Determinants of corporate investment decisions the case study of vietnam

Abstract The purpose of this study is to examme the impact of cash flow, investment opportunities, and other financial factors on corporate investment decisions using panel data for Viet

VIETNAM- NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

DETERMINANTS OF CORPORATE

INVESTMENT DECISIONS:

THE CASE STUDY OF VIETNAM

A thesis submitted in partial fulfilment of the requirements for the degree of

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

PHAN THI ANH DONG

Academic Supervisor:

PHAN DINH NGUYEN

HO CHI MINH CITY, May 2012

I would like to express my deepest gratitude to all people and organizations that supported, provided assistance and information in order to make this thesis Furthermore, I deeply appreciate the lecturers and staff of the project, who helped improve my knowledge and fulfill the program I am also grateful to my close friends for their warm encouragement

Finally, I further wish to thank my family members who have greatly supported me during my study Their love and support mean a great deal to me I would like to reserve the pleasure of the graduate for them Thank you very much to all of you!

Table of Contents

Certification i

Acknowledgements ii

Table of Contents : iii

List of Tables v

' List of Abbreviations vi

Abstract vii

CHAPTER 1: INTRODUCTION 1

1.1 Problem statement 1

1.2 Research Objectives 4

1.3 Research questions 4

1.4 Scope and Methodology of Research 5

1.5 Research structure 5

CHAPTER 2: LITERATURE REVIEW 6

2.1 Theoretical literature 6

2.1.1 Irving Fisher's Theory oflnvestment 6

2.1.2 J.M Keynes theory: Marginal Efficiency oflnvestment 8

2.1.3 Jorgenson's Optimal Theory 10

2.1.4 James Tobin's q theory oflnvestment 12

2.2 Empirical literature · ···· ··· 13

CHAPTER 3: RESEARCH METHODOLOGY 21

3.1 Data sources 21

3.2 Variables 21

3.2.1 Dependent variable 22

3.2.2 Independent variables 22

3.3 Modeling specification 28

3.4 Methods of estimation 29

3.5 Conclusion 32

CHAPTER 4: EMPIRICAL RESULTS AND DISCUSSION 33

4.1 Descriptive Statistics of dependent and independent variables 33

4.2 Correlation analysis 34

4.3 Empirical Results 36

4.3.1 Examining the determinants of corporate investment decisions using FEM estimators 3 7 4.3.2 Examining the determinants of corporate investment decisions using GMM estimator 42

CHAPTER 5: CONCLUSION, RECOMMENDATION AND LIMITATION 47

5.1 Conclusion 47

5.2 Policy Recommendation 50

5.3 Limitation ·51

References 52

Appendix 58

List of Tables

Table 2.1: Empirical Studies about Determinants of Corporate Investment Decisions 59

Table 3.1: A Set of Dependent and Independent Variables 23

Table 4.1: Basic Statistics of the Key Variables 34

Table 4.2: Correlation Coefficients ofthe Explanatory Variables 35

Table 4.3: Regression Analysis oflnvestment Equations 36

Table 4.4: GMM Estimator oflnvestment Equation 42

List of Abbreviations

FEM Fixed Effects Model

GMM Generalized Method of Moment

HET Heteroskedasticity

M&M Modigliani and Miller

MEl Marginal Efficiency of Investment Pooled OLS Pooled Ordinary Least Square

VAR Vector Auto Regressive

WTO World Trade Organization

Abstract

The purpose of this study is to examme the impact of cash flow, investment opportunities, and other financial factors on corporate investment decisions using panel data for Vietnamese listed firm from 2006-2010 This research adopts static model employing Fixed Effects which the most appropriate model in analyzing panel data through specification tests The findings indicate that cash flow is a key determinant of corporate investment decisions However, investment opportunities are positive and insignificant related to investment decisions Other financial factors such as fixed capital intensity, business risk, firm size, leverage are all significant in predicting corporate investment decision Moreover, the study also adopts dynamic model utilizing Generalized Method of Moments The results confirm that cash flow is a main element in making corporate investment decisions Nevertheless, investment opportunities are not significant in determining enterprises investment decisions Besides, the lagged level of investment is negative and statistically significant correlated with investment decisions at firm level Other financial factors, namely fixed capital intensity, sales growth, firm size and leverage are all significant in influencing corporate investment decisions

Keywords: Corporate Investment, Cash Flow, Tobin's q, Financial Constraint

CHAPTER 1: INTRODUCTION 1.1 Problem statement

The goal of any enterprises when operating as a business is oriented towards maximizing the value of the firm, which in tum increases the return of investment for shareholders In order to achieve this goal, companies must implement a variety of measures, including the selection of an appropriate financial structure This is the most important finance function amongst the modem items It implicates decisions to commit sources of financing to total assets of the firms Capital expenditure or investment decision has significant importance to the firm because of the following reasons:

(1) it impacts not only growth of firms in long run but also influences firm's risks;

(2) it involves liability of a large amount of capital;

(3) it is unalterable, or alterable at heavy financial loss; and

(4) it is one of the most difficult decisions to be taken by the firm

Because of its role in the firm value, many researchers have studied this issue For instance, Modigliani and Miller theorem (1958) documented that there has been no relation between the financial structure and financial policy for real investment decisions under certain conditions, because the financial structure would not influence the investment costs According to the q-theory of Tobin (1969) and extended into a proposed model by Hayashi (1982), investment demand could be predicted by the ratio

of the market value of the firm's capital stock to its replacement cost under perfect market assumptions; and its market value could also explain further investment opportunities

Nonetheless, the results of previous studies in different countries using the q-theory of investment are mixed In particular, Hall et al (1998) studied the key factors which affect investment in scientific firms for the United States, France and Japan during the period 1979-1989, and found that the profit, sales, cash flow and investment have connections, but differs for each country Aquino (2000) found contrary results that there was no significant relationship between investment rate and q He also showed that there is an insignificant relationship between the investment rate and cash flow The Vietnamese government has implemented a series of policies aimed at improving the business environment for enterprises in the country This comes in the wake of Vietnam's joining of the WTO in 2007, and since then, a variety of companies have invested in multi-sectors businesses and spread-out, in order to become conglomerates This has conversely created a trend These businesses have been investing in several projects which do not relate directly to their strong main sectors such as real estate and stocks, while the management capacity and inexperience of enterprises, the government's institutions, and infrastructure have not developed as fast as the multi-sector and spreading investments

Instead of investing directly in foundational material such as machinery, construction and renovation of factories, research and development (R&D), and improving human resource managem~nt so as to develop their businesses, they have chased the trend of the multi-sector and spread investment so that they can obtain benefits immediately As

a consequence, the efficiency in investment of corporate businesses lowers, and may even be at the level of a loss Because of this, it can cause stagnant equity, and influence the financial situation of the firms This could ultimately lead to bankruptcy;

as in the cases ofVINASHIN1 and EVN2•

1 VINASHIN is a Vietnam Shipbuilding Industry Group This Group involved in many projects in several different fields of economics beside its main business - shipbuilding; for instance, sea transport, ports, steels,

- - -

-Apart from this, it is not easy for enterprises to access sources of capital when real lending interest rate is so high in recent time (normally, the real lending rate is 18% -20% per year; some cases is 23% per year) The reasons are by economic trends at the domestic, regional and global level This can thus affect the firms' investment decisions and processes of production with their business operations In other words, investment issues affect not only the survival of the businesses, but also the levels of unemployment and economic development of a country

Although there are several papers that have studied on the determinants of investment decisions at the firm level, these however are mainly focused on developed economies and some emerging countries (e.g., the United States, the United Kingdom, Canada, India, China, and Korea) To the best of my knowledge, only a group of researchers have attempted to address this issue as it relates to the scenario in Vietnam, while investment decision of the firms as become a big issue in recent years Concretely, Ninh L.K et al (2007) analyzed some factors involved with the impact on investment decisions of private enterprises in the Mekong River Delta Nonetheless, this research did not determine other variables, namely investment opportunities, region, or business risk, which might have an influence on investment decisions at the firm level This thesis, therefore, proposes to investigate this situation as it relates to a larger scale

cements, beers, air services, insurance, banking, import (cars and motorbikes) and agricultures_ Because of sector and spread investment, VINASHIN has been facing to financial problems in heavily (more than VND 80,000 billions or over USD 4 billions of debt) and facing lawsuits to be raised by foreign creditors (e.g., Elliott Yin, Netherlands)

multi-2

EVN is a Vietnam Electricity Group This group invests not only in electricity- main sector, but also spreads in hospitality, tourisms, media, real estate, etc As a result, the group has been facing a large losses in recent years (in 2010, the loss is VND 8,400 billions or over USD 400 millions) and facing large debts (as of June.30, 2011, EVN has remained in debt to PetroVietnam about VND 8,860 billions or over USD 440 millions, and Vietnam National Coal, Mineral Industries Corporation about VND 1,200 billions or over USD 50 millions)

1.2 Research Objectives

With investment situation of enterprises in Vietnam and the continuing importance of

c~rporate investment decisions in mind, the overall goal of this thesis is to examine factors which affect investment decisions at the firm level in Vietnam

To achieve this overall goal requires meeting the following specific objectives:

(1) To determine whether cash flow affects corporate investment decisions;

(2) To determine whether investment opportunities exerts influence on investment decisions of the firms;

(3) To test whether other financial factors impact on investment decisions at the micro level such as leverage, sales growth, business risk, fixed capital intensity, etc;

(4) To suggest policy recommendations for the enterprises in making decisions

1.3 Research questions

Specifically, the research aims to address the following questions:

(1) Does cash-flow affect the investment decisions ofVietnamese firms?

(2) Do investment opportunities influence corporate investment decisions in Vietnam?

(3) Can corporate investment decisions be explained by other financial factors in Vietnam?

- - - - - - - - -

-1.4 Scope and Methodology of Research

The thesis will study this issue via 500 firms listed on the stock market in Vietnam during the period of 2006 - 2010 Both static and dynamic approaches are utilized to estimate the deterininants of corporate investment decisions through STATA 11 software Specifically, the static econometric model specifications consist of Pooled Ordinary Least Square (Pooled OLS), Random Effects Model (REM), and Fixed Effects Model (FEM) to find the most appropriate model; whilst Generalized Method

of Moment (GMM) is employed in the dynamic econometric model

1.5 Research structure

The thesis is organized in five chapters, including this introduction Chapter 2 reviews theories of investment and empirical studies of investment decision at the micro level Chapter 3 describes data collection and methodology in which the model for estimation and method of estimation are outlined Chapter 4 presents the results from analyzing data and discussion Chapter 5 briefly draws the conclusion, recommendations and limitations of the thesis

CHAPTER2: LITERATURE REVIEW

In this chapter, section 2.1 reviews key theories that are relevant for understanding investment at the firm level Following this, empirical researches will be also showed

in section 2.2 with the different contexts of the world in general, and of Vietnam in specific focus

2.1 Theoretical literature

The research introduces theories of investment in the time sequence, and begins with the investment theory of Fisher ( 1930) in section 2.1.1 He concluded that investment and interest rate have a negative relationship Next, Keynesian theoty (1936) with

General Theory is discussed in section 2.1.2 He also had critiques on Fisher's works but still having the same concept of marginal efficiency of investment Finally, neoclassical theories of investment are developed and reformulated by Jorgensen (1963) and James Tobin (1968) in section 2.1.3

2.1.1 Irving Fisher's Theory of Investment

Irving Fisher is the first person who introduced theory of investment in the Rate of Interest in 1907, and further developed in Theory of Interest in 1930 He assumed that

all capital was used up in the process of production, called circulating capital or investment Given that output is related to investment, a production function can be Y

= f(L, I) where Y, L, I denoted by output, labor, and investment respectively Then, he assumed that investment in any time period only produce output in the next period Therefore, returns from investment are defined as 1t = Yt+I- (1 + r)lt where 1t denoted

by profits and r denoted by the rate of interest

The formula of profit maximization of the firms can be written as:

max 1t = f(lt)- (1 + r)lt

- - - -

Hence, the optimal investment decisions will be where/'= (1 + r) or if' - 1) = r Fisher called if ' - 1) as "the rate of return over cosf' where both cost and return are

differences betWeen two optimal income streams Precisely, f (11) is a concave curve,

so, when 11 increases, f' will decrease Because interest rate increases, it leads to a decrease in investment Therefore, there is a negative relationship between investment and interest rate

Although Fisher found that investment is relevant to the rate of interest, his theory still raises problems relating to ownership structure and financial decision If supposing that firms are owned by entrepreneurs, might it not be that corporate investment decisions are influenced by the desired consumption-saving decisions of the owners? Moreover,

is there a relationship between investment decisions and financial decisions? These two questions would be answered by reworking his full theory of investment into a "two-stage" budgeting process; Hirshleifer (1958, 1970) noted these are:

(1) the firm's investment decision is separate from its owner's attitudes towards the investment; and

(2) the investment decision is separate from the financial decision

In addition, Keynes (1936) criticized the term 'interest rate' in Fisher's investment theory as well Keynes acknowledged that "Professor Fisher uses his 'rate of return over cost' in the same sense and for precisely the same purpose as I employ 'the marginal efficiency of capital' " (Keynes, 1936: p.140) Therefore, the optimal

condition for corporate investment decisions is that marginal efficiency of investment equals to the rate of interest

However, Keynes commented on two assumptions of Fisher which are necessary for a determinate theory The first assumption, savings today is consumption for future

Keynes illustrated the first assumption "it does not necessitate a decision to have a dinner or to buy a pair of boots a week or a year hence or to consume any specified thing at any specified date" (Keynes, 1936: p.21 0) The second assumption looks at the effect of interest rate in its regulation of the degree of impatience Set capacities would limit the output, as it compared with one of Fisher's "ineligible" options The bottom line for profit lies in the tally of the complete income derived from the investment, and

ex ante saving with all projects

In brief, the first theory of investment is displayed by Irving Fisher in 1930 He concluded that investment and the rate of interest have a negative connection Nevertheless, Keynes debated the nature and source of interest in Fisher's theory and find another invest111ent theory reviewed in the next section

2.1.2 J.M Keynes theory: Marginal Efficiency of Investment

In General Theory, Keynes (1936) emphasized the central role of investment in the theory of aggregate output and employment His view differed from traditional views

in two fundamental ways First of all, the importance of investment did not result only from its long-run effect on capital stock growth, but also on driving force of aggregate demand and short-run fluctuations in economic activity

Secondly, he rejected the micro-foundations of investment that were based exclusively

on technological conditions of capital productivity by stressing uncertainty, finance, and monetary factors as fundamental determinants of investment This theory provided

a rich source of theoretical and empirical literature, which supported for financial influence on investment through significant effects of liquidity and profits in a variety

of empirical investment functions

In the General Theory, he also put forward the relationship between investment decisions and interest rate in an investment function, namely I= I0 + I(r) He assumed

that firms got series investment projects that depended on their internal rate of return Firms needed to choose one or some of them to undertake Consequently, which projects would be chosen? He concluded that given a rate of interest, firms would choose projects whose the interest rate was below marginal efficiency of investment (MEl) or internal rate of return

In other words, given available projects, firms will invest until their internal rate of return is equal to the interest rate 3 This means that a decrease in interest rates should reduce the investment costs relative to the potential yield Consequently, the marginal capital investment of projects might be worthy Therefore, firms would invest until the discounted yield exceeds the projects' costs; or, the relationship between investment and the interest rate becomes negative

However, there were several critiques on Keynes's theory Firstly, Alchian (1955) and Hirshleifer (1970) ~riticized the view that when it came to interest rates, ranking or

priority projects may not be unaffected Keynesian theory specifically functions consistently when there is the maximization of the standard present value provided that

at least one investment project and one outside option exist In a scenario where multiple investment projects were present, they Keynesian ranking would differ specifically in the value maximization as the interest rates affect the ranking

Secondly, Asimakopulos (1971, 1991) and Garegnani (1978) criticized on the possibility of a downward-sloping MEl function in the presence of unemployment Specifically, the multiplier issue of Keynes refers that output and aggregate demand would increase when investment is performed by the multiplier However, considering

3

J.M Keynes definited the internal rate of return as the marginal efficiency of capital, which Abba Lerner ( 1944, 1953) renamed as the marginal efficiency of investment "I define the marginal efficiency of capital as being equal to the rate of disco~nt which would make the present value of the series of annuities given by the returns expected from the capital asset during its life equal its supply price (or replacement cost)" (Keynes, 1936: p.l35)

the dependency of the MEl function on future returns, could an increased level of income and profit imply that the multiplier would make a prediction of higher returns possible?

If this is in fact the case, then the MEl functions have no other option but to shift outwards to the right It means that an increase in investment leads to another increase

in aggregate demand; and, hence the MEl curve would shift outward once again, increasing investment, and so on As a result, investment is not determinate in circumstances of unemployment in which the multiplier works its marvelous This could be interpreted that if the MEl curve was in fact continuously shifting, then all of the investment projects would be eventually given the capacity to be undertaken, not just the ones whose level of profitability determine their viability The problem of interest rate movement will always affect the level of profit gained by individual projects, as well as total demand for the project across the broad sector of the population

In short, in his theory, Keynes made much of investment decision but was quite about the underlying fixed capital He proposed a negative link between investment and internal rate of return or MEl Alternatively, a firm will invest in a project if MEl is greater than or equal to interest rate Nevertheless, some researchers debated about the assumption of rank in various investment projects depending on their MEl; and, the MEl concept of Keynes and "rate of return over cost" of Fisher is not the same if having an unemployment situation

2.1.3 Jorgenson's Optimal Theory

Based on the neoclassical theory of optimal capital accumulation, Jorgenson (1963,

1967, 1971) developed an alternative investment theory He began with definition of the present value of the firm

Let output at any particular time be related through the production function: Y = f (L,

K)

Then, returns at any particular time are given by:

R(t) =total revenue- total costs= p.Y- w.L - q.l

Where Y, L, and I denoted by levels of output, variable input, and investment in

durable goods and p, w, and q denoted by the corresponding prices

- dH/dK = -pfK + }.() = d)Jdt- rA.; dH/dA =I- <>K

The second condition isJL = w/p From(*) we have q =A., so dq/dt = d)Jdt

Hence, dq/dt -rq = -P/K + q() or p.fk = q[() + r- ( dq/dt)/q]

If we callfK = dY/dK, the marginal product of capital is:fK = q[<> + r- (dq/dt)/q]/p

Then, "real user cost of capital" defined as: c = q[o + r- (dq/dt)/q] So, pfk =cor /K = p/c

Using Cobb-Doughlas function Y = KaL(a-1), we have:fK = a(YIK), then K* =paY/c Generally, K* = f(Y, p, r, q, o, dq/dt) = f(Y, p, c) where K* relies positively on Y and p

I,= A-oM( +A,M;_, + +A nb.l(_n

This pattern has proved controversial in the literature, namely, Lucas (1967), Jame Tobin (1968) It not only leads to auto-correlated errors but also becomes almost indistinguishable the accelerator theory of investment Consequently, Jorgensen's theory of investment, which depends massively on prices as independent variables,

shows that it based on ad hoc stock adjustment mechanism and is incompetent at the

level of practice

In summary, Jorgensen's theory of investment derives the optimal capital stock under constant returns to scale and exogenously given output (Hayashi, 1982) In order to obtain the investment, he subsequently added controversial delivery lags However, this theory still has some problems, i.e., the rate of investment cannot be determined; it

is difficult to verify in practice

2.1.4 James Tobin's q theory of Investment

Tobin's q theory of investment was presented in 1969 This theory resolved the problem of Jorgensen's theory of investment, undetermined investment rate It is a

function of q, whic~ is a ratio of the value of the firm to the replacement cost of the firm's capital stock

Tobin's idea is that if market evaluates a firm which is higher than its physical capital,

it is a signal that the market suggests that this company has the potential for growth

Moreover, Tobin's q theory proposed that when q is more than or equal to 1, a firm

will promote investment for growth Otherwise, when q is less than 1, the firm will disinvest by selling physical capital or reducing the investment lower than depreciation

in order to decrease physical capital automatically

However, Hayashi (1982) noted that with a certain assumption (homogeneity, linear costs), Tobin's q is shadow marginal benefit of capital It means that Tobin's q is more than or equal to 1, the firm will invest $1 in machinery and equipment and profit will

be more than $1 in the future In fact, this seems like a rather obvious truth but it marks

an advance in the ·economic world From that, they can endogenize the investment

function in the model rather than using an ad hoc investment function as before, i.e.,

Keynesian investment

2.2 Empirical literature

The relationship between investment and finance is popular with the matter that financial structure is relevant to corporate investment decisions since imperfect capital markets exist Meyer and Kuh (1957) emphasized the role of financial variables in firms' investment decisions and existence for internal source of funds Studies investigated how financial choice of a corporation impacted on its investment delayed

in 1960s, following the work by Modigliani and Miller (1958), hereafter M&M, who identified the link between financial structure and financial policy for real investment decisions under four certain conditions; and extended this to neoclassical models of investment; for instance, Jorgenson (1963); Hall and Jorgenson (1967)

Tobin (1969) and Hayashi (1982) explored q-theory of investment as a reformulation

of the neoclassical theory and developed it assuming a perfect capital market and convex costs of adjusting the capital stock According to the q-theory, the ratio of market value of the firm's capital stock to its replacement cost could demonstrate for investment demand In other words, the central method which creates an impact on financial policies and events on aggregate demand is by altering the assessment of physical asset relative to its replacement cost

M&M (1958) postulated that the financing and real investment decisions of the companies made separately from each other Furthermore, this theorem claimed that the enterprises' ·investment should be embarked upon only according to those factors which would enlarge the profitability, cash flow or net worth of the firm and there was

no connection between financial markets and corporate real investment decisions Nevertheless, this theorem will only be correct in a world of perfect capital markets (symmetric information, no transaction costs, no default risk, and no taxation)

M&M theorem cannot interpret investment decisions at the micro level if having asymmetric information in the market Concretely, imperfect markets exist in developing countries, firms have more information about the profitability and risks of investment projects than the suppliers of funds have Besides, corporate finance theory also suggests that market imperfections may repress the capacity of the corporate to fund investments and would perpetually influence the investment decisions of the firms

Moreover, the theoretical models of asymmetric information also referred to the magnitude of investment decision For instance, Akerlofs (1970) examined the role of

4

The second version of the neoclassical approach suggested by Tobin and Hayashi is that the rate ofinvestment

is a function of q, the ratio of the market value of an additional unit of capital or of existing capital to its

replacement cost (Hayashi, 1982, p.214)

asymmetric information in the market for lemons He built an economic theory and proved how markets fail when buyers have less information than sellers which leads to

an adverse selection, moral hazard or both This is other corollaries of informational asymmetry The cost of higher interest rate might lead to nearly good companies with safer projects so as to leave the applicant pool It might also cause enterprises to take

on riskier projects with higher expected returns Thus, if there are adverse selection and moral hazard, the ratio of 'lemon' in the applicant pool and the probability of default will increase He then illustrated through some applications that later researchers could put this theory into the firms' seeking funds from lenders; for instance, Stiglitz and Weiss (1984) with similar arguments5•

Fazzari et al (1988) investigated the effect of financing constraints on the

investment-to -cash-flow sensitivity After controlling for investment opportunities with Tobin's q, they employed the dividend rate so as to distinguish firms which were facing financial constraints or not They found that cash flow could impact investment because of the capital market imperfection, the asymmetric information and the lemon problem Alternatively, the effect of investment on cash flow considered as a policy problem of welfare reduction, a capital market failure or an inefficient fund that is similar to problems mentioned in previous researches (e.g., Akerlof, 1970; Stiglitz and Weiss,

1981 ) In addition, Fazzari et al (1988) also observed that internal sources of funds are less costly than external sources of funds in the capital market imperfection, which is suitable for Myers and Majluf(1984)6•

Added to this, there are also two further issues - agency costs and transaction costs that can explain fluctuations in the investment Firstly, agency costs theory developed by Jensen and Meckling (1976) can answer the problem that why a firm that is confronting the costs of higher interest rate does not try to get money from other sources (i.e., debt, equity market) Agency problems arise when having a conflict of interests between managers, creditors, and shareholders because of differing goals Secondly, the costs of a transaction combined with the issue of debt and equity issue might increase the cost of external financing It is supposed that debt is the only channel of external funds available to the firm Debt financing allows the creditors to

be entitled to the interest payment, and have their principals at the expiry date If not making scheduled payments, then the physical assets of firm will be sold in order to raise funds This depends on the firm's ability and its degree to which it can redeploy its assets There are usually non-redeployable durable assets (i.e., a building, a ship, or

a factory) in a high specified investment project; thus, it is quite difficult to recover funds from liquidation In this circumstance, in order to protect the creditors' interests, they will create disadvantages for the debtors with higher interest payments, restricting the size of loans and so forth

A large level of empirical literatures followed, namely Hall et al ( 1998) and used the Panel Data version of the Vector Auto Regressive (V AR) methodology to examine the determinants of investment in scientific firms for the United States, France, and Japan during the period 1979-1989 They found that there were tighter relations between investments on the one hand, and profits, sales, and cash flow on the other hand differs for each country Hubbard (1998) analyzed various factors (e.g., inventory investment, research and development (R&D), employment, business formation and survival, pricing, and corporate risk management) which determine the link between cash flow

and investment decisions by using the U.S data Hubbard's results strongly support that there was a significant relationship between investment and changes in net worth Furthermore, Carpenter and Guariglia (2008) estimated investment regressions distinguishing the firms' abilities to the face financial constrain in the UK firms over the period 1983-2000 They observed that cash flow could not explain the sensitive nature of investment decision for large firms; however, its explanatory power was still the same for small firms It implies that the significance of a cash-flow variable in investment equation could be caused by information asymmetries in the capital market

In addition, there were several researchers who afforded an opportunity to analyze the link between investment and imperfect capital market without employing q as a proxy for investment opportunities, but applying different measures of investment fundamentals that also supported the findings' Fazzari et al (1988) In particular, Gilchrist and Himmelberg (1995) used VAR methodology to examine an available information database relating to firms from the period 1979-1989 in the United States They afterward estimated a linear expectation of the present discounted value of marginal profits, as a measure of corporations' investment opportunities; then estimated regressions of investment on the latter variable and cash flow Finally, they concluded that the neoclassical model without cash flow only holds for firms less likely to face financial constraints (Carpenter and Guariglia, 2008, p.1896)

Nevertheless, Kaplan and Zingales (1997) disclaimed results of Fazzari et al (1988) They investigated that accustomed use of the sensitivity of investment to cash flow like

a measurement of financial constraint They then implied that the less financial constraints the firms face in corporate investment decisions, the more sensitive to the availability of cash·flow they are In the same way, Erickson and Whited (2000) also argued that the link between cash flow and investment will not appear once explaining investment on a measurement error in q and cash flow

In addition, Gomes (200 1) showed that although the presence or the absence of financial frictions is neither sufficient for significant cash flow effects nor necessary to obtain these cash flow effects The results strongly supported the controversy that the success of the investment-to-cash-flow sensitivity is possibly due to the existence of a measurement error in q In recent times, Cleary et al (2007) indicated that capital budgeting displays aU-shape towards the available internal sources of financing

These empirical studies are somewhat controversial as they relate to what probably caused the observed relationship between investment opportunities, cash flow and investment decisions at a firm level Nonetheless, this research will not resolve this issue as it will be limited to the first conclusions of Fazzari et al (1988) Confirming such a relationship would reject the purely neoclassical theory and cannot, but hint at the existence of the imperfect capital market (Saquido, 2003)

Furthermore, there are certain micro level factors (i.e., past investment, firm size, profitability, cash flow and growth opportunities) which are available to firms are all significant in forecasting investment decisions (Bokpin and Onumah, 2009) Ruiz-Porras and Lopez-Mateo (2011) documented that the effects of firm size, cash-flow, and investment opportunities are mostly positively significant on investment decisions Nonetheless, Saquido (2003) concluded that liquidity and firm size insignificantly related to investment; but, there remains a significant relationship between investment and revenue growth and fixed capital intensity Aviazian et al (2005) investigated the impact of financial leverage on the corporate investment decisions by employing a panel of publicly traded Canadian companies during the period 1982-1999 They showed that the link between leverage and investment is negative, and that affect significantly stronger for firm with low growth opportunities than those with high growth opportunities However, the findings of Li et al (2010) were mixed significantly the relationship between debt financing and corporate investment

decisions, by using the method of the multiple linear regression on the data from

2006-2008 of 60 Chinese real estate listed companies Table 2.1 (appendix) summarizes further empirical investment decisions studies

In Vietnam, determinants of corporate investment decision issue have just researched

by Ninh L.K et al (2007), to my current knowledge They used data from 606 private enterprises in the Mekong River Delta to investigate factors that affect investment decisions of the firm Their research concluded that educational and professional qualifications of managers and growth of revenue and investment have positive relationship However, they also indicated that there is a negative link between firm size and investment decision at the firm level

Recently, enterprises investment decisions have become a big problem but only the above group of researchers studied in Vietnam It is not enough and not sure that research explored all the elements related to the issue of investment Therefore, this thesis will analyze factors that impact on corporate investment decision as Ninh L.K et

al (2007) mentioned to confirm Moreover, this thesis will also investigate whether financial variables such as investment opportunities, business risk, and ownership concentration have any relationship with investment decisions

2.3 Conclusion

Obviously, there are several theories of investment in the sequence of time but all appear to still possess a couple of drawbacks Investment theory of Fisher (1930), for example, documented that the relationship between interest rate and investment is

negative In the General Theory (1936), Keynes found that firms will invest in projects

in which interest rate is less than MEL The theory of investment of Jorgensen (1963) is more about optimal capital than investment However, he added a function of distributed lag in order to obtain investment Tobin's q theory (1969) remedied

Jorgensen's problem by endogenizing the investment function in the model instead of

using ad hoc investment function The thesis also reviews empirical studies focusing

on financial factors affect investment decisions at the firm level Researchers investigated this issue in various contexts with different methods

In the Vietnamese context, this research is to explore the factors influencing listed firms investment decisions In order to be able to make a reliable finding, the thesis needs an appropriate model This will be presented in the chapter 3

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CHAPTER 3: RESEARCH METHODOLOGY

Within this chapter, the study presents the design methodology The thesis specifically identifies and describes the sources of data used in the investigation of the determinants of corporate investment decisions Moreover, the research also performs the model for estimation and testing procedures

3.1 Data sources

The research employs data of firm-level which is listed on the stock market in Vietnam (HOSE and HNX) As of2010, there were 644 firms listed on Vietnam's stock market However, the thesis just analyzes non-financial firms because the determinants of their investment decisions are different from that of financial companies In particular, enterprises which operate in the financial sector have different Balance Sheets from those of the non-financial firms Besides that, the thesis excludes enterprises which have been no longer listed as BBT; or, companies where there is not enough information on Financial Statements

Therefore, the research investigates a sample of 500 of 644 listed firms during the years 2006 to 2010 The information of listed firms is mainly obtained from VNDIRECT and Cophieu68 websites; others are from companies' websites Based on Financial Statements of these listed enterprises, the study calculates the values of variables which determine investment decisions In brief, the unbalanced panel data covers a 5-year period from 2006 to 2010 with observations on 500 listed firms, which

is a total of 1,538 observations

3.2 Variables

The thesis presents the variables used to analyze the determinants of corporate investment decisions The set of dependent and independent variables is summarized in

Table 3.1 Furthermore, the research chooses these independent variables under literature and empirical studies on the factors affect investment decisions at the firm level

3.2.1 Dependent variable

Investment rate

Investment rate, which is used as dependent variable, reflects corporate investment decisions It is the ratio of investment expenditure to capital stock; and, described by following formula:

Ii,t I Ki, t-1 = (Capital Expenditureending- Capital Expenditurebeginning) I Ki, t-1

in which capital stock equals fixed assets This variable is taken from Balance Sheets

3.2.2 Independent variables

Cash-flow

The thesis uses cash-flow as a proxy for internal net worth of company It is generated

by the sum of net income after tax and depreciation and amortization This variable is taken from Balance Sheets and Income Statements of firms Cash-flow is an important determinant for investment decisions of firms because if firms have enough cash inflows, it can be utilized in investment activities In other words, firms already know about potential investment opportunities; however, they cannot invest because access

to external funds is limited When cash-flow is improved, they can participate in attractive opportunities that might be otherwise unavailable

Table 3.1: A Set of Dependent and Independent Variables

siens Dependent variable

Investment rate Oi,t I Ki, t-I) Ii,t I Ki, t-1= (Capital Expenditureending- Capital Expenditurebeginning) I Ki,

t-BS

I

Independent variables

Cash-flow (CF) sum of net income after tax and depreciation & amortization BS and IS +

Tobin's q Q =Market value of total asset/ Book value of total asset BSand +

AR

+I-Fixed capital intensity

(FCI)

Sales growth (GROWTH) GROWTH= (Salesending- Salesbeginning) I Salesbeginning IS +

Business risk (RISK) RISK = standard deviation (Revenuet- Revenuet-1) I mean (Revenue) IS

+I-Dummy variable Ownership (OWN) OWN: takes I if state stock holding equals or more than 50% AR

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Audretsch and Elston (2002), Saquido (2003), Aivazian et al (2005), Azzoni and Kalatzis (2006), Adelegan and Ariyo (2008), Jangili and Kumar (2010), Li et al (2010), Nair (2011), Ruiz-Porras and Lopez-Mateo (2011) also found that cash flow impacts positively on firm investment decisions However, only Bokpin and Onumah (2009) concluded that the relationship between cash flow and investment is negative Therefore, the expectation of this link in this thesis is positive

Hypothesis 1: Higher cash-flow of firms will be associated with higher investment rate

Tobin's q

Tobin's q is used as a proxy for investment opportunities of enterprises The measurement of q is the ratio of market value of total assets to book value of total assets Based on the proposal of Li et al (2010), the market value of total assets is employed by following formula:

Market value of total assets = (Liability + stock price * number of tradable share + net

asset per share * number of untradeable share) Information of this variable is taken from Balance Sheets and Annual Reports of firms,

as well as the website of Cophieu68 for stock prices It can be stated that investment opportunities are involved in the investment decisions Higher investment opportunities would cause higher investment in a world where enterprises attempt to maximize the value of firm through net present value positive projects In terms of empirical studies, Saquido (2003), Aivazian et al (2005), Baum et al (2008), Carpenter and Guariglia (2008), Bokpin and Onumah (2009), Li et al (20 1 0) also documented that the link between investment and q is positive Thus, the thesis expects that investment

decisions are positively influenced by investment opportunities

Hypothesis 2: There will be a positve relationship between investment opportunities and investment rate of enterprises

Leverage

Measure of leverage in the research is the ratio of total liabilities to total assets This variable is calculated from Balance Sheet of each firm Leverage might have a negative impact on corporate investment decisions through two channels First of all, an increase in leverage might strengthen bankruptcy risks; managers are afraid that shareholders would be move to decline borrowings and/or reduce investment Secondly, higher levels of debt result in reducing funds in hand; therefore leverage has

an inverse effect on investment decisions at the firm level This connection is also negative in the research of Aivazian et al (2005) On the contrary, Azzoni and Kalatzis (2006), Ninh L.K et al (2007), Adelegan and Ariyo (2008), Jangili and Kumar (2010), and Nair (2011) found that there is positive relationship between leverage and investment The reason is that firms which have more investment opportunities, higher risk projects, and more debts, it might push the asset substitution by increasing more investment to cover their performance Moreover, Li et al (20 1 0) concluded that the relation between debt financing and investment is mixed Thus, the relationship between investment decisions and leverage is expected as negative or positive

Hypothesis 3: There will be positive or negative connection between leverage and investment

Fixed capital intensity

The thesis also uses fixed capital intensity in the model of investment although it is rarely employed However, Aquino (2000) and Saquido (2003) analyzed this variable and found that setup costs related to high fixed capital expenditures put some restraint

on additional investment in the context of Philippines Fixed capital intensity is

measured by fixed assets divided by total assets that are taken from Balance Sheets of firms It is clear that when fixed capital increases, it means the firms invest more in machinery to satisfy demand for production Hence, this variable is expected to have positive relationship with investment

Hypothesis 4: Higher fzxed capital intensity of companies will be positively correlated with investment activities

Sales growth

Growth of sales is used as a proxy for firms' growth that may affect investment decision It is normally stated in terms of a percentage growth from the prior year Sales growth's values are calculated from Income Statements of firms It can be stated that if demand for consumer goods goes up, it leads to an increase in demand for production, or sales growth Hence, the demand for capital and machinery will increase

as well Most of previous studies, namely, Saquido (2003), Ninh L.K et al (2007), Carpenter and Guariglia (2008) also found that the relationship between investment decisions and sales growth is positive It means that increase in sales leads to the firm invest more and otherwise The expectation of this connection, therefore, is positive

Hypothesis 5: There will be positive link between growth of sales and investment activities of firms

Business risk

According to theory, investment decisions should be affected by changes in risk levels7• The thesis, therefore, also employs this variable in analysis of investment decisions It is generated by variation of revenue with following formula:

Business risk= standard deviation (Revenuet- Revenuet-t) I mean (Revenue)

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Robert S.Pindyck ( 1986) - Capital risk and models of investment behavior

In order to calculate the value of business risk, the thesis takes information from Income Statements of firms Because of different types of risk attitudes, the expected sign of this business risk variable will be alternative correlated with investment Specifically, if managers of firms are risk neutral or risk averse people, this variable is expected to be inversely related to investment In other words, enterprises will be afraid of investing in the projects which has more risks Otherwise, the connection between investment and business risk is expected as positve if firms' managers are risk lover Put differently, it is stated as high risk high return investments

Hypothesis 6: Higher business risk will be negatively or positive associated with investment rate of firms

Firm size

From previous researches, there are three measurements of firm size such as log value

of total assets, total revenue, and total employees Some information is not complete because the Annual Reports of some firms contain the information of number of employees, while some firms have not Additionally, since total asset is used for measuring Tobin's q, leverage and fixed capital intensity, the thesis therefore employs the total revenues measurements to analyze The information of total assets is obtained from Income Statements One on hand, Ninh L.K et al (2007), Bokpin and Onumah (2009) proved that firm size as a negatively significant determinant of investment decisions The reas.on is that the management capabilities or human resource cannot control all things or meet requirements in a large firm; thus, they tend to less investment One the other hand, Adelegan and Ariyo (2008), Jangili and Kumar (2010), Li et al (2010), Ruiz-Porras and Lopez-Mateo (2011) had opposite findings The reason is that large firms should have better access to external capital sources, more stable cash flows and more diversified than small firms Therefore, it leads to