INTRODUCTION
Problem statement
Corporate governance principles establish a framework that enables firms to achieve their objectives and manage performance effectively This framework encompasses the interactions among management, the board, and shareholders Research indicates that robust corporate governance enhances firm success by minimizing agency conflicts and optimizing capital structure, thereby fostering better management and financial outcomes.
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, shielded from corporate governance disciplines, prioritize their interests over those of shareholders, potentially leading to increased leverage Jensen and Meckling (1976) argue that entrenched managers may raise debt levels beyond optimal limits to mitigate takeover risks and secure their positions, while Qi and Wald (2008) note that stronger anti-takeover measures correlate with higher leverage ratios Conversely, Welch (2004) suggests that entrenched managers, after benefiting from substantial stock returns, may prefer issuing equity over debt, resulting in lower debt ratios Additionally, John et al (2008) highlight that managers often pursue conservative investment strategies to avoid severe financial distress, further contributing to reduced leverage.
The relationship between managerial entrenchment and market timing behavior regarding leverage ratios remains underexplored Market timing is significantly influenced by managers' financing decisions, impacting whether companies opt for debt or equity to fund investment opportunities Therefore, this study aims to simultaneously analyze managerial entrenchment and market timing behavior.
Entrenched managers tend to reduce debt levels and make cautious investment choices to avoid bankruptcy, which can effectively mitigate takeover threats (Zwiebel 1996) However, this aversion to debt may prevent firms from benefiting from low-cost financing options like tax shields When external financing needs arise, these managers are more inclined to issue significant equity, especially when market conditions appear favorable (Graham and Harvey 2001) This behavior aligns with market timing theory, suggesting that a firm's capital structure reflects past efforts to time the equity market (Baker and Wurgler 2002) Research by Kayhan and Titman (2007) indicates that a firm's history, including financial deficits and stock price performance, plays a vital role in shaping its leverage ratio through market timing behavior.
In Vietnam, there is a scarcity of research examining the impact of managerial entrenchment and market timing effects on firms' leverage ratios, despite the application of trade-off and pecking order theories in existing studies like Vo and Tran (2015) The nascent stage of Vietnam's securities market contributes to information asymmetry and agency problems, hindering firms' ability to accurately estimate stock prices and determine optimal leverage levels Nguyen (2015) highlighted both short-term and long-term market timing effects on leverage for Vietnamese IPO firms, noting that sector value deviations and past stock prices significantly influence equity issuance and market timing However, this study overlooked the roles of managerial entrenchment and firms' histories Therefore, this paper aims to fill the empirical gap regarding these critical factors within the Vietnamese context.
Research objectives
This study examines how managerial entrenchment and market timing influence leverage ratios, considering the historical context of firms The research is guided by four primary objectives aimed at understanding these dynamics.
(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 the impact of managerial entrenchment on leverage ratios in Vietnamese firms, comparing both high and low entrenchment regimes and considering the firms' historical contexts Unlike previous research, this analysis uniquely focuses on the interplay between managerial entrenchment and leverage, highlighting the distinct characteristics of Vietnam's corporate landscape.
For the first time in Vietnam, this study examines the impact of managerial entrenchment and market timing effects on 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 LeastSquares (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 of 289 non-financial firms from the Ho Chi Minh Stock Exchange (HOSE) covering the period from 2006 to 2015 The secondary data was sourced from various platforms, including annual reports, financial statements, and information available on websites such as cafef.vn, cp68.vn, and vietstock.vn Financial firms 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 establishes the research hypotheses and outlines the conceptual framework that influences 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 serve as a vital framework for companies to achieve their objectives and enhance performance through effective management, board, and shareholder interactions Strong corporate governance is essential for reducing agency conflicts and optimizing capital structure, ultimately promoting firm success in both management and finance Additionally, these principles provide policymakers with effective tools to foster economic growth and ensure financial stability.
Corporate governance principles do not offer a one-size-fits-all model for countries; instead, they integrate common elements from diverse corporate structures These principles present various objectives and methods for establishing effective corporate governance This flexibility allows management to create tailored governance frameworks that align with the expectations of 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?
Hart (1995) identifies two key factors contributing to corporate governance issues: the agency relationship, which highlights the conflict of interest between owners and management, and agency costs, which arise from this conflict and are not mitigated by 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 mitigate these conflicts and benefit significantly Establishing strong connections with capital flows from developed countries allows for the adoption of widely accepted corporate governance agreements that align with international standards Effective supervision and mechanisms foster trust among shareholders and debtholders, leading to a reduced cost of capital and enhanced wealth for both owners and management, ultimately creating a mutually beneficial relationship.
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 context, shareholders and debtholders act as principals, while top managers serve as agents tasked with making decisions that aim to maximize owners' wealth However, the interests of the principals may not always align with the actions of the agent due to the inherent utility-maximizing nature of their relationship.
To safeguard their interests, principals implement incentives to curb the agent's abnormal behaviors, primarily by promoting increased managerial ownership This rise in ownership compels managers to prioritize shareholders' wealth over personal gains However, with significant power, managers may become entrenched, evading replacement or punishment from the principals This entrenchment often leads managers to exploit their position, manipulating investment opportunities to secure their own well-being (Morck, Shleifer, and Vishny 1988).
Debt financing serves as a significant deterrent against managers' tendencies to pursue empire-building, as it introduces the risk of bankruptcy (Grossman and Hart 1982; Jensen 1986; Hart 1995) This financial pressure compels managers to efficiently manage cash flows and diligently oversee investment projects to ensure sufficient cash generation for future interest and principal payments.
Signaling theory posits 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 about investment opportunities, leading outsiders to seek information from various sources However, access to the true value of a firm's investments is often restricted, necessitating verification of information reliability Consequently, shareholders and debtholders may be affected by financing changes initiated by insiders For instance, an increase in debt levels signals to outsiders an expectation of high future cash flows, while financing through new equity issuance suggests a decline in firm performance, resulting in shared losses with new investors Thus, outsiders interpret managers' confidence in future performance as linked to increased leverage.
In their influential 1976 study on corporate governance, Jensen and Meckling emphasize that capital structure theory is synonymous with ownership structure They argue that key proxies for capital structure extend beyond just the totals of debt and equity; they also include the equity held by managers Consequently, three primary determinants of capital structure are identified to effectively illustrate this theory for firms of a specific size.
The total market value of the equity is calculated as:
� = � � + � 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 value is influenced by agency costs, with a constant firm size and a distinction between actual value (V) and the theoretical value (V*) when agency costs are absent Additionally, the total amount of outside financing, represented as (B + S0), remains unchanged, while the optimal equity fraction of outside financing is determined.
0 FRACTION OF OUTSIDE FINANCING OBTAINED FROM EQUITY
The optimal ratio of outside equity to debt is determined by analyzing total agency costs, represented as a function of outside equity For a given firm size, total outside financing is denoted as E, where the costs associated with outside equity are minimized at total agency costs A V ∗ The optimal fraction of outside financing occurs at E (E), while the agency costs related to debt are expressed as 0 0 ⁄(B + S) Understanding these relationships is crucial for effective financial management and optimizing capital structure.
Figure 2.1 illustrates two key components of agency costs: (i) total agency costs associated with equity held by the owner-manager, represented as A S 0 (E), and (ii) total agency costs related to debt, denoted as A B (E) Overall, the total agency cost encompasses both of these factors.
A T (E) = A S 0 (E) + A B (E) The agency costs related to the amounts of equity held by the owner-manager is
When S 0 equals zero, it indicates a lack of outside equity If the total equity differences correspond to an increase in equity held by outside investors, managers may be incentivized to exploit this external equity minimally, which can lead to an increase in agency costs A S 0 (E).
Agency costs associated with debt financing, denoted as A B (E), include the reduction in the firm's value and the monitoring expenses incurred when wealth is reallocated from bondholders to managers to enhance equity value These agency costs reach their peak when external funding is entirely sourced from debt, resulting in S 0 = E 0 Conversely, when all external funding is derived from equity, agency costs are minimized.
When the level of debt approaches zero, agency costs are minimized, leading to a decline in managers' motivations to reallocate wealth from bondholders This is due to two main factors: first, with no debt available, there is nothing to shift from debtholders to managers; second, as equity increases, the manager's total equity significantly decreases The overall agency costs, which include both outside equity and debt financing, can be represented by the equation i/(S₀ + Sᵢ) The curve Aₜ(E) illustrates that the total agency costs reach their lowest point for a given firm size at Aₛ₀(E) and Aᵦ(E), while the optimal level of outside financing through equity, Aₜ(E), is achieved at a specific combination of debt and equity.
2.1.4 Managerial entrenchment and capital structure decisions theory
Empirical evidence
2.2.1 The influence of managerial entrenchment on leverage ratio
Research indicates a positive correlation between managerial ownership and leverage ratios, suggesting that higher managerial ownership can lead to increased debt levels to mitigate agency costs associated with equity issuance (Kim & Sorensen, 1986; Stulz, 1988) Supporting this, Agrawal and Mandelker (1987) found that managers with significant ownership are more inclined to accept financial distress by raising debt ratios Furthermore, John and Litov (2010) discovered that entrenched managers, who have better access to debt markets, tend to increase their firms' leverage ratios Additionally, Bin-Sariman, Ali, and Nor (2016) argue that managerial entrenchment positively influences debt ratios, particularly in relation to the quality of the board of directors.
Research by Friend and Lang (1988), Bathala, Moon, and Rao (1994), and Chen and Steiner (1999) indicates that higher managerial ownership in firms leads to a decrease in debt ratios, as managers are wary of increasing financial risk Additionally, findings from Berger, Ofek, and Yermack support this relationship.
(1997), Becht, Bolton and Rửell (2003), Hermalin and Weisbach (2003), Holderness
Research by Novaes and Zingales (2003) and Kayhan (2008) indicates that entrenched managers often reduce debt ratios when stock prices rise due to market timing effects This trend is further supported by Ganiyu and Abiodun (2012), who found a negative impact of managerial entrenchment on leverage ratios in listed firms in Nigeria, as well as similar findings in China by Wen, Rwegasira, and Bilderbeek (2002) and Quang and Xin (2013).
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 determining a firm's hierarchy and the effects of market timing Specifically, financial deficit refers to the net balance of a company's issued and repurchased debt and equity within a given year.
According to the pecking order theory proposed by Myers (1984), Myers and Majluf (1984), and Shyam-Sunder and Myers (1999), firms facing high financial deficits or low free cash flow tend to increase their external capital and leverage Conversely, when firms have sufficient free cash flow, their leverage tends to decrease as they utilize retained earnings to address financial deficits and pay down debt However, Frank and Goyal (2003) challenge this theory by demonstrating that both large and small firms are significantly influenced by financial deficits, leading them to prefer equity issuance over debt financing.
Market timing influences managerial preferences for financing, as noted by Baker and Wurgler (2000), Kayhan and Titman (2007), and Kayhan (2008), who argue that managers favor equity over debt when they believe they can capitalize on favorable equity market conditions, leading to reduced debt financing Additionally, Law and Chong (2011) highlight that financial deficits adversely impact the leverage ratios of Thai firms.
2.2.2.2 Market timing and Leverage ratio
A timing measure indicates that companies are more likely to finance their growth through equity rather than debt, particularly when stock prices rise (Baker and Wurgler, 2002).
According to the research by Baker and Wurgler (2002), Kayhan and Titman (2007) identify two distinct types of timing measures that emphasize the importance of 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 lead to increased funding due to short-term overvaluation, as reflected in the current market-to-book ratio compared to previous years In contrast, the long-term timing measure evaluates the market-to-book ratio not only in relation to a firm's historical ratios but also in comparison to those of all firms within the market.
Seyhun (1986, 1990) and Liu (2009) utilize insider sales as a unique market timing metric, calculated by the ratio of net volume from secondary share offerings to the total shares outstanding at the year's end.
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 findings from Hovakimian, Opler, and Titman (2001) and 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 affect 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 of previous years serves as a proxy for market timing Their findings suggest that firms experience a decrease in leverage ratio when they benefit from elevated 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 maintain their positions In situations where the consequences for underperformance are more severe, these managers tend to lower debt levels to mitigate the risk of hostile takeovers.
Jung, Kim, and Stulz (1996) reveal that firms prioritize equity issuance over debt financing when faced with poor investment opportunities Their research indicates that firms that issue equity possess greater investment capacity than those that rely on debt Consequently, they conclude that entrenched managers often opt for equity issuance, driven by significant agency costs, despite the potential for improved firm value through debt financing.
Research by Berger, Ofek, and Yermack (1997), Kayhan and Titman (2007), and Kayhan (2008) indicates that a decrease in debt ratio is influenced by the managerial entrenchment effect This phenomenon suggests that managers may utilize debt financing as a means to shield themselves from performance pressures, mitigate risks associated with limited investment diversification, and extend their tenure within the firm.
Hypothesis 1 There is a negative relationship between managerial entrenchment and leverage ratio.
2.3.1.1 Block-holder holdings and Leverage ratio
Beneficial ownership, defined as block-holder holdings of at least 5 percent, plays a significant role in corporate governance Block-holders, as representative owners, can greatly influence managerial decisions, including leverage ratios and the degree of managerial entrenchment (Grossman and Hart 1980; Shleifer and Vishny 1986) However, they may also align with managers against the interests of minority investors (Becht, Bolton, and Rüell 2003) Additionally, the strong presence of block-holders often does not correlate with critical corporate decisions, further entrenching management (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) suggests that larger board sizes positively influence leverage ratios, as these boards are more inclined to increase debt to enhance corporate value However, in cases of significant agency conflicts, managers may become entrenched and engage in free-riding, which diminishes the effectiveness of larger boards in managing financing decisions and leverage ratios, as noted by Yermack (1996) Additionally, findings from Berger, Ofek, and Yermack (1997) and Kayhan further explore these dynamics.
(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 are more prone to increased managerial entrenchment, leading to less effective monitoring and higher CEO turnover (Berger, Ofek, and Yermack, 1997; Vafeas, 2003) Additionally, older directors often resist increasing debt ratios, prioritizing their own interests over the company's financial strategies (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 chairman position, they often make financing and leverage decisions without oversight, resulting in increased managerial entrenchment This lack of control can adversely affect financing choices Research by Berger, Ofek, and Yermack, along with studies by Kayhan and Ganiyu and Abiodun, indicates that the dual role of CEO and chairman negatively impacts the leverage ratio.
Hypothesis 5 The duality role of managers negatively impacts leverage ratio.
2.3.1.5 Board composition and Leverage ratio
According to Hermalin and Weisbach (2003), limited access to firm information for outside directors contributes to increased managerial entrenchment Their research indicates that a higher number of outside directors on the board correlates with greater CEO entrenchment in leverage decisions (Hermalin and Weisbach 1988; Hermalin and Weisbach 2003) Additionally, to mitigate the scrutiny from outside directors, managers tend to reduce the leverage ratio, thereby minimizing the pressure from substantial fixed interest obligations (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
Experienced older CEOs holding dual positions significantly influence management dynamics, enhancing their negotiating power with the board and reducing their susceptibility to evaluation These leaders are inclined to limit increases in leverage ratios to navigate corporate governance challenges and solidify their tenure.
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
Pecking order theory, as proposed by Myers (1984), Myers and Majluf (1984), and Shyam-Sunder and Myers (1999), suggests that firms increase external capital to address financial deficits or free cash flow shortages, resulting in higher leverage Conversely, when firms have sufficient free cash flow, their leverage tends to decrease as they utilize retained earnings to cover deficits and repay debt In contrast, Frank and Goyal (2003) argue that both large and small firms are significantly influenced by financial deficits when it comes to equity issuance over debt financing Additionally, Baker and Wurgler (2000), Kayhan and Titman (2007), and Kayhan (2008) highlight the market timing effect, indicating that managers often prefer equity over debt for raising external capital, allowing them to capitalize on favorable equity 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, Baker and Wurgler (2000) informed Kayhan and Titman's (2007) distinction between two types of timing measures related to financial deficits: yearly and long-term timing The yearly timing measure focuses on the covariance between total financial deficit or external finance and the market-to-book ratio, indicating that equity issuance capitalizes on short-term overvaluation based on the current market-to-book ratio compared to previous years Conversely, the long-term timing measure assesses the market-to-book ratio in relation to both a firm's historical performance and that of all firms in the market, where an increasing market-to-book ratio signals enhanced growth opportunities Consequently, debt financing is preserved for future needs, emphasizing the strategic use of external financing (Law and Chong 2011).
Liu (2009) utilizes insider sales as a market timing measure, calculated by the percentage of net volume from secondary share offerings relative to total shares outstanding at year-end The insider sales variable represents the difference between selling and purchasing shares, with repurchased shares typically occurring during stock price increases, while selling shares is more common when prices rise (Seyhun 1986) Seyhun (1990) indicates that insider sales enable top managers to achieve approximately a 3 percent return on their transactions Consequently, as stock prices rise, insider trading activity among managers increases, suggesting 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), indicating that high stock prices often lead to increased equity issuance Conversely, falling stock prices typically prompt companies to repurchase shares, which decreases their leverage ratio Additionally, research by Kayhan and Titman (2007), Kayhan (2008), and Law and Chong (2011) shows that the disparity between one-year stock returns and prior years' returns serves as a market timing proxy, concluding that firms reduce their leverage ratio when benefiting from elevated market stock returns.
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 substantial profits and cash flow, leading them to use retained earnings to reduce debt and lower leverage ratios Myers (1984) also highlights the significance of financial distress and interest tax shields, while Auerbach (1979) notes that personal-level taxes on profit distributions diminish the benefits of dividend payouts for shareholders To optimize tax efficiency, firms often negotiate with shareholders to retain dividends for reinvestment, further decreasing their debt ratios Additionally, research by Hennessy and Whited (2005), Strebulaev (2007), Titman and Tsyplakov (2007), and Frank and Goyal (2009) demonstrates that taxes on profit distributions negatively impact debt ratios, suggesting 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 desired target leverage, indicating that firms with lower leverage ratios are likely to increase debt, while those with higher ratios may reduce it Additionally, changes in target leverage reflect the difference between the current and previous target leverage ratios, as noted by Kayhan and Titman (2007) and 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.
• Leverage ratio includes the book leverage ratio and the market leverage ratio.
Analytical framework
This study presents a conceptual framework that simultaneously examines the influence of managerial entrenchment and the historical context of firms on their leverage ratios.
Figure 2.2 Analytical framework The relationship between management entrenchment, firms’ histories and leverage.
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 integrated into the Law on Enterprises 2005 (Law No 60/2005/QH11) While these principles have been effectively translated and applied, there remain significant legal gaps that need to be addressed The issues of ownership structure separation and uncertainty, along with a lack of transparency in financial information, continue to hinder progress in corporate governance.
The corporate governance assessments in Vietnam conducted in 2006 and 2013 highlighted several critical issues: first, the institutions' capabilities and resources are insufficient to effectively regulate and develop the market; second, investors and shareholders face significant barriers to institutional protection; and third, management restricts investors' access to information regarding agency conflicts.
In 2010, the Baseline Report on Vietnam's corporate governance scorecard revealed that the corporate governance practices of the 100 largest listed companies in the country were 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 and both primary and secondary legislation Vietnamese enterprises are required to adhere to these legal standards to ensure effective governance practices.
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 unclear and inconsistent While the General Meeting of Shareholders (GMS) has the authority to select and dismiss board members under the Law on Enterprises 2005, it lacks the ability to initiate class action lawsuits against boards in cases of severe shareholder conflict This gap in the law, not addressed in the 2005 legislation, leaves minority shareholders vulnerable, particularly as larger shareholders with political ties often evade legal consequences Consequently, the existing laws fail to effectively address agency conflicts, allowing larger shareholders to prioritize their interests over those of minority shareholders.
Vietnamese firms often exhibit poorly designed corporate governance structures, which limits shareholders' ability to self-regulate Additionally, the principles of corporate accountability have not evolved sufficiently to adapt to the rapidly changing business environment (Minh and Walker, 2008).
The corporate charter is essential for establishing corporate governance in Vietnamese firms, outlining key aspects such as objectives, structure, and operations It emphasizes minority shareholder protection more than the Law on Enterprises 2005 However, many corporate charters in Vietnam are similar and adhere to the Model Charter 2007 set by the Ministry of Finance, leading to weak enforcement and continued neglect of minority shareholder rights (Freeman and Nguyen 2006).
3.1.2 The background of Vietnam’s securities market
The economic renovation known as Doi Moi in 1986 prompted Vietnam to establish a market-oriented economy and develop a securities market In November 1996, the State Securities Commission (SSC) was created as the primary regulator for capital markets, overseeing market intermediaries and public enterprises under Decree No 48/1998/ND-CP Governed by the Law on Securities 2006, the SSC supervises the Ho Chi Minh Stock Exchange (HOSE) and Hanoi Stock Exchange (HNX), and, in collaboration with the Ministry of Finance, it also sets corporate governance principles and charters for public companies.
These statements contribute to the establishment of a comprehensive securities regulatory framework, as outlined by Nguyen and Eddie (2003) and further supported by reports from the International Finance Corporation and the State Securities Commission of Vietnam in both 2006 and 2013.
The growth of the Vietnamese securities market faces several challenges despite initial successes in implementing a securities administration system Key issues include the need for a broader range of equity and debt instruments, enhanced transparency in financial information, and improved education for both investors and SSC staff Additionally, the technology infrastructure of the two Securities Trade Centers requires upgrades, and the market's scale does not align with the country's development potential due to the absence of major industries Furthermore, securities companies have struggled to effectively serve as intermediaries between individual and enterprise capital needs, while a small group of influential investors manipulates a significant number of shares, increasing market vulnerability.
Established in 2000, the Ho Chi Minh Stock Exchange (HOSE) began with only two listed companies, marking a modest start Despite its initial limitations, HOSE has become a significant symbol of Vietnam's financial landscape It attracts more attention than the Hanoi Stock Exchange, as companies listed on HOSE are generally larger and receive greater foreign investment Furthermore, firms seeking to list on HOSE must meet stricter 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-driven economy.
The gradual growth of the securities market is closely linked to advancements in market infrastructure and the overall financial market Well-organized securities market structures are essential for supporting a developing economy and financial markets Ultimately, a robust securities market contributes to ensuring stability for future growth (Nguyen and Eddie 2003).
Data sources
This study analyzes a dataset comprising 289 non-financial firms from the Ho Chi Minh Stock Exchange (HOSE) over the period from 2006 to 2015 The secondary data is sourced from various materials, including annual reports, financial statements, and official company information from websites like cafef.vn, cp68.vn, and vietstock.vn Financial firms, such as banks, insurance companies, and investment funds, were excluded from the sample due to their distinct capital structures, which differ significantly from those of non-financial firms.
Research methodology
There are three parts of analysis in this section First, by using the Ordinary Least
The two-stage Ordinary Least Squares (OLS) method is utilized to establish the target leverage level and estimate key independent variables, including leverage deficit and changes from the target leverage This approach quantifies the impact of managerial entrenchment and the historical context of firms on their leverage ratios Additionally, the Generalized Method is employed to enhance the analysis.
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.
: 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 determined using the predicted values derived from Ordinary Least Squares (OLS) regression analysis This analysis incorporates 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 analyzes the impact of managerial entrenchment on firms' leverage ratios using Ordinary Least Squares (OLS) and Generalized Method of Moments (GMM) Following the frameworks established by Kayhan and Titman (2007) and Kayhan (2008), the regression model incorporates two dependent variables: book leverage ratio and market leverage ratio It also examines three sets of independent variables, which include pecking order theory (financial deficit and profitability), market timing theory (annual timing, long-term timing, and stock returns), and trade-off theory (leverage deficit and changes in target leverage).
The model which is applied to estimate the impact is performed as follows.
� 9 �������� ����� + � � � 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 are categorized into book leverage and market leverage Book leverage measures the ratio of book debt to total assets, reflecting a historical perspective on a company's debt relative to its assets In contrast, market leverage assesses the ratio of the book value of debt to the combined book value of debt and market value of equity, offering a forward-looking view by relating total debts to the market firm's value According to Barclay et al (2006) and Florackis and Ozkan (2009), this distinction highlights the different implications of each leverage type in assessing financial health.
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 their significant presence can greatly influence managerial decisions, helping to control and mitigate 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 Companies with boards dominated by older directors often experience increased managerial entrenchment, which can lead to diminished oversight Vafeas (2003) highlights that such older boards may struggle with effective monitoring, resulting in a higher turnover rate among CEOs.
Director age = Ln (Median director age)
CEOs who also hold the position of chairman often make financing and leverage decisions with fewer restrictions, which can result in increased managerial entrenchment (Goyal and Park, 2002) This relationship is represented as a dummy variable, where a value of 1 indicates that the CEO is also the chairman, while a value of 0 signifies that the CEO does not hold the chairman position.
CEO-Chairman duality = 1 if CEO is chairman; 0 otherwise
The composition of a board significantly influences corporate governance, with a higher percentage of outside directors correlating with reduced CEO entrenchment in leverage decisions Research by Hermalin and Weisbach (1988, 2003) indicates that an increased presence of outside directors on the board enhances oversight and mitigates the potential for entrenched CEO behavior.
Older CEOs, with their extensive experience and established reputations, tend to exert a significant influence on internal control mechanisms This age advantage provides them with greater bargaining power in negotiations with the board and makes them less susceptible to scrutiny, as highlighted by Berger, Ofek, and Yermack (1997).
CEO age = Ln (CEO age)
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(2008).
Firms tend to raise equity when stock prices are rising and opt for debt when prices are falling, as highlighted by Baker and Wurgler (2002) Timing measures, which include the yearly timing measure (YT) and the long-term timing measure (LT) as described by Kayhan and Titman (2007), assess this behavior The yearly timing measure evaluates the covariance between a firm's financial deficit and its market-to-book ratio, while the long-term timing measure compares the market-to-book ratios of different firms.
Insider sales, a key alternative timing measure, is calculated as the ratio of the difference between shares sold and shares repurchased to the total number of shares at the end of the year This variable serves as a reliable short-run market timing proxy, as supported by research from Seyhun (1986, 1990), Lee (1997), and Liu (2009) The data for insider trading is sourced from all buy and sell transactions executed by top executives, including CEOs and chairpersons.
�= published in websites cafef.vn and vietstock.vn.
Stock returns are measured by logarithm of the difference between share price in the end (P1) and the beginning of one financial year (P0) plus dividends
(DIV) divided by share price in the beginning of the year (P0).
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 When a firm has lower leverage ratios than its target, it is likely to increase its debt ratios, while a company with higher leverage ratios tends to decrease its debt levels Understanding leverage deficit is crucial for firms aiming to optimize their capital structure.
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) =
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 The market leverage is the ratio of book value of debt to the sum of the book value of debt and the market value of equity.
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.
Yearly timing The yearly timing is the covariance between financial deficit and market-to-book ratio.
Long-term timing The long-term timing is formed by comparing one firm’s market-to-
Financial deficit (FD) = Investment+Dividends+∆Working capital−Cash flow
Yearly timing (YT) = ∑ t−1 FD ∗ (M/B) s ⁄t − F̅̅̅D̅ ∗ M̅̅̅/̅̅B̅ = Cov (FD, M/B) Long-term timing (LT) = ∑ t−1 (M/B) s /t ∗ ∑ t−1 FD ⁄t = M̅̅̅/̅̅B̅ ∗ F̅̅/̅̅D̅ book ratio to another firm s=0 s=0 s
Insider sales refer to the ratio calculated by taking the difference between the number of shares sold and the number of shares repurchased, divided by the total number of shares outstanding at the end of the year This metric is expressed as Insider sales t = (Number of selling shares - Number of repurchased shares) / Total shares at year-end Understanding insider sales is crucial for investors as it provides insights into the trading behavior of company executives and can indicate their confidence in the company's future performance.
Number of shares at the end of a fiscal year t
Stock returns can be calculated using the logarithm of the difference between the ending share price (P1) and the starting share price (P0) for a financial year, adding any dividends (DIV), and then dividing by the initial share price (P0).
Profitability The sum of earnings before interest, and taxes (EBIT) divided by total assets.
Leverage deficit The difference between the realized leverage from its target leverage Leverage deficit (LDEF) = L i,(t−n) − L i,(t−n)
Change in target leverage The difference between the current target leverage ratio and the previous target leverage ratio Change in target leverage (ΔTARGET) = L it i,(t−n)
Industry dummy Vietnam standard industry codes Vietnam standard industry codes (VSIC) s=
3.3.2 The Generalized Method of Moments (GMM)
THE EMPIRICAL RESULTS
Data descriptions
Table 4.1 summarizes the descriptive statistics of sample mentioned in the study.
On average, book leverage stands at 45.20 percent, while market leverage is higher at 55 percent This book leverage ratio is comparable to that of Chinese companies (44.57 percent), Thai enterprises (44.36 percent; 42.79 percent), and U.S firms (46.10 percent; 47.50 percent) However, it significantly exceeds the leverage ratios of Dutch firms (8.00 percent) and listed companies in the Asia-Pacific region, including Australia (18.56 percent), Malaysia (26.97 percent), and Singapore (24.01 percent).
Vietnamese firms exhibit a significant reliance on debt financing, with a market leverage ratio of 16.79 percent (Florackis, 2009), which is notably lower than that of companies in the US (35.60 percent - Kayhan, 2008; 39.50 percent - Liu, 2009), Thailand (43.59 percent - Law and Chong, 2011), and the Netherlands (7.50 percent - De Jong and Veld, 2001) This reliance highlights the need to investigate the impact of managerial entrenchment and historical factors on the leverage ratios of Vietnamese companies.
The managerial entrenchment effect reveals that the average age of a CEO in a board of directors is 47, with 38.30 percent of boards exhibiting CEO-Chairman duality Typically, a board consists of 9 directors, including 2 outsider directors averaging 44 years in age Additionally, block-holders significantly impact board decisions, controlling 48 percent of the total shares.
Firm characteristic determinants play a crucial role in three distinct capital structure theories In the pecking order theory, financial deficits account for 29.60%, significantly higher than the figures for US firms, which are 7.52% (Frank and Goyal 2003), 2.00% (John and Litov 2010), and 4.73% (Ogden and Wu 2012) Additionally, the market-to-book ratio indicates that an increase in total assets corresponds to a rise in both book and market debt ratios, contributing 70.60% Book profitability (EBIT book) represents 8.30%, while profitability in market scale (EBIT market) accounts for 15.40% In market timing theory, yearly timing and long-term timing variables contribute 10.90% and 16.50%, respectively, whereas insider sales only account for 3.80% The average one-year stock returns stand at 8.30%, closely aligning with the US firms' average of 8.80% (Welch).
In contrast to the negative impact observed in Thai companies, which reported a decrease of -11.97 percent (Law and Chong, 2011), the trade-off theory reveals that the average book leverage deficit is -2.50 percent, while the market leverage deficit stands at -9 percent Additionally, there is a significant change in target leverage, with book target leverage increasing by 47.70 percent and market target leverage experiencing a change of 63.90 percent.
Table 4.1 Descriptive statistics The sample comprises 289 listed companies in Ho Chi Minh Stock Exchange from 2006 to 2015.
Variables Measurement Obs Mean Std Dev Min Max
Total assets − Book equity + Market equity
Block-holder holdings Shareholdings of beneficial investors 2890 0.480 0.218 0.050 2.136
Board size Ln (Board size) 2890 9.584 4.078 3 34
Director age Ln (Median director age) 2890 44.342 6.564 26 62
CEO-Chairman duality CEO-Chairman duality = 1 if CEO is chairman; 0 otherwise 2890 0.383 0.486 0 1
Board composition Number of outside directors on the board 2890 2.444 2.376 0 11
CEO age Ln (CEO age) 2890 47.585 7.916 24 72
Financial deficit Investment + Dividends + ∆Working capital − Cash 2890 0.296 1.383 -42.821 47.978
Insider sales Number of selling shares � − Number of repurchased 2890 0.038 0.940 -33.156 23.021
One-year stock returns fiscal year Number of shares at the end of a t P 1 − P 0 + DIV
Book leverage deficit Book debt + Market equity Target i,(t−n) L i,(t−n) − L Book 2890 -0.025 0.197 -0.571 0.874 Market leverage deficit
Selling expense Selling expense Sales
Book target leverage change L Book Target − L Book Target 2890 it i,(t−n) 0.477 0.136 0.033 0.864
Market target leverage change L Market Target
Market-to-book Total assets − Book equity + Market equity 2890 1.706 0.817 0.001 14.022
Total assets Net property, plant and equipment 2890 0.129 0.111 0 0.500
Research and development Research and development Total assets 2890 0.079 0.388 0 12.917
Table 4.2 highlights the factors contributing to managerial entrenchment, including the presence of block-holders' shareholdings, board size, the age of board directors, CEO-Chairman duality, the number of outside directors, and CEO age It indicates that larger boards tend to have a higher proportion of outside directors (0.505) and block-holders (0.107) Additionally, the data shows that older CEOs (0.307) are often designated as both CEO and Chairperson (0.151) simultaneously.
Table 4.2 Correlation among managerial entrenchment proxies Table 4.2 presents the correlation among the managerial entrenchment variables.
Five Board size Director age Duality Outside director CEO age
In Table 4.3, the correlation between the book and market leverage ratio, the managerial entrenchment effect and the firm characteristics is displayed.
A larger board comprised of older directors and more outside members, along with a senior CEO serving as chairperson, leads to an increase in the book leverage ratio Conversely, this same large board structure negatively impacts the market leverage ratio, resulting in lower debt levels and a greater reliance on equity issuance to finance investments.
According to the pecking order theory, managers prioritize retained earnings from profits to satisfy investment needs, viewing debt and equity financing as secondary options This approach allows firms to utilize profits to reduce debt and alleviate financial distress, leading to a decrease in leverage Consequently, there is an inverse relationship between financial deficit and profitability (EBIT) with the leverage ratio.
Market timing theory suggests that when stock prices rise, companies prefer equity issuance over debt financing as a means of raising funds This approach leverages stock overvaluation to optimize external capital acquisition Additionally, the pecking order theory connects to market timing through the concepts of market-to-book ratios and both yearly and long-term timing assessments, with yearly timing specifically evaluated by comparing these ratios.
The current market-to-book ratio of firms is assessed in relation to previous years, while long-term comparisons between firms highlight growth opportunities An increasing market-to-book ratio indicates favorable growth prospects and helps reduce financial deficits Consequently, managers tend to favor equity issuance over debt, preserving borrowing capacity for future needs.
The trade-off theory highlights the dilemma firms face regarding the benefits and drawbacks of debt when addressing financial deficits To mitigate bankruptcy risks, managers often reduce the debt ratio as financial deficits rise Leverage deficit, defined as the gap between actual and target leverage, shows a negative correlation with the leverage ratio; thus, an increase in leverage deficit results in a decreased leverage ratio Additionally, changes in target leverage indicate how quickly the observed leverage ratio adjusts beyond its intended target.
Table 4.3 Correlation among managerial entrenchment, firms’ histories and firms’ leverage ratio
This Table 4.3 describes the correlation between leverage ratios and the firm characteristics and the managerial entrenchment variables.
Variables Book leverage Market leverage
To provide a visual view of the relationship between managerial entrenchment and firm characteristics to the book leverage and market leverage ratio, Figure 4.1, Figure 4.2, and Figure 4.3 are represented.
Figure 4.1 illustrates the relationship between managerial entrenchment and both book and market leverage ratios In terms of book leverage, factors such as the presence of block-holders, board size, and the age of the CEO and directors, along with CEO-Chairman duality, contribute to a higher level of entrenchment, positively impacting the book leverage ratio Conversely, the size of the board and the age of the CEO and directors negatively affect the market debt ratio.
Financial deficit, profitability, and leverage deficit negatively impact leverage ratios, as illustrated in Figure 4.2 Companies tend to rely on retained earnings from profits rather than external debt to mitigate financial deficits, which leads to a leverage deficit—where the actual leverage significantly exceeds the desired target ratio.
Figure 4.3 illustrates a strong correlation between market timing proxies and leverage ratios, indicating that yearly and long-term timing measures, along with insider sales and stock returns, significantly contribute to a decrease in debt ratios.
,000 -,020 -,040 -,060 -,080 -,100 -,120 Yearly timingLong-termInsider sales Stock return timing
Figure 4.1 Managerial entrenchment effect The correlation of managerial entrenchment and leverage ratios is displayed by graph.
Figure 4.2 Firm characteristics The correlation of firm characteristics and leverage ratios is illustrated by graph.
Figure 4.3 Market timing effect The correlation of market timing and leverage ratios is presented by graph.
4.2 The target leverage ratio estimation
Table 4.4 illustrates the estimation results of the target leverage ratio, revealing that the signs of the estimated variables align in both book leverage and market leverage ratios, with exceptions noted for market-to-book and selling expenses It is suggested that the sensitivities of the market-to-book ratio to leverage ratios are influenced by market timing effects, where an increase or decrease in the market-to-book ratio corresponds to reduced or increased debt issuance Additionally, the negative relationship between profitability (EBIT) and book leverage supports the pecking order theory, indicating that firms prioritize using internal funds to finance their projects.
The influence of managerial entrenchment effect and firms’ histories on
histories on Vietnam firms’ leverage ratio
4.3.1 The choosing of time period (t-n) – lag order selection for the model specification
The model can be presented as below.
L it − L i(t−n) : Difference in leverage ratio of firm i in year t, t-n,
FD: Financial deficit 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 proxies 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.
Tables 4.5 and 4.6 illustrate the selection of the time period (t-n) for lag order using the Levin-Lin-Chu (2002) test, alongside model selection criteria such as the Akaike Information Criterion (AIC) and Bayesian Information Criterion (BIC).
Table 4.5 presents the qualified lag orders for model specification, revealing that the p-values for lag 1, 2, and 3 are significant at the 1 percent level, while lag 4 is not significant This indicates that only lags 1, 2, and 3 are relevant for the model.
Table 4.5 Levin-Lin-Chu (2002) test
Book leverage Statistic p-value Market leverage Statistic p-value
Table 4.6 presents the model selection criteria, including the Akaike Information Criterion (AIC) and Bayesian Information Criterion (BIC), to identify the suitable lag order A lower value of these criteria indicates a better fit of the time period of variables to the model The bold numbers highlight the optimal information criterion, revealing that a lag order of 3 is the most appropriate choice.
Leverage fluctuations are more effectively observed over extended time periods, necessitating the use of managerial entrenchment proxies and firm histories that span longer durations The primary reason for analyzing these longer horizons is the significant variability in leverage ratios, coupled with the fact that firms often avoid immediate rebalancing of their leverage due to the high costs involved.
Table 4.6 The model selection criteria The model selection criteria includes AIC (Akaike information criterion) and BIC (Bayesian information criterion) Bold numbers denote the best information criterion.
Book leverage AIC BIC Market leverage AIC BIC
4.3.2 Multicollinearity, autocorrelation and heteroskedasticity test
Table 4.7 showcases the multicollinearity analysis through the Variance Inflation Factor (VIF), while Tables 4.8 and 4.9 examine autocorrelation and heteroskedasticity using the Wooldridge test and the Breusch-Pagan/Cook-Weisberg test, respectively.
Table 4.7 demonstrates that the model specifications exhibit no multicollinearity, with the highest Variance Inflation Factor (VIF) recorded at 3.92 for the model using book leverage as the dependent variable and 3.75 for the model utilizing market leverage as the dependent variable.
Table 4.7 Multicollinearity Variance Inflation Factor (VIF).
Variables VIF – Book leverage VIF – Market leverage
The Wooldridge test for autocorrelation in panel data, as shown in Table 4.8, reveals a significant F-statistic with a probability of less than 5 percent, indicating significance at the 1 percent level This result confirms the presence of autocorrelation in the model where book leverage and market leverage ratio serve as the dependent variables.
Table 4.8 Autocorrelation The Wooldridge test for autocorrelation.
Table 4.9 presents the results of the Breusch-Pagan/Cook-Weisberg test for heteroskedasticity, indicating a significant chi-squared value at the 1 percent level, with a probability below 5 percent This suggests clear evidence of heteroskedasticity within the model.
Table 4.9 Heteroskedasticity The Breusch-Pagan/ Cook-Weisberg test for heteroskedasticity.
The endogeneity problem arises when an independent variable is correlated with the error term, leading to biased Ordinary Least Squares (OLS) estimates Financial deficit is identified as an endogenous variable, as a favorable debt market increases external funding and consequently raises financial deficits (Kayhan and Titman, 2007) To assess the endogeneity of financial deficit, the Durbin-Wu-Hausman test is utilized, as illustrated in Table 4.10.
The Durbin-Wu-Hausman test for endogeneity, as shown in Table 4.10, evaluates models with both book leverage and market leverage ratios The null hypothesis posits that the independent variable, financial deficit, is exogenous However, with a Durbin (score) Chi-squared and Wu-Hausman F-statistic probability of less than 5 percent on both sides, the null hypothesis is rejected, indicating that financial deficit is entirely endogenous.
Table 4.10 Endogeneity test The Durbin-Wu-Hausman test for endogeneity.
Durbin (score) Chi-squared 12.372 Durbin (score) Chi-squared 7.076
Prob Chi-squared 0.001 Prob Chi-squared 0.008
4.3.4 Managerial entrenchment effect, firms’ histories and leverage ratio
Table 4.11 illustrates how managerial entrenchment and company histories impact leverage ratios, specifically the debt ratio, through pooled Ordinary Least Squares (OLS) and Generalized Method of Moments (GMM) methodologies The study utilizes book leverage, represented by the book debt ratio, and market leverage, indicated by the market debt ratio, as proxies for assessing firms' leverage ratios.
OLS estimates reveal that while some managerial entrenchment proxies do not affect the leverage ratio, most significantly influence firms' financing decisions Specifically, four out of six entrenchment proxies—board size, director age, CEO-Chairman duality, and CEO age—show a significant impact on book leverage ratio at the 1 percent level Larger boards with older directors tend to issue less book debt, resulting in a lower book leverage ratio Additionally, CEOs holding dual positions, especially those who are older and have longer tenures, restrict increases in book leverage ratio Conversely, director age negatively affects market leverage ratio, with older directors significantly reducing it.
The influence of a firm's history on its market leverage ratio is primarily constrained by the book leverage ratio, which is impacted by factors such as profitability (EBIT), market timing (including long-term timing and stock returns), and trade-off considerations (leverage deficit) Overall, the historical performance of firms plays a significant role in shaping their market leverage ratios.
Endogeneity, autocorrelation, and heteroskedasticity in the error term can bias OLS estimates, as highlighted in Section 3.2.2 The presence of autocorrelation and heteroskedasticity is confirmed by the Wooldridge test (Table 4.8) and the Breusch-Pagan/Cook-Weisberg test (Table 4.9) Additionally, the Durbin-Wu-Hausman endogeneity test (Table 4.10) identifies financial deficit as an endogenous variable To enhance the efficiency and validity of the estimation, the Generalized Method of Moments (GMM) is utilized.
In 1982, the system GMM method proposed by Blundell and Bond (1998) was utilized, with the lagged financial deficit identified as an instrumental variable The validity of this instrument was confirmed through the Arellano-Bond test for first-order (AR(1)) and second-order (AR(2)) autocorrelation, along with the Sargan test The p-value of the z-statistic in the AR tests further supports these findings.
CONCLUSION AND POLICY IMPLICATIONS
Concluding remarks
Corporate governance principles establish a framework that enables firms to meet their objectives through effective interactions among management, the board, and shareholders Empirical studies consistently demonstrate that robust corporate governance enhances firm success in management and finance by minimizing agency conflicts and optimizing capital structure The impact of corporate governance on capital structure has been extensively examined, with particular focus on the interplay between managerial entrenchment and leverage ratio, drawing significant interest from academics, practitioners, and policymakers alike.
This study analyzes a sample of 289 non-financial firms listed on the Ho Chi Minh Stock Exchange from 2006 to 2015 to address significant gaps in corporate governance research within Vietnam It uniquely examines the influence of corporate governance, managerial entrenchment, and market timing behavior on leverage ratios Managerial entrenchment is represented through metrics such as block-holder holdings, board size, director age, CEO-Chairman duality, board composition, and CEO age, while market timing behavior is assessed via firms' historical leverage ratios, calculated as the ratio of book leverage to market leverage Additionally, the research categorizes the impact of managerial entrenchment on leverage ratios into high and low entrenchment regimes Employing a two-stage methodology, the study first establishes target leverage levels and subsequently evaluates how managerial entrenchment and historical leverage affect the actual leverage levels of listed Vietnamese firms, utilizing various econometric techniques.
P a g e | 66 with the traditional Ordinary Least Squares (OLS) method, are incorporated such as the Generalized Method of Moments (GMM) and endogenous switching regression method.
Key findings achieved from this study can be summarized as below.
Empirical evidence reveals a negative correlation between managerial entrenchment and leverage ratio, suggesting that entrenched managers may lower leverage by issuing equity, aligning with market timing strategies Furthermore, the study identifies a negative impact of historical factors such as financial deficits, timing measures, and stock price histories on the leverage ratios of listed firms in Vietnam during the research period.
A large board comprised of older directors and CEOs, along with CEO-Chairman duality, tends to lower the book leverage ratio In contrast to the managerial entrenchment effect associated with book debt, an increase in block-holders and outside directors on larger boards leads to a decrease in the market leverage ratio.
Financial deficits negatively affect leverage ratios, indicating that managers restrict debt levels to avoid financial distress when investments surpass internal cash flow Additionally, profitability, as measured by EBIT, reduces leverage ratios since firms prefer using retained earnings to finance investments or repay past debts This highlights that firms view external financing as a last resort in their financial strategy.
Market timing proxies, including yearly timing, long-term timing, and stock returns, negatively influence the leverage ratio, indicating firms' market timing behavior in seeking external finance (Baker and Wurgler 2000; Kayhan and Titman 2007; Kayhan 2008) When stock returns increase, corporate shares become more appealing to investors, leading to higher demand for stock and enabling firms to opt for equity issuance over debt financing The yearly and long-term timing are influenced by a firm's market-to-book ratio, where a higher ratio signifies better growth opportunities and a reduction in financial deficits Consequently, managers tend to prefer equity issuance, preserving debt financing capacity for future needs.
When insider sales are used as an alternative timing measure instead of yearly and long-term timing, the findings reveal that firms actively time the market This is evidenced by the negative impact of insider sales and stock returns on the leverage ratio.
Share repurchase happens when stock prices drop, while selling shares occurs with price increases (Seyhun 1986) As stock prices rise, insider trading by managers increases, indicating a preference for equity issuance over debt financing This trend makes shares more appealing to investors due to higher stock returns As a result, managers opt to issue equity instead of relying on debt, leading to a decrease in the book debt ratio.
The negative significance of leverage deficit in relation to leverage ratio indicates that firms tend to issue more equity than debt, causing the current leverage ratio to deviate from its target level Additionally, the adjustment towards the target market leverage ratio occurs at a faster pace compared to the book leverage ratio Consequently, managers in Vietnam do not adhere to the established target leverage ratio.
This study highlights the influence of both high and low managerial entrenchment regimes, along with the historical performance of firms, on their book and market leverage ratios The findings indicate that managers with high entrenchment are more focused on market timing and can capitalize on favorable conditions in the equity market, leading to a decrease in the leverage ratios employed by their firms.
The results indicate that the high managerial entrenchment regime includes larger number of block-holders, larger boards, older CEOs with CEO-Chairman duality and more outside directors.
This study provides empirical evidence that changes in leverage ratios negatively respond to financial deficits, profitability (measured by EBIT), and various timing measures, including yearly and long-term timings as well as insider sales Additionally, stock price returns also influence these changes Notably, the reduction in debt ratios is significantly impacted by the presence of highly entrenched managers.
The significant influence of entrenched managers on the board may indicate weak corporate governance in Vietnam, as highlighted by reports from the International Finance Corporation and the State Securities Commission of Vietnam.
(2006) and International Finance Corporation and the State Securities CommissionVietnam (2012).
Policy implications
This study aims to empirically demonstrate how managerial entrenchment and the historical context of firms affect leverage ratios among publicly listed companies in Vietnam The research presents key findings that offer valuable insights for policymakers, the Government of Vietnam, and relevant authorities, alongside recommendations for Vietnam’s listed firms.
5.2.1 The implications for listed firms in Vietnam
To listed firms in Vietnam, varieties of proposals are provided to support the companies in achieving successful corporate governance framework and promoting their ability to compete with other enterprises.
It is crucial for top executives and company owners to recognize the significant role of board members in shaping strategic planning and monitoring Board members offer valuable insights that can help achieve corporate objectives; however, their influence is often undermined when entrenched managers dominate key decisions Therefore, executives and owners must carefully weigh the advantages and disadvantages of allowing entrenched managers to maintain control over corporate governance.
The corporate governance principles established in 2004 and 2015, along with the Vietnam corporate assessment report from 2012, play a crucial role in enhancing the governance of Vietnam’s listed firms by leveraging the expertise of experienced outside directors These directors, skilled in finance and knowledgeable about the firms, can help counterbalance the influence of entrenched managers, who often prioritize their own interests over the company's benefits As a result, effective external oversight is essential to ensure adherence to corporate governance mechanisms, reduce managerial entrenchment, and protect the interests of the owners.
Firms' management must clearly define the role of outside directors, adhering to Circular 121/2012/TT-BTC issued by the Ministry of Finance, which serves as a valuable guideline for public company management By taking full responsibility for assigning tasks and overseeing performance, management can effectively differentiate between the roles of independent directors and non-executive directors The inclusion of outside directors not only enhances company strategy but also reduces managerial entrenchment, ultimately fostering an increase in the market value of the companies.
The study reveals that managerial entrenchment negatively impacts leverage ratios, as entrenched managers prefer issuing equity over debt to capitalize on perceived market timing opportunities This preference leads to heightened agency conflicts between management and owners, as equity issuance signals to debtholders a lack of security and creates information asymmetry Furthermore, the unpredictable nature of securities markets increases the risk of stock mispricing, potentially resulting in significant profit losses due to poor market timing Consequently, the interests of debtholders, shareholders, and overall firm value are jeopardized Therefore, listed firms in Vietnam must carefully evaluate the balance between debt and equity in their capital structure decisions.
5.2.2 The implications for Vietnam’s investors
Findings from this empirical study are also to provide evidence for investors to consider their investment strategy in Vietnam’s stock market.
Investor education is crucial for the growth of Vietnam's securities market A comprehensive understanding of enterprise law is essential for investors, enabling them to better protect their rights and investments from potential conflicts of interest.
Shareholders must demand comprehensive disclosure of corporate documents to access previously restricted information and assess company operations during instances of managerial entrenchment By establishing robust corporate governance mechanisms and threatening to dismiss underperforming managers, owners can mitigate the risks associated with managerial entrenchment If management fails to comply, shareholders have the right to sue for withholding information and infringing on their rights, or they may ultimately choose to withdraw their investments.
Debtholders must conduct thorough investigations into all investment projects, as entrenched managers may manipulate leverage ratios to finance poor investments for their own benefit To mitigate risks associated with these bad investments, creditors can either increase interest rates or cease debt financing altogether.
5.2.3 The recommendations to the Government of Vietnam and relevant authorities
To the Government of Vietnam and relevant authorities, some following suggestions are proposed to fill in the legal gaps.
The government must not only oversee listed companies' physical operations and financial management but also enforce strict adherence to enterprise laws and corporate governance standards This proactive approach ensures that any violations of legal requirements are identified, allowing for the continuous improvement and refinement of the legal framework.
The Government and relevant authorities must finalize Circular 121/2012/TT-BTC, issued by the Ministry of Finance on July 26, 2012, which outlines management prescriptions for public companies While the document's interpretation is reasonable, its application has not been consistently or conveniently adopted by companies Therefore, a clearer and more cohesive resolution is essential for effective implementation.
The regulations should provide a clearer definition of outside directors, as the current general concept lacks sufficient detail regarding the distinct roles and responsibilities of independent versus non-executive directors on corporate boards Outside directors play a vital role in executing company development strategies and overseeing the compensation and rewards of executive directors This oversight encourages managers to adhere to corporate governance mechanisms, potentially reducing the effects of managerial entrenchment.
The Vietnamese government must enhance awareness regarding the significant influence of boards on listed companies In many cases, entrenched managers, rather than the board of directors, primarily dictate the strategic direction of these firms, leading to a misalignment of interests that ultimately undermines the company's benefits in favor of managerial gains.
Due to managerial entrenchment and market timing, firms often prioritize equity over debt when raising external funds for investments This equity-focused governance can signal risk to debtholders, exacerbating information asymmetry and increasing conflicts between management and owners In Vietnam's nascent securities market, these issues can lead to significant mispricing of stocks and a decline in firm value, ultimately harming both debtholders and shareholders.
In this way, the policymakers are obligated to generate the availability of transparent market information and to improve the meticulousness of designed regulations.
5.3 The limitation and further improvement
This research explores the influence of managerial entrenchment and company histories on leverage ratios within the Vietnamese context, highlighting its relevance to emerging markets Despite the valuable insights provided, certain limitations persist in the study.
The dataset's quality may hinder the research objectives due to its limited timespan, covering only a decade from 2006 to 2015, which affects long-term estimations of corporate governance's impact on leverage, particularly regarding managerial entrenchment and market timing Additionally, the lack of transparency in corporate governance disclosures—such as voting indices and CEO protection—stemming from the cultural tendency for secrecy in Vietnamese firms, along with non-compliance in publishing accurate annual reports, undermines the reliability of the findings Furthermore, the research would benefit from including more developing countries with similar characteristics to Vietnam, enhancing the robustness and persuasiveness of the results.