Determinants of leverage case study of vietnam seafood processing and exporting industry both for listed and unlisted firms

UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS VIETNAM- THE NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS DETERMINANTS OF LEVERAGE: case study of VIETNAM SEAFOOD PROCESSING AND EXPORTING INDUSTRY both for listed and unlisted firms By PHAM THI TRUC LAM A thesis submitted in partial fulfillment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS Academic Supervisor: Assoc Prof NGUYEN TRONG HOAI HO CHI MINH CITY, DECEMBER 2012 CERTIFICATION ;; "I certificate that the substance of the thesis has not already been submitted for any degree and is not currently submitted for any other degree I certify that to the best of my knowledge and help received in preparing the thesis and all sources used have been acknowledged in the thesis." Signature Pham Thi True Lam Date ACKNOWLEDGMENTS = First and foremost, I would like to send my dearest thank to my supervisor, Assoc Prof Nguyen Trong Hoai for his guidance and support In addition, I would also like to express my gratitude to all persons and organizations for their support, provision of assistance and information that made this thesis possible I am also grateful to the lecturers and staff of the project who • helped improve my knowledge and fulfill the programme Finally, I am greatly indebted to my family for their love for and support of me, keeping me in good condition for learning I am also grateful to my close friends for their warm encouragement 11 ABSTRACT Although there are many prior studies about leverage as well as capital structure on the world in general and Vietnam in particular, results of these researches are still inconsistent Moreover, in context of Vietnam, most of studies about leverage are of listed firms So, this study works with data of both listed and unlisted firms The purpose of this study is to examine the relative importance of ' some factors to the leverage of Vietnam seafood processing and exporting enterprises A sample of 20 listed and 15 unlisted enterprises for a period of years from 2009 to 20 11 was chosen and tested base on pecking order theory and trade off theory The results finding from the thesis is that firm growth opportunities and firm size have positive related to leverage, profitability, liquidity have a negative effect to leverage whereas tangibility assets and non-debt tax shield have no impact on leverage of Vietnam seafood processing and exporting enterprises Key words: leverage, pecking order theory, trade off theory 111 CONTENTS Certification i Acknowledgement ii Abstract iii Contents iv List of Tables vii List of Abbreviations vii CHAPTER I: INTRODUCTION FOR THE STUDY 1.1 Problem statement: 1.2 Research objectives: 1.3 Research questions: 1.4 Research Methodology: 1.5 Structure of the thesis: CHAPTER II: LITERATURE REVIEW FOR DETERMINANTS OF LEVERAGE 2.1 Key Concepts: 2.2 Related theories: 2.2.1 The Modigliani-Miller theorem: 2.2.2 Agency cost theory: 2.2.3 Trade-off theory: 2.2.4 The pecking-order theory: 2.3 Determinants of leverage: 10 2.3.1 Leverage and Profitability: 12 2.3.2 Leverage and firm size: 13 2.3 Leverage and Firm Growth: 15 2.3.4 Leverage and Non-debt tax shield : 16 2.3.5 Leverage and tangible assets: 17 2.3.6 Leverage and liquidity: 19 2.4 Empirical review on determinants of leverage: 20 2.4.1 Empirical evidences finding from the world: 20 IV 2.4.2 Empirical evidences finding from Vietnam perspective: 24 2.5 Chapter remarks: 25 CHAPTER III: RESEARCH METHODOLOGY 27 3.1 Data and variables description: 27 3.1.1 Data: 27 1.2 Description of variables: 27 3.2 Methods of estimation: 29 3.2.1 Ordinary Least Squares (OLS) estimator: 30 2.2 Fixed Effects (FE) estimator: 31 3.2.3 Random Effects Estimator (RE): 32 3.2.4 Hausman specification test: 32 3.3 Hypotheses 33 3.4 Chapter remarks: 33 CHAPTER IV: OVERVIEW OF SEAFOOD PROCESSING AND EXPORTING ENTERPRISES 4.1 Introduction of the seafood export industry: 35 4.2 Analysis of capital structure of the seafood enterprises: 38 4.2.1 Debt to equity ratio: 38 4.2.2 The equity growth rate: 41 4.3 Chapter remarks: 42 CHAPTER V: EMPIRICAL RESULTS 43 5.1 Descriptive statistics 43 • 5.2 Analysis of the correlation between all variables: 44 5.3 Test multicollinearity: 45 5.4 Empirical results: 46 5.4.1 OLS estimator: 46 5.4.2 Hausman specification test: 48 5.4.3 Fixed effects estimator: 49 • v - 5 Chapter remarks: 53 CHAPTER VI: CONCLUSION, POLICY RECOMMENDATION AND LIMITATION 55 6.1 Conclusion 55 6.2 Policy recommendation 57 6.3 Limitation and suggestion for further study: 61 Reference 62 Appendix 68 " • Vl LIST OF TABLES Table 2.1: Summary of leverage determinants Table 3.1: Variable, description and its expected sign Table 4.1: The equity growth rate Table 5.1: Descriptive statistics of sample variables Table 5.2: Correlation coefficient matrix Table 5.3: Result of auxiliary regression models of each dependent variable Table 5.4: Result ofOLS estimator Table 5.5: Result ofHausman test Table 5.6: Result of Fixed effects estimator vii LIST OF ABBREVIATIONS NDTS Non debt tax shield SEAs Seafood processing and exporting enterprises SMEs Small and medium enterprises FE Fixed effects RE Random effects GDP Gross Domestic Product GSO General Statistics Office of Vietnam OLS Ordinary Least Square STD Short term debt LTD Long term debt TTD Total debt EQTY Equity ASS Total assets Vlll CHAPTER 1: INTRODUCTION FOR THE STUDY This chapter will explain the reason for choosing the thesis, its objectives and research questions In addition, this part also presents a brief of methodology and finally abbreviates the structure of the thesis 1.1 Problem statement: One of the most important decisions confronting a firm in corporate finance is the design of its capital structure In order to finance for investment, the firms can choose either internal or external funds Internal fund is the firm retained earnings whereas external fund can be raised from issuing equity or taking debt Sometimes, firms may take too much or without taking debt An effective debt ratio or leverage should not only help reducing the weighted average cost of capital of the firm but also it still can increase firm value To decide how much leverage the firm should take on, the firms need to know which factors affect leverage However, over 50 years since the first research of Modigliani and Miller (1958) about leverage, the question of them about what factors affect leverage are still unresolved until now This seems to be the most enigmatic and interested issue of many researchers However, until now, the effort of researchers to solve the debt equity choice also does not bring results that satisfy all of them The results are still inconsistent between researches at different countries and different industries Moreover, Myers ( 1984) also suggests that "the average debt ratio will vary from industry to industry because asset risk, asset type and requirements for external fund also vary by industry" (p.578) In case of Vietnam, there are also some studies testing for determinants of the leverage of Vietnam companies, such as Nguyen and Ramachandran (2006), Dzung et al (2012) and the empirical results of these studies also contain conflicts as results from many other studies in the world Seafood is considered to be one of major industries and one of the key export sectors of Vietnam Each year, it contributes largely to GDP Particularly, only factors are found significant with fixed effect and only significant variables with OLS method With fixed effect, the result founding is that there are two variables which are found to have no effect on leverage as NDTS and tangibility assets, firm size and growth are found to have positive related and profitability and liquidity are found to have negative related to leverage This result confirms that profitable firms or firms with higher liquidity tend to employ less debt than the others Due to having more retained earning and free cash flow available, they will use this source for financing investment and avoid borrowing from bank with complicated procedures whereas large firms and growth firms will make use of their prestige or potential development chance to get more debt with lower loan interest rate from bank to finance for further development Especially, in context of Vietnam SEAs, they still can enjoy trade credit to finance for business This credit form does not need collateral as loan from bank The results finding from the thesis have both consistent and inconsistent with researches of other countries as well as other researches of Vietnam case About indicator profitability, the negative related result is the same with mostly researches as Gurcharan (20 10) for Indonesia, Thailand, Philippines and Huang and Song (2002) for China The result also complies with research of Dzung et al (2012) of Vietnam listed enterprises whereas it is different with Cuong (2008) and Nguyen and Ramachandran (2006) Positive related of firm size is consistent with most researches Result of firm growth is consistent with result for China in research of Huang and Song (2002) and Thailand, Philippines, Malaysia in research of Gurcharan (20 10) while inconsistent with result for Indonesia in the same research Other researches of Vietnam case also find positive related between firm growth and leverage As research of Gurcharan (20 10) about Thailand, Indonesia and Philippines, the thesis also finds insignificant impact of NDTS on leverage Although there are not much researches mentioning about liquidity, the thesis also find consistent with research of Zehra (2008) and Dzung et al (2012) Especially, whereas other researches in the world as well as in 56 Vietnam find significant effect of tangibility, the thesis finds insignificant result The reason may be characteristic of seafood industry Most of firms are export firm, so they can borrow from bank by others way instead of using fixed assets to assure for loan Determinants of leverage of Vietnam SEAs in fact behave according to both pecking order and trade off theory Firm growth, profitability and liquidity variables support for pecking order theory whereas effect of firm size is consistent with trade off theory Non-debt tax shield and tangibility are not consistent with any theories which the thesis mentions 6.2 Policy recommendation Looking at descriptive statistics, we can see that some firms have too high leverage ratio (90%) whereas there is also firms have too low ratio (7%) in their capital structure At one side, high debt ratio should help firm inherit tax deduction, however at another side, it also make firms meet problem with liquidity ; leads to bankruptcy when many loan debt items become due at the same time and firms can not afford to repay for bank This has been evidenced by many Vietnam seafood firms during last time Hundred of enterprises goes bankrupt, many of them must request to be postponed schedule of repayment One of the reasons is that most of them used short term loan to finance for long term business as building new factory or buying new equipment Research of Cuong and Canh (2012) has proved that the target leverage that can help SEAs increase their firm value is 59.27% So this section will give recommendations to help for having appropriate leverage of the firm by increasing or decreasing leverage through influencing profitability, firm size, firm growth and liquidity ratio Recommendations for each factor will be presented one by one as follows: 6.2.1 Profitability: Due to having inverse related to leverage, the more profitable the firms are, the more retained earnings they have to finance for new investment and the less dependent on debt the firms will Therefore, firms with too high ratio of debt over 57 total assets would like to reduce depending on debt should concentrate on solutions to increase profit Profitability of Vietnam SEAs have been turned down due to many reasons such as increasing in input cost include raw material, labor salary, hiring operating department cost, falling demand from traditional markets as the United Stated, Europe, Japan due to the economic crisis or being rejected from importing markets due to not satisfy quality requirement of import countries and unfavorable exchange rate as well as interest rate In order to continue maintaining profit, the firms can follow many ways as decrease input while output unchanged, increase output together with input unchanged or decrease input and increase output The best way is how to reduce selling price and increase tum over In particularly, the firms should diversify their seafood products as well as expand their markets toward various potential export markets in Americas or South America as Mexico, Brazil beside its traditional • market Instead of only selling at primary product, firms should pay attention to producing valued added product to get higher price Together with expanding market, firms also should improve its quality product to satisfy require of all export markets Minimizing cost of management and raise effective of operation is also one of solutions which will help to increase profit of the firms Most of firms have debt on bank are afraid of varying of interest rate With export seafood enterprises, especially with temporary import for re-export enterprises which main business is import material to produce and then export finished-product again, they still worry about changing of exchange rate due to it will affect their profit While the problem of interest rate is not decided by the firms, exchange rate problem can be controlled Therefore, to ensuring for their profitable as well as sustainable development, the firms should be more active in their business The firms should balance between output values with input cost In order to prevent decreasing or increasing of exchange rate, the firms can use derivatives as forward contract, option or swap to assure about the profit which they will receive in future 58 - • - - - 6.2.2 Liquidity: With the same direction as profitability, increase ratio of liquidity will • reduce depending on debt of firms due to its negative related to leverage Firms should invest much more on short term assets rather than only concentrating on long term assets During last period, a lot of firms have to go to bankrupt due to using short term debt to invest on long term assets as building factory or buying new machinery and loose its liquidity due to not afford to repay debt at due time Although investing much on equipment system, most of the firms only use 4050% power of these equipments due to lacking of short term fund for material One of another problem of Vietnam SEAs now is ratio of inventories is high and slow moving That not only ties up warehouse space but also drains capital of the firms Firms should force moving faster for inventories by reducing price or introducing firm brand to new customer At the same time, firms should collect accounts receivable as soon as possible by replacing deferred payment with • at sight payment with some markets which firm products are fond of These solutions will help firms to increase current assets and then increase its liquidity 6.2.3 Firm size and growth opportunities: Both these ratio are based on total assets and found to have positive related to leverage, so this section will combine both to give recommendations Firms who would like to increase leverage more should give attention to increasing its size as well as its growth opportunities Particularly, they should provide potential project and evidence its development through year by year to attract the lenders One of obstacles of Vietnam SEAs is lacking of material for producing due to most of the firms collect material from farmers or seafood traders, so they can not control about quantity and quality of input products This prevents growing as well as profitability of firm Therefore, expansion in farming, heading to an integrated production from farming to processing and exporting to control strictly the product quality is necessary to progress with firms That does not only broaden firm size but also create opportunity for firms to provide products with 59 • competitive price and get more profit Having larger size will help firms easily to borrow from bank due to its positive related with leverage as results the thesis • found Accompany with development opportunities and integrated of the economic, large firm with high growth will seek for capital loan to take advantage of that opportunity and promote its business And leverage will help to increase value of the firms Due to firm size and growth have positive related to leverage, larger and growth firm should pay more attention to its leverage to avoid problem of bankruptcy Although large firm seldom meet problem with bankruptcy rather than smaller firm, in reality, during last time, many strong seafood firms also go to bankrupt Only at the beginning of the year 2012, 470/800 seafood enterprises must close their firm Most of debt of firms are from bank loan, so whenever debt policy of banks change as tighten credit or higher interest rate will affect strongly operating of the firms These firms should balance between debts with investment to avoid over optimal business A suitable leverage could help firms in developing ' business and inherit tax shield deduction, however, once leverage of these firms become too high, they also should change to another channels of collecting funds According to pecking order theory, the firms should give priority to issuing equity instead of only relying on debt With vantage of seldom meeting problem with information asymmetries or having potential developing, cost of issuing equity of these firms will get more attention of investors The investors will increase in investing on these firms due to believing in its further development Therefore, the firms can reduce depending on debt by issuing equity With firms need long term debt to finance for long operation as building factory or buying new machinery, in case they can not borrow long term debt, these firms should issuing equity instead of using short term debt Although now seafood field still face with many problems as short of material, anti-dumping or lower needed of importing countries, this industry also contains potential development and attracts investors because of its advantages as having high position in most leading markets, diversified channel of distribution as well as large farming area and 60 • outstanding inland water resources There are much developing opportunities for firms with high growth To be more attracted with outside investors, firms should reduce asymmetric problem as raising quality of information given on financial report, audit report to help investors to have a detail and real about operating of the firms Maybe, a namely financial company should be hired to value its business to create belief in investors A reasonable dividend payment of managers does not only maintain supporting of shareholders but also have retained earnings for its further growth 6.3 Limitation and suggestion for further study: The sample size is small The study only uses data of 20 listed and 15 unlisted firms while total firm of seafood processing and exporting now is over 600 firms Moreover, the study is limited to data of processing and exporting seafood firm only, leaving out other industry concerning seafood, as well as other • factors also affecting leverage The factor profitability may depend on some firm characteristics which probably lied beyond of the thesis' model There are many indicators which proxy leverage as well as independent variables and result of each measure are also different (Zehra (2008), 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Pro b PRO -0.475183 -0.500925 0.007640 0.7684 LGSIZE 0.129546 0.036722 0.000446 0.0000 GRO 0.000309 0.000440 0.000000 0.0005 NDTS -0.208831 -0.218969 0.010432 0.9209 LIQ 0.003171 -0.023004 0.000068 0.0015 TANG 0.113276 -0.088189 0.007897 0.0234 Table 6: result offixed effect model regression " 69 ' Variable Coefficient Std Error t-Statistic Pro b c -1.053324 0.103414 -10.18548 0.0000 PRO -0.516951 0.110441 -4.680784 0.0000 LGSIZE 0.135947 0.008107 16.76938 0.0000 ORO 0.000300 6.13E-05 4.891046 0.0000 NDTS -0.206952 0.129297 -1.600598 0.1144 LIQ -0.010873 0.004044 -2.688510 0.0091 TANG 0.084826 0.067901 1.249259 0.2161 Effects Specification Cross-section fixed (dummy variables) Weighted Statistics R-squared • 0.989095 Mean dependent var 1.609967 Adjusted R-squared 0.982279 S.D dependent var 1.838608 S.E of regression 0.069775 Sum squared resid 0.311589 F -statistic 145.1218 Durbin-Watson stat 2.545103 Prob(F -statistic) 0.000000 Unweighted Statistics R-squared 0.909509 Mean dependent var 0.566857 Sum squared resid 0.368485 Durbin-Watson stat 2.353093 Redundant Fixed Effects Tests Equation: FIX Test cross-section fixed effects Effects Test Statistic d.f Pro b Cross-section F 73.778125 (34,64) 0.0000 70 ... works with data of both listed and unlisted firms The purpose of this study is to examine the relative importance of ' some factors to the leverage of Vietnam seafood processing and exporting enterprises... data of 35 seafood processing and exporting enterprise in Vietnam for the period 2009-2011 include both listed and unlisted • firms To estimate the impact of independent variables as profitability,... affect leverage of Vietnam seafood processmg and exporting enterprises? - What policy recommendations for Vietnam seafood processing and exporting enterprises to raise effect of using leverage?