Trade off theory or pecking order theory with a state ownership structure the vietnam case

International Review of Business Research Papers Vol 11 No March 2015 Issue Pp 114 – 132 Trade-Off Theory or Pecking Order Theory with a StateOwnership Structure: The Vietnam Case Sébastien Dereeper1 and Quoc Dat Trinh2 The process firms use to choose their capital structures is explained by different corporate finance theories in which trade-off and pecking order are the two most popular hypotheses Testing these two models will help to determine whether a target debt ratio exists, and if so, how rapidly firms adjust their current leverage levels to match this target level The findings in this paper determined that the pecking order theory might not be applied in Vietnam when internal funds and new equity issuance are independent with the leverage level In contrast, our empirical results proved that the long-run target debt ratio does exist in the Vietnamese market The partialadjustment model has shown that both private firms and state-owned firms rapidly adjust to their optimal levels of debt However, the state ownership structure does not affect the amount of debt taken during the year by the firms Field of Research: capital structure, state-owned firms, private firms, speed adjustment Introduction Although being published in stock exchange is an efficient way to raise middle and longterm funds, firms still continue borrowing from financial intermediaries such as banks or financial companies for many reasons The conflicts among shareholders and managers of the firms might be one of those reasons When raising funds from the stock market, firms‟ managers need to report business activities to many other new shareholders This means they are loosening their control to the firms and they need to disclose more inside information to public This is not what managers want because Jensen and Meckling (1976), with the concept of “separation of ownership and control”, indicated that managers can be more interested in transferring firms‟ resources into their personal benefits instead of spending efforts on leading the firms The decisions made by managers will not totally maximize firm‟s value as it would be In contrast, although shareholders not directly control and manage firm‟s activities, they own the firm and receive a fraction of the gain Shareholders will need to pay some costs to the managers and establish appropriate monitoring solutions with the hope that the managers will act for the best benefits of shareholders However, raising funds from banking system also faces many difficulties These might be the costs of bankruptcy if firms are out of payment, or other accurate borrowing conditions issued by the banks that firms must satisfy Generally, banks approve firm‟s loans based on their own appraisal processes However, in emerging market, where the effect of the state on financial market is quite obviously, the decisions of banking system on how to give loans to firms might be remarkably affected by the government‟s policy Dr Sébastien Dereeper, Professeur des Universités, Université de Lille - SKEMA Business school, ECCCS research center, sebastien.dereeper@univ-lille2.fr; Quoc Dat, Trinh, Université de Lille - SKEMA Business school, ECCCS research center, quocdat.trinh@etu.univ-lille2.fr; Dereeper & Trinh La Porta et al (2002), Dinc (2005) suggested that profit might not be considered as the top priority concern rather than serving primarily for political purposes of state-owned banks In China, Liu et al (2011) found that the influence of government intervention to financing behaviors is significant and they suggested that state-owned firms would have the chance to borrow more while non-stated firms would meet difficulty in borrowing The economic reform (Doi Moi) policy, started from 1986, has created a great change over the whole economy of Vietnam from the centrally planned economy into the market oriented economy Along with the market mechanisms, applied since Doi Moi, an equitization of state-owned enterprises was implemented in 1990 and dramatically promoted from 1996 In the year of 2000, Ho Chi Minh stock exchange was established for the first time in Vietnam, and five years later, in 2005, Ha Noi stock exchange was established with slightly lower requirements on equity scale to listed firms Those events were the steps that the government executed to bring more efficient and transparent management mechanisms to all enterprises However, not all the firms are fully equitized Government still holds ownership control in different specific and important-to-nation industries such as energy, exploitation of natural resources, agriculture and forestry That leads to the existence of partly-equitized firms even in the stock market Therefore, examining the intervention of Vietnamese government on how firms support their financial needs is necessary A study on the effect of state ownership to capital structure of small and medium unlisted enterprises in Vietnam was conducted by Nguyen (2006) By considering 558 small and medium unlisted firms, from 1998 to 2001, Nguyen provided a consensus with Liu et al (2011) for China case by showing that state-owned small and medium enterprises have more advantages in accessing bank loans than non state-owned enterprises Another study, two years later, in 2008, conducted by Nahum Biger et al., confirmed the relationship between firms‟ characteristics and capital structure in Vietnam The leverage ratio is positively related to firm size, growth opportunities and managerial ownership but it is negatively correlated with non-debt tax shield, fixed assets and profitability In 2012, Okuda and Nhung, investigated the opaque relationship between state-owned firms and government banks through an empirical analysis of a panel data sample from 2006 to 2009 These two authors stated that agency cost theory clearly explains the mechanism of debt choices for enterprises in Vietnam Companies prefer to use more debt when managerial ownership ratio is high, and vice versa, lower level of managerial ownership would come along with lower level of debt Okuda and Nhung also found similar result with Nguyen (2006) by suggesting that state-owned companies in average have higher debt ratio than private companies in both Ho Chi Minh and Hanoi stock market Although the relationship between government control and leverage ratio of firms in Vietnam has been studied by Nguyen (2006), Nahum Biger et al (2008), Okuda and Nhung (2012), an empirical test for the application of the two classical models, tradeoff theory or pecking order theory, the Vietnam case, has not been precisely conducted In addition, the confirmation of whether an optimal level of debt exists for Vietnamese firms is questionable And if an optimal level of leverage exits, at which speed the firms will adjust current debt level toward target debt level is also to be concerned Our study aims to provide a clear explanation for these issues and together with other researches; we hope our paper will contribute to clarify the effect of government ownership on firms choices of‟ capital structure in Vietnam; and answer the question of at which speed firms will adjust their borrowing behaviors toward the optimal choices to maximize the firm value 115 Dereeper & Trinh The paper is organized as follows The first section is Introduction which aims to set up the idea of the paper and show how this study is important to Vietnam The second section is Literature Review This section provides a brief summary of what other studies have suggested about the capital structure theories, both in developed and developing countries Section two also reviews the relationship between ownership and debt ratio Moreover, section two states three hypotheses which are going to be tested in the paper The third section specifies how regression model was built to conduct an empirical test for three hypotheses stated in section two Section four explains the variables and shows how the data were collected Section five and section six provide our analysis results on the application of tradeoff theory and pecking order theory in Vietnam market, respectively Final section is conclusion and areas for further research Literature Review Since the study of Miller and Modigliani (MM) in June 1958, capital structure theory has been continued studying properly The trade-off theory, which rejects the irrelevance preposition by considering imperfect and friction capital market, suggests that a firm should maximize its value by balancing the costs and benefits of borrowing debts While costs of debts are majored as the financial bankrupt cost or distress cost when firms used extravagant debts and might not be able to meet the deadline of interest and principal payments, the most significant gain of debt is identified by the debt-tax shield through interest deduction The optimal debt level is considered as the intersection between marginal costs and marginal benefits of using more debts (Myers, 1984) Therefore, static trade-off theory recommends that a firm should substitute between equity and debt till it reaches the target ratio to maximize its value However, in a dynamic world, firm itself changes overtime The dynamic tradeoff theory states that optimal debt ratio of the firm is adjusted by the change of exogenous and endogenous factors In contrast, the pecking order theory, which considers the asymmetric information assumption, predicts that no optimal leverage level is preferred In fact, firms prefer to use internal funds to finance for their capital demand before borrowing debts or issuing stock The main assumption of the theory, asymmetric information, indicates the costs of adverse selection This predicts that firms‟ owners (insiders) normally have more information of the firms than investors (outsiders) Because of that, if firms issue equity to finance for new projects, the market might consider those projects as ineffective or high risk projects Consequently, equity would be underpriced New projects are going to be rejected even they have positive NPV Leland and Pyle (1977) stated that it could be a signal of low-return business results if firms decide to sell equity to the outside investors and vice versa In addition, management purpose is also another reason that firms are not willing to issue new stock to call for capital Kenny Bell and Ed Vos (2009), concluded “if given the unconstrained choice between external debt and internal funds, SMEs will, in general, choose not to utilise debt due to the preference for independence, control and financial freedom.” Consequently, the pecking order, firstly, starts with internal finance (using retained earnings and adapting target dividend payout ratio to investment opportunities), then continues with safe securities such as debt and convertible bonds if internal funds provide insufficiently Equity is only chosen as the last resort Given the importance of these two theories in capital structure, several empirical tests have been conducted to examine the application of these theories in practice The authors who are supported for perking order theory, such as Shyam-Sunder and Myers (1999), by testing 116 Dereeper & Trinh a sample of 157 firms in US, has concluded that pecking order theory provides a “good firstorder approximation” of firm financing behaviors They concluded that within their sample and model of testing, the basic pecking order theory explains actual debt ratio much better in time-serial variance than static trade-off theory Graham and Harvey (2001) figured out that the marginal benefits of tax shield seem to be far bigger than the marginal costs of bankruptcy for almost all the firms In this case, firms should use more debts (increase leverage) because they were under-leveraged Both pecking order theory and trade-off theory are supported at a given level but not really clear when little evidences are significant for the choices of debts based on asset substitutions, asymmetric information, transaction costs and personal taxes However, J.Qiu and F.Smith (2007), predicted that pecking order theory might not be the first-order if sample difference and nonlinearity are taken into account For the trade-off theory, the relation between firm‟s features and leverage has been tested widely among researchers One of those features is ownership structure Interesting relations have been found Brailsford et al (2002) figured out that there exists a demonstration of an association between capital structure and ownership structure Particularly, they found “a positive relationship between external block-holders and leverage, a curvilinear relationship between the level of managerial share ownership and leverage” Low level of managerial ownership will create a fall in agency conflicts, and thus, bring a higher level of debt in capital structure For emerging market such as China and Vietnam, the presence of government on firm‟s ownership is remarkable Liu, Tian and Wang (2011) examined a case study with the sample of over 1000 firms in both state-owned and non state-owned enterprises (SOEs and non SOEs respectively) in China They found that SOEs use more debts than non SOEs and financial behaviors of SOEs are influenced more by the government; whereas non SOEs are more market-oriented Jiang and Zeng (2010) also considered the role of state intervention on debt level of all the listed firms in China from 2000 to 2006 They found that regarding short-term loans, listed state-owned firms received a better policy of appraisal from the state-owned banks than private listed firms In addition, as mentioned in Introduction section, Nguyen (2006) and Okuda and Nhung (2012) suggested state-owned companies in average have higher debt ratio than private companies in Vietnam Therefore, the first hypothesis tested in the paper is: “state-owned listed firms use more debt or have higher leverage ratio than private listed firms” In a different study, considering 79 listed firms, Fauzi (2012) tried to investigate the application of trade-off theory and pecking order theory in New Zealand He found that tradeoff theory is more appropriately explained for New Zealand listed firms However, Qiu and La (2010) using unbalanced panel data of 367 firms for the period of 15 years, suggested that pecking order theory is applied for the Australia case Bruslerie and Latrous (2007) conducted a detail empirical test on the relationship between ownership structure and debt leverage With a sample of 112 listed firms on the French stock market, over the period from 1998 to 2009, they found a U-shape relationship between shareholders‟ ownership and leverage Controlling managers firstly at the low level of ownership prefer to use more debt to resist the attempted acquisition (takeovers) from outsiders However, when the distress costs increases along with the higher level of debt and when the level of ownership reaches a certain point, controlling shareholders converge into using other resources to support for business activities rather than debts These studies bring us the second hypothesis to test: “there exists an optimal level of debt for each firm in accordance 117 Dereeper & Trinh with its characteristics” This hypothesis aims to prove the application of trade-off theory in Vietnam Other authors used firm‟s characteristics to determine target leverage and considered the speed that a firm would adjust its leverage level toward the optimum Leary and Roberts (2004) concluded that firms, in the presence of adjustment costs, tend to partly adjust their debt ratios toward the optimal leverage level Flannery and Rangan (2005), using a huge US dataset from 1965 to 2001, stated the existence of target debt level and firms partially moved toward the optimal debt level by the rate of 32% of the gap between current and target debt ratio each year From that, we continue to test the third hypothesis: “a firm continuously adjusts its leverage level toward the optimal level for both state-owned and private listed firm” Regression Model Specification The paper considers the market debt ratio as total interest-bearing borrowings to the sum of interest-bearing debts and market value of outstanding common shares (1) The market debt ratio (MDR) is conducted based on the ideas of Flannery and Rangan (2005) to consider the market capital capacity of the firm In which, is defined as interest-bearing debt of firm i at time t while S i,t indicates the number of common shares outstanding of firm i Pi,t denotes the price per share of stock i at time t The tradeoff theory states that target leverage ratio might differ overtime and across firms following firms‟ characteristics And there always exists an optimal level of debt ratio, which is specified by the following form: MDR*i,t+1= βXi,t (2) Where MDR*i,t is the desired market debt ratio, β is coefficient vector, and X i,t is the vector set of firm‟s characteristics The trade-off theory suggests that β # and the variation in MDR*i,t+1 should be non zero Firms would shift their leverage ratios forward the target ratio immediately in perfect and frictionless market (there are no costs of transaction and adjustment) However, in an imperfect world, immediate movement of debt ratio toward the desired ratio might be prevented Firms intend to adjust their leverages toward the optimal leverage level but partially Following the ideas of Rangan and Flannery, we construct a standard partial adjustment model as follows: ( ) (3) In which, λ is the speed adjustment toward optimal leverage level of firm i at time t Substitute equation (2) into equation (3) we have the standard model which is used to test the speed adjustment toward optimal level mentioned by the tradeoff theory (4) 118 Dereeper & Trinh Equation (4) will be used as the core specification for the paper Because pecking order theory mainly refers to internal factors inside firms; hence, while using market debt ratio in testing trade-off theory, we are going to use book debt ratio (total of short term and long term interest-bearing debt to total assets) in testing pecking order theory regression instead Pecking order theory implies that firm‟s financing deficit is one of the most important explanatory variables to the choice of capital funding Due to adverse selection, firms intend to balance the need of dividend payment, new investment and working capital by internal resources before borrowing debt Table 2, page 229, Frank and Goyal (2003) mentioned a firm‟s financing deficit (FINDEF), which was defined as the ratio of sum of (dividend payments + investment +change in working capital – internal CASHFLOW)/total assets We will use this definition of FINDEF in our regression model Therefore, replacing the book debt ratio for market debt ratio and adding FINDEF (financing deficit) as an explanatory variable into equation (4), we have the pecking order behavior testing specification as follows: (5) The equation (5) implies that a firm‟s financing deficit clearly explains current changes in its book debt ratio Because ΔBDRi,t+1 = BDRi,t+1 - BDRi,t, substitute into (5) we will have: BDRi,t+1= λβXi,t+ (1- λ) BDRi,t + FINDEFi,t+1 + δi,t+1 (6) Running regression by equation (6), if financial deficits variable (FINDEF) is found statistically significant to book debt ratio, pecking order theory is suggested as applicable in Vietnamese market However, if FINDEF is significant but it makes no differences/changes on the coefficient β of the other explanatory variables used in equation (4), we can conclude that pecking order theory is just a subset of trade-off theory, or on the other hand, trade-off theory is a generalized model of pecking order theory Data and Variable Explantations Generally in Vietnam, only listed companies are forced to publish their audited financial reports, business performances and activities while unlisted firms are free to this obligation In addition, contrary to the information transparency of listed companies, data collected from unlisted companies might be manipulated for private purposes of companies‟ owners Therefore, to entrust the empirical results, the paper only focused on the database from companies listed in Vietnam stock exchange In addition, we tried to ensure the database used in the paper is sufficient in term of time period and number of observations Hence, we considered all the listed firms in Vietnam stock market that we could access their data within the period of at least four years Consequently, from those reasons, data in this paper were collected from over 300 hundred listed companies categorized by 15 industries (classified by Vietnam Standard Industrial Classification 2007); in Hanoi and Ho Chi Minh stock exchange, from 2005 to 2011 We eliminated all the firms which have been listed in the stock exchange after 2007 In addition, to guarantee our database is consistent in term of demand side only, we ignored all the financial companies and banks listed in the stock exchange because they are normally considered as debt suppliers 119 Dereeper & Trinh We re-defined industry variable down into sectors to make the empirical analysis become more precise Industry variable included: Agriculture, forestry and fishing; Energy exploitation and distribution; Manufacturing; Construction and Transportation; and Other industries However, some variables contained missing observations and we decided not to drop any of those variables Thus, an unbalanced panel dataset was observed and used for the regression test with total of over 1600 firm-year observations Because, the paper aims to test three hypotheses mentioned in Section I, we divided our data into two subsets, state-owned firms and private firms Based on the state proportion in firm‟s ownership structure, we defined a state-owned firm as a firm with at least 36 percent of equity belonging to the government, and vice versa, a firm with less than 36% of government control was considered as non state-owned (or private) firm We chose 36% of equity ownership because this percentage was legally regulated as the minimum requirement for shareholders to have the right of veto, i.e., the right or the power to reject any business proposal given by other shareholders Moreover, 36% of registered capital owned by state normally guarantees that government will have two members in the Board of Directors, which allows government increases its direct control over the firm‟s regular activities and strategies We did not use the normal rate 50% of state ownership to split our sample because this percentage leads to a huge unequal subset of our data The determinants of capital structure were mainly selected as previous papers have done Those factors appeared frequently in the literature review of Fama and French (2001), Hovakimian (2003) and Flannery and Ranga (2006) Two other factors added by us were FIRM-AGE and FIRM-CASH at the fiscal year end Proxies and expectations of those factors are as followsi: MDR: This variable stands for market debt ratio It is defined as total debt (short-term debts plus long-term debts) to the sum of total debt and a multiple of outstanding shares and stock price BDR: this variable stands for book debt ratio of the firm It is defined as the ratio of total debts (short-term plus long-term interest bearing debts) to total assets Generally, BDR is smaller than MDR in our study LN_TA: this is the logarithm of total assets It shows firm size or business scale of firms Blackwell and Kidwell, 1988, with the flotation-costs assumption, considered that larger firms preferred to use more debts than smaller ones in order to make economies of scale In addition, larger firms may have lower asset volatility and they might have more power to access debt supply market EBIT_TA: Earning before interest and tax to total assets This factor indicates the ability of firms on paying loans EBIT_TA also shows how the profitability affects debt borrowing behaviors It is expected to be positively correlated to the leverage level However, on the other hand, because of high retained earnings, firms might borrow less debt to reduce the bankruptcy risks and protect their profitability‟s proxy Therefore, a firm with high EBIT could prefer to operate with both higher and lower portion of interest-bearing debt MB: Market to book ratio of assets Following the asymmetric information assumption, firms with high market to book ratio (MB) are considered as having brightly prospective growth Therefore, those firms will try to keep their debt ratio low and try to protect these 120 Dereeper & Trinh advantages by limiting the leverage level The market timing theory also predicts lower level of debt for firms with high market value of stock price DEP_TA: This is the ratio of depreciation to total asset of the firm High depreciation leads to low accounting profit but high CASH capacity Therefore, firms with high depreciation may have more cash and need less debt from borrowing activities compared to firms with low depreciation FIRM_AGE: Traditional and long historical firms might be well-known with financial intermediary system They can borrow with ease, and consequently, firms with long history might be able to remain high leverage ratio to receive the benefits of tax deduction However, on the other hand, long traditional firms may also have advantages of using the non-interest bearing debt from late payment policies from their suppliers, which lead to a low level of debt FA_TA: This stands for the ratio of fixed asset to total assets Firms with high proportion of fixed assets might refer to have high production capacity As a result, those firms might need more debts to support for their activities That means a positive relationship between FA_TA and leverage ratio is expected CASH: Is the beginning CASH in the balance sheet of financial report This variable is only used when the paper tests the existence of pecking order theory Because we believe CASH policies have a strong effect on the FINDEF, the main explanatory variable in the empirical test of pecking order theory, and the behavior of debts INDU: Is defined for Industry classification and we encoded industries as from to FINDEF: Denoted as financing deficit This ratio is defined as the ratio of a sum of (dividend payments + investment + change in working capital – internal cash-flow) to total assets This ratio is assumed to wipe out all other variables significant effect If this ratio is significant and creates remarkable changes in other variables in equation (5), it is considered as an obvious signal for the existence of the pecking order theory in Vietnamese market The following table briefly specifies statistic summary of our database used in the paper: 121 Dereeper & Trinh Table 1: Summary Statistics of the data Variable YEAR INDU MDR BDR FINDEF CASH LNTA EBIT_TA DEP_TA FA_TA FIRM_AGE MB Obs Mean Std Dev Min Max 1654 2008.710 1.671 2005 2011 1654 3.438 1.440 1.000 5.000 1654 0.299 0.283 0.000 0.900 1653 0.224 0.208 0.000 0.901 1574 -0.039 0.224 -1.181 1.834 1568 10.196 0.774 7.330 12.570 1654 26.536 1.436 23.220 31.201 1654 0.066 0.102 -0.901 0.609 1608 0.037 0.054 -0.650 0.750 1654 0.306 0.210 0.001 0.976 1654 20.826 12.752 5.000 67.000 1654 33.426 39.391 0.900 560.000 Noted: Variables are described in the description above In average, the market debt ratio differs from book debt ratio an amount of 0.07 and they both range from to over 0.9 percent This shows our data cover a wide range from nonleverage to heavy leverage-bearing firms In fact, MDRs in some cases equaled to zero, because, some firms have recently joined the market and they had no demand (or hard to access) for long-term debt for some first years, whereas at some moments, MDRs of some companies in construction industry were close to the value of because at that time, the price of outstanding shares decreased dramatically and the number of outstanding shares was small too Particularly, the maximum MDR is approximated to Book debt ratio also follows the trend of MDR Values of BDR fluctuate from to 0.9 The book debt ratio which approximates 90% reflects the fact that firm heavily depended on outside resources and it was in danger of bankruptcy Beside that, average debt levels for MDR and BDR are around 0.29 and 0.22, respectively This guarantees the sufficiency of our sample, a great range of leverage ratio from different industries but with reasonable mean Data of other variables also present gaps among firms We considered from very young firm which was lately established within years to very traditional and long-lasted history firm which was operated over 60 years ago With the wide set of data, we expected that our empirical results could be applied to explain for financial behavior of all firm types However, some observations were abnormally far away from most of other observations as running firm-level empirical analysis, outlier error was another issue that we considered A paper written by Ghosh and Vogt, in Joint Statistical Meeting of American Statistical Association, 2012, questioned on how small of the tail probability is to declare a value of an outlier They figured that while the outliers might not be in the range of the model or a pattern, most of the observations seem to follow the same principles or satisfy the model In general, treatments for outlier issues are often conducted by one of these three methods: 1) keeping outliers as normal data In this case, we will ignore the issue of outlier and conduct the empirical test with the whole sample of our database; 2) wisorizing the outliers at a given level (e.g at the level of 1% or 5%); and 3) eliminating/trimming outliers from database or the sample While wisorizing or eliminating outliers will create statically bias and undervalue the outliers because of the significance impact by decreasing standard errors, keeping them as normal data in regression process might lead to overvalue the outliers and may create remarkable results which vary remarkably from the true population value However, our database was 122 Dereeper & Trinh collected from HOSE and HNX which were quite standardized in the requirements of the firms‟ equity size, profitability and transparence In addition, our database was slightly small for a panel regression; therefore, we decided to treat potential outliers as normal data in our empirical test to ensure the variability of the sampleii In addition, our explanatory variables looks closely related because we have employed several internal characteristics of the firm in empirical analysis Therefore, we conducted a multi-collinearity test followed by instruction of Philip B Ender, from UCLA Office of Academic Computing, distributed on 23/11/2010, to isolate the effect of each control variable to dependent variable Table 2: Multi-collinearity Test Variables CASH LN_TA EBIT_TA DEP_TA FA_TA FIRM_AGE MB Mean VIF 1.14 VIF SQRT-VIF Tolerance R-Squared 1.10 1.05 0.9091 0.0909 1.17 1.08 0.8531 0.1469 1.23 1.11 0.8146 0.1854 1.11 1.05 0.9005 0.0995 1.13 1.06 0.8832 0.1168 1.02 1.01 0.9789 0.0211 1.20 1.09 0.836 0.164 – Condition Number 1.6808 From table 2, VIFs, variance inflation factor, and Condition Number, index of the global instability of regression coefficients, were all less than That means each independent variable could be considered as non-linear combination with other independent variables in our model Consequently, multi-collinearity is not a serious problem for our empirical analysis Finally, to ensure the resulting standard errors are consistent with the panel autocorrelation and heteroskedasticity issues, we used robust standard errors in our regression analysis Trade-off Theory and Regression Test Results The first step of this study was testing the existence of an optimal level of debt for each firm given its characteristics The explained variable is MDR, and explanatory variables included firm size, profitability, market-to-book value of total assets, firm age, depreciation and fixed assets Running unbalanced panel regression by OLS, random effects and fixed effects, with the results can explain over 44% of the sample test (R2=0.4) We found that the desired market debt ratio does exist but significantly depends on plausible firm features In this case, those features are firm size, profitability, fixed assets and prospective firm growth However, depreciation and history of the firm not statistically influence the debt choice Industry groups and time-varying effects not elicit changes, as we received the same results for the significance of control variables to the output when adding the dummy variables in columns (4), (5) and (6), except for the variable of market-to-book ratio of assets 123 Dereeper & Trinh Table 3: Testing optimal leverage and firms featuresiii Equation 2: MDR*i,t+1= βXi,t In which, Xi,t included: - LN_TA: logarithm of total asset – denoted for firm size EBIT_TA: Earning before interest and tax/total asset – denoted for profitability DEP_TA: Depreciation/total asset – denoted for Depreciation FA_TA: Fixed asset/total asset – denoted for Fixed asset Firm_Age: total year since firm established – denoted for history of firm MB: Market to book ratio of assets – denoted for prospective growth in future (1) Control Variables LN_TA EBIT_TA DEP_TA FA_TA FIRM_AGE MB OLS 0583*** (15.44) -1.179*** (-20.11) -0.042 (-0.42) 0.104*** (3.97) 0.001* (2.41) -0.002*** (-11.96) 1608 0.4473 (2) Random effects 0882*** (15.61) -.8922*** (-14.98) -.1389 (-1.55) 1301*** (3.77) 0007 (1.05) -.0016*** (-13.17) 1608 (3) Fixed effects 0881*** (15.61) -.8922*** (-14.98) -.1388 (-1.55) 1300*** (3.77) 0007 (1.05) -.0016*** (-13.17) 1608 4054 (4) (5) (6) OLS (dummy) Random effects (dummy) Fixed effects (dummy) 0407*** (11.20) -1.116*** (-20.56) 09005 (0.93) 1662*** (6.67) 0008* (2.29) -.0004** (-2.73) 1608 0.5540 N R2 (within) t statistics in parentheses - legend: * p