CAPITAL STRUCTURE AND FIRM PERFORMANCE IN VIETNAM

As capital structure plays an important role in a firm’s well-being, it must have a certain kind of relationship with firm performance.. Implications and Recommendations to improve firm

FOREIGN TRADE UNIVERSITY FACULTY OF BANKING AND FINANCE

GRADUATION THESIS Major: Banking and International Finance

IN VIETNAM CAPITAL STRUCTURE AND FIRM

PERFORMANCE IN VIETNAM

Student’s Full Name: Duong Hong Ngoc

Student ID: 0953040063 Intake: 48 – A3 – CLC

FOREIGN TRADE UNIVERSITY FACULTY OF BANKING AND FINANCE

GRADUATION THESIS Major: Banking and International Finance

CAPITAL STRUCTURE AND FIRM PERFORMANCE

IN VIETNAM

Student’s Full Name: Duong Hong Ngoc

Student ID: 0953040063 Intake: 48 – A3 – CLC Supervisor: Duong Thi Hong Van, MSc.

Hanoi, June 2013

Table of Figures 5

Introduction 6

CHAPTER I Backgrounds on capital structure and firm performance 8

1.1 Firm’s capital and capital structure 8

1.1.1 Cost of capital 8

1.1.1.1 Cost of equity 9

1.1.1.2 Cost of debt 11

1.1.1.3 Cost of preferred stock 12

1.1.1.4 Weighted Average Cost of Capital (WACC) 12

1.1.2 Capital structure and capital structure policy 13

1.1.2.1 Leverage, Capital Structure and Optimal Capital Structure 13

1.1.3 Measurement of Firm Performance 16

1.2 Theories of capital structure 17

1.2.1 Modigliani and Miller (M&M) 19

1.2.3 The Pecking Order Theory 25

1.2.4 Agency Costs Theory 26

1.3 Several academic research on the relationship between capital structure and firm performance 26

CHAPTER II Analysis of the impacts of capital structure on firm performance 29

2.1 Overview of Vietnam’s economy 30

2.1.1 Overall economic performance 30

2.1.1.1 GDP growth rates 30

2.1.1.2 Foreign Direct Investment 31

2.1.1.3 Imports and Exports 31

2.1.1.4 Inflation 32

2.1.1.5 Interest Rates 33

2.1.2 Vietnam’s Financial Market 34

2.1.2.1 Equity Market 34

2.1.2.2 Bond Market 36

2.2 Capital structure of Vietnamese listed firms 37

2.3 Empirical model on the relationship between capital structure and firm’s performance 39

2.3.1 Research Question 39

2.3.2 Hypotheses 39

2.3.3 Data 40

2.3.3.1 Dependent variables 40

2.3.3.2 Independent variables 41

2.3.4 Descriptive Statistics 42

2.3.5 Regression analysis 44

2.3.5.1 Research model 44

2.3.5.2 Using Hausman Test to determine whether Fixed Effects Model or Random Effects Model is a better model 44

2.3.5.3 Using FEM and REM to estimate regression model 47

2.3.5.4 Tests of regression model 55

2.3.6 Analysis of empirical model 62

CHAPTER III Implications and Recommendations 65

Vietnamese firms to improve their performance 653.2.1 Recommendations to Vietnamese firms 653.2.1.1 Solutions to avoid agency conflicts 663.2.1.2 Solutions for better use of capital and lower the use of debt when it

becomes too much 673.2.1.3 Solutions to improve the use of fixed asets for Vietnamese firms 693.2.2 Recommendations to the Government 703.2.2.1 Solutions for the Government to improve capital markets to help reduce agency conflicts and cost of capital for firms 703.2.2.2 Solutions to improve legal framwork to improve the use of capital

strucutre and firm performance 723.2.2.3 Solutions to provide easier bank access to companies in order to improve their capital structure 73Conclusion 74List of References 75

Table of Figures

There are three basic questions that all financial management decisions of a firm are concerened with They are caputal budgeting, capital structure and working capital questions While capital budgeting decision concern with the planning and managing

of a firm’s long-term investment, capital structure decisions involve figuring out how

to finance these investment in the most efficient way As capital structure plays an important role in a firm’s well-being, it must have a certain kind of relationship with firm performance If we are able to find out what the relationship is, firms will have a stronger support for managing the firm financially As for the Government, it will be able to come up with proper policies to make ways for firm to improve their

performance As for banks, they will be able to know more about the firm’s

performance through its capital structure, therefore avoid information assymetry

problem

There are numerous of research on the subject of capital structure The pioneer theory

is Modigliani and Miller propositions, developed in 1958 After that, other theories have come out like the static tradeoff theorywhich was developed by Bradley et al in

1984, pecking order theory which was proposed by Myers and Majluf (1984) and the agency cost theory which was developed by Jensen and Meckling in 1976 On a globel scale, many studies have been conducted to find out the relationship betwwen capital

Margaritis and Psillaki in 2010 on New Zealander companies

Although there are many research on the relationhsip betwwen capital structure and firm performance in the wrold, there are only few research on this relationship in

Vietnam That is the reason why the author chooses the topic “Capital Structure and Firm Performance in Vietnam” as the topic of the graduation thesis.

The objective of this research is to find out what are the determinants of both

accounting and market firm performace in addtion to capital structure and which relationship each determinant has on firm performace Based on the results, the writer proposes some solutions to both companies and the authority to help firms improve their performance through proper decisions

The subjects of this research are determinants of firm performance, namely leverage, size and growth Leverage is measured by total debt/total asset, short-term debt/total asset and long-term debt/total asset Size is measured by the natural logarithm of sales Growth is measured by the growth rate of sales

The scope of this research is 233 companies listed on Hanoi Stock Exchange (HNX) and Ho Chi Minh Stock Exchange (HOSE) in the period of 2008-2011

The methodology of this research is:

The method of collecting data is gathering secondary data from listed companies’ financial statements from 2008 to 2011

The method of processing data is based on panel estimation models, which are fixed effects model (FEM) and random effect model (REM)

The structure of this research is:

Chapter 1: Backgrounds on Capital Structure and Firm Performance

Chapter 2: Analysis of the relationship between capital structure and firm performanceChapter III Implications and Recommendations to improve firm performance based

on capital structure policy

Hanoi, June 2013 Writer Duong Hong Ngoc

CHAPTER I Backgrounds on capital structure and firm

as the opportunity cost associated with the firm’s capital investment.1 (Ross et al., 2003)

For the company as a whole, its cost of capital is defined as the expected return on a portfolio of all the company’s existing securities It is used to discount the cash flows

on projects that have similar risk to that of the firm as a whole.2 (Brealey−Meyers, 2003)

1 Ross et al., 2003: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition, McGraw-Hill, P.442

of forms and that these different forms of capital may have different costs associated with them These forms of capital are equity, debt and prefered stock.

1.1.1.1 Cost of equity

This section discusses two approaches to determining the cost of equity: the dividend growth model approach and the security market line, SML, approach

The easiest way to estimate the cost of equity capital is to use the dividend growth model Under the assumption that the firm’s dividend will grow at a constant rate g, theprice per share of the stock, P0, can be written as:

Because RE is the return that the shareholders require on the stock, it can be interpreted

as the firm’s cost of equity capital

- Advantages and Disadvantages of the Dividend Growth Approach

The primary advantage of the dividend growth model approach is its simplicity It is both easy to understand and easy to use There are a number of associated practical problems and disadvantages Firstly, we can only calculate cost of equity based on SML approach for companies that pay dividends This means that the approach is useless in many cases Furthermore, even for companies that do pay dividends, the key

underlying assumption is that the dividend grows at a constant rate More generally, themodel is really only applicable to cases in which reasonably steady growth is likely to occur.

Secondly, the estimated cost of equity is very sensitive to growth rate For a given stock price, an upward revision of g by just one percentage point, for example,

increases the estimated cost of equity by at least a full percentage point Because D1 will probably be revised upwards as well, the increase will actually be somewhat largerthan that

Finally, this approach really does not explicitly consider risk Unlike the SML

approach (which we consider next), there is no direct adjustment for the riskiness of theinvestment For example, there is no allowance for the degree of certainty or

uncertainty surrounding the estimated growth rate for dividends As a result, it is difficult to say whether or not the estimated return is commensurate with the level of risk

The primary conclusion was that the required or expected return on a risky investment depends on three things:

- The risk-free rate, Rf

- The market risk premium, E(RM) – Rf

- The systematic risk of the asset relative to average, which we called its beta

coefficient

Using the SML, we can write the expected return on the company’s equity, E(RE), as:

E(RE) = Rf + βE * (ERM – Rf)

where E is the estimated beta To make the SML approach consistent with the

dividend growth model, we will drop the Es denoting expectations and henceforth write the required return from the SML, RE, as:

RE = Rf + βE * (ERM – Rf)

- Advantages and Disadvantages of the Approach

Thus, it may be useful in a wider variety of circumstances.

However, there are some disadvantages when using the SML approach Firstly, it is notalways easy to estimate both the market risk premium and the beta coefficient If we can not estimate these estimates, the cost of equity can not be figured out For example,our estimate of the market risk premium, 9.1 percent, is based on about 75 years of returns on a particular portfolio of stocks Using different time periods or different stocks could result in very different estimates In addtion, as we use the information in the past to tell about the future when using SML approach, the results are not always significant as past information can not always guide future direction in this changing world In the best of all worlds, both approaches (the dividend growth model and the SML) are applicable and the two result in similar answers If this happens, we might have some confidence in our estimates We might also wish to compare the results to those for other, similar, companies as a reality check

1.1.1.2 Cost of debt

The cost of debt is the return that the firm’s creditors demand on new borrowing In principle, we could determine the beta for the firm’s debt and then use the SML to estimate the required return on debt just as we estimated the required return on equity This isn’t really necessary, however Unlike a firm’s cost of equity, its cost of debt can normally be observed either directly or indirectly, because the cost of debt is simply theinterest rate the firm must pay on new borrowing, and we can observe interest rates in the financial markets For example, if the firm already has bonds outstanding, then the yield to maturity on those bonds is the market-required rate on the firm’s debt

Alternatively, if we know that the firm’s bonds are rated, say, AA, then we can simply find out what the interest rate on newly issued AA-rated bonds is Either way, there is

no need to estimate a beta for the debt because we can directly observe the rate we want to know

There is one thing to be careful about, though The coupon rate on the firm’s

outstanding debt is irrelevant here That rate just tells us roughly what the firm’s cost

of debt was back when the bonds were issued, not what the cost of debt is today.5 This

is why we have to look at the yield on the debt in today’s marketplace For the sake of consistency with our other notation, we will use the symbol RD for the cost of debt

1.1.1.3 Cost of preferred stock

Determining the cost of preferred stock is quite straightforward As we know, preferredstock has a fixed dividend paid every period forever, so a share of preferred stock is essentially a perpetuity The cost of preferred stock, RP, is thus:

as bonds, the cost of preferred stock can be estimated by observing the required returns

on other, similarly rated shares of preferred stock

1.1.1.4 Weighted Average Cost of Capital (WACC)

Weighted Average Cost of Capital (WACC) is the weighted average of cost of each component in a company’s capitap structure These components can be debt, equity, preferred stock, options, warrants, etc However, we usually limit the components to debt, equity and preferred stock to come up with the formula of WACC below:

invest elsewhere.

1.1.2 Capital structure and capital structure policy

1.1.2.1 Leverage, Capital Structure and Optimal Capital Structure

a Capital Structure

A firm’s capital structure (or financial structure) is the specific mixture of debt and

equity the firm uses to finance its operations.3

As for capital structure question, the financial manager has two concerns in this area First, how much should the firm borrow? That is, what mixture of debt and equity is best? The mixture chosen will affect both the risk and the value of the firm

A primary reason for studying the WACC is that the value of the firm is maximized when the WACC is minimized To see this, recall that the WACC is the discount rate that is appropriate for the firm’s overall cash flows Because values and discount rates move in opposite directions, minimizing the WACC will maximize the value of the firm’s cash flows Thus, we will want to choose the firm’s capital structure so that the WACC is minimized

For this reason, we will say that one capital structure is better than another if it

results in a lower weighted average cost of capital Further, we say that a particular debt equity ratio represents the optimal capital structure if it results in the lowest

possible WACC This optimal capital structure is sometimes called the firm’s target capital structure as well

However, it is not an easy task to find out a firm’s optimal structure Therefore,

different theories have been developed to solve this problem Modigliani and Miller theory, the Static trade theory, the Pecking order theory and the Agency costs theory are among the most popular theories These theories will be discussed in the second section of this chapter

c Leverage

In general, leverage is the result of the use of fixed-cost assets or finds to magnify the returns to the company’s shareholders Leverage is categorized into operating leverage and financial leverage However, in ths thesis, the author only focuses on financial leverage, which refers to the extent to which a firm relies on debt The more debt financing a firm uses in its capital structure, the more financial leverage it employs When deciding on how much debt to use, the financial manager must consider

carefully as leverage magnifies both returns and risks the company has to face The type of risk here is financial risk, which is the additional risk concentrated on common stockholders as a result of financial leverage It is not business risk, which is the risk ofcompanies’ fixed assets without any debt The figure below illustrates how leverage magnifies both risk and return for a company

Figure1 1 How leverage magnies both risk and return of a firm

Interest 0 0 0

EPS

Risk measure: σ ROE = 2.12%

Risk measure: CV ROE = 0.24

Company L: Debt = 10.000; Equity = 10.000; Tax rate = 40%

Risk measure: σ ROE = 4.24%

Risk measure: CV ROE = 0.39

Source: http://www.umflint.edu/~mjperry/361-CH13Concise.ppt

Leverage and capital structure are connected in the way that they contribute to how a firm chooses to finance its projects in order to maximize shareholders’ value The proper use of debt in a company’s capital structure in the right time can increase

returns to shareholders significantly while the abuse of debt in bad time can damage shareholders’ value to an incredible extent Throughout this research, leverage is used

to represent capital structure and the effect of leverage on firm performance is the same

as the effect of capital structure on firm performance

1.1.3 Measurement of Firm Performance

The concept of performance is a controversial issue in finance largely due to its

multidimensional meanings Research on firm performance emanates from

organization theory and strategic management (Murphy et al., 1996) Performance measures are either financial or organizational Financial performance such as profit

maximization, maximizing profit on assets, and maximizing shareholders' benefits are

at the core of the firm effectiveness (Chakravarthy, 1986) Operational performance measures, such as growth in sales and growth in market share, provide a broad

definition of performance as they focus on the factors that ultimately lead to financial performance (Hoffer and Sandberg, 1987) The usefulness of a measure of

performance may be affected by the objective of a firm that could affect its choice of performance measure and the development of the stock and capital market For

example, if the stock market is not highly developed and active then the market

performance measures will not provide a good result The most commonly used

performance measure proxies are return on assets (ROA) and return on equity (ROE)

or return on investment (ROI) These accounting measures representing the financial ratios from balance sheet and income statements have been used by many researchers (e.g., Demsetz and Lehn, 1985; Gorton and Rosen, 1995; Mehran, 1995; and Ang, Coleand Lin, 2000) However, there are other measures of performance called market performance measures, such as price per share to the earnings per share (PE) (Abdel Shahid, 2003), market value of equity to book value of equity (MBVR), and Tobin’s Q.Tobin’s Q mixes market value with accounting value and is used to measure the firm's value in many studies (e.g., Morck, Shleifer, and Vishny, 1988; McConnel and

Serveas, 1990; and Zhou, 2001) The performance measure ROA is widely regarded as the most useful measure to test firm performance (Reese and Cool, 1978; Long and Ravenscraft, 1984; Abdel Shahid, 2003, among others) The stock market efficiency and other economic and political factors could affect a firm performance and its

reliability (See Abdel Shahid, 2003) Firm performance may also affect the choice of capital structure As Berger and Bonaccorsi di Patti (2006) point out, regressions of firm performance on leverage may confound the effects of capital structure on

performance with the reverse relationship from performance on capital structure This reverse causality effect is in essence a feature of theories considering how agency costs(Jensen and Meckling, 1976; Myers, 1977; and Harris and Raviv, 1990); corporate control issues (Harris and Raviv, 1988); and in particular, asymmetric information

1.2 Theories of capital structure

The topic of capital structure, especially optimal capital structure is of interest of many researchers throughout the years They have been trying to find out which is the best mixture of debt and equity for a firm by finding the answers to these questions:

- When should firms finance?

- Which sources of finance among debt, equity, preferred stock, etc should

firm choose to finance their projects?

- If debt is employed, how much short-term debt and long-term debt

should be used?

- If shares are issued, which groups of stock should be issued?

Below is the summary of popular capital structure theories

Table 1.2 Summary of popular capital structure theories

Fist, benefit for present shareholders and then an

opportunity for new investors↑

Conflict of interest between management, shareholders andcreditors↓

Buyback their shares

V↑

L= Leverage, K= Cost of capital, V= Value, R= Expected return, ↑= increase and ↓= decrease

Source: Hamed Ahmadinia, Javad Afrasiabishani, Elham Hesami, 2012 A Comprehensive Review on Capital Structure Theories Romanian Economic

Journal P.7,8

order theory and Agency cost theory.

1.2.1 Modigliani and Miller (M&M)

a The no-tax case

Proposition I: The value of the firm levered (VL) is equal to the value of the firm

unlevered (VU):

VL =VU

Figure 1.3 M&M Proposition I: Two Pie models of capital structure

Sour ce: Ross, A.S., Westerfield, W.R., and Jordan, D.B., 2003 Fundamentals of

Corporate Finance 6th ed New York: McGraw-Hill

Implications of Proposition I:

1 A firm’s capital structure is irrelevant

2 A firm’s weighted average cost of capital (WACC) is the same no matterwhat mixture of debt and equity is used to finance the firm

Proposition II: The cost of equity, RE, is:

RE = RA + (RA – RD) * (D/E)

Figure 1.4 The Cost of Equity and the WACC: M&M

Propositions I and II with No Taxes

where RA is the WACC, RD is the cost of debt, and D/E is the debt-equityratio.Implications of Proposition II:

1 The cost of equity rises as the firm increases its use of debt financing

2 The risk of the equity depends on two things: the riskiness of the firm’soperations (business risk) and the degree of financial leverage (financial

risk) Business risk determines RA; financial risk is determined by D/E

b The tax case

Proposition I with taxes: The value of the firm levered (VL) is equal to the value

of the firm unlevered (VU) plus the present value of the interest tax shield:

VL = VU + TC * D

Figure 1.5 M&M Proposition I with taxes

Source: Ross, A.S., Westerfield, W.R., and Jordan, D.B., 2003 Fundamentals of

Corporate Finance 6th ed New York: McGraw-Hill

where TC is the corporate tax rate and D is the amount of debt

where RU is the unlevered cost of capital, that is, the cost of capital for the firm

if it has no debt Unlike the case with Proposition I, the general implications of

Proposition II are the same whether there are taxes or not

1.1 The Static Tradeoff Theory

The second theory of capital structure is called the static theory of capital structure,

first presented by Jensen and Meckling (1976) It says that firms borrow up to the point

where the tax benefit from an extra dollar in debt is exactly equal to the cost that comes from the increased probability of financial distress We call this the static theory

because it assumes that the firm is fixed in terms of its assets and operations and it only considers possible changes in the debt-equity ratio.

This trade-off theory of capital structure recognizes that target debt ratios may vary from firm to firm Companies with safe, tangible assets and plenty of taxable income to

shield ought to have high target ratios Unprofitable companies with risky, intangible assets ought to rely primarily on equity financing.

If there were no costs of adjusting capital structure, then each firm should always be at its target debt ratio However, there are costs, and therefore delays, in adjusting to the optimum Firms cannot immediately offset the random events that bump them away from their capital structure targets, so we should see random differences in actual debt ratios among firms having the same target debt ratio

All in all, this trade-off theory of capital structure choice tells a comforting story Unlike MM’s theory, which seemed to say that firms should take on as much debt as possible, it avoids extreme predictions and rationalizes moderate debt ratios

Figure 1.7 The Static Theory of capital structure: Optimal capital structure and

the cost of capital

Source: Ross, A.S., Westerfield, W.R., and Jordan, D.B., 2003 Fundamentals of

Corporate Finance 6th ed New York: McGraw-Hill Figure 1.8 The Static Theory of capital structure: Optimal capital structure and

the value of a firm

1.2.3 The Pecking Order Theory

The pecking order theory of capital structure is one of the most influential theories of corporate finance The pecking order theory suggests that firms have a particular preference order for capital used to finance their businesses (Myers and Majluf, 1984) Owing to the information asymmetries between the firm and potential investors, the firm will prefer retained earnings to debt, short-term debt over long-term debt and debt over equity Myers and Majluf (1984) argued that if firms issue no new security but only use its retained earnings to support the investment opportunities, the information asymmetric can be resolved That implies that issuing equity becomes more expensive

as asymmetric information insiders and outsiders increase Firms which information asymmetry is large should issue debt to avoid selling under-priced securities The capital structure decreasing events such as new stock offering leads to a firm’s stock price decline

1.2.4 Agency Costs Theory

The agency cost theory (Jensen and Meckling, 1976) proposes that the optimal capital structure is determined by agency costs, which include the costs for both debt and equity issue The costs related to equity issue may include: (a) the monitoring expenses

of the shareholders (b) the bonding expenses of the managers and (c) ‘residual loss’ due to the divergence of managers’ decision from those of the shareholder’s (Jensen and Meckling, 1976) On the other hand, debt issue increases the shareholders’ and managers’ incentives to invest in high-risk projects that yield high returns to the

shareholders but increase the likelihood of failure that the bond holders have to share if

it is realized If debt-holders anticipate this, a high premium would be charged, which

in turn would increase the cost of debt Thus both equity and debt incur agency costs, and hence the optimal capital structure involves a trade-off between the two types of costs

1.3 Several academic research on the relationship between capital

structure and firm performance

Figure1 9 Summary of recent studies on the relationship between capital

structure and firm performance

structure on firm performance

performance Performance has a strong quadratic or cubic correlation with

capital structure when debt ratio under 100%

2 Wei Xu (2005) Performance ↑↑ capital

structure when debt ratio

= 24.52% to 51.13%

Performance has a strong quadratic or cubic correlation withcapital structure when debt ratio under 100%

3 Berger (2006) Leverage ↑↑ profit

Zoysa and

Chandrakumar

a (2010)

Source: The writer

In Vietnam, few research has been conducted to study the realtionship between capital structure and firm performance In 2008, Tran Hung Son and Tran Viet Hoang tests therelationship between capital structure and firm performance of 50 non-financial listed companies in Ho Chi Minh Stock Exchange Firm performance is measured by the average of ROA and ROE The authors admitted that the studies is not able to find out the relationship when firm performance is measured by a market financial indicator and further studies are needed Capital structure is measured by total debt/total equity, short-term debt/total asset and long-term debt/total asset The results show that there is

a positive correlation between a firm capital structure and performance The corporate performance has a strong quadratic or cubic correlation with the capital structure when they use the debt ratio under 100% The performance has a positive correlation with thecapital structure when the debt ratio is in the range from 0.9755 to 2.799

Wei Xu, et al (2005) analyzes the relationship between corporation performance and capital structure of 1,130 listed companies in China The corporation performance has

a strong quadratic or cubic correlation with the capital structure when they use the debt ratio under 100% The performance has a positive correlation with the capital structure when the debt ratio is in the range from 24.52% to 51.13%

Allan N Berger, et al (2006) uses a new approach to test agency theory in US banking industry and the findings are consistent with the agency costs hypothesis - higher leverage or a lower equity capital ratio is associated with higher profit efficiency over almost the entire range of the observed data And the results are statistically significant,economically significant, and robust

Tian & Zeitun (2007) examines the impact which capital structure has had on corporateperformance in Jordan in which they controlled the effect of industrial sectors, regionalrisk, such as the Gulf Crisis 1990-1991 and the outbreak of Intifadah in the West Bank

in September 2000 They have used a cross-sectional data representing of 167

Jordanian companies during 1989-2003 The results show that a firm capital structure has a significantly negative impact on the firm performance measures, in both the accounting and market measures An interesting finding is that the short-term debt to total assets level has a significantly positive effect on the market performance measure (Tobin’s Q), which could to some extent support Myers (1977) argument that firms with high short-term debt to total assets have a high growth rate and high performance Firm size is found to have a positive impact on a firm performance, as large firms have low bankruptcy costs The insignificance of the market performance measure PE indicates that the Jordanian equity market is not efficient, so the best performance measure is the accounting performance measure ROA

Margaritis and Psillaki (2010) use a sample of 12,240 firms from the 2004 New

Zealand Annual Enterprise Survey to investigate the relationship between firm

efficiency and leverage as well as the reverse causality relationship They find evidencesupporting the theoretical predictions of the Jensen and Meckling (1976) agency cost model More precisely, they find support for the core prediction of the agency cost hypothesis in that higher leverage is associated with improved efficiency over the entire range of observed data They use quantitative regression analysis to show that the effect of efficiency on leverage is positive at low to mid-leverage levels and

negative at high leverage ratios Thus their results suggest that in the upper range of theleverage distribution the income effect resulting from the economic rents generated by high efficiency dominates the substitution effect of debt for equity capital They also show that the more efficient firms will choose higher debt ratios because higher

efficiency acts as a buffer against the expected costs of bankruptcy or financial distress.The effect of tangibles and profitability on leverage is positive Firm size has a

Manawaduge, Zoysa and Chandrakumara (2010) when studying about 171 Sri Lankan companies find that levereage negatively influences ROA while positively influences Tobin’s Q The result supports agency cost theory in terms of rising cost of debt owing

to management conflicts and part of the pecking order theory where firms prefer

retained earning financing over debt financing

CHAPTER II Analysis of the impacts of capital structure

on firm performance

2.1 Overview of Vietnam’s economy

economy with state subsidies to a socialist-oriented market economy in implementation

of industrialization, modernization of the country, diversification and multilateraldevelopment of economic external relations for an open–door, world integration policy

2.1.1 Overall economic performance

2.1.1.1 GDP growth rates

Figure 2.1 GDP growth rate of Vietnam from 2008 to 2012

2008 2009 2010 2011 2012 0.0

Source: General Statistics Office of Vietnam and Asian Development Bank

In the period of 2008 to 2012, GDP growth fluctuated around 6%, which peaked at6.8% in 2011 and bottomed at 5% in 2012 Actutally, this rate is the slowest in 13years, as fiscal and monetary tightening in 2011 continued to have an impact

into last year While the policies took a toll on growth, they achieved sharp reductions

in inflation and a more stable exchange rate, and they contributed to a record currentaccount surplus and to rebuilding foreign reserves

All sectors—agriculture, industry, and services—recorded slower growth in 2012 than

in 2011 Manufacturing decelerated to 4.5%, reflecting weak domestic demand, highinventories, and reduced bank lending Construction grew by a modest 2.1% after

year Tourism-related services benefited from 9.5% growth in visitor arrivals, thoughthis was a slowdown from 2011 Agriculture grew by just 2.7%.

2.1.1.2 Foreign Direct Investment

International trade and inflows of foreign direct investment – mainly into export oriented manufacturing sectors – have been the main drivers of growth Vietnam was ranked third among Asian nations in terms of attracting investment in the 2007 –

2010 period, behind China and India Foreign direct investment (FDI) increased by

an annual average of 16.6% between 2001 and 2008, but contracted by 13% in 2009 due to the global economic crisis However, FDI recovered again in 2010 Growth has been driven equally by the expansion of the export sector and strong domestic investment, with private consumption playing a somewhat lesser role Agriculture’s share of economic output has continued to shrink, from about 24.5% in 2000 to

20.9% in 2009 However, despite the very good economic performance overall,

unemployment increased from 4.3% in 2008 to an estimated 6.5% in 2010

2.1.1.3 Imports and Exports

The integration of Vietnam into the global economy has accelerated sharply in recentyears Exported goods and services represented 68.3% of GDP in 2009, compared to 34% in 1994, and are concentrated in six product groups – crude oil, textiles and garments, footwear, seafood, wood products and electronic goods – which together account for around two-thirds of total exports Vietnam’s exports remain heavily dependent on imported equipment and intermediate goods Indeed, the strong import demand, further boosted by lower import barriers, has outpaced exports This

traditional trade pattern is reflected in an increasing deficit with ASEAN countries China and South Korea, only partly balanced by surpluses with the European Union and the United States The substantial merchandise trade deficit continues to be one

of the two main weaknesses in the Vietnamese economy, along with high inflation The annual trade deficit in 2010 amounted to an estimated $13.3 billion, slightly higher than the $12.9 billion deficit recorded in 2009

2.1.1.4 Inflation

Figure 2.2 Monthly inflation rate of Vietnam from Jan 2010 to Mar 2013

Source: General Statistics Office of Vietnam

The stabilization policies, together with good domestic harvests and soft global foodprices, tamed inflation in 2012 It decelerated sharply from over 20% year on year inOctober 2011, bottoming out at 5.0% in August 2012 On a year-average basis,inflation receded to 9.2%, half the rate of 2011

2.1.1.5 Interest Rates

Figure 2.3 Interest Rates of Vietnam from Jun 2010 to Apr 2013

Vietnam repeatedly raised interest rates in 2011 to rein in double-digit inflation, with the refinancing rate peaking at 15 percent But with the economy cooling and Steep declines in inflation also allowed the State Bank of Viet Nam, the authorities last year launched a new stimulus drive by decreasing the refinancing and discount rates to 8% and &% respectively.

In 2013, to achieve 6 percent annual growth in economy-wide productivity, while not without precedent, is a challenging goal, and a productivity revolution of this

magnitude cannot be achieved solely with incremental change Deep structural reforms within the Vietnamese economy will be necessary, as well as strong and sustained commitment from policy makers and firms

Vietnam needs to further develop its capabilities across all sectors of the economy, become increasingly versatile, and build on recent successes The economy needs to be

needs to identify new sources of growth to replace those that are becoming exhausted Because state-owned enterprises (SOE) still hold enormous weight, accounting for about 40 percent of the nation’s output, we find that reform of the ownership and management incentives for these enterprises is likely to be crucial, as will the need to improve the overall capital efficiency of SOE operations.

2.1.2 Vietnam’s Financial Market

2.1.2.1 Equity Market

Unlike its neighbors like Thailand or Singapore, Vietnam’s capital market is a young and in the process of development Although the first law on Companies and Private Enterprises was passed in 1990 and SOE’s equitization started in 1992, not until 2000 that the first stock exchange, that is Ho Chi Minh Stock Trading Center HoSTC was established with 7 companies being licensed In 2005, Hanoi Stock Trading Ccenter was opened Although the equity market have been in operation for more than 10 years,the rate of development is pretty fast In 2011, there are over 500 listed companies withtotal market capitalization of more than 30% of GDP The value of the bond market hasalso reached 15% of GDP from a insignificant level

Figure 2.4 Growth rate of newly listed companies in Vietnam from 2008 to 2012

Although in 2012, the market is more prosperous than 2011, equity market has not really fulfilled the role of capital mobilization channel business If raising capital through issuing shares surged more than 49.000 billion in 2010, this figure in the next two years has tended to decline only gradually reached 10.000 billion in 2012 In addition, via IPO market also attracted approximately 300 billion, less than 1/10

compared with the more than 3.000 billion by 2011 This is partly due to the stock market goes down continuously, reflecting the grim situation of the domestic economy and the world in the past two years Besides, less positive outlook and deteriorating business performance of the majority of businesses made shares of these firms also became less attractive to investors

Just because the stock market does not really play well as a channel to raise capital for unlisted companies are not interesting in going public Accordingly, the growth rate of the number of listed companies (g) on the stock exchanges showed strong signs of decline in 2011 (9,29%) and 2012 (2,59%), completely different than an impressive 35% in the period from 2008 to 2010 As can be seen, in recent years the flow of

capital into the stock market is still quite weak.

2.1.2.2 Bond Market

Figure 2 5 Vietnam’s Bond Market since 2000 to 2011 (% GDP)

Sourc e: Asian Bonds Online

Vietnam’s listed bonds value rose from VND159,54 billion in 2009 inception to

VND339.34 billion as of August 31, 2012

Vietnam’s government bond market officially opened on September 24, 2090, marking

a big milestone for Vietnam securities market

Bond market has been serving as an effective fund raising channel for State budget andthe government has raised a total of VND224,696 trillion in forms of government bonds from the market from Sept 24, 2009 to August 31, 2012

Bond market also saw bigger size tickers as the number of listed bonds has been

declined to 428 tickers now versus 500 tickers in 2009 while the value of the market were more than double The number of treasury bonds, for example, fell from 212 tickers worth VND82,27 trillion in 2009 to VND103 tickers worth VND200,17

trillion Auction activities have been getting more active with some bidding sessions

monetary market, but since the birth of bond market, winning coupons have been consistently 1-2% lower than deposit rates.

Trading value of the bond market has been consistently risen Outright transactions as

of September 19, 2012 reached VND105,537 trillion and repos transactions were VND37,252 trillion with 178 transaction sessions or VND802 billion/day Foreigners accounted for 33% of the total transactions

2.2 Capital structure of Vietnamese listed firms

Figure 2 6 Comparison of Vietnamese capital structure with those of other

countries Average LTD/TA (%)

Average STD/TA (%)

Average TD/TA (%)

4 Wei Xu, Xiangzhen Xu, Shoufeng Zhang (2005) An Empirical Study on Relationship between Corporation Performance and Capital Structure China-USA Business Review 4(4)

5 Zeitun, R and Tian, G.G (2007) Capital structure and corporate performance: evidence from Jordan The Australasian Accounting Business & Finance Journal 1(4)

6 Manawaduge, Zoysa and Chandrakumara (2010), Capital structure and its implications: empirical

According to the business survey Vietnam's General Statistics Office 1999-2002, the proportion of debt to equity in 1999 was 1.32 times, 1.93 times in 2000 and 2002 was 1.96 times.

Rate payable on the equity in the business of construction and real estate is the highest total liabilities 2 times higher than equity, ie 207% The non-listed companies financial ratio is 153%, 144% energy Low consumer goods sector is 80%

This rate in corporations, government corporations accounted for more than 1.73 times,higher than 1.5 times the average of the listed companies in general

More worryingly, according to Thanh, creditors tend to face many obstacles

degradation Since the credit institutions, banks to invest in the safety of financial assets such as bonds or short-term valuable papers, rolled over, and as a result, money

is vicious in the banking system and the credit institutions have recently added item

"other assets" in the balance sheet From the business side, business has good cash flowtends to reduce debt And now difficult to borrow new debt but the debt burden is too big to be borrowed

Mr Nguyen Nam Son - board members, Thien Vietnam Securities Company, CEO Vietnam Capital Partners - said that "the financial weakness of the company Vietnam alarming Total liabilities to equity holders of the Company Vietnam up to 120% compared with an average of 45% in the region This is alarming because only just over 60% of enterprise risk bankruptcy if markets deteriorate, "Son said

He also stressed that the company will fail due to typical industry has left investors, investment opportunities and are not based on core competencies

"Lack of long-term financial strategy, real estate firms Vietnam Financial leverage the highest in Asia And most will not survive the crisis, when banks tightened lending Meanwhile, international funds are available, but only for the good and transparent company, "Son said

H1: Leverage does influence firm’s performance

Building on Myers (1977) and Jensen (1986), Stulz (1990) develops a model in which debt financing is shown to mitigate overinvestment problems but aggravate the

underinvestment problem This model predicts that debt can have both a positive and a negative effect on firm performance and presumably both effects are present in all firms

H2: Growth positively influence firm’s performance

As high growth firms are more likely to make better profit from investment than low growth firm, sales growth is expected to have a positive influence on firm performance.Claessens et al.,2002; Maury, 2006; King and Santor, 2008 and Margaritis and Psillaki,

2010 suggest that there is a positive relationship between sales growth and firm

performance Wei Xu (2005) also shows that there is a strong positive correlation between growth and return on equity (ROE)

H3: Size positively influences firm’s performance

A firm size is measured by log of sales (SIZE) The firm size is hypothesized to be positively related to the firm performance, as large firms benefit from better

management quality, advanced technology and economies of scale, which lead to betterfirm performance This hypothesis is confirmed by Himmelberg et al, 1999 and

Margaritis and Psillaki, 2010

2.3.3 Data

From firms’ public financial statements, the writer gathers financial data of 233

Vietnamese listed companies in both Hanoi Stock Exchange (HNX) and Hochiminh Stock Exchange (HOSE) in the form of panel data for a period of 2008 to 2011

Although there are 669 listed compnies on HNX and HOSE, only 233 companies have adequate information for the author to calculate necessary ratios like Tobin’s Q,

leverage, growth and size for a whole period of 2008-2011 The method used is panel least square method, which includes both Fixed Effects model and Random Effects model

2.3.3.1 Dependent variables

Assets

ROA= Net Income

Average Total Assets

2 Tobin’s Q Tobi n ' s Q= Market value of equity + Book value of debt

Book value of asset

The first measure, return on assets (ROA), is frequently used by researchers as a

measure of firm performance (e.g.,Balakrishnan et al., 1996; Barber and Lyon, 1996; Barua et al., 1995; Bharadwaj, 2000; Hitt and Brynjolfsson, 1996; Weill, 1992) Since ROA incorporates both firm profitability and efficiency (Skousen et al., 1998), it tends

to be a useful overall performance indicator

Tobin’s Q mixes market value with accounting value and is used to measure the firm's value in many studies (e.g., Morck, Shleifer, and Vishny, 1988; McConnel and

Serveas, 1990; and Zhou, 2001)

The reason to use both ROA and Tobin’s Q is that ROA as performance measures is that while ROA is an backward looking accounting-based performance measure, Tobin’s Q is a forward looking market-based performance measure Some previous studies have found indications that the results differ depending on the chosen measure

Financial leverage, measured by total debt/total asset, short term debt/ total asset, long

term debt/total asset were used by Zeitun and Tian (2007)

Growth opportunities were measured by growth of sales This measure of growth is

used by Claessens et al.,2002; Maury, 2006; King and Santor, 2008 and Margaritis and

Psillaki, 2010

Firm size was defined by natural log of sales These measures were used by many

researchers (e.g., Mudambi and Nicosia, 1998, Lauterbach and Vaninsky, 1999,

Durand and Coeuderoy, 2001, Tzelepis and Skuras, 2004)

2.3.4 Descriptive Statistics