The impacts of capital structure on firm’s operational efficiency

From that, the author examine the impact of some factors such as company’s size, asset structure, total asset growth and short - term liquidity ratio to operational efficiency as well a[r]

The impacts of capital structure on firm’s operational efficiency

Group sciences: Nguyễn Thị Quỳnh Thi

Trịnh Thu NgânNguyễn Thị Phương ThảoPhí Minh Huệ

Class: AC2015CScience advisor: Đỗ Phương Huyền

1 Thesis statement

This thesis studies how capital structure does affect the operational efficiency ofcompanies listed on the Vietnamese stock market Most of companies want tomaximize profit and move toward added corporate value Therefore, for an enterprise,

it is very important to improve operational efficiency and make decision in selection ofinvestment opportunities

This thesis consists 4 chapters

Chapter I: Literature Review and Theoretical Framework of Capital Structureand Operational Efficiency

Chapter II: Data and Research Methodology

Chapter III: Results and Experimental Discussion

Chapter IV: Conclusions and Recommendations

2 Rationale

Is there an optimal financial structure for each business? If optimal capitalstructure exists, how does it impacts on corporate value That has always been thesubject of debate in the financial community over the past several decades In 1958,Modigliani and Miller[CITATION Mod58 \n \t \l 1033 ] had published their study

“The cost of capital, corporation finance and theory of investment” in the AmericanEconomic Review The result showed that with perfect condition of capital market

expectations are identical, the value of company is independent from capital structure.The study above contributed to the formation of modern capital structure theories.

In fact, successful managers who can determine the optimal capital structure byminimize company financial cost and maximize company profit As can be seen,capital structure affects on firm’s operational efficiency

However, the empirical evidence about relationship between capital structureand firm’s performance in Vietnam is not much and has some limitations

Within the scope of personal knowledge, author has implemented the topic

“The impacts of capital structure on firm’s operational efficiency” From that, theauthor examine the impact of some factors such as company’s size, asset structure,total asset growth and short - term liquidity ratio to operational efficiency as well asthe influence of capital structure on performance of companies that listed on HanoiStock Exchange and Ho Chi Minh City Stock Exchange

3 Significance

The finding of this study shows the empirical evidence on the relationshipbetween capital structure and firm's operational efficiency in Vietnam The authorprovides some evidence to prove that capital structure have negative effect oncompany’s performance This study also suggests some recommendation forCompetent Authorities and Enterprises

CHAPTER1: LITERATURE REVIEW AND THEORETICAL FRAMEWORK

OF CAPITAL STRUCTURE AND OPERATIONAL EFFICIENCY

An overview of Capital structure

Capital structure is the way a company finances itself by mixing long- termdebt, short- term debt and equity[CITATION Ros05 \t \l 1033 ];[CITATION Hsi09

\t \l 1033 ] It refers to the way that the company finances its overall operations andgrowth by using different sources of funds There are some factors that can cause thechange of capital structure, such as age of company, company size, asset structure,profitability, company growth, company risk and liquidity[CITATION AlN08 \t \l

1033 ] However, whether or not an optimal capital structure exists is one of the mostimportant and complex issues in corporate finance An optimal capital structure of a

balance between ideal debt- to- equity range and minimizes the firm’s cost capital.Therefore, the firm must consider risk, tax position financial flexibility and managerialconservatism or aggressiveness because these factors are very crucial in determiningcapital structure target Moreover the operation conditions also may cause the actualcapital structure differ optimal capital structure.

The important decision for any firm is a decision about appropriate capitalstructure It is not only because of the need maximizes profit for organization, but also

is for organization’s complete ability The first opinion about capital structure wasresearched by Modigliani and Miller[CITATION Mod58 \n \t \l 1033 ] It refers thatoptimal capital structure exist which balance the risk of bankruptcy with the taxsavings of debt Once established, this capital structure should provide greater returnfor stock holder than they would receive from all-equity firm

In theory, the modern financial technical would allow manager to calculaterelation between debt and equity of each firm However, in practice, there are manystudies which found that the most companies do not have optimal capital structure Capital structure is the combination of the debt and equity of a firm It can also beknown as the way that a firm finances it through some combinations of debt andequity The various composition of a firm’s capital structure according to Inanga andAjayi[CITATION Ina99 \n \t \l 1033 ] may be classified into 3 parts Those are equitycapital, preference capital and long- term loan (debt) capital Equity capital is thecontributed capital, money originally invested in the business in exchange for share ofstock, and retained profits, profit from past years that have been kept by the company

to strengthen the balance sheet, growth, acquisition and expansion business.Preference capital is the mixture that combines the features of debentures and sharesexcept the benefit Debt capital refers to the long- term debt that company used tofinances its investment decisions while coming up with its principal and also payingback interest

Theoretical Framework of Capital Structure:

The irrelevance theorem[CITATION Mod58 \t \l 1033 ]has come to be one ofthe most important studies within the area of capital structure They stated that thevalue of a company did not depend on its financial system in competitive capital

when Modigliani and Miller[CITATION Mod58 \n \t \l 1033 ] assumed the corporateincome tax and they recognized that the value of a levered firm was equal to the value

of an unlevered firm plus the present value of the "tax shield" The M&M theoryconsidered the advantages of the tax shield However, the argument about maximizingdebt ratio to benefit from tax shield was not appropriate because it did not care aboutthe bankruptcy costs, the asymmetric information as well as the agency cost that mightoccur when lending From the limitations of M&M theory, many other investigationshave been developed to build modern capital structure theories The ability ofbusinesses fall into bankruptcy which depends on not only the business risk but alsothe policy of mobilizing, managing, operating and using capital of enterprises

The trade-off theory was developed by Kraus and Litzenberger[CITATIONKra73 \n \t \l 1033 ], considered that the capital structure of an enterprise affect inboth cost and benefit sides A company would borrow until the marginal benefit of thetax reduction (tax shield from the debt) was equal to the increase in the present value

of the bankruptcy costs

Another research, the pecking order theory, which was supported by Myers andMajluf [CITATION Mye84 \n \t \l 1033 ] when they examined the asymmetricinformation that existed between managers, shareholders, and investors This theorypointed out that there is no optimal capital structure for a company and that itexplained the prioritization of capital sources and loans when business mobilizecapital It means the companies would like to fund themselves firstly with internalresources, then with loans, and eventually with the equity provided by shareholders

Agency cost theory which provided by Jensen and Meckling [CITATION Jen76

\n \t \l 1033 ] is discussing the expenses that derived from the conflict of interestbetween principals (shareholders) and decision makers (agents) of firms (managers,board members, and so on), this occurred because of divergences in executivedecisions This costs concurrent related to the argument between shareholders andcreditors when the company's debt increased and shareholders received benefits incase of bankruptcy

1.1.1 The capital structure theory of Modigliani and Miller (M&M)

The Modigliani-Miller Theory (M&M) is the first theory of capital structure It

capital structure does not influence company's value This suggests that the valuation

of a firm is irrelevant to the capital structure of a company Whether a firm is highlyleveraged or has lower debt component in the financing mix, it has no bearing on thevalue of a firm

The capital structure theory of M&M is based on the following key assumptions:There are no taxes

Transaction cost for buying and selling securities as well as bankruptcy cost is zero

There is symmetry of information This means that an investor will have access tosame information that a corporate would and investors would behave rationally

The cost of borrowing is the same for investors as well as companies

Debt financing does not affect debt on a company's earnings before interest and taxes.Proposition 1: In the assumptions of “no taxes”, the capital structure does not influencethe valuation of a firm In other words, raising the capital structure does not increasethe market value of the company The profits are equal between the debt holders in thecompany and equity shareholders

Proposition 2: In the assumptions of "no bankruptcy costs", cost of capital effect oncapital structure which refers that borrowing gives tax advantage, because the interestwill deduct from the tax which result what is known as tax shields, which in turnreduce the cost of debt and then maximize the firm performance

1.1.2 Trade- off theory:

Trade-off theory aims to explain the fact that corporations usually are financedpartly by debt and partly by equity An important reason why the businesses cannot getenough capital is that because of having benefits from the debt shield The use of debtfinance also generates the highest cost This is financial exhaustion which has 2components: 1) costs that arise when financial exhaustion or bankruptcy; and 2) thepossibility of financial exhaustion and bankruptcy These costs include direct costs andindirect costs

With each percentage point increase in debt, while the benefits of the tax shieldincrease, the cost of financial exhaustion also increases It will come at a time, wheneach unit of debt increases, the benefits from the tax shield are no higher than the cost

of financial exhaustion, debt is no longer beneficial for business Therefore, companies

are always looking to optimize the total value of the business based on this balance todetermine how much debt and how much equity to choose in their capital structure.

Trade-Off theory suggested by Myers[CITATION Mye841 \n \t \l 1033 ]emphasize a balance between tax saving arising from debt, decrease in agency cost andbankruptcy and financial distress costs The Trade-Off theory is the oldest theory andconnected to the theory from Miller and Modigliani on capital structure that emphasize

on optimal capital structure Kraus and Litzenberger[CITATION Kra73 \n \t \l 1033 ]commented that the optimal financial leverage represents a trade- off between the taxbenefits of debt and the cost of bankruptcy According to Myers[CITATIONMye841 \n \t \l 1033 ], an enterprise that follows the static tradeoff theory establishes

a debt ratio based on target corporate value and gradually adjusts for that goal Thistarget rate is determined by balancing the benefits from the tax shield for debt andbankruptcy costs

The Trade-off theory is an important one while studying the FinancialEconomics concepts The theory describes that the companies or firms are generallyfinanced by both equity and debt The Trade-off theory of capital structure refers to theidea that a company chooses how much debt finance and how much equity finance touse by balancing the costs and benefits Trade-off theory of capital structure basicallyentails offsetting the costs of debt against the benefits of debt

1.1.3 Pecking Order Theory

In corporate finance, pecking order theory (or pecking order model) postulatesthat the cost of financing increases with asymmetric information

Financing comes from three sources, internal funds, debt and new equity When acompany need cash for a new investment companies prioritize their sources offinancing, first preferring internal financing, and then debt, lastly raising equity as a

"last resort"

According to Myers[CITATION Mye841 \n \t \l 1033 ], due to adverseselection, firms prefer internal to external finance When outside funds are necessary,firms prefer debt to equity because of lower information costs associated with debtissues

The theories based on the asymmetry information between manager and

subject to serious adverse selection problems while debt has only a minor adverseselection problem

If there is an inadequate amount of retained earnings, then debt financing will

be used Thus, for a firm in normal operations, equity will not be used and thefinancing deficit will match the net debt issues

Managers are more understandable about the real value and the risk of businessthan investors that affect to decision of the investor.Company just issue stock whentheir stock value is higher than internal stock value Therefore, when the companyannounced information about issuing stock, they will send to investor a message aboutthis problem Then, the market appear a lot of issuing information and it is a bad signal fordevelopment of enterprise and it leads to reduce stock price

Therefore, to avoid the reducing stock price, company will not issue the new equity

1.1.4 Agency cost theory:

Agency cost is a type of cost that arise when an organization gets a problem oflack of agreement between the purpose of manager and the owner and the informationasymmetry Management can not make decision in profit of the owner or damage tothose rights For example, instead of increase the value of company, manager usemoney for his purpose In order to solve this problem, the owner find the approach tocontrol and ensure that manager actions are in line with their interests such asrequirements on annual reports annual meeting, and bonus for directors based onmanagement effectiveness Therefore, the conflict between manager and ownerincrease agency cost

The better the enterprise is managed, the lower agency costs .Using debtincrease that leads to reduce agency cost As the debt ratio rises, manager will have tomore cautions about new debt and using capital decision will helps they manage theirorganization more effective

Agency cost of debt capital occurs when the information asymmetry betweenorganization and the business and creditors The owner of business are shareholderswho have rights to decide about business operation while the creditors give thebusiness loan and they can not vote in the shareholder meeting When a company takepart in an investment project that shareholders are more profitable than the creditors,

the more asymmetric information between business and creditors, the more agencycosts.

For example, when shareholder and creditor want to invest in a project,theyhave to trade-off between risk and profit If it is high-risk project, it will create muchprofit for shareholder but it increase the probability to bankruptcy for the creditors

Agency costs theory illustrate that agency cost of equity has the positiverelated with the debt ratio, but agency costs of debt capital directly related to businessfinancial leverage

Literature review:

Since M&M theory has been published, there are many researchers stillstudying the relationship between capital structure and operational efficiency Not only inforeign countries, but also in Vietnam, there are many articles on this subject

1.1.5 International literature review:

Phillips and Sipahioglu [CITATION Pau07 \n \t \l 1033 ]had a research aboutrelationship between capital structure and operational efficiency To do this research,they followed “Theoretical Framework of Capital Structure” of Franco Modigliani andMerton Miller (M & M)[CITATION Mod58 \n \t \l 1033 ] and using data fromcollected from 43 UK quoted organizations which possess an interest in owning andmanaging hotels to test this theory And their finding was similar to M&M theory, inother words, capital structure not related to operational efficiency

Moreover, Iorpev and Kwanum[CITATION Ior12 \n \t \l 1033 ]also study therelationship between capital structure and operational efficiency of manufacturingcompanies listed on the Nigerian Stock Exchange They covered a period of five yearsfrom 2005- 2009 The result concludes that capital structure is not a main determinant

of firm’s operational efficiency

In other research of Shyu [CITATION Jon13 \n \t \l 1033 ] (Department ofBusiness Administration, National Taiwan University of Science and Technology,Taiwan, Republic of China), he focused on Taiwanese group‐affiliated firms His studyseeks to examine how agency problems and internal capital markets in group‐affiliatedfirms are mutually influenced by the ownership structure, capital structure, andperformance Like other above studies, he found that the capital structure decisions of

Abu-Rub and Abbadi [CITATION DrN12 \n \t \l 1033 ] have done the research

by using panel procedure for a sample of 28 listed companies the Palestinian Stockexchange (PSE) over the period 2006 to 2010 This study established a model tomeasure the effect of capital structure on the bank efficiency measured by ROE, ROA,Total deposit to asset, total loans to assets and total loans to deposits were used tomeasure capital structure The result showed that capital structure had a positiveimpact on the firm’s operational efficiency

Using panel data consisting of 257 South African firms over the period 1998 to

2009, Fosu [CITATION Sam13 \n \t \l 1033 ] investigated the association betweencapital structure and firm performance To test the relationship, he used GMMregression approach and found a positive and significant relation between capitalstructure and firm’s operational efficiency

Pouraghjan et al ,[CITATION Abb12 \n \t \l 1033 ] also found a significantpositive link between capital structure and firm performance in the Tehran StockExchange The main objective of this study is to investigate the impact of capitalstructure on the financial performance of companies listed in the Tehran StockExchange They collected data from 400 firms that belong to 12 industrial groups from

2006 to 2010 In this study, authors used ROA and ROE to measure financialperformance of companies Results indicate that there is a strong negative andsignificant relationship between debt ratios and performance measures of Iranian firms(ROA and ROE)

Chinaemeram & Anthony[CITATION Chi12 \n \t \l 1033 ] researched aboutthe impact of capital structure on the operational efficiency of Nigeria companies.They used the income balance sheet data from 30 companies listed on the Nigeriastock exchange in the period from 2004 to 2010 and they used Pooled OLS method.The result showed that capital structure had a negative impact on operationalefficiency

Also other research about Nigeria, group of authors Akeem et al[CITATION Law14 \n \t \l 1033 ]examined the effect of capital structure on firm’s performance ofmanufacturing companies in Nigeria from 2003 to 2012 After that, from their finding,they observed that capital structure measures (total debt and debt to equity ratio) are

Moreover, group of authors including Awais et al[CITATION Awa16 \n \t \l

1033 ] also found the similar conclusion In detail, they used a sample of 100 financial firms listed on the Karachi Stock Exchange during the 2004 – 2012 duringthe research The finding of research suggests that company’s financial managershould consider debt as a last alternative to finance their operation as it has a negativeimpact on the company performance

non-Kinsman and Newman[CITATION Kin98 \n \t \l 1033 ] studied therelationship between debt level (including three measures of debt level) and firm’sperformance and detected diverse results This study found that earnings are negativelycorrelated with short-term debt, but are positive with long-term debt A similar resultwas found by Mesquita and Lara[CITATION Mes15 \n \t \l 1033 ] in Brazil

Tianyu[CITATION Tia13 \n \t \l 1033 ] examined the influence of capitalstructure on firm’s performance in both developed and developing markets A sample

of 1200 listed firms in Germany and Sweden and 1000 listed firms in China for theperiod 2003-2012 has been used in his study Applying OLS regression method, hedocumented that capital structure has a significant negative effect on firm’sperformance in China, whereas significant positive effect in two European countries,i.e., Germany and Sweden, before financial crisis in 2008

1.1.6 Vietnamese literature review:

Doan Ngoc Phuc [CITATION Doan \n \t \l 1033 ] studied and evaluated theeffect off capital structure on businesses operational efficiency with the data sourceused include 217 companies that are listed on two exchanges in Ho Chi Minh and HaNoi city (2007- 2012) The independent variable that used in this research is return ofasset (ROA) and return of equity (ROE) The result showed that the long term debt hadpositive effect on ROA and ROE, while the short-term debt and total debt had negativeeffect on business operational efficiency

Nguyen Thanh Cuong [CITATION Ngu14 \n \t \l 1033 ] also studied about thisissue He investigated whether there is an optimal capital structure that can makemaximum the company’s value The author has used data of among 90 unlistedSeafood Processing Enterprises in South Central region of Vietnam (SEASCRs) during2005-2011 For some enterprises, collected data consists of balance sheets and annual

through 7 years This research depend on the advanced panel threshold regressionestimation developed in 1999 by Hansen that indicate whether there are positive ornegative impacts of capital structure on firm operation The author concluded that therelationship between capital structure and firm value has a nonlinear relationshiprepresent a convex Parapol shape He thinks that to ensure and enhance the firm value,the scope of optimal debt ratio should be less than 57.39%.

Le & Phung[CITATION LeV13 \n \t \l 1033 ] study investigates the impact ofcapital structure on operational efficiency in all firms listed in Vietnamese StockExchange during the period from 2007 to 2011 They used return on assets (ROA),return on equity (ROE) and Tobin Q to measure the firm’s operational efficiency, while

to measure capital structure they used short-term debt, long-term debt and total debtratio They founds that capital structure has a significant negative impact on firmoperational efficiency

Tran Hung Son[CITATION Tra08 \n \t \l 1033 ] studied about the capital structureand the effect on business operation The research using data from 50 non-financialcompanies that listed on the Ho Chi Minh City Stock Exchange and has the largestmarket value as of September 2008 The author uses the profit variable as the mean ofROA and ROE to measure the performance of the business The results show that theperformance of an enterprise is positively correlated with the capital structure

Tran Thi kim Oanh [CITATION Tra17 \n \t \l 1033 ] studied about effect ofcapital structure on enterprises efficiency operation The author analyses data of 81companies that were listed on the Vietnam Stock Exchange during 2009-2015 withtable data processing technique and regression analysis The results show thatcompany performance is influenced by capital structure, asset structure, solvency, CITand risk

1.1.7 Literature review summary:

Table 1 shows the summary result of the studies of previous authors related to theimpact of capital structure on firm operation

Table 1: Summary of the results of previous studies.

The capital structure have no effect on firm operation

Paul A Phillips and

Palestine

Fosu[CITATION Sam13 \n

\t \l 1033 ]

He used GMM regressionapproach and found apositive and significantrelation between capital

operational efficiency

SouthAfrica

performance in the TehranStock Exchange

enterprise is positivelycorrelated with the capitalstructure

The capital structure has negative effect on firm operation

Vietnam

Tianyu[CITATION Tia13 \n

\t \l 1033 ]

Applying OLS regressionmethod, he documentedthat capital structure has asignificant negative effect onfirm’s performance in China,whereas significant positiveeffect in two Europeancountries, i.e., Germany andSweden, before financialcrisis in 2008

Germany,Sweden,China

Source: Author’s collection

Relationship between capital structure and operational efficiency

Optimal capital structure is the capital structure at which corporate value ismaximized In other words, the financial cost is minimal and thus maximizes therevenue of the firm If capital structure have effect on firm’s operational efficiency, thecapital structure also impact on financial health as well as bankruptcy ability

The important issues of operational efficiency include profit maximization,maximizing return on assets, maximizing shareholders benefit.

The measurement of operational efficiency is affected by firm’s goals Therefor

it maybe impact on the way to measure operational efficiency of business and thedevelopment of stock market and capital market

CONCLUSION CHAPTER 1

There are three main points which are capital structure theories, literaturereview and the relationship between capital structure and operational efficiency inchapter 1 In detail, writer mentions some popular theories about capital structure,including the capital structure theory of Modigliani and Miller (M&M), trade-offtheory, agency costs theory and pecking order theory About literature review, writerfinds four different perspectives, including capital structure not related to operationalefficiency, capital structure has a positive effect on operational efficiency, capitalstructure has a negative impact on operational efficiency and existing of target capitalstructure or optimal capital structure for the enterprise At the end of chapter 1, theauthor mentions the experimental research about the impaction of capital structure tothe operational efficiency of enterprises through the methods used widely in the worldand Vietnam

CHAPTER 2: DATA AND RESEARCH METHODOLOGY

2.1 Data Description

To identify the correlation between factors in Table 1 and operational efficiency

of firms, the author used raw data from enterprises that collected randomly from jointstock companies on the HNX and HOSE Therefore, it can represent enterprises’diversification in the economy Besides, to show the novelty of this study, data wasselected from last three quarters of 2016 to three next quarter of 2017 (from April,

2016 to September, 2017) Data is extracted from Finance.Vietstock.vn by authors.Moreover, enterprises, which have not enough data to fill full variables in the modelfor the period from 2016 to 2017, will not be included in the model As the result, wehave a sample of 150 joint stock companies (150x6 = 900 observations)

Some tables below show the results describing in detailed data that related to thevariables in the study See more in APPENDIX A

Table 2: The averaged value of variables

Source: Author’s calculation

In table 2: the averaged value of variable, there are no exotic index TDR, SIZE,TANG and LIQ index are stable in difference industries during period from secondquarter 2016 to third quarter 2017 GRO is unique variable that is unstable in averagedvalue In detail, percentage of average value of TDR is about 44%, it means debtaccounts about 44% of total asset Although author selected data randomly, averagedvalues of SIZE is stable, it means in this period, Viet Nam economy has no big change.About TANG or asset structure, averaged value is about 22%, it means fixed assetoften account about 22% of total asset or about ¼ total asset of company Writerrecognized that with doing-well companies, fixed asset often accounts about 22% oftotal asset About LIQ, most of enterprises keep short-term liquidity (LIQ) in smallnumber, about 3.3 Vibration amplitude of GRO is larger than other variables, it’s from

2016, GRO tend to decrease, 16.22% to 10.66% On the other hand, upward trend ofGRO is next period, from first quarter in 2017 to third quarter in 2017, 9.7% to 18.5%,

so it is too difficult to evaluate with GRO However, only averaged value of variable

is not meaningful for this research

Table 3:ROE Description

Source: Author’s calculation

Table 3 describe about mean, minimum and maximum of operational efficiency (ROE)from second quarter in 2016 to third quarter in 2017 Writer recognized that ROEchanges in a wide range that lead to the average of ROE is small, for example, insecond quarter in 2016, ROE run from -16.43% to 58.4%, mean is only 3.87% In thistable 3, it’s easy to see -145.92% is exotic percentage This percentage came fromCMISTONE Viet Nam Joint stock company in third quarter in 2017 This negativepercentage of ROE show that CMISTONE had financial problem, the company cansuffer heavy losses After finding out the case of exotic percentage, author discoveredthat CMISTONE is on top in rude companies 2017 list The reason of loss of CMI isquite different from the loss of other companies because the company has to overcome

the consequences of the previous accounting period.

Source: Author’s calculation

Table 4 gives three important statistics (mean, minimum, maximum) of variable TDR

in our analysis The mean ratio shows that an average firm uses 44 percent debt in itstotal assets in Vietnam It means that the companies use debt that are lightly lower thanequity Third and fourth column give details of firm’s ratio in terms of minimum andmaximum values respectively The ratios have slight fluctuation among the quaters.Beside, the gap between minimum and maximum is big, about 94 percent In ouranalysis, the variable TDR seem to be normally distributed

1.2 Research model

Determination of regression model

According to Chinaemerem and Anthony [CITATION Chi12 \n \t \l 1033 ], themultivariate regression model described as follows:

ROE it = α i + β 1 TDR it + β x X it + σ 1 FLOOR + ε it

In with:

- i = 1, 2, , N (N is the number of enterprises)

- t = 1, 2, , T (T is the observation time in the model)

- FLOOR is the dummy variables that identify stock exchange markets ofenterprises in research If enterprises listed on Ho Chi Minh City Stock Exchange, theFLOOR equal to one (1) and FLOOR equals to zero (0) if enterprises listed on HanoiStock Exchange

- α is the estimated constant; βx&σ1 are estimated coefficients; ε is the residual

Variables in the model

There are many diverse variables, which are used base on previous studies in themodel In detail, dependent variable is the rate of return on average equity (ROE),independent variable is the ratio of debt to total assets, control variable has enterprise

size (SIZE), asset structure (TANG), total asset growth (GRO) and short-termsolvency (LIQ) In addition, dummy variable is a stock exchange in this model Table

4 below will show all variable in a systematic way

Table 4: Variables of the model and Measurement Type of variable Sign Variable Formulary

Dependent Variable ROE Return on equity Profit after tax/ Average equityIndependent

Equal to 1 if enterprises listed

on Ho Chi Minh City Stock Exchange, and equal to 0 if enterprises listed on Hanoi Stock Exchange

 Dependent variable:

As mentioned above, dependent variable is the return on equity (ROE) Majorshareholders often use the ratio as a key factor because ROE will show exactly howmuch earned from one unit of capital In normal, investors analyze ROEs then theycompare with other shares in similar industry on the market and decide typicalshares.The higher value of ROE, the higher efficiency used of company equity.Thismeans that the enterprise make effective control of balance between equity andexternal borrowings to gain more its competitive advantage in capital mobilization, aswell as expanding its scale That is why, the higher value of ROE, the more attractivethe stock is

 Independent variable

Total debt to total assets (total debt ratio) is accounting measurement to showhow much of a company’s asset are funded by borrowing This ratio help

company to meet long-term obligations A ratio greater than 1 shows that aconsiderable portion of debt is funded by assets, in other words, the company has moreliabilities than assets A high ratio also indicates that a company may be putting itself

at a risk of default on its loans if interest rates were to rise suddenly A ratio below 1translates to the fact that a greater portion of a company's assets is funded byequity.Like all other ratios, the trend of the total debt to total assets should also beenevaluated over time This will help assess whether the company’s financial risk profile

is improving or deteriorating For example, an increasing trend indicates that abusiness is unwilling or unable to pay down its debt, which could indicate a default atsome point in the future

 Control variable:

Size of enterprise (SIZE)

Business size is also a key factor to evaluate the capacity of bankruptcy of thebusiness Businesses with big size often have lower risk of bankruptcy because theyhave large and diversified assets, so the risk divided into several parts Moreover, largeenterprises are often highly transparent, thus minimizing asymmetry information andreducing agency costs when they need a loan

Asset structure (TANG)

Asset structure is control value in model Formula of asset structure is fixed asset/total asset.Asset structure is one of factor to evaluate financial health of a business

Total Asset Growth (GRO)

Total assets growth (GRO) is increase or decrease of asset over period To assetsgrowth can be a negative number, that mean asset in this period is smaller than asset inprevious period With investors, total assets growth is complicated ratio to evaluateenterprise That means positive number of total assets growth is not always good.When analyzing asset growth rates, investors always see a lots of elements such aswhat is the purpose of asset growth, what type of asset is growing, where fundsfinanced and so on If enterprises use mainly loan capital, we need to reconsider thiscompany In detail, loans will have to pay both interest and principal, the use ofinvestment loans will take many risk, and making the wrong investment decision canlead to heavy losses or bankruptcy

Using term liquidity ratio help investors see the ability of a firm to use term assets such as cash, inventory or receivables to pay off its short-term liabilities.The higher the ratio, short-term assets is bigger than short-term liability, so we canbelieve that the firm can repay short-term debt However, if this ratio is too high, it isnot good expression because too high ratio proves inefficiency capital structure On theother case, this ratio is less than one (1), we can believe that the firm is in a negativefinancial position, but we do not said that the company goes bankrupt because thereare many solutions to raise more capital.

short-Dummy variable

Stock Exchange Market (FLOOR)

Data collected from two different market, it is Ho Chi Minh City Stock Exchange andHanoi Stock Exchange This variable receives a value of one (1) if the company listed

on the Ho Chi Minh City Stock Exchange Market (HOSE), and receives a value of 0 ifthe company listed on the Hanoi Stock Exchange (HNX)

Table 5:Pearson correlation matrix between variables

ROE

TDR

TANG (%)

GRO

FLOO R

Through regression analysis, it is possible to measure that how independent variableaffect the dependent variable in term of both magnitude and tendency Therefore, theauthor can provide the valid evidence for the issue in this research

Hypothesis construction

In this research, the author tries to find out the relationship between capital structureand firm’s operational efficiency Representing the capital structure is the ratio of totaldebt/ total assets (TDR) and representing for operational efficiency expressed throughreturn on equity(ROE) Moreover, according to previous studies, firm’s operationalefficiency affected by the variables including of size, asset structure, total asset growthrate, short-term liquidity

The hypotheses in this study are as follows:

Hypothesis 1: The debt-to-asset has negative effect on operational efficiency ofenterprises.

According to Agency-Cost Theory enterprise operational efficiency is inopposite line with the debt-to-asset ratio

Hypothesis 2: Fixed assets (TANG) considered having no effect on operationalefficiency of the business

Hypothesis 3: The size (SIZE) of the company has a positive relationship withfirm’s operational efficiency

Hypothesis 4: Total assets growth (GRO) has no effect on firm’s operationalefficiency

Hypothesis 5: Short-term liquidity (LIQ) has a same direction effect on firm’soperational efficiency

CONCLUSION CHAPTER 2

This chapter shows all the data and research methods about effect of capital structure

on firm’s operational efficiency in this study Through the data of 150 joint-stockcompanies listed on two stock markets HOSE and HNX, 75 companies on HOSE and

75 companies on NHX on period of 6 quarters from second quarter in 2016 to the thirdquarter in 2017, the author has collected 900 observations

The author use independent variable is the ratio of total debt / total asset (TDR)represent to capital structure and the dependent variable is the return on equity (ROE)represent to firms operational efficiency The other control variables are size ofenterprise (SIZE), asset structure (TANG), asset growth (GRO), and the ability ofshort-term liquidity (LIQ) Besides, author also uses the FLOOR as dummy variable