The impact of board structure on financial leverage of Vietnamese listed firms - TRƯỜNG CÁN BỘ QUẢN LÝ GIÁO DỤC THÀNH PHỐ HỒ CHÍ MINH

Empirical studies have shown that a number of corporate governance characteristics, including board size, frequency of meetings during the year, number of female membe[r]

THE IMPACT OF BOARD STRUCTURE ON FINANCIAL LEVERAGE OF VIETNAMESE LISTED FIRMS Hoang Mai Phuong a* , Nguyen Thanh Hong An a

a The Faculty of Economics and Business Administration, Dalat University, Lam Dong, Vietnam

* Corresponding author: Email: phuonghm@dlu.edu.vn

Article history

Received: November 1 st , 2020 Received in revised form: November 22 nd , 2020 | Accepted: November 30 th , 2020

Abstract

This study examines the impact of board structure on financial leverage decisions, as measured by the ratio of total debt to total assets, of nonfinancial firms listed on the Ho Chi Minh City Stock Exchange Based on a dataset of 1,592 observations collected from 199 firms for the period from 2012 to 2019, the analysis shows a correlation between board characteristics and a firm’s financial leverage Specifically, the higher the number of annual board meetings or the larger the number of female members on the board of directors, the lower the rate of financial leverage On the other hand, the size of the board and the presence

of CEOs on the board do not have a significant influence on financial leverage decisions A robust test using the system of generalized method of moments (GMM) to control for endogeneity generally confirms the results

Keywords: Agency theory; Board structure; Capital structure; Corporate governance;

Financial leverage; Vietnamese listed firms

DOI: http://dx.doi.org/10.37569/DalatUniversity.10.3.785(2020)

Article type: (peer-reviewed) Full-length research article

Copyright © 2020 The author(s)

Licensing: This article is licensed under a CC BY-NC 4.0

TÁC ĐỘNG CỦA CẤU TRÚC HỘI ĐỒNG QUẢN TRỊ LÊN ĐÒN BẨY TÀI CHÍNH CỦA CÁC DOANH NGHIỆP NIÊM YẾT TẠI

VIỆT NAM Hoàng Mai Phương a* , Nguyễn Thanh Hồng Ân a

a Khoa Kinh tế - Quản trị kinh doanh, Trường Đại học Đà Lạt, Lâm Đồng, Việt Nam

* Tác giả liên hệ: Email: phuonghm@dlu.edu.vn

Lịch sử bài báo

Nhận ngày 01 tháng 11 năm 2020 Chỉnh sửa ngày 22 tháng 11 năm 2020 | Chấp nhận đăng ngày 30 tháng 11 năm 2020

Tóm tắt

Nghiên cứu này kiểm chứng sự tác động của cấu trúc hội đồng quản trị tới quyết định đòn bẩy tài chính, cụ thể là tỷ lệ tổng nợ trên tổng tài sản, của các doanh nghiệp phi tài chính niêm yết tại Sở giao dịch chứng khoán Thành phố Hồ Chí Minh trong vòng tám năm từ năm

2012 đến 2019 Dựa trên bộ dữ liệu gồm 1,592 quan sát thu thập từ 199 doanh nghiệp, kết quả phân tích cho thấy có mối tương quan giữa đặc điểm hội đồng quản trị và đòn bẩy tài chính Cụ thể, số lượng cuộc họp hội đồng quản trị hàng năm càng nhiều hay số lượng thành viên nữ trong hội đồng quản trị càng lớn thì tỷ lệ đòn bẩy tài chính càng thấp Trong khi đó, quy mô hội đồng quản trị và vai trò kiêm nhiệm của giám đốc điều hành không có ảnh hưởng đáng kể tới các quyết định tài chính Các phương pháp kiểm định tăng cường, mô hình động

và phương pháp ước lượng system-GMM được sử dụng để ước lượng hệ số hồi quy, tăng tính chính xác và khẳng định kết quả thu được từ mô hình nghiên cứu

Từ khóa: Cấu trúc hội đồng quản trị; Cấu trúc vốn; Công ty niêm yết tại Việt Nam; Đòn bẩy

tài chính; Lý thuyết người đại diện; Quản trị doanh nghiệp

DOI: http://dx.doi.org/10.37569/DalatUniversity.10.3.785(2020)

Loại bài báo: Bài báo nghiên cứu gốc có bình duyệt

Bản quyền © 2020 (Các) Tác giả

Cấp phép: Bài báo này được cấp phép theo CC BY-NC 4.0

1 INTRODUCTION

In recent years, along with the development of the stock market in Vietnam, the number and quality of listed companies have continuously improved Today's businesses are not only larger in scale but also increasingly professional and diversified in their operations In this context, abundant capital is a prerequisite for businesses to maintain and expand production and to promptly meet their growth needs Therefore, choosing an appropriate capital structure is an important financial decision that businesses need to consider to achieve the expected performance

Corporate governance is an emerging field of research in Vietnam In recent years, empirical work has mainly focused on (1) finding the factors that affect the governance structure or capital structure, and (2) examining the effects of ownership structure, governance structure, and capital structure on financial performance, leaving the relationship between governance structure and capital structure underexplored Therefore, examining the relationship between the governance structure and capital structure of listed companies in Vietnam is necessary and can provide useful insights This is especially important in the context of an integrated economy, where Vietnamese businesses are in dire need of effective management strategies to improve competitiveness as well as corporate value

Based on the agency theory of Jensen and Meckling (1976), one of the fundamental theories of corporate governance, we argue that the characteristics of the agent, in this case the board of directors, can influence the financial decisions of businesses, particularly financial leverage decisions Using a dataset of 1592 observations collected from 199 nonfinancial companies listed on the Ho Chi Minh City Stock Exchange from 2012 to 2019, our research results show that, in general, the characteristics

of the board of directors have an impact on the financial leverage ratio of businesses Firms with active boards of directors, represented by the number of meetings per year, often control their financial leverage at a lower level than businesses with less active boards of directors In addition, the more women present on the board of directors, the lower the level of leverage in general On the other hand, board size and the presence of the Chief Executive Officer (CEO) on the board have no significant impact on financial leverage

Apart from providing a comprehensive picture of the financial leverage of Vietnamese listed companies, this research is also one of the rare studies using a large dataset analyzed and verified through many steps, including the use of static Models, the Lagrange multiplier (LM) and Hausman tests, dynamic Models, and the system generalized method of moments (GMM) These estimation and test methods are used to ensure control of the correlation between instrument variables and errors, correct for endogeneity, and estimate regression coefficients consistently In addition, the use of many different definitions of the variables also enhances the reliability of the results The results of this study shed light on the relationship between board characteristics and the financial leverage decisions of Vietnamese listed firms and may provide managers with some suggestions for management and governance

The paper is organized as follows: First, we briefly present the basic theory and empirical studies on the relationship between governance structure and capital structure, from which research hypotheses are developed Then, the next section presents the research method and the Models Finally, we present and discuss the empirical results and their implications

2.1 Literature review

The seminal study of Modigliani and Miller (1958) is one of the initial studies on capital structure Their proposed theory is formulated in two important propositions related to firm value and the cost of capital Modigliani and Miller (1958) show that the use of debt gives owners a higher rate of return, and their later theory (Modigliani & Miller, 1963) shows that, with the existence of corporate income tax, the use of debt will increase the value of the business In other words, a reasonable level of financial leverage will satisfy the requirements of managers (about the value of the business) as well as those

of shareholders (about income)

Following Modigliani and Miller’s (1963) research, a series of theories were built with different perspectives on the corporate capital financing Model Of these, the agency theory of Jensen and Meckling (1976) is one of the prominent theories on the relationship between optimal capital structure and governance structure in controlling conflicts of interest between shareholders and managers Conflicts of interest arise from the transfer

of certain decision-making powers to the agent in the relationship between the principal (shareholders) and the agent (managers) Both sides want to advance their interests, and there are always reasons to believe that the agent does not always act in the best interest

of the principal In other words, the managers will be motivated to use the resources of the business for their personal benefit instead of for the benefit of the shareholders

To mitigate this problem, in addition to reducing the resources available to managers, increasing financing through borrowing or increasing the manager's equity will minimize losses due to conflicts between managers and shareholders An optimal capital structure is achieved when agency costs are minimal Fama and Jensen (1983) and Demsetz (1983) also argue that there are always negative effects and difficulties for governance, leading to an increase in opportunism in governance and management Jensen (1986) found that managers can try to outgrow the optimal firm size for their personal benefit These efforts may lead to increased power and higher status for managers, but they harm company performance Therefore, corporate borrowing with a commitment to pay off debts in cash will reduce the amount of available cash, making it impossible for managers to use it for personal gain This minimizes the conflict between managers and equity holders, creating the benefits of borrowing Furthermore, Friend and Lang (1988) discuss in depth the role of managers’ self-interest in capital structure decisions Their research finds a negative relationship between the debt ratio and management's ownership structure Berger, Ofek, and Yermack (1997) further investigated the relationship between management authority and a firm’s capital

structure Their research shows that executives strive to avoid debt, and when there is no demand from the shareholders, the debt ratio is kept at a lower-than-optimal level Consequently, if measures to minimize management entrenchment are applied, the leverage ratio tends to increase

Taking a closer look at the theoretical discussion on the relationship between managers and shareholders addressed by agency theory, the divergence of interests between shareholders and managers can be reduced by establishing effective monitoring mechanisms to limit the managers' self-interested behavior More specifically, the decision to borrow is one of the monitoring options that makes managers hesitate because this will place the business under the supervision of many outside parties Hence, understanding the effects of governance characteristics on capital structure decisions can help us understand effective monitoring mechanisms Empirical studies have shown that

a number of corporate governance characteristics, including board size, frequency of meetings during the year, number of female members, and CEO duality, influence corporate debt decisions A brief discussion of board characteristics and their relationship

to financial leverage is given below

2.1.1 Board size and capital structure decisions

A company's financing decisions are governed by its board of directors (BOD) The operational efficiency of the BOD is the key to the success of the business According

to Adams and Mehran (2003), a large board of directors can effectively monitor the company's operations and provide better expertise On the other hand, Lipton and Lorsch (1992) claim that large boards perform less efficiently than small ones Board size should

be limited to a maximum of ten members and boards with eight or nine members is the most reasonable

Existing studies on the relationship between board size and financial leverage yield inconclusive findings Berger et al (1997) and Anderson, Mansi, and Reeb (2004) find a significant, negative correlation between board size and financial leverage Conversely, the studies of Kyereboah-Coleman and Biekpe (2006), Abor (2007), Bokpin and Arko (2009), and Rose, Munch-Madsen, and Funch (2013) find a positive relationship between board size and the capital structure of businesses This shows that the effectiveness of the board in monitoring management behaviors can directly, or indirectly, improve a company's access to debt Finally, Wiwattanakantang (1999) and Wen, Rwegasira, and Bilderbeek (2002) find no relationship between board size and financial leverage

2.1.2 Number of board meetings and a firm’s financial leverage

Enterprises are encouraged to organize regular BOD meetings to closely manage the tasks and responsibilities of the managers In some markets, it is imperative to disclose the number of annual board meetings and the details of each member's attendance The frequency of board meetings is considered an important way to improve board performance, according to Adam and Ferreira (2009) In their studies, Brick and

Chidambaran (2007) and Ntim and Osei (2011) find a positive relationship between the frequency of board meetings and firm performance Regular BOD meetings often tend to produce better financial performance (Johl, Kaur, & Cooper, 2015) and the number of board meetings should be at least four meetings each year according to Eluyela et al (2018) Buchdadi, Ulupui, Dalimunthe, & Pamungkas (2019) and Kajananthan (2012) indicate that regular board meetings can lead to more debt decisions, thereby taking advantage of outside capital to modernize, expand, exploit investment opportunities, and increase the market value of the business The study also uncovers the important role of supervision through board meetings in agency theory Firms with high leverage are also likely to have more frequent board meetings (Al-Najjar, 2011) A study by Francis, Hassan, and Wu (2015) finds that companies with infrequent board meetings performed significantly worse during the financial crisis Stephanus, Anastasia, and Toto (2014) find

a significant negative relationship between the frequency of board meetings and debt ratio Frequent board meetings can increase costs, time, and administrative support requirements for a company

2.1.3 Board gender diversity and a firm’s financial leverage

Globally, over the past two decades, female representation on corporate boards of directors has increased significantly in a number of markets At the same time, the issue

of board gender diversity has also been debated and is the basis to consider the impact of female directors on a company's operations, including whether a greater presence of women on a BOD affects corporate financial decisions, and why, in fact, few women are

on boards The pioneering research on this topic was conducted by Morrison, White, and Velsor (1987), and this topic has increasingly attracted the attention of many researchers globally, both in developed and developing countries

First, it has been shown that the maturity of a firm affects the composition of its board A high degree of board diversity is positively related to corporate financial results Looking at recent empirical studies, Tran, Hoang, and Tran (2015) investigate the impact

of gender diversity in the BOD on company performance and find that the proportion of women directors on the board had a significant positive effect on the financial results of banks in ASEAN from 2009 to 2013 A BOD is more active in the presence of at least three female representatives Gender-balanced boards are also more likely to replace ineffective managers (Schwartz-Ziv, 2017) Rose et al (2013) and Marinova, Plantenga, and Remery (2015) studied the effects of women directors on the activities of companies

in Germany and the Nordic bloc in 2010 However, their results show that the proportion

of women on a BOD has no apparent influence on financial decisions In two other studies, Harris (2014) and Abobakr and Elgiziry (2015) find a significant negative relationship between the proportion of female directors and financial leverage, especially

on boards where the presence of females accounts for 25% or more

2.1.4 CEO dual roles and a firm’s financial leverage

The CEO has the primary responsibility for initiating and implementing strategic decisions, while the Board is responsible for approving and monitoring the CEO's

decisions Duality exists when the CEO of a company is also the chairman of the board

On the one hand, according to Sheikh and Wang (2012), duality provides clear direction from a single leader who can react more quickly to outside events On the other hand, duality increases the CEO's decision-making power by providing a broader base of power and strengthening control (Boyd, 1995) As a result, assigning both tasks to the CEO can weaken the board's control and influence financial decisions

Empirical research on this relationship gives mixed results Fosberg (2004) asserts that a dual leadership structure is effective in increasing the amount of debt in a firm's capital structure Abor (2007) finds a significant positive relationship between CEO duality and financial leverage A CEO often tries to finance the company's operations using debt capital instead of issuing new equity (Bokpin, & Arko, 2009) Meanwhile, Kyereboah-Coleman and Biekpe (2006) find a clear negative relationship between CEO duality and short-term and total leverage, asserting that agency costs increase when a CEO is chairman of the board, which discourages investors from investing in the business They also report a positive link between CEO duality and long-term leverage, but this relationship is not statistically significant Research by Tarus and Ayabei (2016) also confirms the negative relationship between CEO duality and financial leverage CEOs who are also chairs of the BOD are given too much power and have the ability to use less financial leverage to avoid risks associated with borrowing The study by Simpson and Gleason (1999) examines the effect of CEO duality on the use of financial leverage at

300 banks The results show that CEOs can influence the internal control system in a way that reduces the likelihood of financial difficulties for the company This means that they take less risk, resulting in underuse of financial leverage

2.2 Research in Vietnam

In Vietnam, recently published studies focus on finding factors that influence the capital structure of firms listed on the Vietnamese stock markets Specifically, Đặng and Quách (2014) identify three factors that have a strong impact on the capital structure of a firm, namely, firm size, profitability (positive impact), and taxes (negative impact) Previously, Trương and Võ (2008) affirm that capital structure is positively correlated with company size, industry, and revenue growth and is inversely correlated with profitability In addition, capital structure is positively correlated with the number of directors Recently, a series of studies on factors affecting the capital structure of firms in specific industries was also conducted The studies included firms in the logistics industry (Lương, Phạm, Nguyễn, Nguyễn, Nguyễn, & Phạm, 2020), the food industry (Lê, Bùi, &

Lê, 2020), the Vietnam Oil and Gas Group (Vũ & Nguyễn, 2013), and the seafood industry (Nguyễn, 2008) Most studies show that firm size, growth rate, and profitability are positively correlated with capital structure Some other factors that are negatively correlated are also mentioned, including taxes, liquidity, profits, and business risk

Most of the research on Vietnam markets mentioned above use relatively small datasets over short time periods and focus on factors affecting capital structure Only in the last few years have some specific studies on the relationship between corporate governance and capital structure been published Nguyễn, Trần, Nguyễn, Võ, and Nguyễn

(2016) examine the impact of corporate governance (state ownership, financial institutions, foreign investors, members of the BOD, and the largest shareholders of the firm) and firm characteristics (size, profitability, tangible assets, tax shield, and the gap between optimal leverage and observed leverage) on capital structure decisions Research results show that corporate capital structure not only depends on the characteristics of the business, but is also influenced by enterprise ownership characteristics In another study

by Phan, Trần, and Trần (2017), the role of CEO duality is examined Their study confirms that firms with a dual leadership structure performed more effectively

As previous research is still inconclusive, a comprehensive study with a large set

of data on companies listed on the Vietnamese stock market would provide significant insights into the relationship between BOD structure and capital structure (financial leverage)

Based on the theory and previous research results, this study hypothesizes that:

• H1: Board size has an impact on financial leverage

• H2: The number of annual board meetings has an impact on financial leverage

• H3: The number of female directors on the BOD has an impact on financial leverage

• H4: CEO duality has an influence on financial leverage

3.1 Definitions of variables and data collection method

This study examines the relationship between the BOD structure and the financial leverage of companies listed on the Vietnamese stock market For quantitative analysis, the authors use leverage ratio, which is defined as the ratio of total debt to total assets of the firm, similar to the study by Haque, Arun, and Kirkpatrick (2011)

The independent variables used in this study include the size of the board, the number of board meetings per year, the number of female directors on the board, and an indicator variable indicating whether the chairman also holds a CEO position To increase the effectiveness of the estimate, two variables representing board size and the number of board meetings were converted to logarithms prior to analysis In addition to the number

of female directors on the board, the authors also use two other definitions of gender diversity of the BOD, namely, the percentage of female directors on the board and an indicator variable indicating the presence of female directors Using different definitions

of the gender variable in the analysis will help increase the reliability of the results

To control the impact of other factors on a firm's leverage, the authors use firm size, fixed assets, liquidity, profitability, and business growth rate as control variables,

similar to studies on the effect of firm characteristics on financial leverage according to Bradley, Jarrell, and Kim (1984), Castanias (1983), Long and Malitz (1985), and Titman and Wessels (1988) These studies generally agree that financial leverage has a positive relationship with firm size, fixed assets, and growth rate, and an inverse relationship with returns and liquidity

Detailed definitions of the variables are presented in Table 1

Table 1 Variable definitions

Dependent variable

Independent variables

Control variables

The data are collected from audited financial reports, annual reports, and annual executive reports of nonfinancial companies listed on the Ho Chi Minh City Stock Exchange from 2012 to 2019 Companies with insufficient data are excluded from the sample

3.2 Research method

To analyze the relationship between the variables representing the characteristics

of the BOD and the leverage ratio, the authors propose the following research Model:

𝐿𝑒𝑣𝑖𝑡 = 𝛽1+ 𝛽2𝐿𝑏𝑠𝑖𝑧𝑒𝑖𝑡+ 𝛽3𝐿𝑚𝑒𝑒𝑡𝑖𝑡+ 𝛽4𝐹𝑒𝑚𝑎𝑙𝑒𝑖𝑡+ 𝛽5𝐶𝑒𝑜𝑑𝑢𝑎𝑙𝑖𝑡

+ 𝛽6𝐿𝑓𝑠𝑖𝑧𝑒𝑖𝑡+ 𝛽7𝐹𝑖𝑥𝑒𝑑_𝑎𝑠𝑠𝑒𝑡𝑠𝑖𝑡+ 𝛽8𝑅𝑂𝐴𝑖𝑡+ 𝛽9𝐿𝑖𝑞𝑢𝑖𝑑𝑖𝑡𝑦𝑖𝑡

To estimate Model (1), the authors use the ordinary least squares method with panel data (POLS) However, estimation by this method does not guarantee consistency for two reasons First, the omitted factors are likely to interact with the independent

variables in the Model, causing the estimate to be biased and inconsistent Second, since this Model does not take advantage of information from the differences between firms, the estimates may be less accurate (Wooldridge, 2002)

As a remedy, the authors restructure Model (1) to incorporate the differences among companies (representing by  in the new Model) in the dataset:

𝐿𝑒𝑣𝑖𝑡 = 𝛽1+ 𝛽2𝐿𝑏𝑠𝑖𝑧𝑒𝑖𝑡+ 𝛽3𝐿𝑚𝑒𝑒𝑡𝑖𝑡+ 𝛽4𝐹𝑒𝑚𝑎𝑙𝑒𝑖𝑡+ 𝛽5𝐶𝑒𝑜𝑑𝑢𝑎𝑙𝑖𝑡

+ 𝛽6𝐿𝑓𝑠𝑖𝑧𝑒𝑖𝑡+ 𝛽7𝐹𝑖𝑥𝑒𝑑_𝑎𝑠𝑠𝑒𝑡𝑠𝑖𝑡+ 𝛽8𝑅𝑂𝐴𝑖𝑡 + 𝛽9𝐿𝑖𝑞𝑢𝑖𝑑𝑖𝑡𝑦𝑖𝑡 + 𝛽10𝑆𝑎𝑙𝑒𝑔𝑟𝑜𝑤𝑡ℎ𝑖𝑡+ 𝜇𝑖 + 𝜀𝑖𝑡

(2)

Model (2) is estimated by the regression method with random and fixed effects, respectively The LM test is used to choose between the POLS regression Model and the regression Model with random effects Then, the Hausman test is used to choose between the regression Model with random effects and the regression Model with fixed effects

However, the recent research of Liao, Mukherjee, and Wang (2015) indicates that firms tend to adjust their leverage toward an optimal value over time As discussed, if the BOD actually impacts financial leverage decisions, the adjustment effect implies that the BOD would refer to the past leverage level when deciding the future leverage ratio In

other words, Lev it and Lev it-1 are correlated The fact that Model (2) omits this important

variable (i.e., Lev it-1 ) reduces the accuracy of the estimates Furthermore, if Lev it-1 is correlated with the present structure and operation of the BOD, a case which is raised in

previous research by Berger et al (1997), the omission of Lev it in Model (2) would render the estimates inefficient and inconsistent As a remedy, Model (2) is restructured as follows:

𝐿𝑒𝑣𝑖𝑡 = 𝛽1+ 𝛽2𝐿 𝐿𝑒𝑣𝑖𝑡+ 𝛽3𝐿𝑏𝑠𝑖𝑧𝑒𝑖𝑡+ 𝛽4𝐿𝑚𝑒𝑒𝑡𝑖𝑡 + 𝛽5𝐹𝑒𝑚𝑎𝑙𝑒𝑖𝑡

+ 𝛽6𝐶𝑒𝑜𝑑𝑢𝑎𝑙𝑖𝑡+ 𝛽7𝐿𝑓𝑠𝑖𝑧𝑒𝑖𝑡 + 𝛽8𝐹𝑖𝑥𝑒𝑑_𝑎𝑠𝑠𝑒𝑡𝑠𝑖𝑡+ 𝛽9𝑅𝑂𝐴𝑖𝑡 + 𝛽10𝐿𝑖𝑞𝑢𝑖𝑑𝑖𝑡𝑦𝑖𝑡+ 𝛽11𝑆𝑎𝑙𝑒𝑔𝑟𝑜𝑤𝑡ℎ𝑖𝑡 + 𝜇𝑖 + 𝜀𝑖𝑡

(3)

Model (3) cannot be consistently estimated by the methods used for Models (1)

and (2) because the endogeneity problem caused by the inclusion of the variable Lev it-1 Instead, Model (3) is estimated using the system GMM method by Blundell and Bond (1998) This method provides a plausible solution for endogeneity when valid instruments are not available, which is a common problem encountered by researchers in the field of corporate governance (Nguyen, Locke, & Reddy, 2015) In particular, this method utilizes

a set of instrument variables derived from the available dataset, namely, lagged and differenced variables of the endogenous variables Together with the estimation method using moments, the system GMM produces consistent estimates