Capital structure and firm performance of listed companies in vietnam

The kind of combination of debt and equity that will minimize the firms cost of capital and hence maximizes the firm‟s profitability and market value is the optimal capital structure.. a

CAPITAL STRUCTURE AND FIRM PERFORMANCE OF LISTED COMPANIES

IN VIETNAM

In Partial Fulfillment of the Requirements of the Degree of

MASTER OF BUSINESS ADMINISTRATION

CAPITAL STRUCTURE AND FIRM PERFORMANCE OF LISTED COMPANIES

IN VIETNAM

In Partial Fulfillment of the Requirements of the Degree of

MASTER OF BUSINESS ADMINISTRATION

In Fianance

by Ms: Nguyen Thi Van Anh ID: MBA04050 International University - Vietnam National University HCMC

Acknowledge

This thesis report is about the Capital Structure and Firm Performance would not have been possible without valuable contribution of all teachers from School of Business

I would like to thank to the International University, Vietnam National University –

Ho Chi Minh City for giving me a great opportunity to practice and learn more knowledge I especially appreciated the School of Business that helped us have good condition to do the necessary research work and archive the results I am deeply indebted to my thesis project advisor Dr Duong Nhu Hung, for his patience, guidance and advice throughout this semester

He was always keeping his eyes on my research This gave me the efforts which proved valuable for the success of this thesis project Moreover, my gratitude goes to my beloved husband Mr Nguyen Thanh Tung for his love, insightful guidance, assistance, and support during the entire process of my mater‟s study and the writing of this dissertation

Finally, I would like to thank my parents, also my friends for supporting and encouraging me throughout my studies With their love, I could finish this work

I hope this will serve as a valuable resource for whose major or carrier related to this field

Plagiarism Statements

I would like to declare that, apart from the acknowledged references, this thesis either does not use language, ideas, or other original material from anyone; or has not been previously submitted to any other educational and research programs or institutions I fully understand that any writings in this thesis contradicted to the above statement will automatically lead to the rejection from the MBA program at the International University – Vietnam National University Hochiminh City

Copyright Statement

This copy of the thesis has been supplied on condition that anyone who consults it is understood to recognize that its copyright rests with its author and that no quotation from the thesis and no information derived from it may be published without the author‟s prior consent

© Nguyen Thi Van Anh/ MBA04050/ 2011 - 2013

Table of Contents

Chapter One - Introduction 1

1.1 Background 1

1.2 Research objective 5

1.3 Data and methodology 6

1.4 Limitation 6

1.5 Structure of the study 6

Chapter Two - Literature Review 8

2.1 Theories on capital structure 8

2.1.1 The Miller and Modigliani Theory 8

2.1.2 Static Tradeoff Theory 9

2.1.3 Agency Cost Theory 10

2.1.4 Pecking Order Theory 12

2.2 Previous studies on capital structure and firm performance 13

2.2.1 Internationally empirical findings 13

2.2.2 Empirical findings from Vietnamese perspective 14

2.3 Determinants of Capital Structure and Their Hypothesis 16

2.3.1 Dependent Variables 16

2.3.2 Independent Variables 16

Chapter Three – Data and Methodology 24

3.1 Data collection 24

3.2 Data Analysis Method 24

Chapter Four - Empirical Result 28

4.1 Descriptive Statistics 28

4.2 Multi – collineartity 32

4.3 Regression results and discussions 35

4.3.1 Profitability Firm Performance 37

4.3.2 Size 39

4.3.3 Tangible assets 40

4.3.4 Growth opportunity 40

4.3.5 Inflation rate 41

4.3.6 Asset specificity 41

4.3.7 Parent companies and Their Affiliated Companies 42

Chapter Five – Conclusions and Recommendations 45

References 49 Appendix 1 A1 - 1 Appendix 2 A2 - 1 Appendix 3 A3 - 1 Appendix 4 A4 - 1 Appendix 5 A5 - 1 Appendix 6 A6 - 1 Appendix 7 A7 - 1 Appendix 8 A8 - 1

List of Tables

Table 1: Summary the findings of the previous studies 15

Table 2: Summary of the implications of theories and all hypotheses of the study 23

Table 3: Description of Variables 26

Table 4: Descriptive statistics of Variables 29

Table 5: Correlation matrix 33

Table 6: Estimation Results for Panel Data Models Using ROA 35

Table 7: Estimation Results for Panel Data Models Using ROE 36

Table 8: Estimation Results for Panel Data Models Using TOBINQ 36

Table 9: Regression Result of Capital Structure 42

Table 10: Regression Result of Firm Performance 43

Abstract

Capital structure decisions have been the most significant decisions to be taken by any business organization for maximization of shareholders wealth and sustained growth The study examines the relationship between capital structure and firm performance of 200 listed firms on the HOSE for a period of five years from 2008 to 2012 This study employed panel data analysis by using fixed-effect estimation Empirical result shows that the listed firms on the HOSE employ mostly short-term liabilities to finance their operations According to the results, all measures of firm performance are found to have a significant and negative impact

on all measures of firm capital structure This result is contrary to the predictions of trade-off theory but consistent with the pecking order theory The result also reveals that firm size has

a positive and significant impact on the leverage, tangible asset is negative and significantly related to STDTA and TDTA, growth opportunity variable has a negative and significant coefficient with LTDTA and TDTA, the inflation rate has a negative effect on TDTE, the coefficient of asset specificity is negative and significantly related to all measures of leverage (except STDTA) There appears two interesting findings are that TDTA of the parent companies has a negative impact on TDTA of their affiliated companies and two measures of firm performance (ROA and ROE) of the parent companies have a significantly positive impact on two measures of firm performance (ROA and ROE) of their affiliated companies

Keywords: capital structure, firm performance, parent company, affiliated company, listed

firm, Ho Chi Minh Stock Exchange, panel data, fix-effect model

Chapter One - Introduction 1.1 Background

One of the most important reference theories in enterprises financing policy is the theory of capital structure The capital structure of an enterprise is the mix of debt including preference stock and equity; this is referred to as the firms‟ long term financing mix (Watson and Head, 2007) Capital structure decision is fundamental for any business organization This decision is important because the organizations need

to maximize return to various stake holders and it also has an effect on the value of the firm Besides that, the impact from the decision will help the firm‟s ability to deal with its competitive environment Capital structure decisions represent another pivotal financial decision of a business organization apart from investment decisions It is important since it involves a huge amount of money and has long- term implications

on the firms One crucial issue confronting managers today is how to choose the combination of debt and equity to achieve optimum capital structure that would

minimize the firm‟s cost of capital and improves return to owners of the business Even though generally firms have a choice as to how to combine debt and equity, managers attempt to ascertain a particular combination that will maximize profitability and the firm‟s market value The kind of combination of debt and equity that will minimize the firms cost of capital and hence maximizes the firm‟s profitability and market value is the optimal capital structure Unfortunately, financial managers do not have a clear cut guideline that they can consult when taking decision

in connection with optimal capital structure The idea of modern theory of capital structure is originated from the path breaking contribution of Modigliani and Miller (1958) under the perfect capital market assumption Modigliani and Miller (1958) assumed that under condition of no bankruptcy cost and frictionless capital markets

without taxes, firm‟s value is independent of its capital structure Modigliani and Miller (1963) in considering of the existence of corporate taxes suggested that firms should use as much debt capital as possible in order to maximize their value by maximizing the interest tax shield

Other theories that have been advanced to explain the capital structure of firms include the static tradeoff theory, the agency cost theory, and pecking order theory Pecking order theory suggests that firms will initially rely on internally generated funds, and then they will turn to debt if additional funds are needed and finally they will issue equity to cover any remaining Thus, according to the pecking order hypothesis, firms that are profitable and therefore generate high earnings are expected

to use less debt capital than those who do not generate high earnings Hence, internal funds are used first, and when that is depleted, debt is issued, and when it is not sensible to issue any more debt, equity is issued (Myers and Majluf, 1984)

Agency costs are the costs that arise from the principal-stakeholder relationship, such

as between shareholders or managers of the firm and debt-holders Moreover, the given incentives to the firm will benefit shareholders at the expense of debt-holders Thus, debt-holders need to restrict and monitor the firm‟s behaviour Consequently, costly monitoring devices of contractual covenants are incorporated into debt agreements to protect the debt-holders Hence, it should increase the cost of capital offered to the firm Therefore, firms with relatively higher agency costs due to inherent conflicts between the firm and the debt-holders should have lower levels of outside debt financing and leverage

Furthermore, according to Gleason et al (2000), the utilization of different levels of debt and equity in the firm‟s capital structure is one such firm-specific strategy used

by managers in the search for improved performance Hence, most firms have tried to

achieve an optimal capital structure in order to minimize the cost of capital or to maximize the firm value, thereby improving its competitive advantage in the marketplace through a mixture of debt and equity financing Thus, selecting the right type of debt is an equally important issue as opting for an appropriate debt to equity ratio However, as noted by Myer (2001), each theory works under its own assumptions and propositions, hence, none of the theories can give a complete picture

of the practice of capital structure

Ross (1977), Heinkel (1982) and Noe (1988) suggest that increasing leverage, by acquiring debt should have positive implications for firm value and performance Furthermore, this result is also supported by Hadlock and James (2002) where they concluded that companies prefer debt (loan) financing because they anticipate a higher return According to Champion (1999), the use of leverage is one way to improve the performance of the firm

Due to the lack of a consensus about what would qualify as optimal capital structure,

it is pertinent to examine the effect of debt utilization on firms‟ performance Several such studies were conducted in European countries and in the United States They found contradictory results when Gleason (2000) supported a negative impact of leverage on the profitability of the firm while Roden and Lewellen (1995) found a significant positive association between profitability and total debt as a percentage of the total buyout-financing package in their study on leveraged buyouts Thus, there is

no universal theory about debt-equity choices and have different views regarding the financing option

The contribution of these studies would help the manager of the companies to make good decisions on the proportions of their capital structure If they have taken too much debt in the operations of the company, this can jeopardize the company‟s future,

thus can make the companies go bankrupt Hence, this will provide and add new knowledge to corporate managers as a benchmark in making their own decision on the company‟s performance

In Vietnam, lack of empirical evidence, that investigate the relationship between firm capital structure and firm performance, is an issue for both academics and practitioners Vietnam is also absent in international analyses of capital structure in emerging markets In 2008, Tran Hung Son and Tran Viet Hoang tested the relationship between capital structure and firm performance by using data sample of

50 non-financial companies in Hochiminh Stock Exchange for the period September

2008 The results show that there is a positive correlation between a firm capital structure and performance, which is measured by average of return on assets and return on equity In addition to that, Nguyen Thanh Cuong and Nguyen Thi Canh tested the panel threshold effect of capital structure on firm value among 92 Vietnam‟s seafood processing enterprises (SEAs) from 2005 to 2010 The result shows that there exists double thresholds effect between debt ratio and firm value However, they have not used market performance measures and have not explored the optimal capital structure to maximize the performance of the firm And, the controlled variables are major specific of business There has not considered to environmental variables of business

Therefore, problem to be contributed in this study is to examine the effect which firm capital structure has on corporate market performance in both firm accounting performance and market performance measure, and the effect of firm performance on firm capital structure combined with other variables such as asset specificity, and inflation rate on firm capital structure Besides that, this study also contributes an interesting finding about parent company which owns or controls another company,

known as the subsidiary The parent company is able to direct the business practices

of the subsidiary because it controls the voting, thus making determinations like who should sit on the board of the subsidiary It is not uncommon for a single parent company to control a large number of subsidiaries This study considers the effect of parent companies on their affiliated companies in the field of capital structure and firm performance Finally, this study will show solutions or choices to adjust adequately firm capital structure which may help business overcome economic crisis with high inflation rate as present and have good firm performance

 Determine the effect of parent companies‟ capital structure and firm performance on their affiliated companies‟ capital structure and firm performance

Research Questions:

 Which theories may be best explained capital structure of the listed firms in HOSE?

 What are the factors affecting the capital structure of the listed firms in HOSE?

 Has the relationship between the parent companies and their affiliated companies effected on capital structure and firm performance?

1.3 Data and methodology

The purpose of this research is listed firms on Ho Chi Minh Stock Exchange (HOSE)

in the period from 2008 to 2012 Sample size of this research is top 200 largest firms listed on HOSE

Quantitative research based on ordinary least square regression model to estimate the relationship between firm performance, size, tangible asset, growth opportunity, inflation rate, asset specificity and firm capital structure, as well as the relationship between parent companies and their affiliated companies This model was used in the studies of Rajan and Zingales (1995), Kuznetsov and Muravyev (2001) Tian & Zeitun (2007)

The author uses data analysis tools to implement the research such as descriptive statistics, multiple regression models with Eviews 6 for Windows

1.4 Limitation

This study has still existed some limitation for future research First of all, due to limit

of time, the data was mainly collected from the website that may cause some inaccurate in uploading data Therefore, it is necessary to collect data from the audited hard copy financial statement and balance sheet of the firms In the second, this study only chooses 200 listed firms on Ho Chi Minh Stock Exchange Thus, the results of this study has not convinced yet There should have the combination of all listed firms

on Ho Chi Minh Stock Exchange and Hanoi Stock Exchange In the third, few measures of capital structure and firm performance have not been used such as debt to market value (D/MV), price per share to earnings per share (PE), and market value of equity and book value of liabilities divided by book value of equity (MBVE)

1.5 Structure of the study

The structure of the study is divided into five chapters:

Chapter 1: Introduction

This chapter presents the background of the study, as well as, research objectives, research questions, research methodology and limitation of this study

Chapter 2: Literature Review

In this chapter, there has summarized some modern theories about capital structure, shown previous studies about capital structure and firm performance, mentioned the essential determinants of capital structure, and made the hypothesis for this empirical study

Chapter 3: Data and Methodology

This chapter particularly presents about data and the methodology of this study

Chapter 4: Empirical Results of the Research

Chapter 4 includes three parts In the first part, there has used descriptive statistics to explore the features of explanatory variables, as well as the relationship between each variable In the second part, there examines the possible degree of collinearity among variables In the final part, the regression analysis is used to explore the relationship between the capital structure and firm performance of listed companies on Ho Chi Minh Stock Exchange

Chapter 5: Conclusions

Chapter 5 presents main conclusions based on the results of the previous chapters

Chapter Two - Literature Review

Chapter 2 summaries the modern theories and mentions to the fundamental ideas on capital structure, as well as firm performance This chapter also presents hypothesis of the study

2.1 Theories on capital structure

2.1.1 The Miller and Modigliani Theory

Modigliani and Miller challenge the traditional view as to the effect of leverage on the cost of capital They develop a behavioral justification support for the net operating income approach Without taxes, the cost of capital and market value of the firm remain constant throughout all degrees of leverage (Modigliani and Miller, 1958).The Modigliani and Miller (MM) theory proves that under a very restrictive set of conditions, a firms value is unaffected by its capital structure which implies that the financing choice of firms is irrelevant Modigliani and Miller come to this conclusion

under the following assumptions:

 Firms with the same degree of business risk are in a homogenous risk class

 Investors have homogenous expectations about earnings and risks

 There is an existence of perfect capital markets

 Interest rate on debt is the risk-free rate

 All cash flows are perpetuities

The MM theorem further states that the expected return on equity is positively related

to leverage because the risk of equity increases with leverage

However, Miller and Modigliani (1963) correct their earlier proposition on capital structure with the inclusion of corporate taxes The theory proposes that the value of the firm is equal to the value of the firm‟s cash flow with no debt tax shield (value of

an all equity firm) plus the present value of tax shield in the case of perpetual cash flows

The MM model with the corporate taxes was extended by Miller to include personal taxes (Miller, 1977) Miller introduced a model where leverage affects the firm value when both corporate and personal taxes are taken into account

According to this theory, financial distress is generated by the presence of debt in the capital structure which could lead to bankruptcy It states that the larger the fixed interest charges created by the use of leverage, the greater the probability of decline in earnings and greater the probability of incurrence of costs of financial distress (Harris and Raviv, 1991; Riahi-Belkaoni, 1999) Costs of financial distress include the legal and administrative costs of bankruptcy as well as the subtler agency, moral hazard, monitoring and contracting costs which could erode firm value even if formal default

is avoided (Myers, 1984)

2.1.2 Static Tradeoff Theory

An important motive of trade-off theory of capital structure is to explain the way in which firms can typically be financed partly with debt and partly with equity Trade-off theory states that there are benefits of financing with debt i.e tax shield benefit, agency benefit and there are also costs of funding with debt e.g costs of financial distress, agency costs Therefore the firm that is maximizing its value will focus on offsetting costs against benefits of debt when making decision about how much debt and equity to use for financing its business Ross et al (2008) argue that firm can optimize its value at a point where marginal costs of debt and marginal benefits of debt are balanced

According to Myers (1984), each firm that follows trade-off theory has target debt and

it gradually moves toward its target debt Target leverage is determined by balancing

the cost and benefits of leverage but structure of target leverage is not clear (Frank & Goyal, 2009) argue that this target debt can be classified into two ways First the target debt may be static which might be identified by single period trade-off between costs and benefits of debt and is called static trade-off theory Second the target debt may be adjusting over time with change in magnitude of costs or benefits of debt While examining the US firms, Huang and Ritter, (2009) say that US firms moving toward their target leverage with moderate speed US firms take 3.7 years average period to achieve their targeted capital structure in the condition of any deviation from the target debt The UK firms adjust to their target debt ratio relatively quickly Leary and Robert (2005) showed the behavior of US firms, in time of market friction, adjusting their leverage as if they follow dynamic trade-off policy Consistent with trade-off model, Cook and Tang, (2010) argue that firms moving faster toward target debt rate in the country where economic condition are good as compared to country where economic conditions are bad Graham and Harvey (2001) indicate that about 80 percent of chief financial officers confirms having target leverage Antoniou et al (2008), report that firms have target leverage ratio Firms that are experiencing higher market to book value ratio, tend to have low target debt ratio (Hovakimian et al 2004)

2.1.3 Agency Cost Theory

In the modern corporations, there has always a separation of ownership and control where most firms are managed by managers who act as agents of shareholders These managers do not necessarily own shares in the firm and as such this relationship is fraught with agency problems The shareholders and managers, consciously or unconsciously, serve their own interests While shareholders would want to see the maximization of firm value, the management wants to maximize their own selfish interests Examples of such interests may be to invest in certain projects which yield

the best result on net profits in the short-term in order to inflate their bonuses Also they may be inclined to misuse company funds by incurring huge on the job expenses (Gwatidzo, 2008:86)

The investors of a firm are aware of the managers‟ opportunistic behavior and thus take it into account when valuing the firm‟s shares They will offer a lower price than when there is no opportunistic behavior According to the agency theory, the observed capital structure of a firm should thus aim to minimize the potential for opportunistic behavior in the firm The extent of opportunistic behavior depends on the environment in which the firm is operating For example, an efficient legal system that protects investors‟ rights curbs opportunistic behavior by management In most developing economies the legal system is not efficient; therefore there are high chances for opportunistic behavior by management Some of the ways of mitigating the conflict between management and investors (Gwatidzo, 2008:90) are:

Issuing debt - Issuing debt rather than equity forces management to contractually commit themselves to a given level of payment to investors (lenders), thus reducing opportunistic behavior;

Issuing short-term debt – Issuing short-term debt forces management to the negotiation table periodically, thus making the issuance and payment of debt more like a repeated game in which the management is punished by the creditors if they are seen to be behaving in any way detrimental to the creditors;

In addition to the above, the conflict of interest between equity holders and debt holders can be mitigated by designing debt covenants that protect the interests of debt holders;

In the event that long-term debt is issued, it may be secured with specific assets;

Another way is to just increase debt levels in industries where the potential for

opportunistic behavior is high

2.1.4 Pecking Order Theory

The foremost prediction of the model is that firms will not have a target optimal capital structure, but will instead follow a pecking order of incremental financing choices that places internally generated funds at the top of the order, followed by debt issues, and finally only when the firm reached its “debt capacity” new equity financing Myers and Majluf (1984) noted that this theory is based upon costs derived from asymmetric information between managers and the market and the idea that trade-off theory costs and benefits to debt financing are of issuing new securities The asymmetric information means that the firm managers (insiders) have more information about their firm compared to the outside investors The well informed managers try to send positive information to the market or ill informed investors to increase the firm value.The cost of equity includes the cost of new issue of shares and the cost of retained earnings The cost of debt is cheaper than the cost of both these sources of equity funds Considering the cost of new issue and retained earnings, the latter is cheaper because personal taxes have to be paid by shareholders on distributed earnings while no taxes are paid on retained earnings as also there is no floatation costs incurred when the earnings are retained As a result, between the two sources of equity funds, retained earnings are preferred It has been found in practice that firms prefer internal financing If the internal funds are not sufficient to meet the investment outlays, firms go for external finance, issuing the safest security first They start with debt, then possible hybrid securities such as convertible debentures, then perhaps equity as a last resort

2.2 Previous studies on capital structure and firm performance

2.2.1 Internationally empirical findings

The literature on the relationship between firm performance and capital structure has

produced mixed results Gleason et al (2000) also found a negative and significant

relation of leverage level with firm performance measured by the ROA (return on assets) and profit margin in the European countries Deesomsak (2004) in his study on the Malaysian firms found a negative relation of leverage level with firm performance measure by the gross profit margin Malaysian firms use internally generated source

of funds when profits are high supporting the pecking order theory Further, the relation between the leverage and firm performance in Singapore, Taiwan and Australian firms was negative but insignificant The effect of firm size on leverage was positive and significant for all the countries except Singapore with an insignificant relationship because firms in Singapore have government support and are less exposed to financial distress costs Huang and Song (2006) said that although Chinese market for equity financing are in development phase and firms should have been dependent on the debt capital from banks But most of the Chinese companies are state controlled and prefer equity financing over debt financing because they still hold the controlling interest and weak laws exist to protect the rights of shareholders

A negative relation exists between leverage measured by long term debt and total debt and profitability measured by the return on assets Further, larger companies employ more debt and increase in firm size lead to increase in leverage Majumdar and Chhibber (1997) and Ghosh (2007) reached that level debt (capital structure) associated inversely with firms‟ performance The result refers to the creditors who are using loans as disciplinary tool on the firm This tool bases on the restrictions that impose by creditors on the firm as prevention the firm from distribute the earnings on

the shareholders or impose restrictive conditions on the loans by increasing the interest rates or impose sufficient collaterals on loans Thus, these restrictions will lead firm to focus on how pay the debt burden without concerning in achieving earnings and reflect adversely on firm performance Abor (2007) evaluated the relation of capital structure with performance of the firm in small and medium size firms (SMEs) of South Africa and Ghana He found a significantly negative relation between financial leverage measured by ratio of short term debt, long term debt (significant but positive), total debt to total assets and firm performance measured by gross profit margin for both South Africa and Ghana Further a negative relation existed among the measures of capital structure and firms performance measured by return on assets in Ghanaian firms Zeitun and Tian (2007) investigated the effect which capital structure has had on corporate performance using a panel data sample representing of 167 Jordanian companies during 1989-2003 Their results showed that a firm‟s capital structure had a significantly negative impact on the firm‟s performance measures, in both the accounting and market‟s measures They also found that the short-term debt to total assets (STDTA) level has a significantly positive effect on the market performance measure (Tobin‟s Q) Arbiyan and Safari (2009) investigate the effects of capital structure on profitability using 100 Iranian listed firms from 2001 to 2007 They found short-term and total debts are positively related to profitability (ROE) which indicate a negative relation between long-term debts and ROE

2.2.2 Empirical findings from Vietnamese perspective

In 2008, Tran Hung Son and Tran Viet Hoang tested the relationship between capital structure and firm performance by using data sample of 50 non-financial companies in Hochiminh Stock Exchange for the period September 2008 The results show that

there is a positive correlation between a firm capital structure and performance, which

is measured by average of return on assets and return on equity

Dzung et al (2012) used a panel GMM (generalized method of moments) system estimator to analyze the determinants of the capital structure of 116 non-financial listed firms on either the Ho Chi Minh Stock Exchange or the Hanoi Stock Exchange for the period 2007-2010 The results indicate that profitability negatively affect leverage

The following table is to summarize the above studies related to the relationship between capital structure and firm performance

Table 1: Summary the findings of the previous studies

Huang and Song

(2006) Chinese companies

A negative relationship exists between leverage (measured by LTD and TD) and profitability (measured by ROA)

Abor (2007) SMEs of Ghanaian

firms

A negative relationship exists between capital structure and firm performance (measured by ROA)

Zeitun and Tian

(2007)

167 Jordanian companies during 1989-

2003

Capital structure has a negative impact on all firm performance measures (the accounting and market measures)

Shah and Khan

(2007)

Pakistani firms listed

on three Stock Exchanges

A negative relationship between leverage and performance

Son and Hoang

(2008)

50 non-financial companies in HOSE for September 2008

There is a positive correlation between firm capital structure and performance, which is measured by average of ROA and ROE

(2012)

116 non-financial listed firms for the period 2007-2010

Profitability negatively impacts on leverage

2.3 Determinants of Capital Structure and Their Hypothesis

2.3.1 Dependent Variables

Leverage refers to the use of a relatively small investment or a small amount of debt

to achieve greater profits That is, leverage is the use of assets and liabilities to boost profits while balancing the risks involved There are two types of leverage, operating and financial Operating leverage refers to the use of fixed costs in a company's earnings stream to magnify operating profits Financial leverage, on the other hand, results from the use of debt and preferred stock to increase stockholder earnings Although both types of leverage involve a certain amount of risk, they can bring about significant benefits with little investment when successfully implemented

Leverage ratio is taken as dependent variable while searching for the determinant of the capital structure Total debt to total assets (TDTA), total debt to total equity (TDTE), long-term debt to total assets (LTDTA), short-term debt to total assets (STDTA) are proxies for firm leverage These proxies could be easily collected from the balance sheet These measures were used by Zeitun and Tian (2007)

2.3.2 Independent Variables

2.3.2.1 Profitability

Profitability can be main independent variable that determines capital structure and represent pecking order and trade-off theories quite clearly, which is also the most important indicator to measure the performance of firms There are conflicting theoretical predictions on the effects of profitability on leverage As mentioned in literature review that trade-off theory says firms identify the target debt ratio by comparing benefit from and cost of leverage Any decrease (increase) in cost (benefit) allows the firm to readjust target leverage by enhancing debt Profitable firm are less risky with frequent cash flow from business decreasing the cost of financial distress

such as bankruptcy cost It is unanimously recognized that more profitability in world

of tax with more leverage can save more tax for shareholder showing benefit from leverage More benefit from leverage will disturb cost benefit relationship thus allows the firm to borrow more Frank and Goyal (2009) argue that expected cost of financial distress is low for profitable firms thus finding tax shield more valuable This reflects the positive relationship between leverage and profitability Agency cost perspective also regarded debt as a disciplinary measure and more valuable for firms with high profit producing the more free cash flow (Jensen, 1986) It means trade-off theory suggests positive relationship between profitability and leverage Margaritis and Psillaki (2007) argue that profitability has positive effect on leverage of firm Abor (2005) also evaluated the relationship of the profitability with capital structure for firms listed on the Ghana Stock Exchange He found a positive relation for short term debt to total assets and return on equity because of low interest rates Short term financing represents 85 percent of total debt in Ghanaian firms and is a major component of financing for them

Contrary to trade-off theory, pecking order theory suggests that profitable firm prefer

to use retained earnings to finance their current or potential projects Myers (1984) argues that firms with no profit or insufficient profit prefer to borrow debt and then issue equity securities if requirement for the funds is not fulfilled by debt borrowing

It means pecking order theory predicts negative relationship between profitability and leverage Some empirical evidences also validate negative correlation between profitability and leverage Shah and Khan (2007) on the Pakistani firms listed on three Stock Exchanges found a negative and significant relation among leverage levels and performance Seppa (2008) found that the Estonian firms follow Peking Order hypothesis in deciding about the optimal capital structure Estonian firms first utilize

internal funds to finance opportunities then move towards external source of financing Hence, the hypothesis to be tested is:

Hypothesis 1: There is a negative relationship between firm performance and

capital structure

2.3.2.2 Size

Size can be another important determinant of capital structure Larger firms are more diversified, have less default risk, and lower cost of financial distress Larger firm‟s diversification advantage reduces bankruptcy (Titman & Wessels, 1988) Therefore according to trade-off theory any decrease in cost of leverage allows the firm to increase leverage thus predicts positive relationship between size and leverage because size of firm diminishes the cost of leverage

However, pecking order theory is interpreted as it predicts negative relationship between size and leverage because larger firms are well known and have longer/older history of adding retained earnings in their capital structure (Frank & Goyal, 2009) Therefore firm with more retained earnings additions should have less leverage Margaritis and Psillaki (2007) find non-monotonic relationship between size and leverage They find size is negatively related to low debt ratio and positively related

to mid and high debt ratios Larger firm generates more profit as compared to small firm therefore according to pecking order theory profitable firm prefers internal financing than external one This suggests that size is negatively related with debt The following hypothesis will be tested:

Hypothesis 2: The firm size is expected to have a positive influence on a firm capital structure

2.3.2.3 Tangible Asset

A firm with more physical asset can borrow at cheaper cost of debt capital as compare

to company with less physical assets The tangibility of assets offers the bargaining power to company Jensen and Meckling (1976) point out that agency cost between the creditors and shareholders exists because firm may invest in riskier projects after borrowing and may transfer the wealth from creditors to shareholder Companies having more fixed asset can borrow more by pledging their fixed asset as collateral and mitigating lenders‟ risk of bearing such agency cost of debt (Ross et al 2008) Therefore firm with low agency cost can increase the debt it means trade-off theory predicts positive relationship between tangibility of assets and debt Margaritis and Psillaki (2007) argue that tangibility of firm is positively related to leverage Studies conducted by Jong, et al (2008) and Huang & Song (2006) also suggest the positive correlation between fixed asset and leverage Frank and Goyal (2009) found positive relationship between tangibility and leverage level Therefore, the hypothesis to be tested here is:

Hypothesis 3: There is a positive relationship between tangibility and capital

structure

2.3.2.4 Growth opportunities

Growth can be a good independent variable and derived from pecking order theory and trade-off theory There are conflicting views found in theories of corporate capital structure regarding the relationship between growth and leverage of the firm According to pecking order theory the company first finances its projects by internal financing (Ross, et al 2008) that may not sufficient in the condition of growth So the company should increase its leverage during growth period It means pecking order theory indicates the positive relationship between growth and leverage Tong and

Green (2005) find significant positive relationship between growth and leverage Nguyen and Ramachandran (2006) explore the capital structure of 558 Small and Medium sized Enterprises (SMEs) for the period 1998-2001 They find that firm growth is positively associated with short-term debt as high growth firms have high demand for working capital On the other side growth is increasing cost and probability of financial distress when the company borrowing more debt to support growth opportunities And increasing cost of financial distress may restrict firm from borrowing more; it means trade-off theory suggests negative relationship between growth and leverage of firms Jong et al (2008) and Huang and Song, (2006) showed out the negative relationship between the growth opportunities and leverage of the firm The following hypothesis will be tested:

Hypothesis 4: There is a negative relationship between growth and capital structure

(2009) found that when firm expected that the inflation rate would be higher in future

or realizing the current rate of inflation was low, the companies was issuing debt securities Hatzinikolaou et al (2002) argued that inflation uncertainty put forth a strong negative effect on capital structure of the firm

We can derive inflation as variable from trade-off theories of capital structure Inflation is macroeconomic variable that has impact on price of debt and equity Whenever the inflation is increasing the creditors demand more interest rate on the funds, they have furnished to organization in order to balance the opposite effect of inflation that diminishes purchasing power of currency of particular country It means there is positive relationship between the inflation and cost of debt Issuing debt at higher cost may increase the costs of financial distress Therefore trade-off theory suggests the negative relationship between inflation rate and leverage Hence, the hypothesis to be tested here is:

Hypothesis 5: There is a negative relationship between inflation and capital

structure

2.3.2.6 Asset Specificity

The more specific the asset, the lower will be its liquidation value In this context, debt acts as a straitjacket for investment opportunities Lenders will not lend to very specific projects since, in the event of failure (liquidation), the amount realized will be very low Thus, leverage should decrease as the degree of asset specificity rises

Balakrishnan and Fox (1993) argue that asset specificity creates problems for debt financing due to the non-redeploy ability characteristics of specific assets More specifically, asset specificity adversely affects a firm‟s ability to borrow Balakrishnan and Fox (1993) suggest that examples of firm-specific assets are intangible assets such as brand names, research and development expenditure and other reputational

investments The intangible asset variable may also capture a firm‟s discretionary investment opportunities Myers (1977) argues that agency costs associated with intangibles assets are higher than those associated with tangible assets did The extent that intangible asset picks up this effect; it will be negatively related to the D/E ratio Hence, the hypothesis to be tested here is:

Hypothesis 6: There is a negative relationship between asset specificity and capital structure

2.3.2.7 Parent Companies and Their Affiliated Companies

Parent company is a company which controls other companies by owning an influential amount of voting stock or control Parent companies will typically be larger firms that exhibit control over one or more small subsidiaries in either the same industry or other industries Parent companies can be either hands-on or hands-off with subsidiaries, depending on the amount of managerial control given to subsidiary managers Affiliated companies are companies that is owned and controlled by the same parent company Parent company only possesses a minority stake in the ownership of affiliated companies

A research King and Santor (2008) had been done to examine the linkage between family ownership, firm performance and capital structure on Canadian firms Based

on Tobin‟s ratios, the result shows that self- supporting family who owned firms with

a single share class has similar market performance compared to other firms Comparatively, family owned firms with dual- class shares have similar ROA and financial leverage According to this research, there expects that parent company and its affiliated companies have also same leverage and firm performance Hence, the hypothesis to be tested here is:

Hypothesis 7a: There is a positive relationship between the leverages of parent company and its affiliated company

Hypothesis 7b: There is a positive relationship between the firm performance of parent company and its affiliated company

Table 2: Summary of the implications of theories and all hypotheses of the study

Potential determinants Expected sign by theories

Growth

˗ (trade off) + ( pecking order) Inflation Rate ˗ (trade off)

Asset Specificity ˗ (trade off)

Chapter Three – Data and Methodology 3.1 Data collection

Vietnam is a developing country and has a very thin capital market This study includes 200 listed firms on the Ho Chi Minh Stock Exchange during the period from

2008 to 2012 The data for the research is taken from secondary source from “Balance Sheet Analysis of Joint Stock Companies listed on the HOSE” on the websites

http://www.cophieu68.vn, http://finance.tvsi.com.vn, and http://vietstock.vn/ Besides, some information and data for inflation rate is provided by

http://data.worldbank.org/indicator

3.2 Data Analysis Method

Data was analyzed using quantitative approach In the quantitative approach, descriptive statistics was used to compare variables numerically and to ascertain a pattern in the data set According to Saunder et al (2007), every statistics to describe a data is usually summarizes the information in the data by disclosing the average indicators of the variables used in the study

For the quantitative analysis, following (Booth et al 2001), (Shah and Khan, 2007) and (Shah and Hijazi, 2004) this study is using the panel data Panel data takes into consideration both time series features and cross section features This means panel data considers multiple variables for multiple periods of times to draw the true picture

of relationship between variables Panel data has many advantages over time series and cross sectional sets of data It provides large number observations; enhances the level of freedom and decreases level of co-linearity among independent variables This study has used the fixed effect model put forth by panel data analysis in order to capture the individual firm effect on leverage To control for omitted variables that are different among firms but are constant over time this study take into consideration the

individuality of each firm belonging to an industry thus the intercept for each firm will be different as mention by with in formula given below:

LEVit = β0 i + β Xit + uit

Where,

LEVit = the measure of leverage of firm at time

β0 i = the intercept of equation for firm

β = Coefficient for Xit

Xit = independent variables for leverage

u=error term

i = number of firms i.e = 1, 2, 3……N

t1 = the time period i.e = 1, 2, 3…… T

The specification of formula to analyze the panel data in this study is as following (Tong & Green, 2005) and (Frank & Goyal, 2009) respectively

LEVit = β0 i + β1PROF it + β2SIZE it + β3TANG it + β4GROW it + β5INFit

+ β6INTA it + uit

Where,

LEV1it = leverage (measured by STDTA, LTDTA, TDTA, TDTE)

PROF it = profitability (measured by ROA, ROE, or TOBINQ)

SIZE it = firm size

1 Panel data is also called time series cross sectional data therefore in these models “t” is used only for showing that data is used for multiple periods of time but we did not run the “t” in models

TANG it = tangible asset

GROW it = growth opportunity

INF it = inflation rate

INTA it = asset specificity

uit = error term of a firm at time

Table 3: Description of Variables

Total Debt / Total Assets, Total Debt / Total Equity, Long-term Debt / Total Assets, Short-term Debt / Total Assets

TD/TA, TD/TE, LTD/TA, STD/TA, TD/MVTA, LTD/MVTA

(Booth et al, 2001), (Shah & Hijazi, 2004), (Shah & Khan, 2007), (Jong, et al 2008), and (Frank & Goyal, 2009)

Assets Net Income / Total Assets

Net Income / Total Assets (Tong & Green, 2005), (Huang

& Song, 2006), (Margaritis & Psillaki, 2007), and (Frank & Goyal, 2009)

TOBINQ Tobin‟s Q Market Capitalization / Total

SIZE Size Natural logarithm of total

assets

Natural logarithm of total assets (Zeitun & Tian, 2007), (Abdul 2012), (Zuraiah, et al 2012),

al, 2008)

GROW Growth Change in the total assets

(BVTAt – BVTAt-1) / BVTAt-1 (Shah & Hijazi, 2004), (Shah & Khan, 2007), and (Eldomiaty & Ismail, 2009)

INF Inflation

Rate Consumer price index

Consumer price index (Huang & Ritter, 2009), and (Frank & Goyal, 2009)

Note: Total Debt = TD, Total Assets = TA, Total Equity = TE, LTD = Long-term Debt, STD =

Short-term Debt, TDTA = Total Debt to Total Assets, TDTE = Total Debt to Total Equity, LTDTA = term Debt to Total Assets, STDTA = Short-term Debt to Total Assets, TD/MVTA = Total Debt to Market Value of Total Assets, LTD/MVTA = Long-term Debt to Market Value of Total Assets, BVTA t = Book Value of Total Assets at time t, BVTA t-1 = Book Value of Total Assets at time t-1

Long-Chapter Four - Empirical Result

This chapter examines the data analysis and interpretation of results First of all, the descriptive analysis results for the dependent variables and explanatory variables reveal various issues that are fully expatiated under Table 4 The correlation matrix for the variables is reported in table 5 It examines the correlation that exists among variables The regression results for the panel data for each of leverage measures and for the full sample of observations for the period 2008 to 2012 are displayed in Table

6 to Table 8 and fully discussed so that meaningful conclusions are drawn The analyses are used to test the above formulated hypotheses to establish the relationship which exists among the variables expressed

4.1 Descriptive Statistics

Table 4 presents the descriptive statistics of the dependent variables and independent variables for the whole sample firms of the study, as well as the relationship between each variable

Table 4: Descriptive statistics of Variables

Note: Long-term Debt to Total Assets (LTDTA = Long-term Debt / Total Assets), Short-term Debt to Total Assets (STDTA = Short-term Debt / Total Assets), Total Debt to

Total Assets (TDTA = Total Debt / Total Assets), Total Debt to Total Equity (TDTE = Total Debt / Total Equity), Return on Assets (ROA = Net Income / Total Assets), Return

on Equity (ROE = Net Income / Shareholder’s equity), Tobin’s Q (TOBINQ = (Market Capitalization) / Total Assets), Firm Size (SIZE = Natural Logarithm of Total Asset), Tangible Assets (TANG = Net Fixed Assets / Total Assets), Growth opportunity (GROW = Change in the total assets), Inflation Rate (INF = Consumer Price Index), Asset Specificity (INTA = Total Intangibles / Total Assets).

The results in the Table 4 show a summary of the descriptive statistics for all the variables including the dependent variables and independent variables Dependent variables are LTDTA, STDTA, TDTA and TDTE while independent variables are ROA, ROE, TOBINQ, SIZE, TANG, GROW, INF and INTA The above table shows that all of the variables have a positive mean Moreover, mean statistics provide some interesting evidence It is also observed that all values for variables are positively skewed except the value for TDTA All of the kurtosis value is also positive First of all, the mean (median) of the short term debts is 36.28 (33) % of the total assets The mean STDTA of Vietnamese companies is lower than the mean STDTA ratio of Chinese companies (43.21%) (Wei Xu, et al, 2005) Examining the second measure of leverage that is long term debt to total assets (LTDTA), the reported mean value is 11.71% for Vietnamese firms This ratio is higher than the mean LTDTA ratio of Chinese companies (6.62%) (Wei Xu, et al, 2005) However, in order to compare to the G7 countries data in Rajan and Zingales (1995), ratio of Vietnamese companies LTDTA was relatively low (i.e., 11.71% versus 33% (United States); 25% (Japan and France); 42% (Germany); 24% (Italy); 18% (United Kingdom); 37.2% (Canada)) Based on the low mean value of the long term debt to assets (11.71%), it can be stated that listed companies in Vietnam do not use much long-term debt in their respective capital structure choice This supports earlier studies that have been conducted on Vietnamese firms (see Nguyen and Ramachandran, 2006) The result also suggests that large and small firms have particular difficulty in accessing long-term finance with low and declining leverage ratios This could also be attributed to the low return

on assets recorded because long-term finance is needed for capital projects The mean (median) of the total debt is about 48 (51) % of the total assets during the period This result shows that about 48% of the total assets of listed companies in HOSE are