Bank leverage effect case of listed companies on ho chi minh stock exchange

luận văn, khóa luận, chuyên đề, đề tài

MINISTRY OF EDUCATION AND TRAINING

UNIVERSITY OF ECONOMICS HO CHI MINH CITY

-o0o -

TRINH THI HANG

BANK LEVERAGE EFFECT – CASE OF LISTED COMPANIES ON HO CHI MINH STOCK EXCHANGE

MASTER THESIS

Ho Chi Minh – 2011

MINISTRY OF EDUCATION AND TRAINING

UNIVERSITY OF ECONOMICS HO CHI MINH CITY

-o0o -

TRINH THI HANG

BANK LEVERAGE EFFECT – CASE OF LISTED COMPANIES ON HO CHI MINH STOCK EXCHANGE

MAJOR: BANKING AND FINANCE

MAJOR CODE: 60.31.12 MASTER THESIS

INSTRUCTOR: PROFESSOR BUI KIM YEN

Ho Chi Minh – 2011

my Master of Banking and Finance course

I also wish to thank all my coworkers in Military Bank, my friends in Bank for Investment and Development of Viet Nam, Au Viet Securities for their great support during my master thesis writing

Finally, my greatest thanks would go to my family including my parents, my sisters and my brothers who are the greatest encouragement for me to overcome all difficulties in my life

ABSTRACT

The thesis aims to add empirical evidence to the corporate finance literature

by looking at firms’ debt choice and performance This thesis also find the relationship between firms’ debt choice and bank loans in companies listed on Ho Chi Minh Stock Exchange (HOSE) of Vietnam as an emerging market

The thesis consists of five chapters After an introductory chapter, the study reviews the existing literature on the capital structure controversy with an emphasis

on the recent empirical works The following third chapter provides the research methodology for the study The study applies panel data procedures, least square regression to test surrounding issues of capital structure of 92 firms listed on HOSE for the period 2007 and 2010 While the main findings of this study which are consistent with theories are reported in the fourth chapter, there are new major insights that represent the special case of emerging markets in general and Vietnam

in particular These main insights, as well as the main conclusions of the study, are summarized in Chapter 5, including some limitations and recommendations for future researches

Our findings are that many of the factors that are found to be significant in the determination of capital structure and performance of the firms listed on HOSE are the same as those found in developed and developing capital markets such as firm size, asset turnover Besides, we find that the listed firms’ debt choice affect performance negatively

In addition to the State Bank of Vietnam‘s general lending principals such as legal establishment of firm, legal purpose of loan, earning capacity of the business and profitable project, our findings suggest that banks should take more considerations on firms’ asset tangibility, size and asset turnover when making decisions on loans to corporate

Keywords: Capital structure, firm performance, bank loan, Vietnam, HOSE

CONTENTS

Acknowledgement i

Abstract ii

Contents iii

List of Figures v

List of Tables vi

Abbreviations vii

CHAPTER 1: INTRODUCTION 1.1 Research Background 1

1.2 The usefulness of the research 2

1.3 Research objectives 2

1.4 Scope and methodology 3

1.5 The structure of the study 3

CHAPTER 2: LITERATURE REVIEW 2.1 Introduction 5

2.2 Capital structure theory and firm performance 5

2.3 Maturity structure and bank loan theory 12

2.4 Conclusion 20

CHAPTER 3: RESEARCH METHODOLOGY 3.1 Introduction 21

3.2 Data specifications 21

3.2.1 Research sample description 21

3.2.2 Variable Explanation 22

3.2.2.1 Financial leverage 22

3.2.2.2 Return on equity 23

3.2.2.3 Return on assets 23

3.2.2.4 Asset tangibility 24

3.2.2.5 Asset turnover 24

3.2.2.6 Firm Size 25

3.2.2.7 Firm age 25

3.2.2.8 Growth opportunities 26

3.2.2.9 Industrial sector 26

3.3 Hypothesis and empirical model specification 27

3.3.1 Model 1: Firm Leverage Model 27

3.3.2 Model 2: Firm Performance Model 28

3.3.3 Model 3: Bank Loan Model 30

CHAPTER 4: DATA ANALYSIS AND FINDINGS 4.1 Introduction 32

4.2 Descriptive Statistics 32

4.3 Results of Leverage Model 34

4.4 Results of Firm Performance Model 37

4.5 Results of Bank Loan Model 43

CHAPTER 5: CONCLUSION 5.1 Introduction 48

5.2 Conclusion 48

5.3 The implications of the research 49

5.4 Limitations and recommendations for future research 50

References 52

Appendix A – Regression results of models 59

Appendix B – Industry classification 72

Appendix C – Financial ratios of 92 firms listed on HOSE from 2007 to 2010 75

Appendix D – Creations of variables for the models 91

LIST OF FIGURES

Figure 1.1: Research methodology 3 Figure 3.1: Outline of chapter 3 21 Figure 3.2: Summary of research data collection 22

LIST OF TABLES

Table 4.1: Number of companies per industry 32

Table 4.2: Descriptive statistic for the variables used in the study 33

Table 4.3: The correlations between ROA and others variables 33

Table 4.4: The correlations between ROE and others variables 34

Table 4.5: The reported results of Leverage Model 34

Table 4.6: The final reported results of Leverage Model 37

Table 4.7: The reported results of Firm Performance Model (by using ROA) 38

Table 4.8: The reported results of Firm Performance Model (by using ROE) 42

Table 4.9: The final reported results of Firm Performance Model (by using ROA) with significant variables 42

Table 4.10: The final reported results of Firm Performance Model (by using ROE) with significant variables 43

Table 4.11: The reported results for TOBIT´s estimations of Bank Loan Model 44 Table 4.12: The final reported results of TOBIT´s estimations of Bank Loan Model 47

ABBREVIATIONS

BAS Basic Material

CONS Construction and material

CUS Customer good and services

GLS Generalized least square regression

GROWTH Growth opportunities

HNX Ha Noi Stock Exchange

IT Information Technology

LEV Financial leverage

ROA Return on assets

ROE Return on equity

UTI Utilities

CHAPTER 1: INTRODUCTION 1.1 RESEARCH BACKGROUND

The capital structure theory has been one of the most important background literatures when studying the corporate finance This theory was originated in 1958

by Modigliani and Miller who gave a rigorous proof of the independence of a firm’s values and its capital structure mix The capital structure of a firm explains the ways

in which a firm finances its investment and overall operations It consists mainly of

a combination of debt and equity as well as all other sources of finance available to the firm It has been obvious from various studies that one factor which has affected and will continue to affect a firm’s financial performance is the choice of its capital structure mix There have been many studies conducted to find out the optimal capital structure for corporate from this background but no formula or theory that decisively provides optimal capital structure for a firm has been found yet

There are many factors affecting the choice of firm’s capital structure These factors may vary substantially from company to company, from industry to industry and from country to country While the studies on the determinants on the capital structure and the effects of capital structure on firm performance have been very popularly conducted in almost every developed country in the world, these kinds of research have still been limited in Viet Nam Meanwhile the way an organization is financed is of paramount importance to both the managers of firms and providers of funds This is because if a wrong mix of finance is employed, the performance and survival of the enterprise may be seriously affected This is the motivation for me to

do this study with the hope to have deeper understanding about the role of capital structure on firm’s performance Besides, we also do a research on the conditions and determinants firms must have when accessing funds from banks These examinations are conducted in Viet Nam as a developing country

The rest of this chapter provides the overview of the usefulness of the research, the research objectives, research methodology and the structure of the research

1.2 THE USEFULNESS OF THE RESEARCH

Firstly, this study helps firm managers to identify and implement the optimal capital structure best for their firms, applicable to their industry and minimize the cost of financing while maximizing the firm’s overall value and financial performance

Secondly, the study is a contribution to the debate on what determinants affecting the choice of capital structure of Viet Nam firms in general and firm listed

on HOSE, in particular Our findings are the same as those found in developed countries’ researches that firm size, asset turnover affect the choice of firm’s capital structure The findings do not support the effects of industry factors on the capital structure choice and firm performance

Finally, this study helps banks to make right decisions when making decisions on loans to enterprises in the manners to limit the risks incurring from loans Especially, this study gives empirical evidence regarding to the use of bank loan for the period of 2007 and 2010 of firms listed on HOSE of Viet Nam From this finding, banks will have suitable strategies in choosing the best firms and the best industry to finance in

1.3 RESEARCH OBJECTIVES

This study is conducted to answer the four following questions:

- What are the determinants affecting the leverage of firms listed on HOSE?

- What are the relationships between the leverage and firm performance of firms listed on HOSE?

- What are the relationships between industrial sectors, firms leverage and firms performance?

- What are the determinants banks take more concern when issuing loans to

firms listed on HOSE in general and in Viet Nam situation in particular?

1.4 SCOPE AND METHODOLOGY

My study uses the data collected from the audited financial statements of 92 firms listed on Ho Chi Minh Stock Exchange for the period from 2007 and 2010 These companies are classified into 8 main industrial sectors in the economy

I have the Eview software version 4 to test all my data The main tools used are Descriptive statistic, Model regression, etc., to obtain the results for financial models

Figure 1.1: Research Methodology

1.5 THE STRUCTURE OF STUDY

The structure of the study consists of 5 chapters:

Literature reveiw

This chapter introduces the general knowledge about the study They are research background, research usefulness, research objectives, the scope and the methodology of the study

Chapter 2: Literature Review

The purpose of literature review is to present the theories conducted by economists in the past From these theories, we mention to the points used for the studying of this paper

Chapter 3: Methodology

This chapter shows the way we conduct my thesis It is a quantitative research to test the suitable of popular financial models in the world to Viet Nam The data used for this model are collected directly from the audited financial statements of listed firms on Ho Chi Minh Stock Exchange in Viet Nam

Chapter 4: Data analysis and findings

The purpose of this chapter is to give the results after processing the data In other words, the results of financial models mentioned in chapter 3 are shown

Chapter 5: Conclusions, Recommendations and Limitations

This chapter will conclude the whole content of the study It also gives out the limitations of the study and raise up some problems for further studies

CHAPTER 2: LITERATURE REVIEW

The purpose of this chapter is to review the theories related to capital structure, firm performance and bank loan Besides, the empirical studies of various researchers in many countries have also been mentioned in order to show an overall picture related to capital structure issue

Modern capital structure theory consists of two independent variables: debt and equity financing Modigliani and Miller (1958) propose in their article that a change in the firm’s capital structure has no long – term effect on its market value and firm’s value is completely independent on its combination of debt and equity The theory is developed in the context that the capital market is perfect (there is no tax, bankruptcy and transaction cost), the corporate can borrow at the same interest rate as individual do and all investors have the same information

Many criticisms have been appeared due to these unrealistic assumptions First of all, the assumption that corporate and personal leverage can become a perfect substitute was a mirage and unrealistic In a real world situation, corporate borrow at a lower rate than individuals (Durant, 1959) Secondly, in their assumptions Modigliani and Miller exclude transaction cost such as brokerage cost, etc that both corporate and individual would have to bear in real world situation (Ghosh, 2008) Thus in 1963, they introduce corporate tax and transaction cost and conclude that leverage would increase firm’s value because of tax deductible from interest payment on loans while dividend income from shares has not

In the field of capital structure, there have various propositions and model been argued by different studies on why firms make use of debt financing The most prominent of such theories or models have been trade-off-theory, agency cost model, optimal capital structure theory and the pecking order theory

The trade-off models have dominated the capital structure literature The pioneers of this theory are Modigliani and Miller (1963) DeAngelo and Masulis (1980) predict that firms will seek to maintain an optimal capital structure by balancing the benefits and the costs of debt The benefits include the tax shield whereas the costs include expected financial distress costs The implication of these trade-off models is that firms have target leverage and they adjust their leverage toward the target over time

The agency theory focused on determining the most efficient contract governing the principal-agent relationship There are two kinds of conflict: the conflict between the owners of the firm and the managers and the conflict between the owners of the firm and the debt holders The conflict becomes obvious when there is a risk of default This may create underinvestment or “debt overhang” problem (Myers 1977) In such a scenario, debt would have a significant negative effect on a corporate financial performance The implication of the agency cost theory is to determine an optimal capital structure by minimizing the costs arising from conflicts between the parties involved

Pecking order theory proposed by Myers that firms prefer to finance new investment, first internally with retained earnings, then with debt, and finally with

an issue of new equity The implication of the pecking order theory and the optimal capital structure theory is that the profitable firm will have low debt-to-equity ratio and will only borrow or issue debt securities when its investment requirement exceed its internal source of financing such as cash flow and retained earnings There is not only the capital structure theory but theory of performance also remains a controversial issue in finance due to its multidimensional meanings Economists measure firm’s performance for both financial and organizational angles Research on firm performance originates from organization theory (Murphy

et al., 1996) that three fundamental theoretical approaches measure organizational effectiveness are involved goal-based approach, systems approach and multiple constituency approach Evaluating financial performance through profit

maximization, maximizing profit on assets and maximizing shareholders’ benefits are the core of the firm effectiveness of Chakravarthy (1986) Hoffer and Sandberg (1987) demonstrate that growth in sales, growth in market share are often used to measure operational performance and a widespread definition of performance was also provided that ultimately lead to financial performance The financial ratios collected from balance sheet and income statements such as return on assets (ROA), return on equity (ROE) or return on investment (ROI) have also been used by many researchers (Demsetz and Lehn, 1985; Gorton and Rosen, 1995; Mehran, 1995; and Ang, Cole and Lin, 2000) Besides, there are also other ways to measure firm performance in term of market value Abdel Shahid (2003) use price per share to the earnings per share (PE), market value of equity to book value of equity (MBVR), and Tobin’s Q

The choice of capital structure may also be affected by firm performance and vice versa Berger and Bonaccorsi di Patti (2006) do a regression model of firm performance and leverage and confine the effects of capital structure on performance with the reverse relationship from performance on capital structure Building an optimal capital structure is a difficult decision for any business organization The decision is important not only because of the need to maximize shareholders’ wealth but also because of the impact such a decision has on the organization’s ability to deal with its competitive environment The task of an excellent manager is to recognize when optimal capital structure is achieved and know how to maintain it over time By doing this, corporate will minimize the weighted average cost of capital and financing costs and thus the corporate will maximize their value and performance One of the ways that helps managers to do these things is to determine exactly the factors affect the choice of firm’s finance In term of leverage and firm performance, there are many factors that have been studied to have influences on Some following typical factors are followed

Asset tangibility: Normally, lenders always prefer to lend money to firms

with sizable fixed assets which can be used as collateral against the inability of the

debtor to repay the debt Firms which do not have collateral to compensate the risk for financial distress have to accept a higher interest expense Therefore, firms with lower value of fixed assets find debt financing more costly than equity financing and thus they expect to have a lower degree of leverage relative to their high – valued fixed assets counterpart Tangibility is defined as the ratio of fixed assets to total assets (Titman and Wessels, 1988; Rajan and Zingales, 1995; Frank and Goyal, 2003) In the most common researches, tangibility has a positive relationship with debt ratio and firm performance Mackie – Mason (1990) conclude that a firm with high tangible assets in term of plant and equipment make the debt choice more likely and influences the firm performance Akintoye (2008) show that a firm with large investments in tangible assets will have smaller costs of financial distress than

a firm that rely on intangible assets

Asset Turnover: Asset turnover ratio is important in financial management

It is used to access the efficiency of the management of a firm in the way and manner managers utilize the assets of the firms to yield positive returns to the firm Onaolapo (2010) demonstrate that asset turnover has a positive relationship with firm performance when ROA and ROE were used to calculate the firm’s performance

Firm Size: Firm size is considered to be an important determinant of firm’s

capital structure and performance There are many theoretical reasons why firm size would be related to the capital structure and performance of the firm Smaller firms may find it relatively more costly to resolve the asymmetric information with lenders and financiers (Kester, 1986 and Titman and Wessels, 1988) Consequently, larger firms are more diversified and tend to fail less than smaller ones The tradeoff theory (Marsh 1982, Rajan and Zingales 1995, Chittenden et al.1996) estimate a positive relation between firm size and debt, since larger firm have been shown to have lower agency costs of debt, relatively smaller monitoring costs, less volatile cash flows, easier access to credit market, and require more debt to fully benefit from tax shield gains Penrose (1959) conclude that larger firms can enjoy

economies of scale and these can favorably impact on performance Firm size is measured by the logarithm of the firm’s sales (Titman and Wessels, 1988; Rajan and Zingales, 1995; and Ozkan, 2001) and has a positive relationship with firm performance

Firm age: The age of a company is an important factor affecting the ability

of firm debt financing A longtime business often is more reliable and easier to access debt than enterprises with shorter lives corporate (Diamond, 1889) It may also have an impact on firm’s performance Stinchcombe (1965) show that older firms can achieve experience – based economies and can avoid the liabilities of newness Normally, the age is calculated as the number of years that companies

have existed for

Growth Opportunities: Several empirical studies have observed that firms

with high debt-to-equity ratios have higher growth opportunities in their investments compared to those with low debt-to-equity ratios (Zeitun et al 2007) These assertions are supported by Hoffmann and Gonzalez (2005) and Billett, King and Mauer (2007) in their empirical In the research in 1986, Jensen observe that when firms are pursuing a higher growth opportunities in their business strategies, they are faced with lower free cash flow and there would be less need for the use of debt as a disciplinary tool over manager’s behavior But Gonzalez et al (2005) argue that firms with higher growth opportunities have the tendencies of developing agency conflicts between shareholders and debt holders as shareholders in such firms have stronger incentives to under invest and greater probabilities of substituting or shifting risk (Myers(1977), Smith and Warner (1979)).The pecking order theory suggests a positive relationship between leverage and growth opportunities (Gonzalez et al 2006) because financial needs are driven by investment opportunities hence the issuance of debt to meet those needs

Industrial Sector: Bradley, Jarrell and Kim (1984) are among the first

authors to report significant differences and variation in corporate leverage between

industry sectors Mac key and Phillips (2005) find in a US sample that industry fixed effects explain about 13% of the variation in leverage, while firm fixed effects account for 54% in variation of leverage Even though these unobservable firms fixed effects elucidate the majority of leverage variation over time Roberts (2002) highlight that the average degrees of leverage ratios analyzed for fifty industrial sectors in the U.S Furthermore, Almazan and Molina (2005) argue that intra-industry capital structure dispersion is larger in industries that are more concentrated, using less more intensively, and exhibit looser corporate governance practices With regard to country-specific evidence, Glen and Singh (2004) report that companies in emerging market display lower debt than their peers in industrialized countries Hence, industrial sector is seen to affect firm’s financial performance

From these theoretical background knowledge mentioned above, many studies have been done in many countries to find out the conformity of the model in the context of each country Some prominent researches are as followed:

DilipRatha, et al (2003) do a research to test the relationship between firm performance and firm finance in developing countries The result is that the all performance indexes (profits, earning before taxes, taxes, depreciation, amortization) decline when firm use more debt in their assets

In China, Wei Xu, et al (2005) do a research on 1,130 listed on China Stock Exchange They discover that the relationship between firm’s performance and leverage is negative The performance is cubic correlation with the capital structure when corporate use 100% debt in their capital structure With the debt ratio is among 24.52% to 51.13%, this relationship is positive

In the United States, Allan N Berger, et al (2006) use the data in banking industry to test the agency costs hypothesis The findings are suitable with what have been proved in the past The higher leverage the firm takes in the capital

structure, the higher profit firm will have These results are statistically significant, economically significant and robust

In New Zealand, Margaritis and Psillaki (2007) do a research to test the relationship between firm capital structure and firm efficiency of 12,240 corporate The results show that the higher leverage the corporate use, the more efficiently the corporate get The quantitative regression analysis shows that more efficient firms will choose higher debt ratios because higher efficiency acts as a buffer against the expected costs of bankruptcy or financial distress The research also show that tangibles and profitability affect positively on leverage while firm size affects negatively at the lower half of the leverage distribution and positively at the upper half of the distribution

Tian & Zeitun (2007) use a cross-sectional data of 167 Jordanian companies during 1989-2003 to show that a firm capital structure has a significantly negative impact on the firm performance measures, in both the accounting and market measures An interesting finding is that the short-term debt to total assets level has a significantly positive effect on the market performance measure (Tobin’s Q), which could to some extent support Myers (1977) argument that firms with high short-term debt to total assets have a high growth rate and high performance The results also find that firm size have a positive impact on a firm performance because large firms have low bankruptcy costs Besides, the study shows that the best performance measure is the accounting performance measure ROA

Roshan Boodhoo (2009) use the accounting data from 2002 to 2006 of 40 Mauritian firms to test the capital structure and performance of listed firms The results are consistent with past researches The study show that the agency costs, tax rate, capital expenditures and the equity ratio take a fundamental role in financing decision However, tangibility and performance are not statistically significant to Roshan Boohoo’s research

Huynh Anh Kiet (2010) use the data of 162 firms listed on the Ho Chi Minh Stock Exchange (HOSE), Viet Nam for the accounting data periods of 2008 to test the relationship between the capital structure and firm performance, firm value The paper examines the impact which firm performance has on corporate capital structure combined with others variables such as firm size, growth opportunities and asset tangibility, and the impact which firm capital structure has had on corporate firm value The results from the ordinary least square regression model show that firm profitability have a significant and negative impact on all firm capital structure measures total debt to total assets, total debt to total equity, long-term debt to total assets, short-term debt to total assets Besides, firm size has a positive and significant impact on the leverage measures total debt to total assets, total debt to total equity, short-term debt to total assets Firm asset tangibility is found to be positive and significant impact on total debts to total assets and long-term debt to total assets, while have insignificant impact on total debt to total equity.

2.3 MATURITY STRUCTURE AND BANK LOAN THEORY

Corporate debt structure is how a company finances its assets through various types of debt financing Corporate debt is characterized by heterogeneity The debt structure can take any form or combination of long-term debt, medium-term debt or short-term debt Firm’s debt structure can also be classified into bank debt, straight bond debt, convertible bond debt, program debt (such as commercial paper), mortgage debt, and all other debt

Debt structure choice in a firm’s capital structure has been proved to have a significant impact on a firm’s overall financial performance and firm failure (Zeitun

et al 2007) Barclay and Smith (1995) observe that debt maturity structure have important effects on firm financial performance Their studies also provide evidence

to show that large firms prefer to issue long-term debt in capital structure This is the same as those found by Stohs and Mauer (1996) Schiantarelli and Sembenelli

(1999) that firms tend to match assets to liabilities when choosing a maturity structure for debt They also conclude that firm with more profit in term of cash flow to capital, tend to depend more on long term debt in capital structure Besides, short term debts have been observed by many empirical studies exposed firms to liquidity risk and the risk of refinancing As the maturity period of loan is very short which is usually less than or equal one year and it puts serious financial pressure on

a firm and make firm less productive (Stohs et al 1996, Zeitun 2007) Furthermore, the most concerned problem in the model of asymmetric information about borrower is liquidity risk According to Zeitun (2007), the only external source of financing available to firms with low and bad credit rating outside retained earnings and equity financing is short-term debt but this source of fund puts immense financial pressure on a firm Such pressures can negate a firm’s productivity and financial performance

However, while examining the effect of short term liability on German and U.S firms, Baum, Schafer and Talavera (2007) recognize that German firms were likely to be more profitable when relying more heavily on short term debts It is also evidenced from the research of Zeitun et al (2007) that short term debts have positive and significant effect on a firm’s performance Hart and More (1994) examine how the debt maturity of firms varies with the timing of project return and show that the faster the return arrives, the shorter the optimal repayment maturity structuring of the debt would be This result supports other researches that the maturity of asset and liability should be matched (Schiantarelli et al 1999)

In reality, while long-term debt allows firms to invest in long-term projects, short-term debt is used to finance the shortage of fund in short time Short term debt could increase the efficiency of the firm because it acts as a disciplinarian factor due

to the continuous tracking by the creditors A combination between short term debt and long term debt that is the best for a company is called the optimal debt maturity

The optimal debt maturity, besides being influenced by macroeconomic and institutional factors, is determined by a series of visible parameters at the corporate

level Among these parameters are the possibility of self-funding projects, the value

of assets and the size of the company, etc The last variable is the key factor because small company faces great difficulties to get long term financing mainly because of lacking significant collaterals At the same time, because big companies have a greater negotiation and power, they have an easier access to long-term loan Meanwhile, banks often give short term loans to firm base on the short term assets such as inventory, receivable, inventory turnover, receivable turnover, current asset turnover, etc Another important aspect to point out is the trend to match the expiration of their assets and liabilities which determines the faster the investment returns are gotten, the lesser the optimum expiration structure will be In the light of these theories, there are many variables used to explain the reasons for firms to choose debt over equity finance considering sizes of firms

As mentioned above, firms can increase debt for business only by issuing many kinds of bond, lending from bank and other debt such as trade credit In Viet Nam, it is hard for corporate to issue bond to mobilize fund The main reason is that

of the illiquidity of bond Firms listed on HOSE sometimes issue convertible bond

to investors to raise money when they need funds for investment But this channel

of mobilizing is not favorable by investors due to long-lasting to convert bond into stock which help investors to sell whenever they want if they need money It is the reason why nearly one hundred percent of firms listed on HOSE choose bank loan

At present, in the context of bank loan limitation for real estate sector of the State Bank of Vietnam, many corporate in this industrial sector try to issue bond to mobilize for the projects They attract two kinds of clients The first kind of client is the individual clients who have the demand to buy the house when the projects finish in the future The second kind of customer is banks In the first kind of client,

it is hard for company to issue bond because individual clients do not know much about the project and the investor Furthermore, these individual clients will have the risks of not becoming true of the projects and then they will lose money Contrary to the first kind of bond issue, corporate aims at bank in the second kind of

issue in the form of a loan Instead of issuing loans for firms to do the projects, bank buy the bonds issued by these firms after careful evaluation process By doing this, bank will own the right to collect the debt when the time of bond is due One of the safety methods banks often do in this case is that bank will control all the cash flow generated from the project to limit the risk of default This way of doing becomes popularly now In January 2011, Military Bank – SaiGon Branch was successful in the deal of buying VND300 billion of Thai Son Corporate‘s bond for the office building project In July 2011, Military Bank – Ho Chi Minh Branch was also successful in buying VND200 billion of Investco Corporation‘s bond for the Investco Greencity project in district 7 In March 2011, Viet A Bank bought bond of Vietnam Medical Products Import-Export Joint Stock Company (VIMEDIMEX VN) with the total amount of VND200 billion

When doing transaction with banks, firms must obey the Credit Organizations’ Law No 47/2010/QH12 which is effective on January 1st

2011 of the State Bank of Viet Nam and Credit Organizations’ Lending Principals No 1627/2001/QD-NHNN dated on December 31st 2001 of the State Bank of Viet Nam and other related documents According to these documents, firms must satisfy at least five following conditions to be considered to issue loans

Firstly, firms are established legally by Corporate Law It means that firms must have charter capital, the representative person in daily business and business transactions that the Government does not ban

Secondly, the purpose of loans is legally This means that the transactions between parties signed up by registered representative persons, the goods and services in these transactions are belongs to registered business of firms which are not be banned by the Government

Third factor is earning capacity of the business and financial situation This means that the financial and business operation must benefit to full fill the loans

Next, projects submitted to banks must be feasible This means that the projects must be beneficial to repay the amount of loans

Lastly, firms must fulfill stipulations related to collaterals for loans

In practice, Vietnamese Banks often do the following steps in their loan evaluation:

Step 1: Purpose examination

It is important for bank to have a clear understanding and appreciation of the purpose of the facility issued to the borrower As a general guide, lenders should always ensure that the purpose is consistent with the borrower’s nature of business Many companies have failed because money has been directed to purposes not intended for it Common purposes include fixed asset purchase, working capital, refinancing, project financing, etc

Step 2: Facts analysis

Bank need to assess the fact on the borrowers such as: track record including business constitution of the borrower, name of shareholders and directors and the working experiment of them

Step 3: Qualitative analysis

Qualitative analysis will assist the bank in identifying operating risks in a borrower’s business Key areas of operating risk are supply, production, product, demand and collection The critical qualitative areas often to be assessed include:

Management integrity and competence: Bank often size up the borrower’s management when engaging in conversations Although it is often difficult to assess the integrity of the borrowers, bank will have to exercise their best judgment in this matter The area of management competence would be easier as it is often based on the past experience of the management and their technical qualifications Competence includes breadth and depth management as well as having a succession

in place

Suppliers and terms of trade: This deals with the ability of the borrower to

source the product or raw materials that they need to sell or use Possible areas of

concern are: Over concentration on a single supplier; scarcity of raw materials; price volatility of products or raw materials; quality of products and raw materials;

and terms extended by the suppliers to the borrower

Manufacturing process and production cycle: the purpose of this action is

to confident that the borrower has the necessary technical know-how in their business If they are dependent on external technology, it is important to establish who the party is and what steps are taken to ensure continual transfer of technology Bank often also assess the sufficiency of skilled labor and the necessity for state of the art machinery in the business

Nature of the product: Bank often concern about the nature of the

borrower’s business’ product The three key areas of product nature are perishability, obsolescence and customization of the products to the unique requirements of the buyers

Customers and terms of trade: It is pointless to have a high quality product

to sell when there is nobody to sell to Bank often assess whether there is demand for the products and services provided by the borrower In this respect, it is essential

to recognize whether the borrower is an Original Equipment Manufacturer or a supporting industry If it is the latter then the demand for the borrower’s products or services tends to be a derived demand In other words, bank will make an effort to check with industry or sector the borrower is effectively selling to

Collection: The best tool to enable bank to assess the collection function of

the company is to request for the borrower to submit a copy of debtors ageing analysis Through the debtors ageing analysis, bank will be able to assess the spread

of the debtors Essentially, bank will be aware of whom the borrower is selling to (need to assess financial/credit standing of the major customers) and on what terms the sales are based on It is also important to assess whether the borrower has an effective credit control system in place and to compare with industry norms the reasonableness of the credit period extended to the customers by the borrower

Competitiveness of the industry: For this aspect, bank use more macro in

their assessment In other words, they should try to understand the global trend for the industry and know who the international players are Assessing the global trend may reveal new areas of threats or opportunities It is necessary for bank to be aware of the competitive factors in the industry In other words, what do the players

in the industry compete with each other on? How does a company become successful in the industry? This is to assess whether the borrower has what it takes

to compete If they do not have the necessary ingredient to succeed then when the wave of intense competition hits our shores, they will be swept away with it Essentially, qualitative analysis is a SWOT analysis, SWOT stands for Strengths, Weaknesses, Opportunities and Threats For each credit consideration, lenders normally look at the internal strengths or weaknesses of the borrower while the external environment may reveal areas of threats or opportunities

Step 4: Quantitative analysis Quantitative analysis is essentially financial

analysis The objective is to identify financial risks facing the borrower such as over gearing (inability to service obligations on the borrowings), overtrading (operating a size of business beyond the limits of its financial resources) weak cash flow, fluctuating profits, etc The focus is essentially on the financial aspects of the borrower It is to assess the financial information on the borrower The three key areas of analysis are earning capacity (or profit or loss statement), financial position (or balance sheet) and liquidity position (or cash flow statement)

Earning capacity of the business: This deals with the profitability of the

business’s borrower Bank often assess the quality of the profitability and try to gain insight into its future profitability The focus of analysis is the profit and loss statement of the borrower

Financial position: The balance sheet is the focus of analysis Bank officers

should be concerned about the consistency of the assets with the business nature, short-term solvency of the business, long-term financial stability of the business and

funding stability (appropriateness of the sources of cash) Ratios such as current ratio and gearing ratio can assist bank officers in such assessment

Liquidity position: Bank often needs to understand the sources and

application of cash in the borrower business This will enable banks to assess whether borrower was able to generate good cash flow on its business and whether the cash has been used for the right purpose Although bank can determine the amount of cash increase or decrease in a financial year through the balance sheet, it does not reveal the sources and applications of cash clearly

Step 5: Ways out analysis

In every credit, lenders must be able to identify the sources of repayment Lenders are not charitable organizations When a loan is extended, lenders expect to

be repaid Sources of repayment can be broadly categorized into primary or secondary sources of repayment The primary source of repayment, or first way out,

is normally from the borrowers’ day to day operation or from specific project or activity identified The secondary source of repayment, or second way out, can be collateral held, guarantees

Step 6: Collaterals evaluating

Nowadays, in Vietnamese Banks, collaterals are a key element in the relationship between bank and company, for the conditioning of the loan The existence of collaterals could cause a decrease in the associated problems to adverse selection by increasing the company’s probability of getting credit and reducing the interest rate A related problem is that sometimes there might be an incorrect allocation of resources due to the possibility that the most efficient project be presented by companies which may not have enough guaranties to obtain financing The collateral’s magnitude could generate similar errors as the ones already defined for the adverse selection case since high failure probability projects with enough guaranties are at the end of the line funded On the other hand, if the project has high probabilities of success, but the company lacks the appropriate collateral

requested, it will be turned down emphasizing the mistake of not financing those projects that would become ex-post profitable with time

Step 7: Structuring the loan

After assessing a credit, building a loan is important It must provide the lenders with sufficient control and meet the needs of the customers This will enable the lenders to maximize the risk-return The structure must consider the following: amount must be sufficient to meet the needs of borrower; tenor of the loan or facility; committed for a term or callable on demand; appropriateness of the type of facility for the intended purpose; direct or indirect exposure; collateral required; and

appropriate terms and conditions

In this study, we use firms’ long-term bank loans to firms’ total assets (LTA) and firms’ short-term bank loans to firms’ total assets (STA) used by firms when raising funds from banks as two proxies for short-term and long-term bank finance

of firm The purpose of this decision is to have an assessment of the ability to raise fund from banks of firms listed on HOSE as well as to find out what determinants affect the fund mobilization channel from banks of firms listed on HOSE

2.4 CONCLUSION

This chapter states a general view of firm’s capital structure, firm performance and bank loan Choosing a reasonable combination between debt and equity does not only affect firm’s efficiency but also affect its competiveness and development strategies The chapter also mentions the main factors may affect the choice of firm’s leverage as well as firm performance Besides, many empirical studies in other countries are also introduced to make a comparison for research issue between these countries and Viet Nam The end of the chapter introduces one channel of outside mobilization through banking system as well as a general process

of lending evaluation This above cognition makes the background for me to do the research in the next following chapters in three aspects: the factors affect the choice

of firm’s capital structure, the relationship between capital structure and firm

performance and the firm’s bank loan choice

CHAPTER 3: RESEARCH METHODOLOGY 3.1 INTRODUCTION

The purpose of this chapter is to show the way we do the research After reading it, the readers will know about the collection of data, variable creations and model choices for the answers of the research objectives The specified contents are

as followed:

Figure 3.1: Outline of chapter 3

3.2 DATA SPECIFICATIONS

3.2.1 Research sample description

The dimension of the research is corporate listed on Ho Chi Minh Stock Exchange The number of the observations is 92 firms for the period of financial years 2007 to 2010 The criteria for the observations are:

- Firms listed on the HOSE for more than or equal to 2 years

- They are not in any of the financial services sectors such as Banking, Insurance/Life Assurance, Investment Companies, etc These kinds of firm are excluded from the observations because their balance sheet structures are quite different from those of normal enterprises and their operational

Hypothesis and Empirical Models

Data Specifications

Research sample description Variables Explanations

Introduction

regulations are highly controlled by authorities (Fama and French (2001), DeAngelo et al (2006))

- Firms’ financial statements are audited yearly by audit firms operating in Viet Nam

The variables in the study include both dependent and explanatory variables Financial leverage plays a role as dependent variable in model 1 but it will be an explanatory variable in model 2 Besides, return on assets (ROA) and return on equity (ROE) will become dependent variables in model 2 The other variables such

as firm size, firm age, asset tangibility, asset turnover and growth opportunities are explanatory or independent variables Especially, there is an appearance of short-term bank loan to total asset variable and long-term bank loan to total asset as dependent variables in model 3 Industrial sector variables are dummy variables These above variables are calculated from the annual audited financial statements of

92 listed firms for 4 years Especially, industry sectors are referenced to the classification of industries of listed firms quoted on the Vietnam International Securities Company (http://vise.com.vn/)

Figure 3.2: Summary of Research Data Collection

3.2.2 Variable Explanation

3.2.2.1 Financial Leverage (LEV)

Collecting the Audited Annual Financial Statements

Calculating varibles

Leverage, ROA, ROE, Firm Size,

Firm age, Tangibility, Asset

Turnover, Growth Opportunity

Classifying Industries firms

belongs to

Industry dummies

In this study, financial leverage is an important proxy for large part of the research Financial Leverage plays two main roles: dependent variable and independent variable The agency cost theory predict that higher leverage is expected to lower agency costs, reduce inefficiency and thereby lead to improve firm’s performance Berger (2002) show that the increase in leverage ratio would result in lower agency costs of outside equity and increase firm performance, all else held constant However, Myers (1977) shows a negative relationship between debt and firm performance This study measures financial leverage by debt ratio (Zeitun et al, 2007) The formula for leverage is:

Leverage Total liabilities

Total assets

3.2.2.2 Return on equity (ROE)

Return on equity measures the rate of return on the ownership interest (shareholders' equity) of the common stock owners It measures a firm's efficiency

at generating profits from every unit of shareholders' equity (also known as net assets or assets minus liabilities) ROE shows how well a company uses investment funds to generate earnings growth

As mentioned above, return on equity measures the firm’s efficiency Then,

in this study ROE is used to calculate firm’s performance ROE is mainly used in examining the effects of leverage on firm performance In this study, ROE is defined by dividing return after tax and interest to total equity (Harris and Raviv, 1991) The equation is as followed:

Return on Equity Profit after tax and interest

Total equity

3.2.2.3 Return on assets (ROA)

Return on Assets (ROA) measures how profitable a company is relative to its total assets In turn, it measures how efficiently a company uses its assets Generally, ROA should be used to compare companies in the same industry Everything else being equal, a higher ROA is better, as it means that a company is

more efficient about using its assets Furthermore, companies use both debt and equity to acquire their assets and ROA can be used to determine how effectively they are turning their funding into earnings The crucial difference between ROA and Return on Equity (ROE), the other major profitability ratio, is that the ROA remain relatively unaffected by a company's choice of capital structure - the choice

of using debt versus equity to fund operations

Like ROE, Return on assets is also used to measure the firm’s efficiency ROA is mainly used in examining the effects of leverage on firm performance In this study, ROA is defined as a ratio of total profit after tax and interest to total assets (Myers et al, 1984) The equation is as followed:

Return on Assets Profit after tax and interest

Total assets

3.2.2.4 Asset Tangibility (TANG)

Normally, lenders always prefer to lend money to firms with sizable fixed assets which can be used as collateral against the inability of the debtor to repay the debt Firms which do not have collateral to compensate the risk for financial distress have to accept a higher interest expense Therefore, firms with lower value of fixed assets find debt financing more costly than equity financing and thus they expect to have a lower degree of leverage relative to their high – valued fixed assets counterpart In this research, tangibility is defined as the ratio of net fixed assets to total assets (Titman and Wessels, 1988; Rajan and Zingales, 1995; Frank and Goyal, 2003; and Hall et al., 2004) The formula for tangibility is as followed:

Tangibility Net fixed assets

Total assets

3.2.2.5 Asset Turnover (TURN)

As analyzed in the literature review chapter, asset turnover ratio is important

in determining firm’s mobilization of source Specifically, company which has a high asset turnover ratio can attract funds from inside and outside easier than one

with low turnover A high asset turnover shows that firm use assets efficiently It is the reason why investors feel trustful to invest in these companies In this study, asset turnover variable is calculated by dividing total net sales to total assets (Onaolapo Adekunle A, 2010) The formula is as followed:

3.2.2.6 Firm Size (SIZE)

Based on the above discussion of the literature review, firm size is considered to an important determinant of capital structure and firm’s profitability

A large firm typically has better access to capital markets and finds it easier to raise funds with lower cost and fewer constraints compared to a small firm There are many theoretical reasons why firm size would be related to the capital structure of the firm Smaller firms may find it relatively more costly to resolve the asymmetric information with lenders and financiers (Kester, 1986 and Titman and Wessels, 1988) Consequently, smaller firms are offered less capital, or are offered capital at significantly higher costs to larger firms, which discourage the use of outside financing Firm size is expected to have a positive relationship with firm performance and is calculated by Natural logarithm of total assets (Anaolapo, 2010, Zeitun et al, 2007) The formula for firm size is as followed:

3.2.2.7 Firm Age (AGE)

According to the discussion in the literature review, firm age is an important factor affecting the ability of enterprise debt financing A longtime business usually

is more reliable and easier access to debt than enterprises with shorter lives (Diamond, 1989) The age of a firm may also have an impact on firm’s performance Hence the introduction of explanatory variable, AGE in this study is necessary Stinchcombe (1965) argue that older firms can achieve experience-based

economies and can avoid the liabilities of newness In practice, when making a loan

to corporate, bank often takes more concerns on the number of years corporate operate The longer time the firm operates the more relationship the firm can create The firm’s market value is also widespread if it has been operating for a long time Age is calculated as the number of years that companies have existed for (Nguyen Xuan Thang, 2010) Thus, the formula for firm age as follows:

Age = Year of observation – Year of initial public offering

3.2.2.8 Growth Opportunities (GROWTH)

A review of literature reveals several explanations for growth opportunities One explanation is that a firm with high growth opportunities tends to develop agency conflicts between shareholders and debt holders as shareholders in such firms have stronger incentives to under invest and greater probabilities of substituting or shifting risk (Myers, 1977 and Smith and Warner 1979) Other explanations are that a firm with high growth opportunities will need more money

to invest in such opportunities Hence the need for issuance more debt is necessary Similar to Zeitun et al (2007), this study uses net sales growth rate as a proxy variable for growth opportunities The formula for net sales growth rate is as follows:

rowth opportunities Net sales (t) Net sales(t 1)

Net sales(t 1)

3.2.2.9 Industrial Sector (IND)

Many characteristics of the firms may be reasonable similar within the industry groups, but cannot be captured easily Firms in the same industry also follow some different characteristics or procedures Hence, industrial sector is seen

to affect firm’s financial performance Thus, there is need for the introduction of industrial sector (IND) as a dummy variable in this study 8 sectors are used in this study are Customer Goods and Services Sector (35 companies), Basic Material Sector (19 companies), Industrial Sector (10 companies), Oil and gas sector (8

firms), Construction and Material Sector (7 companies), Transportation Sector (6 companies), Utilities Sector (6 companies) and Information Technology Sector (1 company) The number of Information technology companies listed on HOSE is two When the research’s data are collected, there is only one company’s financial statement being audited It is the reason why there is only one company in Information technology sector in this study The dummy variable takes the value 1

if the firm is in that industry and the value 0 if is not

3.3 HYPOTHESIS AND EMPIRICAL MODEL SPECIFICATION

3.3.1 Model 1: FIRM LEVERAGE MODEL

This model tests the determinants on debt choice of firms listed on Ho Chi Minh Stock Exchange The model uses firm leverage as a proxy for the dependent variable and ROE, ROA, Growth opportunities, firm size, asset tangibility and asset turnover are explanatory variables In the research methodology chapter, ROA is mentioned to be relatively unaffected by a company’s choice of capital structure In this model, we continue use this variable to test the consistence in Vietnamese firms In case there is a difference with what have proved, this is an exceptional case of Vietnamese firms

3.3.1.1 Hypothesis:

H1: ROA has a positive correlation with firm leverage

H2: ROE has a positive correlation with firm leverage

H3: Firm size is expected to have a positive influence on a firm leverage

H4: Firm age is expected to have a positive influence on a firm leverage

H5: Asset Tangibility is expected to be positively related to firm leverage

H6: Growth opportunities are expected to be positively related to firm leverage H7: Asset turnover is expected to be positively related to firm leverage

H8: Industrial sector affects firm’s leverage

Thus, the model is:

LEV =  0 +  1 ROA it +  2 ROE it +  3 SIZE it +  4 AGE it +  5 TANG it +  6 GROWTH it +

- n 1…8: number of industry sector

- ROAit, ROEit, SIZEit, AGEit, TANGit, TURNit and GROWTHit: are vectors

of determinant that vary across both firms and time

- INDni: dummies of eight classified industries of firms

- eit: is residual error for firm i in year t

3.3.2 Model 2: FIRM PERFORMANCE MODEL

This model employs Return on Asset (ROA) and Return on Equity (ROE) as the two dependent variables, and measures of firm performance Although there is

no unique measurement of firm performance in literature, ROA and ROE are chosen because they are important accounting-based and widely accepted measures

of financial performance ROA can also be viewed as a measure of management’s efficiency in utilizing all the assets under its control, regardless of source of financing

Some authors such as Bettis and Hall (1982), Demsets and Lehn (1985), Habib and Victor (2006), Rao at al (2007), Zeitun and Tian (2007) among others, make use of ROA and ROE as performance proxies in their studies The market based financial performance which is extensively used in the empirical literature in Tobin’s Q However, the market value of debt, an important variable adopted in the determinant of Tobin’s Q is not provided by the selected firms, hence could not be used in this study Also, many researchers, as reported by Xu and Wang (1997) and

Zeitun and Tian, 2007, see Tobin’s Q as a noisy signal and not a good performance measure

The only main independent variable in this model is the Leverage ratio (LEV) It serves as the proxy for financial structure However, a number of factors may impact on firm performance Hence, it is necessary to include more explanatory variables in the model The following explanatory variables are used: firm leverage (LEV), asset turnover (TURN), firm’s size (SIZE), firm age (AGE), asset tangibility (TANG), and growth opportunities (GROWTH) Besides, Industrial sector is considered to be affect firms’ profitability So, it is necessary to include variable IND to other variables

3.3.2.1 Hypothesis:

H1: A firm’s financial leverage should have a negative impact on its performance H2: There should be a positive relationship between asset turnover and firm performance

H3: There should be a positive relationship between size and firm’s performance H4: There should be a positive relationship between firm’s age and its performance H5: There should be a positive relationship between firm’s asset tangibility and its performance

H6: There should be a positive relationship between a firm’s growth opportunities and its performance

H7: Industrial sector affects firm’s performance

The model 2 can be expressed as followed:

ROA =  0 +  1 LEV it +  2 TURN it +  3 SIZE it +  4 AGE it +  5 TANG it +  6 GROW it +

7 IND ni + e it ROE =  0 +  1 LEV it +  2 TURN it +  3 SIZE it +  4 AGE it +  5 TANG it +  6 GROW it +

7 IND ni +e it

Where:

- 0: Constant

- j (j=1, ,7): is the coefficients of the explanatory variables and dependent variable, respectively

- i 1…92: cross-sectional observation unit in the sample

- t 1…4: time period

- n 1…8: number of industry sector

- LEVit, SIZEit, AGEit, TANGit, TURNit and GROWTHit: are vectors of determinant that vary across both firms and time

- INDni: dummies of eight classified industries of firms

- eit: is residual error for firm i in year t

The co-efficient of the explanatory and controllable variables (1,…,7) can be estimated by the use of LS technique

3.3.3 Model 3: BANK LOAN MODEL

Like researches of Demirguc-Kunt and Maksimovic (1999), this model uses two ratios: Long-term bank loans to total assets (LTA) and short-term bank loans to total assets (STA) as two dependent variables to test the determinants when firms get funds from the banks This study uses LTA and STA as proxies for firm’s debt

in terms of structure and maturity Here are the hypothesis creations and equation for empirical model

3.3.3.1 Hypothesis

H1: There should be a positive relationship between bank loan and asset turnover H2: There should be a positive relationship between bank loan and firm size

H3: There should be a positive relationship between bank loan and firm age

H4: There should be a positive relationship between bank loan and firm tangibility H5: There should be a positive relationship between bank loan and firm growth opportunities

H6: Industrial sector affects the choice of firm when mobilize funds from banks The model3 can be expressed as followed:

LTA =  0 +  1 TURN it +  2 SIZE it +  3 AGE it +  4 TANG it +  5 GROW it + 6 IND it + e it

STA =  0 +  1 TURN it +  2 SIZE it +  3 AGE it +  4 TANG it +  5 GROW it + 6 IND it +e it

- n 1…8: number of industry sector

- SIZEit, AGEit, TANGit, TURNit and GROWTHit: are vectors of determinant that vary across both firms and time

- INDni: dummies of eight classified industries of firms

- eit: is residual error for firm i in year t