Determinants of leverage , case study of vietnam seafood processing and exporting industry both for listed and unlisted firms

The results finding from the thesis is that firm growth opportunities and firm size have positive related to leverage, profitability, liquidity have a negative effect to leverage whereas

VIETNAM- THE NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

DETERMINANTS OF LEVERAGE: case study of VIETNAM SEAFOOD PROCESSING AND EXPORTING

INDUSTRY both for listed and unlisted firms

By

PHAM THI TRUC LAM

A thesis submitted in partial fulfillment of the requirements for the degree of

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

Academic Supervisor:

Assoc Prof NGUYEN TRONG HOAI

HO CHI MINH CITY, DECEMBER 2012

Finally, I am greatly indebted to my family for their love for and support of me, keeping me in good condition for learning I am also grateful to my close friends for their warm encouragement

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ABSTRACT

Although there are many prior studies about leverage as well as capital structure on the world in general and Vietnam in particular, results of these researches are still inconsistent Moreover, in context of Vietnam, most of studies about leverage are of listed firms So, this study works with data of both listed and unlisted firms The purpose of this study is to examine the relative importance of some factors to the leverage of Vietnam seafood processing and exporting enterprises A sample of 20 listed and 15 unlisted enterprises for a period of 3 years from 2009 to 20 11 was chosen and tested base on pecking order theory and trade off theory The results finding from the thesis is that firm growth opportunities and firm size have positive related to leverage, profitability, liquidity have a negative effect to leverage whereas tangibility assets and non-debt tax shield have no impact on leverage of Vietnam seafood processing and exporting enterprises

Key words: leverage, pecking order theory, trade off theory

CONTENTS

Certification i

Acknowledgement ii

Abstract iii

Contents iv

List of Tables vii

List of Abbreviations vii

CHAPTER I: INTRODUCTION FOR THE STUDY 1

1.1 Problem statement: 1

1.2 Research objectives: 3

1.3 Research questions: 3

1.4 Research Methodology: 3

1.5 Structure of the thesis: 4

CHAPTER II: LITERATURE REVIEW FOR DETERMINANTS OF LEVERAGE 5

2.1 Key Concepts: 5

2.2 Related theories: 6

2.2.1 The Modigliani-Miller theorem: 6

2.2.2 Agency cost theory: 7

2.2.3 Trade-off theory: 8

2.2.4 The pecking-order theory: 8

2.3 Determinants of leverage: 10

2.3.1 Leverage and Profitability: 12

2.3.2 Leverage and firm size: 13

2.3 3 Leverage and Firm Growth: 15

2.3.4 Leverage and Non-debt tax shield : 16

2.3.5 Leverage and tangible assets: 17

2.3.6 Leverage and liquidity: 19

2.4 Empirical review on determinants of leverage: 20

2.4.1 Empirical evidences finding from the world: 20

2.4.2 Empirical evidences finding from Vietnam perspective: 24

2.5 Chapter remarks: 25

CHAPTER III: RESEARCH METHODOLOGY 27

3.1 Data and variables description: 27

3.1.1 Data: 27

3 1.2 Description of variables: 27

3.2 Methods of estimation: 29

3.2.1 Ordinary Least Squares (OLS) estimator: 30

3 2.2 Fixed Effects (FE) estimator: 31

3.2.3 Random Effects Estimator (RE): 32

3.2.4 Hausman specification test: 32

3.3 Hypotheses 33

3.4 Chapter remarks: 33

CHAPTER IV: OVERVIEW OF SEAFOOD PROCESSING AND EXPORTING ENTERPRISES 3 5 4.1 Introduction of the seafood export industry: 35

4.2 Analysis of capital structure of the seafood enterprises: 38

4.2.1 Debt to equity ratio: 38

4.2.2 The equity growth rate: 41

4.3 Chapter remarks: 42

CHAPTER V: EMPIRICAL RESULTS 43

5.1 Descriptive statistics 43

• 5.2 Analysis of the correlation between all variables: 44

5.3 Test multicollinearity: 45

5.4 Empirical results: 46

5.4.1 OLS estimator: 46

5.4.2 Hausman specification test: 48

5.4.3 Fixed effects estimator: 49

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5 5 Chapter remarks: 53

CHAPTER VI: CONCLUSION, POLICY RECOMMENDATION AND LIMITATION 55

6.1 Conclusion 55

6.2 Policy recommendation 57

6.3 Limitation and suggestion for further study: 61

Reference 62

Appendix 68

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LIST OF TABLES

Table 2.1: Summary of leverage determinants

Table 3.1: Variable, description and its expected sign

Table 4.1: The equity growth rate

Table 5.1: Descriptive statistics of sample variables

Table 5.2: Correlation coefficient matrix

Table 5.3: Result of auxiliary regression models of each dependent variable Table 5.4: Result ofOLS estimator

Table 5.5: Result ofHausman test

Table 5.6: Result of Fixed effects estimator

- - - -

-NDTS SEAs SMEs

FE

RE GDP GSO OLS STD LTD TTD EQTY ASS

- -

-LIST OF ABBREVIATIONS

Non debt tax shield Seafood processing and exporting enterprises Small and medium enterprises

Fixed effects Random effects Gross Domestic Product General Statistics Office of Vietnam Ordinary Least Square

Short term debt Long term debt Total debt Equity Total assets

CHAPTER 1: INTRODUCTION FOR THE STUDY

This chapter will explain the reason for choosing the thesis, its objectives and research questions In addition, this part also presents a brief of methodology and finally abbreviates the structure of the thesis

1.1 Problem statement:

One of the most important decisions confronting a firm in corporate finance

is the design of its capital structure In order to finance for investment, the firms can choose either internal or external funds Internal fund is the firm retained earnings whereas external fund can be raised from issuing equity or taking debt Sometimes, firms may take too much or without taking debt An effective debt ratio or leverage should not only help reducing the weighted average cost of capital of the firm but also it still can increase firm value To decide how much leverage the firm should take on, the firms need to know which factors affect leverage However, over 50 years since the first research of Modigliani and Miller (1958) about leverage, the question of them about what factors affect leverage are still unresolved until now This seems to be the most enigmatic and interested issue of many researchers However, until now, the effort of researchers to solve the debt equity choice also does not bring results that satisfy all of them The results are still inconsistent between researches at different countries and different industries Moreover, Myers ( 1984) also suggests that "the average debt ratio will vary from industry to industry because asset risk, asset type and requirements for external fund also vary by industry" (p.578) In case of Vietnam, there are also some studies testing for determinants of the leverage of Vietnam companies, such

as Nguyen and Ramachandran (2006), Dzung et al (2012) and the empirical results of these studies also contain conflicts as results from many other studies in the world

Seafood is considered to be one of major industries and one of the key export sectors of Vietnam Each year, it contributes largely to GDP Particularly,

at the beginning of the year 2012, 470/800 exporting seafood firms must stop working, not exclude large companies The problem is these enterprises depend too much on debt while the way of using debt is ineffectively So, now restructuring of capital structure become the most important problem for Vietnam seafood enterprises To improve financial ability and avoid risk of financial, seafood enterprises need to have a suitable leverage In order to do that, it's very important for firms to know whether leverage of firms may be impacted by which factors Finding factors affecting leverage will help enterprises to control its leverage through impacting on these factors

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1.2 Research objectives:

The main objective of this thesis is to examine the impact of some factors

as profitability, firm growth opportunities, firm size, tangibility assets, non debt tax shield and liquidity on leverage in context of Vietnam seafood processing and exporting enterprises It is to consider whether these factors are significant, if yes,

it is positive or negative related to leverage and which theory help to explain leverage of the firms better: pecking order or trade off theory The specific objectives are as follows:

- To examine the significant impact of factors on leverage

- To give some policy recommendations to the firms to find a better way of financing debt for Vietnam seafood processing and exporting enterprises

1.3 Research questions:

The study focuses on answering the questions:

- What factors affect leverage of Vietnam seafood processmg and exporting enterprises?

- What policy recommendations for Vietnam seafood processing and exporting enterprises to raise effect of using leverage?

Basing on the list of factors affecting on leverage from the prior literatures, this study will do the examination on some selected factors in case of Vietnam seafood processing and exporting enterprises

1.4 Research Methodology:

This paper uses annual panel data of 3 5 seafood processing and exporting enterprise in Vietnam for the period 2009-2011 include both listed and unlisted firms

To estimate the impact of independent variables as profitability, non-debt tax shield, firm size, firm growth opportunities, tangibility assets and liquidity on leverage of the firms, two methods will be used: Ordinary Least Square and Fixed

effects (FE) or Random effects (RE) which is decided by Hausman specification test (Dougherty (20 11) )

1.5 Structure of the thesis:

This thesis is organized in six chapters as follows:

Chapter 1: explains the reason for choosing the thesis, its objectives and

research questions and briefly about methodology which is used to test for hypotheses

Chapter II: demonstrates the literature review It starts with the concept of leverage and capital structure Following is some theories and prediction of theories about determinants of leverage Empirical studies are also presented in this part

Chapter III: descriptions data and variables which be used in the model This chapter also presents about different estimation techniques together with hypothesis testes

Chapter IV: presents turnover of seafood firms through some years, its export market as well as major seafood product This chapter also analyzes capital structure of these firms

Chapter V: indicates empirical results corresponding to each estimation technique as well as results of hypothesis testes

Chapter VI: gives conclusion of empirical results, suggest recommendations and limitation of the thesis

CHAPTER II: LITERATURE REVIEW FOR DETERMINANTS OF

LEVERAGE

This chapter firstly presents about concept of capital structure as well as leverage and optimal capital structure Next are some leverage theories including Modigliani - Miller theorem, agency cost theory, pecking order theory and trade off theory It also includes prediction of these theories about several factors affecting leverage Finally, empirical studies concerning these factors will be mentioned

2.1 Key Concepts:

+Capital structure: refers to the way that a firm finances its assets through mixing of long term debt, short term debt, common equity and preferred equity It's measured by some targets as ratio of debt per total assets (also called leverage), ratio of equity per total assets or ratio of debt per equity

+Leverage: this study will use ratio of debt per total assets (or leverage) to define for capital structure to consider the proportion of debt used to finance the assets of the company This ratio still shows the capacity of repayment of the firms

in case firms do not work effectively with debt A higher this ratio represents for the more debts compared with assets the companies have, the more leveraged as well as the riskier it is considered to be

Depending on the objective of analysis, leverage is estimated by some ways First, it is the ratio of total liabilities to total assets This is a measure of

"what is left for shareholders in case of liquidation" (Rajan and Zingales, 1995, p8) Second, it is the ratio of debt (include both short term and long term debt) to total assets Many researchers have chosen ratio of debt to present for leverage as Bevan and Danbolt (2002), Huang and Song (2002) with short term and long term debt to be examined separately, Cuong & Canh (2012) combine both short term and long term debt This thesis will use the ratio of liabilities to total assets to measure for leverage include both short term, long term debt and trade credit

+ Optimal capital structure: the best debt to equity ratio that a firm can have Modigliani and Miller ( 1963) state firms will select the mix of debt and equity that minimizes their weighted average cost of capital Blank (2000) claims that the optimal capital structure refers to such a ratio of using debt and equity that maximizing the firm' market value

+ Bankruptcy cost: is understood as the increased costs when the firms finance with debt instead of equity that result from a higher probability of bankruptcy Bankruptcy cost occurs when the fixed obligations to creditor can not

be met (Robert and Lemma (1978))

+ Agency cost: a cost of the agency relation ship which is "a contract under which one or more persons (the principal(s) engage another person (the agent) to perform some service on their behalf which involves delegating some decision making authority to the agent" (Jensen and Meckling (1986))

In short, "leverage" is the main concept in the thesis It's used as dependent variable and the thesis will find factors affecting it Bankruptcy cost and agency cost are used in explaining about effect of factors to leverage

2.2 Related theories:

2.2.1 The Modigliani-Miller theorem:

Whenever mentioning about leverage, almost studies base on theory of Modigliani and Miller proposition This is considered the pioneer and the most important theory about leverage in modem sense It's usually still called MM theory

As Murray and Vidhan (2007, p.6) stated: "the Modigliani-Miller theorem does not provide a realistic description of how firms finance their operations, it provides a means of finding reasons why financing may matter" This theorem is also the pattern for many later theories about leverage of the firm

Modigliani and Miller (1958) consider linking between cost of capital and debt of enterprise Every model must base on certain assumptions, Modigliani and Miller theory was not also out of this rule Under assumptions about perfect

-markets: no transaction cost, no tax, no bankruptcy cost or no unequal access to information, the theory concludes that firm value do not base on capital structure, leverage have no effect on firm's value However, assumptions about perfect markets do not exist in reality Until 1963, there is a progress on this theory by adding corporate income tax on cost of capital This leads to the results that leverage concern with firm value Due to tax deductibility of interest payment on debt, the higher debt ratio the firm use, the higher value the firm get So, this theory supports that the firm should use debt as much as possible to inherit tax deduction The result of this theory has become an interest for many economists later

Since this pioneer theory, many other theories have been suggested to decide determinants of leverage of the firms Three fundamental theories which be usually used by many researchers will be presented in next following parts

2.2.2 Agency cost theory:

Research concerning this theory was initiated by Jensen and Meckling (1976) Jensen and Meckling (1976, p.308) defined the agency relationship as "a contract under which one or more persons (the principal) engage another person (the agent), to perform some service on their behalf which involves delegating some decision making authority to the agent" According to Jensen and Meckling (1976), there are two types of conflict, the first is between shareholders and managers, the second is between shareholder and debt holder Benefit of shareholders is related to firm's profitability, so shareholders wish for management to run the company in a way that increases shareholder value While benefit of management connects closely with their income, so they may wish to grow the company in ways that maximize their personal power and wealth that may not be in the best interests of shareholders

Due to conflict between various group, Jensen and Meckling (1976) argue that agency cost play an important role in financing decisions and the optimal

capital structure will be determined by minimizing the costs arising from these conflicts

2.2.3 Trade-of/theory (Myers, 1984) (or Tax based theory):

Theories about leverage are divided into two groups - theory which proposes the optimal debt-equity ratio and theory which define no well-defined target debt-equity ratio (Patrik (2004)) Trade off theory relating to group of theories proposing the optimal debt-equity ratio is basing on theorem of Modigliani and Miller (1963), this proposes that corporate income tax was added

to cost of capital and postulate the existing of an optimal capital structure

It refers to the idea that a company should choose how much debt finance and how much equity finance to balance the costs and benefits Another way, it requires a trade off between tax advantages of borrowed and cost of financial distress Both debt and equity used policy also have its own advantage and disadvantage While company heavily relies on debt have to utilize largely part of its income for paying interest payment, a debt free company can use all of its net income to refinancing for new investment (Zehra (2008)) However, to compensate for loss income from paying interest payment, these companies can inherit tax shield - is understood as the differences between taxes of a company having debt and company without having debt on its capital structure (Wrightsman (1978))- from its interest payment

The optimal capital structure is at which interest tax shield balance with bankruptcy costs and agency costs In another way, trade off theory says that optimal capital structure will be obtained by determining to trade off between benefits of debt with the costs

2.2.4 The pecking-order theory (also being called as the information asymmetry theory):

Talking about pecking order theory, almost researches mentioned about Myers and Majluf while Harris and Raviv (1991) raised that this theory first is

resulted from the work of Donaldson ( 1961) and then developed by Myers and Majluf(1984)

This theory mentions about three sources of funds as retained earnings, debt and equity It begins with the basic assumptions that managers have more information about value of the firm's assets than potential investors So this theory

is still called asymmetry theory and to be considered as contestant with "trade-off theory Both manager and investor know about this fact According to Myers and Majluf (1984 ), due to lacking of information about the firm, outside investors will tend to misprize equity of the firm Even if NPV of the project is positive, it also may not be accepted (Harris and Raviv, (1991))

In order to minimize the problem of information asymmetry between managers (insiders) and investors (outsiders) and avoid underinvestment, this theory encourage using other ways of collecting fund instead of issuing equity Myers and Majluf (1984, p.46) went to the result that "firms should go to bond market for external capital, but raise equity by retention if possible That is, external financing using debt is better than financing by equity" Particularly, this theory proposes that when the firms collect capital for new investment, it should follow a hierarchy financing Firstly, it will choose internal funds (retained earnings) and only when this source of fund is exhaust, it will acquire external funds Using external funds, firms also give priority to debt instead of equity Issuing equity is considered the most expensive way to collect fund for new investment, so in order to avoid transaction costs, firms will choose this way as the last channel of collecting fund (Fama and French (2004)) when it does not have any other selection The decision rule of Myers and Majluf (1984, p.3) is "take every positive- NPV project, regardless of whether internal or external funds are used to pay for it" This theory also argues that there is no well-defined target leverage and leverage depends on active business and investment need Due to raising the role of internal funds, according to this theory, profitability of the firm

is one of the most important factors affecting leverage of the firm

Deciding to choose external financing to finance new investment is not only because of existing asymmetric information problem but also relating to position

of organizational sales and structure of the firms (Mehmet and Eda (2008)) Firms with stable sales will create belief in lenders about collecting loan due to stable profitability, so they will easily to borrow than other firms Similarly with firms which have larger size and structure since they will have more collateral assets to ensure for their loan

Murray and Vidhan (2007, p.1) recognize that "private firms seem to use retained earnings and bank debt heavily Small public firms make active use of equity financing Large public firms primarily use retained earnings and corporate bonds"

From the above theories, some important factors affect leverage of the firms as profitability, growth rate, firm size, tangibility assets, liquidity and non-debt tax shield which will be explained clearly in next part

2.3 Determinants of leverage:

Determinants of leverage can be divided into two groups as firm specific factors which are considered as internal factors and industry or country specific factors which are considered as external factors (Antoniou et al (2002) and Gurcharan (20 1 0) ) External factors including macro elements are out of control of the firms Due to limitation of data, this study only bases on investigating about firm characteristics that can be controlled by the manager of the firm Moreover, it seems that firm specific factors affect leverage more strongly than industry specific factors (Mac (2010)) DeJong et al (2008) considering both firm specific factors and country specific variables also conclude that firm specific factors have dominant role to determinants of leverage

There are many factors having means to leverage, however as Harris and Raviv (1991, p.299) claims in their research: "the models surveyed have identified

a large number of potential determinants of capital structure The empirical work

of liquidity ratio as Zehra (2008) uses to check for Vietnam seafood processing and exporting enterprises Three factors which the study investigates as profitability, tangibility and firm size are also three of six core factors that make changing up to 27% of the leverage in many studies before (Murray and Vidhan (2007))

Pecking order theory and trade off theory are considered as two mam theories in explaining determinants of leverage of the firms in almost previous studies Both of these theories can explain leverage although explanation of each theory about effect of factors is different Some researches support that pecking order theory explain better choice of leverage (DeJong et at (2008), some others incline to follow trade off theory (Murray and Vidhan (2007) or Jason and Eric (2009)) whereas there are also researches argue leverage is consistent with prediction of both pecking order and trade off theory (Deesomsak et al (2004 ), Antoniou et al (2002) In context of Vietnam firms, Dzung et al (2012) states that pecking order theory explains better leverage of firms

This study also focuses on both pecking order theory and trade off theory to find whether leverage of Vietnam's firm is affected by which theory The following section will explain impact of each factor on leverage according to point

of view of pecking order theory and trade off theory one by one Pecking order theory seems to be better than trade off theory in explaining leverage of the firms due to according trade off theory, firms should take more debt to inherit tax shield

2.3.1 Leverage and Profitability:

Theoretical prediction about effect of this factor on leverage is inconsistent According to trade-off theory, profitability of a firm clearly has positive relationship with leverage and it's also a key point of this theory (Fama and French (2002), Mehdi et al (2011)) Profitable firms seldom meet problem with financial distress and they also find interest tax shield more valuable (Murray and Vidhan (2007)) Therefore, higher profitability encourage firm to take more debt

to finance investment in order to inherit tax benefit of debt Moreover, a firm with high profitability may create belief in lender, so it's easy for them to borrow than firms with bad profitability (Philippe et al (2003))

On the contrary, the pecking order theory supports a negative relationship between them Because of asymmetric information situation, cost of collecting outside capital will be always higher than inside capital So manager likely to use retained earning for self supporting if any Especially, firms with higher profitability will certainly have more retained earnings Therefore, the firm will use this internal source of fund to finance its investment, without depending on external finance to avoid problem of changing of interest rate or pressure of repayment at due date, so level of ratio of debt will be at low degree

Most empirical studies are in line with pecking order theory that profitability have negatively correlated with leverage Murray and Vidhan (2007, p.32) supports that "firms that have more profits tend to have less leverage" Akinlo (2011) uses data of 66 Nigerian listed firms over the period 1999-2007 argues that good profitability firms tend to reduce their need for external debt Li-

Ju and Shun-Yu (2010) find the most significant variable impact on leverage is profitability and its coefficient is negative This result found base on data of 305 Taiwan electronic companies, one of most important industry in Taiwan, during

the year 2009 Titman & Wessels ( 1988), Schoubben and Van Hulle (2004) also have the same results While supporting for trade off theory, Mehdi et al (2011) find that profitability is the most influential factor on leverage and it has positive impact on leverage

In context of Vietnam, enterprises feel difficult to borrow from bank due to high transaction cost plus of so many requests as tangibility assets, aim of using fund or checking after supplying loan so enterprises with more retained earning likely to use this source for financing and avoid taking debt from bank It seems that pecking order theory is more suitable to explain for leverage of Vietnam firms So, a first hypothesis is conducted for the relationship between profitability and leverage as follows:

Hl: There will be negative relationship between profitability and leverage

2.3.2 Leverage and Firm size:

One of main conditions to be considered whenever lenders approve of financing for a firm is related to its size From the point of view of pecking order and trade offtheory, the effect of firm size on leverage is mix

Pecking order theory predicts a negative relationship between size and leverage of a company Large firms seldom meet problem with information asymmetries, so the costs of issuing equity for large firms are lower than small firms Moreover, due to information about large firms is more popular with outside investors, they will likely to get equity of these firms (Huang and Song (2002)) With low cost of issuing and preference of outside investors, certainly large firms will give priority to issuing equity to finance for new investment project to economize the cost instead of taking debt

With trade off theory, the relationship is positive Due to the larger the firms are, the more diversified they are, so size is still considered as an inverse proxy of probability of bankruptcy (Titman and Wessels, (1988)) Large firms will less be impacted by bankruptcy, hence they are easily to borrow with lower interest rate (Pinches and Mingo, (1973)), so the leverage will be higher Besides,

lenders also prefer to supply debt to larger firm than smaller firm due to it's easier for them to get repaid (Joshua, (2008))

Empirical studies support for the trade off theory and find the positive relationship as Patrik (2004) with data of Czech Murray and Vidhan (2007) with data of publicly traded American firms conclude that "larger firms tend to have high leverage" (p.32) Research of Amarjit (2011) about 166 Canadian listed firms for the period of 3 years from 2008 to 2010 also find that leverage positive related

to firm size Rajan and Zingales (1995) find positive relationship for almost countries in G-7 except for Germany Pervez (2009) supports that large firm tend

to borrow more debt than smaller do With data of Vietnam, Anh (20 1 0) also find the positive relationship between firm size and leverage In a research about demand of debt of six African countries, Bigsten et al (2000, p 7) supports that

"small and medium sized firms are less likely to get a loan" In this research, the writer argues that smaller firms usually meet problem with credit So, although these firms have high demand of debt, their request usually are rejected than larger firms While ratio of demand but rejected of micro firms is 64%, small firms is 42% and medium firms is 21%, this ratio is only 10% for large firms

In opposite with those results, Abel (2008) follows pecking order theory and do not agree with positive relationship between firm size and leverage in case size is explained as a inverse proxy for bankruptcy cost The result of the research about 71 quoted firms in Nigerian stock market during the period 17 years from

1990 to 2006 supports for a negative related due to "larger firms that have built enough reserves may choose to finance their operations through their respective internal markets, rather than passing through the difficulties inherent in accessing the external financial markets" (p.9)

In context of Vietnam, larges firms usually receive favors of many banks These banks competes each other to attract them through reducing interest rate and cost

So, a second hypothesis is conducted for the relationship between firm size and leverage as follows:

H2: There will be positive relationship between firm size and leverage

2.3.3 Leverage and Firm Growth:

The relationship between growth and leverage of the firm is still unclear with different theories While the pecking order theory argues a positive relationship, trade off theory states a negative one

With trade off theory, growing of the firms is only intangible assets, so it can't be used as collateral to borrow Moreover, firms with more investment chances tend to have lower leverage since they have stronger incentives to avoid under-investment and asset substitution that can arise from stockholder-bondholder agency conflicts (Drobetz and Fix (2003))

Researches of Raj an and Zingales ( 1995) plus of Titman and Wessels (1988) supports for this negative relationship Huang and Song (2002) also find that in China, firms with high growth rate in the past tend to have higher leverage while firms with good growth opportunity at present have lower leverage Patrik (2004) states that firms with higher growth opportunities tend to give priority to using equity Gurcharan (2010) agrees that firm with high growth have many other developing chances, so they do not need to take much debt to avoid the restriction

of lenders Akinlo (20 11) also supposes that growing firms do not depend too much on debt financing for Nigerian case

From the perspective of pecking order theory, the requirement of finance of the firms will increase together with its growing The internal fund cannot fill their need And if only depending on this source of fund, the growth of firms may be restricted So the firms tend to take more second source of finance - debt - to finance for their investment Researches encourage for this theory as Baskin (1989), Bevan and Danbolt (2002) Most of researches for Vietnam context indicate that firms with high growth will finance with more debt (Nguyen and Ramachandran (2006) and Biger et al (2008)) Therefore, a third hypothesis is conducted for the relationship between firm growth rate and leverage as follows:

H3: There will be positive relationship between growth rate and leverage

2.3.4 Leverage and Non-debt tax shield:

Non-debt tax shield is a characteristic that fits in with only the trade off theory According to this theory, firms should take more debt to inherit deducting corporate tax However, besides this way, firms also can reduce corporate tax by using non-debt tax shield as depreciation Therefore, this theory supports for a negatively correlated between non-debt tax shield and leverage The more depreciation the firms have, the less potential debt they will use De Angelo and Masulis ( 1980), one of the persons who care and raise the role of non-debt tax shield argue that non-debt tax shields are substitutes for a debt-related tax shield,

so firms with large non-debt tax shield can also inherit tax deduction and have less demand of debt on their capital structure However, Scott (1977) proposes a contradiction Scott ( 1977) connects debt capacity of the firm with non debt tax shield to explain for positive relationship between leverage and non-debt tax shield According to his opinion, firm with more collateral assets also have more depreciation Besides getting tax deduction from depreciation, these firms will make use of having lower interest rate from secured debt to borrow more So, together with increasing of non-debt tax shield, leverage of these firms also increase

In reality, most of empirical studies support for negative relationship of trade off theory and De Angelo and Masulis (1980) although there are also some exceptions depending on country characteristics Linda and George (200 1) with Dutch data, Patrik (2004) with Czech data support for this negative relationship that non-debt tax shield as substitutes to debt-related tax shield whereas Bradley et

al (1984) reports a positive relationship Gurcharan (20 1 0) with study about some selected countries in Asean region claims that due to being inherited benefit from non-debt tax shield, firms likely to reduce using debt Liaqat (20 11) used data of

170 Indian companies in the textile industry for the period 2005-2010 find a

positive result inconsistent with theory that increasing in non-debt tax shield also leads to increasing in leverage ClarifYing for this contradiction, the researcher claimed that "expected income streams of textile firms in India, against which interest expenses and non debt tax shield (depreciation), can be deducted are very high as compared to the total of debt and non-debt tax deductions Therefore, depreciation does not work as a "substitute to the tax benefits of debt financing in the Indian textile firms" (p.58)

With research about the role of tax in capital structure of Arab tax and non tax economy, Mounther and Ramesh (2004, p.ll) assume that in taxed countries,

if non-debt tax shield proxies for its "intended effect", it should have a adverse related with leverage" whereas if it proxies for collateral effect, it expect "either a positive, negative or insignificant coefficient for non debt tax shield in taxable regimes depending on the relative strength of the substitution vs collateral effects" So, a fourth hypothesis is conducted for the relationship between non-debt tax shield and leverage as follows:

H4: There will be negative relationship between non-debt tax shield and leverage

2.3.5 Leverage and tangible assets:

While profitability is mentioned as key rejection of leverage, tangible asset

is considered as the major factor which determines increasing of leverage of the firm (Titman and Wessels (1988) and Harris and Raviv (1991)) Most of researches show that there is positive relationship between tangible assets and leverage That also complies with pecking-order theory and trade off theory, the more tangible assets the companies have, the more easily for them to take loan because these assets will be used as collaterals to assure for their loan Debt being assured with tangible assets also make smaller lost for lender in case the firm go into distress, so lender also like to supply debt for firms with high tangible assets (Murray and Vidhan (2007)) Bigsten et al (2000) also find that one of the reasons

of not taking debt of firms is that the collateral is inadequate with their demand

Some other empirical studies support this positive relationship as Rajan and Zingales ( 1995), Murray and Vidhan (2007), Dilek et al (2009), Mehdi et al (20 11) with data of 72 Iranian listed companies find the result complying with pecking order theory and trade off theory that leverage has positive associated with tangibility Nguyen and Ramachandran (2006) give result that Vietnam firms with more tangibility assets also have more debt

Research of Jason and Eric about leverage of firms in a group of countries including American, Asian and Europe also states that tangibility has positive impact on leverage Explaining about positive relationship between leverage and tangibility assets, Farooqi (2006) link with growth options of the firms due to firms with more tangibility assets usually are "mature firms"

Mounther and Ramesh (2004) suggest that collateral asset will increases the debt repayment capacity of the firm and therefore leverage will increase at the same direction with tangibility assets

Although most of researches supports that firms with more tangibility assets will get more debt, there are also several researches find the opposite result Example Daskalakis and Psillaki (2009) find an inverse impact between leverage and fixed assets in small and medium firms Joever (2006) also has the same result for less developed economies Florinita (2012) with data of 100 firms listed in

2010 in Romania find that "companies with large portion of fixed assets discourage to employ debt capital" (p.529) Explaining for this, the researcher proposes maybe these firms have already found "a stable source of return which provides them more internally generated funds and discourage them from turning

to external financing" (p.529) Researching about determinants of leverage of European countries of Antoniou (2002), the result about relationship between leverage and tangibility assets is completely different between countries While the result found for Germany is positive related between leverage and tangibility assets, the result for the UK is negative and insignificant in France Explaining for insignificant value in French, the researcher argues that bankruptcy laws in France

is "strongly favor the rehabilitation of firm hence reducing the need to recover the

loan by selling tangible assets" (p.13) So, a fifth hypothesis is conducted for the relationship between tangible assets and leverage as follows:

HS: there will be positive relationship between tangible asset and leverage

2.3.6 Leverage and liquidity:

This is the proxy which attracts researchers less than other variables Empirical studies about effect of this factor on leverage are not as much as above factors This factor is represented for the capacity of returning debt of a firm

According to pecking order theory, to finance for new investment project, firms prefer to use internal finance to external finance Firms with more liquidity asset will have more cash flow to finance for its investment instead of depending

on debt So it supports an inversely related between leverage and liquidity That leads to its leverage will be at low degree Supporting for this idea, Mehdi et al (20 11) with research about leverage of Iranian listed firms by using data of 72 firms from 2003 to 2009 find the result that "companies with more liquid assets use lesser amount of debt compare to companies with lower liquidity ratio" (p.168) With data of four countries in Asia Pacific region include Thailand, Malaysia, Singapore and Australia over the period 1993-2001, Deesomsak et al (2004) conclude that liquidity has a significant negative relationship with leverage for all countries they estimate They state that "firms tend to use their liquid assets

to finance their investment in preference to raising external debt" (p.15)

On the other hand, sometimes, firms with higher liquidity ratio tend to have higher leverage Since their capacity to match with short term obligations when they fall due, they may be easily to borrow than firms with low liquidity ratio This encourages a favorable relationship between liquidity and leverage Research of Zehra (2008) about UK listed companies from 1998-2007 supports for this idea Ntogwa (2012) also argues a positive related in case of Tanzanian non-financial companies in the sense of "high liquidity eases the availability of debt" (p.418)

Due to the main element of Vietnam' firms is current liabilities (Vuong and Tran, 201 0), liquidity is a factor that should be attended more in determinants

of leverage So, a sixth hypothesis Is conducted for the relationship between liquidity and leverage as follows:

H6: there will be an adversely related between liquidity and leverage

Table 2.1: Summary of leverage determinants

Trade off Result of Pecking

Expected order theory theory empirical

prediction prediction studies sign

-Source: by the author after literature review done

2.4 Empirical review on determinants of leverage:

Through many past years, a lot of researches about leverage of a specific country, comparison between two countries or a region of area have been done to find out which factors affect leverage of the firm However, the finding results are not the same Even more, some studies show contradiction with theories This section will be divided into two parts include researches concerning countries on the world and researches concerning Vietnam context

2.4.1 Empirical evidences finding from the world:

Gurcharan (20 1 0) looks at leverage of some selected countries in Asean area as Malaysia, Indonesia, Philippine and Thailand On one hand, the researcher uses firm specific factors which be used by many other researches as profitability, growth opportunities, non-debt tax shields and firm size On the other hand, he still observes country-specific factor as size of banking industry and stock market, gross domestic product growth rate and inflation

Data which is selected to test for relationship between leverage and specific factors are of 155 main listed firms on stock exchange (excluded financial companies) during the period 2003 to 2007 while data for country-specific are chosen mostly from World Bank and Euromonitor International The research finds that profitability, growth and non-debt tax shield have negative relationship with leverage but insignificant with Malaysia for indicator profitability, with Indonesia for indicator growth and significant with only Malaysia for indicator non-debt shield About firm size, the results are significant with Indonesia and Philippine for positive effect whereas the results for two rest of countries Malaysia and Thailand are insignificant with negative correlation The study also shows that country factors as stock market and GDP growth rate have negative impact on leverage whereas bank size and inflation have no correlation with leverage This result implies that factors affect leverage will vary from country to country

firm-Huang and Song (2002) also do a research with data of over 1000 companies in China - the largest developing and transition economy of the world-

up to the year 2000 They divide leverage into short term debt and long term debt and the result they find that China tend to have much lower long term debt They checks for the role of some proxies as profitability, firm size, non-debt tax shield, fixed assets, corporate tax, growth opportunities, volatility, ownership structure and managerial shareholdings They uses both book value and market value of equity, so they uses until 6 measures of leverage, within total liabilities is main measure and others as long-term debt ratio ands short-term plus long term debt ratio are used to check for robustness The results of effect of these factors to leverage of the firm are consistent with other previous researches They conclude that profitability is "strongly negatively related" with leverage Growth rate and non-debt tax shields also have adverse impact on leverage while size, tangibility, volatility and ownership of institutes have favorably influence Remain factors as tax and management share holdings have no impact on leverage Especially, in China, leverage ratio of listed companies is much lower They tend to use more equity rather than debt in their capital structure It's hardly for firms to take debt

due to the credit market in China contains many regulation and mostly being decided by central bank Moreover, bond market is still at early stage of development The situation of China is contrary to the prediction of pecking order theory that gives priority to debt instead of equity

Zehra (2008) analyzes the determinants of leverage of UK firms and bases

on data of 173 firms over a period of ten years from 1998 to 2007 The study used three dependent variables to measure for leverage as total debt, long term debt and short term debt The explanatory variables included firm size, growth opportunities, non-debt tax shield, profitability, liquidity, uniqueness and asset tangibility Two techniques of regression of panel data method as pooled OLS and fixed effect model have been employed to investigate the effect of these variables

to leverage after being checked by Breusch and Pagan Lagrangian Multiplier test between random effects model and pooled OLS and Hausman test between random effects and fixed effects model The results of the study are as follow:

- Size has positive related to all three variable - total leverage, long term and short term leverage under pooled OLS This result is suitable with trade off theory and expected sign of the study However, with fixed effect model, size only has positive effect to total and long term leverage and negative effect to short term leverage So, the study encourages that large firm should chooses long term debt instead of short term debt to finance for its investment

- Growth opportunities has negative relationship with total leverage and short term leverage and positive related to long term leverage under pooled OLS while fixed effect regression give negative result for all kind of leverages

- Non-debt tax shield is found to have positively related with total leverage, short term leverage and long term leverage under fixed effect method but it's only significant with total leverage while with pooled OLS, a negative related between non debt tax shield and long term leverage is supposed

- Profitability: this research use two indicator for profitability as the ratio of operating profit to total assets and the operating profit to sales For the first

indicator, the pooled OLS gives a negative related between profitability and long term leverage and a positive related with total and short term leverage whereas fixed effect model shows negative relationship for all three measure of leverage The second indicator of profitability is found to have positive related with leverage for all Only one independent variable but with different estimation way, it may be consistent with pecking order theory or trade off theory

- Liquidity: the result is consistent between pooled OLS and fixed effects model A negative relationship between liquidity and total and short term debt is found while long term debt is insignificant with leverage

- Tangibility: under pooled OLS method, tangibility increase at the same directions with long term debt and increase at an opposite direction with total and short term debt Fixed effect method gives insignificant result for all three dependent variables

In short, learning from the above researches, many factors have effect to changing of leverage and the relations are not the same under different countries, different technique estimations as well as different measures of leverage This thesis will follow the way of Gurcharan (20 1 0) by using one measure of leverage

to test, without following the way of Huang and Song (2002) by using 6 measures

of leverage and Zehra (2008) using 3 measures of leverage Besides 4 factors as profitability, non debt tax shield, growth and firm size which Gurcharan (2010) employs to check for Malaysia, Indonesia, Philippine and Thailand, this thesis will check for two more proxy as liquidity and tangibility assets as research of Zehra (2008) due to these two proxies are important in context of Vietnamese firms Above researches are divided into two group include Asia region and Europe region with both developed and developing countries The results of researches in Asia region seem to have consistent while the results in Europe are mix Vietnam

is also in group of developing countries in Asia, so maybe the results found will be the same that profitability, growth opportunities of the firm, NDTS have negative related to leverage and firm size have positive related to leverage Although

- - - -~

following the research of Gurcharan (20 1 0), this thesis only check for firm specific factors, leaving out country specific factors due to limitation of data

2.4.2 Empirical evidences finding from Vietnam perspective:

Nguyen and Ramachandran (2006) have done a research about leverage of

558 small and medium sized enterprises (SMEs) over the period 1998-2001 Vietnam stock market has only been established since the year 2000, so this research is certainly for unlisted firm only They conclude that leverage of Vietnam SMEs increases at the same direction with growth, firm size, business risk, net working and relationship with banks In contrast with theories, they state tangibility assets have negative effect on leverage and profitability is found to have no impact on leverage The study concludes that to finance for new investment, SMEs depend mostly on short liabilities

Dzung et al (2012) also consider factors affecting leverage of Vietnam firms but for listed companies They employ data of 116 firms listed on both stock exchange- Ho Chi Minh stock exchange (HOSE) and Ha Noi stock exchange (HNX) for the period 2007-2010 The research uses book value data to measure total, short-term and long term leverage They tests determinants of leverage at both side - firm specific factors including profitability, tangibility, size, growth opportunity and liquidity and country specific factor as state-ownership The state-ownership is checked by using dummy variable to distinguish between firm with over and less than 50% state-owned share Difference with many researches, this study uses panel data regression with GMM model Completely contradicting with research of Nguyen and Ramachandran (2006) about insignificant relationship between profitability and leverage of unlisted firms, this research finds that profitability has inverse relationship with leverage for all measures of leverage and it's also the most strongly factor effect to leverage This result is consistent with pecking order theory During this period, firms likely to finance its investment with internal sources of finance About tangibility and size indicator, the results are mixed It has no impact on total leverage while impact on short term and long

Another research about determinants of leverage of Vietnam firms is research of Cuong (2008) With data of 22 seafood companies in Khanh Hoa province, the study finds that firm size is the strongest factors affect to leverage of companies and it has positive related Fixed assets have inverse related to leverage shows that these firms tend to use equity to finance for long term investment while profitability and growth have positive related to leverage

In short, results of some researches in Vietnam context also have inconsistence Although research in Asia group proposes a negative related between firm growth and leverage, researches in Vietnam show a contradiction results Most of them argue a positive related between firm growth and leverage The main findings from the studies about Vietnam context is Vietnamese firms mostly rely on short term debts

2.5 Chapter remarks:

This chapter presents four mam points Firstly, some main concepts concerning content of the thesis have been explained as capital structure, leverage, optimal capital structure, agency cost and bankruptcy cost Secondly, two main theories which the thesis bases on are also presented as trade off theory and pecking order theory Thirdly, some factors affecting leverage which are

withdrawn from many previous researches such as profitability, firm size, NDTS, growth opportunities, tangibility assets and liquidity are forecasted about its effect according to point of view of theories one by one Lastly, this section also includes some empirical evidences from the world as well as Vietnam context The results

of these researches are not the same at different countries, different measures of leverage as well as different techniques of regression These variables may be positive or negative significant or even more it shows an insignificant result Learning from the result on the world and Vietnam context, this thesis proposes a positive related between firm size, tangibility assets and firm growth with leverage and a negative related between profitability, NDTS and liquidity with leverage

CHAPTER III: RESEARCH METHODOLOGY

This chapter will be divided into three sections The first is the introduction

of data source as well as description of variables includes dependent and independent variables Next, the description of different estimation methods will

be introduced including: Ordinary Least Square, Fixed Effect and Random Effects Hausman test to choose between Fixed and Random Effect method are also presented in this section Finally are some hypotheses which will be tested in the study

3.1 Data and variables description:

3.1.1 Data:

The study consist data on balance sheet of 35 Vietnam processing and exporting enterprises during the period 2009 to 2011 including both listed and unlisted enterprises Data of 20 listed enterprises which be taken from either the

Ho Chi Minh city stock exchange (HOSE) or the HaNoi stock exchange (HNX) and 15 unlisted enterprises will be tested 3 5 enterprises for period 3 years will create 105 samples for the study

Due to investigating both listed and unlisted enterprises, this study will base

on book value of data only

3.1.2 Description of variables:

(a) Dependent variable: leverage (L VE)

Learning from the research of Rajan and Zingales (1995), dependent variable "leverage" employed here is the ratio of total liabilities over total assets According to them, trade credit should be included in leverage since it also represent for debt which firms have responsibility to pay When the creditors consider of supplying debt for the firm, they not only give attention to long term debt but also care about current debt and trade credit due to it will reduce debt capacity of a firm (Huang and Song (2002)) Jason and Eric (2009) also have the

(b) Independent variables for determinants ofleverage:

•!• Firm size (LGSIZE):

Size of the firm may be estimated by some indicators such as logarithm of revenues sale (Gurcharan (2010), DeJong et al (2008), Amarjit (2011)), logarithm

of total assets (Joshua (2008), Deesomsak (2004), Huang and Song (2002))

This study chooses natural logarithm of assets to measure for firm size

•!• Firm Growth (GRO):

Firm growth is measured by different ways by different researchers, m general two scales for measurement are percent change of total assets (Liaqat (20 11 ), Akinlo (20 11) or percent change of total revenues sale (Pramuan et al (2003) or Mehdi et al (2011))

In this study, growth will be measured by percent change of total assets

•!• Non-debt tax shield (NDTS): is measured by ratio of depreciation to total assets (as Wald (1999), Titman and Wessels (1988), Zehra (2008)) Due to ratio of depreciation is data of whole year while total asset is data at a period, so to calculate for this ratio, the study will use the average total assets of the beginning and the end of a given year

•!• Profitability (PRO) is measured by the ratio of earning before interest and taxes (EBIT) to total assets following research of Huang and Song (2002), Ntogwa (20 12) Total assets in this ratio are also average total assets of a given year

•!• Tangibility (TANG-value of tangible assets) is measured by ratio of fixed assets to total assets It has been argued by Bevan and Danbolt (2000), Husni and Ali (2010)

•!• Liquidity (LIQ) is measured by current asset over current liabilities as De Jong et al (2008)

All proxies in the model are compared with total assets to assure about logical of the model

Table 3.1: Variable, description and its expected sign

Variable Description Expected sign

Dependent variable

Total liabilities/total LEV

Total depreciation/total NDTS

-assets Percent change in total + ORO

assets TANG Fixed assets/Total assets +

Current asset/ current LIQ

-liabilities

3.2 Methods of estimation:

The relationship between leverage and other factors as profitability, size, tangibility assets, growth opportunities, non-debt tax shield and liquidity will be examined with quantity method by using different empirical techniques of panel

regression analysis data which is a combination of times series data and section data Using panel data has many advantages such as it can controls for individual heterogeneity, supply more degrees of freedom as well as more variables Moreover, it still can reduce problem of multicollinearity which is the problem time series data method usually meet (Baltagi (2001)) Comparing with only cross section or times series method, panel data method seem the better method to use for analyzing with both cross-section and time series data and this method is also usually used by many researchers in term of investigating determinants of leverage

cross-Next is the description about Ordinary Least Squares (OLS) method and then about Fixed Effects (FE) and Random Effects (RE) In order to choose which model is more suitable between FE and RE, a test which is called Hausman test will be done

3.2.1 Ordinary Least Squares (OLS) estimator:

Sample of the thesis include both data across firms and overtime, so using of panel data is more appropriate to study the dynamics of change First, ordinary least square estimator, the most simple method will be applied

Given a model as follows:

Yit = ao + X\t~ + ui,t (*)

Where Yit is dependent variable, Xi,t is a (K-l)xl vector of exogenous regressors and ui,t ~ N(O,cr~: 2 ) is random disturbance The error term ui,t in OLS method is assumed to be independent and normally distributed with zero mean and constant variance It means:

E(ui,t Uj,s) = 0, i:;t:j, tt:s,

E(Xi,t Uj,s) = 0 V i,j,t,s

Panel OLS may increase sample size, however with data contained observations on the same cross-sectional units over several time periods, maybe there is cross sectional effects on each firm or on a set of group of firms The