Empirical studies on coroorate capital structure in viet nan

EMPIRICAL STUDIES ON CORPORATE CAPITAL STRUCTURE IN VIETNAM LINH, DOAN NGOC DUY1 Department of Business Administration Graduate School of Soongsil University, Korea ABSTRACT The purpose of the study is to examine the influence of firm characteristics (profitability, investment opportunity “market-to-book ratio”, tangibility, size, growth) and industry effect to capital structure of stock companies in Vietnam The study uses OLS regression method to analyze a data set consisting of 522 nonfinancial companies listed in the two stock exchanges Ho Chi Minh Stock Exchange (HSX) and Ha Noi Stock Exchange (HNX) during the period from 2008 to 2011 The aggregate market-based leverage ratio in Vietnam is about 0.29 Despite the differences in business environment and management, this ratio is consistent to the statement from Frank and Goyal (2007) “Over the past half century the Corresponding author Email address: doanngoc_duylinh@yahoo.com - - Electronic copy available at: https://ssrn.com/abstract=2957353 aggregate market-based leverage ratio has been about 0.32” The empirical results show that profitability, tangibility, and growth are the major three determinants to debt ratios The strong negative correlation between profitability and all debt ratios supports the prediction of the pecking order theory and it is considered as a serious defect of the trade-off theory Tangibility has a strong positive correlation with long-term debt ratio but it has a negative correlation with short-term debt ratio This result is consistent with the maturity mismatch principle “Firms tend to use long-term debt to finance fixed assets to prevent maturity mismatch; consequently, firms with high fraction of tangibility are expected to have high long-term debt ratio but low short-term debt ratio” The strong positive correlation between growth and all debt ratios is consistent to the statement of Jensen and Meckling, 1976 “Debt disciplines managers and mitigates agency problems to free cash flow since debt must be repaid to avoid bankruptcy” However, the fact that firms that have cash on hand actually issue debts is considered a serious problem of the pecking order theory (Frank and Goyal, 2007) As per the empirical results the corporate capital structure of the whole data is dominated by short-term debt, but the corporate capital structure at industry level is sometimes dominated by long-term debt It is consistent with the result of Gilson (1997) “Industry leverage is used as a proxy for target capital structure” According to Hovakimian et al (2001), firms actively adjust their debt ratios towards the industry average And similar persistence at firm level is reported in Lemmon et al (2007) The differences of corporate capital structure at industry level and the - - Electronic copy available at: https://ssrn.com/abstract=2957353 similar persistence of capital structure at firm level reflect the role of industry effect as the crucial determinant of the target debt ratios - - CHAPTER 1: Introduction 1.1 Introduction To finance their business operations, companies have to use either equity capital or debt capital The combination of equity and debt, called the capital structure, is affected by many factors and keeps changing Modigliani and Miller (1958; 1963) set a foundation for implementation of empirical research and development of alternative theories on capital structure These theories have been tested through a series of empirical studies to identify which determinants have a major role on capital structure decision This study is the first empirical test of the capital structure theories in the Vietnam market Since it is the first empirical work on the capital structure in Vietnam, this study introduces capital structure theories and provides empirical evidences for managers and investors of companies in Vietnam which help them to understand how and which determinants affect their debt policy decisions at firm level and industry level As per Frank and Goyal (2007), industry median leverage, profitability, tangibility, market-to-book ratio, size, and inflation are six core factors which account for more than 27% of the variation in leverage That is the reason why the study examines the effect of firm characteristics (profitability, tangibility, investment opportunity, size, and growth) on debt ratios at firm level and then expanding into industry level in order to examine the industry effect The empirical results are reliable because they are based on the raw data of 552 firms listed in the - - Stock Exchanges in the period from 2008 to 2011 The study is organized as follows Chapter 1, the study illustrates the capital market in Vietnam and reviews the literature on capital structure The study is then divided into two essays (chapter and chapter 3) Chapter 2, which examines the effects of a firm’s characteristics, consists of four sections: section develops hypotheses between a firm’s characteristic factors and leverage; section discusses data collection and designs model; section presents empirical results; and section presents the conclusion of the chapter Chapter 3, which examines the industry effect, consists of four sections: section summarizes industry groups in Vietnam; section designs model; section presents empirical results; and section presents the conclusion of the chapter Chapter concludes the study 1.2 The capital market in Vietnam In 1986, Vietnam implemented “Doi Moi” policy This policy set a big change in the concept of an economy that transformed the command economy to a market economy The privatization program was the key issue in the process of economic transformation at that time In the process of economic transformation, the government promoted private ownership and launched the privatization program which transformed the State-Owned Enterprises (SOEs) to joint stocks companies There has been an impressive reduction in the number of SOEs from 12,000 SOEs in 1991 to 1,200 SOEs in 2010 (IMF, 2010; WB, 2012) As a result, a lot of stock companies were created in the market at that time, which set the foundation for the - - development of an equity market in the future 1.2.1 Bank lending channel The Vietnam capital market is a bank-centered financial system According to the National Financial Supervisory Committee, up until 2009, 80% of the capital of the national economy was bank loans (Nguyen, H., 2010) According to Manh Quan Nguyen, deputy general director of HDBank, most of the capital in the bank is short-term funds, while the demand from the market for longer term loans is increasing rapidly (MHB, 2009) The capital market, which is overly dependent on bank finance, reflects the lack of stable long-term financing channels and underdevelopment of the capital market in Vietnam 1.2.2 The equity market in Vietnam The equity market has strongly developed since the establishment of the two stock exchanges HSX and HNX, which were founded in 2000 and 2005 respectively From the beginning in 2000, there were only companies with market capitalization, accounting for 0.2% GDP listed in the equity market Ten years later in 2010, there were 600 companies with market capitalization of USD 35 billion, accounting for 45% GDP, listed in the equity market The booming of the equity market has offered a long-term financing channel to reduce the burden on the banking system It has also offered an effective channel to attract foreign investment capital - - 1.2.3 The bond market in Vietnam Despite its recently rapid development, the size of Vietnam’s bond market remains very small, compared to many other emerging East Asian markets such as China, South Korea, Singapore, Thailand, Malaysia and The Philippines According to Hoang Huy Ha, the chairman of the Vietnam Bond Association, the local bond market now accounts for only 17% of GDP while that number in China, Thailand, Singapore, and Malaysia is 53%, 58%, 74% and 82% respectively (Vietnam Business Forum, 2010) Government bonds are the key instrument in the Vietnam bond market, occupying the largest portion (86%) of the whole market The corporate bond occupies 10% and the municipal occupies 4% (Vietnam’s Ministry of Finance, 2009, quoted in Vuong & Tran, 2010) Moreover, corporate bonds are mainly a playing field of large and famous enterprises The fact that most small and medium enterprises (SMEs) are unable to access this long-term finance channel results in a definitive increase in the number of enterprises which file for bankruptcy (from 40,000 to 53,000 to 54,000 and to 61,000 in the four consecutive years 2010, 2011, 2012, 2013 respectively) Bolton and Freixas (2008) argue that bond financing, as a form of long-term finance, does not expose firms to risks of bank runs and systemic crisis While bank-financed firms are fully exposed to risks of bank loans, bond-financed firms are shielded from adverse effects of a financial crisis, and therefore are more likely to survive As a consequence, bond issuers in a financial crisis are more likely to - - survive than non-issuers 1.3 Literature Capital structure can be defined as the mixture of a firm’s capital with debt and equity and it has been one of the most argumentative subjects in corporate finance, since the outstanding study of Modigliani and Miller in 1958 (Bevan and Danbolt, 2004) Many theories have been developed in the literature for examining determinants of capital structure and they focus on which determinants are more likely to have a major role on the leverage decisions How firms finance their operations? And what factors influence their capital structure choices? Weston (1955) raises the above questions and argues whether it is possible to answer these questions And Steward C Myers (1984) starts the paper “Capital Structure Puzzle” by asking the question, “How firms choose their capital structures?” then answering it, “We don't know” In fact, it is still debated over what the determinants of capital structure are and how they impact capital structure decisions, even though there have been various studies conducted on the subject As per Frank and Goyal (2007), taxes, bankruptcy costs, transaction costs, adverse selection, and agency conflicts have all been advocated as major explanations for the corporate use of debt financing Myers (1984) describes the “trade-off theory” as the hypothesis that firms balance tax savings from debt against deadweight bankruptcy costs He also describes the “pecking order theory” - - as the hypothesis that due to adverse selection, firms first look to retained earnings, then to debt, and only in extreme circumstances to equity for financing However, no currently available model appears capable of simultaneously accounting for all of the stylized facts Over long periods of time, aggregate leverage is stationary (Frank and Goyal, 2007) Similar persistence at the firm level is reported in Lemmon et al (2007) The persistence in leverage ratios places important limits on theory It means that a satisfactory theory must account for why firms keep leverage stationary In other words, the theory must explain why the environment serves to maintain the leverage despite a difference in management Over the past half century, the aggregate market-based leverage ratio has been about 0.32 There have been surprisingly small fluctuations in this ratio from decade to decade (Frank and Goyal, 2007) Following Myers (1984), it may seem that the stability of aggregate leverage is consistent with the trade-off theory In fact, there is too much stability for the simple version of tax versus bankruptcy theory For most of the 1950s and the 1960s, the top corporate tax rate was roughly 50% In the 1990s, it was around 35% Despite this large difference in tax rates, the market leverage ratio averaged 0.32 in both the 1950s and in the 1990s, while, in the 1960s, it averaged 0.27 Have bankruptcy costs really fluctuated in just the right manner to account for this evidence? It seems hard to imagine This evidence, while not a proof, is certainly a serious warning sign for the trade-off theory The remarkable stability of leverage ratios also poses a problem for the pecking order - - theory Leverage should fluctuate as the financing deficit ebbs and flows, according to the standard pecking order theory In order to account for this evidence, something must be added to the basic pecking order theory (see Frank and Goyal, 2007) Thus the standard versions of both the trade-off theory and the pecking order theory appear to be inadequate Both approaches need to be improved to account for the known facts Recently, proponents of the trade-off approach have focused their efforts mainly on developing dynamic structural trade-off models An attractive feature of these models is that they try to provide a unified framework that can simultaneously account for many facts Examples include Leary and Roberts (2007), Hennessy and Whited (2005), Ju et al (2005), and Strebulaev (2007) Proponents of the pecking order theory have focused recently on the development of a satisfactory notion of “debt capacity” (see, Lemmon and Zender, 2004) and on more complex adverse selection models (see Halov and Heider, 2005) 1.3.1 Modigliani-Miller Theorem(1958) Modigliani and Miller start by assuming that the firm has a particular set of expected cash flows When the firm chooses a certain proportion of debt and equity to finance its assets, all that it does is to divide up the cash flows among investors Investors and firms are assumed to have equal access to financial markets, which allows for homemade leverage The investor can create any leverage that was - 10 - In the primary service group, growth has an insignificant positive relation to all debt ratios at a 5% significance level (p-value > 0.05) Similarly, tangibility has an insignificant positive relation to short-term debt book value and short-term debt market value at a 5% significance level (p-value > 0.05) Likewise, investment opportunity has an insignificant negative relation to short-term debt book value and short-term debt market value at a 5% significant level (p-value > 0.05) [Table 3-4] Regressions of total debts in the primary service group total debt book value Coef p-value profitability -0.9537 0.0000 tangibility 0.3755 Investop total debt market value Coef p-value profitability -1.2059 0.0000 0.0000 tangibility 0.4465 0.0000 -0.0102 0.0010 Investop -0.0126 0.0010 Size 0.0315 0.0030 Size 0.0388 0.0020 Growth 1.0194 0.7020 Growth 0.0829 0.9800 Cons -1.6943 0.5290 Cons -0.8995 0.7830 Observation= 93 Observation= 93 F( 5, 1560 )= 15.81 F( 5, 1560 )= 16.07 Prob > F = 0.000 Prob > F = 0.000 R-squared = 0.4761 R-squared = 0.4801 Adj R-squared = 0.446 Adj R-squared = 0.4503 - 62 - [Table 3-5] Regressions of short-term debts in the primary service group short-term debt book value Coef short-term debt market value p.value Coef p.value Profitability -0.3346 0.004 profitability -0.4449 0.005 Tangibility 0.0021 0.958 tangibility -0.0059 0.915 Investop -0.002 0.239 Investop -0.0027 0.246 Size 0.0134 0.028 Size 0.0159 0.055 Growth 1.3376 0.390 Growth 0.7332 0.729 -1.5893 0.313 Cons -1.0088 0.637 Cons Observation= 93 Observation= 93 F( 5, 1560 )= 3.36 F( 5, 1560 )= 3.00 Prob > F = 0.0081 Prob > F = 0.0153 R-squared = 0.1617 R-squared = 0.1469 Adj R-squared = 0.1136 Adj R-squared = 0.0978 [Table 3-6] Regressions of long-term debts in the primary service group long-term debt book value Coef p.value Profitability -0.6191 0.002 Tangibility 0.3734 Investop -0.0082 long-term debt market value Coef p.value profitability -0.761 0.002 0.000 tangibility 0.4524 0.000 0.005 Investop -0.0099 0.005 - 63 - Size 0.0181 0.078 Size 0.023 0.063 Growth -0.3182 0.904 Growth -0.6503 0.837 Cons -0.105 0.969 Cons 0.1093 0.973 Observation= 93 Observation= 93 F( 5, 1560 )= 10.99 F( 5, 1560 )= 11.25 Prob > F = 0.000 Prob > F = 0.000 R-squared = 0.3871 R-squared = 0.3927 Adj R-squared = 0.3518 Adj R-squared = 0.3578 It is reasonable to assume that the primary service group has debt ratio which is dominated by long-term debt because it has high tangibility As per the [table 3-1], the primary service group has the highest tangibility (0.4280 = 42.8%) Therefore, the long-term debt is higher than short-term debt due to the maturity mismatch principle that states: “Firms tend to use long-term debts to finance fixed assets to prevent the maturity mismatch.” It seems tangibility in this case can explain why the primary service group has debt ratio which is dominated by long-term debt How about the debt ratios of the industrial group and the consumer goods group? These two groups have the same tangibility 3.3.2 Comparison of the industrial group and the consumer goods group How about the debt ratios of the industrial group and the consumer goods group? As per the table 3-5, the tangibility of the industrial group and the consumer goods - 64 - group is 0.2899 (or 29%) and 0.2974 (or 29.7%) respectively The study will examine the debt ratio of the two groups which have the same tangibility And the results are as below In the industrial group [table 3-2a], [table 3-3a], the short-term debt at market value is 0.1855 = 18.6% and long-term debt at market value is 0.1109 = 11.1% The ratio (short-term debt/ long-term debt = 18.6%/11.1%) is 167% In the consumer goods group [table 3-2a], [table 3-3a], the short-term debt at market value is 0.2889 = 28.9% and long-term debt at market value is 0.0671 = 6.7% The ratio (short-term debt/ long-term debt = 28.9%/6.7%) is 431% The results are summarized in the [table 3-7] as below [Table 3-7] Comparison of industrial group and consumer goods group consumer goods group Variable Obs Mean short-term debt/ long-term debt short-term debt 264 0.2889 431% long-term debt 264 0.0671 Variable Obs Mean short-term debt/ long-term debt short-term debt 759 0.1855 167% long-term debt 759 0.1109 industry group Although the consumer goods and industrial group have the same tangibility, - 65 - their debt ratios are totally different The ratios (short-term debt/ long-term debt) in the industrial group and the consumer goods are 167% and 431% respectively In this case, tangibility is not a satisfactory explanation As previously stated, industry effect is the combination of effect of firm characteristics and effect of omitted factors in each industry It is still debated what the role of industry effect to capital structure is and how it impacts capital structure decisions, even though there have been various studies conducted on the relevant subject This is due to the fact that industry effect reflects a set of correlated, but otherwise omitted factors Firms in an industry face common forces that affect their financing decisions These could reflect product market interactions or the nature of competition These could also reflect industry heterogeneity in types of assets, business risk, technology, or regulation Future study should examine the effect of other variables such as receivable and payable accounts to debt ratios 3.4 Conclusion This part of the study examined industry effect to corporate capital structure Industry effect is the combination of effect of firm characteristics and effect of omitted factors in each industry To examine the industry effect on capital structure, the study has examined effect of firm characteristics on capital structure in each industry group Based on the empirical results of the study, one of the findings is that firm - 66 - characteristic factors have statistically significant relation to debt ratios in the whole data as per the empirical results of chapter 2; however, these factors have statistically insignificant relation to debt ratios in some specific industries That means when data is large enough, capital structure theories are true or feasible But in industry level or company level when the data is smaller, these theories sometimes are not true or feasible Another finding is that the corporate capital structure of the whole data is dominated by short-term debt; whereas, the corporate capital structure of some specific industry groups such as the primary service group or oil & gas is dominated by long-term debt In some case, the firm characteristics, such as tangibility, can give a satisfactory explanation But it cannot give a satisfactory explanation in other cases because the effect of firm characteristics is just one component of industry effect and because there are unknown effects of omitted factors As per Frank and Goyal (2007), industry median leverage, profitability, tangibility, market-to-book ratio, size, and inflation are the six core factors which account for more than 27% of the variation in leverage A future study should examine the effects of other variables, such as receivable and payable accounts to debt ratios - 67 - CHAPTER 4: Conclusion of the Study Based on the empirical results of my study, the aggregate of the market-based leverage of Vietnam’s economy is 29.5% Despite the differences in management, this result is consistent with the results of Frank and Goyal (2007), that “Over the past half century the aggregate market-based leverage ratio has been about 0.32.” The empirical results show that profitability, tangibility, and growth are the three major determinants to debt ratios The strong negative correlation between profitability and all debt ratios supports the prediction of the pecking order theory, and it is considered to be a serious defect of the trade-off theory Tangibility has a strong positive correlation with long-term debt ratio, but it has a negative correlation with short-term debt ratio This result is consistent with the maturity mismatch principle that states “Firms tend to use long-term debt to finance fixed assets to prevent maturity mismatch; consequently, firms with high fraction of tangibility are expected to have high long-term debt ratio and low short-term debt ratio.” The strong positive correlation between growth and total debt ratio is consistent with the statement of Jensen and Meckling, 1976: “Debt disciplines managers and mitigates agency problems to free cash flow since debt must be repaid to avoid bankruptcy.” However, the fact that firms having cash on hand actually issue debts is considered a serious problem of the pecking order theory (Frank and Goyal, 2007) Industry effect reflects a set of correlated, but otherwise omitted factors Firms - 68 - in an industry face common forces that affect their financing decisions These could reflect product market interactions or the nature of competition These could also reflect industry heterogeneity in types of assets, business risk, technology, or regulation In this study, industry effect is considered to be a package consisting of effect of firm characteristics and effect of omitted factors in each industry One finding is that firm characteristics factors have statistically significant relation to debt ratios in the whole data These factors, however, have statistically insignificant relation to debt ratios in some specific industries That means when data is large enough, capital structure theories are true or feasible But in industry level or company level when the data is smaller, these theories are sometimes not true or feasible Another finding is that the corporate capital structure of the whole data is dominated by short-term debt, whereas the corporate capital structure of some specific industry groups, such as the primary service group or oil & gas, is dominated by long-term debt It is consistent with the result of Gilson (1997): “Industry leverage is used as a proxy for target capital structure.” According to Hovakimian et al (2001), firms actively adjust their debt ratios towards the industry average And similar persistence at firm level is reported in Lemmon et al (2007) The differences of capital structure in each industry and the similar persistence of leverage at firm level reflect the role of industry effect as the crucial determinant of the target debt ratios As per Frank and Goyal (2007), industry median leverage, profitability, - 69 - tangibility, market-to-book ratio, size, and inflation are the six core factors which account for more than 27% of the variation in leverage A future study should examine the effect of other variables such as, receivable and payable accounts to capital structure decision - 70 - REFERENCES Arnold, G Corporate Financial Management, 4th edition Harlow: Financial Times Prentice Hall, 2008 Baker, M., and J Wurgler Market timing and capital structure Journal of Finance 57, 1–32, 2002 Barclay, M., and Smith, C.W The Capital Structure Puzzle: Another Look at the Evidence Journal of Applied Corporate Finance, 12, 1, 8- 20, 2005 Bennett, M., and R Donnelly The Determinants of Capital Structure: Some UK Evidence British Accounting Review, Vol 25, pp 43-59, 1993 Berk, J., and DeMarzo, P Corporate Finance Pearson International Edition: Addison Wesley, 2007 Bevan, A.A., and Danbolt, J Dynamics in the Determinants of Capital Structure in the UK Working Paper No 2000-9, 2000 Bevan, A.A., and Danbolt, J Capital structure and its determinants in the United Kingdom – A decompositional analysis Applied Financial Economics, 12 (3), pp 159-170, 2002 Bolton, P., and X Freixas How Can Emerging Market Economies Benefit from a Corporate Bond Market? in E Borensztein, K Cowan, B Eichengreen and U Panizza, eds, Bond Markets in Latin America On the Verge of a Big Bang MIT Press, 2008 Easterbrook, F Two-Agency Cost Explanations of Dividends American Economic - 71 - Review, Vol 74, pp 650-659, 1984 Fama, E., and K.R French Testing trade-off and pecking order predictions about dividends and debt Review of Financial Studies 15, 1-33, 2002 Fama, E., and K.R French Financing decisions: Who issues stock? 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