Determinants of debt to equity ratio (financial leverage) vietnamese firms case study

UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS DETERMINANTS OF DEBT-TO-EQUITY RATIO (FINANCIAL LEVERAGE)-VIETNAMESE FIRMS CASE STUDY BY NGUYEN THANH BIEN MASTER OF ARTS IN DEVELOPMENT ECONOMICS HO CHI MINH CITY, September 2012 UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS DETERMINANTS OF DEBT-TO-EQUITY RATIO (FINANCIAL LEVERAGE)-VIETNAMESE FIRMS CASE STUDY A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By NGUYEN THANH BIEN Academic Supervisor: LE ANH TUAN HO CHI MINH CITY, September 2012 Table of Contents List of Tables……………………………………………………………………… List of Figure……………………………………………………………………… Abstract…………………………………………………………………………… Chapter Introduction…… 1.1 Problem Statement…………………………………………………… 1.2 Research Objectives……………………………………………………… 10 1.3 Research Questions……………………………………………………… 11 1.4 Research Scope………………………………………………………… .11 1.5 Research Contribution 12 1.6 Research Structure……………………………………………………… 12 Chapter Literature Review 13 2.1 Theoretical Review .13 2.1.1 Static Trade Off Theory 13 2.1.2 Pecking Order Theory … 15 2.1.3 Agency Cost Theory … .16 2.2 Empirical Studies 17 2.2.1 Bevan, A and Danbolt, J., 2002 17 2.2.2 Deesomsak, R., Paudyal, K., and Pescetto, G (2004) 18 2.2.3 Buferna, F., Bangassa, K., and Hodgkinson, L (2005) 19 2.2.4 Um, T (2010), Capital structure determinants of Thai listed companies 20 Chapter Research Methodology 22 3.1 An Overview - Vietnamese Firm 22 3.2 Conceptual Framework 23 3.2.1 Dependent Variable 23 3.2.2 Explanatory Variable 23 3.2.2.1 Tangibility of firm 23 3.2.2.2 Size of firm .24 3.2.2.3 Profitability of firm 24 3.2.2.4 Growth of firm 25 3.2.3 The Regression Model .25 3.3 Data Collection .26 Chapter Data Analysis 28 4.1 Data Description 28 4.1.1 Variable Descriptive Statistic 28 4.1.2 Correlation Matrix … .29 4.2 Regression Result … 30 4.2.1 Fixed-effects and Random-effects Regression Result .30 4.2.2 Hausman Test … .30 4.3 Regression Result Discussion 31 4.3.1 Regression Equation 31 4.3.2 Coefficients Significance 32 4.3.3 Coefficients Sign .32 4.3.4 Multicollinearity and Auto Correlation … 33 4.3.5 Heteroscedasticity … 34 4.3.6 Industrial Groups Effect 34 4.3.7 Public and Private Firm Comparison … 35 4.3.7.1 Financial Leverage Degree … .35 4.3.7.2 Determinants of Financial Leverage 35 Chapter Conclusion and Recommendation 37 5.1 Conclusion 37 5.2 Recommendation 38 5.3 Research Limitation .39 REFERENCE .41 List of Tables Table Descriptive Statistics of Leverage and Explanatory Variables … 28 Table Correlation Matrix of Leverage and Explanatory Variables … 29 Table Fixed-effects and Random-effects Regression Result 30 Table Hausman Test 31 Table Coefficients of Variables -FEM Model 32 Table Sign of Variables-FEM Model 32 Table VIF Value of Variables 34 Table Wald Test for Heteroscedasticity 34 Table Descriptive Statistics of Public and Private Firms 35 Table 10 Regression Result of Public and Private Firms … 35 List of Figures Figure Market Value of Firm – Debt Relation 14 Abstract This study points out determinants of debt-equity ratio (financial leverage) of 396 Vietnamese firms listed on Stock Exchange (HOSE and HNX) during 2006-2010 The result of regression indicates consistence of Vietnamese case with capital structure theories including trade-off, pecking order and agency The study also investigates differences between public and private companies related to tangibility Chapter Introduction 1.1 Problem Statement Financial leverage and operating leverage are two popular ways of getting leverage to improve profitability of companies However, operating leverage is only applied for several specific industries, such as metallurgical, pharmaceutical industry, and is not suitable for tourism or services industries Thus, operating leverage is limited in reality when firms want to improve their profit On the contrary, financial leverage can be applied for every types of firms due to its alternative characteristics and therefore, it is preferred than operating leverage In fact, financial leverage appears in every capital structures of firms with different degrees Depending on the degree of financial leverage, the firm decides the level of debt equivalent to the degree and thus, debt-to-equity ratio is also named as financial leverage When a firm decides to issue debt, the firm has to refer to several internal elements, for example, how much fixed assets the firm has, how much revenue the firm gets And the firm must consider some external conditions at the same time, for example, government policies and macroeconomic conditions It means that there are several factors that influence the degree of financial leverage of each firm and therefore, determinants of financial leverage are needed to understand and estimate the difference in the degree of financial leverage These determinants may be different depending on each industry When Vietnam joined the WTO in 2007, it seemed that new East Asian export powerhouse was on the scene The country’s mix of young demographics with 27year-old average age and political, macroeconomic stability was a perfect set-up for manufacturing exports Credit growth during 2006-2010 was 35% on average, which almost doubled the country’s nominal GDP growth As a result, thousands of enterprises have been established and these firms have been operating under market economy disciplines Therefore, capital structure of Vietnamese companies has changed in the trend similar to capital structure of companies in developed countries or even more aggressively Private and joint-stock companies have substituted publicowned companies thanks to having better and effect operation Consequently, financial leverage is used frequently as a main financial instrument to lift profit especially as Vietnam economy has had symptoms indicating overheat in recent years Thus, it is necessary to study financial leverage and its determinants in Vietnamese company cases In summary, Vietnamese firms are using debt as a major instrument to invest and increase its capital Financial leverage has become an important issue in Vietnam economy and thus, determinants of financial leverage and their relationship need to be clarified The correlation between financial leverage and determinants is also estimated to predict the trend of capital structure of Vietnamese firms The difference among degree of leverage of different industries is also considered 1.2 Research Objectives The research is implemented to study and identify both internal and external factors that affect debt-to-equity ratio, or financial leverage of firms, including both public and private In addition to identifying the determinants of financial leverage, the relationship between leverage and its determinants will also be clarified in this study These relationships will be explained in details to assess the significance of these determinants on financial leverage In addition, the difference between financial leverage degree of public and private firms, and the leverage level of different industries need to observed and compared, to understand why the difference exists Moreover, macro elements are also considered to answer how external factors impact the leverage of firm Assessing external aspects is important because firms are controlled not only by internal factors but also external ones As part of globalization process, the Vietnamese government has conducted open policies to develop economy and improve living standard As a result, Vietnamese 10 negatively related to tangibility implying the high profitable firms tend to have low tangible assets 4.2 Regression Result 4.2.1 Fixed-effects and Random-effects Regression Result When using panel data, OLS regression is not reliable due to autocorelation among variables OLS dismisses impact of time and individual in observations Therefore, fixed effects model (FEM) and random effects model (REM) is suitable for panel data However, two models are compared to find out the better model for regression Table Fixed-effects and Random-effects Regression Result Variables D1 Fixed Effect Panel (S.E,) 0341 (.0854) 0.094 (.0329)* 0.040 (.0065)* -.494 (.0482)* 0.0004 (.0004) -.419 (.1538* - D2 - D3 - D4 - Constant Tangibility Size Profitability Growth Rate Number of observation R2 1476 0.1796 4.2.2 Hausman Test 30 Random Effect Panel (S.E.) -.0965 (.0712) 0.097 (.0272)* 0.0444 (.0046)* -.576 (.0448) 0.0003 (.0004) -.438 (.1541) 0.053 (.0327) 0.212 (.0345)* 0.094 (.0402)* 0.039 (.0356) 1476 0.2969 To decide the better model between FEM and REM, Hausman test is used based on chi2 comparison with 0.05 (significance 5%) The below result (Prob>chi2 chi2 = 0.0000 (V_b-V_B is not positive definite -4.3 Regression Result Discussion 4.3.1 Regression Equation 31 FEM model is suitable to study determinants of financial leverage in this case Therefore regression equation has to follow result of FEM that is written below Leveragei,t = 0.0341344 + 0.094048*Tangibilityi,t + 0.0406536*Sizei,t 0.4938459*Profitabilityi,t + 0.0003646*Growthi,t 0.4195734*Ratei,t + εi,t 4.3.2 Coefficients Significance Coefficients of variables from FEM regression are gathered into the following table Table Coefficients of Variables -FEM Model Variables tangibility size profitability growth rate Coefficients 2.85 6.16 -10.24 0.75 -2.73 According to the t-test method with 5% significant level, all variables are statistically significant except for growth variable due to having co-efficient value of 0.75 < 1.96 (rule of thumb) Four variables including tangibility, size, profitability and rate influence significantly on leverage Therefore, we can conclude that four determinants of firm leverage are tangibility, size (size of firm), profitability, and rate (interest rate) 4.3.3 Coefficients Sign Table Sign of Variables-FEM Model Variables Sign tangibility size profitability growth rate + + - + - The sign of relationship between tangibility and leverage is positive, in line with theoretical studies involving trade off, pecking and agency theory This sign provides 32 an empirical evidence to prove the consistency of capital structure theories for Vietnamese firms:higher tangibility comes together with higher leverage degree Firm size has a similar influence on leverage like tangibility, meaning a positive relationship Firms with bigger size have higher leverage degrees This relationship is consistent with trade off and agency theory Consequently, the relationship between size and leverage in Vietnam is similar to other countries indicated in several empirical studies as Buferna et al (2005) and Um (2010) The sign of profitability coefficient is negative, which shows a negative relationship between profitability and leverage in line with pecking order theory Empirical results show that Vietnamese firms that earn higher profit often rely on internal fundings instead of seeking for external funds As a result, higher profitability comes together with lower debt level, meaning lower leverage degree The same relationship is identified in Deesomsak et al (2004), Rajan and Zingales (1995), and Um (2010) Interest rate has a negative impact on leverage in Vietnam proven by a negative coefficient of “rate” Interest rate increase leads to higher cost of borrowing debt, demand of issuing debt will thereby be decreased Therefore, the negative relationship between interest rate and leverage found in this study is consistent with theory Interest rate is an external factor and also a macro factor that found significantly influencing debt ratio of firm Finally, there is an empirical evidence to show impact of macro policies, specifically interest rate in this circumstance, on financial leverage of firm 4.3.4 Multicollinearity and Auto Correlation Referring to table 2, correlation between a pair of variables is weak and thus, there is almost no multicollinearity in this case In addition, value of VIF is approximately 1.8, too small compared to potential VIF (10) when there is multicollinearity Consequently, we can conclude that there is no multicollinearity in this empirical study 33 Table VIF Value of Variables Variable tang~ profit~ size growth rate D1 D2 D3 D4 VIF 1.13 1.04 1.04 1.01 1.01 3.35 3.05 2.56 1.99 1/VIF 0.888 0.957 0.960 0.990 0.993 0.298 0.328 0.391 0.503 Auto correlation is eliminated in fixed effects regression, thus the result of FEM regression is not affected by auto correlation 4.3.5 Heteroscedasticity Table Wald Test for Heteroscedasticity Modified Wald test for groupwise heteroskedasticity in fixed effect regression model H0: sigma(i)^2 = sigma^2 for all i chi2 (369) = 1.8e+06 Prob>chi2 = 0.0000 The above result comes from Stata with xttest3 command and indicates the presence of heteroscedasticity in fixed effects regression model 4.3.6 Industrial Groups Effect The impact on different industries measured by four dummy variables is merged into the intercept in fixed effects model regression In the regression result, there is one intercept and no coefficient for dummy variables Therefore, leverages of industrial 34 groups are similar and effects of determinants on industrial leverage are same among industries 4.3.7 Public and Private Firm Comparison 4.3.7.1 Financial Leverage Degree Table Descriptive Statistics of Public and Private Firms Firm Variable Public Private Mean Std Dev Min Max Leverage 5498976 2224747 0026154 9275444 Leverage 4804288 2184071 9896139 Leverage means in table show important information between public and private firm Leverage mean of public firms is around 55%, higher than that of private firms, 48% This implies public firm possesses advantages to reach external funds 4.3.7.2 Determinants of Financial Leverage Regression result of public and private firms below Table 10 Regression Result of Public and Private Firms Variables Constant Tangibility Size Profitability Growth Private Firms (S.E,) 0942 (.0933) 0.131 (.0387)* 0.035 (.0072)* -.4801 (.0529) 0003 (.0004) 35 Public Firms (S.E.) -.4726 (.2114)* 0.041 (.0610) 0815 (.0160) -.6676 (.1148) 0588 (.0127) Rate Number of observation R2 -.598 (.1813) 1084 0.1345 0712 (.2797) 392 0.3392 Table 10 is obtained from fixed effect model regression with public data Tangibility and rate explanatory variables not affect financial leverage of firm, whereas size, profitability and growth variables strongly influence leverage In detail, size and growth are positively related while profitability is negatively related to leverage This implies possible supports from government to public firms It is particularly important to be aware that tangible assets and interest rate not impact significantly on financial leverage of public firm This happens because public firms always borrow money without collateral from banks and other financial institutions thank to government subsidy The result of sub regression with data of private firms is presented in table 10 Based on t values of the table, four explanatory variables involving tangibility, size, profitability and rate are statistically significant as absolute value of t is larger than 2, meaning they have significant influence on financial leverage of private firms Otherwise, growth variable is not significant for private firms, different from its influence on public firms It is obvious that tangible assets and interest rate determine the financial leverage degree of private firms instead of growth in public firm case In summary, the determinants of financial leverage of private firm are tangibility, size, profitability and rate In conclusion, one major point found in considering determinants of financial leverage between public and private firm is different impacts of two variables “tangibility” and “rate” For public firms, they have influence while no impact on private firms is found The other important point is that public firms tend to have higher financial leverage degree than private firms 36 Chapter Conclusion and Recommendation 5.1 Conclusion The research investigated dataset of 369 Vietnamese firms listed on stock exchange and found that four significant determinants of financial leverage involve tangible assets, firm size, profitability of firm and interest rate The internal determinants include tangibility, size and profitability, and external one is interest rate Tangibility and size affect positively while effect of profitability and rate are negative on financial leverage of firm The econometric model utilized to estimate variables is fixed effects model regression with balanced panel data in the period of 2007-2010 By using Stata software, results obtained from regression shows consistency with capital structure theories in Vietnamese case Through tests in Stata, there is no multicollinearity; and autocorrelation is eliminated by FEM regression However, heteroscedatiscity still remains in the model and influences the effectiveness of the model, meaning forecasting of the model is not effective although coefficients are still unbiased and slopes of coefficients are correct The impact of determinants on leverage is considered from an owner’s structure aspect with two objects including private company and public company The research result identified that public company tend to finance debts more than private company due to government supports Moreover, financial leverage and its determinants are also measured with alternative industrial groups in dataset and finding is no difference among groups in term of financial leverage It means determinants and their impact on financial leverage of firm are similar across all industrial groups Nevertheless, mean 37 of property and construction industry is higher than the other industries due to focusing of capital on this area The research indicates the relevance of capital structure theory in studying capital structure of firms in Vietnam business environment The result also shows higher leverage degree of Vietnamese firms compared to a neighbor country as Thailand with relatively equivalent conditions It is an warning of overheated economic growth and credit funds invested largely on property markets that could create property bubbles 5.2 Recommendation Firms can use the result of this research to reflect on their financial leverage degrees as referring average level of industry For comparison, firms can adjust their financial leverage in case the leverage value is too far from mean value to stable degree In addition, optimal financial leverage value is also determined for firms based on on regression results Depending on the optimal value, firms can build potential financial leverage degrees and maintain debts close to our target values Nowadays, several firms operate on a few industries and thus, firm should consider financial leverage of other industries from this research information of industry leverage before deciding to extend operation Regarding policy makers, there are many policy factors that impact enterprises however it is easy to identify the direct influence of interest rate on them Consequently, the research will supply more reference for government in case government wants to assess effects of interest rate changes on firm debts Moreover, the research shows specific differences of financial leverage among industries that government can implement to help manage the correct financial leverage level across industries For external investors, the research provides a lot of information about financial leverage and factors impact on it in term of enterprise finance Individual investors 38 and institutional investors can refer to the research in terms of overall leverage mean, group industrial leverage and determinants of leverage to make critical investment decision External investors can have more information to estimate potential risks if investment is conducted In addition, financial institutions like banks or institutional funds can utilize the research in assessing debt degree of firms and decide to supply finance 5.3 Research Limitation This research is conducted based on standardized conceptual framework, consistent methodology and available data collection However, a number of important limitations need to be considered in terms of theoretical problems, the effectiveness of model predictions and measuring variables and collecting data Firstly, the study was not specifically designed to evaluate elements associated with macroeconomics There are several specific macro factors besides interest rate that influence significantly Vietnam economy that lead to impact on all enterprises, for instance inflation rate, import-export balance, investment policies and foreign exchange rate However, only interest rate was chosen to present for other external factors given its influence on capital structure of firm Secondly, the heteroscedasticity exists in final regression model caused the prediction of the model to be not exact as expectation Therefore, the effectiveness of model in forecasting is sharply low while coefficients are not biased The fixed effects model and random effects model are considered to decide the final model of research due to balance panel data structure of the dataset As a result, FEM was chosen after implementing Hausman test Auto correlation was eliminated in FEM but heteroscedasticity still remains and causes low effectiveness in forecasting of model In order to get rid of this woe, it is necessary to change into another model with various different variables, which may not be the focuses of this study Hence, the FEM was chosen.Measuring financial leverage depends on debts and assets Nonetheless, debts consist of short-run and long-run debts and thus, to evaluate 39 correctly financial leverage it is necessary to calculate financial leverage in short-run debts and financial leverage in long-run debts but the research did not conduct that due to some problems in analyzing debt data In addition, dataset does not include firms that are not on the stock exchange due to data collection difficulties Consequently, further research should separate total debts into short-term debts and long-term debts to observe deeply inside financial leverage of firm and, collect more data of none-listed companies From a globalization aspect, the research has not considered and examined the effects of financial crisis happened in 2008 that began from United States, even though Vietnam economy has been somewhat influenced The opening of the Vietnam economy after reforms in 1986 have made various investment channels possible into Vietnam and thus, capital inflows and outflows are easier to operate Foreign investment capital growth has led to the growth of Vietnamese firms Therefore, it is necessary to expand investigation into the financial leverage of Vietnamese firms in of the context of global economics 40 REFERENCE Antoniou, A , Guney, Y., and Paudyal, K., 2002 Determinants of Corporate Capital Structure : Evidence from European Countries, Working paper, University of Durham Ariccia , G., 2000 Asymmetric information and the structure of the banking industry, European Economic Review 45, pp 1957-1980 Bevan, A and Danbolt, J., 2000 Dynamics in the determinants of capital structure in the UK, Working paper, University of Glasgow Bevan, A and Danbolt, J., 2002 Capital structure and its determinants in the UK- a decompositional analysis, Applied Financial Economics 12, pp 159-170 Booth, L., Aivazian, V., Demirguc-Kunt, A., and Maksimovic, V., 2001 Capital structures in Developing Countries, The Journal of Finance LVI, pp 87-130 Buferna, F., Bangassa, K., and Hodgkinson, L (2005), Determinants of capital structure: evidence from Libya, Research Paper Series, 8, University of Liverpool Chen, J., 2004 Determinants of capital structure of Chinese-listed companies, Journal of Business Research 57, pp 1341-1351 Chung, K.H., 1993 Asset characteristics and corporate debt policy: An empirical test, Journal of Business Finance and Accounting 20, pp 83-98 Deesomsak, R., Paudyal, K., and Pescetto, G., 2004 The determinants of capital structure: Evidence from the Asia Pacific region, Journal of Multinational Financial Management 14, pp 387-405 Dewenter, K., and Malatesta, P., 2001 State-Owned and Privately Owned Firms: An Empirical Analysis of Profitability, Leverage, and Labor Intensity, American Economic Review 91, pp 320-334 41 Dudley, E., 2007 Testing Models of Dynamic Trade Off Theory, Working paper, University of Rochester Gleason, K., Mathur, L., and Mathur, I., 2000 The Interrelationship between Culture, Capital structure, and Performance: Evidence from European Retailers, Journal of Business Research 50, pp 185-191 Hall, G., Hutchinson, P., and Michaelas, N., 2004 Determinants of the Capital Structures of European SMEs, Journal of Business Finance & Accounting 31, pp 711-728 Harris, M and Raviv, A., 1991 The Theory of Capital Structure, Journal of Finance 46, pp 297-355 Homaifar, G., Zietz, J., and Benkato, O., 1994 An Empirical Model of Capital Structure: Some new evidences, Journal of Business Finance and Accounting 21, pp 1-14 Hovakimian, A., Hovakimian, G., and Tehranian, H., 2004 Determinants of target capital structure: The case of dual debt and equity issues, Journal of Financial Economics 71, pp 517-540 Huang, S and Song, F., 2002 The determinants of capital structure: Evidence from China, Working paper, The University of Hong Kong Jensen, M and Meckling, M , 1976 Theory of the Firm : Managerial Behavior, Agency Costs and Ownership Structure, Journal of Financial Economics 3, pp 305360 Mishkin, F., 1990 Asymmetric Information and Financial Crises: A Historical Perspective, Working paper No 3400, NBER Working Paper Series Myers, S , 1984 The capital structure Puzzle, The Journal of Finance 39, pp 575-592 Modigliani, F and Miller, M., 1958 The Cost of Capital, Corporation Finance and the Theory of Investment, American Economic Review 48, pp 261-297 Nuri, J., 2000 A study of capital structure in the UK: Hotel and retail industries, unpublished PhD thesis, Surrey University Omet, G and Nobanee, H., 2001 The Capital Structure of Listed Industrial Companies in Jordan, Arabic Journal of Administrative Sciences 8, pp 273-289 42 Pandey, M., 2001 Capital structure and the firm characteristics: Evidence from an emerging market, Working paper, Indian Institute of Management Ahmedabad Rajan, R and Zingales, L., 1995 What Do Know about Capital Structure? Some Evidence from International Data, The Journal of Finance 50, pp 1421-1460 Titman, S and Wessels, R., 1988 The determinants of capital structure Choice, The Journal of Finance 43, pp 1-19 Welch, I., 2010 Common Problems in Capital Structure Research: The FinancialDebt-To-Asset Ratio, and Issuing Activity vs Leverage Changes, Brown University and NBER Um, T., 2010 Capital structure determinants of Thai listed companies, Working paper 43 44 ... out determinants of debt- equity ratio (financial leverage) of 396 Vietnamese firms listed on Stock Exchange (HOSE and HNX) during 2006-2010 The result of regression indicates consistence of Vietnamese. .. : the ratio of total debt to total assets of firm i at time t Tangibilityi,t : the ratio of fixed assets to total assets of firm i at time t Sizei,t : the natural logarithm of net sales of firm... necessary to define in details and demonstrate formula of calculating leverage value In simple, the leverage of firms is ratio between total debts and total assets of firms Thereby leverage of firms,