Corporate Financing – Theories in Vietnam Realities

For centuries, economists have been preoccupied with the growth of nations. However, it seems that they can never reach a consensus on the recommendations for governments to promote economic growth

Website: http://www.docs.vn Email : lienhe@docs.vn Tel : 0918.775.368 Hanoi National Economics University VIETNAM – NETHERLANDS DEVELVOPMENT ECONOMICS AND PUBLIC POLICY CENTER ESSAY on INTRODUCTION TO FINANCE Topic: Corporate Financing – Theories in Vietnam Realities Student: Le Trong Quan Class: MDE 14 Lecturer: Dr Do Kim Son Hanoi 2007 CH số 11 - B1 - ĐH KTQD Chuyên Photocopy - Đánh máy - In Luận văn, Tiểu luận : 6.280.688 TABLE OF CONTENTS Part I: Introduction 3 Part II: Background General Concepts Equity Debt Other sources 5 5 7 9 Part III: Development Theories in Vietnam realities Economics Legal and customary aspects 12 12 17 Part IV: Conclusions and recommendations 18 Part V: Appendix Appendix 1: Number of acting enterprises as of annual 31 Dec.by type of enterprise Appendix 2: Annual average capital of enterprises by type of enterprise Appendix 3: Value of fixed asset and long term investment of enterprises as of annual 31 Dec. by type of enterprise Appendix 4: Net turnover of enterprises by type of enterprise Appendix 5: Number of enterprises as of 31 Dec. 2005 by size of employees and by type of enterprise Appendix 6: Capital resources of enterprises Appendix 7: Gross domestic product constant 1994 prices by ownership and by kind of economic activity Appendix 8: State budget revenue final accounts 20 21 22 23 24 25 26 27 28 Reference 29 I. INTRODUCTION 2 CH số 11 - B1 - ĐH KTQD Chuyên Photocopy - Đánh máy - In Luận văn, Tiểu luận : 6.280.688 For centuries, economists have been preoccupied with the growth of nations. However, it seems that they can never reach a consensus on the recommendations for governments to promote economic growth. However, their efforts provide us a better understanding of the sources of economic growth, in which, one of the most important factors is the growth of enterprises. In other words, the growth of enterprises is one of most important motivation to promote the growth of economy. To survive and prosper, any company must produce and sell products and services at a profit. Therefore, it needs many assets, plant, equipment, offices, computers, technology and so on as well as other necessary current assets. The company also has to decide which assets to buy and how to pay for them. Therefore, the company must deal with an unavoidable problem of how to raise money for such purchases. That is the problem of corporate financing, an avoidable problem for any enterprises in the modern economy. When a company needs financing, in general, it can invite investors to put up cash in return for a share of profits or borrow the money from investors. In the first case, the investor receives newly issued shares of stock and becomes a shareholder, a part-owner of the firm. In the second case, the investor becomes a lender who must one day be repaid, usually with interest. The decision in the source of financing determines its capital structure, consequently greatly effect its profitability and risky level of the company. Therefore, the financing, together with the capital budgeting are the vital decisions made by financial managers. Any company must solve the problems for during its growth and development. Recognizing the importance of corporate financing, this essay focus on the theory and reality of the problems in Vietnam in five parts as follows: Part I: Introduction 3 CH số 11 - B1 - ĐH KTQD Chuyên Photocopy - Đánh máy - In Luận văn, Tiểu luận : 6.280.688 Part II: Background General Concepts Part III: Development Theories in Vietnam realities Part IV: Conclusions and recommendations Part V: Appendix 4 CH số 11 - B1 - ĐH KTQD Chuyên Photocopy - Đánh máy - In Luận văn, Tiểu luận : 6.280.688 II. BACKGROUND - GENERAL CONCEPTS When financing the capital demand, a company can rely on internal capital (current equity plus retained earnings and depreciation) or external capital (borrowing or issuing more stock). For the internal capital, it is the most convenient way to for the financial manager to have enough capital for operating his company. Obviously, the financial manager shall consider the internal capital prior to any other capital sources. However, the internal capital is hardly enough for new investment as well as other new capital demanded because they have been divided into many current as fixed assets of the company. If the company has enough internal capital for its operation, the problem of financing may can be solved by itself. Therefore, it is customary to classify external sources of finance as debt or equity. When the firm borrows, it promises to repay the debt with interest. If it doesnt keep its promise, the debt-holders may force the firm into bankruptcy. However, no such commitments are made to the equity- holders. They are entitled to whatever is left over after the debt-holders have been paid off. For this reason, equity is called a residual claim on the firm. Equity If a company wishes to raise more money, it can sell more shares or stock. However, there is a limit to the number that it can issue without getting the approval of the current-share. Normally, this limit is approved in a General Shareholder meeting. Nevertheless, the proposal to issue more share is not always passed easily by the meeting. A company, pursuant to the approval of General Shareholder meeting, can issue common stock or preferred stock. 5 CH số 11 - B1 - ĐH KTQD Chuyên Photocopy - Đánh máy - In Luận văn, Tiểu luận : 6.280.688 In general, a joint-stock corporation is owned by its common stockholders. Some of this common stock is held directly by individual investors, but the other proportion may belong to financial institutions such as banks, pension funds, and insurance companies. Common stock, also referred to as common or ordinary shares, is, as the name implies, the most usual and commonly held form of stock in a corporation. Common stocks are units of ownership of a public corporation. Owners typically are entitled to vote on the selection of directors and other important matters as well as to receive dividends on their holdings. In the event that a corporation is liquidated, the claims of secured and unsecured creditors and owners of bonds and preferred stock take precedence over the claims of those who own common stock. For the most part, however, common stock has more potential for appreciation. Some other companies also have preferred stock or preferred shares. They are the shares that have preferential rights to dividends or to amounts distributable on liquidation, or to both, ahead of common shareholders. Preferred stock is given preference over common stock. Holders of preferred stock receive dividends at a fixed annual rate. The earnings of a corporation are applied to this payment before common stockholders receive dividends. If corporate earnings are insufficient for the fixed annual dividend, the preferred stock will absorb the total amount of earnings, and the common stockholders will be precluded from receiving a dividend. When corporate income exceeds the amount that is needed to pay preferred stockholders, the remainder is generally paid to common stockholders. Preferred stock can be cumulative or noncumulative. If it is cumulative and if the fixed dividend remains unpaid, it becomes a debit upon the surplus earnings of succeeding years. Accumulated dividends must be paid in full before common stockholders can receive dividends. When preferred stock 6 CH số 11 - B1 - ĐH KTQD Chuyên Photocopy - Đánh máy - In Luận văn, Tiểu luận : 6.280.688 is noncumulative, its preference is extinguished by the failure of the corporation to have sufficient earnings to pay the fixed dividend in a given year. Some preferred shares have special voting rights to approve certain extraordinary events (such as the issuance of new shares or the approval of the acquisition of the company) or to elect directors, but most preferred shares provide no voting rights associated with them. Some preferred shares only gain voting rights when the preferred dividends are in arrears for a substantial time. Besides, there are some other kinds of preferred stock such as convertible preferred stock, exchangeable preferred stock, participating preferred stock and perpetual preferred stock. A company also can buy back the stocks issued by itself to reduce the number of outstanding stocks on the open market. These stocks are call treasury stocks, treasury shares or reacquired stocks. In case of necessary, the company can sell its treasury stocks at market value to finance its operation. However, the selling or buying of treasury stocks still depend on the limit set by company charter as well as other regulation set by the General shareholder meeting, Board of management and other relevant authorities. Debt In order to raise money for operation, a company can also borrow capital from different sources in different forms. When companies borrow money, they promise to make regular interest payments and to repay the principal. However, this liability is limited. Stockholders have the right to default on the debt if they are willing to hand over the corporations assets to the lenders. Clearly, they will choose to do this only if the value of the assets is less than the amount of the debt. 7 CH số 11 - B1 - ĐH KTQD Chuyên Photocopy - Đánh máy - In Luận văn, Tiểu luận : 6.280.688 When companies borrow money, they promise to make regular interest payments and to repay the principal. However, this liability is limited. Stockholders have the right to default on the debt if they are willing to hand over the corporations assets to the lenders. Clearly, they will choose to do this only if the value of the assets is less than the amount of the debt. In general the mixture of loans that each company issues reflects the financial managers response to a number of questions: 1. Should the company borrow short-term or long-term? It depends on the characteristics of the capital demand and current financial situation of the company. Normally, short-term loan is to finance current assets and long- term loan is for fixed assets. However, depend on the financial balance of the company, the financial manager can decide to finance long-term investment by sort-term loan or finance current assets by long-term loans. Obviously that this decision must be accepted by the bankers. 2. Should the debt be fixed or floating rate? The interest payment, or coupon, on long-term bonds is commonly fixed at the time of issue. However, most bank loans and some bonds offer a variable, or floating, rate. For example, the interest rate in each period may be set at 1 percent above LIBOR (London Interbank Offered Rate), which is the interest rate at which major international banks lend dollars to each other. When LIBOR changes, the interest rate on your loan also changes. 3. Should you borrow in domestic currency or some others? The financial manager shall decide the problem base on the interest rate, exchange rate, source of revenue and forecast of above-mentioned factor. 4. What promises should you make to the lender? Lenders want to make sure that their debt is as safe as possible. Therefore, they may demand that their debt is senior to other debt. If default occurs, senior debt is first in line to be repaid. The junior, or subordinated, debtholders are paid only after all 8 CH số 11 - B1 - ĐH KTQD Chuyên Photocopy - Đánh máy - In Luận văn, Tiểu luận : 6.280.688 senior debtholders are satisfied (though all debtholders rank ahead of the preferred and common stockholders). The firm may also set aside some of its assets specifically for the protection of particular creditors. Such debt is said to be secured and the assets that are set aside are know as collateral. Thus a retailer might offer inventory or accounts receivable as collateral for a bank loan. If the retailer defaults on the loan, the bank can seize the collateral and use it to help pay off the debt. 5.Should you issue straight or convertible bonds? Companies often issue securities that give the owner an option to convert them into other securities. These options may have a substantial effect on value. The most dramatic example is provided by a warrant, which is nothing but an option. The owner of a warrant can purchase a set number of the companys shares at a set price before a set date. Warrants and bonds are often sold together as a package. A convertible bond gives its owner the option to exchange the bond for a predetermined number of shares. The convertible bondholder hopes that the issuing companys share price will zoom up so that the bond can be converted at a big profit. But if the shares zoom down, there is no obligation to convert; the bondholder remains a bondholder. Other sources Besides above mentioned sources of financing, a company also can look for other capital sources based on specific cases. Leases come in many forms, but in all cases the lessee (user) promises to make a series of payments to the lessor (owner). The lease contract specifies the monthly or semiannual payments, with the first payment usually due as soon as the contract is signed. The payments are usually level, but their time pattern can be tailored to the users needs. For example, suppose that a manufacturer leases a machine to produce a complex new product. There will be a years shakedown period before 9 CH số 11 - B1 - ĐH KTQD Chuyên Photocopy - Đánh máy - In Luận văn, Tiểu luận : 6.280.688 volume production starts. In this case, it might be possible to arrange for lower payments during the first year of the lease. When a lease is terminated, the leased equipment reverts to the lessor. However, the lease agreement often gives the user the option to purchase the equipment or take out a new lease. Some leases are short-term or cancelable during the contract period at the option of the lessee. These are generally known as operating leases. Others extend over most of the estimated economic life of the asset and cannot be canceled or can be canceled only if the lessor is reimbursed for any losses. These are called capital, financial, or full-payout leases. Financial leases are a source of financing. Signing a financial lease contract is like borrowing money. There is an immediate cash inflow because the lessee is relieved of having to pay for the asset. But the lessee also assumes a binding obligation to make the payments specified in the lease contract. The user could have borrowed the full purchase price of the asset by accepting a binding obligation to make interest and principal payments to the lender. Thus the cash-flow consequences of leasing and borrowing are similar. In either case, the firm raises cash now and pays it back later. A large part of this chapter will be devoted to comparing leasing and borrowing as financing alternatives. Most financial leases are arranged for brand new assets. The lessee identifies the equipment, arranges for the leasing company to buy it from the manufacturer, and signs a contract with the leasing company. This is called a direct lease. In other cases, the firm sells an asset it already owns and leases it back from the buyer. These sale and lease-back arrangements are common in real estate. 10 [...]... authorities Even joint stock companies equitized from State companies have easier access to credit from state commercial banks The legal frameworks are on the way of amending to suitable for the economic realities in Vietnam Furthermore, the remaining of centrally planning system still has strong effect in the financing sector Therefore, the shortcoming of financial system in corporate financing is unavoidable... issue more equity than borrowing However, beside the economic side, the problems of capital structure also need considering when deciding the source of corporate financing In developed financial markets, there are many sources of corporate financing However, due to the restriction of the government as well as customs of Vietnam enterprises, many channels of corporate financing can not perform as they... many sources of financing to choose, which may lead to the non-optimal selection In Vietnam, a company only can finance it operation by issuing equity, borrowing or leasing Many other sources of financing such as Preferred stock, Commercial paper, Senior unsecured notes, Revenue bonds, Promissory notes are not existed or popular in Vietnam 4 Limiting the investment in state company in very necessary... are in serious lacks of capital and can not find the suitable source for its corporate financing In order to improve the source for corporate financing, the government should carry series of synchronous method to improve the financial market: 1 Creating a really fair playground for every enterprise of every economic type to access financial sources It is undeniable that the state companies can finance... aspects: Vietnam is one of the countries with least economic freedom According to Heritage Foundation and the Wall Street Journal, the Vietnam s index of economic freedom in 2007 is 50.00 ranking 138 th among 161 countries Therefore, corporate financing in Vietnam is strongly affected by the government Under current regulation, in general, all the companies have right to find the capital source to finance... KTQD Chuyªn Photocopy - §¸nh m¸y - In LuËn v¨n, TiÓu luËn : 6.280.688 Because RD, TC, V are out of the control of financial mangers or exogenous for financial manger The only way to minimize to WACC is to choose the financing source to minimize WACC by adjusting the capital structure On the other words, under fixed requirement on financing the corporate operation, the financial manager only decides to... payment in advance These payments are important source of financing, especially for small companies However, except for the case of monopolistic companies, these methods usually associated with the conditions in prices and other term Furthermore, the sustainability of the company corresponding to the source of financing is a very important factor greatly effecting the decision in choosing financial... General Shareholder voting rights, Board of Management and/or Board of Directors, which greatly effect the company’ management Therefore, economic sides in not the unique problem should be considered when finding the sources of financing Beside WACC, we also analyze other factors for the best decision in corporate financing 16 CH sè 11 - B1 - §H KTQD Chuyªn Photocopy - §¸nh m¸y - In LuËn v¨n, TiÓu luËn... - In LuËn v¨n, TiÓu luËn : 6.280.688 PART III: DEVELOPMENT – THEORIES IN VIETNAM REALITIES Economic aspects: If firms were all-equity financed, then calculating the cost of capital would be as simple as applying one of the approaches we've already covered, though with some changes in the necessary assumptions underlying the pertinent formulas However, when firms use multiple sources of capital, including... in Vietnam is about 20% When the Vn index stand around 1100points, RE now is even less than 2%, which much lower than interest rates after deducting corporate income tax This RE rate is even much lower than long-term deposit interest rate declared by all of the banks in Vietnam This is the reason to the fact that many joint stock corporations even issue more equity with no specific expansion plan In