Understanding capital structure of companies in vietnam effects of profitability, tanggible assets, growth opportunities, firm size ownership typeand non debt tax shields

The research collected panel data from the annual financial statement of 124 companies to examine the six factors such as profitability, tangibility, growth opportunities, firm size, ow

INTERNATIONAL SCHOOL OF BUSINESS -

MASTER THESIS

Understanding capital structure of companies in Viet Nam

Effects of profitability, tangible assets, growth opportunities, firm size,

ownership type, and non-debt tax shields

Author: Vo Tien Dung

Student No.: 22110010

Email address: tiendung.usp@gmail.com

Supervisor: Dr Pham Quoc Hung

Email address: phquhung76@yahoo.com

November 2013

TABLE OF CONTENTS

TABLE OF CONTENTS 1

ACKNOWLEDGEMENTS 4

ABSTRACT 5

CHAPTER 1: INTRODUCTION 6

1.1 Background of the research 6

1.2 Research problem 7

1.3 Research question 8

1.4 Research objectives 8

1.5 Expected contribution 9

1.6 Organization of the study 9

CHAPTER 2: LITERATURE REVIEW AND HYPOTHESES 11

2.1 Theoretical background 11

2.1.1 Capital structure 11

2.1.2 The trade-off theory 12

2.1.3 Pecking order theory 13

2.1.4 Market timing theory 13

2.1.5 Signalling problem 14

2.1.6 Agency cost problem 15

2.1.7 Asymmetric information problem 16

2.2 Empirical literature review 17

2.2.1 Leverage (Lev) and capital structure 17

2.2.2 Profitability (PRO) and leverage. 18

2.2.3 Tangibility (TANG) and leverage 20

2.2.4 Growth opportunities (GROW) and leverage 20

2.2.6 Ownership type (OWNT) and leverage

2.2.7 Non –debt tax shields (NDTS) and leverage

CHAPTER 3: RESEARCH METHODOLOGY

3.1 Sample size and data set

3.2 Calculation of the variables

3.2.1 Dependent variable

3.2.2 Independent variables

3.3 Model specification

3.4 Method of data analysis

CHAPTER 4: RESULT ANALYSIS

4.1 Screening and cleaning the data

4.2 Checking assumptions of multiple regression

4.2.1 Outliers

4.2.2 Checking normality, linearity, homoscedasticity of residuals

4.2.3 Checking multicollinearity problem

4.2.4 Testing autocorrelation problem

4.3 Results of multiple linear regressions

4.3.1 Descriptive statistics

4.3.2 Evaluation of the model

4.3.3 Evaluating the independent variables

CHAPTER 5: CONCLUSIONS AND IMPLICATIONS

5.1 Conclusions

5.2 Limitation of the study

5.3 Implications

APPENDICES 55

Table 5: Correlations 55

Table 6: Histogram 56

Table 7: Normal P-P Plot of regression standardized residual 56

Table 8: Scatterplot 57

Table 9: List of non-financial companies 63

Table 10: Interest rate from banks in Viet Nam 64

Table 11: Summary of some theoretical results 65

First of all, I would like to express my deep gratitude to my master thesis

supervisor, Dr Pham Quoc Hung who spends very much time teaching me manythings from the beginning of the master thesis

I would like to thank you Ho Chi Minh Stock Exchange, cophieu68, and cafef

whose published data on the website to support me saving the collected time

Special thanks are given to International school of business (ISB) supporting me vary information, guiders relating to the master thesis in order to help me finish themaster thesis on time

Finally, I am deeply grateful for support, understanding of my wife who spends alot of time to take care of all works in my family in order to make more free timefor me during nearly two-year MBUS program

The objective of this article is to understand the effect of capital structure of 124 non-financial companies listed on the Ho Chi Minh City Stock Exchange (HOSE) in Viet Nam The research collected panel data from the annual financial statement of

124 companies to examine the six factors such as profitability, tangibility, growth opportunities, firm size, ownership type, and non-debt tax shields effect to capital structure (leverage) Under trade off and pecking order theories, the empirical

results found that there was a negative (-) relationships between profitability,

ownership type and leverage The Tangibility, size of firm, and non-debt tax shield were a positive effect to leverage Growth opportunities had a not statistically

significant impact on the capital structure.

Key words: Capital structure, leverage, trade off, pecking order, non-financial companies, Viet Nam.

CHAPTER 1

INTRODUCTION

1.1 Background of the research

Capital structure plays a very important role in corporate financial management There are many research papers talking about capital structure and how to find out the particular model for the optimal capital structure for the business

The most important task of the financial manager is to balance the debt and equitycapital to ensure capital structure is better, hence strive to find out the optimal corporate capital structure (Tong and Green, 2005), lower cost of capital will lead

to maximizing value of a company (Shah and Kahn, 2007)

A firm faces with a financial deficit during doing business, thus the manager of thefirm should find out a fund to support new investments in order to maintain the activity of a firm stably as well as making a right financial decision One way that can be chosen is to undertake a capital structure of a firm, especially debt

restructuring In order to take a capital structuring, a manager has a high

acknowledgement in financial filed and analytic capabilities hence a manager can minimize the cost of capital and maximize the value of the firm, the composition

of capital structure consists of debt and equity, the resource of funds include

retained earning, debt, and equity Orderly, retained earnings is cheapest fund due

to without borrowing cost, cost of debt always lower than a cost of equity due to the shareholders requires a rate of return bigger than the interest rate Based on

capital analysis, the managers raise the fund for investments by issuing debt orequity or retained earnings reasonable.

Previously, there are two studies from Franco Modigliani and Merton H Miller in

1958 with title “Cost of capital, corporate finance and theory of investment” states that the capital structure is not impacted on the value of the company and the revised publish in 1963 named “Corporate income tax es and the cost of capital: a correction” to reverse that corporate income tax ef fect on the value of the

company it mean that capital structure also impacts to the value of the firm Those great theories above encouraged many researchers around the world to study models of capital structure, the result states that there is different outcome

regarding to capital structure comparing between research from developing

countries (Graham and Harvey, 2001), (Tong and Green, 2005), (Shah and Khan, 2007) and developed countries (Mazur, 2007), (Rajan and Zingales, 1995) in term

of the score factors effect to capital structure of the firm

Previous studies examined the interaction between leverage on behalf of

capital structure and exogenous such firm growth opportunities, firm size, firm profitability, ownership type, intangible assets, non-debt tax shied, firm

performance, dividend policy, uniqueness, tax, volatility, asset structure, etc

This research will focus on six independent variables such as growth

opportunities, firm size, profitability, tangibility (collateral), ownership type, and non-debt tax shields effect to dependent variable defined leverage

1.2 Research problem

There are many empirical researches regarding to the impact of factors on capital structure in many different approaches of researchers in term of techniques,

models, variable selections, countries Different approaches leading to many outcomes relating to positive or negative impact of factors on capital structure Forinstance, there is a negative effect of profitability (Kester, 1986), (Shyam-Sunder and Myers, 1999) and firm size (Kester, 1986), (Titman and Wessels, 1988) to leverage upon pecking order theory whereas trade-off theory is a positive impact (Bowen, Daley and Huber, 1982), table 11 shows some of theoretical results

related to capital structure This study identifies the capital structure of listed companies in Viet Nam and responds to the gap that there are many issues related

to the selection of capital structure in every country in the world Furthermore, the manager of a firm can consider the cost and benefit of capital structure based on the theories in order to finance their financial deficit or new investments

1.3 Research question

The research is going to answer the following major research question:

Which factors have significant effects on capital structure of companies in Viet Nam?

1.4 Research objectives

Capital structure decision is mainly influenced by the trade-off theory and the pecking order theory, based on the research question, the objectives of this

research are to examine the effects of six independent variables such as

profitability, asset tangibility, growth opportunities, size of firm, ownership type,

and non –debt tax shields to debt ratio (leverage r atio) as implied by the off theory and pecking order theory, then the research finds out the relationship between above six dependent variables and leverage.

trade-The objectives of the research are to investigate how do firms in Viet Nam financefor investments by internal or external resources?

1.5 Expected contribution

The purpose of this research will not produce a theory that applying to all

populations, the objectives of research is trying to examine the six mentioned independent variables effect to debt ratio of listed companies in Viet Nam The research finds out what factors influence the choice of capital structure? How firmsfinance capital for investments, by internal or external resources, since this study will conducts firms to make the choice of capital structure

1.6 Organization of the study

CHAPTER 1: Introduction CHAPTER 2: Literature

review and hypotheses

CHAPTER 4: Result analysis CHAPTER 3: Research

methodology

CHAPTER 5: Conclusions

and recommendations

Appendices

The organization of the research is illustrated in the above figure In more detail,chapter 1 provides an introduction about the thesis, including the background, research problem, research question, research objectives, expected contribution, and organization of the study.

Chapter 2 reviews about the theoretical framework consisting of capital structure,the trade -off theory, the pecking order theory, market timing theory together withsignalling problem, agency cost problem, and the asymmetric information

problem This chapter provides an overview regarding to capital structure from previous studies in many countries, and identifies dependent and independent variables and link these to relevant research question, expectation, and

hypotheses of the research

The work in chapter 3 is to introduce research methodology Chapter 4 integratesboth presentations of data and analysis of results

Chapter 5 is to summarize the main points of the research objectives and draws theconclusions, recommendation, and suggestion for future research Finally, the appendices show information gathered during the research

CHAPTER 2

LITERATURE REVIEW AND HYPOTHESES

This chapter will focus on some theories relating to capital structure, Literaturereview is review of definitions and past research done by previous researchers

Literature review includes an overview of the trade off theory, pecking order theory, market timing theory, signalling problem, agency cost problem,

asymmetric information together with the argument the impact of independentvariables on capital structure of the firm

The independent variables include profitability, firm size, tangibility, type of ownership, non-debt tax shields, the dependent variable is leverage that is a proxyfor capital structure This chapter will explain and find the theoretical framework supporting the research

2.1 Theoretical background

2.1.1 Capital structure

Capital structure of firms is a combination of debt, equity and other sources offinance that firms use to fund for its operation

The pioneer study of capital structure is coming from Franco Modigliani and Merton

H Miller published in 1958 (called M and M theory), the theory states that the value

of a firm is independent of capital structure, whatever the firms finance the

investments by issuing debt or equity under a few assumptions in the context of a market without taxes, without transaction cost, the capital market is perfect and

complete Otherwise, the result of M and M theory in 1958 shows that an

unlevered company has the same value as a levered one There are many highly critiques of research on being irrelevant due to the theory built on unrealistic assumptions leading to the revision of M and M in 1963 to correct the correct the previous theory by adding the effect of taxes to revise the irrelevance capital structure theory The revised theory in 1963 shows that corporate income taxes effect to value of company, after published research from M and M, since there are

a lot of studies focused on capital structure by adding agency cost and bankruptcy cost to fill in the gap of M and capital structure, the exploit studies shows evidencethat there are relationship between bankruptcy cost (Sliglitz, 1974), (Krause and Litzenberger, 1973), agency cost (Jensen and Meckling, 1976) with capital

structure decision Since there are many researchers in the world studying the capital structure depends on specific countries, industry, fields, etc., in order to find out the effect of independent variables to capital structure The outcome of researches is not total consistence with each other due to there are many

approaches to study capital structure in many different ways

2.1.2 The trade-off theory

The framework of this theory is to identify the optimal capital structure relating tobenefit of corporate income taxes/debt and cost of financial distress or the savingsfrom tax shields against the deadweight cost of financial distress (Kraus and

Litzenberger, 1973), (Myers, 1984)

The theory mentions about the balance between benefit from taxes on debt and

bankruptcy cost, firms tend to use debt to finance working capital on a firm’s

activities or for new investment opportunity but firm also carefully considers

keeping the balance between Debt and Equity in order to maintain a positive

balance from benefit from taxes of debt minus financial distress cost

Trade-off theory impacts on capital structure and following this model many

researches find out independent variables effect leverage positive or negative such

( firm size (Marsh, 1982), (Rajan and Zingales, 1995), (Chittenden Et al,

1996); (-) Growth opportunities (Long and Malitz, 1985); (+) Asset structure (Long and Malitz, 1985); (-) Cost of financial distress (Bradley, Jarrell, and Kim, 1984), (Walsh and Ryan, 1997); (+) Tax shields (Bradley, Jarrell, and Kim, 1984)

2.1.3 Pecking order theory

The concept states the different ways of raising the working capital for a businesswith internal finance and external finance, internal finance denote as retained earning whereas external finance such as debt and equity Pecking order theory prefers internal finance over external finance such as retained earnings are better than debt and debt is better than equity based on asymmetric information (Myers and Majluf, 1984)

2.1.4 Market timing theory

Market timing theory told about the way that firms make the right decision by issuingdebt or equity depends on current company or market circumstance The market timing theory explains that firms do not care about whether to finance with debt or equity In case of funding by equity, the firm will look at the current by market

whichever currently looks more favorable, the firm issues the equity when

stock price is high (Hovakimian et al, 2004) or increase on the way (Graham and Harvey, 2001), the firms are more likely to issue equity when the market values are high base on a book and past market values and repurchase equity (treasury stocks) when the market values are low (Baker and Wurgler, 2002) Mayers (1984)argues that in case of external issuance, firms apparently try to time the stock issues when the security are high, then firms like to issue stocks (equity) rather than debt issuance.

For debt issuance, a firm decides to finance working capital by issuing debt at the time which the interest rate is low comparing to its historical level of debt (Barry

et al, 2008), furthermore, According to the survey from previous empirical

research of Harvey et al (2004) finds that the finance manager issue debt securitieswhen the interest is low also

The market timing theory assumes that the mispricing of financial instrument exists and the firms have an ability to detect that mispricing effectively upon asymmetric information and the theory explains that the selection between debtand equity is depending on misprice on financial instrument at timing the firmswants to fund for new investment

2.1.5 Signalling problem

Firms send valuable information about dividend policy, income, firm growth opportunities to outside with bad signal or good signal of the firm For instance, high dividend implies that the management is very optimistic about future

profitability Base on good signal the outside investments can value the price stock

and the creditors/banks can make the right decision on supporting credits for thatcompany and in the conversion (Baker and Powell, 1999).

Mayers (1984) states that when firms announce a stock issuance, the stock pricetrends to fall Otherwise the stock price rises when firms announce a stock

repurchase

2.1.6 Agency cost problem

Firm size and complication in high level economy made challenges for a manager who is on behalf of the owner to run business smoothly and efficiently The

manager must have a good skill, quality to make thing differences with other people in order to run a large firm effectively Firms have to separate managementand control right within a company It means that ownerships have to hire good people outside to run businesses in order to maximize the profitability for

investment However, there are many problems arising during operating time that

is the profit conflict between hiring manager and ownerships due to the differencetargets This conflict will make the agency cost for firms

Manager inside with more information and outside shareholders with less

information will raise benefit conflicts between managers and shareholder leading

to develop agency cost (Jensen and Meckling, 1976) For instance, in case of absence investment opportunities, managers will use available free cash to financenew investments (overinvestment) to enlarge the firm size or maximum their personal benefit event that projects is ineffective, overinvestment problem

decrease firm value and minimize profitability thus shareholders make agreement

with manager to determine the firm target otherwise manager receive benefit from that agreement, additional shareholders hire controllers to oversee manager in order to ensure targets keep on track, moreover, monitoring operation will limit thecreative power and initiative of manager (Burkat, Gromb and Panunzi, 1997).

2.1.7 Asymmetric information problem

Firstly, linking with agency cost Asymmetric information theory show that firms send information to inside investors and outside investors are different, more information for inside or big investors and less information for outside or small investors Under this theory, the firm value over the market can be low or high around real value, as the result the people who have more information will get more advantage to win the transaction than the less one For instance the managerswant to issue debt by sending documents with some fake information to the

creditor in order to get loan, in this case the creditor easy to make the mistake in making the right decision on the valuation Another case is that the internal

investors who have more information can use this advantage to sell or buy the bulk

of stock in the market to get a profit in the future, etc Asymmetric information is the form of market failure leading to moral hazard problem

Secondly, asymmetric information made the conflicts between shareholders and debt/bond holders in that the manager on behalf of shareholders borrow money from debt holders who depends on the plans issued from manager then put money for that project Debt holders release loan for investment and expect to get a fixed interest base on the risk of collateral and risky projects while managers invest money to projects with high risk and expect more returns (high risk, high return),

since profit transfer from debt holders to shareholders and risk shifted from

shareholders to debt holders

2.2 Empirical literature review

2.2.1 Leverage (Lev) and capital structure

Capital structure including is a combination of debt and equity Equity including many sources from investing capital, undistributed profit, share premium,

differences upon asset revaluation and other capital Debt including short term debtwhich is below 12 moths mature while long term debt that has mature time over 12months

Capital structure uses leverage ratio Financial leverage is one of the financial toolsthat firms use to finance working capital and maximizing the benefit during

operation, a firm that successfully use leverage tool will magnify the profitability for shareholders, tax deductible, improvement of credit rating, credit approach from banks, increase of free cash Conversely, the firm will face with inability to pay debt on time and facing with bankruptcy situation Under working capital management, firms will use short-term debt to fund current assets while long term debt is for non-current asset

In order to study the leverage and its measurements, the research can separate the long term debt and short term debt in debt structure in order to identify whether thedebt structure of the firms in each environment in every country will differ anotherone or not For instance, according to information collected from previous research

in China listed company (Chen, 2004) states those Chinese firms usually use short

term loans rather than long term debt to finance the investment while other countriessuch as G-7 countries (Rajan and Zingales, 1995), developing countries (Booth et al., 2001) has long term debt higher than short term debt ratio, meaning that equity

is the main source of finance for capital investment in Chinese firms

Another argument about whether firms should choose a book value or market value to measure the leverage Almost previous studies chose a book value to measure leverage instead of market value when run regression (Hovakimian, Oplerand Titman, 2001), (Fama and French, 2002), furthermore, book value was used tobetter reflect the target debt of business due to market value also depend on many factors far away firm control and can not be measured exactly the debt ratio (Thiesand Klock , 1992)

2.2.2 Profitability (PRO) and leverage.

According to the pecking order theory, retained earnings are the first choice for raising capital then debt and equity Otherwise, firms tend to avoid a cost of

issuing new equity and also personal tax for shareholders in paying dividends thusfirm tendency forward retained earnings to build up capital instead of borrow debt,further more, firm do not like to issue equity to avoid stock price dilution Base onpecking order theory, profitability has a negative relationship with leverage and familiar with previous research from Titman and Wessels (1988) in the US, Frank and Goyal (2009), Harris and Raviv (1991), Rajan and Zingales (1995) in

developed countries, Wiwattanakan (1999) and Booth et al (2001) in developing countries, Kester (1986) in the US and Japan, even strongly claims that

profitability has robust relation with leverage, Wald (1999) Fama and French

(2002) argued that debt increases when investment exceed retained earnings anddecrease when the investment is lower than retained earnings, firm trend to saveprofit instead of paying out dividends to shareholders from beginning until

earnings is strong Published firms can issue equity for new investments

According to tax based models and trade off theory, high profitability firms do notconcern about the loan at mature due to firm can handle principal and interest of Loan, tax based models and trade off theory suggest that firms with high profit should borrow more debt in order to reduce income tax to maximize profit for shareholders and firm value thanks to tax shields, fewer studies found that

profitability positive effect to leverage but it seem to be weakness and statisticallyinsignificant (Long and Malitz, 1985) Most of empirical studies show that

profitability is a negative relationship with leverage such as Hariss and Raviv (1990), Wald (1999), Titman and Wessels (1988), Rajan and Zingales (1995), Booth et al (2001), Wiwattanakantang (1999)

Theoretical, profitability has a negative (-) or positive (+) effect to leverage in term

of pecking order theory or trade off theory

This research expects that profitability has a negative relationship with leverageunder the pecking order theory The hypothesis is given as under:

H1: There is a negative relationship between profitability and leverage

2.2.3 Tangibility (TANG) and leverage

Agency cost theory indicated that the agency cost of debt of the firm may shift to riskier investment after issuing debt to sponsor tangible assets Under this theory, wealth will be transferred from creditors to shareholders Tangible assets are easy

to collateralize thus lead to reduce the agency costs such as preferred interest rate, transaction costs, etc A firm with more tangible assets have more chance to

approach the credit and firms have close relationships with creditors Furthermore,

a profitable firm trend to purchase new tangibility to change the old one in order

to enhance either productivity or quality and firms also get profits from non–debt tax shields by depreciating tangible assets Moreover, the value of tangible assets should be higher than the value of intangible assets in case of bankruptcy All above explanations indicate that an increase of tangible assets will lead to increasedebts, in other words, tangibility has a positive relationship with leverage, this argument similar with previous empirical research such Harris and Raviv (1991), Rajan and Zingales (1995), Wald (1999), Friend and Lang (1988), Long and

Maltiz (1985), Marsh (1982)

Thus, the study expects that Tangibility has a positive relationship with leverage.The hypothesis is given as under:

H2: There is a positive relationship between Tangibility and leverage

2.2.4 Growth opportunities (GROW) and leverage

Firm with high debt level will face with difficulty in finding capital support from creditors for firm activities and purchasing new assets (Lang, Ofek and Stulz,

1996), firms with less debt ratio has more advantages to build up finance for newinvestment chances, thus firms have low leverage easy to get capital for future growth.

Myers (1977) argues that a firm with high growth opportunities may have a more realistic option for future investment and firms issue more debt may lead to reducethe present market value of a firm who hold real option, otherwise, firms with highgrowth opportunity trend to issue extra equity to finance option in the future and limit to issue debt for avoiding agency cost

The trade off theory shows that the firm's optimal chose the capital structure by balancing benefits against borrowing cost, the firm with higher opportunities has achance to approach the lower interest loan, the benefit from borrow exceeds the cost of equity issuance so the firm trend to issue more debt than equity The trade off theory explains the positive relationship between firm growth and leverage The explanation is in line with empirical study from Chen and Zhao (2006)

Titman and Wessels (1988) argue that growth opportunities are capital assets that add value to a firm but can not be collateralized and cannot contribute to the

reducing income tax thus company with high growth opportunities has low debt This suggests that growth opportunities have a negative relationship with leverage

Most of the studies predominated support theoretical prediction that growth

opportunity negative effects to leverage and consistency with the findings of Wald (1999), Rajan and Zingales (1955), Long and Malitz (1985), Chen (2004) except for the researches from Kester (1986) in Japanese and US companies shows a

positive relationship between growth opportunities but not a statistic

significant Thus this research expects that there is a negative relation between growth opportunities and leverage Thus the hypothesis will be as follows:

H3: There is a negative relationship between growth opportunity and leverage

2.2.5 Firm size (SZ) and leverage

Large firms with the profitability trend to use debt to support firm’s activities in order to meet with increase of capacity, the firm need to find more capital from external sources such as loan from creditors or issuing equity, equity choice willspend too much cost of issuing equity and lead to decrease stock prices (Mayer, 1977) and stock price dilution (Asquith and Mullins, 1984), thus issuing debt is first choice for financing capital for the firm

According to trade off theory, large firms are more diversified so that firm has less exposed to the risk of bankruptcy (too big to fail), since the firm can reduce

borrowing cost from long term debt issuance The cost of issuing debt and equity related to firm size, small firm pay much more cost of equity issuance than the large one (Smith, 1977) This suggests that small firm has less debt and large firm has more debt level leading to the result that there is a positive relationship

between firm size and leverage A positive relationship is consistent with empiricalstudy from Frank and Goyal (2009) based on the data from publicly traded U.S firms

According to the pecking order theory, asymmetric information between insiders and capital markets within a firm are lower expected in large firms, thus large firms may be more capable of issuing equity for financing (Kester, 1986) The

empirical research from Titman and Vessels (1988) found that there is a negativeeffect between firm size and leverage.

The hypothesis is given as follows:

H4: There is a positive relationship between firm size and leverage

2.2.6 Ownership type (OWNT) and leverage

Government ownership proxies for Ownership type, Previous researchers states that private owned enterprises run business better than state owned enterprise afterprivatization in term of productivity, revenue and performance (Frydman, Gray, Hessel and Rapaczynski, 1999) Too much government control lead to no good forenterprises although there are political supports from government (Sun, et al, 2002)

The agency cost theory shows that there is benefit conflicts between manager and outside shareholders, manager tend to use free cash flow to finance new projects when there is absence a new investment opportunity whereas outside shareholders who own firm always want to build up their finance by increasing debt Assuming that outside shareholders are representative of government and shareholders have astrong power in financial decision in firm together with strong financial support from banks, of course, there is good chance for firm approaching the credits from the banks or creditors in order to finance the working capital hence debt will increase, in other words, State-controlled ownership will lead to increase debt or positive relation to leverage This argument is also familiar with the previous research (Gul, 1999), (Dewenter and Malatesta, 2001)

Moreover, the state controlled companies face with a shortage of budget (Truong,2013) which is happening in transition economies These explanations imply that state owned banks seem to impose less restriction on loans to state controlled companies, since state-owned companies tend to issue more debt for financing itsoperation Thus Ownership type is a positive relationship with leverage The hypothesis is following:

H5: There is a positive relationship between ownership type and leverage

2.2.7 Non –debt tax shields (NDTS) and leverage

Firms have more fixed assets will issue more secured debt in order to maximizefirm value (Scott, 1977) Moreover, firms can approach the credits with a lowerinterest rate than other thanks to the secured assets Depreciation of fixed assetswill make tax profit for firms due to depreciation cost reduce corporate taxes which are denoted non – debt tax shields, as the re sult, there is positive

relationship between non-debt tax shields and debt ratio This argument is

tendency with previous studies (Harris and Raviv, 1991), (Bradley, Jarrell and Kim, 1984), (Scott, 1977)

DeAngelo and Masulis (1980) argue that non debt tax shields are substitutes forthe tax benefits of debt financing and a firm with large non debt tax shields is expected to issue less debt and consistency with its examination Mackie and Marson (1990) find a negative relationship between non-debt tax shields and leverage The study expects that ownership type has a positive relationship withleverage The hypothesis is set as below:

H6: There is a positive relationship between ownership type and leverage

All the hypotheses discussed above are summarized in the following model:

Research model

H1 (-)Profitability

CHAPTER 3

RESEARCH METHODOLOGY

3.1 Sample size and data set

This study used secondary data from the annual report of 124 Vietnamese financial listed companies for the period 2008 -2012 The financial statements are prepared under the Vietnamese Accounting Standard (VAS) and data achieved from consolidated financial statement of a firm The balance sheet from financial sectors (for instance: banks, insurance companies, stock companies) has a differentstructure from non-financial companies which are excluded from the sample

non-Stevens (1976) recommends that a predictor is needed about 15 subjects for

reliable equation Tabachnick and Fidell (2001) give a formula for calculating sample size requirements, taking into account the number of independent

variables Since sample size N > 50 + 8m (where m is the number of

independent variables) For stepwise regression there should be a ration of 40 cases for every independent variable This study used data of 124 firms with 602 observations extracted from its financial reports, those numbers are suitable with the requirement

All sample companies are still working, either none of them are bankruptcy or temporary stop The sample includes many fields such as: real estate (45 firms); Rubber (9 firms); Chemical and pharmaceutical (10 firms); Mineral (9 firms); Gas,electrical, power (12 firms); Steel (10 firms); crude oil (11 firms); trading and manufacturing (19 firms)

3.2 Calculation of the variables

3.2.1 Dependent variable

Leverage (Lev)

The financial report of the firm includes income statement, balance sheet, cash flow and the explanation to the financial statement All reports indicate the pictureregarding the financial status of the firm The left side of balance sheet shows the value of total assets and the right side indicates the source to finance the total assets

The Vietnamese accounting standard system has some difference from other countries together with the uniqueness of each national thus total debt is a

combination of short term debt and long term debt should be classified according

to nature of debt The debt on the Vietnamese financial report includes many items that the firm has an obligation to refund in the future such as a deposit from

customers, prepaid expense, internal payable, standby for short term payable, fund for a reward, etc In order to mitigate the effects of these debts when studying capital structure, the data in term of debts should be collected from “short term debt and loan”, “long term debt and loan” where a f irm either borrows money from banks or other creditors According to VAS (2006) guides that the value of a

“short term debt and loan” that borrowed from the b anks, creditor with less month mature plus “long term debt mature” The val ue of “long term debt and loan” extracted from debt that borrowed from banks, creditors with over 12 month mature Rajan and Zingales (1995) imply that total debt should not include items

12-like account payables, advances from customers, Accrued expenses, Other

payable, etc., due to these items does not provide a good indication whether the firm is at risk in the future, which may be used for transaction purposes rather than for financing Furthermore, Myers (2002) argues that the manner in which a firm reacts to a given factor may depend on the firm’s circumstances Since this study uses data from the two those items such as “short t erm debt and loan” and

“long term debt and loan” extracted from the balance shee t for finding the real picture about leverage ratio

There are many measurements from previous studies to define the leverage ratiofor capital structure

Leverage is measured by some ratios as follows: (1) Total debt to total assets (TDTA), (2) total debt to total equity (TDTE), (3) long-term debt to total assets(LTDTE), (4) short-term debt to total assets (STDTA)

Most studies focus on a single measure of leverage (Frank and Goyal, 2007) This study uses the ratio of combination of “short term debt and loan” and “long term debt and loan” (TD) over book value total assets (B VTA) to define leverage

3.2.2 Independent variables

Profitability (PRO)

Profitability ratios measure the ability of a firm to generate earnings to sales, equity, assets The different profitability ratios indicate the insights of financial health and performance of a firm A higher value is desirable However,

Profitability ratio gives meaningful information only when they are analyzed in

comparison to competitors or compared to the ratios in previous periods

Therefore, trend analysis and industry analysis are required to draw

meaningful conclusions about the profitability of a company

Finding the relationship between profitability and capital structure, there are manymeasurements to define profitability Profitability ratio defined as return on total equity (ROE) or returns on total asset (ROA) or earnings before interest and tax over book value total assets (EBIT/BVTA) Due to income tax, interest rate is the differences between companies so the study uses EBIT index in order to ignore theeffect of interest rate and income tax rate when compared with other firms, EBIT

is preferable use to clarify and value the profitability of business

This study used earnings before interest and tax (EBIT) divide by total book valueassets (BVTA) to define profitability, data for profitability collected from incomestatement of a firm

The study predicts that profitability has a negative relationship with leverage

The formula is set as: Profitability = EBIT / book value total assets

Tangibility (TANG)

Some studies computed a tangibility ratio by separating tangible and intangible assets over total assets (Frank and Goyal, 2003) to define tangibility, sum of fixedassets and inventories to total assets (Chen, 2004)

In this study, tangibility is measured as net fixed assets scaled by total assets which

is extracted from the balance sheet statement of firms, the measurement is the

same calculation with Huang and Song (2002), Li and Yue and Zhao (2006), Mazur (2007), Shah and Khan (2007) As the argument from literature review,Tangibility has a positive effect to leverage.

Tangibility = Net fixed assets (NFA)/ / book value total assets (BVTA)

Growth opportunities (GROW)

Previous works define growth opportunities is computed sales growth total assets growth (Chen, 2004), Wald (1999) defined as the five year average of sales growth

to test what effect growth has on leverage, Frank and Goyal (2003) use market to book ratio to define firm growth, Titman and Wessels (1988) use capital

expenditure over total assets, growth of sales (Opler and Titman, 1994), (Wald, 1999), growth rate of employment (Lang and Stulz, 1996), Market to book ratio (Billett, King and Mauer, 2007)

Firm’s growth ratio has many measurements such as growth of assets based on ttime and t-1 (BVTA t – BVTA t-1)/BVTA t-1 (Sha and Khan, 2007), capital

expenditure over total assets (Titman and Wessels, 1988), Growth of sales (Oplerand Titman, 1994), Wald, 1999), growth rate of employment (Lang and Stulz, 1996), Market to book ratio (Billett, King and Mauer, 2007)

This study used a percentage of total assets change in five years of each firm todefine growth opportunities The measurement for this study is the same with formula from Shah and Khan (2007) Thus the computation for this ration is:

Growth opportunities = (book value total assets (time t) – book value total

assets (time t-1))/ book value total assets (time t-1)

Firm size (SZ)

The size of the company shows whether the company is large or small, some empirical researches use the natural logarithm of net revenue from sales such as Huang and Song (2006), Shah and Khan (2007), Titman and Vessels (1988) Thisstudy uses the logarithm of assets to compute the size of the firm as same as the measurement from Frank and Goyal (2003), Chen (2004) in order to access the relation between firm size and leverage The study predicts that there is a positivecorrelation between firm size and leverage Thus, Firm size = logarithm of total assets

Ownership type (OWNT)

State ownership is still playing an important role in the progress of reform in the Vietnamese economy The financial system is typically centralized and heavily dependent on state-owned banks to provide access to finance Vietnamese

Government is trying to equitize state owned company in order to reduce the state’s shareholding to 51 percent by 2010 There are five state owned commercialbanks (SOCBs) controlling about 70 percent of banking sector assets and 70 percent of total bank loans (Truong, 2013)

Ownership type is dummy variable and this study implies that there are two groups

of the company, the division depends on whether a firm has stating–owned

shareholder or not According to enterprise law (2005) of Viet Nam, there are

many criteria to determine whether a company is controlled by another company depends large on stock holdings and the regulation of company This study is based on the value of stocks on hand that government whether is holding more or less 50 percent over owner’s equity in a company A firm with more 50 percent should be controlled by government As a dummy variable, the calculation takes 1 for the value over 50 percent, and takes 0 if the value is less than 50 percent There

is a positive relationship between ownership type and leverage

Ownership type = 1 (Yes): There is an impaction of state-ownership to leverage

Ownership type = 0 (No): There is not an impaction of state-ownership to leverage

Non-debt tax shields (NDTS)

The tax deduction for depreciation and investment tax credits are called non debt tax shields, Bradley, et al (1984) employ the sum of annual depreciation charges and investment tax credits divided by the sum of annual earnings before

depreciation, interest, and taxes (EBITDA) Frank and Goyal (2003) use operatingincome before depreciation, Interest, and tax (EBITDA) over total assets (TA) Wald (1999) employs annual depreciation charges over total assets in the same period

The investment tax credits are applied for a few companies who have a preferable income tax from the government under the rural development policy Thus this studyignored the effect of the investment tax credits when determining the formula of non dent tax shields The study used annual depreciation over the sum of annual earningsbefore depreciation, interest, and taxes (EBITDA), the formula

is consistent with computation of Bradley, et al (1984) but excludes investment taxcredits The study predicted that non debt tax shield is a positive relationship with leverage.

Non debt tax shields = Depreciation/EBITDA