Capital structure and growth option evidence from vietnams stock market

In addition, this finding proves the existence of Pecking Order Theory in Vietnamese firms’ capital structure during this period because Vietnam has more financial constraints in getting

VIETNAM - THE NETHERLANDS PROGRAMME FOR M.A

IN DEVELOPMENT ECONOMICS

CAPITAL STRUCTURE AND GROWTH OPTION: EVIDENCE FROM VIETNAM’S STOCK MARKET

by Nguyen Cong Thanh

A thesis submitted in partial fulfilment of the requirements for

the degree of

Master of Art in Development Economics

Ho Chi Minh city, October 2017

VIETNAM - THE NETHERLANDS PROGRAMME FOR M.A IN

DEVELOPMENT ECONOMICS

CAPITAL STRUCTURE AND GROWTH OPTION: EVIDENCE FROM VIETNAM’S STOCK MARKET

by Nguyen Cong Thanh

A thesis submitted in partial fulfilment of the requirements for

the degree of

Master of Art in Development Economics

Academic Supervisor:

Dr Nguyen Vu Hong Thai

Ho Chi Minh city, October 2017

DECLARATION

I hereby declare that my dissertation entitled “Capital Structure and Growth Option: Evidence from an Emerging Market” is the result of my own work and includes nothing which is the outcome of work done in collaboration except as declared in the Preface and specified in the text

My dissertation is not substantially the same as any that I have submitted, or, is being concurrently submitted for a degree or diploma or other qualification in any other University or similar institution except as declared in the Preface and specified in the text

I further state that no substantial part of my dissertation has already been submitted, or, is being concurrently submitted for any such degree, diploma or other qualification at any other University or similar institution except as declared in the Preface and specified in the text

Date: October 10th, 2017 Signature

Full name: Nguyen Cong Thanh

ACKNOWLEDGEMENT

A successful thesis cannot be fulfilled without the unrelenting support of my dedicated supervisor, Dr Nguyen Vu Hong Thai, who has devoted all of his time, efforts, and energy to guiding me during the course of doing the thesis His dedication

is what makes me feel impressive when I have a chance to work with him, his friendliness is what makes me feel comfortable when I ask him some difficult questions, and his enthusiasm is what makes me feel energetic when I have difficulty in solving a problem in my research All of these leave me with the most unforgettable memory and experience My purpose of this acknowledgement is to express my inexpressible gratitude to my dear supervisor There is a good teacher, there is an excellent student

I would like to send my special thanks to Prof Nguyen Trong Hoai, Dr Pham Khanh Nam, Dr Truong Dang Thuy for their valuable command, guidance and support during the program Furthermore, I am extremely grateful to give Dr Nguyen Phuc Canh and Dr Tran Thi Tuan Anh all my best thanks from bottom of my heart for everything they have done to support me

Besides, my thanks are given to all of the lectures who have been my knowledge guiders and the staff who have been my service supporters throughout the master program at University of Economics and Erasmus University Rotterdam Without their help, never can I have an opportunity to proceed and complete my master thesis

The last but not least, I would like to thank Dr Tran Gia Tung, Pham Thi Anh Thu and Tran Le Khang who have always been a pillar for me to rely on during the hardships

of attempting to achieve the master thesis It is their unspoken sacrifice and untiring work that bring me more spare time to be able to reach the final destination of my progress

ABSTRACT

The research identifies the impacts of growth opportunities on capital structure of Vietnamese companies All of the listed firms on Ho Chi Minh Stock Exchange (HOSE) and Hanoi Stock Exchange (HNX) from 2008 to 2015 are included in the research data The regression methods for panel data including Pooled Ordinary Least Squared (POLS), Fixed Effects Models (FEM), Random Effects Models (REM), and System Generalized Method of Moments (SGMM) are used for the whole sample and two subsamples for the years after and during the financial crisis The results indicate that growth opportunities have significantly positive effects on leverage measured by both short-term and long-term debt over total assets Interestingly, the sign of this relationship remains unchanged in the pre-crisis and post-crisis In addition, this finding proves the existence of Pecking Order Theory in Vietnamese firms’ capital structure during this period because Vietnam has more financial constraints in getting the bank loans during the crisis, its legal systems are strictly controlled by the government or by state-owned enterprises, its law codes are too weak to protect the rights of shareholders and bondholders, and most of its firms are virtually comprised of small and medium enterprises

Keywords: capital structure, growth option, emerging markets, pecking order

theory, trade-off theory

JEL classifications: G31, G34

TABLE OF CONTENTS

CHAPTER 1: INTRODUCTION 1

1.1 Problem Statement and Significance of research 1

1.2 The Research Objectives and Research Questions 3

1.3 Structure of Thesis Design 3

CHAPTER 2: RELATED THEORIES AND LITTERATURE REVIEW 4

2.1 Overview of the related theories 4

2.1.1 Theory of irrelevancy 5

2.1.2 Trade – off theory 7

2.1.2.1 Static trade-off theory 7

2.1.2.2 Dynamic Trade-off Theory 8

2.1.3 Pecking order theory 10

2.1.4 The market timing theory 13

2.1.5 Theory of agency costs 14

2.2 Literature Review 15

2.2.1 Some previous review on trade-off theory and pecking order theory 15

2.2.2 Some previous studies on growth options and firm leverage 17

2.2.3 Some related literature in Vietnam 26

CHAPTER 3: METHODOLOGY AND DATA 30

3.1 Research Methodology 30

3.2 Research Data 32

CHAPTER 4: RESULTS AND DISCUSSIONS 35

CHAPTER 5: CONCLUSIONS 46

5.1 Remarkable conclusions 30

5.2 Limitation and further research 32

REFERENCES 47

Appendix 1 Table 4 Column 1 result 53

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LIST OF TABLES Table 1 Control variables definition 31 Table 2 Descriptive Statistics 33 Table 3 Correlation Matrix 34 Table 4 Estimated results using POLS with Total Debt to Total Asset represented

for Leverage 35

Table 5 Estimated results using POLS with Short-term Debt to Total Asset

represented for Leverage 36

Table 6 Estimated results using POLS with Long-term Debt to Total Asset

represented for Leverage 37

Table 7 Estimated results using FEM with Total Debt to Total Asset represented for

Leverage 38

Table 8 Estimated results using FEM with Short-term Debt to Total Asset

represented for Leverage 39

Table 9 Estimated results using FEM with Long-term Debt to Total Asset

represented for Leverage 40

Table 10 Estimated results using REM with Total Debt to Total Asset represented

for Leverage 41

Table 11 Estimated results using REM with Short-term Debt to Total Asset

represented for Leverage 42

Table 12 Estimated results using FEM with Long-term Debt to Total Asset

represented for Leverage 43

Table 13 Parameters Test, Hausman Test and Breusch & Pagan Lagrange multiplier

Test 44

Table 14 Estimated results using SGMM with Total Debt to Total Asset represented

for Leverage 46

Table 15 Estimated results using SGMM with Short-term Debt to Total Asset

represented for Leverage 48

Table 16 Estimated results using SGMM with Long-term Debt to Total Asset

represented for Leverage 50

ABBREVIATIONS

HNX: Hanoi Stock Exchange

HOSE: Ho Chi Minh Stock Exchange

POLS: Pooled Ordinary Least Squared

FEM: Fixed Effects Model

REM: Random Effects Model

SGMM: System Generalized Method of Moments

CHAPTER 1: INTRODUCTION

1.1 Significance of research

The relationship between capital structure and growth options is explained in two main theories including pecking–order theory and trade–off theory in the financial literature Specifically, an immense of studies have been done in order to examine the aforementioned relationship in the economic field of finance and capital analysis following these theories (for instance, see Adedeji (2002), Antoniou et al (2008), Antoniou et al (2008)) Actually, these empirical justify the capital structure and growth options under the light of trade–off theory and pecking–order theory have been taken in the context of developed countries such as US, Japan, UK, which have strong market disciplines, corporate governance and less agency problems (Harford et al., 2012)

Some recent studies consider these theories in the context of emerging countries such as China with the results favoring the existence of pecking – order theory For example, Chen (2004) discovers there has no persuadable explanation for the capital choices of the Chinese firms from the pecking-order and the trade-off model hypothesis derived from the Western Obviously, the capital choice decision of Chinese enterprises

is predictably followed a “new pecking-order” that includes long-term debt, retained earnings and equity One explanation is that China cannot access easily foundational assumptions supporting the Western countries Besides, negative correlations between profitability and leverage is found to be significant by Tong and Green (2005) Meanwhile, positive correlation is found to be significant between current leverage and past dividends as well as supports the pecking-order hypothesis over trade-off theory in Chinese companies Yao-hui and Yuan-lue (2007) employ independent variables which are arranged properties of ordered probit model, so once again the pecking-order theory

is appeared to be presented in Chinese companies Additionally, Ni and Yu (2008) examine if the financial structure of Chinese companies follows a pecking-order that is from debt to equity; especially, when they rise funds to invest firms’ projects, they find

no evidence related to Chinese companies follow a pecking-order Importantly, they indicate that big companies follow a pecking-order whilst small and medium ones do

not that lead to suggestion that the Chinese capital market is under development precisely

Moreover, the turbulences of the 2008 global financial crisis have revised the attention to the relationships between growth options and financial leverages in emerging markets, especially in a small one such as Vietnam, which is suffered from a hardship period from 2008 to 2012 with many cases of firm’s bankruptcy and problem

in banking system (Vo and Nguyen, 2014) In addition, the stock market of Vietnam has been developed from the beginning of 2000 (Vo and Nguyen, 2016), which creates new channel for Vietnamese firms in choosing funds for their projects besides the loans from commercial banks as the traditional way, as a consequence, the behaviors of Vietnamese firms may be impacted Therefore, this study fills the gap of financial literature by clarifying the relationship between growth options and financial structure

of Vietnamese firms during the period of 2008 – 2015

In summary, this study will examine the impacts of growth option on capital structure of Vietnamese firms during the period of 2008 – 2015 with many sophisticated problems in Vietnam First of all, the period of 2008 – 2015 sees the high turbulences

in Vietnamese banking system with the problem of bad debt and other problems This fact creates more financial constraints for Vietnamese firms in getting bank loans Secondly, the wide disparity between governing firms' operations and legal systems specially the intervention of Vietnamese government and the presence of government

in the economy through the state-owned enterprises Next, the Vietnam law system is still weak to protect the rights of shareholders and also bondholders which creates the asymmetric information problem Finally, almost the Vietnamese firms are still in small and medium sizes according to the world’s standardized view The most important feature is the low development of equity market and especially bond markets which limits the options of firm managers in managing their capital structure Therefore, this study states that the significant low development of equity and bond markets, the presence of asymmetrical information, the financial constraints from getting bank loans and these mentioned problems in Vietnam are the conditions for the presence of the pecking–order theory when explaining the capital structure of Vietnamese firms In addition, after 4 years from the beginning of the global financial crisis in 2008, the

Vietnamese economy has a sign of the recovery in corporate sector, banking sector, and the overall economy Hence, the relationship between growth options and the capital structure may be influenced

1.2 The Research Objectives

in the economy through the state-owned enterprises

Third, the Vietnam law system is still weak to protect the rights of shareholders and also bondholders which creates the asymmetric information problem

The most important feature is the low development of equity market and especially bond markets which limits the options of firm managers in managing their capital structure

=> These mentioned problems in Vietnam are the conditions for the presence of the pecking–order theory when explaining the capital structure of Vietnamese firms In this case, it is the pecking order theory that can lead to the positive relationship between growth option and leverage; therefore, the study identifies whether this relationship is true for the case of companies in Vietnam It is the underlying motivation for this study

And base on this problem statement I come out with three research questions:

 Is the relationship between growth opportunities and capital structure positive?

 Is the impact of growth option on capital structure linear or non-linear for Vietnamese firms?

 Is this effect different in the two period during and after the financial crisis?

1.3 Structure of Thesis Design

This study firstly estimates the relationship between growth options and financial leverages of Vietnamese firms, then I divide the data into two sub-periods: the period from 2008 to 2011 which presents for the period of crisis, and the period from 2012 to

2015 which presents for the period of post – crisis The rest of this study is organized

as following manners Chapter 2 presents some related theories and previous literature review on the relationship between growth options and financial leverage following the pecking – order and trade – off theory Chapter 3 presents the data and methodology Chapter 4 shows the estimation results and discussions The final chapter gives some remarkable conclusions and discuss limitation of the study

CHAPTER 2: RELATED THEORIES AND LITTERATURE REVIEW

2.1 Overview of the related theories

Since the introduction of the Modigliani and Miller's “Irrelevance Hypothesis”, capital structure has gained its popularity in analysis (Modigliani and Miller, 1958) Based on this work, Damodaran (1999) refers capital structure as the proportion distributed between the shares of assets processed by inside and outside investors Thanks to the research on the cost of capital, funds of partnerships, and investment, capital structure stands still for a very long time (Ibrahimo and Barros, 2009) Moreover, the fundamental masterpiece of Modigliani and Miller (1958) shows that when the economic situations are immaculate and rearranged, the creators infer that capital structure is insignificant to the assurance of the partnership esteem, from which a new skyline of hypothesis has been created and incorporated thoughts of genuine economic situations and the operators of conducts (Kayo and Kimura, 2011, Bastos et al., 2009)

Along the way of development arose three noteworthy categories of capital structure’s theories which veer from the presumption of faultless capital markets to the approach of an imperfect ones First is Trade-off Theory, which indicates the exchange between the benefits and costs of obligations on the firms’ financing to optimize capital structure in the presence of defects in the business sector such as taxes, insolvency expenses, and floatation costs Second is Pecking-order Theory given by Myers (1984), which suggests the financing hierarchy of an organization in order to limit the issue of information asymmetry between inside managers and outside shareholders Third is Market Timing Theory proposed by Baker and Wurgler (2002), which expresses the formation of the capital structure as the past endeavors of firms to time the market This theory holds that companies will issue new shares to the market when they find that the market price for their shares are overpriced and repurchase its shares when they consider that their shares are underpriced Although the interest in Market Timing Theory has been settled down, this theory still demonstrates that the impact of market timing on capital structure is exceptionally distinguished

There is some previous empirical research of joins the approaches of the three capital structure theories

 The decisions on the capital structure at the cross-section level

 The determinants of the capital structure over time

 The studies investigating the consequences of indebtedness at the corporation’s scope (Parsons and Titman, 2009)

The polarization on the conventional points of view between Trade-off Theory and Pecking-order Theory has paved the way for the development in the methodology

of the capital structure through utilized factors, analyzing models, and inspecting qualities (Graham and Leary, 2011)

The disagreement among these hypotheses in the field of corporate finance gives

an opportunity for researchers around the world to synthetize literature reviews and extend the examinations Lately, endeavors in writing about capital structure were attempted, in which the explorations by Tudose (2012), Graham and Leary (2011) as well as Parsons and Titman (2009) were highlighted After the presuppositions of Modigliani and Miller (1958), the theories that energize the examination with respect

to the decisive components of corporate capital structure were Pecking-order Theory and the Trade-off Theory (Myers, 1984, Graham and Leary, 2011), These speculations bring the development of other critical components to the examination of financing in

an organization:

 The influence of income tax in financial expenses (Myers and Turnbull,

1977, Myers, 1977)

 The cost of bankruptcy (Titman, 1984)

 Agency costs (Jensen and Meckling, 1976)

 Asymmetric information (Stulz, 1990)

 The firm’s prioritization on the source of funds (Myers and Majluf, 1984)

2.1.1 Theory of irrelevancy

Irrelevance Capital Structure Theory, introduced by Modigliani and Miller (1958) (M&M theory), is viewed as the development of capital structure (Damodaran, 2002, Graham and Harvey, 2001, Feld et al., 2013)

The creative point of view of the creators restricted customary that expected an incredible significance to financing as indicated by the distinctions in variety of cost of value and diverse levels of obligations (Myers and Turnbull, 1977, Myers, 1977) The formalization of the traditional thinking before M&M can be proved by the work of Durand (1952) that creators are viewed as a pioneer in the investigations of capital structure (Santosa and de Moraes Farinellib, 2015)

The suggestions of M&M were dissected First is the consideration of a monetary situation without tax assessment on income and with full market effectiveness (Kayo and Kimura, 2011) Thoughts under these suggestions prompted to the conclusion that the estimations of an enterprise cannot be related to the costs of obligations, especially, obligation approaches (Ibrahimo and Barros, 2009)

Therefore, the estimations of an association ought to speak to the estimations of its benefits by ascertaining the estimations of free money streams in a manner that the increments in obligations do not have an impact on weighted marginal cost of capital (Damodaran, 2002) Keeping in mind that the lasting goal is to bolster the preface of insignificance M&M exhibited that the obligation costs will not differ in the view of the measurement However, if it happens by chance, there would be a plausibility from outer gatherings By the way, the costs of value would have a positive and direct connection with the level of obligations Thus, in the view of budgetary hazard, accepting an outsider in order to raise equity has a cost of capital lower than the value

of the capital, and this would bring about a higher net value (Modigliani and Miller, 1958)

After assessing the model, M&M presented another paper in 1963 perceiving the significance of the deductibility of money related costs in the computation of wage assessment (Modigliani and Miller, 1963) Be that as it may, the premises related to the ideal market and the objectivity of specialists were condemned in the earlier decades,

and they brought in the development of Trade-off Theory and Pecking-order Theory (Ibrahimo and Barros, 2009)

2.1.2 Trade – off theory

The term trade-off theory is employed by various researchers to portray a group

of related theories In this hypothesis, a manager managing a firm identify the different costs and benefits of arranged options Frequently, an inside preparation is expected to

be acquired so that minimal expenses and negligible advantages are adjusted The first form of the trade - off theory became out of the open deliberation over the Modigliani-Miller hypothesis At the point, when corporate salary duty comes to an excess, this made an advantage of obligations in that it served to avoid expenses Since the company's target is straight and there is no optimal expense of obligations, this inferred 100% obligations for financing

Initially, the objective is not specifically discernible, but it might be credited from confirmation Therefore, diverse papers include the structure in various ways (Campbell and Kelly, 1994, Hackbarth et al., 2007, Ju et al., 2005, López-Gracia and Sogorb-Mira,

2008, Hovakimian et al., 2011) Second, the obligation is considerably more intricate than what is expected by the hypothesis Contingents, upon which components of the expense code, are incorporated, and diverse conclusions with respect to the objective can be instilled Graham (2003) gives a helpful survey of the writing on the assessment

of the impacts Third, insolvency costs must be incurred instead of exchanges starting with one obligation requirement and then the next one The way of these expenses is essential as well Haugen and Senbet (1978) give a valuable discourse of insolvency costs Fourth, exchange costs must take a particular shape for the examination to work For the conformity, to be as slow as opposed to what is unexpected, the peripheral costs

of alteration increase when the alteration is bigger Leary and Roberts (2005) portray the ramifications of options of alteration cost suspicions

2.1.2.1 Static trade-off theory

The static trade – off theory states that firms have an optimal capital structure, which they can figure out by trading off the costs against the benefits of obligations and value One of the advantages is the upside of an obligation for tax shield One of the

disservices of obligations is the cost of potential money-related trouble, particularly when the firm depends on an excessive number of obligations As of now, this prompts

to a trade – off between the tax break and the detriment of higher danger of related trouble Be that as it may, there are more costs and advantages required together with the utilization of obligations and value Another real cost comprises of organizational expenses Organizational costs originate from the irreconcilable circumstances between the diverse partners of the firm and due to asymmetric information (Jensen and Meckling, 1976, Jensen, 1986) Hence, integrating organization costs into the static trade – off theory implies that a firm decides its capital structure by trading off the expense preferred standpoint of obligations against the expenses of budgetary pain of a lot of obligations and the office expenses of obligations against the office costs of value Numerous cost components have been recommended under the trade – off theory, and the theory would prompt far to examine them all As a result, this examination is in line with the confirmation that a vital expectation of the static trade – off theory is that organizations pay attention to their capital structures For instance, in case that the real proportion strays from the one considered ideal, the firm will regulate its financing practice to reach the ideal capital structure

money-2.1.2.2 Dynamic Trade-off Theory

Dynamic models perceive that time determines various perspectives that are normally disregarded in a single-period model Out of the specific significance are the desires and alteration costs In a dynamic model, the appropriate financial choice relies

on the financing margins that the firm is still doubtable in the following timeframe Some companies desire to pay out funds in the following timeframe, while others hope

to raise funds On the off chance that assets are to be raised, they may appear as obligations or value By and large, a firm embraces a blend of these activities An essential forerunner to modern dynamic trade-off theories was Stiglitz (1973), who looks at the impacts of the assessment of tax from an open fund

The very first dynamic trade – off model considering the tax savings in comparison with insolvency costs was built by Kane et al (1985) & Brennan and Schwartz (1984) Both broke down constant time models with instability, taxes, and insolvency costs but

no exchange costs Since firms respond to unfriendly stuns quickly by re-adjusting

cost-less, firms keep up abnormal amounts of obligations to exploit the tax advantages Dynamic trade-off models can likewise be utilized to consider the alternative aspects instilled in conceding choices to the following timeframe Goldstein et al (2001) show that firms with low leverage today have the resulting alternative to expand the leverage Under their presumptions, the alternative to build up the rate of leverage that then is served to lessen the generally ideal level of leverage at present

Strebulaev (2007) investigated a similar model to Fischer et al (1989) and Goldstein et al (2001) Additionally, if firms are held back intermittently due to the transaction costs, then almost all firms with obligations will veer off from the ideal capital structure In the model, the company's capital structure reacts less in the short-run and more in the long-run Certain opinions are genuinely wide in element models The suitable monetary decision at present depends on whether the capital structure is considered ideal in the following timeframe In the following timeframe, it might be ideal to rise subsidies or to pay them out If new subsidies are raised, it may be ideal to bring in them under obligations or value For each situation, what is relied upon to be ideal in the following timeframe will bind the applicable correlation for the firm in the present timeframe

A significant part of the work on dynamic trade-off models is genuinely late Thus, any judgments on their outcomes must be to some degree provisional This work has now generally adjusted our comprehension of mean inversion of the part of benefits, the part of retained income, and the way of reliance Subsequently, the trade-off theory now has the characteristics of encouragement than it used to be even only a couple of years in advance

Trade - off Hypothesis expresses that enterprises ought to go for a capital structure that is high in obligations, which would conform to the likelihood of finding a level where the cost of capital is limited (Hovakimian and Li, 2011) An association that does not have any significant bearing outsiders' capital in the synthesis of its capital structure would exhibit a cost of subsidizing equivalent to the net substance esteem (Damodaran, 2002) In the supposition of outsiders" capital, its weighted average cost of capital (WACC) will diminish as the tax reduction lessens the powerful costs of obligations and by the assumption that the outsiders cost of capital is lower than the capital value

The partnership would substitute a costlier source of fund to a less expensive one (Wu and Yue, 2009)

Consequently, there would be a restrain, because of the likelihood of insolvency costs (Graham and Harvey, 2001) These expenses are pondered by the rates of giving back that are required by the loan bosses and financial specialists in the view of the monetary and corporate attributes of the business and market liquidity (Forte et al., 2013)

Insolvency costs happen at various stages To start with, they are related with the association's low liquidity, which requires more noteworthy contributions of here and now advances, punishment installment and default premium and costs with transaction with lenders, providers and loss of market certainty At a later stage, insolvency costs comprise of legitimate charges, misfortunes from offers of settled resources, loss of customers and income, diminishment in the operational cycle and, with in a roundabout way, the expansion in working capital and connections amongst shareholders and the market (Damodaran, 2002, Kayo and Kimura, 2011, Titman, 1984)

2.1.3 Pecking order theory

The Pecking-order Theory does account for an optimal capital structure at the beginning stage However, it rather states the exact reality that organizations demonstrate a particular inclination for utilizing the interior over outside fund If interior assets are not sufficient to fund venture openings, firms might procure outer financing

If they do so, they will pick among the diverse outside back sources so as to limit extra expenses of awry data The final expenses essentially imitate the “lemon premium” (Akerlof, 1970) that outside speculators request the danger of disappointment for the normal firm in the market The subsequent pecking request of financing is as per the following: inside created finances initially, trailed by separately generally safe obligation financing and share financing

Myers and Majluf (1984) hold that rational investors may discount the firm’s stock price when managers use equity but not debt in the capital structure To avoid this problem, the firms’ managers often limit the use of equity to the minimum level They predict that those who adopt Pecking Order Theory are restored to internal funds first,

then risky debt, and finally equity Without investment opportunities, firms use retained profits and set up financial slack to get away from the fact that they have to raise external finance later in the future According to the theory, the market-to-book ratio is considered as the measure of investment opportunities (Myers and Majluf, 1984) Based

on these explanations, Myers (1984) & Fama and French (2000) suggest that the static Peking Order Theory fails to interpret the relationship between the market-to-book ratio and capital structure This theory also proposes that the debt capacity will be pushed to the high levels with the increase in investment opportunities To some extent, high past investment goes hand in hand with high previous market-to-book ratio Nevertheless,

in these periods, the financial leverage is kept at a lower level The two theories are virtually supported by the empirical evidence and are deemed as the best predictors for capital structure (Shyam-Sunder and Myers, 1999, Fama and French, 2002) (Shyam -Sunder and Myers, 1999; Fama and French, 2002)

Myers and Majluf (1984) state that outside financial specialists sanely make the company's stock cost reduce when directors issue value rather than riskless obligation

To maintain a strategic distance from this rebate, directors keep away from the value at the point that they can conceive Myers and Majluf (1984) predict that administrators will follow a pecking request, spending inside assets to begin with, then spending hazardous obligation, lastly turning to value Without speculation openings, firms hold benefits and develop monetary slack to abstain from rising outside fund later on The pecking order hypothesis considers the market-to-book proportion as a measure of speculation openings On account of this interpretation, both Myers (1984) & Fama and French (2000) highlight that a contemporaneous relationship between the market-to-book proportion and capital structure is hard to accommodate with the static pecking request display Emphases of the static form likewise recommends that times of high venture openings will tend to push use higher toward an obligation limit If high past market-to-book ratio really agrees with high past venture, in any case, comes about propose that such periods tend to push use lower Observational proofs supported both the pecking order and the trade – off theory Exact tests to see whether the pecking-order theory or the trade - off theory is a superior indicator of capital structures bolster

both speculations of capital structure (Shyam-Sunder and Myers, 1999, Fama and French, 2002)

Pecking Order Theory, made by Myers and Majluf (1984), is created through the fundamental hypothesis related to the asymmetry of data, which recognizes that chiefs have distinctive data with respect to the organization’s points of view than the financial specialists can afford Moreover, data asymmetry in this way does not permit the speculators to access the genuine estimation of the association (Graham and Leary, 2011) On the contrary to Trade off Theory, Pecking Order Theory proposes that associations don't seek after an incredible level of obligations and that capital structure

is a combined consequence of the progression of inclinations of subsidizing all through time (Damodaran, 2002) The request of inclinations of the sources or progression of capital takes after the commence that associations have as primary sources of assets as they held in their income, are free from exchange costs, and depend on obligations and the issuance of shares in a specific order only if the necessities of speculation are better than the collection of retained benefits The consequence of these presumptions is that the appropriation rate of the profits that ought to be kept at sensible levels must keep away from the weariness of retained income (Kayo and Kimura, 2011)

The hesitance to issue new shares is expected, for the most part, to be estimated

by the market because of the asymmetry of data between the potential financial specialists and association's directors in connection to money streams anticipated from the association's benefits This asymmetry would make the company loss an incentive for the present shareholders if another share issue was affirmed as new valuations would not be accurately considered by the market, bringing on a sub assessment of the new shares and an exchange from the old to new shareholders (Graham and Harvey, 2001)

A harmony amongst value and outsiders' capital happens when the estimation of assessment impetuses of the obligation coming about because extra interests are precisely repaid by the extra expenses of conceivable monetary troubles Along these lines, the associations ought to substitute the value capital for outsider capital and the other way around expecting to expand its esteem and discover an aimed capital structure (Parsons and Titman, 2009)

2.1.4 The market timing theory

The market timing theory argues that organizations know the time to issue new stocks when the stock cost is overvalued and buy back possessed offers when it is undervalued Subsequently, variances in stock costs influence firms’ capital structures There are two forms of value market timing that prompt to comparative capital structure flow The main expect financial operators to be normal Organizations are hoped to issue stocks specifically after a positive situation which lessens the asymmetric problem between the company's administration and stockholders The abatement in information asymmetry corresponds with an expansion in the stock cost Accordingly, firms make their own planning openings

The second theory accepts the monetary operators to be unreasonable (Baker and Wurgler, 2002) Because of nonsensical conduct, a period of mispricing of the supply

of the organization follows Administrators issue stocks when they trust its cost is substantially low and buy back when they trust its cost is nonsensically high Knowing that the second form of market timing does not require that the market really be wasteful, it doesn't ask chiefs to effectively anticipate stock returns The suspicion is essential that supervisors trust that they can time the market In a review by Graham and Harvey (2001), administrators conceded attempts to time the value market, and the vast majority of those considering the issue of basic stocks reports that "the amount of value that the stock is underestimated or overestimated" was a critical thought This review bolsters the supposition in the market timing hypothesis is that supervisors trust they can time the market However, it does not quickly recognize the mispricing and the element awry data form of market timing Baker and Wurgler (2002) confirm that market timing persistently affects the capital structure of the firm They characterize a market timing measure, which is a weighted normal of outside capital needed in recent years The utilized weights are market to book estimations of the firm They find that changes are emphatically and decidedly identified with their market timing measure, so they reason that the capital structure of a firm is the combined results of past endeavors

to time the market

2.1.5 Theory of agency costs

The theory of agency costs or theory of agency was combined from the paper of Jensen and Meckling (1976) By this hypothesis, surprisingly, it was referred to the fact that organization issues are brought about by irreconcilable circumstances that are introduced in all business exercises among people in various levels of circumstances between the fundamental party and the specialist (Paligorova and Xu, 2012) In the investigation of Jensen and Meckling (1976), two types of organization expenses were distinguished Specially, the first is named agency cost of equity capital and alludes to the irreconcilable circumstance among administrators and shareholders, in which directors settle choices in light of their own advantages but do not boost shareholders’ rich The second type of agency cost of debt, produced by the contention among debtholders and shareholders principally in circumstances of money related troubles, where the shareholders tend to self-respect and substitute generally safe speculations for higher hazard interests Keeping in mind, the lasting goal is to acquire a more noteworthy return rate, regardless of the possibility that it influences the association's esteem This practice expands default hazard However, the shareholder hazard is partitioned with the debt holder (Damodaran, 2002) As for Harris and Raviv (1991), the agency costs hypothesis can be conclusive in the capital structure of the enterprise, and it has been a standout among the most essential devices in looking at the suggestions about hierarchical financing As needs be, office expenses can change for each phase of organization’s life cycle in which writing focuses on two circumstances:

 When there is over-investment, the ordinary circumstance exists in solidified and money producing companies in which representatives can accept ventures of lower net present esteem (NPL), and

 Under-investment when the administration doesn’t execute activities of financial feasibility because of hazard and lack of possessed assets (Wang,

2011, Damodaran, 2002)

2.2 Literature Review

2.2.1 Some previous review on trade-off theory and pecking order theory

Capital structure remains one of the core issues in financial management of corporations and tends to draw much attention from researchers, especially after the work of Modigliani and Miller (1958) The related literature has advanced to a great extent in explaining the factors that are crucial to financial leveraging decisions Among the proposed theories, two major ones stand outs, including Pecking order theory and Trade-off theory that suggest a number of important determinants for the corporate capital structure

Trade-off theory: As per predictions of trade-off theory, firms have unique leverage ratios resulted from the process of balancing benefits and costs of debt that help firms achieve their highest value Initially, the benefits include interest deductibility, whereas costs involve bankruptcy risks Later, additional benefits have been added to the research framework which is the capability of reducing agency costs arising from free cash flow (Jensen, 1986) Meanwhile, other additional costs are also taken into consideration: underinvestment (debt overhang) for firms with precious growth opportunities (Myers and Turnbull, 1977, Myers, 1977) and asset substitution problem (Jensen and Meckling, 1976)

Trade-off theory can be considered as a focal theory in the field of capital structure due to its strong performance in empirically explaining capital structure versus other theories (Smart et al., 2007) Besides “still” pictures, this theory also depicts firm’s existing capital structure as a result of the adjustment of capital structure towards its optimal ratio, or a dynamic process

Frank and Goyal (2009) suggest that this theory only explains part of financing decisions of firms Other studies focusing on the adjustment of capital structure of firms like Fama and French (2002) & Shyam-Sunder and Myers (1999) indicate the significant yet low power in explaining capital structure adjustment towards its optimal ratio, which suggests that trade-off theory is only partly valid

Empirically or in practice, it is difficult to measure costs and benefits of debt financing, rendering the application of this theory a challenging task Besides, even

when firms can establish their optimal structure rightfully, the ratios may change from time to time (Brigham and Ehrhardt, 2013), so firms will have to identify new optimal ratios What is more, most studies point out the negative relationship between firm profitability and leverage, which obviously violates what is predicted by trade-off theory

Pecking – order theory contends that when firms wish to seek financing for their projects, internal sources like retained earnings will be utilized first If this type of source cannot meet the demand then firms will draw external resources, with priority given to debt and then equity This is due to the problem of information asymmetry, which tends to be highest in the case of equity and then debt and the lowest for internal financing source (Myers and Majluf, 1984, Myers, 1984)

In the face of information asymmetry, managers can take advantage of the valuation of their stocks and sell them to the market However, investors can anticipate this opportunism and discount the firm’s risky securities accordingly In turn, since managers are aware of deep discounts for their stocks, they may just ignore profitable investment opportunities, so it amounts to the distortion of investment decisions (Fama and French, 2002) Myers (1984) also states that if internal funds are larger than investment needs, then firms will pay off debt or invest in stocks, implying that firms with and without capital surplus behave in different ways with regard to financing decisions According to pecking-order theory, concern about optimal leverage as stated

over-in the trade-off model is not crucial

In summary, the pecking order hypothesis voices the non-existence of an optimal leverage, and instead firms will have the following preferences:

 Internal funding is most preferred

 Firms will pay target dividends according to the investment opportunities available

 If external financing is unavoidable, firms will issue debt, then convertible bonds, then equity as the final resort

Even though Pecking Order Theory helps explain some aspects of firm financing decisions, this theory fails to uncover several leverage-related issues For example,

Pecking Order Theory cannot explain the impact of tax, bankruptcy cost and stock issuance costs… (Smart et al., 2007) Moreover, Pecking Order Theory has not addressed the agency issue when firms have too much financial slack

2.2.2 Some previous studies on growth options and firm leverage

Growth options have been considered as a crucial determinant of firm leverage under both Trade-off and Pecking order theory Empirically literature finds both negative and positive links between this factor and firm leverage, with the former being more of conventional findings The explanatory power of growth options, which are often put the proxy by market-to-book ratio, tend to vary according to different research contexts and cannot reach a universally established relationship with firm leverage

Myers (1977) utilizes the concept of agency costs between bondholders and shareholders to explain the role of growth options in leverage decisions Accordingly,

a highly leveraged company could find a potential investment opportunity futile since embarking on this project is just a wealth transfer from shareholders to bondholders Therefore, firms with valuable sets of growth opportunities tend to employ less debt

On the other hand, firms can rely on debt, especially short-term debt, to mitigate potential agency conflicts between managers and shareholders (Stulz, 1990) This is due

to the fact that debt forces firms to pay in cash, which limits managerial abilities to conduct suboptimal operations Shareholders of firms with poor investment options may want their firms to take on more debt to preclude managers from overinvesting in unproductive projects at the shareholders’ expense On the contrary, for firms with potential growth prospect, the owners may want less leverage so as to avoid high risk

in financing the coming projects

Growth options could affect optimal leverage via the trade-off between tax benefits of interest deductibility, reduction of agency costs by reducing free cash flow and underinvestment costs for firms with potential growth opportunities (Lin, 2015) To

be specific, when growth options increase in value, tax benefits of debt deductibility reduce, while costs related to underinvestment problem increase On the other hand, the motivations to deal with agency issues via debt financing will be weakened because expected free cash flows will fall due to high demand in investment financing Besides,

Market Timing Theory argues that if a company is aware of the over-valuation of its stocks (high market-to-book ratio), then chances are that managers are inclined to raise fund via issuing equity Consequently, both trade-off theory and market timing theory come to the same anticipation that firms with higher value of growth opportunities are more willing to issue stocks than to borrow, and so growth options will have negative relationship with the amount of debt firms employ

Additionally, Pecking Order Theory predicts that for firms with higher growth options (investment opportunities), internal funds will soon be too constrained to match financing needs External debt is to be called for in such cases As per prediction by Pecking Order Theory, given the same profitability level, firms that have higher growth opportunities have to take up more debt

Another aspect of role of growth options is firms’ reactions when it realizes a growth option Conventionally, Tradeoff Theory suggests that firms that exercise growth opportunities have lower expected bankruptcy likelihood, thus lower bankruptcy costs Therefore, firm target leverage should be increasing Also, the same prediction can be sought under Pecking Order Theory since it predicts firms will use up internal funds, then debt and finally equity if any This is because as mentioned earlier, the cost associated with information asymmetry when issuing equity is highest, next is debt and finally internal source Purnanandam and Rajan (2016) argue that both explanations from these two theories are incomplete and propose a model that shows that firms use less debt as they exercise their growth options Empirically, the authors conduct tests that employ capital expenditures as a proxy for growth option exercise The results strongly back up their theoretical argument

Purnanandam and Rajan (2016) claim that the decrease in leverage when firms exercise their growth options is due to the decrease in information asymmetry related

to the firm itself This in turn helps with the reduction in costs of issuing stocks, the most expensive source of funds under information asymmetry hypothesis Consequently, exercising growth options are bound to facilitate a reduction in debt Grenadier and Malenko (2011) also find that the option exercise conveys information about the projects themselves, which is strongly consistent with the findings by Purnanandam and Rajan (2016)

Researchers have carried out tests of static trade-off theory, and the overall results seem to be in line with the hypothesis Studies have empirically tested static trade-off theory and the results generally show that market to book ratio (a common proxy for growth opportunities) tends to have negative but weak relationship with leverage (Bradley et al., 1984, Fazzari et al., 1988, Harris and Raviv, 1991, Barclay et al., 1995, Barclay et al., 1997) Bradley et al (1984) show that industries associated with high growth options tend to have low market leverage Rajan and Zingales (1995) extend this analysis to show that the negative relation between market leverage and market to book ratio is negative and significant across 7 different countries Antoniou et al (2008) find that for both market-oriented (UK and US) and bank-dominated economies (France, Japan and Germany) leverage ratios are positively related to asset tangibility and firm size, but negatively related to growth opportunities and profitability

Booth et al (2001) examine the effectiveness of trade-off and pecking-order theories in 10 developing countries Results show that the macro-economic characteristics of each country affect the capital choice, but the overall trend is more profitable firms use less debt, consistent with the prediction under pecking-order theory The growth factor in this study is measured by market-to-book ratio, and the result indicates weak effects of growth options towards leverage When country factors are not considered, the growth options are negatively related to leverage but the effect vanishes as country dummies are added into the regression

Deesomsak et al (2004) investigates the determinants of firm leverage in the Asia Pacific namely Thailand, Malaysia, Singapore and Australia Research results suggest that firm leverage decision is influenced by the macro-characteristics of the country in which firms operate, together with firm-specific factors Besides, the 1997 financial crisis also has a profound by varied impacts on firm leverage across the region The growth factor in this study is measured by difference between book value of total assets minus book value of equity plus market value of equity, all divided by book value of total assets Results suggest that growth opportunity has different roles in different countries Firms in Thailand growth have no significant effects after crisis, while for Malaysian firms, this factor is significant in the post-crisis The authors argue that

Malaysian firms with growth opportunities tend to use less loan in the post-crisis since they could generate more internal funding than their Thai counterparts

Frank and Goyal (2009) probe for consistent and reliable factors of capital structure using data of US firms from 1950-2003 The authors come up with 6 factors, including market to book ratio, a common proxy for growth options The study shows that the factors that have highest explanatory power are median industry leverage, market to book ratio, profitability, firm size, expected inflation and tangibility Additionally, it is documented that firms that pay dividends tend to use less debt However, when using book leverage, firm size, inflation, and market-to-book ratio are

no longer reliable So, the overall evidence tends to give favorable support for trade-off theory

Awan et al (2010) show that for the sample of 110 Pakistani firms during

1982-1997, positive relationship between firm leverage and growth is captured The link is exceptionally significant for low and median growth opportunities The authors offer some explanations: owners of those firms may deem growth options risky and try to transfer the risk to debtholders

Chen (2004) use a sample of 77 firms listed on stock exchanges in China to study leverage determinants The results show that firm profitability and size have negative relationship, while growth rate and fixed assets have positive relationship with leverage Besides, the authors emphasize that Chinese companies in general use more short-term debt than firms in developed economies Finally, Chen (2004) contends that pecking order theory has better explanatory power versus trade-off theory

Bhaduri (2002) provides evidence that growth options, cash flow, firm product and industry characteristics and firm size can affect how firms deem optimal capital structure for Indian firms Growth opportunities have positive relations with both total and long-term leverage of Indian firms, consistent with Trade-Off Hypothesis The growth option in this study is measured by the ratio of capital expenditure to total assets

as well as growth of total assets

Bancel and Mittoo (2004) find that managers show the strong concern about earnings per share dilution (when issuing stock and how to maintain financial flexibility

when issuing debts for firms in 16 European countries The authors also show that managers make capital structure decisions by weighting the pros and cons of debt financing, in line with trade-off hypothesis For the proxy for growth opportunities which is P/E ratio (larger than 14 implies growth firms), this variable does not vary across firms with different settings This means that growth opportunities have no significant effects on firm leverage in the study sample

Atta and Hijazi (2005) examine the determinants of firm leverage in Pakistan They find that growth options are negatively related to leverage, and the authors conclude that firms in Pakistan generally finance their research with equity rather than debt, so they reject the prediction under Pecking Order Theory that firms with more growth opportunities will take on more debt rather than equity due to the effect of information asymmetry The growth options are measured by the annual rate of the change in total assets

Papers such as Demirgüç-Kunt and Maksimovic (1999), Booth et al (2001) and Bancel and Mittoo (2004) study the macro-level determinants of capital structure and find that firm’s leverage is also affected by country-specific factors De Jong et al (2008) also find that the firm-specific determinants of leverage change in each country out of the 42 countries examined The authors advance the literature by showing that country-specific factors can influence leverage in 2 ways: 1) directly (like development

of bond and stock markets); 2) indirectly through the influence on the impact of specific factors on leverage The authors find that in most countries, growth opportunities are a significant factor that has negative effect on capital structure

firm-Serrasqueiro and Caetano (2015) find evidence suggesting that old and profitable companies in Portugal use less debt, confirming the prediction under Pecking Order Theory However, firms that are larger use more debt, consistent with both Trade-Off Theory and Pecking Order Theory The sample firms also behave as if they are adjusting debt level towards optimal leverage, strongly supporting trade-off theory Consequently, the authors conclude that both Trade-off and Pecking Order Theories are valid and not mutually exclusive in explaining firms’ leverage in Portugal The results indicate insignificant links between growth options and debt for SME firms

Delcoure (2007) finds that both trade-off and pecking order fail to explain firm leverage and that companies follow not normal but the “modified” Pecking Order for firms in emerging Central and Eastern European (CEE) Besides, significant determinants of corporate leverage in CEE countries are banking system characteristics, legal system features, laws governing the protection of rights of shareholders and bondholders, development of bond and equity markets and the way firms are governed This research uses 5 years’ sales growth to total assets growth as a proxy for growth opportunities In this study, the growth aspect does not significantly affect firm total-debt, short-term and long-term debt leverage

Fosu et al (2016) test whether information asymmetry is a determinant of firm value conditional on firm leverage The authors also investigate the impact of information asymmetry on firm value for firms with high and low growth options in the

UK Results show that information asymmetry has negative effect on firm value, and the influence of information asymmetry on firm value tends to be higher (lower) for firms that have more (fewer) growth options

Dynamic nature of capital structure is also examined using dynamic version of trade-off theory that dissects the deviations between actual leverage and optimal one

As the adjustment process is not free and in fact costly, continuous adjustments to maintain optimal leverage are virtually not practical and should only be done in the face

of higher benefits versus costs Empirical studies in this field tend to find support for the adjustment process toward the optimal target leverage, but the process can take quite long to reach target ratios (Flannery and Rangan, 2006, Lemmon et al., 2008) So, even though the coefficients of the adjustment process are significant, the results cannot be interpreted as supporting evidence for Dynamic Trade-off Hypothesis These results are captured when the market-to-book ratio as well as other traditional proxies for growth opportunities are employed to estimate target leverage This leads to Flannery and Rangan (2006)’s urging for another proxy for growth opportunities to be found in order

to enhance the power of the theories in hand

Also, the explanatory power of the model is not satisfactory (Ogden and Wu, 2013), implying that there may be an omission of important factors or mismeasurement

of them Also, Ogden and Wu (2013) show that the very single explanatory power of

market-to-book ratio (proxy for growth options) is not high despite the fact that this factor should be highly significant according to the above arguments related to the possible effects of growth options on leverage At the same time, median industry leverage has strong explanatory power according to the findings by Frank and Goyal (2009)

Some solutions have been offered As shown in Flannery and Rangan (2006), when firms effects are controlled, the problem of underestimation of adjustment speed

to target leverage can be solved Hovakimian and Li (2011) show that; however, the inclusion of firms effect results in the bias in the estimation of adjustment speed, so refuting this approach of Flannery and Rangan (2006) Another way to salvage the power of growth options factor is to consider the convexity hypothesis The hypothesis about the convexity in the link between optimal leverage and market-to-book ratio is built on by first discussing how the benefits and costs of debt financing can be related

to growth options As mentioned, benefits include tax benefit, reduction in agency costs

of free cash flow, and costs are those related to bankruptcy and underinvestment and asset substitution Ogden and Wu (2013) analyze how the balance of costs and benefits

of debt changes as growth opportunities enhance since this can determine the shape of the relationship between growth options and optimal leverage

Using a framework developed by Myers (1977), Barclay et al (2006)break down firm market value into 2 components: value of assets already in place and value of growth options Barclay et al (2006) develop a dynamic model that gauges the evolution of trade-off (between underinvestment costs and free cash flow benefits) as growth options increase Keeping assets in place unchanged, as growth options increase, Barclay et al (2006) suggests that optimal book leverage falls as growth options increase This is because as growth options increase, the cost of debt from underinvestment issue rises while the benefit of reducing free cash flow falls What is more interesting is that Barclay et al (2006) also suggest that the relationship between growth options and optimal market leverage is not linear but convex, but the authors have not provided empirical supporting evidence

Using sample of the US non-financial companies from 1971 -2010, Ogden and

Wu (2013) extend Barclay et al (2006)’s study by empirically testing both static and

dynamic trade-off hypotheses to investigate the growth effect on leverage The results confirm the missing factor associated with growth opportunities, and the use of the conventional market-to-book ratio in traditional leverage regressions invariably results

in model misspecification Also, employing a non-linear transformation to the to-book ratio helps increase the adjusted R-squared and subsumes the power of median industry leverage in leverage regressions The authors state that the link between optimal leverage and growth opportunities is negative and convex

market-Adopting the approach by Ogden and Wu (2013), Lin (2015) uses market-to-book ratio and its inverse exponential transformation to proxy for growth options and find that growth opportunities tend to have negative and convex impact on firm leverage in China, consistent with evidence from Ogden and Wu (2013) for US firms The study also confirms that the inverse exponential transformation of market-to-book ratio fits better and yields stronger explanatory power in its capacity as a proxy for growth opportunities than market to book ratio in both static and dynamic tests of trade-off hypothesis Besides, the new proxy (the inverse exponential transformation of market

to book ratio) is arguably more robust and dependable through a battery of models and methods of estimation and subsamples compared to the market to book ratio

Compared to more developed markets with little or even no ownership concentration, developing markets are deemed plagued by wide divergence between control rights and cash-flow rights, and controlling shareholders are of extreme power

in developing than in advanced markets (La Porta et al., 2000) Another factor that firms

in developing markets may face is financial constraints that hinder firm’s access to external funds The growth effect on firm’s capital structure is harder for firms with large divergence between control and cash flow rights of the owner and those with more financial constraints As per finding in Lin (2015), the effect of growth options differs depending whether firms are prone to different levels of financial constraints Proxies for financial constraints are whether firms are state-owned or private enterprises, big or small and firms do pay dividends in the period considered

Wu and Yeung (2012) examine the link between firm growth types and leverage The authors find that firms tend to invest and fund projects according to their growth types To be more specific, firms of low growth embrace high debt level, firms that have

strong growth have low leverage, and those with middle growth level also have middle leverage during at least 20 years Firms do change their financing pattern upon perceiving the change in economic and market conditions: firms with low growth prefer

to issue debt than equity and, on the contrary, firms with high growth prefer equity over debt The authors also find that high growth firms are least likely to use debt and tend

to issue equity and register losses as a result of their constant intangible investments in R&D whose cash flows are slow to receive The authors claim that the mechanism (increase in external equity and decrease in internal equity which essentially does not affect leverage) can be a reason to maintain leverage persistence following trade-off theory Therefore, growth types do matter for capital structure research

According to Lin (2015), current studies on the effect of growth opportunities on firm leverage in general concentrate on developed economies, where market discipline

is considered to be harsher together with more dedicated and efficient corporate governance Similar studies are limited for less developed countries where more relaxed market discipline and stronger corporate ownership concentration are present, which enhances the managerial ability to cater for the benefits of controlling shareholders (Lin, 2015) (Lin, 2015) So, under the new context, one research question is that the relationship between target leverage and growth opportunities is still negative and highly convex as found in more developed market by Ogden and Wu (2013)

To sum up, existing literature on linear link between firm growth options, and leverage is rather mixed Also, more recent studies like Ogden and Wu (2013), Lin (2015) and Wu and Yeung (2012) point out the potential role of growth options which tend to be undermined in the literature Those studies suggest that more research should

be put in place with respect to growth options, such as the convexity aspect of the link between this factor and firm leverage What is more, existing studies of the effect of growth opportunities mainly concentrate on developed markets with stronger market discipline, better corporate governance In less developed countries, with weaker market discipline and corporate governance plagued by more concentration in corporate ownership, the findings of Ogden and Wu (2013) may not sustain The attempt to investigate the complexity in the link between growth opportunities and leverage is not granted with decent attention in the context of emerging markets

2.2.3 Some related literature in Vietnam

Biger et al (2007) use unlisted firms from census data in Vietnam in 2002-2003 The results show that firm leverage has positive relationship with firm size, managerial ownership, and growth opportunities but negatively relationship with profitability and non-debt tax shield The findings that growth opportunities are positively related to firm leverage are not consistent with the findings in other countries However, the proxy for growth options in this study is changed in total assets from 2002-2003, scaled by total assets Finally, corporate tax has negative yet insignificant influence on capital structure The authors relate the result to the fact that Vietnam’s stock market is still in its infancy, and firm financing, therefore, has to rely mostly on external debt or retained earnings

Nguyen and Ramachandran (2006) examine the determinants of Vietnamese SME firms The results show that Vietnamese SMEs mainly rely on short-term borrowings

to finance their operations Growth opportunities, business risk, firm size, the relationship with banks have positive links with firm leverage; at the same time, fixed assets have negative relation with firm leverage Surprisingly, firm profitability does not matter for capital structure decisions The authors state that the significant impact

of ownership structure, size, and relationship with bank reflect the imbalance of capital deployment in transition economies like Vietnam The positive link between leverage and growth options is consistent with the findings in Biger et al (2007)

Okuda and Nhung (2010) examine determinants of capital structure for firms listed on HOSE and HNX from 2006-2009 Research results indicate that capital structure of those firms can be explained using the modified Modigliani and Miller and agency cost theory In order to borrow long term debt, collaterals play an important role even for listed firms Firms with some state ownership have little motivation to take advantage of debt financing, and they are also deemed less risky in comparison with other types of firms Finally, there is virtually no major difference among the determinants of financial leverage for firms listed in both Ho Chi Minh City and Hanoi The business growth has the proxy of Tobin’s Q, and this variable is significantly negative towards leverage

Le (2012) examines the leverage determinants of real-estate firms listed on Ho Chi Minh Stock Exchange from 2007-2011 Results show that operations efficiency and firm size and asset characteristics have negative relationship with firm leverage, while growth rate has positive relationship with leverage Beside, Tran (2013)compares the determinants of leverage for listed and unlisted manufacturing firms in Ho Chi Minh City For listed firms, the confirmed determinants are size, profitability, investment expenditure, fixed assets, tax and liquid ratio The capital expenditure is positively related to firm leverage, suggesting that bank loans are mainly the only source for many firms even listed ones The author also compares the adjustment speeds toward target (optimal) leverage ratio for the two groups of firms The results show that the adjustment speed of listed firms is faster (at 70%/year), while that of unlisted firms is just 27%/year Furthermore, the author also provides evidence that the adjustment speeds also depend on whether firms have financial constraints with or without financing deficits and whether firms are above or below target leverage

Le (2013) examines the factors affecting capital structure of listed firms in Vietnam from 2007-2010 The study utilizes the framework offered by Trade-off, Pecking and Market Timing Theories as well as behavioral finance The results suggest that tax, industry leverage, and managerial behavior have positive relationship with firm leverage; meanwhile, inflation and market-to-book ratio (firm growth options) and ROA (firm profitability) are negatively related to leverage The author concludes that Pecking Order Theory has higher explanatory power compared to that of Trade-off Theory

Dang and Quach (2014) study the capital structure determinants of listed firms on HOSE with fixed effects regression The factors in focus are size, profitability, growth, asset, tangible fixed assets, liquidity of asset, market condition, tax and debt market condition The results from a sample of 180 companies from 2010-2013 show that only size, profitability, and tax have significant impact on leverage, whereas firm growth rate, fixed assets, stock and debt market conditions do not have sizable impacts The growth aspect is measured by the growth in total assets of firms

Linh (2015) investigates the effects of several factors including ownership, size, asset type, ROA, tax rate, growth on firm capital structure using data of 165 HCMC-

based listed SOEs from 2008-2012 The result suggests that asset tangibility, ROA, and firm liquidity are negatively associated with leverage, while firm size is positively related to leverage and short-term debt ratio for 2 groups of firms but negative relation for Group 3 In this study, growth has the proxy of increased income, which is rarely seen in the literature in Vietnam context

To conclude, there are numerous studies about firm capital structure in Vietnam, for different types of firms like listed, unlisted, SMEs, using both dynamic and static models With respect to the effect of growth opportunities, generally the literature employs several proxies including market-to-book ratio, Tobin’s Q, asset growth rate There are mixed results, and quite a large number of studies find positive link between growth options and leverage, but those which employs market to book ratio like Le Dat Chi (2013) generally register a negative link between growth and leverage None of the studies attempt to verify whether there is a convexity factor in the link and just focus on linear relationship between firm growth and leverage

The current study examines the influence of growth option on capital structure of Vietnamese firms in the period of 2008 – 2015 with a lot of complex problems in Vietnam Initially, the research interval of time experiences unstable period in Vietnamese banking system with the problem of bad debt and some other problems due

to the world financial crisis As the matter of fact creates more constraints in credit supply from commercial banks for Vietnamese firms Secondly, the legal systems governing firms' operations become more and more disparate, especially the interference of the government through the state-owned enterprises Thirdly, the Vietnamese law system may not sufficient to protect the rights of shareholders and also bondholders, which is believed to be a significantly factor creating the asymmetric information issues Moreover, most of listed firms in Vietnam are still in small and median sizes compared to the world’s standards Last but not least, the low development

of equity market is considered as one of the most essential features; especially, bond markets which come into sight to be limited due to less options of firm managers in managing their capital structure

Thus, this article argues that the presence of asymmetric information, the low development of equity and bond markets, the financial constraints from getting bank