (or the cost) of equity increases

proportionately with the gearing ratio

 Proposition III: The rate of return for new projects is equal to the

WACC, which is unchanged regardless of the financing used

Proposition I and II is similar to scenario 2 mentioned before: when the proportion

of debt increases, the cost of debt will decrease since debt financing is cheaper than

equity financing Nevertheless, a rise in debt level also means a rise in financial

risks, and the equity owner (or shareholders) will require compensation for the

excessive financial risks Thus, the cost of equity will increase enough to offset the

benefit from the low cost of debt As a result, the cost of capital is constant, the

value of the firm is unchanged In another term, the value of the firm is independent

from its capital structure, which can be visualized in figure 2.1 And since the

WACC of a firm doesn’t depend on its choice of debt and equity according to

proposition I and II, when a firm decides to bring the debt level to 0, then the cost

of equity will still be equal to the WACC, which is stated in proposition III

Figure 2.1: M&M (1958) proposition I and II

Source: Arnold & Lewis (2019)

Although the assumptions and propositions from the work of Modigliani & Miller (1958) stray far from reality, it remains an important foundation for the following research on capital structure theories By relaxing the assumptions one by one, future theoretical research becomes closer to the real world As a matter of fact, the authors themselves introduced their next capital structure theorem in 1963, taking into account the effect of taxation Thus, debt financing has more than one benefit:

it is cheaper and at the same time, the interest expense is tax deduction This is similar to scenario 3 as mentioned in the analysis on the initial approach of capital structure theory: when the proportion of debt increases, the rise in the cost of equity will not neutralize the benefits of the cost of debt As a result, the cost of capital will be lower and the value of the firm will be higher, which can be illustrated in

figure 2.2 It is undeniable that if this is the only case, there wouldn’t be any

concerns on the choice of debt and equity at all, since firms will keep borrowing until they reach their full capacities Therefore, the approaches after the work of Modigliani & Miller (1963) should either focus on the effect of taxation, or continue

to relax the remaining assumptions from the 1958 theorem

Figure 2.2: M&M (1963) – with tax

Source: Arnold & Lewis (2019)

As for the impact of taxation on capital structure decisions, it is worth mentioning the research of Miller (1977): he examined the effect of personal taxes on the choice

of debt and equity, and the results were not in line with what he and his partner proposed in 1963 Owing to the fact that shareholders can take advantage from low personal taxes on equity, debt holders will also demand more on their lending rates

As a result, by increasing the proportion of debt, the cost of debt will gradually lose the benefit of being a cheap source of finance and in turn, wipe out the benefit from corporate tax reduction At the same time, the cost of equity will also increase as the debt level increases, thus the cost of capital will be higher and the value of the firm will be lower This result is similar to scenario 4, although the mechanism of explanation is different Another notable mention is the research of DeAngelo & Masulis (1980): the author examined corporate rate as well as personal tax, and discovered the benefit from non-debt tax shield (NDTS) It consists of accounting depreciation deduction and investment tax credits, which can be used as a substitution for debt tax shield In addition, the authors concluded that the optimal capital structure of each firm is unique and depends on the effect of taxation on the return of debt and equity In the research of Graham (2000), less than 10% of the firm value benefit from taxation and if personal tax is excluded, the number is only

about 5% He also came to the conclusion that large firms in a good financial position have the tendency to follow a conservative strategy, while others often decide to take on a more aggressive direction considering the advantages and disadvantages of financial leverage

2.1.3 Financial distress, bankruptcy and agency theory

As for the continuation of relaxing assumptions, it is worth mentioning the work of Gordon (1970) According to the author, the development of the financial distress theory is pointed out to be essential after the severe consequences of the great depression led to the downfall of numerous large corporations When a company is

in a poor financial condition and unable to generate a sufficient amount of money

to meet the financial obligations, it can be concluded the company is facing the problem of financial distress at the moment Ultimately, that company will file for bankruptcy if the financial distress can’t be resolved in a given time The prediction for the potential bankruptcy is stated in the research of Altman (1968) using financial ratios and the bankruptcy costs are proved to be significant later in another research of the author in 1984 Apart from finding the solutions for their liquidation position, a company also has to deal with the direct and indirect costs during the time of financial distress and bankruptcy (Altman, 1984) Typical examples for direct costs include legal (lawyers, courts, filing…), accounting and management activities In terms of the indirect costs, it is a consequence of a poor reputation when a company is in the state of financial distress or bankruptcy A poor reputation will lead to a badly damaged relationship between the company and their customers

or suppliers, an underperformance by employees, a higher returns or a higher cost from debt holders and shareholders and eventually, a decline in the profit of the company (Arnold & Lewis, 2019)

Another notable research is the work of Jensen & Meckling (1976) on the agency theory According to the authors, it is believed that the agents, who are hired to manage the firm, don’t always act on the benefit of the principals/the owners of the firm This is due to the fact that there is a problem of asymmetric information: the agents/managers will have more access to the information since they run the firm’s operations Therefore, the principals/owners have no choice but to mitigate this

risks and harmful activities, or to monitor the activities of the managers – an agency cost The theory of agency was continued to develop by Jensen (1986) regarding the control advantage of debt finance: since the agents are tied to meet the future obligations, they won’t have the incentive to spend the firm’s resources ineffectively, thus the agency costs can be reduced However, it is also noted that the restrictive covenants from lending are able to prohibit firms from making flexible decisions in their investments Moreover, debt holders could ask for a higher return for taking excessive risks in the case of high NPV investments (Arnold

& Lewis, 2019)

2.1.4 Trade off and pecking order theory

By taking into account the effect of taxation, financial distress/bankruptcy costs and agency costs, trade off theory is established in order to explain the impact of capital structure on the value of the firm A firm has to weigh between the benefits from the cost of debt (the low cost and the debt tax shield) and the drawbacks from the costs of financial distress and agency whenever there’s an increase in the proportion

of debt As a result, there will be a point of balance in which the cost of capital is

at its lowest point and the value of the firm will be the highest, which can be

described in figure 2.3 as an “optimal capital structure” (Arnold & Lewis, 2019)

As for the static trade off model, some authors such as Kraus & Litzenberger (1973) and Scott (1977) only took into consideration the effect of the bankruptcy costs in their research Others like Myers (1977) and Bradley et al (1984) incorporated both the costs of bankruptcy and agency in their studies Since this is the static trade off model, which means the data is cross-sectional and usually employs the number at the end of the period, it is necessary to have a dynamic trade off model In the research of Fischer, et al (1989) using company-specific characteristics in multiple periods, it is pointed out that there will be an adjustment towards the optimal gearing level, but the speed of adjustment is not the same for different types of firm Furthermore, it is also noted that a large amount of transaction costs are required even though there’s only a small adjustment

Figure 2.3: Trade off theory – Optimal Capital Structure

Source: Arnold & Lewis (2019)

Another important approach on the capital structure decision is the pecking order theory, which appeared in the research of Myers (1984) as well as Myers & Maljuf (1984) It can be considered as the opposite to the research of Modigliani & Miller theorem in 1958 and 1963 as well as the trade off theory in terms of “no optimal capital structure” The authors divided the source of equity into internal and external finance, and the retained profits (internal financing) from the previous fiscal year will be prioritized as the first choice in the financing decision When the source of internal finance is used up and a company needs additional capital for their operations, the prioritization will be the least to the most risky financial instruments

As a result, debt issuance will be the second best choice and the company should only issue new shares as the last option This is owing to the fact there’s a presence

of both agency theory and asymmetric information: since the managers have more information on the price of their firms’ shares, they have the incentive to issue new shares when the shares are overvalued and issue more debts when the shares are undervalued At the same time, investors also recognize this mechanism and any acts of issuing new shares are considered as a bad signal from the company, thus the price of equity will decline Therefore, the authors argued that managers would rather choose debt over equity for external financing, unprofitable firms often have

2.1.5 Signalling and market timing theory

The incentive-signalling by Ross (1977) is also a notable mention of capital structure theory The author claimed an increase in the proportion of debt will result

in a rise of the firm’s value Although the conclusion advocates the theorem of Modigliani & Miller (1963) as well as the trade off theory in terms of debt preference, the explanation of this theory is not similar According to the author, the managers are the ones who guarantee an on-going business of a firm so they will suffer most if the firm goes bankrupt Therefore, any acts of increasing financial leverage can be considered as a good signal for the outlook of the company under the view of the investors and this will result in an increase in the share price

In contrast, the market timing theory by Baker & Wurgler (2002) advocates the pecking order theory also in terms of “no target capital structure” Similarly, the authors also argued that managers have the tendency to issue new shares if the shares are overvalued and repurchase them in the case of undervalued As a consequence, the changes in capital structure will depend mostly on the price movements of the shares

In summary, the choice of debt and equity, theoretically, is still debatable However,

it seems the debates either advocate the trade off theory or pecking order theory in general Therefore, they can be considered to be the “main” capital structure theories and it seems reasonable for the dissertation to focus on the empirical research of trade off vs pecking order

2.2 Empirical evidence of trade off vs pecking order theory

2.2.1 Empirical evidence on Vietnamese firms

As for the research on the companies in Vietnam, trade off theory vs pecking order theory only appears directly in one accessible empirical study by Dereeper & Trinh (2015) with a state-ownership structure In this research, the authors examined more than 300 non-financial listed companies on Hanoi Stock Exchange (HNX) and Ho Chi Minh City Stock Exchange (HOSE) from 2005 to 2011, using pooled OLS, fixed effects and random effects The results don’t support the pecking order theory because internal equity funds and new equity issuance don’t have a significant impact on the financial leverage On the contrary, the results indicate an existence

of a target capital structure and there’s a rapid adjustment towards the optimal level

in both private and state-owned firms Nevertheless, it is also pointed out that the relationship between the state-ownership structure and the debt ratio is insignificant regarding the scope of the research

Although there hasn’t been much empirical evidence that focuses on the theory of trade off and pecking order in Vietnam, there has been a number of research on the determinants of capital structure over the years Since the research of two theories

is also based on examining the potential factors that could have significant influence

on the choice of debt and equity, it is also important to look in the research on determinants of capital structure in Vietnam

In a research on small and medium-sized companies (SMEs) in Vietnam, Nguyen

& Ramachandran (2006) examined 558 SMEs firms in the period of 1998-2001 However, it is unclear which types of statistical model was used in order to conduct

a linear regression on this research The outcomes indicate the favor of using term liabilities by SMEs to finance for their operations In addition, a number of factors including growth, business risk, firm size, networking and relationships with banks have a positive and significant impact on capital structure In contrast, the tangibility factor has a negative and significant impact on financial leverage Nevertheless, there’s no significant relationship between firm profitability and capital structure

short-The empirical analysis of Biger et al (2008) on Vietnamese firms using census firm data from the years 2002-2003 is also unclear on the choice of statistical model However, the authors indicated some of the findings are similar to other countries, including a positive and significant impact of firm size and managerial ownership

on financial leverage as well as a negative and significant impact of profitability and non-debt tax shield on capital structure Other findings include a positive and significant effect of growth opportunities as well as a negative and significant effect

of fixed assets on the debt ratio that are not in line with other countries’ results Finally, there’s little significant relationship between corporate income tax among the sample

In another research on determinants of capital structure in Vietnam, Nguyen et al

generalized method of moments (GMM) and data in the period of 2007-2011 The authors came to a conclusion that short-term debt was a main source of finance, especially high growth firms, in spite of the fact that there was an emergence of equity during that time The empirical results indicate a positive and significant influence of state-ownership and growth on financial leverage, while profitability and liquidity have a negative and significant influence on leverage ratios It is also noted that the influence of these factors are also different on each type of leverage: size, tangibility and growth have more influence on long-term debt, while liquidity has more influence on short-term debt Among the determinants, profitability and tangibility have the largest influence on debt ratios More importantly, according to the authors, it is clear that the empirical results advocate pecking order theory rather than trade off theory

The empirical research of Vo (2017) also employed the GMM estimator to investigate determinants of capital structure of non-financial listed companies on HOSE, using accounting data from 2006 to 2015 The outcomes are also different for long-term and short-term debts: there’s a positive and significant relationship between tangible assets and long-term leverage but the relationship is inverse when

it comes to short-term debt The same goes with firm size Profitability has a higher positive and significant impact on long-term debt than short-term debt The relationship between liquidity and short-term leverage is negative and significant, but positive and insignificant when it comes to long-term leverage Growth opportunity doesn’t have a significant impact on debt ratios, regarding both long and short-term

A similar approach on non-financial listed firms in HOSE in the period of

2007-2014 was explored in a research by Thai (2017), with an emphasis on state ownership using pooled OLS, FEM, REM and clustered-robust errors FEM The results indicate an U-shape and significant relationship between state investment and short-term debt and total debt The results also indicate a significant relationship between other determinants including size, profitability, tangibility, growth, market-to-book ratio and median industry average, except for the case of non-debt tax shields

2.2.2 Empirical evidence on non-Vietnamese firms

As for the research on companies in other countries, there has been several notable research in regard to trade off theory vs pecking order theory, with different types

of results over the years In the empirical studies of Tong & Green (2005) on top

50 non-financial listed Chinese companies using data from 2001 to 2003, the statistical results advocate the pecking order over trade off theory The empirical results in favor of pecking order theory can also be found in the research of Jarallah

et al (2018) on listed Japanese companies from 1991 to 2015 using GMM econometric framework, as well as Chipeta & McClelland (2018) on South African non-financial firms using both GMM model and Censored Tobit Regressions The outcomes in the research of López-Gracia & Sogorb-Mira (2008) on Spanish SMEs from 1995 to 2004 indicate both trade off and pecking order help explain the capital structure: the source of finance follows a hierarchy but there’s also a slow adjustment towards optimal leverage Using the GMM procedures, all of the factors including NDTS, growth opportunities, internal resources, size and age have a significant influence on capital structure Similar results can also be found in the research of Serrasqueiro & Caetano (2015) on SMEs in a particular region of Portugal using least square dummy variable corrected (LSDVC) estimation method

In another research on companies in Portuguese by Serrasqueiro et al (2011), the empirical evidence indicate different results among types of firms and selected industries: the choice of debt and equity in service SMEs support the assumptions

of pecking order theory more than trade off theory compared to other types of firm, including large firms in the service industry, manufacturing and construction SMEs and large firms in the manufacturing and construction industry

Different results among types of companies can also be found in the work of Koksal

& Orman (2015) on small, large, listed and listed manufacturing and manufacturing firms in Turkey The statistical results using firm-level data indicate

non-a fnon-avor on trnon-ade off theory non-as non-a whole non-and pnon-articulnon-arly for lnon-arge privnon-ate compnon-anies

in the non-manufacturing industry However, when it comes to small listed manufacturing companies in an unstable economic environment, the outcomes lean

In summary, it can be concluded that the results on trade off vs pecking order theory are still controversial: they are different across and even within the countries and industries Moreover, the empirical studies of these two theories on multiple industries separately are still limited in Vietnam Therefore, the dissertation expects

to fill the gap with a more up-to-date dataset and a comparison between the construction and real estate industry in Vietnam

The key information of this chapter’s empirical evidence can be outlined in the

table 2.1 as follow:

Table 2.1: Summary of selected empirical research regarding

trade off vs pecking order theory topic

Total debt ratio (including lag 1), firm size, growth, profitability, fixed assets, age, depreciation rate, cash, industry classification, financing deficit

Supports trade off theory

Supports the use

of term debt (trade off theory)

short-Biger et al

(2008) Unstated

Total liabilities and total debt ratios, firm size , growth opportunities, profitability, fixed assets, non-debt tax shield, corporate income tax rate, managerial ownership, industry classification

Supports pecking order theory

Total debt, short-term debt, long-term debt ratios, firm size, growth opportunity, profitability, tangible assets and liquidity

Unstated

11 As mentioned, this is the only research that directly related to the topic Other empirical evidence