INTRODUCTION
Problem statement
Corporate governance principles are essential for firms to achieve their objectives, providing a framework that facilitates interactions among management, the board, and shareholders Strong corporate governance is linked to enhanced firm success, as it mitigates agency conflicts and optimizes capital structure, according to both theoretical frameworks and empirical evidence (Jensen 1986; Klock et al 2005; G20/OECD principles of corporate governance 2015).
The impact of corporate governance on capital structure has been extensively studied, particularly the relationship between managerial entrenchment and leverage ratios Managerial entrenchment occurs when managers manipulate financing decisions to serve their interests over those of shareholders (Berger, Ofek, and Yermack, 1997) This phenomenon can lead to increased leverage, as entrenched managers may raise debt ratios to mitigate takeover risks and ensure their job security (Jensen and Meckling, 1976; Harris and Raviv, 1988; Stulz, 1988; Wald and Long, 2007) Conversely, some studies suggest that managerial entrenchment can also result in lower leverage, as entrenched managers may prefer issuing equity after experiencing significant stock returns, thereby reducing debt ratios (Welch, 2004) Additionally, concerns about financial distress may drive managers to adopt conservative investment strategies, further limiting their use of debt (John et al., 2008).
The interplay between managerial entrenchment and market timing behavior regarding leverage ratios remains underexplored Market timing is significantly influenced by managers' financing decisions, determining whether companies opt for debt or equity to fund their investment opportunities Therefore, this study aims to concurrently analyze managerial entrenchment and market timing behavior.
Entrenched managers often aim to reduce debt levels and make responsible investment decisions to avoid bankruptcy, which can mitigate takeover threats (Zwiebel, 1996) However, this cautious approach may hinder firms from benefiting from low-cost financing options, such as tax-shield advantages When seeking external financing, these managers are more inclined to issue significant amounts of equity during favorable market conditions (Graham and Harvey, 2001) This aligns with market timing theory, suggesting that a firm's capital structure is shaped by previous attempts to capitalize on equity market fluctuations (Baker and Wurgler, 2002) Additionally, research by Kayhan and Titman (2007) indicates that a firm's historical financial performance, including deficits and stock price movements, plays a vital role in influencing its leverage ratio.
In Vietnam, there is a scarcity of studies exploring the impact of managerial entrenchment and the market timing effect on firms' leverage ratios, despite existing research like Vo and Tran (2015) focusing on trade-off and pecking order theories The nascent development of Vietnam's securities market contributes to information asymmetry and agency problems, complicating firms' abilities to accurately assess stock prices and determine optimal leverage levels Nguyen (2015) highlighted both short-term and long-term market timing effects on leverage decisions for Vietnamese IPO firms, noting that sector value deviations and historical stock prices influence equity issuance and market timing However, the roles of managerial entrenchment and firms' histories were overlooked in this analysis This paper aims to fill these gaps by providing empirical evidence on these critical factors within the Vietnamese context.
Research objectives
This study examines how managerial entrenchment and the market timing effect influence a firm's leverage ratio over time The research focuses on four key objectives to understand these dynamics better.
(i) Analyzing the determinants of managerial entrenchment together with firms’ characteristics that influence leverage ratio of Vietnam firms
(ii) Evaluating the target leverage ratio of Vietnam firms
(iii) Estimating the effect of managerial entrenchment and the market timing presented through firms’ characteristics on leverage ratio
This study investigates how managerial entrenchment, within both high and low entrenchment regimes, influences the leverage ratios of firms in Vietnam, taking into account the firms' historical contexts Unlike previous research, this analysis uniquely focuses on the interplay between managerial entrenchment and leverage, providing fresh insights into corporate finance practices in the Vietnamese market.
For the first time in Vietnam, this study examines the impact of managerial entrenchment and market timing effects, as reflected in the leverage ratios of all listed firms on the Ho Chi Minh Stock Exchange.
Second, the effect of managerial entrenchment on firm’s leverage ratio is classified as high entrenchment regime and low entrenchment regime
The article incorporates various measurements of firms' characteristics, including financial deficits, leverage deficits, timing measures, and stock price returns Notably, insider sales serve as an alternative proxy for assessing timing measures.
Fourth, various econometric techniques including the Ordinary Least
Squares (OLS), the Generalized Method of Moments (GMM) and endogenous switching regression method are employed in this study.
Research questions
In attempts to achieve the above objectives, the following four research questions have been raised:
(i) What are the determinants of managerial entrenchment and which are firms’ factors that significantly influence leverage ratio in Vietnam firms?
(ii) Do Vietnam firms use target leverage and apply the market timing theory to determine leverage ratio?
(iii) How do managerial entrenchment and the market timing effect presented through firms’ histories affect leverage ratio in Vietnam firms?
(iv) How do managerial entrenchment in both high and low entrenchment regime and firm’s histories affect leverage ratio in Vietnam firms?
Research scope
This study analyzes a dataset comprising 289 non-financial firms from the Ho Chi Minh Stock Exchange (HOSE) spanning the years 2006 to 2015 The secondary data was sourced from various platforms, including annual reports, financial statements, and company information from websites such as cafef.vn, cp68.vn, and vietstock.vn Financial firms, including banks, insurance companies, and investment funds, were excluded from the sample due to their distinct capital structures, which differ significantly from those in the non-financial sector.
The thesis structure
This thesis comprises five chapters The main content of each chapter is organized as follows:
Chapter 1 introduces an overview of the thesis containing the problem statement, the research objectives, questions, and the research scope
Chapter 2 explores existing theories and empirical evidence related to agency conflicts, managerial entrenchment, market timing, and firm characteristics It subsequently outlines the research hypotheses and establishes a conceptual framework that examines the factors influencing firms' leverage ratios.
Chapter 3 describes the methodology including the data measurements and quantitative models employed in the thesis Additionally, econometric technique used to achieve the research objectives will be elaborated
Chapter 4 expresses the empirical results In particular, main findings are revealed and compared to other empirical evidences
Chapter 5 provides the key findings and the discussions The implications are delivered to shed light on the policy purposes Finally, the chapter indicates the limitations for future improvements.
LITERATURE REVIEW
Literature review
Corporate governance principles establish a framework that enables companies to achieve their objectives while effectively managing performance This framework focuses on the interactions among management, the board, and shareholders Strong corporate governance is essential for enhancing firm success by minimizing agency conflicts and optimizing capital structure As a result, these principles provide policymakers with valuable tools to promote economic growth and ensure financial stability.
Corporate governance principles do not serve as a universal model for all countries; instead, they integrate common elements from various corporate structures They offer diverse objectives and methods for establishing effective corporate governance This flexible approach allows management to create tailored governance frameworks that align with the expectations of their shareholders and debtholders, as outlined in the G20/OECD Principles of Corporate Governance 2015.
2.1.1.2 Why does corporate governance matter for an organization?
According to Hart (1995), issues in corporate governance stem from two main factors: the agency relationship, which highlights the conflict of interest between an organization's owners and its management, and agency costs, which arise from this conflict and cannot be mitigated simply through contractual agreements.
Corporate governance principles are designed to address conflicts between owners and management, especially in the context of globalization By engaging with international capital markets, companies can align their governance practices with global standards, fostering trust among shareholders and debtholders Effective supervision and mechanisms will not only enhance confidence but also reduce the cost of capital, ultimately benefiting both owners and management This creates a mutually advantageous relationship, as outlined in the G20/OECD principles of corporate governance (2015).
2.1.2 The theoretical framework of corporate governance
In their influential 1976 paper, Jensen and Meckling introduce agency theory, highlighting the relationship between firm owners and top management that arises from the separation of ownership and control In this framework, shareholders and debtholders serve as principals, while top managers act as agents tasked with making decisions that maximize owners' wealth However, the interests of the principals may not always align with those of the agent, as the agent's utility-maximizing behavior can lead to conflicts.
To safeguard their interests, principals implement incentives to curb the abnormal behaviors of agents One key strategy is to enhance managerial ownership, which compels managers to prioritize shareholders' wealth over personal gains However, increased managerial power can lead to entrenchment, where managers become difficult to replace or penalize by the principals This entrenchment often results in managers exploiting their positions to influence investment decisions in ways that protect their own well-being.
Debt financing serves as a significant deterrent against managers' tendencies to pursue excessive growth, often referred to as "empire building" (Grossman and Hart 1982; Jensen 1986) By imposing the risk of bankruptcy, debt acts as a powerful motivator for managers to efficiently manage cash flows and closely oversee investment projects This careful management is essential for generating the necessary cash flows to meet future interest and principal payments (Hart 1995).
Signaling theory highlights that agency relationships arise not only from conflicts of interest between owners and management but also from asymmetric information between insiders (top managers) and outsiders (shareholders and debtholders) Insiders typically possess more information regarding a firm's investment opportunities, leading outsiders to seek information from various sources However, access to the true value of a firm's current and future investments is often restricted, and the reliability of information requires verification Consequently, shareholders and debtholders may be vulnerable to changes in financing made by insiders For instance, an increase in debt levels signals to outsiders that the firm anticipates high future cash flows, while financing through new equity issuance may suggest declining performance, leading outsiders to share losses with new investors Thus, outsiders interpret managers' confidence in the firm's future performance as a reflection of increased leverage.
Jensen and Meckling's (1976) influential study on corporate governance emphasizes that capital structure theory is fundamentally linked to ownership structure They argue that key capital structure indicators extend beyond mere debt and equity totals to include the equity held by managers Consequently, the theory identifies three critical determinants of capital structure to effectively represent firms of varying sizes.
The total market value of the equity is calculated as:
𝑆 = 𝑆 𝑖 + 𝑆 0 The total market value of the firm is measured by:
Si: inside equity (held by the manager),
S0: outside equity (held by outside investors of the firm),
B: debt (held by outside investors of the firm)
The theory is developed to determine the optimal ratio of outside equity to debt (Jensen and Meckling 1976)
The determination of the optimal ratio of outside equity to debt is
The firm's size is considered constant, with V representing its actual value influenced by agency costs V* indicates the firm's value at a specific scale when agency costs are nonexistent Additionally, the total amount of outside financing, represented as (B + S0), remains unchanged, while the optimal proportion of this outside financing derived from equity is emphasized.
The optimal ratio of outside equity to debt is determined by analyzing total agency costs, A T (E), which depend on the amount of outside equity For a firm of size V ∗, total outside financing is represented as E ≡ S 0 ⁄ (B + S 0 ) The agency costs associated with outside equity are denoted as A S 0 (E), while those related to debt are A B (E) The minimum total agency costs occur at the optimal fraction of outside financing, E ∗, where A T (E ∗) is achieved.
Figure 2.1 illustrates two key components of agency costs: (i) the total agency costs associated with the equity held by the owner-manager, represented as A S 0 (E), and (ii) the total agency costs related to the amount of debt, denoted as A B (E) Collectively, these elements contribute to the overall agency cost.
The agency costs related to the amounts of equity held by the owner-manager is
The equation A S 0 (E) indicates that when E ∗ ≡ S ∗ ⁄(B + S 0 ) equals zero, there is no outside equity present This absence of external investment results in agency costs A S 0 (E) increasing, as managers are incentivized to exploit any available outside equity at minimal levels Consequently, when the total equity differences reflect an increase in outside equity held by investors, it drives up agency costs due to managerial exploitation.
A GENC Y C OS T S ( M E A S U R E D I N U N IT S OF CU R R E N T W E A L T H)
FRACTION OF OUTSIDE FINANCING OBTAINED FROM EQUITY
Agency costs associated with debt are represented by A B (E) and include the reduction in the firm's value and the monitoring expenses incurred when wealth is shifted from bondholders to managers to enhance the manager's equity value These agency costs reach their peak when all external financing is derived from debt, resulting in S 0 = E = 0 Conversely, when external funds are entirely sourced from equity, agency costs are minimized.
With E = 1, the agency costs are minimized due to a near-zero debt level The manager's incentive to redistribute wealth from bondholders is diminished for several reasons: first, as debt approaches zero, there is no debt available to reallocate; second, an increase in equity S0 significantly reduces the manager's total equity, as indicated by the equation E ≡ Si / (S0 + Si).
Empirical evidence
2.2.1 The influence of managerial entrenchment on leverage ratio
Research by Kim and Sorensen (1986) and Stulz (1988) demonstrates that higher managerial ownership positively influences leverage ratios, suggesting that it can help mitigate agency costs associated with equity issuance Supporting this, Agrawal and Mandelker (1987) found that managers with significant ownership are more inclined to accept financial distress by increasing debt levels Furthermore, John and Litov (2010) highlight that entrenched managers, who have better access to debt markets, tend to raise their firms' leverage ratios Additionally, Bin-Sariman, Ali, and Nor (2016) argue that managerial entrenchment, in conjunction with the quality of the board of directors, contributes to an increase in debt ratios.
Research by Friend and Lang (1988), Bathala, Moon, and Rao (1994), and Chen and Steiner (1999) indicates that companies with greater managerial ownership tend to have lower debt ratios due to concerns about increasing financial risk Additionally, findings from Berger, Ofek, and Yermack support this notion, highlighting the relationship between managerial ownership and financial leverage.
(1997), Becht, Bolton and Rửell (2003), Hermalin and Weisbach (2003), Holderness
Research by Novaes and Zingales (2003) and Kayhan (2008) indicates that entrenched managers, influenced by rising stock prices due to market timing effects, often reduce debt ratios This trend is further supported by Ganiyu and Abiodun (2012), who found a negative relationship between managerial entrenchment and leverage ratios in listed firms in Nigeria Similar findings were reported in studies conducted in China by Wen, Rwegasira, and Bilderbeek (2002) and Quang and Xin.
2.2.2 The impacts of firms’ histories on leverage ratio
2.2.2.1 Financial deficit and Leverage ratio
Myers and Majluf (1984), Shyam-Sunder and Myers (1999) and Baker and Wurgler
In 2002, it was established that financial deficit plays a crucial role in both the pecking order theory and the market timing effect Financial deficit, or external finance, refers to the net amount of a firm's issued and repurchased debt and equity within a specific year.
According to the pecking order theory established by Myers (1984), Myers and Majluf (1984), and Shyam-Sunder and Myers (1999), companies typically increase their external capital in response to high financial deficits or low free cash flow, resulting in higher leverage Conversely, when firms have sufficient free cash flow, their leverage tends to decrease as they utilize retained earnings to address financial deficits and reduce debt However, Frank and Goyal (2003) challenge this theory by demonstrating that both larger and smaller firms are significantly influenced by financial deficits, leading them to prefer equity issuance over debt financing.
Research by Baker and Wurgler (2000), Kayhan and Titman (2007), and Kayhan (2008) indicates that managers often favor equity over debt for external capital due to their ability to time the equity market, leading to a reduction in debt financing Additionally, Law and Chong (2011) found that financial deficits adversely impact the leverage ratios of Thai firms.
2.2.2.2 Market timing and Leverage ratio
Firms are more likely to finance their growth through equity rather than debt when stock prices rise, as highlighted by Baker and Wurgler (2002).
In their study, Baker and Wurgler (2002) are referenced by Kayhan and Titman (2007), who identify two types of timing measures crucial to understanding financial deficits: yearly timing and long-term timing The yearly timing measure assesses the covariance between total external finance and the market-to-book ratio, indicating that equity issuance can increase funds due to short-term overvaluation as reflected in the current market-to-book ratio compared to prior years Conversely, the long-term timing measure evaluates the market-to-book ratio in relation to not only a firm's historical ratios but also the ratios of all firms within the market, highlighting its broader market context.
Seyhun (1986, 1990) and Liu (2009) utilize insider sales as an alternative measure for market timing, calculated by the ratio of net volume from secondary share offerings to the total shares outstanding at the end of the year.
As a result, the author points out that the market timing variable is insignificant to leverage
2.2.2.3 Stock price returns and Leverage ratio
Graham and Harvey (2001) align with the findings of Hovakimian, Opler, and Titman (2001) as well as Welch (2004), indicating that elevated stock prices often lead to increased equity issuance Conversely, falling stock prices typically prompt companies to repurchase shares Consequently, stock returns significantly and negatively influence the leverage ratio.
Research by Kayhan and Titman (2007), Kayhan (2008), and Law and Chong (2011) indicates that the difference between one-year stock returns and those from previous years serves as a proxy for market timing Their findings suggest that firms experience a decrease in leverage ratios when they capitalize on high market stock returns.
Hypotheses
2.3.1 Managerial entrenchment effect and Leverage ratio
According to Novaes and Zingales (1995, 2003), managers often manipulate their debt choices to enhance their job security and extend their tenure In response to increased takeover pressure and stricter punishment mechanisms, these managers tend to reduce their debt levels.
Jung, Kim, and Stulz (1996) reveal that firms prioritize equity issuance over debt financing, particularly when faced with poor investment opportunities Their research indicates that companies issuing equity possess a greater investment capacity than those relying on debt Consequently, the study highlights that entrenched managers often opt to issue equity, driven by significant agency costs, despite the potential for better firm value outcomes through debt financing.
Research by Berger, Ofek, and Yermack (1997), as well as Kayhan and Titman (2007) and Kayhan (2008), indicates that a decrease in debt ratio is linked to the managerial entrenchment effect This suggests that managers may leverage debt financing to shield themselves from performance pressures, mitigate the risks associated with under-diversified investment choices, and secure their positions within the company.
Hypothesis 1 There is a negative relationship between managerial entrenchment and leverage ratio
2.3.1.1 Block-holder holdings and Leverage ratio
Block-holder holdings, defined as ownership of at least 5 percent of a company's shares, play a crucial role in corporate governance These significant shareholders can greatly influence managerial decisions, including leverage ratios and control over management practices, as noted by Grossman and Hart (1980) and Shleifer and Vishny (1986) However, block-holders may also collaborate with management to the detriment of minority investors, as highlighted by Becht, Bolton, and Rüell (2003) Moreover, the strong presence of block-holders does not necessarily correlate with positive corporate decision-making, often leading to increased managerial entrenchment, as discussed by Holderness (2003).
Berger, Ofek and Yermack (1997) and Kayhan (2008) indicate that a rising of block-holder holding brings about a decrease in leverage ratio
Hypothesis 2 The higher proportion of block-holder holdings gives rise to the higher of managerial entrenchment and the lower of leverage ratio
2.3.1.2 Board size and Leverage ratio
Research by Jensen (1993) and Wen, Rwegasira, and Bilderbeek (2002) indicates that larger board sizes positively influence leverage ratios, as they tend to increase debt levels to enhance corporate value However, in cases of severe agency conflicts, larger boards may lead to entrenched and free-riding managers, resulting in diminished effectiveness in managing financing decisions and leverage ratios (Yermack, 1996) Further studies by Berger, Ofek, and Yermack (1997) and Kayhan support these findings, highlighting the complexities of board size and its impact on corporate governance.
(2008) and Quang and Xin (2013) provide a negative relationship between board size and leverage ratio due to managerial entrenchment
Hypothesis 3 Board size has a negative impact on leverage ratio
2.3.1.3 Director age and Leverage ratio
Firms with boards dominated by older directors often experience increased managerial entrenchment, leading to less effective monitoring and a higher turnover of CEOs (Berger, Ofek, and Yermack, 1997; Vafeas, 2003) Additionally, older directors tend to resist rising debt ratios to safeguard their own interests (Berger, Ofek, and Yermack, 1997; Wen, Rwegasira, and Bilderbeek, 2002; Kayhan, 2008).
Hypothesis 4 Older directors save firms from a surge in leverage ratio
2.3.1.4 CEO-Chairman duality and Leverage ratio
When CEOs also hold the position of chairman, they often make financing and leverage decisions without oversight, resulting in increased managerial entrenchment This lack of control in decision-making can negatively impact financing choices Research by Berger, Ofek, and Yermack (1997), Kayhan (2008), and Ganiyu and Abiodun (2012) supports the notion that the dual role of CEO and chairman can lead to detrimental effects on corporate governance and financial decision-making.
Hypothesis 5 The duality role of managers negatively impacts leverage ratio
2.3.1.5 Board composition and Leverage ratio
Hermalin and Weisbach (2003) indicate that outside directors face restricted access to firms' information, resulting in significant managerial entrenchment Their research shows that a higher number of outsider directors correlates with increased CEO entrenchment in leverage decisions (Hermalin and Weisbach 1988; 2003) Additionally, to mitigate the pressures of large fixed interest payments, managers tend to reduce leverage ratios when faced with closer monitoring from outside directors (Jensen 1986; Wen, Rwegasira, and Bilderbeek 2002; Kayhan 2008).
Hypothesis 6 The percentage of outside directors on the board is in association with a decline in leverage ratio
2.3.1.6 CEO age and Leverage ratio
Older CEOs with dual roles leverage their extensive experience and established reputations to exert significant influence over management, enhancing their bargaining power with the board and reducing their vulnerability to evaluations This demographic is inclined to prevent increases in the firm's leverage ratio as a strategy to navigate corporate governance issues and reinforce their tenure in office.
Hypothesis 7 CEO age exhibits a negative relation to leverage ratio
2.3.2 The relationship between firms’ histories and leverage ratio
2.3.2.1 Financial deficit and Leverage ratio
According to pecking order theory, firms typically increase external capital in response to high financial deficits or low free cash flow, resulting in higher leverage (Myers, 1984; Myers and Majluf, 1984; Shyam-Sunder and Myers, 1999) Conversely, when firms have sufficient free cash flow, their leverage tends to decrease as they utilize retained earnings to address financial deficits and reduce debt However, research by Frank and Goyal (2003) indicates that both large and small firms are significantly influenced by financial deficits when it comes to equity issuance rather than debt financing Additionally, the market timing effect, as discussed by Baker and Wurgler (2000), Kayhan and Titman (2007), and Kayhan (2008), suggests that managers prefer equity over debt for raising external capital, allowing them to capitalize on favorable market conditions and thereby reduce reliance on debt financing.
Hypothesis 8 There remains a negative effect of financial deficit on leverage ratio
2.3.2.2 Market timing measures and Leverage ratio
In their study, Kayhan and Titman (2007) categorize timing measures into yearly and long-term types, both emphasizing the significance of financial deficits The yearly timing measure assesses the covariance between total financial deficit or external finance and the market-to-book ratio, indicating that equity issuance can capitalize on short-term overvaluation reflected in the current market-to-book ratio compared to previous years Conversely, the long-term timing measure evaluates the market-to-book ratio in relation to both the firm's historical performance and that of all firms in the market, suggesting that a rising market-to-book ratio signals improved growth opportunities Consequently, firms may reserve debt financing for future needs, as noted by Law and Chong (2011).
Liu (2009) utilizes insider sales as a market timing measure, calculated as the percentage of net volume from secondary share offerings relative to total shares outstanding at year-end The insider sales variable reflects the difference between shares sold and shares purchased, with repurchased shares typically arising from rising stock prices and selling shares occurring during price increases (Seyhun, 1986) Seyhun (1990) indicates that top managers can achieve approximately a 3 percent return on transactions through insider sales, suggesting that as stock prices rise, insider trading activity among managers increases This trend indicates a preference for equity issuance over debt financing.
Hypothesis 9 An increase in market timing measures attributes a decline to leverage ratio
2.3.2.3 Stock price returns and Leverage ratio
Graham and Harvey (2001) align with findings from Hovakimian, Opler, and Titman (2001) and Welch (2004), showing that high stock prices encourage equity issuance, while falling stock prices lead to share repurchases and a reduced leverage ratio Additionally, research by Kayhan and Titman (2007), Kayhan (2008), and Law and Chong (2011) indicates that the disparity between one-year stock returns and prior years' returns serves as a market timing proxy, ultimately concluding that firms benefit from high market stock returns, which contributes to a decrease in leverage ratio.
Hypothesis 10 Stock price returns performs a negative influence on leverage ratio
According to the pecking order theory proposed by Myers (1984) and Jensen (1986), firms with strong growth and investment opportunities generate significant profits and cash reserves, leading them to utilize retained earnings to reduce debt and lower their leverage ratios Myers (1984) highlights the importance of financial distress and interest tax shields, while Auerbach (1979) points out that personal-level taxes on profit distributions prevent shareholders from benefiting from dividend payouts Consequently, firms may negotiate with shareholders to retain dividends for reinvestment, further decreasing their debt ratios Research by Hennessy and Whited (2005), Strebulaev (2007), Titman and Tsyplakov (2007), and Frank and Goyal (2009) supports the notion that taxes on profit distributions negatively affect debt ratios, indicating that firms with high profits may face financial distress due to excessive leverage.
Hypothesis 11 A rise in profitability gives way to a decrease in leverage ratio
2.3.2.5 Leverage deficit and Change in target leverage
Leverage deficit refers to the gap between a firm's actual leverage and its target leverage When a firm has lower leverage ratios than its target, it is likely to increase its debt ratios, while a firm with higher leverage ratios tends to decrease its debt Additionally, the change in target leverage is calculated by the difference between the current and previous target leverage ratios (Kayhan and Titman, 2007; Kayhan, 2008).
Hypothesis 12 Leverage deficit and change in target leverage are expected to diminish or expand by virtue of change in target leverage ratio
Firms' histories •Leverage ratio includes the book leverage ratio and the market leverage ratio.
Figure 2.2 Analytical framework The relationship between management entrenchment, firms’ histories and leverage.
Analytical framework
This study presents a conceptual framework that simultaneously examines the impact of managerial entrenchment and the historical context of firms on their leverage ratios.
RESEARCH METHODOLOGY AND DATA
Vietnam’s corporate governance and securities market framework
3.1.1 Vietnam’s corporate governance and institutional background
3.1.1.1 Vietnam’s adoption of corporate governance standards
The G20/OECD principles of corporate governance which were first publicized in
Since their introduction in 1999 and subsequent improvements in 2004 and 2015, Vietnam's corporate governance framework has been guided by principles incorporated into the Law on Enterprises 2005 (Law No 60/2005/QH11) While these principles have been effectively translated and implemented, there remain significant legal gaps that need to be addressed Key issues include the unclear ownership structure and its functions, as well as a lack of transparency in financial information, which must be progressively resolved to enhance corporate governance in Vietnam.
Vietnam's corporate governance assessments in 2006 and 2013 highlighted several critical issues, including the limited capacity and resources of institutions to effectively regulate and develop the market Additionally, shareholders face challenges in institutional protection, while management restricts investors' access to information regarding agency conflicts.
In 2010, the Baseline Report on the Vietnam Corporate Governance Scorecard revealed that the corporate governance practices of the 100 largest listed companies in Vietnam scored below 50 percent, according to the International Finance Corporation and the State Securities Commission of Vietnam.
3.1.1.2 Vietnam’s corporate governance legal framework
The corporate governance legal framework in Vietnam is primarily regulated by the Law on Enterprises 2005, along with various government regulations Vietnamese enterprises are required to comply with these primary and secondary legislative requirements to ensure effective governance.
Enterprises 2005 On the contrary, Vietnam firms are exposed to some following weaknesses
The current legislation regarding conflicts of interest between owners and management remains ambiguous and inconsistent According to the Law on Enterprises 2005, the General Meeting of Shareholders (GMS) has the authority to appoint and remove board members; however, when shareholder-board conflicts escalate to the point of requiring legal intervention, the GMS lacks the ability to initiate class action lawsuits against the board due to outdated provisions in the law Furthermore, the rights of minority shareholders are inadequately protected, as larger shareholders with political ties often evade legal repercussions, leading to manipulation of minority interests Consequently, the existing legislation fails to effectively address agency conflicts within corporations.
Vietnamese firms often struggle with poorly designed corporate governance structures, which limit shareholders' ability to self-regulate Additionally, the principles of corporate accountability are not sufficiently flexible or adaptable to keep pace with the rapidly changing business environment (Minh and Walker, 2008).
The corporate charter is vital for shaping corporate governance in Vietnamese firms, outlining essential elements such as objectives, structure, and operations It offers greater emphasis on protecting minority shareholders compared to the Law on Enterprises 2005 However, many corporate charters in Vietnam lack uniqueness, often mirroring the common requirements of the Model Charter 2007 established by the Ministry of Finance As a result, the enforcement of these charters remains weak, leading to continued neglect of minority shareholder protections.
3.1.2 The background of Vietnam’s securities market
The 1986 economic renovation (Doi Moi) prompted Vietnam to reform its market and establish a securities market, leading to the formation of the State Securities Commission (SSC) in November 1996 As the principal regulator of capital markets, the SSC oversees market intermediaries and public enterprises, as outlined in Decree No 48/1998/ND-CP Regulated by the Law on Securities 2006, the SSC supervises the Ho Chi Minh Stock Exchange (HOSE) and Hanoi Stock Exchange (HNX) and collaborates with the Ministry of Finance to publish corporate governance principles and charters for public companies.
These statements have contributed to the development of the securities regulatory framework, as highlighted by various studies and reports from Nguyen and Eddie (2003) and the International Finance Corporation in collaboration with the State Securities Commission of Vietnam (2006, 2013).
The growth of Vietnam's securities market faces several challenges despite initial successes from the implementation of a securities administration system To enhance market development, there is a pressing need for a broader range of equity and debt instruments, alongside improved transparency in financial information access Education for both Vietnamese investors and Securities and Exchange Commission (SSC) staff is crucial Additionally, the technology infrastructure at the two Securities Trade Centers requires significant upgrades The market's scale does not align with the country's potential due to the absence of key industries, and securities companies have yet to effectively act as intermediaries in balancing capital demand and supply Furthermore, the market's vulnerability is exacerbated by the manipulation of a substantial number of shares by a small group of influential investors.
Established in 2000, the Ho Chi Minh Stock Exchange (HOSE) began with only two listed companies, reflecting its initial modest growth Despite its early limitations, HOSE has become a significant symbol of Vietnam's financial landscape, attracting greater attention than the Hanoi Stock Exchange due to its focus on larger enterprises and higher foreign investment Companies seeking to list on HOSE must meet stringent capital and profit requirements, demonstrating their financial stability for at least two years prior to listing (Nguyen and Eddie 2003; International Finance Corporation and the State Securities Commission Vietnam 2013).
Despite its challenges, the establishment of the Ho Chi Minh Securities Trade Center plays a crucial role in shaping Vietnam's financial system, particularly as the country transitions from a centrally planned economy to a market-oriented economy.
The gradual growth of the securities market is closely linked to advancements in market infrastructure and the overall financial landscape A well-organized securities market structure reflects the strength of developing financial markets, which in turn fosters stability and confidence for future investments.
Data sources
This study analyzes a dataset comprising 289 non-financial firms listed on the Ho Chi Minh Stock Exchange (HOSE) from 2006 to 2015 The secondary data was sourced from various materials, including annual reports, financial statements, and official company websites such as cafef.vn, cp68.vn, and vietstock.vn Financial firms, including banks, insurance companies, and investment funds, were excluded from the sample due to their distinct capital structures compared to non-financial firms.
Research methodology
This section presents a three-part analysis utilizing the Ordinary Least Squares (OLS) method Firstly, a two-stage approach is implemented to identify the target leverage level and to estimate key independent variables, including leverage deficit and changes from target leverage This analysis also aims to quantify the impact of managerial entrenchment and the historical context of firms on their leverage ratios Secondly, the Generalized Method of Moments (GMM) is applied to enhance the robustness of the findings.
Moments (GMM) is used to eliminate the endogeneity problem caused by financial deficit – a determinant of firms’ characteristics to leverage ratios Third, with the aid of
Endogenous switching regression method, the impact of managerial entrenchment in both high and low regime together with firms’ characteristics on leverage ratios is specified
3.3.1 The two-stage approach in determining leverage ratios
3.3.1.1 The target leverage ratio estimation
Following Kayhan and Titman (2007), the Ordinary Least Square (OLS) method is utilized to construct the target leverage
L Target it : Target leverage level of firm i in year t,
M/B: Growth opportunities – the market-to-book ratio of firm i in year t,
PPE: Property, plant and equipment of firm i in year t,
EBIT: Profitability of firm i in year t,
R&D: Research and development expense of firm i in year t,
SE: Selling expense of firm i in year t,
SIZE: Firm size of firm i in year t
The target leverage is measured by the predicted value from the Ordinary Least
The Ordinary Least Squares (OLS) regression analysis is based on key observed variables, including profitability measured by EBIT, asset tangibility represented by PPE, research and development expenses (R&D), selling expenses (SE), firm size (SIZE), and the market-to-book ratio (M/B).
X5: Research and development dummy (R&D dummy)
Firm size (SIZE) = Ln (Sales)
The study investigates the connection between managerial entrenchment and the historical leverage ratios of firms using Ordinary Least Squares (OLS) and Generalized Method of Moments (GMM) methodologies Following the frameworks established by Kayhan and Titman (2007) and Kayhan (2008), the regression analysis incorporates two dependent variable measurements: the book leverage ratio and the market leverage ratio Additionally, it examines three categories of independent variables, which include pecking order theory factors such as financial deficit and profitability, market timing theory elements like yearly timing, long-term timing, and stock returns, as well as trade-off theory components involving leverage deficit and changes in target leverage.
The model which is applied to estimate the impact is performed as follows
Also, leverage deficit (LDEF) and change in target leverage (ΔTARGET) is constructed from the target leverage estimation
L it − L i(t−n) : Difference in leverage ratio of firm i in year t, t-n,
FD: Financial leverage of firm i in year t, t-n,
YT: The yearly timing measure of firm i in year t, t-n,
LT: The long-term timing measure of firm i in year t, t-n,
R: Stock price histories of firm i in year t, t-n,
MEs: Managerial entrenchment variables of firm i in year t, t-n,
EBIT: Profitability of firm of firm i in year t, t-n,
LDEF: Leverage deficit of firm i in year t, t-n,
ΔTARGET: Change in target leverage of firm i in year t, t-n
Leverage ratios consist of book leverage and market leverage Book leverage, defined as the ratio of book debt to total assets, is viewed as a backward-looking measure due to its correlation with total debts and asset value In contrast, market leverage, which compares the book value of debt to the combined book value of debt and market value of equity, is considered forward-looking as it relates total debts to the firm's market value According to Barclay et al (2006) and Florackis and Ozkan (2009), these distinctions highlight the differing perspectives on financial leverage.
Beneficial ownership refers to the percentage of block-holder holdings, specifically those holding at least 5 percent of a company's shares Block-holders serve as representative owners and can significantly impact managerial decisions, thereby controlling and mitigating managerial entrenchment.
Board size: number of directors on the boards A large board results in a negative relationship between the board and the management process by virtue of agency conflicts (Yermack 1996)
Board size = Ln (Board size)
The age of directors, quantified by the logarithm of the median age on the board, plays a significant role in corporate governance Boards dominated by older directors often lead to increased managerial entrenchment, which can diminish effective oversight Vafeas (2003) indicates that such older-dominated boards may struggle with monitoring, resulting in a higher turnover rate for CEOs.
Director age = Ln (Median director age)
The dual role of CEO and Chairman often leads to unrestricted financing and leverage decisions, resulting in increased managerial entrenchment (Goyal and Park 2002) This relationship is captured by a dummy variable, which is assigned a value of 1 when the CEO also holds the chairman position, and 0 when they do not.
CEO-Chairman duality = 1 if CEO is chairman; 0 otherwise
The composition of a board, specifically the percentage of outside directors, significantly influences the level of CEO entrenchment in leverage decisions Research by Hermalin and Weisbach (1988; 2003) indicates that a higher proportion of outside directors correlates with increased CEO entrenchment, impacting the strategic financial choices made by the company.
Older CEOs, equipped with extensive experience and established reputations, tend to exert significant influence over internal control mechanisms This demographic often enjoys enhanced bargaining power in negotiations with the board and is less susceptible to scrutiny, as noted by Berger, Ofek, and Yermack (1997).
CEO age = Ln (CEO age) Firms’ histories:
A financial deficit is calculated by summing investment (I), dividends (DIV), changes in working capital (ΔWC), and net cash flow (CF), then dividing this total by total assets This concept is explored in the research conducted by Shyam-Sunder and Myers.
(1999), Frank and Goyal (2003), Kayhan and Titman (2007), and Kayhan
Timing measures indicate that companies tend to raise equity when stock prices are rising and opt for debt when prices are falling, as noted by Baker and Wurgler (2002) These measures include the yearly timing measure (YT) and the long-term timing measure (LT), as described by Kayhan and Titman (2007) The yearly timing measure is calculated by assessing the covariance between a firm's financial deficit and its market-to-book ratio, while the long-term timing measure involves comparing the market-to-book ratios of different firms.
Insider sales, defined as the ratio of the difference between shares sold and shares repurchased to the total number of shares at the end of the year, serves as a valuable short-run market timing indicator (Seyhun 1986; Seyhun 1990; Lee 1997; Liu 2009) This data is derived from the buy and sell transactions of top executives, including CEOs and chairpersons, and is readily accessible on platforms such as cafef.vn and vietstock.vn.
Stock returns are calculated using the logarithm of the difference between the ending share price (P1) and the beginning share price (P0), plus dividends (DIV), divided by the initial share price (P0) at the start of the financial year.
Profitability is the sum of earnings before interest, and taxes (EBIT) divided by total assets
Leverage deficit refers to the gap between a company's actual leverage and its target leverage This concept suggests that firms with lower leverage ratios than their target are likely to increase their debt ratios, while those with higher leverage ratios tend to decrease their debt levels.
Change in target leverage (ΔTARGET) is the difference between the current target leverage ratio and the previous target leverage ratio
Change in target leverage (ΔTARGET) = 𝐿 𝑇𝑎𝑟𝑔𝑒𝑡 𝑖𝑡 − 𝐿 𝑇𝑎𝑟𝑔𝑒𝑡 𝑖,(𝑡−𝑛)
Industry dummy is the Vietnam standard industry codes (VSIC) to regulate characteristics of Vietnam industry
Book leverage The book leverage is the ratio of book debt to total assets Book leverage = Book debt
Market leverage is defined as the ratio of the book value of debt to the combined total of the book value of debt and the market value of equity This metric is calculated using the formula: Market Leverage = Book Debt / (Book Debt + Market Equity) Understanding market leverage is essential for assessing a company's financial structure and risk profile.
Total assets − Book equity + Market equity
Five The percentage of block-holder holdings (at least 5 percent of shareholdings) Five = Shareholdings of beneficial investors
Board size The number of directors on the boards Board size = Ln (Board size)
Director age The logarithm of median age of director on the board Director age = Ln (Median director age)
CEO-Chairman duality The variable is a dummy variable that equals to 1 when CEOs are also the chairman and 0 as CEOs are not the chairman
CEO-Chairman duality = 1 if CEO is chairman; 0 otherwise
Board composition The percentage of number of outside directors on the board Board composition = Number of outside directors on the board
CEO age The logarithm of CEO age CEO age = Ln (CEO age)
Financial deficit The ratio between the sum of investment (I), dividends (DIV), changes in working capital (ΔWC), and net of cash flow (CF) divided by total assets
Financial deficit (FD) = Investment+Dividends+∆Working capital−Cash flow
Yearly timing The yearly timing is the covariance between financial deficit and market-to-book ratio
Yearly timing (YT) = ∑ t−1 FD ∗ (M/B) s s=0 ⁄ − FD t ̅̅̅̅ ∗ M/B ̅̅̅̅̅̅ = Cov (FD, M/B)
Long-term timing The long-term timing is formed by comparing one firm’s market-to- book ratio to another firm
Long-term timing (LT) = ∑ t−1 s=0 (M/B) s /t ∗ ∑ t−1 s=0 FD s ⁄ t = M/B ̅̅̅̅̅̅ ∗ F/D ̅̅̅̅̅