The relationship between investment and dividend in cash flow uncertainty condition a vietnam case

ABSTRACT This paper aims to show the relationship between investment and dividend in cash flow uncertainty condition by using data of 246 Vietnamese listed firms from 2011 to 2014.. Howe

VIETNAM – NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE RELATIONSHIP BETWEEN INVESTMENT AND DIVIDEND IN CASH FLOW UNCERTAINTY CONDITION: A

VIETNAM CASE

By TRAN THI NHAT LINH

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

Ho Chi Minh City, April 2017

ABSTRACT

This paper aims to show the relationship between investment and dividend in cash flow uncertainty condition by using data of 246 Vietnamese listed firms from 2011 to 2014 The study shows that in the relationship between investment and dividend does not significant in both two alternative measurement methods of cash flow uncertainty However, in the case cash flow uncertainty is measured by cash flow shortfall, the relationship between investment and dividend

in each level of shortage is significant at 10% Besides, the study shows that Vietnamese firms tend to reduce liquid assets to deal with cash flow shortage and Vietnamese firms tend to invest

in other firms despite of they are facing with cash flow shortfall

Keywords: dividend, investment, cash flow shortfall, Vietnamese firms

ACKNOWLEDGEMENT

Firstly, I would like to sincerely thank Dr Vu Viet Quang I am grateful to his

enthusiastic instruction crucial advice and valuable guidance during the time I worked with this thesis

In addition, I would like to thank you to all professors and staff of Vietnam-Netherlands Program as well as classmate for their help during my thesis process

Finally, I would like to express my gratitude to my family, who have supported me with the master program and motivated me to finish this thesis

ABBREVIATIONS

HoSE: Ho Chi Minh Stock Exchange

OLS: Ordinary least squares

GLS: Generalized least squares

FE: Fixed Effect

RE: Random Effect

WLS: weighted least squares

TABLE OF CONTENTS

CHAPTER 1 : INTRODUCTION 1

1.1 Problem Statement 1

1.2 Research Objectives 2

1.3 Data and Methodology 3

1.4 Thesis Structure 3

CHAPTER 2 : LITERATURE REVIEW 5

2.1 Literature review 5

2.1.1 The tradeoff theory between dividend and investment 6

2.1.2 Agency cost theory of free cash flow 6

2.2 Empirical research related to the link between investment and dividend 7

2.2.1 Separated results 7

2.2.2 Dependence results 7

2.2.3 Others finding 9

2.4 Summary 12

CHAPTER 3 : DATA AND METHODOLOGY 13

3.1 An overview of dividend, investment in Vietnam 13

3.1.1 An overview of dividend 13

3.1.2 An overview of investment 14

3.2 Analytical framework 15

3.3 Sample data and collection 17

3.4 Methodology model 17

3.4.1 Empirical model 17

3.4.2 Variable measurements 18

3.5 Econometrics framework 21

3.5.1 Ordinary Least Square estimation 21

3.5.2 Fixed effect estimation 21

3.5.3 Random Effect estimation 22

3.5.4 OLS, FE, and RE, which one is better? 22

3.5.5 Other tests 23

CHAPTER 4 : EMPIRICAL RESULTS AND DISCUSSION 25

4.1 How can firms solve cash flow shortfall 25

4.2 Empirical results and discussion 35

4.2.1 Cash flow uncertainty is measured by CFVol 35

4.2.2 Cash flow uncertainty is measured by cash-short 39

4.2.3 Regression results 40

4.3 Results summary 42

CHAPTER 5 : CONCLUSION 43

5.1 Main conclusion 43

5.2 Implication 43

5.3 Limitation 44

REFERENCES 45

APPENDICS 48

LIST OF TABLES

Table 3.1: Variables definition 20

Table 4.1: Description statistics of the main variables (in billions VND or times) 26

Table 4.2: The main methods to deal with cash flow uncertainty (based on cash flow shortfall - in billions VND) 27

Table 4.3: The main methods to deal with cash flow uncertainty (based on cash flow shortfall) – with negative sample and positive sample - in billions VND 31

Table 4.4: The main methods to deal with cash flow uncertainty (based on cash flow volatility) – with negative sample and positive sample - in billions VND 33

Table 4.5: The correlation maxtric and variance inflating factor (VIF) (CFVol) 38

Table 4.6: The results of Modified Wald test and Wooldridge test 39

Table 4.9: Regression results 41

LIST OF FIGURES

Figure 3.1: Number of listed firms payout dividend 14

Figure 3.2: Number of Vietnamese listed firms use internal fund (retain earnings) 15

Figure 3.3: Conceptual Framework 15

Figure 4.1: Investment – dividends sensitive with CFVol rank 36

Figure 4.2: Investment – dividends sensitive with cash short rank 39

CHAPTER 1 : INTRODUCTION

1.1 Problem Statement

Investment and dividend policy decisions are two of the most important missions fulfilled

by managements In a perfect market, investment and dividend decision are a separation because firms can raise external fund (Miller & Modigliani, 1961) In an imperfect market, firms cannot obtain funds easily because of the limit resource, thus, investment and payout policy are the most difficult decisions of manager and firms Additionally, maximizing firm value and stockholder wealthy are the main duties of administrators; however, sometimes there is confliction between these duties, especially in cash flow uncertainty conditions To be specific, firms usually use profit after tax to pay out a dividend and reinvest in projects to create value in the future, but in cash flow shortfall case, the manager will take into account for cutting the dividend and investment, or raising external funds In fact, firms can choose no payout a dividend when the director boards believe that firms will have more advantages to increase profit as well as a dividend in the next business cycle by expanding investment activities associated with shareholders’ dividend Nevertheless, these decisions are not always right; Benjamin and Dodd (1934) gave some reasons to protest ones Moreover, dividend payout is not only reflected shareholder wealth, but also a signal for firms’ performance (Fairchild, 2010) Therefore, there is the tradeoff between dividend and investment decision and managers have to choose the relevant plans in order to increase shareholders’ wealth and firm value As the results, dividends and investment decision do not separate and must be jointly determined

In particular, investment and dividend decision are affected by many factors, such as agency cost, financial market Therefore, therearemany studies related to investment and dividend decision over the world but given different results Some studies claimed that dividend

is priority decision (Lintner, 1956), but another one supposed that investment and dividend decision are made simultaneously and interdependently (Brav et al., 2005) To clarify the relationship between investment and dividend, some authors research this relation in a finance constrained (Holt, 2003), financial flexibility (Daniel et al., 2008) or uncertainty cash flow conditions (Deng et al., 2013) Overall, firms have to choose between investment and dividend decisions in conditions of cash flow shortfall Firms with cash flow shortfall are often difficult to

raise external funds and the cost of capital is higher Therefore, this relationship is expressed more clearly in firms with uncertainty cash flow

In Vietnam, it is difficult to clarify the relationship between financial decisions, especially the relationship between investment decisions and dividend decision As reviewed by

Lý, H., & Thị, T (2013), Vietnamese firms’ administrators agree on the importance of dividend policy, but they are not clear how investment policy will affect dividend policy and vice versa Almost previous studies related to developed countries but the effect of the financial decisions in each region is different with others; therefore, it is necessary to investigate the association between dividend and investment decision in an emerging financial market like Vietnam

In this study, the linkage between investment and dividend is the main research objective The results show the investment – dividend-sensitive as well as the change of investment and dividend when cash flow volatility Besides, empirical results also show the way Vietnamese firm resolve cash flow shortfall There are a lot of previous studies that research the connection between investment and dividend with different results In particular, some studies show the

independent relationship between dividend and investment (Morgan & Saint-Pierre, 1978), some

papers illustrate the interdependence between them (Minton & Schrand, 1999; Daniel et al.,

2008) However, Vietnam financial market still immature and incomplete, as well as there are

few studies that link financial decisions in Vietnam, so that the results of this study maybe bring some suggestions for administrators

1.2 Research Objectives

In general, this paper focuses on the link between investment and dividend of Vietnamese firms in uncertainty cash flow In addition, the study aims to find out the methods that Vietnamese firms use to deal with cash flow shortage

Firstly, this paper will determine variables that related to investment, dividend and cash flow based on the method of empirical study, especially, cash flow uncertainty is measured by 2 methods: cash flow shortfall and cash flow volatility Secondly, based on the magnitude of cash flow shortfall, data is divided into 5 groups and variables are analyzed in each group or combined to others Statistic results will provide the evidence of the main channel to solve the shortage of cash flow of Vietnamese firms

Secondly, investment, dividend, and cash flow will be placed in relation to other factors

to run the regression in each level of cash flow shortfall The coefficient of the dividend is

investment – dividend-sensitive Based on the investment – dividend-sensitive in each level of shortfall, we predict the relation of investment, dividend, and cash flow uncertainty then plots the chart

Thirdly, based on the chart, dummy variables are used and included in the model then the results from regression will clarify the relationship between investment and dividend in each level of shortfall

The objective of this study is to identify the relationship between dividends and investments in conditions of cash flow uncertainty for Vietnam listed firms To examine this problem, the thesis will answer the question:

Do investment decision and dividend decision independent when firms face with cash flow volatility?

1.3 Data and Methodology

This study will use the panel data of non-financial companies, which are listed on Ho Chi Minh Stock Exchange (HoSE) from 2011 to 2014 Besides, the study excludes the firms which are listed after 2011 and the firms were not listed in the stock market before November 2015 The final sample includes 984 firm-year observations The data from the financial statement, data will be used to conduct

The descriptive statistics will be used to clarify the relation between dividends and investment at the different level of cash flow uncertainty and find out solutions to resolve cash flow uncertainty The basic regression such as GLS, FE, RE also used to analyze the dividends - investment sensitive to investigate the link between investment and dividend Besides, this paper uses piecewise regression to confirm the results that were predicted in the descriptive statistics part and check the robustness of regression results

1.4 Thesis Structure

This paper is organized including 5 chapters Chapter 2 represents some definition, related literature and empirical Chapter 3 will describe the data and methodology Chapter 4 shows empirical results Finally, Chapter 5 is a conclusion and some limitation

In detail, chap two will illustrate some concepts of dividend, investment, and cash flow After that, the relationship between investment and dividends in empirical research is divided

into various groups depend on different results Finally, based on the summary of results from empirical studies, hypotheses of the study will be given

CHAPTER 2 : LITERATURE REVIEW

In next chapter, firstly, an analytical framework is presented After that, data and variables measurement are presented, the information of data source is given Thirdly, a research model is launched

This chapter will illustrate some concepts of dividend, investment, and cash flow In next part, the literature of the relationship between investment and dividends is reviewed In this section, the empirical studies are mentioned to clarify the relationship between investment and dividends in different conditions Finally, a hypothesis is launched

2.1 Literature review

“If you cannot find investments that make your minimum acceptable rate, return the cash

to owners of your business” (Damodaran, 2004) In fact, the dividend is an after – tax profit which pays for shareholders In discussing the dividend decision, Damodaran (2004) view the dividend decision as an action to refund money for investors when firms do not find profitable investment projects Dividend decision is one of the most important of firms, iteffects to available and the cost of capital In particular, dividend policy is decided by Board of Directors but it must be considered the desire of shareholders Besides that investment decision took into account when firms make dividend decision Therefore, there is confliction between shareholders’ benefit and managers

According to Damodaran (2004), the investment decision means investing in assets that

“earn a return greater than the minimum acceptable hurdle rate”, and "any decision that requires the use of resources is an investment decision” Indeed, the primary goal of investment decision

to reallocates financial resource in order to bring the highest return for firms The source of investment includes internal financial (retained earnings) and external financial (loans and

bonds)

Based on Richardson (2006), “free cash flow is cash flow beyond what is necessary to maintain assets in place (including servicing existing debt) and to finance expected new investment”

Jensen (1986) supposed that “free cash flow is cash flow in excess of that required to fund all projects that have positive net present values when discounted at the relevant cost of capital”

Therefore, the available free cash flow has the important role of firm operations; its major

is used to pay dividends, and reinvestment In addition, cash flow uncertainty caused more problems for firms in both positive cash flow and negative cash flow In particular, high free cash flow lead to higher agency cost and increasing conflicts of interest between shareholders and managers, but firms with negative cash flow have to raise funds to invest in the profitable project Furthermore, it is difficult to attract external funding or payout dividends to shareholders

when firms have negative free cash flow

2.1.1 The tradeoff theory between dividend and investment

Miller and Modigliani (1961) investigated dividend policy, growth, and valuation of share in the perfect capital market The study assumes that firms will pay a dividend when firms have positive cash flows The authors claimed that if firms want a higher dividend payment in any time period, the more cash must be raised from external to keep the desired investment level Thus, changes in investment decisions affect dividend decisions, but not vice versa Besides, cash flow uncertainty only affects dividends rather than investment because firms can raise fund for positive projects in the perfect financial market

2.1.2 Agency cost theory of free cash flow

Jensen and Mecking (1976) defined the concept of agency cost and showed the conflict between managers and shareholder The study claimed that dividend payment reduces managers’ power so firms must depend on financial markets to obtain new capital In order to increase controlling, managers will reduce available free cash flow of firms, it mean, managers will even invest in the low-return project instead payout dividend

Another study of Jensen (1986) related to agency cost claimed that managers could allocate free cash flow by increasing dividend, purchasing a share, investing in low return projects or waste In order to decrease agency cost, firms can choose to reduce cash flow available for spending, so overinvest is a good alternative for firms Besides, Jensen suggests that managers should issue debt, over-investment or misallocate free cash flow and promise to payout

in future Thereby, the manager can retain free cash flow for future and increase the discretion of managers

2.2 Empirical research related to the link between investment and dividend

2.2.1 Separated results

Miller and Modigliani (1961) based on basic assumption then find out the relationship between investment and dividend The results support that the dividend and investment are separable in a perfect market The link between investment and dividend become controversial topics and attracted the attention of economists

Contract to Dhrymes and Kurz (1967), the findings of Higgins (1972) indicate that investment, dividend and external funds are separated but are made simultaneously Higgins (1972) used the cross section data of firms operating in eight industries in the year 1961, 1963,

1965 to examine dividend – saving the model and the factors that maximize firm value The findings show that no evidence which proves the interdependence between investment and dividend

Following the research findings of Miller and Modigliani (1961), Fama (1974) is also

study the link between dividend and investment of firm but in an imperfect market This research based on the model of John Lintner and the data of 298 firms over a23-year period The results indicated that dividend and investment decisions are independent in the imperfect capital market

In addition, dividends related to investment but it was not evaluated by investment

Related to investment and dividend decision, Smirlock and Marshall (1983) use the data

of 194 firms in 20 year period to provide the evidence the relationship between them The purpose of the study is to provide evidence to support M-M theorem and test the independence of investment and dividend by causality test The findings consistent with the study of Fama (1974) and prove that does not exist the interdependence between investment decision and dividend decision

2.2.2 Dependence results

In fact, the firm cannot make both investment and dividend decision simultaneously because of limited capital in the imperfect market So, many studies related to two important financial decisions in market conditions are not perfect but given many contradictory decisions

By using OLS, 2SLS, 3SLS, Dhrymes and Kurz (1967) used the data of 181 from 1951 to 1960

to investigate the relationship between dividends, investment, and new debt The findings against M-M theorem and proposed that the investment and dividend decisions are interdependent, and investment decisions have a significant effect on firms’ dividend behavior

M McCabe (1979) brings a new look related to investment and financing The study uses cross-sectional data including 112 firms from 1966 to 1973 and based on three models of Dhrymes and Kurz (1967).The findings of the study show a negative correlation between investment and dividend In addition, the result shows that investment and dividends decision cannot be determined independently of the others financial variable and in a long term, dividends, investment, and new debt will be set at an equilibrium level

Based on the model of Dhrymes and Kurz (1967) and M McCabe (1979), Peterson and Benesh (1983) tested the link between investment and financing decisions The findings consistent withthe study of Dhrymes and Kurz (1967) and M McCabe (1979) and indicated the significant positive relationship between investment and dividends The results also show a positive correlation between investment and new debt as well as the evidence of study show that investment decision is affected by financing decision and they are jointly determined

By using both cross-sectional and time series data of 378 firms from 1960 to 1972, the study of Baskin (1989) inconsistent with Fama (1974) and the findings show that past dividend has a significant effect on investment

Devereux and Schiantarelli (1990) use panel data of 720 UK firms and the Q model to investigate the linkage between investment, cash flow and financial factors in the UK The results contrast with previous studies of MM and Fama (1974) In fact, the findings show that cash flow have significant related with investment, and leverage has a negative effect on investment In particular, the impact of cash flow on investment is more significant in large firms, and vice versa

Similar to Bhaduri and Durai (2006), Wang (2010) used causality to investigate the relationship between investments, dividend, and financing in the high-tech industry The study uses data from 178 firms in China and Taiwan during the period 2000 – 2007 Wang (2010) indicated that investment and financing have a positively significant relationship but dividend and financing have no significant relationship In addition, the results do not show the direct

relationship between investment and dividend and do not consistent with Fama (1974), Smirlock and Marshall (1983)

Deng et al (2013) obtained data from 2000 to 2010 of nonfinancial firms in China and investigated the relationship between investment decisions and payout policy in cash flow volatility condition The study explored that firms with cash flow uncertainty do not cut dividend

or investment but remained high investment level Besides, Chinese firms used external cash as the main instrument to resolve cash flow uncertainty

2.2.3 Others finding

Based on the data of 116 Canadian firms in the period 1960 -1974 and the methods of Fama (1974), Morgan and Saint-Pierre (1978) test the link between investment and dividends The study examines this relation in short term and long term The results show a negative relationship between investment and dividends in long run but the findings support the results of Miller and Modigliani (1961)

Louton and Domian (1995) also researched on the relationship between dividends and investment but indicated different results with previous studies This study used a database of

212 firms in 37 years and Granger causality test to finding that dividends related to investment decisions in approximately 33 percent of firms, irrespective sectors

Based on M-M theorem, Mc Donald et al (1975) also examined the correlation between investment and dividends of French firms Mc Donald et al (1975) used dividend model, investment model and financing model to clarify the link between investment, dividend and financing decision of French firms The results from dividend model show that investment and external financing are insignificant with dividends In investment model, the results show the positive significant relationship between investment and dividends; this finding is inconsistent with MM theory In conclusion, the evidence from French firm of Mc Donald et al (1975) cannot reject MM theory but they also do not support the study of Dhrymes and Kurz (1967)

Brav et al.(2003) surveyed 384 financial managers by field interview combined with tradition survey methods to find out the factors that drive payout policy The research indicated that priority of firm is maintaining dividend level, and dividend payment is next concern after considering investment and liquidity needs Besides, the manager will consider raising external cash or delaying investment to maintain dividend level Another result show that remains

dividend per share more important than increase investment, however, investment decisions is considered priority than increasing dividends level The research also discusses the impact of free cash flow to payout policy

Differ previous studies, DeAngelo and DeAngelo (2006), Bhaduri and Durai (2006) researched the link between dividend and investment decisions While DeAngelo and DeAngelo (2006) point out the irrelevant assumptions of M – M then Bhaduri and Durai (2006) study based

on data from 265 Indian manufacturing firms in the period 1992 – 2004 and panel Granger causality test to clarify the M-M separation principle in India The results from research reject the M-M separation principle and show that dividend and investment have bidirectional causality relationship for low growth firms and unidirectional causality relationship for high growth firms

The result from the study of Daniel et al (2008) defined the link between investment and dividend The study indicated the change of dividend and investment level when firms faced to cash flow shortfall Authors supposed that firm needs to do one of the options as reduced investment, cut the dividend, raised funds or reduced cash reserves The results of the study show that approximately 6% of firms cut dividend while 68% firm cut investment to solve cash flow shortfall problem Investment cuts resolve approximately 50% shortfalls, the rest were resolved

by debt, equity financing, drawdown cash balance have a minor contribution

Recently, some studies found the link the link between investment and dividend such as DeFusco et al (2014) The study uses VAR Causality method and data of 1056 firms from 1950

to 2006 to clarify the relation of investment, dividends, and earnings The results provide strong evidence the interdependence between investment and dividend decisions and the shocks to dividends impact to investment in long-term and vice versa In addition, the results show a negative relationship between investment and dividend and firms with more profitable projects will have the sharp fluctuations in dividend when investments receive the shock

2.3 Empirical research related to cash flow, investment, dividend and other factors

When discussing the relation between firm size, cash flow, and investment, Kadapakkam

et al (1998) investigated the data from OECD countries then gave some conclusions Firstly, the internal fund has an effect on firms; the significant depend on the size of the firm Secondly, cash flow has a positive effect on investment and cash flow – investment sensitive is highest in large firms and lowest in small firms Related to cash flow shortfall, Bradley et al (1998) study the

role of cash flow to dividend policy by using the sample from 1985 to 1992 in REIT industry The results show the negative relationship between dividend and cash flow volatility as well as the authors proved that payout level will lower if expected cash flow volatility is higher In addition, Bradley et al (1998) claimed that managers will set dividend policy lower if expected cash flow less certain Another important finding of the study is the link between investment and financing decisions

The relationship between cash flow and investment is clarified by Minton and Schrand (1999) The study of Minton and Schrand (1999) showed that cash flow volatility has a negative effect on investment and higher cash flow volatility related to lower average levels of investment; authors suggest firms should skip some investment to operate more smoothly instead retain investment levels in cash flow uncertainty condition The results of the study also point out the negative relationship between dividend payout and net cash flow volatility

Allayannis et al (2005) investigated the relationship between earning uncertainty, cash flow uncertainty, and firm value The empirical results show that cash flow volatility has negatively related to firm value Besides, it increases firm’s cost to raise external cash for firms then cash flow volatility effect to investment policy

By using 58,053 firm-year observations from 1988 to 2002, Richardson (2006) found out the relationship between free cash flow and investment The study pointed out that firm with a high level of free cash flow usually has overinvestment In addition, almost free cash flow is kept

as a financial asset, some evidence proved the free cash flow is contributed from outside The study also indicated the positive relation between investment and cash flow

The research of DeAngelo and DeAngelo (2007) investigated the financial flexibility, dividend policy and capital structure of firms Empirical results showed that firms can use debt financing to create short-term funds in order to solve investment and earning shocks Further, firms should not be cash reserves absent because positive investment projects need funding with

a lag

Empirical results of Chaya and Suh (2009) proved that cash flow volatility plays important role in payout policy and its effects to payout method In addition, the authors indicated that firms will choose to purchase share instead pay dividends when it has high cash

flow uncertainty level The study also pointed out that firms have more difficult and costlier to raise external fund if they faced cashing flow uncertainty

In addition, Daniel et al (2010) found that firm will raise external funds to cover cash flow shortfall However, some evidence showed that cash holdings were the source to resolve cash shortfall In fact, almost firms chose to issue new debt in this situation, minor firms cut cash reserve to reduce the shortfall, asset sales, decrease investment, dividend or equity financing The study also supported the results of DeAngelo and DeAngelo (2007) that leverage is a cushion for cash flow shocks

Bhagat and Obreja(2013) explored the impact of cash flow uncertainty on employment and investment The results indicated the negative relationship between cash flow volatility and corporate investment in the asset In addition, the negative relationship between cash flow uncertainty and investment is stronger in post - recession

2.4 Summary

In general, empirical research shows different results in various regions and market condition but almost research based on the idea of Miller and Modigliani (1961) and the findings

of Dhrymes and Kurz (1967) and Fama (1974) Although there are differences in the methods,

data and the period of time, the results of researches focus in two main groups: independent and separated If Miller and Modigliani (1961) confirm investment dividends and independent in perfect markets, Higgins (1972) and Smirlock and Marshall (1983) conclude them independently both in imperfect markets However, the findings of subsequent studies against M-M theorem and point out the link between investment and dividend decision in various conditions The typical study that does not support M-M theorem is the study of Dhrymes and Kurz (1967) After that, M McCabe (1979), Peterson &Benesh (1983) based on the model and method of Dhrymes and Kurz (1967) to provide evidence against M-M theorem Recently, the studies such as Bhagat and Obreja(2013), DeFusco et al (2014) in different regions, a period of time and method also support the separation In fact, dividends and investment cannot be done simultaneously because

of limit capital in the imperfect market Therefore, this paper supports the idea that exists the relationship between investment and dividend

Hypothesis: there is a positive relationship between investment and divide

CHAPTER 3 : DATA AND METHODOLOGY

The main content of this section is to present the sources of data, how the sample data is collected, variable measurement, and the relationship between dividend and investment in the context of Vietnam Firstly, this chapter will introduce an overview of dividend and investment

of listed companies in HoSE Next, conceptual framework and model specification will be discussed in detail in order show the relationship between investment and dividend Thirdly, research hypotheses and variables measurements are included to clarify the purpose of this study

in next part Finally, data collecting and data filtering method will be mentioned in the last section

3.1 An overview of dividend, investment in Vietnam

3.1.1 An overview of dividend

The dividend payment is defined that the amount of after-tax profit which is distributed to shareholders after firms kept a portion for reinvestment in their operation In fact, if firms do not have enough good projects which have profitable higher than the cost of capital then firms should payout surplus profit to shareholders In Vietnam, firms have two times per year to payout dividend and Board of Director will be face with dividend payout rate as well as the level

of retained profit for their operation There are different in dividend payout rate among various industries in Vietnam (Thu et al., 2013) but almost investors always see dividend payment as a signal to invest According to survey results, to some extent, the managers agreed with the important of dividend policy but the managers are not an aware prioritization of investment decisions and dividend policy (Lý, H., & Thị, T., 2013) In fact, under pressure from investors, many firms use the leverage to expand its operations and pay dividends (Thu, N K et al., 2013)

Dividend policy of Vietnamese firms in 2011 and 2012 was discussed in research of Tran Thu, P (2013) According to Tran Thu, P (2013), more than 18% firms listed on HoSE did not have transparent information about their dividend payment in 2011 In next year, this proportions rose to nearly double (30%) Besides that, those firms have various payment rates, which ranging from 0% to 70% on their capital In particular, approximately 60% firms have dividend payment rate from 0% to 20%, 10% firms paid from 21% to 30% and a minor proportion firms have dividend rate over 30% Another research on Vietnamese firms points out that dividend policy is

a tool for controlling share price as well as investor see dividends as an important factor in making investment decisions In conclusion, dividend policy is an important decision that Executive Board must be faced in corporate management and they must choose the level of dividends payment and the magnitude of retained earnings to reinvestment

In addition, from 2011 to 2013, the number of firms which did not pay dividend increase nearly double but later on it dropped down slightly in 2014 In particular, 100 out of 264 listed firms on HoSE did not pay a dividend in 2013 This ratio slightly decreases to 93 firms in 2014 but still account up to nearly 61% listed firms which are chosen from HoSE

Figure 3.1: Number of listed firms payout dividend

Actually, a good dividend policy should not be considered in isolation It must be combined with investment policy and financial policy based on long-term cash flow of firm

3.1.2 An overview of investment

Investment decisions are one of the key financial decisions of the firm and affect to firms’ profitability and growth Board of directors makes investment decisions based on retained earnings, and firms’ ability to have access to external funds support all of its new investment opportunities Vietnamese firms often have difficult to raise capital from banking, especially small firm, so firms tend to use retained earnings to reinvestment The research of Le, N T et al (2006) pointed out that almost firms rely on retained earnings, savings, or the fund of

050

shareholder instead of external financial In fact, the data of 246 listed firms on HoSE shows that almost firms retained profit for investment purposes From 2011 to 2014, listed firms which do not reinvestment their profit just accounted for 1% to 6% It can be said that reinvested profit is a priority task to generate their profits and growth

Figure 3.2: Number of Vietnamese listed firms use internal fund (retain earnings) 3.2 Analytical framework

Figure 3.3: Conceptual Framework

+ Cash flow uncertainty + Cash flow

+ Firm size + Market to Book ratio + Return of Asset + Leverage + Firm status + External financing

This paper will clarify the relationship between investment and dividend in uncertainty cash flow condition In particular, dividend decision and investment decision are governed by the conditions of cash flow uncertainty, financial performance, and financial decision In this paper, cash flow uncertainty is described by the level of shortage and they are alternatively measured by two methods In addition, financial performance includes operating cash flow, market to book ratio, return on asset, firm size, leverage and financial decision which is represented by external funds

Based on literature finance, the relationship between investment and dividend may be either independent (Miller& Modigliani, 1961, Morgan & Saint-Pierre, 1978), or interdependent (Dhrymes & Kurz, 1967; Brav et al., 2005) from each other’s which and has a positive relationship In addition, in the Linter model, prior dividend may affect the expected dividend of shareholders and board of directors and “dividends represent the primary and active decision variable savings in a given period are largely a by-product of dividend action." Thus, lagged dividends are included in this study Moreover, current profitability (ROA) is a key instruments that determinant of current dividends (Lintner, 1956) These variables are similar with prior literature that tests the relation between investments and dividends (Fama, 1974; Peterson and Benesh, 1983)

Ramalingegowda et al., 2013 find the link between total investments and firm size, leverage, cash flow from operations, cash flow volatility, investment volatility, cash balance and market to book ratio In addition, according to Smith and Watts (1992), firm size is associated with dividend policy and debt When studying about investment, prior models include in size and leverage as variables that influent to investment (Richardson, 2006; Deng et al., 2013) Therefore, firm size, leverage, cash flow, cash flow volatility, market to book ratio are included

in this study

According to Brav et al., 2003; Deng et al., 2013, raising funds from outside is the first order alternative when firms face with cash flow shortfall and the external fund is the solution to resolve cash shortfall problem (Deng et al., 2013) Besides that, the study of Deng et al (2013) is also confirms the role of the firm status in the relationship between investment and dividend Therefore, firm status is included in the model

3.3 Sample data and collection

The sample data is composed of 246 non-financial companies listed in HoSE from the period 2011 to 2014 Moreover, non-financial firms, which are listed after 2011 and delisted before November 2015, are excluded The data is tested to remove outlier, so the final samples include 984 firm-years observations All data is obtained from financial statements from the website of Vietstock1 and Viet Capital Security2

3.4 Methodology model

3.4.1 Empirical model

Based on the study of Lintner (1956), Daniel et al (2008), Deng et al (2013),

Ramalingegowda et al (2013) the relationship between investment and dividend in uncertainty cash flow conditions will be estimated by model:

I_TA = α0 + α1 *DIV + α2*Rank + α3 *Dum1 + α4*Dum 2 + DIV *(α5*Rank+ α6 *Dum1 +

α7*Dum2) + Rank*(α8*Dum1 + α9*Dum2) + DIV*Rank * (α10*Dum1 + α11*

Dum2) + α12*Extcash + α13*CF + α14*Lag (I_TA) + α15*MB+ α16*Size + α17*ROA + α18*LEV + α19*State + ε (1)

Where:

I_TA: investment divided by lagged total asset

Lag (I_TA): I_TA in previous year

DIV: dividend per share divided by lagged total asset per share

Dum 1 and Dum 2: dummy variables which taking value of 1 or 0 depend on the rank of cash flow uncertainty

Rank: the level of cash flow uncertainty, there are 5 level and 2 ways to measure cash flow uncertainty

External cash: fund that is raised from equity financing and debt financing

CF is operating cash flow scaled by lagged total asset

MB: market to book ratio

Size: firm size which is estimated by natural logarithm of total asset

ROA: return of asset

1 http://vietstock.vn/

2 https://www.vcsc.com.vn/

LEV: leverage which is measured by total debt divided by total asset

State: status of firm which is equal 1 if firm is controlled by government and 0 otherwise ε: the regression error term

Independent variables

- DIV represent for the dividend, it is calculated by dividend per share divided by lagged total assets per share

- Rank measures the level of cash flow shortage In this thesis, rank is estimated by cash

flow uncertainty, including cash flow shortfall (CashShort), cash flow volatility (CFVol), and there are 5 rankings for 984 observations Consistent with the literature, rank has a negative relation with investment and dividend (Minton & Schrand, 1999; Bhagat & Obreja, 2013) Based on work by Daniel et al (2008), Deng et al (2013), cash flow uncertainty is measured by cash flow shortfall Then, the cash flow shortfall of the firm is calculated as follows:

Cash flow shortfall = Expected investment + Expected dividend – Available Cash Flow

To calculate cash flow shortfall, expected investment, expected dividend and available cash flow are estimated Firstly, for the expected dividend, we assume that expected dividend is the dividend paid in the previous year (DeAngelo & DeAngelo, 1990) Secondly, I follow Daniel

et al (2008), in which expected investment is measured as the median ratio of investment divided by lagged assets of firm’s industry in that year, and then multiplied by the firm’s lagged assets Throughout this study, investment is capital expenditures on fixed assets, intangible assets, and other long-term assets Thirdly, available cash flow is estimated as operating cash flow plus after tax research and development expenditure minus preferred dividend (Daniel et

al., 2008) However, the financial statements of the companies in Vietnam do not show separately preferred dividend, so this thesis will assume that there is no preferred stock Besides that, Vietnam Accounting Standards allow setting up The Research and Development fund from annual pre-tax income but there is no data publicly available for research and development expenditure every year Therefore, in this study, available cash flow will be equal to net operating cash flow

Following the method of Chaya and Suh (2009), Daniel et al (2008), cash flow volatility are also measured by the standards deviation of one year’s operating cash flow scaled

by lagged total assets Firstly, based on the data from cash flow statement, the standard deviation

of operating cash flow in year t is estimated from that of year t and year t-1 Cash flow volatility

is calculated as standards deviation of one year scaled by lagged total asset

- External cash is money that is raised from outside firms; include equity financing and

debt, which is denoted by Extcash This paper uses the formulation from the study of Deng et al.,

2013 to calculate the value of External cash:

External Cash = Cash received from equity investment – Cash paid for equity investment + Cash received from debt + Cash received from bond issuance – Cash paid for debt – Cash paid for dividend and interest – Cash paid for debt investment + Cash received from debt investment + Cash received from dividend

- CF represented by cash flow, which is net cash and cash equivalents in and out of a firm

A firm with positive cash flow can reinvest, pay dividends or settle the debt In particular, operating cash flow is important because it shows the ability to generate positive cash flow for the development of the company In this thesis, CF is estimated by operating cash flow scaled by lagged total asset

- MB is a market to book ratio, which is calculated by the market value of firm scaled by

book value of the firm

- ROA reflects the profitability of assets In others words, ROA reflects the efficiency of

using assets to generate earnings, sometimes, it called return on investment In addition, ROA gives an idea that how firm invests money to convert to net income Moreover, ROA ratio higher

is better because it proves that firm is earning more money with lower investment

- State is dummy variable that represents for central or government control, in discussing

of Deng et al., 2013, State is important variable reflect the link between dividend and investment

in cash flow uncertainty condition State takes the value of 1 for firms that have more than 50

percent of common shares owned by the government Otherwise is 0

- Size is represented by firm size Firm size is calculated by the natural logarithm of the

book value of total assets

- Leverage is represented by debt of firm, it is denoted by Lev It is included in the

regression model as a variable which represents for outside funds; it also reflects how much external fund from debt In this thesis, leverage is measured as total liabilities divided by total assets, it is denoted as Lev

Table 3.1: Variables definition

I_TA Investment in new

assets Investment divided by lagged total asset

Rank The level of cash

flow shortage

In this thesis, rank is estimated by cash flow shortfall (CashShort), cash flow volatility (CFVol), and there are 5 rankings for 984 observations

-

Extcash

External cash: Funds

is raised from outside

firms, include equity

financing and debt

External cash = Cash received from equity investment – Cash paid for equity investment + cash received from new loan and bond issuance – cash paid for debt, dividend, and interest + cash received from debt investment and dividend

+

CF CF represent for cash

flow from operating

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 Lagged total asset +

MB Market to book ratio 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑓𝑖𝑟𝑚

Book value of firm + ROA Return of Asset 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒

Total asset -

Size Represent for firm

size Nature logarithm of total assets +

Lev Represent for debt of

firm

𝑇𝑜𝑡𝑎𝑙 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 Total asset -

State Dummy variable A dummy variable is equal 1 if the firm is controlled by

the central or local government, and vice versa +

3.5 Econometrics framework

Ordinary least-squares (OLS), the fixed effect and random effect regressions are employed in this paper for empirical analysis and panel data regression

3.5.1 Ordinary Least Square estimation

Based on the method of Deng et al (2013), Ordinary least-squares (OLS) regression is applied This method is a technique that used to estimate the correlation between the different variables The simplest type of regression is:

3.5.2 Fixed effect estimation

Due to the omitted variable problem, the fixed effect method is considered:

The error of the linear regression model (vit) was separated into two components: uit

represent for the error term, αi represent for unobserved time-invariant and do not change over time, and the purpose of the fixed effect method is eliminating αi The FE method finds out the relationship between each individual and the dependent variable, each individual may or may not effect to the dependent variable The first assumption of FE model is that unknown intercept may

be correlated with the predictors, so it mean: E (vit׀xi, αi) = 0

In addition, the FE method does not include time invariant in the predictors, and invariant characteristics are unique for each individual So they do not correlate with other individual characteristics

time-Fixed effect model can be estimated by using least squares dummy variable model (LSDV) or using fixed effects estimator If var (αi׀xi) is constant then model become linear regression model and can be estimated by OLS

3.5.3 Random Effect estimation

Another method to solve the omitted variable problem is the random effect methods In the random effect, the unobserved effect does not correlation with included variables and the time-invariant variable is including in model The random effect model is:

Yit = βXit + α + ui + εit

Where:

α: The intercept that constant across individual

ui: The intercept that uncorrelated with predictor variables

εit: The error term

The error of the linear regression model was separated into three components: α, ui, and εit In particular, α is constant, uiis a deviation from α The random effect model can be estimated by Generalized Least Squares or Feasible Generalized Least Squares

3.5.4 OLS, FE, and RE, which one is better?

F - test and The Lagrange multiplier (LM) test are used to choose appropriate model

between OLS, the fixed effect method, and the random effect method

Firstly, F-test is applied to consider the rationality between OLS and the fixed-effect method The null hypothesis of F – test is all individual intercepts equal zero If p- the value of F tests less than significant level then the null hypothesis is rejected In other words, the fixed effect method is appropriate than the OLS Otherwise, the OLS is more appropriate

Secondly, The Lagrange multiplier (LM) test is applied to check the appropriate between the OLS and the random effect model Variance across individual equal zero is null hypothesis of

LM test If p – value is less than significant level then reject the null hypothesis It means the random effect model is more appropriate than the OLS

Hausman test is used to choose appropriate model between the fixed effect model and the random effect model In particular, the null hypothesis supposes that there are not the correlation between the error term and regressors The null hypothesis is rejected when p – value of Hausman test is less than significant level, in other words, the fixed effect model is appropriate Otherwise, the random effect model is chosen

3.5.5 Other tests

Due to multicollinearity, autocorrelation and heteroscedasticity issues, the paper will use VIF test, Breusch-Pagan test, White’s test, the Durbin-Watson test, and the Breusch – Godfrey test to detect the problems

Multicollinearity occurs when the model includes two or more control variables that are related with other control variables Multicollinearity does not reduce the reliability of the model but distorts the evaluations of the affected explanatory variables Multicollinearity can be classified into perfect and near perfect multicollinearity Multicollinearity problem causes an increase in standard errors of the regression coefficient As a result, multicollinearity makes variables become insignificant even they are actually significant In that case, it could lead to over-reject the null hypothesis Another problem associated with multicollinearity is that a little change in input data can lead to significant change in the regression results

Heteroscedasticity is another common problem that occurs in cross section data due to outliers problem or misspecification, etc Heteroscedasticity does not have an impact on the unbiasedness and consistency of OLS regression; however, if OLS standard errors are not corrected in the presence of heteroscedasticity, then it will cause estimators become less efficient and statistical inference become less reliable Breusch-Pagan test and White’s test are used to