The Government Intervention And Investment Decision: Evidence From Vietnam

The Government Intervention And Investment Decision: Evidence From Vietnam Luong Thi Thao Le Thi Phuong Vy Tran Thi Hai Ly University of Economics Ho Chi Minh City, Vietnam Abstract

The Government Intervention And Investment Decision:

Evidence From Vietnam

Luong Thi Thao

Le Thi Phuong Vy Tran Thi Hai Ly

University of Economics Ho Chi Minh City, Vietnam

Abstract

This paper investigates whether the government intervention affects the investment decision and the efficiency in investment allocation amongst Vietnamese listed firms for the period from 2009 to 2016 The regression coefficients are estimated by two-step system GMM regressions The research results show that government intervention is positively related to investment but could lead to inefficiency in capital allocation Political connection is significantly associated with investment decision and investment efficiency of non-SOEs; however, it is insignificant for those of SOEs

Keywords: Government intervention, investment decision, political connection, state ownership

1 Introduction

There are diversified arguments of the impact of the government intervention on businesses and the economy due to difference in motivation and class interests It is unable to completely deny the role of the state in the economy This role has been particularly enhanced in recent years, especially after the 2008 global financial and economic crisis In fact, the effects and efficiency of government intervention are different from country to country In developed economies, economic system seems to operate rather smoothly and hence, the degree of the government intervention may be lower than emerging and transitional economies

From the point of view of firms, investment is one of the most important financial decisions so considering the relationship between this decision and the government intervention is a practical and attractive matter for researchers across the world Both theoretical arguments and empirical results remain a controversial issue Research results of Chen & Yuan (2004); Pistor & Xu (2005), Wang & Yung (2011) suggest that for an incomplete legal system and/or transition economy, the government intervention plays the key role in improving the economic efficiency Wurgler (2000), Chen et al (2011, 2013), Pan & Tian (2017); however, show that government intervene directly in investment decision of firms through dominant ownership shares and/or

by political connections of chairman or CEO makes firm investment increase but capital allocation efficiency decrease

After more than 30 years of renovation, the transition economy of Vietnam has acquired significant socio-economic-cultural accomplishments, but state management still has many outstanding problems related to public investment, public asset management Especially, investment and investment efficiency of SOEs are always the topic of current interest, attracting the attention of the whole society The explanation for this seems

to be that investment decision plays an important and long-term strategic role for enterprises to gain market share, increase firm value and contribute to economic growth as well

To the best of our knowledge, rather few studies on the impact of government intervention on investment decision are carried out in Vietnam Most of those focus on examining the effects of the dominance of state ownership on investment decisions The influences from the government intervention by political connections embedded in members of the board of directors and/or top management teams on investment as well as investment efficiency have yet addressed This paper aims to fill this gap, to enhance the literature and to enrich the empirical results in emerging markets In addition, research results may offer certain implications for researchers, policymakers and enterprises in Vietnam To achieve these research objectives, the paper seeks

to answer two main questions: (i) Does direct government intervention through dominant ownership or through the political connections impact investment decision and investment efficiency in Vietnam? (ii) Do political connections (PC) have similar affects on investment of state majority-owned companies (SOEs) and that of others (non-SOEs)? Two-step system GMM is used to estimate the coefficients in the research model

on the sample of 336 companies listed on the Ho Chi Minh and Hanoi Stock Exchange over the period of

2009-2016, or 2.688 firm-year observations

Research results indicate that, overall sample, direct government intervention through dominant ownership or through political connections makes firms increase investment However, this intervention leads

to a decrease in sensitivity of investment with investment opportunities and hence the efficiency of capital allocation (investment efficiency; Chen et al., 2011) is deteriorated When examining the subsample of SOEs, the impact of dominant ownership on firm investment is stronger and leads to an insignificant effect of political connections on investment There is a contrary result when we explore the subsample of non-SOEs

In other words, political connections are significantly associated with changes in investment and investment efficiency of non-SOEs in our research sample

2 Literature review

The debates about the role of government in the economy is divided into two main points The first school

of economic thought emphasizes the role of free market, including theories of the Classical economics (Adam Smith, 1776), Neo-classical economics and Neo-liberalism (Milton Friedman) They suggest that the free competition mechanism can regulate the market economy become more stable and hence government intervention in the economy should be minimized The second one appreciates the government role for the economy To be more specific, Keynes and Keynesian School (John R Hicks, Alvin H Hansen), Institutionalist School (Wesley Mitchell), left-wing economists (John K Galbraith) or Progressivism concur that there is no self-regulatory mechanism rather than the government intervention which can boost the capitalist economies

by making full use of their entire resources and make investment activities increase steadily Since investment

is not only an important financial decision of any enterprise but also a vital driving force behind economic growth (Levin & Renelt, 1992), the question of how government intervention affects the firm investment has received the special attention from researchers and policymakers Theoretical arguments and empirical results remain disturbed by the lack of consistency amongst scientific community The researchers believe that government intervention is positively related to firm investment decision because they rely primarily on the assumption that without government intervention, hardly can firms fully address some of the market failures, such as external issues or asymmetric information When intervening in financial decisions of firms, the government may promote corporate investment activities and increase growth rate by accelerating their access

to finance as well as technology transfer process (Rosenstein-Rodan, 1943; Sacristan, 1980; Morris & Adelman, 1988), enhancing macroeconomic stability (Wade, 1990), promoting non-contractible product quality and innovation (Hart et al., 1996) Conversely, advocates of free market and private economy argue that government intervention in economic activities is more likely to cause low growth and inefficient investment because of the government’s diverse goals and asymmetric information (Hayek, 1945; Shleifer & Vishny, 1994)

Two types of government interventions widely studied by scholars around the world are intervention via government dominant ownership and via political connections

2.1 Government intervention via government dominant ownership

The growing research evidence shows that firms with higher level of state ownership tend to make more investment but their investment efficiency is deteriorated Shleifer & Vishy (1994) exhibit that state

majority-owned companies may pursue social and political objectives beside the objective of maximizing value of the firm In addition; to avoid following the government’s goals, firms may be forced to bribe politicians and this

is one of the main causes of reduced performance Evans (1995), however, argues that the existence of the self-interests on the part of politicians and government officials does not necessarily result in adverse effects from government intervention because structural features of state apparatus may restrict their abuse of power and hence make government intervention beneficial to firms In other words, enterprises are able to have more investment opportunities and access valuable resources easily, thereby encouraging firms to expand their investment (Sapienza, 2004) Allen et al (2005) illustrate that executing investment projects governed by political objectives or other non-economic factors often causes firms to over-invest and erode corporate value, supporting the conclusion of Shleifer & Vishny (1994) Chen et al (2011) report that the sensitivity of investment expenditure to investment opportunities in SOEs is significantly lower than that of other firms, implicating that their investment decision is less efficient Chen et al (2013), however, argue that the government intervention is negatively and significantly related to the firm investment and sales growth This relationship is more profound in foreign firms and less significant in SOEs They also offer evidence that when providing firms with good-quality services and institutions, the government seems to foster their investment and sales growth To put it in a nutshell, the evidence relating to the positive relationship between the state ownership and firm investment outweighs the negative one The explanation for this seems to be that SOEs are protected by the government and they easily possess great opportunities to access external finance, even financially distressed SOEs still increase their financial leverage thanks to the supporting from state-owned banks (Yuan & Mottohashi, 2014; Shao et al., 2014; Shen et al., 2016; Ding et al., 2016)

2.2 Government intervention via political connections

Another proxy of government intervention addressed by many studies is political connection, which is represented by top executives’ relationship A firm is considered to be politically connected if its chairman or CEO is a current or former government officer in the governments or the military (Faccio, 2006; Fan et al., 2007; Chen et al., 2011, Pan & Tian, 2017) Most empirical studies have revealed that political connections bring certain advantages to firms, such as quick approach to policy information, easy access to external funding at

a lower cost (Claessens et al., 2008, Piotroski & Zhang, 2014), lessening the constraints of capital rationing (Chan et al., 2012) or getting more relationship-based contracts (Goldman et al., 2013), which in turn can impact investment decision of firms (Lang et al., 1996; Aivazian et al., 2005) According to research results of Wu et

al (2012), Pan & Tian (2017), the affect of political connections is expected to be different for SOEs and non-SOEs To be more detailed, SOEs are obviously connected with the government via the dominance of state ownership and appointing representatives as members in corporate boards or top executives In this situation, investment activities in SOEs are not additionally influenced by political connections In other words, the impact of intervention via political connections is insignificant for SOEs Nonetheless, non-SOEs usually have

a strong incentive to nurture and maintain close relationships with the government, which helps them overcome institutional failures and ideological discrimination against private ownership (Li et al., 2008; Xu et al., 2011) Hence, political connections have significantly positive impact on non-SOEs investment activities

In addition to having an intimate relationship with the government as well as owning much more valuable information may make top executives become overconfident easily Huang et al (2011) demonstrate that

leaders’ overconfidence is one of the reasons why Chinese firm investment is distorted Chen et al (2011) also show that information asymmetry and conflicts of interest between managers and shareholders usually hinder enterprises from implementing optimal investment projects In brief, information asymmetry and agency problems are likely to distort firm investment, leading to investment inefficiency

3 Data and methodology

3.1 Model

To investigate whether government intervention affects investment decision and investment efficiency (optimal investment) of companies, we develop a model of empirical research based on those of Chen et al (2011), Pan & Tian (2017)

𝑰𝑵𝑽𝒊,𝒕= 𝜶+ 𝜷𝟏𝑰𝑵𝑽𝒊,𝒕−𝟏+ 𝜷𝟐𝑻𝑸𝒕+𝜷𝟑𝑮𝑶𝑽𝒊,𝒕+ 𝜷𝟒𝑻𝑸𝒕𝒙𝑮𝑶𝑽𝒊,𝒕+ 𝜷𝟓𝑪𝑭𝒕−𝟏+ 𝜷𝟔𝑹𝑬𝑽𝒊,𝒕−𝟏+ 𝜷𝟕𝑳𝑬𝑽𝒊,𝒕−𝟏

+ 𝜷𝟖𝑺𝑰𝒁𝑬𝒊,𝒕−𝟏+ 𝜸𝑰𝒏𝒅𝒖𝒔𝒕𝒓𝒚 + 𝜺𝒊,𝒕 Where,

INV i, t is the dependent variable, measured by investment expenditure of firm i in year t

INV i, t-1 is a lagged dependent variable that acts as an independent variable in the model Capital structure theory suggests that companies can adjust their investment spending towards optimal capital structure, so investment in the current period may be influenced by investment in the previous period

TQ: According to Modigliani & Miller (1958), in the perfect market, investment opportunity, measured by Tobin’s Q (Tobin, 1969), is the unique factor that affects on corporate investment If market value of the company is greater than the replacement cost of its assets, it tends to issue new shares at high prices to raise funds needed to finance new assets Besides, holding other things constant, the higher prices firms issue, the lower cost of equity they bear that results in a lower minimum required return on investment projects and hence it increases the possibility of new projects acceptance This means that when the investment opportunities increase, the firm investment will also go up

GOVi, t-1 is the independent variable of the model, representing the government intervention in

investment of firm i in year t-1 This variable consists of two different representations that are state dominant ownership (SOE) and the political relationship between firm leaders and government (PC)

SOE: Shao et al (2014) mention that level of state-ownership at an enterprise is above 30%, considered as dominant ownership In Vietnam, nevertheless, according to the latest revisions in the Enterprise Law 2014, condition for conducting the first annual general meeting of shareholders requires the participation of shareholders that own at least 51% of the voting shares (down from 65% the previous years) Besides, the resolutions or/and decisions of shareholders’ meeting are approved by at least 51% of total votes of all participating shareholders This means that unless otherwise provided for in the company’s charter, owning around 26% (≈ 51% x 51%) of total voting shares in the first shareholder meeting is enough to pass important decisions of enterprises In this paper, thus, we define a threshold of 26% for state‐dominant ownership and use this value as a basis for assigning binary value to SOE variable In other words, SOE is a dummy variable equal to 1 for companies that have at least 26% voting shares belonging to the government and 0 for others In state majority-owned companies, the government seems to have the most powerful influence on their financial decisions, especially investment decision To be more specific, these firms, even some financially distressed firms, can access external finance easily with the government support and in return, they have to follow the social and political mandates which cause firms to undertake more investments Based on the foregoing arguments, our first hypothesis predicts that:

H1a: The government intervention via state-dominant ownership tend to induce firms to invest more

PC: is a dummy variable, defined to have value 1 if at least one member in board of directors or in board

of management currently or formerly works in the government agencies or military or state-owned

enterprises; otherwise, this variable has a value of 0 This measure is a little different from that of Faccio (2006), Fan et al (2007), Chen et al (2011), which only study the political connections of the chairman or CEO Thanks

to these relationships, firm leaders could bring many advantages of information, financial capital as well as valuable contracts to their firms (Chan et al., 2012; Goldman et al., 2013) As a consequence, firms may increase their investment However, overconfidence of CEO (Huang et al., 2011), information asymmetry or agency problem (Chen et al., 2011) has adverse effects on efficiency of capital allocation Thus, we expect that:

H2a: The government intervention via political connections may make non-SOEs increase their investment activities but it is not the case for SOEs

Information asymmetry models assume that information disparity between managers and investors often leads to underinvestment (Myers & Majluf, 1984) Owning internal information and knowing that their stocks are being overvalued, managers tend to issue new equity and/or risky debt Rational investors are only willing

to pay a lower price for new issued securities and raising capital to finance potential investment projects of firms may be affected As a result, the sensitivity of investment to investment opportunities is decreased, leading to underinvestment or investment inefficiency If the information asymmetry theory assumes that managers act in the best interests of the shareholders, the agency theory argues that managers may act in their own self-interest rather than owners’ interests (Jensen & Meckling, 1976) They might be tempted to play games at the expense of shareholders, such as denying potentially profitable investment opportunities, taking more risk or willing to pour shareholders’ money into negative NPV projects This makes the real investment

of firms deviated from the optimal investment level and hence, they ineffectively allocate their capital investment We add an interactive variable with the coefficient 𝛽4 to measure the sensitivity of firm investment

to investment opportunities under various forms of government intervention (Chen et al., 2011; Pan & Tian, 2017) A negative correlation means that the sensitivity of the investment (INVt) to investment opportunities will be reduced as the government intervenes in corporate finance decisions and that makes corporate unable

to reach optimal investment level All above, two additional hypotheses are given:

H1b: Firms with higher level of government ownership tend to have lower chance to attain optimal investment level

H2b: The impact of government intervention via political connections on attaining investment level of non-SOEs is more significant than that of SOEs

Control variables include Cash Flow (CF), Firm Size, Revenue (REV), and Industry dummies:

Cash Flow (CF): Myers & Majluf (1984) point out that firms more likely use internal financing due to

information asymmetry problems and signaling effects of external financing More abundant internal financing allows firms to seize opportunities and increase investments (Jensen, 1986; Fazzari et al., 1988; Cleary et al abundant, 2007) Thus, we expect CF to be positively associated with investments

Revenue (REV): According to accelerator effect theory, an increase in revenues is a main determinant

inducing firms to increase investments (Jorgenson, 1963; Knox, 1952)

Financial Leverage (LEV): is a proxy for firms’ financing policies There are empirical evidence supporting

the relationship between financing and investment decisions in imperfect markets (Jensen & Meckling, 1976; Jensen, 1986; Myers, 1977) Lang et al (1996) document that an increase in debt might lead to reduce firms’ investments to relieve financial distress costs Nonetheless, using debts appropriately can help firms maximize the benefits of debts’ tax shields and reduce agency costs

SIZE: a measure representing for size of firm Bigger firms more easily access financing sources (Chen et

al, 2011) Therefore, we expect that firm’s investments are positively related to firm size

Industry: Industry dummies are included to control for the differences amongst industries

3.2 Data

Data used in this paper is obtained from (i) Thomson Reuters Datastream, and (ii) Documents prepared for shareholders meetings, annual reports, corporate governance reports, and financial reports from the official websites of Ha Noi and Ho Chi Minh Stock Exchanges Removing financial firms, firms that were first listed after 2009, delisting firms, and firms that moved to Upcom, we obtain our final sample of 336 firms (out of all

398 listed firms in both the exchanges), representing 63% in terms of both the exchanges’ total market capitalization in 2009

Table 3.1: Variable Definition

Variable Definition

INVt

Net capital expenditure divided by total assets at the beginning of the year Net capital expenditure is calculated by subtracting cash flows of the asset sales from cash flows spent on fixed assets and other long-term assets

Gov A measure of government intervention We use two alternative proxies for government

intervention, SOE or PC

SOE shows how state ownership dominates others SOE is a dummy variable that is equal to

1 if state ownership in a firm is not lower than 26%, and zero otherwise

PC is a dummy variable that equals to 1 if top manager used to or currently works in government agencies, stated-owned companies, or in the army, zero otherwise

TQ Tobin’s Q = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 + 𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝐷𝑒𝑏𝑡𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

CF Operating Cash Flows reported in cash flows statement divided by total assets at the beginning of the year

𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

Size Nature logarithm of Total Assets

Industry Industry dummies

Firms in our sample belong to 9 industries under the classification of Global Industry Classification codes (GICs) This classification system is used by Ho Chi Minh Stock Exchange, but not Ha Noi Stock Exchange Therefore, we manually assign GIC codes for firms listed on Ha Noi Stock exchange according to GICS’s guidance

Table 3.2: The number of firms in each industry in the sample

Source: HSX, GICS, calculated by authors

4 Results

Descriptive statistics in Table 4.1 show that the ratio of investments to assets is 6.4% for the full sample, 7.1% for the state-owned enterprises (SOEs), which is higher than 5.8% for non-SOEs However, a t-test indicates that the difference in investment ratios between the two groups is not statistically significant at 5% State ownership in the full sample is on average 27.6% while that in the SOE sample is 47.4% This indicates that most firms in our sample are under substantial control of the government Indeed, 53.8% of SOEs have top executives who have political connections with the government whereas only 32.9% of non-SOEs do The difference of 20.1% is statistically significant at 1%

Table 4.1: Summary Statistics

Full sample (Maximum Obs: 2.688) (Maximum Obs: 1.397) SOE (Maximum Obs: 1.291) Non-SOE Diff

-11,124***

Table 4.2 reports descriptive statistics for the full sample partitioned by political connections, SEO with PC and non-SEO with PC Although the ratio of investments to assets is not statistically different (at 5%) between firms with and without political connections, firms whose top executives have political connections via their work experience, have more investment opportunities, bigger size, generate more revenues, use more financial leverage, and have more cash flows

Table 4.2: Statistical descriptions for firms with and without political connections

First, we examine the effects of government interventions on firms’ investments and firm’s capital allocation efficiency by inserting each of variable, SOE and PC, into equation (1)

Table 4.3 shows the effects of government interventions via controlling ownership (column 1) and via political connections of executives (column 2) These outcomes suggest that government intervention has a positive effect on firm’s investment, which support the H1a and H2a hypotheses In details, both coefficients

of GOV measured by state ownership and political connection are positive and significant at 1% level of significant, but lightly vary in the magnitude (the coefficient of GOV in column (1) was 0.12, nearly double that of 0.065 in column (2)) Therefore, it could be concluded that the effect of state ownership on firm investment activities is stronger than the effect of political connection Furthermore, the coefficient of leverage

is statistically significant and related positively with investment This result confirms the argument that firms with state ownership or political connection could gain better to access capital markets, thus increase capital expenditure (Shao et al., 2014; Shen et al., 2016; Ding et al., 2016)

In addition, estimated coefficients 𝛽2 on TQ variable, which capture the sensitivity of investments to investment opportunities, are all positive and statistically significant This suggests that firms increase investments when having more investment opportunities This result is in line with the Q-theory of investment and previous empirical research (Chen et al., 2011; Huang & Wang, 2013; Pan & Tian, 2017) Two other variables affecting investments are cash flows (CF) and leverage (LEV) (Abel & Blanchard, 1986; Fazzari et al., 1988; Jensen, 1986) This finding could be explained that firms with more abundant cash flows would have higher financial flexibility and take investment opportunities better

Table 4.3: The impact of government interventions on firm investment Dependent variable - INVt

(1) GOV measured by SOE (2) GOV measured by PC

Statistics t in parentheses; * Significant at the 10% level;** Significant at the 5% level;*** Significant at the 1% level

This research also investigates the sensitivity of investment to investment opportunities when government intervention is considered in corporate finance decisions These results confirm H1b and H2b hypotheses, as well as is consistent with the views of Shleifer & Vishny (1994), Allen et al (2005), Chen et al (2011, 2013 Specifically, the coefficient of the interaction variable (GOV x TQ) in column (1) is 0.135 and column (2) is -0,071 and significant at 1% level These findings show that the impact of investment opportunities on capital expenditure is decreased by government intervention Which means that when investment opportunities increase, firms with government intervention are more likely to fall into the under-investment than other firms because they do not increase capital expenditure to the level that be suggested by growth opportunities But when profitable investment opportunities decline, these firms do not cut corresponding capital expenditure,

or could suffer an overinvestment problem This issue therefore could reduce the efficiency of allocating capital or decreasing the investment efficiency

The research further examines the impact of government interventions on firm investment for state owned enterprises (SOEs) versus non-state-owned enterprises (Non-SOEs) To be specific, estimating two separate regressions for two groups (SOEs and Non-SOEs) is employed The results of two step system GMM is reported in the Table 4.4 The findings once again pointed out that while political connection has positive relation with firm investment, it reduces the association between opportunity growth and investment expenditure The only difference is that the coefficient of PC in SOEs is insignificant This evidence shows that investment activities in SOEs are not considerably influenced by political connections In other words, the impact of government intervention via political connections is trivial for SOEs In contrast, the results in firms without state ownership (non-SOEs) illustrate that a political connection will helps them overcome institutional failures and ideological discrimination against private ownership (Li et al., 2008; Xu et al., 2011) Hence, political connection has significantly positive impact on non-SOEs investment expenditure

Table 4.4: The impact of government interventions on firm investment for SOEs versus Non-SOEs

Dependent variable – INVt

AR (1) 0 0,313

Statistics t in parentheses; * Significant at the 10% level; ** Significant at the 5% level; *** Significant at the 1% level

One point to be noted is that Table 4.3 and 4.4 also reports the results of Hansen test of over identification and the Arellano-Bond test for autocorrelation error The Hansen tests show all p-values above 0.10, thus, over identification restrictions are valid The AR (2) tests give p-values above 0.10, which means that a null hypothesis could not be rejected Therefore, all results of regressions are valid

5 Conclusion

This research investigates the impact of government intervention on investment expenditure in Vietnamese listed firms by using two step system GMM regressions The outcomes indicate that government intervention via state ownership or political connection could increase firm investment In addition, a firm with high government intervention could suffer seriously underinvestment or overinvestment problems, thereby reducing the efficiency of its capital allocation This evidence is in line with most previous studies and once again confirms that firms with state ownership or political connection could have more benefits than others They could easily access the capital market, overcome the institutional barriers, resulting in expansion in capital expenditure Besides, the results also implicate that political relationships are more significant for non-SOEs

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