Foreign capital flows and stock market – case study in vietnam for foreign investors’ decision of trading and their ownership

This paper aims to evaluate how firm’s characteristics affect to foreign investors in their investment both in buying and selling decision into listed firms in Vietnam stock market and t

FOREIGN CAPITAL FLOWS AND STOCK MARKET – CASE STUDY IN VIETNAM FOR FOREIGN INVESTORS’ DECISION OF TRADING AND THEIR OWNERSHIP

A thesis submitted to Vietnam – Netherlands Program in partial fulfillment

of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

Ngo Van Man

Supervisor

Dr Nguyen Trong Hoai

HO CHI MINH CITY, January 2013

ACKNOWLEDGEMENTS

I am not able to finish this thesis without the guidance of my supervisors and committee members, supports from my classmates and colleagues as well as motivation and sharing from my wife

I would like to express my very great appreciation to my supervisors, Dr Nguyen Trong Hoai and Dr Nguyen Xuan Thanh, for their patient guidance, enthusiastic assistance, valuable comments and suggestions as well during my research I also would like to take this change to thank Dr Nguyen Tan Thang for his ideas inspiring

me to pursuit this topic for my thesis I highly appreciate staffs of the Administration Department and Library of Vietnam-Netherlands Program and my classmates in providing me good environment , facilities and supporting me technically to complete the thesis

Finally, I would like to express my love and gratitude to my wife and colleagues for their understanding, supports, and encouragements to finish the research

TABLE OF CONTENTS

CHAPTER 1: INTRODUCTION 1

1.1 Problem Statement: 1

1.2 Research questions: 1

1.3 Research objectives: 1

2.1 Economic theories: 2

2.1.1 Definition of key concepts: 2

2.1.2 Relationship between foreign investor and firm characteristics 3

2.2 Related empirical studies: 5

2.3 Conceptual framework: 6

3.1 Research context: 7

3.2 Source of Data and its definition: 7

3.3 Research Methodology: 9

4.1 Descriptive Data Analysis 10

4.1.1 Summary of Data: 10

4.1.2 Correlation Matrix 13

4.2 Empirical Results: 13

4.2.1 For the whole sample : 13

(a) Firm characteristics and foreign investor’s buying volume: 13

(b) Firm characteristics and foreign investor’s selling volume: 14

(c) Firm characteristics and net purchase variable in relation to foreign investor’s ownership ratio 14

4.2.2 For specified industries: 15

(a) Finance Industry 15

(b) Construction Industry 16

(c) Manufacturing Industry 17

5.1 Conclusions 18

5.1.1 Empirical results 18

5.2 Policy recommendation: 19

5.2.1 For investors: 19

5.2.2 For companies: 19

5.2.3 For government authority: 19

5.3 Limitations and Further research 20

5.3.1 Limitations: 20

5.3.2 Further research: 20

REFERENCES: 21

APPENDICES: 24

LIST OF TABLES

Table 2.1: Summary of related empirical studies as following 5

Table 4.1:Description of variables of the whole sampled stocks 10-11 Table 4.2: The summary of value traded of the whole sample 11 Table 4.3: Percentage of FDI and Portfolio inflows over GDP in Viet Nam 12 Table 4.4: The summary of statistics by mean of each industry 12 Table 4.5: The coefficient signs between buy-volume with other variables 13 Table 4.6: The coefficient signs between sell-volume with other variables 14 Table 4.7: The coefficient signs between ownership ratio with other variables 14 Table 4.8: The coefficient signs for finance industry 15 Table 4.9: The coefficient signs for construction industry 16 Table 4.10: The coefficient signs for manufacturing industry 17

ABSTRACT

Foreign capital flow in empirical studies has recently recovered into the developing countries and emerging markets Their impact on growth of such countries has empirically increased and also created some negative temporary effects Foreign direct investment positive correlates to growth, meanwhile portfolio investment seems

to be negative correlated with it One of such effects through stock market is blamed for the crisis This paper aims to evaluate how firm’s characteristics affect to foreign investors in their investment both in buying and selling decision into listed firms in Vietnam stock market and to figure out their longer positions after that

Keywords: foreign investors, stock market, firm characteristic

CHAPTER 1: INTRODUCTION

1.1 Problem Statement:

Financial integration has so far benefited to not only source countries but also host countries One of those benefits is to increase in investment in which capital flows from the capital-abundant places to hosts especially in developing countries

As a matter of fact, in order to diversify risks in foreign investment as well as to cover the more often crisis in the global economy many hedge funds have also set up and operated to meet such trends Actually, portfolio investment inflows, together with foreign hedge funds, were blamed for the crisis

This paper aims to study the relationship between foreign investors’ investment decision and the stock market via volume of trading of foreign investors in Viet Nam specified to those stocks heavily traded by foreign investors Therefore, this paper also helps to provide investors both domestic and foreign investors an adequate understanding about types of companies attractive the foreign investor’s decision of buying or selling as well as their long term position via ownership ratio

1.2 Research questions:

The final purpose of this paper is to answer the following questions:

(i) Do foreign investor’s buying and selling decisions really focus on stocks of large companies with better profitability?

(ii) How do their buying and selling volume affect to their ownership ratio?

1.3 Research objectives:

The overall objective of this paper aims to evaluate which firm’s characteristics affect to foreign investors’ decision of selling and buying as well as to their ownership ratio for long term position Subsequently, the paper will further clarify them for each related industry

CHAPTER 2: LITERATURE REVIEWS

2.1 Economic theories:

2.1.1 Definition of key concepts:

(a) Foreign capital flows

Typically, foreign capital flows into the host countries especially into developing and emerging ones in three channels: foreign direct investment, portfolio investment and foreign debt Theoretically, foreign direct investment flows into two ways: Greenfield and Merge & Acquisition activities which have been significantly increased in emerging markets (World Economic and Social Survey 2005) Portfolio investment in other hand includes equity securities or debt securities in forms of bonds, money market instruments, and financial derivatives

Investors in country A could invest in country B or vice versa to seek for diversification in their portfolios in term of risk (balancing their portfolios) and expected (equity) return

(b) Foreign investment in relation to stock market

In many empirical studies, Foreign Direct Investment has also significantly and positively affected to domestic stock market development (Adam and Tweneboah) FDI which was found to be a complement of stock market development has positively correlated with market capitalization and domestic value traded (Claessens et al.,2001) Furthermore, along with the more global integration in finance market, foreign investment in portfolio investment has been empirically found increasing with its certain advantages such as a high mobility in flowing out and in markets as well as to reduce some existing limitations in the bond market in developing and emerging markets

In short, foreign investors always seek for investment opportunities In other words, foreign investment flows from firms with low investment opportunities to firms with high ones However, an average return of some types of investors’ portfolios appears rather differentiated in which some investors actually want to own stocks or firms for specified objectives such as their business relationship and control rather than a high investment return (Kim et al, 2005)

(c) Firm characteristics: Financially, analyzing firm characteristics concentrates on ratio analysis According to Ross et al (2005;2010), ratio analysis is often classified into following groups: Market value measures; Profitability Measures; Short term solvency or liquidity measures; Long term solvency measures; and asset management or turnover measures

The paper will mainly focus on four of five above groups including market value, liquidity, profitability and long term solvency measures Furthermore, the paper will also take account of dividend policy because this policy along with others will affect to firm’s ability to sustain growth (Ross et al.,2005;2010)

2.1.2 Relationship between foreign investor and firm characteristics

According to Baker et al (2009), FDI flows are much affected by components of stock evaluations which have been used to reflect mispricing specially in presence of capital account restrictions to limit arbitrage by portfolio investors

a) Relationship between foreign investor with market value measures:

Market capitalization has empirically a strong relationship with stock returns of foreign investors’ investment Due to redemption and liquidity requirement for foreign investment as well as to prevent systematic risk, foreign investors prefer large market capitalization firms

Some studies demonstrated that foreign investors tend to prefer large market capitalization and strong financial firms (Kang and Stulz,1997; Lin and Shiu,2001; and Kim et al.,2005) On the contrary, other studies show a negative relationship that on average, smaller-size firms get higher stock returns than large-size firms (Banz,1981; Keim,1983 and Basu,1983)

In regard to PB and PE ratio, some showed a negative relationship between PB ratio and stock returns ( Fama and French,1992; Daniel and Tittman, 1997) Hence, foreign investors can gain higher stock returns as they buy low PB stocks (Dhatt Kim and Mukherji,1999) On the contrary, others demonstrated that foreign investors prefer stock with high PB ratio (Lin and Shiu,2001 ; Kim et al.,2005; and Bae et al.,2011)

In regard to PE ratio, this is considered to be the single most important variable in determining a share’s price As a matter of fact, Basu (1977), Breen (1978) and Dreman

(1980a,1980b,1979) demonstrated that stocks with low PE ratio can gain a higher average returns than those with high PE ratio However, some recently empirical studies found that foreign investors tend to buy stocks outperformed and sell stocks underperformed relative to the market (Bae et al.,2011)

b) Relationship between foreign investor with Profitability Measures:

According to Kim et al (2005), there has been a positive correlation between foreign ownership and ROE ratio which was considered to be an important variable to foreign investors Similarly, Bae et al (2011) found that foreign investors traded stocks in Korean listed companies with high ROE and ROA ratio in which not only for the same current period but also for the subsequent period, their “buy” stocks have higher profitability than their “sell” stocks Furthermore, Kang et al.(2010) in studying firms listed on Korean Stock Exchange also demonstrated that corporate profitability measured

by the EBITDA has positively correlated with foreign ownership

c) Relationship between foreign investor with liquidity measures:

According to Kang et al.(2010), liquidity ratio has positively correlated with foreign ownership into Korean Stock Exchange listed companies However, Vo Xuan Vinh (2010) found that liquidity ratio has negatively correlated with foreign ownership for firms listed on Ho Chi Minh Stock Exchange

In other words, foreign investors seem to follow a buy and hold strategy for their long term position rather than for short term

d) Relationship between foreign investor with financial leverage ratio:

Many empirical studies revealed that foreign investors favor firms with low debt ratio (Kang and Stulz, 1997; Lin and Shiu,2001; Kang et al.,2010 and Vo Xuan Vinh, 2010) In other words, foreigners prefer firms with low leverage ratio as well Meanwhile, Bae et al.(2011) studied and found that firm leverage is not an important variable affect to foreign investor’s decision of buying or selling This is also consistent with the finding of Mishra and Ratti (2011)

e) Relationship between foreign investor with Dividend Policy:

Besides preferring large-size firms , foreign investors were found to prefer stocks with high dividend yield (Jeon et al., 2010; Mishra and Ratti, 2011 and Bae et al.,2011)

Meanwhile, Dahlquist and Robertsson (2001) found that foreign investors also prefer stocks of lower paid-dividend firms

2.2 Related empirical studies:

Table 2.1: Summary of related empirical studies as following table:

Authors Observations Dependent

Variables

Independent Variables

Research Method Key Findings

Firm’s characteristic

s

Panel data with random effect model

They prefer large firms with high PB ratio, low dividend yield

Firm size, PB ratio, ROE, average return

Fama–French three-factor mode

F.ownership positively correlated with firm size,

PB ratio and ROE

PE,PC,MKC, Price, ownership data

A standard linear model, Panel data with pooled model

Their buying, selling and net purchase have a positive relationship with firm size and negative relationship with PE ratio

Firm’s characteristic

s

A standard linear model, Panel data with Pooled model

Foreigners prefer large firms, firms with low PB,

or low leverage ratio

ROA,ROE, Debt ratio,

PE, PB, Dividend, CF⁄ Sales

three reference pricing models

They buy stocks with higher ROE and ROA than their selling, prefer stocks of large firms and high dividend yield

2.3 Conceptual framework:

All expected relationships among variables could be likely summarized as the following tables:

Table 2.2: Summary of expected signs:

Expected signs Buy volume Sell volume Ownership ratio

Current Ratio (times)

Quick Ratio (times)

SELLING AND BUYING VOLUME Net purchase

CHAPTER 3: RESEARCH METHODOLOGY

3.1 Research context:

Established and operated since 2000 for Ho Chi Minh Stock Exchange (hereafter HSX) and since 2005 for Hanoi Stock Exchange (hereafter HNX), role of stock market in mobilizing capital for the whole economy was very impressive and indispensable with their yearly percentage of the total volume over GDP as the following table

Table 3.1: Viet Nam Market capitalization

Vietnam stock Market capitalization (%GDP)

-% GDP Market capitalization of listed companies (current US$ mil.)

Source: Word Bank – Global Financial Data

3.2 Source of Data and its definition:

Firstly, the research will select data from 2007 to 2011 just because only from 2006 onward the total volume trading by foreign investors has significantly increased

Secondly, the paper will focus on listed stocks of three main industries in HSX and HNX as described above including Construction and Real Estate, Manufacturing and Finance and Insurance which have listed from 2007 backward and their market capitalization for finance industry over VND 100 billion (as of July 13, 2012) and reported the foreign trading generated This sample of more 98 listed firms and observed over 05 years will therefore turn out over 420 observations with their structure as following:

Table 3.2: the structure of industry in dataset(as of July 13, 2012)

Source: Author’s calculate on the data set

Firm characteristics:

(i) Market Capitalization (MKC): this variable is the market capitalization of each firm

at the year-end

(ii) Dividend paid (DIV): how much dividend actually paid to each shareholder

(iii) Price Book ratio (PB): A ratio of a listed firm’s book value to its market value It determines how the market prices a company relative to its actual worth and measured by market value divided its book value

(iv) Price Earning ratio (PE): a share price divided by earning per share

(v) Return on Equity (ROE): Net income divided by the book value of equity at year end

(vi) Return on Asset (ROA): An indicator to measure how profitable a company is generated from the invested capital (assets)

(vii) Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) This indicator is used to eliminate the effects of financing and accounting decisions and therefore to analyze and compare profitability among selected companies better

(viii) Ownership rate (OWN): measured how many percent of shares hold by foreign investors As required by Foreign Investment Laws the maximum room available for

foreigners to invest into each company is not higher than 49% This requirement affects

so much to foreigner’s decision of trading

(ix) Debt to Equity Ratio.(DEBT): defined by total liabilities divided total equity often

The estimated equation is a linear regression model as follows:

Yi,t = αi + X j, i , t β + εit (*)

In where:

- YI,t denotes buying, selling and ownership ratio for firm i at trading year t

- XJ, I, t presents the firm characteristic variables j of firm i at year t which are divided into stock characteristics including MKC, PB, P/E ratio, ROE, ROA, EBITDA , DEBT , C_Ratio, Q_Ratio or Dividend Yield

- αi are random individual-specific effects, β is a vector of our robust estimators; and ε

is a error term;

The paper will employ the panel data which have advantages over pooled data In order

to select the most appropriate models for specified samples, the paper will test all possible regression models including: Fixed-Effects Model (also called Least Squares Dummy Variable Model); Random-Effects Model (or Random Intercept, Partial Pooling Model); Pooled model or population-averaged model

After finalizing the appropriate model, to control for heteroskedasticity the option

“robust” will be employed in regression Finally, in order to detect the likely multicollinearity among variables the paper will use the variance inflation factor after regression model Such tests will be easily found in the appendix of this paper

CHAPTER 4: DATA ANALYSIS AND DISCUSSION

4.1 Descriptive Data Analysis

4.1.1 Summary of Data:

Table 4.1: Description of variables of the whole sampled stocks:

Source: Author’s calculate on the data set with Stata software

Market capitalization of the finance industry is the highest; the construction and manufacturing industry followed as the second and third of market capitalization In addition, stocks of construction field were priced at the highest mean value at 25 times, followed by stocks of finance and manufacturing at 15 and 11 times, respectively

In general, foreign ownership ratio at firms surveyed in three industries is not much different at 20% of both finance and manufacturing industry and 17% of the construction industry And the mean of debt ratio in the construction field is extremely high at 2.35 times followed by manufacturing and finance industry at 1.33 and 0.66 times, respectively