Foreign capital flows and stock market – case study in vietnam for foreign investors’ decision of trading and their ownership

VIETNAM – NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICSFOREIGN CAPITAL FLOWS AND STOCK MARKET – CASE STUDY IN VIETNAM FOR FOREIGN INVESTORS’ DECISION OF TRADING AND THEIR OWNERS

VIETNAM – NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

FOREIGN CAPITAL FLOWS AND STOCK MARKET – CASE STUDY IN VIETNAM FOR FOREIGN INVESTORS’ DECISION OF TRADING AND THEIR OWNERSHIP

A thesis submitted to Vietnam – Netherlands Program in partial fulfillment

of the requirements for the degree ofMASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

Ngo Van Man

Supervisor

Dr Nguyen Trong Hoai

HO CHI MINH CITY, January 2013

I am not able to finish this thesis without the guidance of my supervisors andcommittee members, supports from my classmates and colleagues as well asmotivation and sharing from my wife

I would like to express my very great appreciation to my supervisors, Dr NguyenTrong Hoai and Dr Nguyen Xuan Thanh, for their patient guidance, enthusiasticassistance, valuable comments and suggestions as well during my research I alsowould like to take this change to thank Dr Nguyen Tan Thang for his ideas inspiring

me to pursuit this topic for my thesis I highly appreciate staffs of the AdministrationDepartment and Library of Vietnam-Netherlands Program and my classmates inproviding me good environment , facilities and supporting me technically to completethe thesis

Finally, I would like to express my love and gratitude to my wife and colleaguesfor their understanding, supports, and encouragements to finish the research

TABLE OF CONTENTS

CHAPTER 1: INTRODUCTION 1

1.1 Problem Statement: 1

1.2 Research questions: 1

1.3 Research objectives: 1

2.1 Economic theories: 2

2.1.1 Definition of key concepts: 2

2.1.2 Relationship between foreign investor and firm characteristics 3

2.2 Related empirical studies: 5

2.3 Conceptual framework: 6

3.1 Research context: 7

3.2 Source of Data and its definition: 7

3.3 Research Methodology: 9

4.1 Descriptive Data Analysis 10

4.1.1 Summary of Data: 10

4.1.2 Correlation Matrix 13

4.2 Empirical Results: 13

4.2.1 For the whole sample : 13

(a) Firm characteristics and foreign investor’s buying volume: 13

(b) Firm characteristics and foreign investor’s selling volume: 14

(c) Firm characteristics and net purchase variable in relation to foreign investor’s ownership ratio 14

4.2.2 For specified industries: 15

(a) Finance Industry 15

(b) Construction Industry 16

(c) Manufacturing Industry 17

5.1 Conclusions 18

5.1.1 Empirical results 18

5.2 Policy recommendation: 19

5.2.1 For investors: 19

5.2.2 For companies: 19

5.2.3 For government authority: 19

5.3 Limitations and Further research 20

5.3.1 Limitations: 20

5.3.2 Further research: 20

REFERENCES: 21

APPENDICES: 24

LIST OF TABLES

Table 2.1: Summary of related empirical studies as following 5

Table 4.1:Description of variables of the whole sampled stocks 10-11Table 4.2: The summary of value traded of the whole sample 11Table 4.3: Percentage of FDI and Portfolio inflows over GDP in Viet Nam 12Table 4.4: The summary of statistics by mean of each industry 12Table 4.5: The coefficient signs between buy-volume with other variables 13Table 4.6: The coefficient signs between sell-volume with other variables 14Table 4.7: The coefficient signs between ownership ratio with other variables 14Table 4.8: The coefficient signs for finance industry 15Table 4.9: The coefficient signs for construction industry 16Table 4.10: The coefficient signs for manufacturing industry 17

Foreign capital flow in empirical studies has recently recovered into the developingcountries and emerging markets Their impact on growth of such countries hasempirically increased and also created some negative temporary effects Foreigndirect investment positive correlates to growth, meanwhile portfolio investment seems

to be negative correlated with it One of such effects through stock market is blamedfor the crisis This paper aims to evaluate how firm’s characteristics affect to foreigninvestors in their investment both in buying and selling decision into listed firms inVietnam stock market and to figure out their longer positions after that

Keywords: foreign investors, stock market, firm characteristic

CHAPTER 1: INTRODUCTION

1.1 Problem Statement:

Financial integration has so far benefited to not only source countries but also hostcountries One of those benefits is to increase in investment in which capital flows fromthe capital-abundant places to hosts especially in developing countries

As a matter of fact, in order to diversify risks in foreign investment as well as to coverthe more often crisis in the global economy many hedge funds have also set up andoperated to meet such trends Actually, portfolio investment inflows, together withforeign hedge funds, were blamed for the crisis

This paper aims to study the relationship between foreign investors’ investmentdecision and the stock market via volume of trading of foreign investors in Viet Namspecified to those stocks heavily traded by foreign investors Therefore, this paper alsohelps to provide investors both domestic and foreign investors an adequate understandingabout types of companies attractive the foreign investor’s decision of buying or selling aswell as their long term position via ownership ratio

1.2 Research questions:

The final purpose of this paper is to answer the following questions:

(i) Do foreign investor’s buying and selling decisions really focus on stocks of large companies with better profitability?

(ii) How do their buying and selling volume affect to their ownership ratio?

1.3 Research objectives:

The overall objective of this paper aims to evaluate which firm’s characteristics affect toforeign investors’ decision of selling and buying as well as to their ownership ratio forlong term position Subsequently, the paper will further clarify them for each relatedindustry

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CHAPTER 2: LITERATURE REVIEWS

2.1 Economic theories:

2.1.1 Definition of key concepts:

(a) Foreign capital flows

Typically, foreign capital flows into the host countries especially into developing andemerging ones in three channels: foreign direct investment, portfolio investment andforeign debt Theoretically, foreign direct investment flows into two ways: Greenfieldand Merge & Acquisition activities which have been significantly increased in emergingmarkets (World Economic and Social Survey 2005) Portfolio investment in other handincludes equity securities or debt securities in forms of bonds, money market instruments,and financial derivatives

Investors in country A could invest in country B or vice versa to seek fordiversification in their portfolios in term of risk (balancing their portfolios) and expected(equity) return

(b) Foreign investment in relation to stock market

In many empirical studies, Foreign Direct Investment has also significantly andpositively affected to domestic stock market development (Adam and Tweneboah) FDIwhich was found to be a complement of stock market development has positivelycorrelated with market capitalization and domestic value traded (Claessens et al.,2001).Furthermore, along with the more global integration in finance market, foreigninvestment in portfolio investment has been empirically found increasing with its certainadvantages such as a high mobility in flowing out and in markets as well as to reducesome existing limitations in the bond market in developing and emerging markets

In short, foreign investors always seek for investment opportunities In other words,foreign investment flows from firms with low investment opportunities to firms with highones However, an average return of some types of investors’ portfolios appears ratherdifferentiated in which some investors actually want to own stocks or firms for specifiedobjectives such as their business relationship and control rather than a high investmentreturn (Kim et al, 2005)

(c) Firm characteristics: Financially, analyzing firm characteristics concentrates on ratioanalysis According to Ross et al (2005;2010), ratio analysis is often classified intofollowing groups: Market value measures; Profitability Measures; Short term solvency orliquidity measures; Long term solvency measures; and asset management or turnovermeasures.

The paper will mainly focus on four of five above groups including market value,liquidity, profitability and long term solvency measures Furthermore, the paper will alsotake account of dividend policy because this policy along with others will affect to firm’sability to sustain growth (Ross et al.,2005;2010)

2.1.2 Relationship between foreign investor and firm characteristics

According to Baker et al (2009), FDI flows are much affected by components of stockevaluations which have been used to reflect mispricing specially in presence of capitalaccount restrictions to limit arbitrage by portfolio investors

a) Relationship between foreign investor with market value measures:

Market capitalization has empirically a strong relationship with stock returns of foreigninvestors’ investment Due to redemption and liquidity requirement for foreigninvestment as well as to prevent systematic risk, foreign investors prefer large marketcapitalization firms

Some studies demonstrated that foreign investors tend to prefer large marketcapitalization and strong financial firms (Kang and Stulz,1997; Lin and Shiu,2001; andKim et al.,2005) On the contrary, other studies show a negative relationship that onaverage, smaller-size firms get higher stock returns than large-size firms (Banz,1981;Keim,1983 and Basu,1983)

In regard to PB and PE ratio, some showed a negative relationship between PB ratioand stock returns ( Fama and French,1992; Daniel and Tittman, 1997) Hence, foreigninvestors can gain higher stock returns as they buy low PB stocks (Dhatt Kim andMukherji,1999) On the contrary, others demonstrated that foreign investors prefer stockwith high PB ratio (Lin and Shiu,2001 ; Kim et al.,2005; and Bae et al.,2011)

In regard to PE ratio, this is considered to be the single most important variable indetermining a share’s price As a matter of fact, Basu (1977), Breen (1978) and Dreman

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(1980a,1980b,1979) demonstrated that stocks with low PE ratio can gain a higher averagereturns than those with high PE ratio However, some recently empirical studies foundthat foreign investors tend to buy stocks outperformed and sell stocks underperformedrelative to the market (Bae et al.,2011)

b) Relationship between foreign investor with Profitability Measures:

According to Kim et al (2005), there has been a positive correlation between foreignownership and ROE ratio which was considered to be an important variable to foreigninvestors Similarly, Bae et al (2011) found that foreign investors traded stocks inKorean listed companies with high ROE and ROA ratio in which not only for the samecurrent period but also for the subsequent period, their “buy” stocks have higherprofitability than their “sell” stocks Furthermore, Kang et al.(2010) in studying firmslisted on Korean Stock Exchange also demonstrated that corporate profitability measured

by the EBITDA has positively correlated with foreign ownership

c) Relationship between foreign investor with liquidity measures:

According to Kang et al.(2010), liquidity ratio has positively correlated with foreignownership into Korean Stock Exchange listed companies However, Vo Xuan Vinh(2010) found that liquidity ratio has negatively correlated with foreign ownership forfirms listed on Ho Chi Minh Stock Exchange

In other words, foreign investors seem to follow a buy and hold strategy for their longterm position rather than for short term

d) Relationship between foreign investor with financial leverage ratio:

Many empirical studies revealed that foreign investors favor firms with low debtratio (Kang and Stulz, 1997; Lin and Shiu,2001; Kang et al.,2010 and Vo Xuan Vinh,2010) In other words, foreigners prefer firms with low leverage ratio as well.Meanwhile, Bae et al.(2011) studied and found that firm leverage is not an importantvariable affect to foreign investor’s decision of buying or selling This is also consistentwith the finding of Mishra and Ratti (2011)

e) Relationship between foreign investor with Dividend Policy:

Besides preferring large-size firms , foreign investors were found to prefer stocks withhigh dividend yield (Jeon et al., 2010; Mishra and Ratti, 2011 and Bae et al.,2011)

Meanwhile, Dahlquist and Robertsson (2001) found that foreign investors also prefer

stocks of lower paid-dividend firms

2.2 Related empirical studies:

Table 2.1: Summary of related empirical studies as following table:

Authors Observations Dependent Independent Research Key Findings

Variables Variables Method

Lin and Firms in Taiwan Foreigner’s Firm’s Panel data with They prefer large firms Shiu Stock.E ( 1996- ownership characteristic random effect with high PB ratio, low

20 stocks in Daily PE,PC,MKC, A standard Their buying, selling and

Thailand stock purchase, and Price, linear model,

Market (1999- total value of ownership Panel data with

2003) foreigners data pooled model

relationship with PE ratio Vo

firms listed on Foreigner’s Firm’s A standard Foreigners prefer large

HOSE (2007- ownership characteristic firms, firms with low PB,

Daily trading in Buying and ROA,ROE, They buy stocks with

2000)

investors CF⁄ Sales high dividend yield.

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2.3 Conceptual framework:

FIRM’S CHARACTERISTICS:

OWNERSHIP

Market Capital (VND billion)

Current Ratio (times)

Quick Ratio (times)

Dividend per Share (VND)

All expected relationships among variables could be likely summarized as the

following tables:

Table 2.2: Summary of expected signs:

Expected signs Buy volume Sell volume Ownership ratio

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CHAPTER 3: RESEARCH METHODOLOGY

3.1 Research context:

Established and operated since 2000 for Ho Chi Minh Stock Exchange (hereafter HSX)

and since 2005 for Hanoi Stock Exchange (hereafter HNX), role of stock market in

mobilizing capital for the whole economy was very impressive and indispensable with

their yearly percentage of the total volume over GDP as the following table Table 3.1:

Viet Nam Market capitalization

Vietnam stock Market capitalization (%GDP)

27.5%

25.0%

20,000 21.8%

% GDP Market capitalization of listed companies (current US$ mil.)

Source: Word Bank – Global Financial

Data 3.2 Source of Data and its definition:

Firstly, the research will select data from 2007 to 2011 just because only from 2006

onward the total volume trading by foreign investors has significantly increased

Secondly, the paper will focus on listed stocks of three main industries in HSX and

HNX as described above including Construction and Real Estate, Manufacturing and

Finance and Insurance which have listed from 2007 backward and their market

capitalization for finance industry over VND 100 billion (as of July 13, 2012) and

reported the foreign trading generated This sample of more 98 listed firms and observed

over 05 years will therefore turn out over 420 observations with their structure as

following:

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Table 3.2: the structure of industry in dataset(as of July 13, 2012)

Source: Author’s calculate on the data set

Firm characteristics:

(i) Market Capitalization (MKC): this variable is the market capitalization of each firm atthe year-end

(ii) Dividend paid (DIV): how much dividend actually paid to each shareholder

(iii) Price Book ratio (PB): A ratio of a listed firm’s book value to its market value Itdetermines how the market prices a company relative to its actual worth and measured bymarket value divided its book value

(iv) Price Earning ratio (PE): a share price divided by earning per share

(v) Return on Equity (ROE): Net income divided by the book value of equity at yearend

(vi) Return on Asset (ROA): An indicator to measure how profitable a company is generated from the invested capital (assets)

(vii) Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) Thisindicator is used to eliminate the effects of financing and accounting decisions and therefore

to analyze and compare profitability among selected companies better

(viii) Ownership rate (OWN): measured how many percent of shares hold by foreigninvestors As required by Foreign Investment Laws the maximum room available for

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foreigners to invest into each company is not higher than 49% This requirement affects

so much to foreigner’s decision of trading

(ix) Debt to Equity Ratio.(DEBT): defined by total liabilities divided total equity often

- YI,t denotes buying, selling and ownership ratio for firm i at trading year t

- XJ, I, t presents the firm characteristic variables j of firm i at year t which are divided intostock characteristics including MKC, PB, P/E ratio, ROE, ROA, EBITDA , DEBT , C_Ratio,Q_Ratio or Dividend Yield

- αi are random individual-specific effects, β is a vector of our robust estimators; and ε

is a error term;

The paper will employ the panel data which have advantages over pooled data In order

to select the most appropriate models for specified samples, the paper will test allpossible regression models including: Fixed-Effects Model (also called Least SquaresDummy Variable Model); Random-Effects Model (or Random Intercept, Partial PoolingModel); Pooled model or population-averaged model

After finalizing the appropriate model, to control for heteroskedasticity the option

“robust” will be employed in regression Finally, in order to detect the likelymulticollinearity among variables the paper will use the variance inflation factor afterregression model Such tests will be easily found in the appendix of this paper

CHAPTER 4: DATA ANALYSIS AND DISCUSSION

4.1 Descriptive Data Analysis

4.1.1 Summary of Data:

Table 4.1: Description of variables of the whole sampled stocks:

Source: Author’s calculate on the data set with Stata software.

Market capitalization of the finance industry is the highest; the construction and

manufacturing industry followed as the second and third of market capitalization In

addition, stocks of construction field were priced at the highest mean value at 25 times,

followed by stocks of finance and manufacturing at 15 and 11 times, respectively

In general, foreign ownership ratio at firms surveyed in three industries is not much

different at 20% of both finance and manufacturing industry and 17% of the construction

industry And the mean of debt ratio in the construction field is extremely high at 2.35

times followed by manufacturing and finance industry at 1.33 and 0.66 times,

respectively